<PAGE>
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                       SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549

                            ------------------------

                                   FORM 10-Q

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

               FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999

                        Commission File Number 333-59393

                            ------------------------

                          RHYTHMS NETCONNECTIONS INC.

State of Incorporation: Delaware                I.R.S. Employer ID #: 33-0747515

Address: 6933 South Revere Parkway                   Telephone #: (303) 476-4200

         Englewood, Colorado 80112-3931

Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days                        Yes   X  No

As of November 10, 1999, a total of 77,141,961 shares of the Registrant's Common
Stock, $0.001 par value, were issued and outstanding.

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<PAGE>
                          RHYTHMS NETCONNECTIONS INC.
                                     PART I
                             FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

    The following are three-month third quarter and nine-month year-to-date, as
applicable, consolidated financial statements of the Registrant as of and
through September 30, 1999.

                                       1
<PAGE>
                          RHYTHMS NETCONNECTIONS INC.

                          CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                              DECEMBER 31    SEPTEMBER 30
                                                                  1998           1999
                                                              ------------   -------------
                                                                      (UNAUDITED)
<S>                                                           <C>            <C>
ASSETS:
  Current assets:
    Cash and cash equivalents...............................  $21,315,000    $ 273,694,000
    Short-term investments..................................  115,497,000      171,193,000
    Restricted cash.........................................           --       35,028,000
    Accounts, loans, interest, and other receivables, net...    2,376,000        9,243,000
    Inventory...............................................      340,000        3,132,000
    Prepaid expenses and other current assets...............      230,000          936,000
                                                              ------------   -------------
      Total current assets..................................  139,758,000      493,226,000
  Equipment and furniture, net..............................   11,510,000       99,022,000
  Collocation fees, net.....................................   13,804,000       50,406,000
  Restricted cash...........................................           --       78,332,000
  Deferred business acquisition costs, net..................           --       19,988,000
  Deferred debt issue costs, net............................    6,304,000       16,385,000
  Other assets..............................................      350,000          712,000
                                                              ------------   -------------
                                                              $171,726,000   $ 758,071,000
                                                              ============   =============
LIABILITIES AND STOCKHOLDERS' EQUITY:
  Current liabilities:
    Current portion of long-term debt.......................  $   333,000    $     333,000
    Accounts payable........................................   10,601,000       21,616,000
    Interest payable........................................       39,000       18,226,000
    Accrued expenses and other current liabilities..........    2,816,000       16,541,000
                                                              ------------   -------------
      Total current liabilities.............................   13,789,000       56,716,000
  Long-term debt............................................      472,000          194,000
  13.50% senior discount notes due 2008, net                  157,465,000      174,599,000
  12.75% senior notes due 2009                                         --      325,000,000
  Other liabilities.........................................      180,000          145,000
                                                              ------------   -------------
      Total liabilities.....................................  171,906,000      556,654,000
                                                              ------------   -------------
  Mandatorily redeemable common stock warrants..............    6,567,000        1,069,000
                                                              ------------   -------------
  Stockholders' equity:
    Series A convertible preferred stock, $0.001 par value;
     12,900,000 shares authorized in 1998, no shares
     authorized in 1999; 12,855,094 shares issued and
     outstanding in 1998, no shares issued and outstanding
     in 1999................................................       13,000               --
    Series B convertible preferred stock, $0.001 par value;
     4,044,943 shares authorized in 1998, no shares
     authorized in 1999; 4,044,943 shares issued and
     outstanding in 1998, no shares issued and outstanding
     in 1999................................................        4,000               --
    Common stock, $0.001 par value; 80,049,892 shares
     authorized in 1998, 250,000,000 shares authorized in
     1999; 8,042,530 shares issued in 1998, 77,318,242
     shares issued in 1999..................................        8,000           77,000
    Treasury stock, at cost; 438,115 shares in 1998 and
     488,890 shares in 1999.................................      (18,000)         (28,000)
    Additional paid-in capital..............................   37,212,000      366,293,000
    Warrants................................................           --       10,397,000
    Deferred compensation...................................   (5,210,000)      (9,102,000)
    Accumulated deficit.....................................  (38,756,000)    (167,289,000)
                                                              ------------   -------------
      Total stockholders' equity (deficit)..................   (6,747,000)     200,348,000
                                                              ------------   -------------
                                                              $171,726,000   $ 758,071,000
                                                              ============   =============
</TABLE>

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

                                       2
<PAGE>
                          RHYTHMS NETCONNECTIONS INC.

                      CONSOLIDATED STATEMENT OF OPERATIONS

<TABLE>
<CAPTION>
                                            THREE MONTHS ENDED             NINE MONTHS ENDED
                                        ---------------------------   ----------------------------
                                        SEPTEMBER 30   SEPTEMBER 30   SEPTEMBER 30   SEPTEMBER 30
                                            1998           1999           1998           1999
                                        ------------   ------------   ------------   -------------
                                                (UNAUDITED)                   (UNAUDITED)
<S>                                     <C>            <C>            <C>            <C>
REVENUE:
  Service and installation, net.......  $    166,000   $  3,317,000   $    248,000   $   5,618,000
                                        ------------   ------------   ------------   -------------
OPERATING EXPENSES:
  Network and service costs...........     1,404,000     21,800,000      2,072,000      39,971,000
  Selling, marketing, general and
    administrative....................     7,059,000     28,653,000     14,040,000      64,771,000
  Depreciation and amortization.......       472,000      3,977,000        507,000       6,121,000
  Amortized deferred business
    acquisition costs.................            --      1,550,000             --       3,202,000
                                        ------------   ------------   ------------   -------------
    Total operating expenses..........     8,935,000     55,980,000     16,619,000     114,065,000
                                        ------------   ------------   ------------   -------------
LOSS FROM OPERATIONS..................    (8,769,000)   (52,663,000)   (16,371,000)   (108,447,000)
                                        ------------   ------------   ------------   -------------
OTHER INCOME AND EXPENSE:
  Interest income.....................     2,160,000      7,344,000      3,834,000      15,673,000
  Interest expense (including
    amortized debt discount and issue
    costs)............................    (5,280,000)   (16,500,000)    (8,501,000)    (35,871,000)
  Other income........................         8,000         41,000          8,000         112,000
                                        ------------   ------------   ------------   -------------
NET LOSS..............................  $(11,881,000)  $(61,778,000)  $(21,030,000)  $(128,533,000)
                                        ============   ============   ============   =============
NET LOSS PER SHARE:
  Basic...............................  $      (3.47)  $      (0.89)  $      (7.89)  $       (2.80)
                                        ============   ============   ============   =============
  Diluted.............................  $      (3.47)  $      (0.89)  $      (7.89)  $       (2.80)
                                        ============   ============   ============   =============
SHARES USED IN COMPUTING NET LOSS PER
  SHARE:
  Basic...............................     3,421,097     69,646,044      2,659,426      45,893,691
                                        ============   ============   ============   =============
  Diluted.............................     3,421,097     69,646,044      2,659,426      45,893,691
                                        ============   ============   ============   =============
</TABLE>

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

                                       3
<PAGE>
                          RHYTHMS NETCONNECTIONS INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                    NINE MONTHS ENDED
                                                              -----------------------------
                                                              SEPTEMBER 30    SEPTEMBER 30
                                                                  1998            1999
                                                              -------------   -------------
                                                                       (UNAUDITED)
<S>                                                           <C>             <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net loss..................................................  $(21,030,000)   $(128,533,000)
  Adjustments to reconcile net loss to net cash used for
    operating activities:
    Depreciation of equipment and furniture.................       470,000        4,976,000
    Amortization of collocation fees........................        37,000        1,144,000
    Amortization of deferred business acquisition costs.....            --        3,202,000
    Amortization of deferred debt issue costs and debt
     discount...............................................     8,446,000       17,542,000
    Amortization of deferred compensation...................       407,000        2,541,000
    Amortization of gain on sale of equipment to leasing
     company................................................            --         (110,000)
    Changes in assets and liabilities:
      Increase in accounts, loans, interest, and other
       receivables, net.....................................    (1,179,000)      (6,867,000)
      Increase in inventory.................................      (285,000)      (2,792,000)
      Increase in prepaid expenses and other current
       assets...............................................       (65,000)        (706,000)
      Increase in other assets..............................      (207,000)        (362,000)
      Increase (decrease) in accounts payable...............     2,708,000         (957,000)
      Increase in interest payable..........................            --       18,187,000
      Increase in accrued expenses and other current
       liabilities..........................................     1,330,000       13,725,000
      Increase in other liabilities.........................       209,000           75,000
                                                              -------------   -------------
        Net cash used for operating activities..............    (9,159,000)     (78,935,000)
                                                              -------------   -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
    Purchases of short-term investments.....................  (133,703,000)    (237,273,000)
    Maturities of short-term investments....................            --      181,577,000
    Purchases of government securities as restricted cash...            --     (113,360,000)
    Purchases of equipment and furniture....................    (7,981,000)    (104,271,000)
    Payments of collocation fees............................    (8,450,000)     (37,746,000)
                                                              -------------   -------------
        Net cash used for investing activities..............  (150,134,000)    (311,073,000)
                                                              -------------   -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
    Proceeds from leasing company for equipment.............     6,606,000       23,755,000
    Proceeds from issuance of 13.50% senior discount notes
     and warrants...........................................   150,365,000               --
    Proceeds from issuance of 12.75% senior notes...........            --      325,000,000
    Payments of debt issue costs............................    (6,403,000)     (10,489,000)
    Proceeds from borrowings on long-term debt..............       432,000               --
    Repayments of long-term debt............................      (139,000)        (278,000)
    Proceeds from issuance of common stock..................       229,000      246,756,000
    Proceeds from issuance of preferred stock and
     warrants...............................................    18,292,000       75,000,000
    Payments of equity issue costs..........................       (19,000)     (17,347,000)
    Purchases of treasury stock.............................            --          (10,000)
                                                              -------------   -------------
        Net cash provided by financing activities...........   169,363,000      642,387,000
                                                              -------------   -------------
Net increase in cash and cash equivalents...................    10,070,000      252,379,000
Cash and cash equivalents at beginning of period............    10,166,000       21,315,000
                                                              -------------   -------------
Cash and cash equivalents at end of period..................  $ 20,236,000    $ 273,694,000
                                                              =============   =============
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION:
  Cash paid for interest....................................  $     53,000    $      42,000
                                                              =============   =============
SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITIES:
    Equipment purchases payable, to be financed through
     operating leases.......................................  $    640,000    $          --
                                                              =============   =============
    Equipment and furniture purchases payable...............  $         --    $  11,972,000
                                                              =============   =============
    Intangible business acquisition costs arising from
     issuance of preferred stock and warrants...............  $  6,567,000    $  23,190,000
                                                              =============   =============
</TABLE>

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

                                       4
<PAGE>
                          RHYTHMS NETCONNECTIONS INC.
                 CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
                                                SERIES A              SERIES B             SERIES C
                                               CONVERTIBLE           CONVERTIBLE          CONVERTIBLE
                                             PREFERRED STOCK       PREFERRED STOCK      PREFERRED STOCK
                                            $0.001 PAR VALUE      $0.001 PAR VALUE     $0.001 PAR VALUE
                                          ---------------------  -------------------  -------------------
                                           # SHARES     AMOUNT    # SHARES   AMOUNT    # SHARES   AMOUNT
                                          -----------  --------  ----------  -------  ----------  -------
<S>                                       <C>          <C>       <C>         <C>      <C>         <C>
Balance at December 31, 1998............   12,855,094  $ 13,000   4,044,943  $4,000           --  $   --
Issuance of common stock in initial
  public offering in April 1999
  (unaudited)...........................           --        --          --      --           --      --
Issuance of common stock in secondary
  offering in September 1999
  (unaudited)...........................           --        --          --      --           --      --
Issuance of common stock upon exercise
  of options for cash ($0.04 to $16.00
  per share) (unaudited)................           --        --          --      --           --      --
Issuance of common stock upon cashless
  exercise of warrants ($1.85 per share)
  in May and June 1999 (unaudited)......           --        --          --      --           --      --
Issuance of common stock upon cashless
  exercise of warrants ($0.004 per
  share) in August 1999 (unaudited).....           --        --          --      --           --      --
Issuance of Series C preferred stock and
  warrants for cash ($8.04 per share) in
  March and April 1999 (unaudited)......           --        --          --      --    8,395,655   8,000
Issuance of Series D preferred stock and
  warrants for cash ($8.04 per share) in
  April 1999 (unaudited)................           --        --          --      --           --      --
Business relationship value arising from
  issuance of Series C and Series D
  preferred stock in March and April
  1999 (unaudited)......................           --        --          --      --           --      --
Conversion of preferred stock to common
  upon initial public offering in April
  1999 (unaudited)......................  (12,855,094)  (13,000) (4,044,943) (4,000)  (8,395,655) (8,000)
Costs arising from issuances of Series C
  and Series D preferred stock in March
  and April 1999 (unaudited)............           --        --          --      --           --      --
Costs arising from public offerings in
  April and September 1999
  (unaudited)...........................           --        --          --      --           --      --
Purchase of treasury stock for cash
  ($0.04 to $16.00 per share)
  (unaudited)...........................           --        --          --      --           --      --
Issuance of warrants to leasing
  companies in March, April and July
  1999 (unaudited)......................           --        --          --      --           --      --
Issuance of warrants to business partner
  in April 1999 (unaudited).............           --        --          --      --           --      --
Deferred compensation from grants of
  options to purchase common stock
  (unaudited)...........................           --        --          --      --           --      --
Amortization of deferred compensation
  (unaudited)...........................           --        --          --      --           --      --
Reversal of deferred compensation from
  cancellation of grants to purchase
  common stock (unaudited)..............           --        --          --      --           --      --
Net loss through September 30, 1999
  (unaudited)...........................           --        --          --      --           --      --
                                          -----------  --------  ----------  -------  ----------  -------
Balance at September 30, 1999
  (unaudited)...........................           --  $     --          --  $   --           --  $   --
                                          ===========  ========  ==========  =======  ==========  =======

<CAPTION>
                                               SERIES D
                                             CONVERTIBLE
                                           PREFERRED STOCK       COMMON STOCK        TREASURY STOCK
                                           $0.001 PAR VALUE    $0.001 PAR VALUE         AT COST
                                          ------------------  -------------------  ------------------
                                          # SHARES   AMOUNT    # SHARES   AMOUNT   # SHARES   AMOUNT
                                          --------  --------  ----------  -------  --------  --------
<S>                                       <C>       <C>       <C>         <C>      <C>       <C>
Balance at December 31, 1998............       --   $     --   8,042,530  $8,000   438,115   $(18,000)
Issuance of common stock in initial
  public offering in April 1999
  (unaudited)...........................       --         --  10,781,250  11,000        --         --
Issuance of common stock in secondary
  offering in September 1999
  (unaudited)...........................       --         --     594,279      --        --         --
Issuance of common stock upon exercise
  of options for cash ($0.04 to $16.00
  per share) (unaudited)................       --         --   2,610,158   3,000        --         --
Issuance of common stock upon cashless
  exercise of warrants ($1.85 per share)
  in May and June 1999 (unaudited)......       --         --     252,112      --        --         --
Issuance of common stock upon cashless
  exercise of warrants ($0.004 per
  share) in August 1999 (unaudited).....       --         --   3,961,862   4,000        --         --
Issuance of Series C preferred stock and
  warrants for cash ($8.04 per share) in
  March and April 1999 (unaudited)......       --         --          --      --        --         --
Issuance of Series D preferred stock and
  warrants for cash ($8.04 per share) in
  April 1999 (unaudited)................  441,176         --          --      --        --         --
Business relationship value arising from
  issuance of Series C and Series D
  preferred stock in March and April
  1999 (unaudited)......................       --         --          --      --        --         --
Conversion of preferred stock to common
  upon initial public offering in April
  1999 (unaudited)......................  (441,176)       --  51,076,051  51,000        --         --
Costs arising from issuances of Series C
  and Series D preferred stock in March
  and April 1999 (unaudited)............       --         --          --      --        --         --
Costs arising from public offerings in
  April and September 1999
  (unaudited)...........................       --         --          --      --        --         --
Purchase of treasury stock for cash
  ($0.04 to $16.00 per share)
  (unaudited)...........................       --         --          --      --    50,775    (10,000)
Issuance of warrants to leasing
  companies in March, April and July
  1999 (unaudited)......................       --         --          --      --        --         --
Issuance of warrants to business partner
  in April 1999 (unaudited).............       --         --          --      --        --         --
Deferred compensation from grants of
  options to purchase common stock
  (unaudited)...........................       --         --          --      --        --         --
Amortization of deferred compensation
  (unaudited)...........................       --         --          --      --        --         --
Reversal of deferred compensation from
  cancellation of grants to purchase
  common stock (unaudited)..............       --         --          --      --        --         --
Net loss through September 30, 1999
  (unaudited)...........................       --         --          --      --        --         --
                                          --------  --------  ----------  -------  -------   --------
Balance at September 30, 1999
  (unaudited)...........................       --   $     --  77,318,242  $77,000  488,890   $(28,000)
                                          ========  ========  ==========  =======  =======   ========

<CAPTION>

                                                                                                      TOTAL
                                           ADDITIONAL                                             STOCKHOLDERS'
                                            PAID-IN                    DEFERRED     ACCUMULATED      EQUITY
                                            CAPITAL      WARRANTS    COMPENSATION     DEFICIT       (DEFICIT)
                                          ------------  -----------  ------------  -------------  -------------
<S>                                       <C>           <C>          <C>           <C>            <C>
Balance at December 31, 1998............  $ 37,212,000  $        --  $(5,210,000)  $ (38,756,000) $  (6,747,000)
Issuance of common stock in initial
  public offering in April 1999
  (unaudited)...........................   226,395,000           --           --              --    226,406,000
Issuance of common stock in secondary
  offering in September 1999
  (unaudited)...........................    17,233,000           --           --              --     17,233,000
Issuance of common stock upon exercise
  of options for cash ($0.04 to $16.00
  per share) (unaudited)................     3,114,000           --           --              --      3,117,000
Issuance of common stock upon cashless
  exercise of warrants ($1.85 per share)
  in May and June 1999 (unaudited)......            --           --           --              --             --
Issuance of common stock upon cashless
  exercise of warrants ($0.004 per
  share) in August 1999 (unaudited).....     5,494,000           --           --              --      5,498,000
Issuance of Series C preferred stock and
  warrants for cash ($8.04 per share) in
  March and April 1999 (unaudited)......    60,368,000    7,124,000           --              --     67,500,000
Issuance of Series D preferred stock and
  warrants for cash ($8.04 per share) in
  April 1999 (unaudited)................     6,317,000    1,183,000           --              --      7,500,000
Business relationship value arising from
  issuance of Series C and Series D
  preferred stock in March and April
  1999 (unaudited)......................    21,100,000           --           --              --     21,100,000
Conversion of preferred stock to common
  upon initial public offering in April
  1999 (unaudited)......................       (26,000)          --           --              --             --
Costs arising from issuances of Series C
  and Series D preferred stock in March
  and April 1999 (unaudited)............      (245,000)          --           --              --       (245,000)
Costs arising from public offerings in
  April and September 1999
  (unaudited)...........................   (17,102,000)          --           --              --    (17,102,000)
Purchase of treasury stock for cash
  ($0.04 to $16.00 per share)
  (unaudited)...........................            --           --           --              --        (10,000)
Issuance of warrants to leasing
  companies in March, April and July
  1999 (unaudited)......................            --    1,180,000           --              --      1,180,000
Issuance of warrants to business partner
  in April 1999 (unaudited).............            --      910,000           --              --        910,000
Deferred compensation from grants of
  options to purchase common stock
  (unaudited)...........................     7,009,000           --   (7,009,000)             --             --
Amortization of deferred compensation
  (unaudited)...........................            --           --    2,541,000              --      2,541,000
Reversal of deferred compensation from
  cancellation of grants to purchase
  common stock (unaudited)..............      (576,000)          --      576,000              --             --
Net loss through September 30, 1999
  (unaudited)...........................            --           --           --    (128,533,000)  (128,533,000)
                                          ------------  -----------  -----------   -------------  -------------
Balance at September 30, 1999
  (unaudited)...........................  $366,293,000  $10,397,000  $(9,102,000)  $(167,289,000) $ 200,348,000
                                          ============  ===========  ===========   =============  =============
</TABLE>

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

                                       5
<PAGE>
                          RHYTHMS NETCONNECTIONS INC.

             Notes to Consolidated Financial Statements (Unaudited)

NOTE 1--BASIS OF PRESENTATION:

    THE COMPANY:  Rhythms NetConnections Inc. ("Rhythms" or the "Company"), a
Delaware corporation, was organized under the name Accelerated Connections Inc.
in February 1997. The Company's name was changed to Rhythms NetConnections Inc.
in August 1997. The Company is in the business of providing high-speed data
communications services on an end-to-end basis to business customers and end
users. The Company began service trials in the San Diego, California, market in
December 1997 and began commercial operations in San Diego effective April 1,
1998.

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

    INTERIM RESULTS (UNAUDITED):  The accompanying consolidated financial
statements (unaudited), which include the transactions and balances of Rhythms
NetConnections Inc. and its wholly owned subsidiaries Rhythms Links Inc.
(formerly ACI Corp.) and ACI Corp.-Virginia, have been prepared in accordance
with generally accepted accounting principles for interim financial information
and, therefore, do not include all the information and footnotes required by
generally accepted accounting principles for complete financial statements. In
the opinion of management, these statements have been prepared on the same basis
as the audited financial statements and include all adjustments, consisting only
of normal recurring accruals, that are necessary for the fair statement of
results for the unaudited interim periods. The data disclosed in these notes to
consolidated financial statements is also unaudited. The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the financial statement date, as well as the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. The operating results for the interim period are not
necessarily indicative of the results to be expected for a full fiscal year or
for any future periods. All material intercompany transactions and balances have
been eliminated.

NOTE 2--NET LOSS PER SHARE:

    Basic earnings per share is calculated by dividing the income or loss
available to common stockholders by the weighted average number of common shares
outstanding for the period, without consideration for common stock equivalents.
Diluted EPS is computed by dividing the income or loss available to common
stockholders by the weighted average number of common shares outstanding for the
period in addition to the weighted average number of common stock equivalents
outstanding for the period. Shares subject to repurchase by the Company are
considered Common Stock equivalents for purposes of this calculation. Shares
issuable upon conversion of preferred stock and upon the exercise of outstanding
stock options and

                                       6
<PAGE>
                          RHYTHMS NETCONNECTIONS INC.

       Notes to Consolidated Financial Statements (Unaudited) (Continued)

NOTE 2--NET LOSS PER SHARE: (CONTINUED)

warrants, and shares subject to repurchase by the Company totaling 50,125,301
and 13,261,271 at September 30, 1998 and 1999, respectively, have been excluded
from the computation since their effect would be antidilutive.

NOTE 3--STOCKHOLDERS' EQUITY:

    On July 30, 1999, the Company entered into a 36-month lease line that
provides for $26,000,000 in equipment on an operating lease basis. In connection
with this lease agreement, the Company issued 10,000 warrants to purchase common
stock at a price of $50.00 per share, exercisable immediately. During the third
quarter of 1999, the Company additionally agreed to terms on a 36-month lease
line that provides for $30,000,000 in equipment on an operating lease basis.

    Effective August 17, 1999, the Company completed a secondary public offering
of its common stock in a transaction that allowed certain holders of warrants
issued in connection with the 13.5 percent Senior Discount Notes to exercise
those warrants and sell the resulting Common Stock at $29.00 per share. A total
of 3,961,862 shares were issued in the transaction; the Company received no
proceeds from the sale of these shares. In connection with the secondary
offering, the underwriters of the offering were allowed to purchase 594,279
shares of Common Stock from the Company for $29.00 per share. The sale of these
shares was completed on September 14, 1999 and the Company received proceeds of
$16,415,000, net of underwriting discount.

    During the third quarter of 1999, the Company granted options to employees
to purchase a total 1,103,750 shares of Common Stock pursuant to its Stock
Option/Stock Issuance Plan. During this same time, employees exercised
previously granted options to purchase a total of 53,325 shares of Common Stock
for total proceeds to the Company of $47,000.

NOTE 4--SUBSEQUENT EVENTS:

    On October 29, 1999, the Company completed a strategic investment in OCI
Communications, Inc. ("OCI"), a provider of telecommunications services in
Canada. In exchange for a $5,300,000 cash investment, the Company received
warrants to purchase 763,680 shares of Class B Non-voting stock in OCI. These
warrants are in the process of being registered and are expected to convert into
Class B Non-voting shares before December 31, 1999. As part of this investment
Rhythms received various rights, including the ability to appoint a
representative to OCI's Board of Directors, among others. As part of this
strategic relationship, the Company intends to create a joint venture with OCI
to offer DSL-based services in selected Canadian markets.

                                       7
<PAGE>
                          RHYTHMS NETCONNECTIONS INC.
                                     PART I
                       FINANCIAL INFORMATION (CONTINUED)

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
  OF OPERATIONS

    We have based the following discussion and analysis on the consolidated
financial statements of our company and this should be read in conjunction with
our financial statements and the related footnotes presented previously. Certain
statements we have set forth below constitute forward-looking statements.
Forward-looking statements are based on our current expectations and projections
about future events. They involve known and unknown risks, uncertainties, and
other factors that may cause our actual results, performance or achievements, or
industry results, to be materially different from any future results anticipated
or implied by the forward-looking statements. Given these uncertainties, we
caution investors and prospective investors not to place undue reliance on any
forward-looking statements. Factors discussed in the "Risk Factors" and
"Business" sections contained in the Company's Registration Statement on
Form S-3 as filed with the Securities and Exchange Commission on November 8,
1999 could, among other things, cause or contribute to differences from the
forward-looking statements. We disclaim any obligation to publicly update or
revise information contained in any forward-looking statement, whether as a
result of new information, future events, or otherwise. In light of these risks,
uncertainties, and assumptions, the forward-looking events discussed in this
Form 10-Q might not occur.

RESULTS OF OPERATIONS:

    We are a leading service provider of high-speed local access networking
solutions using DSL technology to businesses. We began offering commercial
services in our first market in April 1998 and as of September 30, 1999 offer
service in a total of 27 markets. We intend to continue our network rollout into
an additional ten markets in 1999 and a further 33 markets by the end of year
2000.

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

    - obtaining required governmental authorizations;

    - negotiating and executing interconnection agreements with incumbent
      carriers;

    - entering into strategic alliances;

    - identifying collocation space and locations for our connection points,
      metro service centers, and business offices;

    - acquiring and deploying equipment and facilities;

    - launching service trials;

    - hiring management and other personnel;

    - raising capital; and

    - developing and integrating our operations support systems and other back
      office systems.

    During the first nine-months of 1999, we continued the development of our
business operations as follows:

    - entered one new market during the first quarter, nine new markets during
      the second quarter and ten new markets in the third quarter;

    - added 155 central office locations during the first quarter, 153 during
      the second quarter and 347 during the third quarter for a total of
      855 central offices at September 30, 1999;

    - added service to 735 DSL lines during the first quarter, 2,105 during the
      second quarter and 3,450 during the third quarter for a total of 6,700 DSL
      lines at September 30, 1999; and

                                       8
<PAGE>
    - increased headcount by 170 employees during the first quarter, 225 during
      the second quarter and 300 during the third quarter for a total of
      approximately 880 employees at September 30, 1999.

    We have incurred operating losses, net losses and negative operating cash
flow for each month since our formation. As of September 30, 1999, we had an
accumulated deficit of approximately $167.3 million. We expect to substantially
increase our expenditures and operating expenses as we continue our rapid
expansion of our infrastructure and network services. We expect to incur
substantial operating losses, net losses, and negative cash flow during the
network build-out and the initial penetration of each new market we enter. We
expect to continue these losses for at least the next several years.

THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS ENDED
  SEPTEMBER 30, 1998

    For the three months ended September 30, 1999, we recorded revenues of
$3.3 million and network and service costs of $21.8 million. This compares to
revenues of $166,000 and network and service costs of $1.4 million during the
same period in the prior year. The substantial increases in both revenues and
costs in 1999 is a result of our continued rapid expansion. Each new market we
enter provides us with an additional revenue opportunity, but also higher costs
until we have an established customer base in the market. As of September 30,
1999 we operated in 27 markets, compared to six markets at September 30, 1998.
Our revenues are derived primarily from DSL service and installation charges,
net of discounts given to customers upon service establishment. Network service
costs include customer installation costs, line and backbone expenses, equipment
operating leases, and repair and support costs.

    Our selling, marketing, general, and administrative expenses for the third
quarter of 1999 were $28.7 million, which compares to $7.1 million in the prior
year. This increase between years reflects our continuing increases in staffing
levels, legal fees, and marketing efforts coinciding with the development and
launch of new markets.

    We recorded depreciation and amortization of $4.0 million during the third
quarter of 1999, a significant increase over the $472,000 recorded during the
third quarter of 1998. This increase reflects the rapid expansion of our network
and includes amortization of collocation fees and depreciation on operating
equipment as we turn up service in each new location.

    During the first and second quarters of 1999, we entered into strategic
arrangements with Microsoft Corporation and Qwest Communications Corporation. In
addition to their investments in our company totaling $45.0 million, the
strategic arrangements provide for certain other business relationships.
Combined, these business relationships are valued at $21.1 million and we have
capitalized these costs as deferred assets. We are amortizing these assets over
three- and five-year periods. Accordingly, during the third quarter of 1999 we
recorded $1.6 million in amortized deferred business acquisition costs that have
no corresponding amortization in the prior year.

    During the third quarter of 1999 we recorded interest income of
$7.3 million. During the third quarter in 1998 we recorded interest income of
$2.2 million. The increase between years primarily resulted from a substantial
increase in invested cash balances. As of September 30, 1999, we had cash and
investments totaling $558.2 million, compared to cash and investments of
$153.9 million at September 30, 1998. The increase during 1999 resulted from a
variety of financing activities, including:

    - issuing Series C and Series D preferred stock and warrants totaling
      $75.0 million in March and April 1999;

    - issuing common stock upon our initial public offering in April 1999 for
      cash proceeds of $210.1 million;

    - issuing 12.75 percent senior debt in April 1999 for cash proceeds of
      $314.5 million;

    - executing equipment lease lines totaling $44.0 million in March and
      April 1999;

                                       9
<PAGE>
    - executing equipment lease lines totaling $56 million in July and
      September; and

    - issuing common stock upon our secondary public offering in August 1999 for
      cash proceeds of $16.4 million.

    While we recorded increased interest income on the invested cash balances,
we also recorded higher interest expense during 1999 as compared to 1998. For
the quarter ended September 30, 1999 we had interest expense of $16.5 million
which compared to $5.3 million for the same period in the prior year. This
increase primarily resulted from the senior debt we issued in April 1999.

    We continue to be in a net operating loss tax position through
September 30, 1999; consequently, we have not recorded a provision for income
taxes for periods through September 30, 1999.

NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED
  SEPTEMBER 30, 1998

    We recorded $5.6 million in revenues for the nine months ended
September 30, 1999 compared to $248,000 in revenues for the nine months ended
September 30, 1998. Our network and service costs for the nine-month periods
were $40.0 million in 1999 compared to $2.1 million in 1998. The increases in
both revenues and costs resulted from the continued expansion of our operations,
as more fully detailed above.

    During the first nine months of 1999, our selling, marketing, general, and
administrative expenses were $64.8 million, which compares to $14.0 million
during the first nine months of 1998. This increase resulted primarily from
additional salary, overhead, marketing, and legal expenses associated with our
continuing expansion, as more fully detailed above.

    Depreciation and amortization for the nine-month periods was $6.1 million in
1999 and $507,000 in 1998. As we continue our expansion into additional markets
and central offices, as discussed above, we employ additional equipment and
collocation sites that we begin depreciating when we place them in service.

    The increase in amortized deferred business acquisition costs between years
from zero for the nine months ended September 30, 1998 to $3.2 million for the
nine months ended September 30, 1999 is a result of the Microsoft and Qwest
business relationships as discussed above.

    Interest income was $15.7 million and interest expense was $35.9 million for
the nine months ended September 30, 1999. This compares to interest income of
$3.8 million and interest expense of $8.5 million for the same nine-month period
in 1998. The increases in 1999 resulted from our financing activities that are
described above. The primary financing activities included our initial public
offering of common stock and our issuance of senior debt in April 1999. We
invested the proceeds from these financings, which provided increased interest
income. Interest and issue cost amortization on the debt, however, contributed
to a large increase in interest expense for 1999.

LIQUIDITY AND CAPITAL RESOURCES:

    The development and expansion of our business requires significant capital
expenditures. These capital expenditures primarily include build-out costs such
as the procurement, design, and construction of our connection points and one or
two metro service center locations in each market, as well as other costs that
support our network design.

    The number of targeted central offices in each market varies, as does the
average capital cost to build our connection points in each market. Capital
expenditures, including payments for collocation fees, were $142.0 million
during the first nine months of 1999. We sold approximately $23.8 million of
these purchases to a leasing company and are currently leasing the equipment
back on an operating-lease basis. We expect our capital expenditures to be
higher in future periods, arising primarily from payments of collocation fees
and the purchase of infrastructure equipment necessary for the development and
expansion of our network.

                                       10
<PAGE>
    Our capital requirements may vary based upon the timing and success of our
rollout and as a result of regulatory, technological, and competitive
developments or if:

    - demand for our services or our anticipated cash flow from operations is
      less or more than expected;

    - our development plans or projections change or prove to be inaccurate;

    - we engage in any acquisitions; and

    - we accelerate deployment of our network services or otherwise alter the
      schedule or targets of our rollout plan.

    Since our primary activities have focused on building our network and
building a customer base, we have operated at a loss since inception. We intend
to continue to expand our operations at a rapid pace and expect to continue to
operate at a loss for the foreseeable future. The nature of expenses
contributing to our future losses will include network and service costs in
existing and new markets; legal, marketing, and selling expenses as we enter
each new market; payroll-related expenses as we continue to add employees;
general overhead to support the operational increases; and interest expense
arising from financing our expenditures.

    We have not paid any dividends to our shareholders and will not pay
dividends for the foreseeable future. Our senior notes contain covenants that
restrict our ability to make certain payments, including dividend payments.

    Through September 30, 1999, we have financed our operations and market
build-outs primarily through:

    - issuing 12.75 percent senior notes in April 1999 for $314.5 million in net
      proceeds;

    - issuing common stock in April 1999 in our initial public offering for
      $210.1 million in net proceeds; issuing common stock in August 1999
      resulting in $16.4 million in net proceeds to the company

    - issuing 13.50 percent senior discount notes in May 1998 for
      $144.0 million in net proceeds;

    - private placements of equity totaling $105.8 million; and

    - executing equipment lease lines totaling $124.5 million.

    As of September 30, 1999, we had $558.2 million in cash and investments and
we had an accumulated deficit of $167.3 million.

    For the nine months ended September 30, 1998 and September 30, 1999, we used
cash of $9.2 million and $78.9 million, respectively in our operating
activities. This cash was used for a variety of operating purposes including
salaries, consulting and legal expenses, network operations, marketing, and
overhead expenses. For the nine months ended September 30, 1998 and
September 30, 1999, we used net cash of $150.1 million and $311.1 million,
respectively, for investing activities. We used this cash primarily for
purchases of short-term investments and equipment and payments of collocation
fees. Net cash provided by financing activities for the nine months ended
September 30, 1998 and September 30, 1999 was $169.3 million and
$642.4 million, respectively. These funds were generated primarily from the
issuances of equity and senior debt as described above.

    We expect our operating losses and capital expenditures to increase
substantially in the near-term, primarily due to our network expansion. We
believe that our existing cash and investment balances as of September 30, 1999,
together with the anticipated future revenue generated from operations, will be
sufficient to fund our operating losses, capital expenditures, lease payments,
and interest payments through approximately October 2000. We expect that
additional financing will be required in the future. We may attempt to raise
financing through some combination of commercial bank borrowings, leasing,
vendor financings, or the private or public sale of equity or debt securities.
Future equity or debt financings may

                                       11
<PAGE>
not be available to us at all, or, if available, may not be on favorable terms.
If we are unable to obtain financing in the future, we will continue the
expansion of our operations on a reduced scale based on our existing capital
resources.

IMPACT OF THE YEAR 2000 ISSUE:

    Many computer programs have been written using two digits rather than four
to define the applicable year. This poses a problem at the end of the century
because these computer programs may recognize a date using "00" as the year 1900
rather than the year 2000. This, in turn, could result in major system failures
or miscalculations, and is generally referred to as the "Year 2000 issue." We
have formulated and, to a large extent, effected a plan to address our Year 2000
issues. Our Year 2000 plan applies to two areas: internal business systems and
compliance by external customers and providers. We have completed our Year 2000
compliance testing for all of our internal systems and believe that they are
Year 2000 compliant. Because we are a young company, we believe we have been
able to build our business systems with the Year 2000 issue in mind in a more
effective manner than many older companies. Therefore, there have been few Year
2000 changes required to our existing systems and applications. We have
substantially completed a compliance check of our external customers and
providers, except for the incumbent carriers. Based on responses from these
third parties, other than the incumbent carriers, we believe that they will not
experience Year 2000 problems that would materially and adversely affect our
business. We have not been able to conduct a compliance check of incumbent
carriers nor assess the incumbent carriers' Year 2000 compliance. To the extent
that one or more incumbent carriers or other third parties experience Year 2000
problems, our network and services could be adversely affected. Furthermore, the
purchasing patterns of our customers may be affected by Year 2000 issues as
companies expend significant resources to correct their current systems for Year
2000 compliance. These expenditures may result in reduced funds available for
our services. Any of these developments could have a material and adverse effect
on our business, prospects, operating results and ability to repay our debt,
including the notes. We have not fully determined the risks associated with the
reasonably worst-case scenario and have not formulated a contingency plan to
address Year 2000 issues. We do not expect to have a specific contingency plan
in place in the future.

RISKS AND UNCERTAINTIES:

    In addition to the other risks stated in this document, you should consider
the following risks and uncertainties in evaluating our company.

WE CANNOT PREDICT OUR SUCCESS BECAUSE WE HAVE A SHORT OPERATING HISTORY

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

BECAUSE OUR MARKET IS NEW AND EVOLVING, WE CANNOT PREDICT ITS FUTURE GROWTH OR
  ULTIMATE SIZE, AND WE MAY BE UNABLE TO COMPETE EFFECTIVELY

    The market for packet-based high-speed digital communication services using
telephone lines is in the early stages of development. Since this market is new
and evolving and because our current and future competitors are likely to
introduce competing services, we cannot accurately predict the rate at which
this market will grow, if at all, or whether new or increased competition will
result in market saturation. Various providers of high-speed digital
communication services are testing products from various suppliers

                                       12
<PAGE>
for various applications, and suppliers have not broadly adopted an industry
standard. Certain critical issues concerning commercial use of DSL for Internet
and local area network access, including security, reliability, ease and cost of
access and quality of service, remain unresolved and may impact the growth of
these services. If the markets for our services fail to develop, grow more
slowly than anticipated or become saturated with competitors, these events could
materially and adversely affect our business, prospects, operating results, and
financial condition.

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

    - rapidly expand the geographic coverage of our network services;

    - raise additional capital;

    - enter into interconnection agreements and working arrangements with
      additional incumbent carriers, substantially all of which we expect to be
      our competitors;

    - deploy an effective network infrastructure;

    - attract and retain customers;

    - successfully develop relationships and activities with our partners and
      distributors, including MCI WorldCom, Microsoft, Qwest and Cisco;

    - continue to attract, retain and motivate qualified personnel;

    - accurately assess potential markets and effectively respond to competitive
      developments;

    - continue to develop and integrate our operational support system and other
      back office systems;

    - obtain any required governmental authorizations;

    - comply with evolving governmental regulatory requirements;

    - increase awareness of our services;

    - continue to upgrade our technologies; and

    - effectively manage our expanding operations.

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

WE CANNOT PREDICT OUR SUCCESS BECAUSE OUR BUSINESS MODEL IS UNPROVEN

    We have not validated our business model and strategy in the market. We
believe that the combination of our unproven business model and the highly
competitive and fast changing market in which we compete makes it impossible to
predict the extent to which our network service will achieve market acceptance
and our overall success. To be successful, we must develop and market network
services that are widely accepted by businesses at profitable prices. We may
never be able to deploy our network as planned, achieve significant market
acceptance, favorable operating results or profitability or generate sufficient
cash flow to repay our debt. Of the approximately 6,700 lines that are in
service, we installed approximately 65% to only five customers. None of our
large business customers has rolled out our services broadly to its employees,
and we cannot be certain when or if these rollouts will occur. We will not
receive significant revenue from our large customers unless these rollouts
occur. Any continued or ongoing failure for any reason of large business
customers to roll out our services, failure to validate our business model in
the market, including failure to build out our network, achieve widespread
market acceptance or sustain desired pricing would materially and adversely
affect our business, prospects, operating results, and financial condition.

                                       13
<PAGE>
WE EXPECT OUR LOSSES TO CONTINUE

    We have incurred losses and experienced negative operating cash flow for
each month since our formation. As of September 30, 1999, we had an accumulated
deficit of approximately $167.3 million. We intend to rapidly and substantially
increase our expenditures and operating expenses in an effort to expand our
network services. We expect to have annual interest and amortization expense
relating to our 1998 senior discount notes and 1999 senior notes of
approximately $52.2 million in 1999 and increasing to $81.0 million in 2003. In
addition, we may incur more debt in the future. Furthermore, as a result of
recent business relationships arising from preferred stock and warrant issuances
and of previous stock option grants, we anticipate that there will be
significant charges to earnings in future periods. We estimate that these
charges will total approximately $6.2 million per year over each of the next
several years. As a result of these factors, we expect to incur substantial
operating and net losses and negative operating cash flow for the foreseeable
future. We will need to obtain additional financing to pay our expenses and to
make payments on our debt. We cannot give you any assurance about whether or
when we will have sufficient revenues to satisfy our funding requirements or pay
our debt service obligations.

OUR OPERATING RESULTS IN ONE OR MORE FUTURE PERIODS ARE LIKELY TO FLUCTUATE
  SIGNIFICANTLY AND MAY FAIL TO MEET OR EXCEED THE EXPECTATIONS OF SECURITIES
  ANALYSTS OR INVESTORS

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

    - the rate of customer acquisition and turnover;

    - the prices our customers are willing to pay;

    - the amount and timing of expenditures relating to the expansion of our
      services and infrastructure;

    - the timing and availability of incumbent carrier central office
      collocation facilities and transport facilities;

    - the success of our relationships with our partners and distributors,
      including MCI WorldCom, Microsoft, Qwest and Cisco;

    - our ability to deploy our network on a timely basis;

    - introduction of new services or technologies by our competitors;

    - price competition;

    - the ability of our equipment and service suppliers to meet our needs;

    - regulatory developments, including interpretations of the 1996
      Telecommunications Act;

    - technical difficulties or network downtime;

    - the success of our strategic alliances; and

    - the condition of the telecommunication and network service industries and
      general economic conditions.

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

                                       14
<PAGE>
IF SALES FORECASTED FOR A PARTICULAR PERIOD ARE NOT REALIZED IN THAT PERIOD DUE
  TO THE LENGTHY SALES CYCLE OF OUR SERVICES, OUR OPERATING RESULTS FOR THAT
  PERIOD WILL BE HARMED

    The sales cycle of our network services can be very lengthy, particularly
for large businesses. The sales cycle for large businesses typically involves:

    - a significant technical evaluation;

    - an initial trial rollout to a relatively small number of end users;

    - a commitment of capital and other resources by the customer;

    - delays associated with the customer's internal procedures to approve large
      capital expenditures;

    - time required to engineer the deployment of our services;

    - coordination of the activation of multiple access lines with incumbent
      carriers; and

    - testing and acceptance of our services.

    For these and other reasons, our sales cycle for large businesses lasts at
least six months. During this lengthy sales cycle, we will incur significant
expenses in advance of the receipt of revenues. If sales that we forecast for a
particular period do not occur because of our lengthy sales cycle, this event
could materially and adversely affect our business, prospects, operating
results, and financial condition during that period.

WE DEPEND ON INCUMBENT CARRIERS FOR COLLOCATION AND TRANSMISSION FACILITIES

    We must use copper telephone lines controlled by the incumbent carriers to
provide DSL connections to customers. We also depend on the incumbent carriers
for collocation and for a substantial portion of the transmission facilities we
use to connect our equipment in incumbent carrier central offices to our Metro
Service Centers. In addition, we depend on the incumbent carriers to test and
maintain the quality of the copper lines that we use. We have not established a
history of obtaining access to collocation and transmission facilities from
incumbent carriers in large volumes. In many cases, we may be unable to obtain
access to collocation and transmission facilities from the incumbent carriers,
or to gain access at acceptable rates, terms and conditions, including
timeliness. We have experienced, and expect to experience in the future, lengthy
periods between our request for and the actual provision of the collocation
space and telephone lines. An inability to obtain adequate and timely access to
collocation space or transmission facilities on acceptable terms and conditions
from incumbent carriers could have a material and adverse effect on our
business, prospects, operating results, and financial condition.

    Because we compete with incumbent carriers in our markets, they may be
reluctant to cooperate with us. The incumbent carriers may experience, or claim
to experience, a shortage of collocation space or transmission capacity. If this
occurs, we may not have alternate means of connecting our DSL equipment with the
copper lines or connecting our equipment in central offices to Metro Service
Centers. We have experienced rejections of some of our collocation applications
on the grounds that no space is available. We may receive additional rejections
in the future. The number of other competitive local exchange carriers that
request collocation space will also affect the availability of collocation space
and transmission capacity. If we are unable to obtain physical collocation space
or transmission capacity from our targeted incumbent carriers, we may face
delays, additional costs or an inability to provide services in certain
locations. In many cases where our application for physical collocation is
rejected, we expect to have the option of adjacent location -- where we install
our equipment in a building that is very close to the incumbent carrier central
office -- or virtual collocation -- where the incumbent carrier manages and
operates our equipment. While we have used adjacent and virtual collocation in
our network, those alternatives reduce our control over our equipment, and
therefore may reduce the level of quality and service we provide to our
customers. We are currently in an arbitration proceeding with SBC
Communications Inc. concerning the availability of DSL-enabled copper lines, as
well as other operational

                                       15
<PAGE>
issues. Delays in obtaining access to collocation space and telephone lines or
the rejection of our applications for collocation could result in delays in, and
increased expenses associated with, the rollout of our services, which in turn
could have a material and adverse effect on our business, prospects, operating
results, and financial condition.

WE ARE UNABLE TO CONTROL THE TERMS AND CONDITIONS UNDER WHICH WE GAIN ACCESS TO
  INCUMBENT CARRIER COLLOCATION AND TRANSMISSION FACILITIES

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

WE DEPEND ON THIRD PARTIES, PARTICULARLY MCI WORLDCOM, MICROSOFT, QWEST AND
  CISCO, FOR THE MARKETING AND SALES OF OUR NETWORK SERVICES

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

    We expect to rely particularly on the sales and marketing efforts of our
strategic partners, including MCI WorldCom, Microsoft, Qwest and Cisco. While
our agreements with MCI WorldCom and Qwest call

                                       16
<PAGE>
for them to sell an aggregate of 200,000 DSL lines, the agreements also enable
MCI WorldCom and Qwest to terminate their respective agreements under certain
circumstances and to receive offsets and credits under other circumstances.
Therefore, MCI WorldCom and Qwest might sell significantly fewer than 200,000
DSL lines, or we might receive significantly lower revenues than we otherwise
would.

    THE MARKET IN WHICH WE OPERATE IS HIGHLY COMPETITIVE, AND WE MAY NOT BE ABLE
TO COMPETE EFFECTIVELY, ESPECIALLY AGAINST ESTABLISHED INDUSTRY COMPETITORS WITH
SIGNIFICANTLY GREATER FINANCIAL RESOURCES

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

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

    Many of these competitors are offering, or may soon offer, technologies and
services that will directly compete with some or all of our service offerings.
Some of the technologies used by these competitors for local access connections
include integrated services digital network (ISDN), DSL, wireless data and cable
modems. Some of the competitive factors in our markets include transmission
speed, reliability of service, breadth of service availability, price
performance, network security, ease of access and use, content bundling,
customer support, brand recognition, operating experience, capital availability
and exclusive contracts. We believe that we compare unfavorably with many of our
competitors with regard to, among other things, brand recognition, existing
relationships with end users, available pricing discounts, central office
access, capital availability and exclusive contracts. Substantially all of our
competitors and potential competitors have substantially greater resources than
us. We may not be able to compete effectively in our target markets. Our failure
to compete effectively would have a material and adverse effect on our business,
prospects, operating results, and financial condition.

                                       17
<PAGE>
OUR NETWORK SERVICES MAY NOT ACHIEVE SIGNIFICANT MARKET ACCEPTANCE BECAUSE OUR
  PRICES ARE OFTEN HIGHER THAN THOSE CHARGED FOR COMPETING SERVICES

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

WE WILL NEED SIGNIFICANT ADDITIONAL FUNDS, WHICH WE MAY NOT BE ABLE TO OBTAIN

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

    - we have no meaningful history of operations or revenues;

    - our estimated funding requirements do not reflect any contingency amounts
      and may increase, perhaps substantially, if we are unable to generate
      revenues in the amount and within the time frame we expect or if we have
      unexpected cost increases; and

    - we face many challenges and risks, including those discussed elsewhere in
      this document.

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

OUR SERVICES ARE SUBJECT TO GOVERNMENT REGULATION, AND CHANGES IN CURRENT OR
  FUTURE LAWS OR REGULATIONS COULD RESTRICT THE WAY WE OPERATE OUR BUSINESS

    A significant portion of the services that we offer through our subsidiaries
is subject to regulation at the federal, state and/or local levels. Future
federal or state regulations and legislation may be less favorable to us than
current regulation and legislation and therefore have an adverse impact on our
business, prospects, operating results, and financial condition. In addition, we
may expend significant financial and managerial resources to participate in
rule-setting proceedings at either the federal or state

                                       18
<PAGE>
level, without achieving a favorable result. The Federal Communications
Commission prescribes rules applicable to interstate communications, including
rules implementing the 1996 Telecommunications Act, a responsibility it shares
with the state regulatory commissions. In particular, we believe that incumbent
carriers will work aggressively to modify or restrict the operation of many
provisions of the 1996 Telecommunications Act. We expect incumbent carriers will
pursue litigation in courts, institute administrative proceedings with the
Federal Communications Commission and other regulatory agencies and lobby the
United States Congress, all in an effort to affect laws and regulations in a
manner favorable to the incumbent carriers and against the interest of
competitive carriers such as us. If the incumbent carriers succeed in any of
their efforts, if these laws and regulations change or if the administrative
implementation of laws develops in an adverse manner, these events could have a
material and adverse effect on our business, prospects, operating results, and
financial condition.

OUR FAILURE TO MANAGE GROWTH COULD ADVERSELY AFFECT US

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

    - improve existing and implement new operational, financial and management
      information controls, reporting systems and procedures;

    - hire, train and manage additional qualified personnel;

    - expand and upgrade our core technologies; and

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

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

OUR SUBSTANTIAL DEBT CREATES FINANCIAL AND OPERATING RISK

    We are highly leveraged, and we intend to seek additional debt funding in
the future. As of September 30, 1999, we and approximately $500.1 million of
outstanding debt and our debt made up 71.3% of our capitalization. We are not
generating any meaningful revenue to fund our operations or to repay our debt.
Our substantial leverage poses the risks that:

    - we may be unable to repay our debt due to one or more events discussed in
      this document;

    - we may be unable to obtain additional financing;

    - we must dedicate a substantial portion of our cash flow from operations to
      servicing our debt once our debt requires us to make cash interest
      payments, and any remaining cash flow may not be adequate to fund our
      planned operations; and

    - we may be more vulnerable during economic downturns, less able to
      withstand competitive pressures and less flexible in responding to
      changing business and economic conditions.

                                       19
<PAGE>
THE TELECOMMUNICATIONS INDUSTRY IS UNDERGOING RAPID TECHNOLOGICAL CHANGE, AND
  NEW TECHNOLOGIES MAY BE SUPERIOR TO THE TECHNOLOGY WE USE

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

WE MAY BE UNABLE TO EFFECTIVELY EXPAND OUR NETWORK SERVICES AND PROVIDE HIGH
  PERFORMANCE TO A SUBSTANTIAL NUMBER OF END USERS

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

OUR SERVICES MAY SUFFER BECAUSE THE TELEPHONE LINES WE REQUIRE MAY BE
  UNAVAILABLE OR IN POOR CONDITION

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

OUR SUCCESS DEPENDS ON OUR RETENTION OF CERTAIN KEY PERSONNEL AND ON THE
  PERFORMANCE OF THOSE PERSONNEL

    Our success depends on the performance of our officers and key employees,
especially our Chief Executive Officer. Members of our senior management team
have worked together for only a short period of time. We do not have "key
person" life insurance policies on any of our employees nor do we have
employment agreements for fixed terms with any of our employees. Any of our
employees, including any member of our senior management team, may terminate his
or her employment with us at any time. Given our early stage of development, we
depend on our ability to retain and motivate high quality personnel,

                                       20
<PAGE>
especially our management. Our future success also depends on our continuing
ability to identify, hire, train and retain highly qualified technical, sales,
marketing and customer service personnel. Moreover, the industry in which we
compete has a high level of employee mobility and aggressive recruiting of
skilled personnel. We may be unable to continue to employ our key personnel or
to attract and retain qualified personnel in the future. We face intense
competition for qualified personnel, particularly in software development,
network engineering and product management.

WE DEPEND ON THIRD PARTIES FOR EQUIPMENT, INSTALLATION AND PROVISION OF FIELD
  SERVICE

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

A SYSTEM FAILURE OR BREACH OF NETWORK SECURITY COULD CAUSE DELAYS OR
  INTERRUPTIONS OF SERVICE TO OUR CUSTOMERS

    Our operations depend on our ability to avoid damages from fires,
earthquakes, floods, power losses, excessive sustained or peak user demand,
telecommunications failures, network software flaws, transmission cable cuts and
similar events. A natural disaster or other unanticipated problem at our owned
or leased facilities could interrupt our services. Additionally, if an incumbent
carrier, competitive carrier or other service provider fails to provide the
communications capacity we require, as a result of a natural disaster,
operational disruption or any other reason, then this failure could interrupt
our services.

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

INTERFERENCE OR CLAIMS OF INTERFERENCE COULD DELAY OUR ROLLOUT OR HARM OUR
  SERVICES

    All transport technologies deployed on copper telephone lines have the
potential to interfere with, or to be interfered with by, other transport
technologies on the copper telephone lines. We believe that our DSL
technologies, like other transport technologies, do not interfere with existing
voice services. We believe that a workable plan that takes into account all
technologies could be implemented in a scalable way across all incumbent
carriers using existing plant engineering principles. There are several
initiatives underway to establish national standards and principles for the
deployment of DSL technologies. We believe that our technologies can be deployed
consistently with these evolving standards. Nevertheless, incumbent carriers may
claim that the potential for interference permits them to restrict or delay our
deployment of DSL services. Interference could degrade the performance of our
services or make us

                                       21
<PAGE>
unable to provide service on selected lines. The procedures to resolve
interference issues between competitive carriers and incumbent carriers are
still being developed, and these procedures may not be effective. We may be
unable to successfully negotiate interference resolution procedures with
incumbent carriers. Moreover, incumbent carriers may make claims regarding
interference or unilaterally take action to resolve interference issues to the
detriment of our services. State or federal regulators could also institute
responsive actions. Interference, or claims of interference, if widespread,
would adversely affect our speed of deployment, reputation, brand image, service
quality and customer satisfaction and retention.

WE DEPEND ON THIRD PARTIES FOR FIBER OPTIC TRANSPORT FACILITIES

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

UNCERTAIN FEDERAL AND STATE TAX AND OTHER SURCHARGES ON OUR SERVICES MAY
  INCREASE OUR PAYMENT OBLIGATIONS

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

OUR INTELLECTUAL PROPERTY PROTECTION MAY BE INADEQUATE TO PROTECT OUR
  PROPRIETARY RIGHTS, AND WE MAY BE SUBJECT TO INFRINGEMENT CLAIMS

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

RISKS ASSOCIATED WITH POTENTIAL GENERAL ECONOMIC DOWNTURN

    In the last few years the general health of the economy, particularly the
economy of California where we have conducted a significant portion of our
operations to date, has been relatively strong and growing, a

                                       22
<PAGE>
consequence of which has been increasing capital spending by individuals and
growing companies to keep pace with rapid technological advances. To the extent
the general economic health of the United States or of California declines from
recent historically high levels, or to the extent individuals or companies fear
a decline is imminent, these individuals and companies may reduce expenditures
such as those for our services. Any decline or concern about an imminent decline
could delay decisions among certain of our customers to roll out our services or
could delay decisions by prospective customers to make initial evaluations of
our services. Any delays would have a material and adverse effect on our
business, prospects, operating results, and financial condition.

WE MAY BE UNABLE TO SATISFY, OR MAY BE ADVERSELY CONSTRAINED BY, THE COVENANTS
  IN OUR EXISTING DEBT SECURITIES

    The indentures governing our 1998 senior discount notes and 1999 senior
notes impose significant restrictions on how we can conduct our business. For
example, the restrictions prohibit or limit our ability to incur additional
debt, make dividend payments and engage in certain business activities. The
restrictions may materially and adversely affect our ability to finance future
operations or capital needs or conduct additional business activities. Any
future senior debt that we may incur will likely impose additional restrictions
on us. If we fail to comply with any existing or future restrictions, we could
default under the terms of the applicable debt and be unable to meet our debt
obligations. If we default, the holders of the applicable debt could demand that
we repay the debt, including interest, immediately. We may be unable to make the
required payments or raise sufficient funds from alternative sources to make the
payments. Even if additional financing is available in the event that we
default, it may not be on acceptable terms.

OUR PRINCIPAL STOCKHOLDERS AND MANAGEMENT OWN A SIGNIFICANT PERCENTAGE OF OUR
  COMPANY AND WILL BE ABLE TO EXERCISE SIGNIFICANT INFLUENCE OVER OUR COMPANY

    Our executive officers and directors and principal stockholders together
beneficially own 75.4% of the total voting power of our company. Accordingly,
these stockholders are able to determine the composition of our Board of
Directors, will retain the voting power to approve all matters requiring
stockholder approval and will continue to have significant influence over our
affairs. This concentration of ownership could have the effect of delaying or
preventing a change in our control or otherwise discouraging a potential
acquirer from attempting to obtain control of us, which in turn could have a
material and adverse effect on the market price of the common stock or prevent
our stockholders from realizing a premium over the market prices for their
shares of common stock.

OUR FAILURE AND THE FAILURE OF THIRD PARTIES TO BE YEAR 2000 COMPLIANT COULD
  NEGATIVELY IMPACT OUR BUSINESS

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

    Our Year 2000 plan applies to two areas: internal business systems and
compliance by external customers and providers. We have completed our Year 2000
compliance testing for all of our internal systems and believe that they are
Year 2000 compliant. Because we are a young company, we believe we have been
able to build our business systems with the Year 2000 issue in mind. Therefore,
there have been few Year 2000 changes required to our existing systems and
applications. We have substantially completed a compliance check of our external
customers and providers, except for the incumbent carriers. Based on responses
from these third parties, other than the incumbent carriers, we have no
information or data to suggest that they will experience Year 2000 problems that
would materially and adversely affect our business. We have not been able to
conduct a compliance check of incumbent carriers nor assess the incumbent
carriers' Year 2000 compliance. To the extent that one or more incumbent
carriers or other third parties experience Year 2000 problems, our network and
services could be adversely affected. Furthermore, the purchasing patterns of
our customers may be affected by Year 2000 issues as companies

                                       23
<PAGE>
expend significant resources to correct their current systems for Year 2000
compliance. These expenditures may result in reduced funds available for our
services. Any of these developments could have a material and adverse effect on
our business, prospects, operating results, and financial condition. We have not
fully determined the risks associated with the reasonably worst-case scenario
and have not formulated a contingency plan to address Year 2000 issues. We do
not expect to have a specific contingency plan in place in the future.

    IF WE ARE REQUIRED TO REGISTER AS AN INVESTMENT COMPANY, WE WOULD BECOME
SUBJECT TO SUBSTANTIAL REGULATION WHICH WOULD INTERFERE WITH OUR ABILITY TO
CONDUCT OUR BUSINESS ACCORDING TO OUR BUSINESS PLAN

    As a result of our previous financings, we have substantial cash, cash
equivalents and short-term investments. We plan to continue investing the excess
proceeds of these financings in short-term instruments consistent with prudent
cash management and not primarily for the purpose of achieving investment
returns. Investment in securities primarily for the purpose of achieving
investment returns could result in our being treated as an "investment company"
under the Investment Company Act of 1940. The Investment Company Act requires
the registration of companies that are primarily in the business of investing,
reinvesting or trading securities or that fail to meet certain statistical tests
regarding their composition of assets and sources of income even though they
consider themselves not to be primarily engaged in investing, reinvesting or
trading securities.

    We believe that we are primarily engaged in a business other than investing
in or trading securities and, therefore, are not an investment company within
the meaning of the Investment Company Act. If the Investment Company Act
required us to register as an investment company, we would become subject to
substantial regulation with respect to our capital structure, management,
operations, transactions with affiliated persons and other matters. Application
of the provisions of the Investment Company Act to us would materially and
adversely affect our business, prospects, operating results, and financial
condition.

WE EXPECT OUR STOCK PRICE TO BE VOLATILE

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

    - our historical and anticipated quarterly and annual operating results;

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

    - the addition or loss of business or service provider customers;

    - variations between our actual results and analyst and investor
      expectations;

    - investor perceptions of our company and comparable public companies;

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

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

    - additions or departures of key personnel;

    - future equity or debt offerings or our announcements of such offerings;
      and

    - general market and economic conditions.

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

                                       24
<PAGE>
WE HAVE NOT PAID AND DO NOT INTEND TO PAY DIVIDENDS

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

ANTI-TAKEOVER PROVISIONS COULD NEGATIVELY IMPACT OUR STOCKHOLDERS

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

    - authorizing the issuance of "blank check" preferred stock;

    - providing for a classified Board of Directors with staggered, three-year
      terms;

    - eliminating the ability of stockholders to call a special meeting of
      stockholders;

    - limiting the removal of directors by the stockholders to removal for
      cause; and

    - requiring a super-majority stockholder vote to effect certain amendments.

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

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

THE PRICE OF OUR COMMON STOCK MAY DECLINE DUE TO SHARES ELIGIBLE FOR FUTURE SALE

    Sales of substantial amounts of our common stock in the public market, or
the appearance that a large number of shares is available for sale, could
adversely affect the market price for the common stock. The number of shares of
common stock available for sale in the public market was previously limited by
lock-up agreements that were entered into in connection with our initial public
offering in April 1999 and our secondary offering in August 1999. Under such
lock-up agreements in connection with our initial public offering, the holders
of approximately 78.4% of our outstanding shares of common stock agreed not to
sell or otherwise dispose of any of their shares until October 4, 1999. Under
the lock-up agreements in connection with our secondary public offering, the
holders of approximately 76.1% of our outstanding shares of common stock agreed
not to sell or otherwise dispose of any of their shares until November 9, 1999.

    In addition to the adverse effect a price decline could have on holders of
common stock, that decline would likely impede our ability to raise capital
through the issuance of additional shares of common stock or other equity
securities.

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<PAGE>
                          RHYTHMS NETCONNECTIONS INC.
                                    PART II
                               OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

    There were no material changes in our legal proceedings during the quarter
ended September 30, 1999.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

    (a) None.

    (b) None.

    (c) During the quarter ended September 30, 1999, we issued the following
       unregistered securities:

       (1) In July 1999, we issued a warrant to GATX Capital Corporation to
           purchase up to 10,000 shares of the Registrant's common stock at an
           exercise price of $50.00 per share in connection with an equipment
           lease financing. This warrant is exercisable immediately and expires
           on July 30, 2004.

    (d) On April 12, 1999, we completed the sale of 10,781,250 shares of common
stock priced at $21.00 per share for an aggregate offering price of
$226.4 million in an initial public offering led by an underwriting group
consisting of Merrill Lynch & Co., Salomon Smith Barney, Hambrecht & Quist, and
Thomas Weisel Partners LLC. The proceeds of the offering to us, net of
underwriting fees and estimated offering expenses were approximately
$210.1 million. The Registration Statement on Form S-1 filed by us with the SEC
in connection with the offering (File No. 333-72409), as amended, was declared
effective by the Commission on April 6, 1999.

    Since the completion of the offering, the net offering proceeds have been
applied to the following uses in the following approximate amounts:

    - $90.0 million to fund payments of collocation fees and purchases of
      equipment and furniture in our continuing development of network services
      in our existing markets and our planned rollout into additional markets;

    - $60.0 million for operating activities including salaries, consulting and
      legal expenses, network operations and overhead expenses; and

    - the remainder of the proceeds are invested in short-term securities to be
      used for future working capital and network build-out needs.

    All of the payments indicated above were direct or indirect payments to
entities or persons other than our directors, officers or their associates,
greater than 10% owners of any of our equity securities or our affiliates.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

    No defaults upon senior securities occurred during the quarter ended
September 30, 1999.

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

    No matters were submitted to a vote of security holders during the quarter
ended September 30, 1999.

ITEM 5. OTHER INFORMATION

    Not applicable.

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<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

    (a) Exhibits:

       27.1 Financial Data Schedule

       10.1 Master Lease Agreement, dated July 30, 1999, by and between the
           Registrant and GATX Capital Corporation

    (b) Reports on Form 8-K:

        There have been no reports on Form 8-K filed during the quarter ended
    September 30, 1999.

                                       27
<PAGE>
                          RHYTHMS NETCONNECTIONS INC.
                                   SIGNATURE

    Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

/s/ SCOTT C. CHANDLER
--------------------------------------------
Scott C. Chandler
CHIEF FINANCIAL OFFICER AND EXECUTIVE VICE PRESIDENT

November 15, 1999

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