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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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(Mark One)

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



For the quarterly period ended September 30, 2004



OR



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



For the transition period from  to
 .



Commission file number 000-24661



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FiberNet Telecom Group, Inc.

(Exact Name of Registrant as Specified in its Charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 52-2255974                          
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)



570 Lexington
Avenue, New York, NY 10022

(Address of Principal Executive Offices)

(212) 405-6200

(Issuers Telephone Number, Including Area Code)



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



The number of shares outstanding of the registrants common stock, as of November 1, 2004, was 51,000,172 shares of
Common Stock, $.001 par value.



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



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INDEX



|         |  |                                                                                                                     |  |     
|-------- |  | ------------------------------------------------------------------------------------------------------------------- |  | ----
|         |  |                                                                                                                     |  | Page
|PART I.  |  | FINANCIAL INFORMATION                                                                                               |  |     
|Item 1.  |  | Condensed Consolidated Financial Statements (unaudited)                                                             |  |     
|         |  | Condensed Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003                                |  | 17  
|         |  | Condensed Consolidated Statements of Operations for the nine months ended September 30, 2004 and 2003 (as restated) |  | 18  
|         |  | Condensed Consolidated Statements of Operations for the three months ended September 30, 2004 and 2003              |  | 19  
|         |  | Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003               |  | 20  
|         |  | Notes to Condensed Consolidated Financial Statements                                                                |  | 21  
|Item 2.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                               |  | 3   
|Item 3.  |  | Quantitative and Qualitative Disclosures About Market Risk                                                          |  | 13  
|Item 4.  |  | Controls and Procedures                                                                                             |  | 14  
|PART II. |  | OTHER INFORMATION                                                                                                   |  |     
|Item 1.  |  | Legal Proceedings                                                                                                   |  | 15  
|Item 2.  |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                         |  | 15  
|Item 3.  |  | Defaults Upon Senior Securities                                                                                     |  | 15  
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                                 |  | 15  
|Item 5.  |  | Other Information                                                                                                   |  | 15  
|Item 6.  |  | Exhibits                                                                                                            |  | 15  



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PART I



FINANCIAL INFORMATION



Item 1.Condensed consolidated financial statements



See attached.



Item 2.Managements Discussion and Analysis of Financial Condition and Results of Operations



This report contains certain forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. Such statements are based on
managements current expectations and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Investors are cautioned that there can be no
assurance that actual results or business conditions will not differ materially from those projected or suggested in such forward-looking statements as a result of various factors, including, but not limited to, those described in our Annual Report
on Form 10-K/A for the fiscal year ended December 31, 2003. As a result, our future operations involve a high degree of risk. Except as required by law, we undertake no obligation to update any forward-looking statement, whether as a result of new
information, future events or otherwise.



Our operations and ability to grow
may be affected by numerous factors, including: the difficulty inherent in operating an early-stage company in a new and rapidly evolving market; our history of operating losses and cash flow deficits; our limited financial resources and uncertainty
as to the availability of additional capital, if necessary, to fund our operations on acceptable terms, if at all; our success in maintaining carrier hotel lease agreements and license agreements with building owners and in obtaining additional
agreements; the financial difficulties and instability that our customers and vendors are experiencing; the lack of growth in demand for our services or the failure to manage the growth of our operations; the frequency of service interruptions on
our networks and the scalability and reliability of our networks; the potential occurrence of a natural disaster or act of terrorism that could impact our networks; the potential loss of key personnel, information support systems or key software
licenses; the potential for litigation from stockholders, customers, vendors or other third parties; continued pricing pressure and price competition for our services; the potential development by competitors of competing products and technologies;
restrictions imposed on us as a result of our debt; and changes in the regulatory environment. Our failure to achieve certain operational results would violate certain debt covenants thereby potentially accelerating the outstanding balance under our
credit facility for immediate payment.



Restatement



As discussed in Note 6 to the condensed consolidated financial statements,
the Companys condensed consolidated financial statements for the nine months ended September 30, 2003 have been restated. The effects of the restatement are reflected in the accompanying Managements Discussion and Analysis of Financial
Condition and Results of Operations.



Overview



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



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



Factors Affecting Future Operations



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



| |  | On-net transport services. Our transport services include the offering of broadband circuits on our metropolitan transport networks and FiberNet in-building networks
(FINs). Over our metropolitan transport networks, we can provision circuits from one of our carrier point facilities to another carrier point facility or to an on-net building via an interconnection with our FIN in that building. We can
also provision circuits vertically between floors in a carrier point facility or an on-net building.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  | Off-net transport services. In 2003, we initiated a new type of transport service offering to provide our customers with circuits on networks that we do not own. We sell this
connectivity to our customers by purchasing the underlying circuits from other wholesale telecommunications carriers.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



All of our revenues are generated in the United States under contracts with our customers. During 2003 and into 2004, we continued to experience a trend of entering into shorter-term contracts with our customers.
Previously, our customers typically entered into contracts with terms of three to five years. Increasingly, our customers are electing to purchase services for a contracted period of one year or only on a month-to-month basis.



Our services are typically sold under fixed price agreements. In the case of
transport services, we provide an optical circuit or other means of connectivity for a fixed price. Revenues from transport services are not dependent on customer usage or the distance between the origination point and termination point of a
circuit. The pricing of colocation services is based upon the size of the colocation space or the number of colocation units, such as cabinets, provided to the customer. Revenues from access management services are typically determined by the square
footage of the commercial office properties to which a customer purchases access. The pricing of all of our services has declined significantly over the past year, with transport services experiencing the greatest decreases. We expect our operating
results to continue to be negatively impacted by decreases in the prices of our services.



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



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



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



Currently our colocation and access services produce less than one-third of our revenues. In the future, we expect this amount to decrease as we generate
significantly more of our revenues from transport services than from our other services. The scalability of our network architecture allows us to increase transport capacity to a greater degree than is possible with our colocation and access
services.



Our transport services have been negatively impacted
by customers disconnecting higher-bandwidth circuits that they are purchasing from us and replacing them with lower-bandwidth circuits to more efficiently manage the access costs of their networks.



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The new transport services that we are providing are typically for lower-bandwidth circuits, as our customers expand
their network connections on a more limited basis. The growth in transport revenues that we experienced on a quarterly basis throughout 2003 and continuing through the third quarter of 2004 was a result of an increase in the number of circuits we
provisioned, offsetting circuit disconnections and price declines.



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



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



Cost of Services. Cost of services is associated with the operation of
our networks and facilities. The largest component of our cost of services is the occupancy expenses at our carrier point facilities, on-net buildings and off-net buildings. These occupancy expenses primarily represent rent expense under direct
leases with landlords. They also include charges for colocation space in other carriers facilities and cross connection fees to interconnect our networks with other carriers networks. Other specific cost of services include maintenance
and repair costs, utility costs and license fees. Our license agreements for our on-net and off-net buildings require us to pay license fees to the owners of these properties. In addition, our leases at 60 Hudson Street in New York City also require
us to pay license fees. The license fees typically are calculated as a percentage of the revenues that we generate in each particular building. Our cost of services also includes the charges that we incur by purchasing connectivity from other
wholesale telecommunications carriers to provide our customers with off-net transport services that are not on our networks. As we provide additional off-net transport services we will purchase more connectivity from other carriers. Other than our
license fees and off-net connectivity charges, our cost of services is generally fixed in nature. We do not anticipate that cost of services will change commensurately with any change in our revenues.



Selling, General and Administrative Expenses. Selling, general and
administrative expenses generally include all of our personnel costs, occupancy costs for our corporate offices, insurance costs, professional fees, sales and marketing expenses and other miscellaneous expenses. Personnel costs, including wages,
benefits and sales commissions, are our largest component of selling, general and administrative expenses. All of our personnel costs are included in selling, general and administrative expenses. We do not allocate any personnel cost relating to
networks operations or sales activities to cost of services. We have increased the number of our employees from 66 at the beginning of 2004 to 75 as of September 30, 2004. Prospectively, we do not anticipate significant changes in headcount, and we
believe that our personnel costs will increase moderately. Professional fees, including legal and accounting expenses, typically represent the second largest component of our selling, general and administrative expenses. These fees, which primarily
are attributed to our required activities as a publicly traded company, such as SEC filings and financial statement audits, could increase prospectively due to the enhanced regulations regarding corporate governance and other compliance matters.
Other costs included in selling, general and administrative expenses, such as insurance costs, may increase due to changes in the economic environment and telecommunications industry.



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



Depreciation and Amortization. Depreciation and amortization expense
includes the depreciation of our network equipment and infrastructure, computer hardware and software, furniture and fixtures, and leasehold improvements, as well as the amortization of certain deferred charges. We commence the depreciation of
network-related fixed assets when they are placed into service and depreciate those assets over periods ranging from three to 20 years.



Critical Accounting Policies



Our significant accounting policies are described in Note 2 to the condensed consolidated financial statements included in Item 1 of this Form 10-Q. Our
discussion and analysis of financial condition and results from operations are based upon our condensed



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



Revenue Recognition



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



We have one reciprocal agreement, whereby we purchase services from one of our customers under a single agreement. The services provided and obtained
through this agreement were priced at fair value as of the date of the agreement. We recognized the transport revenues from this agreement in accordance with our stated revenue recognition policy, and we concurrently recorded the expenses for
colocation services as cost of services in our statements of operations. None of the expenses associated with our reciprocal agreement are capitalized. All of the costs are expensed as incurred. For the nine months ended September 30, 2004
reciprocal agreements accounted for $0.4 million, or 1.4%, of revenues and $0.4 million of our cost of services. For the nine months ended September 30, 2003, reciprocal agreements accounted for $0.4 million, or 1.8%, of revenue and $0.4 million of
our cost of services.



For the quarter ended September 30,
2004, our reciprocal agreement accounted for $0.1 million, or 1.5%, of revenues and $0.1 million of our cost of services. For the quarter ended September 30, 2003, our reciprocal agreement accounted for $0.1 million, or 1.8%, of revenues and $0.1
million of our cost of services.



Allowance for Doubtful Accounts



We continuously monitor collections and payments from our
customers and maintain allowances for doubtful accounts based upon our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been within our expectations, there can be
no assurance that we will continue to experience the same level of credit losses that we have in the past. A significant number of our customers have filed for bankruptcy or are otherwise in significant financial distress. A significant change in
the liquidity or financial position of any one of these customers or a further deterioration in the economic environment or telecommunications industry, in general, could have a material adverse impact on the collectability of our accounts
receivable and our future operating results, including a reduction in future revenues and additional allowances for doubtful accounts.



Impairment of Long-Lived Assets



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



In the second quarter of 2004, we settled a dispute with a dark fiber
provider that had filed for bankruptcy, which resulted in the impairment of previously purchased dark fiber miles. We agreed to concede our claim to 364 unutilized dark fiber miles, or 36.4% of the total dark fiber acquired from this provider in
December 1999 for $34.8 million. We also agreed to pay $750,000 to settle a trade payable dispute with this provider, for which we had accrued $1.1 million as a liability. As a result, we recorded an impairment of $9.5 million due to the write-off
of $12.7 million of dark fiber included in network infrastructure, $2.8 million of related accumulated depreciation and a $0.4 million reduction in accrued liabilities from this settlement for charges for network infrastructure that were previously
capitalized and impaired.



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In the quarter ended September 30, 2004, we did not renew two of our off-net property leases. As a
result, we abandoned the assets associated with these two properties. As a result, we recorded an impairment of $0.1 million due to the write-off of $0.2 million of network infrastructure and $0.1 million of related accumulated depreciation.



Impairment of Goodwill



In June 2001, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets (SFAS No. 142), which requires that goodwill and certain intangible assets resulting from business
combinations entered into prior to June 30, 2001 no longer be amortized, but instead be reviewed for recoverability. Any write-down of goodwill would be charged as a cumulative change in accounting principle upon adoption of the new accounting
standard if the recorded value of goodwill and certain intangibles exceed their fair value. During the fourth quarter of 2003, we performed our annual impairment test and determined that we had an impairment of goodwill. Accordingly, we recorded a
charge of $7.5 million to eliminate our remaining goodwill.



On
January 30, 2004, we completed the acquisition of the operating assets of gateway.realty.new_jersey.llc, also known as Gateway Colocation, and we recorded $2.3 million in goodwill as a result of this transaction. In June 2004, our settlement
agreement with a dark fiber provider required us to record an impairment to property, plant and equipment. Per SFAS No. 144, Impairment and Disposal of Long Lived Assets, this asset impairment required us to perform a test for impairment
of goodwill under SFAS No. 142. As such, we performed our test for recoverability of goodwill from the acquisition of Gateway Colocation, and determined that $2.3 million of goodwill was impaired. We recorded a charge to eliminate all of our
goodwill.



Recognition of Deferred Tax Assets and Liabilities



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



Results of Operations



Nine Months Ended September 30, 2004 Compared to Nine Months Ended September 30, 2003



Revenues.Revenues for the nine months ended September 30, 2004 were
$26.4 million compared to $19.5 million for the nine months ended September 30, 2003. We increased the number of our customers from 133 at September 30, 2003, to 152 at the end of 2003 and to 198 as of September 30, 2004, with the addition of
domestic subsidiaries of international carriers to our customer base and of customers from the acquisition of Gateway Colocation, which closed on January 30, 2004. We believe that there are greater opportunities to serve domestic subsidiaries of
foreign telecommunications companies in our gateway markets, as domestic carriers consolidate and rationalize.



During the nine months ended September 30, 2004, we recognized $2.7 million in revenues due to an award from an arbitration proceeding, in which we were
the prevailing claimant. Revenues recognized in connection with this award accounted for 10.3% of revenue for the nine month period. Upon confirmation of the award, we recognized this amount as revenue during the nine months ended September 30, 2004
for services previously provided and earned. The payment of the award of approximately $2.7 million in cash was received on April 9, 2004. Of the total award payment, $2.4 million related to payment for services previously provided and earned, and
we recognized this amount as revenues in the quarter ended March 31, 2004. The remaining $0.3 million was for the reimbursement of expenses incurred in connection with the proceeding. We have recorded this reimbursement as a reversal of previously
accrued expenses included in selling, general and administrative expenses in 2003. Also in connection with this arbitration award, we recognized an additional $0.3 million in revenues that were previously deferred. We did not recognize revenues
related to this arbitration proceeding or the disputed contract in prior periods as the collectability of amounts due under the contract was in doubt.



Revenues were generated by providing transport, colocation and communications access management services to our customers. We recognized $14.7 million in
on-net transport service revenues for the nine months ended September 30, 2004, up from $12.9 million for the nine months ended September 30, 2003. Off-net transport service revenues for the nine months ended September 30, 2004 were $2.5 million, up
from $0.2 million for the nine months ended September 30, 2003. Revenues from colocation and other services were $4.7 million for the nine months ended September 30, 2004 up from $4.4 million for the nine months ended September 30, 2003, and
revenues from communications access management services declined to $1.8 million for the nine months ended September 30, 2004 from $2.0 million for the nine months ended September 30, 2003.



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The vast majority of our transport and colocation services are provided within and between our carrier
point facilities in the New York City market. Transport revenues increased as we provided a greater number of lower-bandwidth circuits to our customers, offsetting the disconnections and price decreases that we have been experiencing. We benefited
from growth in transport services from our existing customer base, as well as through the addition of new customers. Prospectively, we expect that the current trends in our transport services will continue. Colocation revenues were generated as we
leased additional caged space, cabinets and racks in our facilities. Since we are approaching capacity at some of our colocation facilities, we may have to invest in expanding these facilities to offer additional space to our customers. We are now
expanding our Meet-Me-Room facility at 60 Hudson Street in New York City, and we expect that this project will be substantially completed by the end of 2004. We expect transport services to grow at a faster rate than colocation. Our network
infrastructure has significant capacity to provide additional broadband transport connectivity, and our colocation facilities are approaching more stabilized utilization rates. The decrease in access revenues was due to the severe decline in the
market for building-centric services and the resulting bankruptcies of many building-centric service providers, many of which were our customers. We do not expect to sell any additional access services, and we believe our existing contracts for
access services will not be renewed when they expire.



For the
nine months ended September 30, 2004 and 2003, there were no individual customers that accounted for over 10.0% of our revenues, excluding revenues recognized in connection with the arbitration award. Our reciprocal agreement accounted for $0.4
million, or 1.4%, of revenues for the nine months ended September 30, 2004, compared to $0.4 million, or 1.8%, of revenues for the nine months ended September 30, 2003.



Cost of Services.Cost of services, associated with the operation of our networks and facilities, were $10.0 million
for the nine months ended September 30, 2004, compared to $6.2 million for the nine months ended September 30, 2003. The majority of our cost of services is occupancy expense, consisting of rent and utility costs, for our carrier hotel facilities,
on-net buildings and off-net buildings. Other cost of services include license fees, maintenance and repair costs and off-net connectivity charges.



Occupancy expenses represented 63.0% of cost of services, or $6.3 million, for the nine months ended September 30, 2004, compared to 77.0%, or $4.8
million, for the nine months ended September 30, 2003. This increase was primarily related to the costs of the carrier point facility operated by Gateway Colocation that we acquired in the first quarter of 2004. License fees, which were 16.1% of
cost of services, or $1.6 million for the nine months ended September 30, 2004, compared to 15.2%, or $0.9 million for the nine months ended September 30, 2003, increased due to increased revenues generated from facilities that have revenue sharing
license agreements. On September 1, 2004, we amended our lease agreements for our facilities at 60 Hudson Street in New York City. The amendments include a reduction in the license fee to 12.0% of revenues, and an increase in the total annual rent
amount from $2.1 million to $3.3 million. We expect the effect of these amendments will be a reduction in future rent expense at these facilities, as the reduction in the license fee percentage should more than offset the increase in base rent from
such amendments. License fees are typically calculated as a percentage of the revenues that we generate in the respective facility, per our lease agreement with the facility, and are expensed as cost of services.



Maintenance and repair costs were 2.9% of cost of services for the nine
months ended September 30, 2004, compared to 5.4% for the nine months ended September 30, 2003, and will continue to represent a relatively small and fixed component of cost of services. Off-net connectivity charges were 17.8% of cost of services
for the nine months ended September 30, 2004, compared to 2.0% for the nine months ended September 30, 2003. Going forward, these charges will increase commensurately with our growth in off-net transport services.



Our reciprocal agreement accounted for $0.4 million of our cost of services
for the nine months ended September 30, 2004 compared to $0.4 million of our cost of services for the nine months ended September 30, 2003.



Selling, General and Administrative Expenses.Selling, general and administrative expenses for the nine months ended September 30, 2004 were $11.7
million compared to $11.2 million for the nine months ended September 30, 2003. Personnel costs represented 66.1% of selling, general and administrative expenses for the nine months ended September 30, 2004 compared to 65.1% for the nine months
ended September 30, 2003. Professional fees for the nine months ended September 30, 2004, decreased by $0.3 million from the same period in 2003 due primarily to the reimbursement of legal costs in connection with our arbitration proceeding. We
recorded this reimbursement as a reversal of previously recorded expenses included in selling, general and administrative matters in 2003. We also recorded a one-time termination charge in June 2004 of $0.4 million related to the cancellation of a
lease for unutilized space at a carrier hotel facility. We anticipate selling, general and administrative expenses to increase modestly throughout 2004 with the general growth of our business.



Stock Related Expense.Stock related expense for the nine months ended
September 30, 2004 was $0.4 million. This non-cash expense relates to the amortization of deferred compensation recorded on restricted stock granted to our employees. Stock related expense recorded for the nine months ended September 30, 2003 was
$0.1 million. The restricted shares that have been granted vest on the tenth anniversary of the grant date, and the related expenses are amortized on a straight-line basis over the ten-year period.



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Impairment of Property, Plant and Equipment.During the nine months ended September 30, 2004, we
settled a dispute with a dark fiber provider that had filed for bankruptcy, which resulted in the impairment of previously purchased dark fiber miles. We agreed to concede our claim to 364 unutilized dark fiber miles, or 36.4% of the total dark
fiber acquired from this provider in December 1999 for $34.8 million. We also agreed to pay $750,000 to settle a trade payable dispute with this provider, for which we had accrued $1.1 million as a liability. As a result, we recorded an impairment
of $9.5 million due to the write-off of $12.7 million of dark fiber included in network infrastructure, $2.8 million of related accumulated depreciation and a $0.4 million reduction in accrued liabilities from this settlement for charges for network
infrastructure that were previously capitalized and impaired.



During the nine months ended September 30, 2004, we did not renew two of our off-net property leases. As a result, we abandoned the assets associated with these two properties. As a result, we recorded an impairment of $0.1 million due to
the write-off of $0.2 million of network infrastructure and $0.1 million of related accumulated depreciation. We did not record an impairment of property, plant and equipment during the nine months ended September 30, 2003.



Impairment of Goodwill.In June 2004, our settlement agreement with a
dark fiber provider required us to record an impairment to property, plant and equipment. Per SFAS No. 144, Impairment and Disposal of Long Lived Assets, this asset impairment required us to perform a test for impairment of goodwill
under FASB Statement No. 142, Goodwill and Other Intangible Assets. As such, we performed our test for the recoverability of goodwill from the acquisition of Gateway Colocation, and determined that goodwill was impaired and recorded a
$2.3 million impairment for the nine months ended September 30, 2004. We did not record an impairment of goodwill during the nine months ended September 30, 2003.



Depreciation and Amortization.Depreciation and amortization expense for the nine months ended September 30, 2004 and
2003 was $6.8 million and $6.6 million, respectively. The effects of prior period impairments were offset by the additional depreciation on newly acquired property, plant and equipment.



Loss on early extinguishment of debt, net.The net loss on early extinguishment of debt of $9.0 million for the
period ended September 30, 2003, was the result of both the termination of our capital lease obligations and a partial extinguishment of our credit facility. We recorded a non-cash charge of $9.7 million related to the partial extinguishment of our
credit facility on January 10, 2003. We recorded a loss for the fair value given in excess of the amount of debt extinguished and related pro-rata write-off of original issue discount and deferred financing charges. The fair value given in exchange
for $13.4 million of indebtedness was 4.6 million shares of common stock, the issuance of 2.2 million warrants with an exercise price of $3.60 per share and a term of five years and the re-pricing of the exercise price of 3.0 million existing
warrants from $3.60 to $0.03 per share. Also included in this loss is $1.0 million in fees associated with the consummation of the recapitalization. As this extinguishment of debt represented approximately 38.1% of our outstanding balance, we wrote
off the same percentage of deferred financing charges and original issue discount of $0.9 million and $1.8 million, respectively, which is also included in our calculation of loss on early extinguishment of debt. On March 17, 2003, we entered into
an agreement to terminate all of our remaining capital lease obligations for a payment of $85,000. This termination of our capital lease obligations resulted in a gain on early extinguishments of debt of approximately $0.8 million, partially
offsetting our earlier loss. We did not have any early extinguishment of debt for the nine months ended September 30, 2004.



Interest Income. Interest income for the nine months ended September 30, 2004 was approximately $37,000 compared to approximately $37,000 for the
nine months ended September 30, 2003. Interest income is generated on our cash and restricted cash balances which are at variable rates of interest and are invested in short-term, highly liquid investments.



Interest Expense. Interest expense for the nine months ended September
30, 2004 was $1.5 million, compared to $1.7 million for the nine months ended September 30, 2003. Interest expense decreased primarily due to the repayment of $7.2 million of principal on our outstanding debt during the nine months ended September
30, 2004. All of our indebtedness bears interest at a floating rate, so we are subject to fluctuations in interest rates. We anticipate that interest expense will remain consistent with prior periods, as higher interest rates will be off-set by our
rate reduction from LIBOR +450 basis points to LIBOR +300 basis points on May 18, 2004.



Net Loss.We reported a net loss of $15.9 million for the nine months ended September 30, 2004 compared to a net loss of $15.3 million for the nine months ended September 30, 2003. This change is a result of
the aforementioned changes in our operations.



Three Months Ended
September 30, 2004 Compared to Three Months Ended September 30, 2003



Revenues.Revenues for the quarter ended September 30, 2004 were $8.1 million as compared to $6.7 million for the quarter ended September 30, 2003. We increased the number of our customers from 133 at September
30, 2003, to 152 at the end of 2003 and to 198 as of September 30, 2004, with the addition of domestic subsidiaries of international carriers to our customer base and of customers from the acquisition of Gateway Colocation, which closed on January
30, 2004. We believe that there are greater opportunities to serve domestic subsidiaries of foreign telecommunications companies in our gateway markets, as domestic carriers consolidate and rationalize.



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Revenues were generated by providing transport, colocation and communications access management services
to our customers. We recognized $4.8 million in on-net transport service revenues for the quarter ended September 30, 2004, up from $4.5 million for the quarter ended September 30, 2003. Off-net transport service revenues for the quarter ended
September 30, 2004 were $1.0 million, up from $0.1 million for the quarter ended September 30, 2003. Revenues from colocation and other services were $1.7 million for the quarter ended September 30, 2004 compared to $1.5 million for the quarter
ended September 30, 2003, and revenues from communications access management services remained $0.6 million for the quarter ended September 30, 2004 and 2003.



The vast majority of our transport and colocation services are provided within and between our carrier point facilities in the New York City market.
Transport revenues increased as we provided a greater number of lower-bandwidth circuits to our customers, offsetting the disconnections and price decreases that we have been experiencing. We benefited from growth in transport services from within
our existing customer base, as well as through the addition of new customers. Prospectively, we expect that the current trends in our transport services will continue. Colocation revenues were generated as we leased additional caged space, cabinets
and racks in our facilities. Since we are approaching capacity at some of our colocation facilities, we may have to invest in expanding these facilities to offer additional space to our customers. We are now expanding our Meet-Me-Room facility at 60
Hudson Street in New York City, and we expect that this project will be substantially completed by the end of 2004. We expect transport services to grow at a faster rate than colocation. Our network infrastructure has significant capacity to provide
additional broadband transport connectivity, and our colocation facilities are approaching more stabilized utilization rates. The decrease in access revenues was due to the severe decline in the market for building-centric services and the resulting
bankruptcies of many building-centric service providers, many of which were our customers. We do not expect to sell any additional access services, and we believe our existing contracts for access services will not be renewed when they expire.



For the quarters ended September 30, 2004 and 2003, there were
no individual customers that accounted for over 10.0% of our revenues. Our reciprocal agreement accounted for $0.1 million, or 1.5%, of revenues for the quarter ended September 30, 2004, compared to $0.1 million, or 1.8%, of revenues for the quarter
ended September 30, 2003.



Cost of Services.Cost of
services, associated with the operation of our networks and facilities, was $3.7 million for the quarter ended September 30, 2004, compared to $2.2 million for the quarter ended September 30, 2003. The majority of our cost of services is occupancy
expense, consisting of rent and utility costs, for our carrier hotel facilities, on-net buildings and off-net buildings. Other cost of services includes license fees, maintenance and repair costs and off-net connectivity charges.



Occupancy expenses represented 62.3% of cost of services, or $2.3 million,
for the quarter ended September 30, 2004 compared to 76.0%, or $1.6 million, for the quarter ended September 30, 2003. This increase was primarily related to the costs of the carrier point facility operated by Gateway Colocation that we acquired in
the first quarter of 2004. License fees, which were 13.3% of cost of services, or $0.5 million for the quarter ended September 30, 2004 compared to 17.7%, or $0.4 million for the quarter ended September 30, 2003, increased due to increased revenues
generated from facilities that have revenue sharing license agreements. On September 1, 2004, we amended our lease agreements for our facilities at 60 Hudson Street in New York City. The amendments include a reduction in the license fee to 12.0% of
revenues, and an increase in the total annual rent amount from $2.1 million to $3.3 million. We expect the effect of these amendments will be a reduction in future rent expense at these facilities as the reduction in the license fee percentage
should more than offset the increase in base rent from such amendments. License fees are typically calculated as a percentage of the revenues that we generate in the respective facility, per our lease agreement with the facility, and are expensed as
cost of services.



Maintenance and repair costs were 4.1% of
cost of services for the quarter ended September 30, 2004, compared to 2.1% for the quarter ended September 30, 2003, and will continue to represent a relatively small and fixed component of cost of services. Off-net connectivity charges also were
20.1% of cost of services for the quarter ended September 30, 2004, compared to 3.9% for the quarter ended September 30, 2003. Going forward, these charges will increase commensurately with our growth in off-net transport services.



Our reciprocal agreement accounted for $0.1 million of our cost of services
for the quarter ended September 30, 2004 compared to $0.1 million for the quarter ended September 30, 2003.



Selling, General and Administrative Expenses.Selling, general and administrative expenses for the quarter ended September 30, 2004 were $3.9
million compared to $3.8 million for the quarter ended September 30, 2003. Personnel costs represented 65.8% of selling, general and administrative expenses for the quarter ended September 30, 2004 compared to 62.1% for the quarter ended September
30, 2003. We anticipate selling, general and administrative expenses to increase modestly throughout 2004 with the general growth of our business.



Stock Related Expense. Stock related expense for the quarter ended September 30, 2004 was $0.1 million. This non-cash expense relates to the
amortization of deferred compensation recorded on restricted stock granted to our employees. Stock related expense recorded for the quarter ended September 30, 2003 was $0.1 million The restricted shares that have been granted vest on the tenth
anniversary of the grant date, and the related expenses are amortized on a straight-line basis over the ten-year period.



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Impairment of Property, Plant and Equipment.During the three months ended September 30, 2004, we
did not renew two of our off-net property leases. As a result, we abandoned the assets associated with these two properties. We recorded an impairment of $0.1 million due to the write-off of $0.2 million of network infrastructure and $0.1 million of
related accumulated depreciation. We did not record an impairment of property, plant and equipment during the three months ended September 30, 2003.



Depreciation and Amortization. Depreciation and amortization expenses for the quarters ended September 30, 2004 and 2003 were $2.2 million and $2.2
million, respectively. The effects of prior period impairments were offset by the additional depreciation on newly acquired property, plant and equipment.



Interest Income. Interest income for the quarter ended September 30, 2004 was approximately $18,000, compared to approximately $11,000 for the
quarter ended September 30, 2003. Interest income is generated on our cash and restricted cash balances which are at variable rates of interest and are invested in short-term, highly liquid investments.



Interest Expense. Interest expense for the quarter ended September 30,
2004 was $0.5 million, compared to $0.6 million for the quarter ended September 30, 2003. All of our indebtedness bears interest at a floating rate, so we are subject to fluctuations in interest rates. Interest expense decreased, as our interest
rate was decreased from LIBOR +450 basis points to LIBOR +300 basis points on May 18, 2004.



Net Loss. We reported net loss of $2.3 million for the quarter ended September 30, 2004 compared to a net loss of $2.1 million for the quarter ended September 30, 2003. This change is a result of the
aforementioned changes in our operations.



Liquidity and
Capital Resources



To date, we have financed our
operations through direct equity investments from our stockholders, the issuance of additional debt and equity securities in private transactions and by arranging a credit facility with a group of lenders. We had a loss from operations and net loss
for the nine months ended September 30, 2004 of $14.5 million and $15.9 million, respectively, compared to a loss from operations and a net loss of $4.6 million and $15.3 million, respectively, for the nine months ended September 30, 2003. During
the nine months ended September 30, 2004, cash provided by operating activities was approximately $4.3 million, and cash purchases of property, plant and equipment were $2.3 million, compared to cash used to fund operating activities of $0.5 million
and $1.8 million of cash purchases of property, plant and equipment for the nine months ended September 30, 2003.



For the nine months ended September 30, 2004 we used $42,000 in net cash for financing activities primarily for our repayment of notes payable of $7.2
million, which was offset by our private placement of equity securities in January 2004. For the nine months ended September 30, 2003 we received $2.2 million in net cash proceeds from financing activities primarily in connection with our
recapitalization transaction, which occurred in January 2003.



On January 30, 2004, we completed the acquisition of the operating assets of gateway.realty.new_jersey.llc, also known as Gateway Colocation. Gateway Colocation operated a 49,000 square foot communications hub and colocation facility
located at 165 Halsey Street in Newark, New Jersey. The transaction was structured as an acquisition of assets, and the purchase price paid at closing consisted of 2.9 million shares of our common stock with a fair value of $4.6 million on the
closing date and approximately $170,000 in cash. The purchase agreement includes an earn-out payment based upon the achievement of certain financial objectives with respect to the revenues generated by the facility. More specifically,
the earn-out payment will be based on the gross revenues, on an annualized basis, for a particular month designated by Gateway Colocation during the twenty-four month period immediately subsequent to closing. The earn-out
payment, if payable, will be paid in shares of our common stock. However, the issuance of such additional shares, in the aggregate with the shares of common stock issued on January 30, 2004, will not exceed 19.9% of the issued and outstanding shares
of our common stock as of the closing date without first receiving stockholder approval. We filed a registration statement with the Securities and Exchange Commission covering the resale of the shares issued at closing and have agreed to file a
registration statement with respect to the resale of shares issued, if any, pursuant to the terms of the earn-out provision. As of September 30, 2004, there were no additional shares required under the earn-out provision.



Subsequently, in June 2004, we performed a test for
recoverability of goodwill from the acquisition of Gateway Colocation, and determined that goodwill was impaired and recorded a $2.3 million impairment.



Also on January 30, 2004, in an unrelated transaction, we entered into a common stock purchase agreement with certain investors, pursuant to which we
issued to the investors, in a private offering, an aggregate of 6.4 million shares of common stock at a price of $1.25 per share, for gross proceeds of $8.0 million. Pursuant to the terms of the purchase agreements, we also issued to such investors
warrants to purchase an aggregate of 1.9 million shares of common stock at an exercise price of $1.75 per share with a term



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of three and one-half years. In connection with the purchase agreements, we entered into a registration rights agreement
with the investors, which required us to file a registration statement with the Securities and Exchange Commission with respect to the resale of (i) the shares of common stock issued to the investors and (ii) the shares of common stock underlying
the warrants issued to the investors. These shares were included in a registration statement that was declared effective on April 14, 2004.



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



In connection with the consummation of both the Gateway Colocation acquisition and equity financing on January 30, 2004, we entered into certain
transactions with the lenders under our credit facility. We executed an eleventh amendment to the credit agreement, pursuant to which, among other things, the lenders consented to the above-referenced transactions. The eleventh amendment also
revised the automatic reductions of the commitments underlying the credit facility that are required on a quarterly basis beginning on March 31, 2004. Expressed as a percentage of the aggregate outstanding commitments, the automatic reductions were
revised to a total of 8% in 2004, 40% in 2005, 48% in 2006 and 4% at maturity on March 31, 2007. As of September 30, 2004 we had satisfied the entire 8% of the mandatory reduction of commitments for 2004. In addition, the eleventh amendment also
incorporated adjustments to the financial covenants of the credit facility. As a condition to the lenders entering into the eleventh amendment, we agreed to reduce the exercise price of certain previously issued outstanding warrants held by the
lenders to purchase approximately 379,230 shares of common stock from $3.60 per share to $0.001 per share, which were immediately exercised by the lenders. We compared the value of the warrants prior to repricing with the value of the warrants after
the repricing using the Black-Sholes option pricing model and determined that there was no difference in value. Therefore the repricing of warrants had no impact on our condensed consolidated financial statements.



On February 12, 2004, we issued 200,000 shares of common stock and paid $0.3
million in cash to a customer in settlement of certain litigation matters. The price on the date of the issuance was $1.61 per share. This settlement was accrued for as of December 31, 2003.



On March 10, 2004, we were notified that we prevailed as the claimant in an
arbitration proceeding regarding a breach of contract. We were awarded approximately $2.7 million in cash, payment of which was received on April 9, 2004. Of the total award payment, $2.4 million related to payment for services previously provided
and earned, and we recognized this amount as revenues in the nine months ended September 30, 2004. The remaining $0.3 million was for the reimbursement of expenses incurred in connection with the proceeding. We recorded this reimbursement as a
reversal of previously accrued expenses included in selling, general and administrative expenses in 2003. Also in connection with this arbitration award, we recognized an additional $0.3 million in revenues that were previously deferred. We did not
recognize revenues related to this arbitration proceeding or the disputed contract in prior periods as the collectability of amounts due under the contract was in doubt.



On April 13, 2004, we repaid $1.6 million of outstanding revolving loan indebtedness, which is available to be redrawn in
the future subject to compliance with the terms of the credit agreement.



On September 1, 2004, the Company amended its lease agreements for our facilities at 60 Hudson Street in New York City. The amendments include a reduction in the license fee to 12.0% of revenues, and an increase in
the total annual rent amount from $2.1 million to $3.3 million. In conjunction with the amendments, the Company issued 2,549,858 warrants with an exercise price of $0.01 and a term of five years. The fair value of the warrants as of September 1,
2004 was approximately $2.0 million, using the Black-Scholes option pricing model with the following assumptions used as of September 1, 2004: risk-free interest rates of 3.32%, expected dividend yields of 0%, expected life of five years to
expiration and expected volatility of 357%. In accordance with Emerging Issues Task Force Issue (EITF) 00-18 Accounting Recognition for Certain Transactions involving Equity Instruments Granted to Other Than Employees the
fair value of the warrants was recorded as deferred rent (a contra-equity) to be amortized into cost of services over the life of the leases.



As of September 30, 2004, we had $15.1 million of indebtedness outstanding under our credit facility and $4.8 million of outstanding letters of credit. In
addition, we had $5.5 million of available borrowing capacity and $0.4 million of availability to issue letters of credit under the credit facility, subject to compliance with the terms of the credit agreement. The weighted average interest rate on
our outstanding borrowings under the facility was 4.89% at an applicable borrowing rate of LIBOR+300 basis points. We were in full compliance with all of the covenants contained in the credit agreement underlying the facility as of September 30,
2004. We must comply with financial covenants that include minimum consolidated revenue, minimum consolidated EBITDA (as defined in the credit agreement underlying the credit facility), maximum cumulative capital expenditures, a maximum consolidated
leverage ratio, a minimum consolidated interest coverage ratio and a minimum consolidated fixed charge coverage ratio. The compliance levels and



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calculation of such levels with respect to those covenants are as defined in the credit agreement underlying our credit
facility, as amended, which is on file with the Securities and Exchange Commission. Non-compliance with any of the covenants, requirements, or other terms and conditions under the credit agreement constitutes an event of default and potentially
accelerates the outstanding balance of the credit facility for immediate payment. Under our current operating plan, we do not anticipate any non-compliance with any of the covenants, requirements, or other terms and conditions under the credit
agreement.



We spent approximately $2.3 million in capital
expenditures during the nine months ended September 30, 2004, primarily for the implementation of customer orders, including the purchase of networking equipment to increase capacity and to interconnect with new customers. Our capital expenditures
totaled $1.8 million for the nine months ended September 30, 2003. We have substantially completed the deployment of our FINs, carrier hotel facilities and metropolitan transport networks. In 2004, we expect to invest $3.0 million to $4.0 million in
capital expenditures, primarily for customer order activity and expansion of the 60 Hudson Street Meet-Me-Room facility in New York City. We also intend to upgrade certain information technology systems and key operating systems at our carrier point
facilities. We may expend additional capital for the selected expansion of our network infrastructure, depending upon market conditions, customer demand and our liquidity and capital resources.



During the nine months ended September 30, 2004, holders of warrants
exercised warrants for 0.6 million shares of common stock with an exercise price ranging from $0.001 to $0.03 per share. During the nine months ended September 30, 2004, we granted options to purchase an aggregate of 13,300 shares of common stock to
employees with a weighted average exercise price of $1.42 per share. Also during the nine months ended September 30, 2004, we granted of 0.1 million shares of restricted stock to employees with a weighted average price of $1.67 per share.



As of November 1, 2004, we had approximately 51.0 million
shares of common stock outstanding, or approximately 60.6 million shares of common stock outstanding on a fully diluted basis, assuming the exercise of all outstanding options and warrants.



We believe that the completion of the transactions that constituted our prior
recapitalization in 2002 and 2003 and our recent equity financing significantly enhanced our liquidity and improved our financial position. Under our current operating plan, we do not anticipate requiring any external sources of capital to fund our
operations in the coming year. However, from time to time, we may consider private or public sales of additional equity or debt securities and other financings, depending upon market conditions, in order to provide additional working capital or
finance the continued operations of our business. However, there can be no assurance that we will be able to successfully consummate any such financing on acceptable terms, if at all. For additional disclosure and risks regarding future financings
and funding of our ongoing operations, please see Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2003 as filed
on July 9, 2004. We do not have any off-balance sheet financing arrangements, nor do we anticipate entering into any.



Recent Accounting Pronouncements



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



Item 3. Quantitative and Qualitative Disclosures About Market Risk



Our exposure to financial market risk, including changes in interest rates, relates primarily to our credit facility and marketable security investments.
Borrowings under our credit facility bear interest at floating rates, based upon LIBOR or a base rate plus an applicable margin. As a result, we are subject to fluctuations in interest rates. A 100 basis point increase in LIBOR would increase our
annual interest expense by less than $1.0 million per year. As of September 30, 2004, we had borrowed $15.1 million under our credit facility, with a current weighted average interest rate of 4.89%.



We generally place our marketable security investments in high credit quality
instruments, primarily U.S. government obligations and corporate obligations with contractual maturities of less than one year. We operate only in the United States, and all sales have been made in U.S. dollars. We do not have any material exposure
to changes in foreign currency exchange rates.



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Item 4. Controls and Procedures



Evaluation of Disclosure Controls and Procedures. Our principal executive officer and principal financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report on Form 10-Q, have concluded that, based on such evaluation, our disclosure controls and procedures were adequate and effective to ensure that material information
relating to FiberNet, including our consolidated subsidiaries, was made known to them by others within those entities, particularly during the period in which this Quarterly Report on Form 10-Q was being prepared.



Changes in Internal Controls.There were no changes in the
registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the registrants internal control
over financial reporting.



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PART II



OTHER INFORMATION



Item 1. Legal Proceedings



None.



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds



None.



Item 3. Defaults Upon Senior Securities



None.



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



None.



Item 5. Other Information



None.



Item 6. Exhibits



The following documents are
filed herewith as part of this Form 10-Q:



Exhibit 31.1  Section 302
Certification of Chief Executive Officer



Exhibit 31.2  Section 302
Certification of Chief Financial Officer



Exhibit 32  Section 906
Certification



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SIGNATURES



In accordance with 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.



Date: November 10, 2004



|                             |  |                                                       
|---------------------------- |  | ------------------------------------------------------
|FIBERNET TELECOM GROUP, INC.
|                             | 
|By:                          |  | /S/ JON A. DELUCA                                     
|Name:                        |  | Jon A. DeLuca                                         
|Title:                       |  | Senior Vice PresidentFinance Chief Financial
Officer*

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|* | The Chief Financial Officer is signing this quarterly report on Form 10-Q as both the principal financial officer and authorized officer.
|- | -----------------------------------------------------------------------------------------------------------------------------------------



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FIBERNET TELECOM GROUP, INC.



CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)



(DOLLARS IN 000S)



|                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | -------- | - | ----------------- | - | -------- | -
|                                                                                                                                                                                      |  | September 30, 2004 |          |   | December 31, 2003 |  
|ASSETS                                                                                                                                                                                |  |                    |          |   |                   |   |          |  
|Current Assets:                                                                                                                                                                       |  |                    |          |   |                   |   |          |  
|Cash and cash equivalents                                                                                                                                                             |  | $                  | 5,151    |   |                   | $ | 3,488    |  
|Restricted cash                                                                                                                                                                       |  |                    | 1,873    |   |                   |   | 2,337    |  
|Accounts receivable, net of allowance of $717 and $721 at September 30, 2004 and December 31, 2003, respectively                                                                      |  |                    | 4,032    |   |                   |   | 3,785    |  
|Prepaid expenses,                                                                                                                                                                     |  |                    | 651      |   |                   |   | 754      |  
|                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  
|Total current assets                                                                                                                                                                  |  |                    | 11,707   |   |                   |   | 10,364   |  
|Property, plant and equipment, net                                                                                                                                                    |  |                    | 74,941   |   |                   |   | 86,958   |  
|Other Assets:                                                                                                                                                                         |  |                    |          |   |                   |   |          |  
|Other intangible assets, net of accumulated amortization of $85 at September 30, 2004                                                                                                 |  |                    | 401      |   |                   |   |         |  
|Deferred charges, net of accumulated amortization of $1,376 and $1,402 at September 30, 2004 and December 31, 2003,
respectively                                                      |  |                    | 1,920    |   |                   |   | 2,035    |  
|Other assets                                                                                                                                                                          |  |                    | 1,264    |   |                   |   | 261      |  
|                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  
|Total other assets                                                                                                                                                                    |  |                    | 3,585    |   |                   |   | 2,296    |  
|                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  
|TOTAL ASSETS                                                                                                                                                                          |  | $                  | 90,233   |   |                   | $ | 99,618   |  
|                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                  |  |                    |          |   |                   |   |          |  
|Current Liabilities:                                                                                                                                                                  |  |                    |          |   |                   |   |          |  
|Accounts payable                                                                                                                                                                      |  | $                  | 4,607    |   |                   | $ | 3,598    |  
|Accrued expenses                                                                                                                                                                      |  |                    | 3,691    |   |                   |   | 5,138    |  
|Deferred revenuescurrent portion                                                                                                                                                     |  |                    | 3,847    |   |                   |   | 4,584    |  
|Notes payablecurrent portion                                                                                                                                                         |  |                    | 4,460    |   |                   |   | 1,795    |  
|                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  
|Total current liabilities                                                                                                                                                             |  |                    | 16,605   |   |                   |   | 15,115   |  
|Long-Term Liabilities:                                                                                                                                                                |  |                    |          |   |                   |   |          |  
|Notes payable, less original issue discount of $1,775 and $2,308 at September 30, 2004 and December 31, 2003, respectively                                                            |  |                    | 8,955    |   |                   |   | 18,330   |  
|Deferred revenues                                                                                                                                                                     |  |                    | 3,117    |   |                   |   | 1,439    |  
|                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  
|Total liabilities                                                                                                                                                                     |  |                    | 28,677   |   |                   |   | 34,884   |  
|                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  
|Stockholders Equity:                                                                                                                                                                 |  |                    |          |   |                   |   |          |  
|Common stock, $0.001 par value, 2,000,000,000 shares authorized and 50,999,372 and 40,540,334 shares issued and outstanding at September 30,
2004 and December 31, 2003, respectively |  |                    | 51       |   |                   |   | 41       |  
|Additional paid-in-capital and other                                                                                                                                                  |  |                    | 444,439  |   |                   |   | 429,991  |  
|Deferred compensation                                                                                                                                                                 |  |                    | (4,582   | ) |                   |   | (4,797   | )
|Deferred rent (warrants)                                                                                                                                                              |  |                    | (1,949   | ) |                   |   |         |  
|Accumulated deficit                                                                                                                                                                   |  |                    | (376,403 | ) |                   |   | (360,501 | )
|                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  
|Total stockholders equity                                                                                                                                                            |  |                    | 61,556   |   |                   |   | 64,734   |  
|                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  
|TOTAL LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                            |  | $                  | 90,233   |   |                   | $ | 99,618   |  
|                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  



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



17



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##### Table of Contents

FIBERNET TELECOM GROUP, INC.



CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS



(UNAUDITED)



(DOLLARS IN 000S, EXCEPT
PER SHARE AMOUNTS)



|                                                                            |  |                                 |         |   |                           |   |         |  
|--------------------------------------------------------------------------- |  | ------------------------------- | ------- | - | ------------------------- | - | ------- | -
|                                                                            |  | Nine Months Ended September 30, |        
|                                                                            |  | 2004                            |         |   | 2003                      |  
|                                                                            |  |                                 |         |   | (As restated  seeNote 6) |  
|Revenues                                                                    |  | $                               | 26,379  |   |                           | $ | 19,508  |  
|Operating expenses:                                                         |  |                                 |         |   |                           |   |         |  
|Cost of services (exclusive of items shown separately below)                |  |                                 | 9,999   |   |                           |   | 6,209   |  
|Selling, general and administrative expense excluding stock related expense |  |                                 | 11,732  |   |                           |   | 11,225  |  
|Stock related expense for selling, general, and administrative matters      |  |                                 | 389     |   |                           |   | 89      |  
|Impairment of property, plant and equipment                                 |  |                                 | 9,603   |   |                           |   |        |  
|Impairment of goodwill                                                      |  |                                 | 2,309   |   |                           |   |        |  
|Depreciation and amortization                                               |  |                                 | 6,800   |   |                           |   | 6,602   |  
|                                                                            |  |                                 |         |   |                           |   |         |  
|Total operating expenses                                                    |  |                                 | 40,832  |   |                           |   | 24,125  |  
|                                                                            |  |                                 |         |   |                           |   |         |  
|Loss from operations                                                        |  |                                 | (14,453 | ) |                           |   | (4,617  | )
|Loss on early extinguishment of debt, net                                   |  |                                 |        |   |                           |   | (8,951  | )
|Interest income                                                             |  |                                 | 37      |   |                           |   | 37      |  
|Interest expense                                                            |  |                                 | (1,486  | ) |                           |   | (1,747  | )
|                                                                            |  |                                 |         |   |                           |   |         |  
|Net loss                                                                    |  | $                               | (15,902 | ) |                           | $ | (15,278 | )
|                                                                            |  |                                 |         |   |                           |   |         |  
|Net loss per sharebasic and diluted                                        |  | $                               | (0.32   | ) |                           | $ | (0.42   | )
|Weighted average common shares outstandingbasic and diluted                |  |                                 | 49,904  |   |                           |   | 36,016  |  



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



18



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##### Table of Contents

FIBERNET TELECOM GROUP, INC.



CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS



(UNAUDITED)



(DOLLARS IN 000S, EXCEPT
PER SHARE AMOUNTS)



|                                                                            |  |                                  |        |   |      |   |        |  
|--------------------------------------------------------------------------- |  | -------------------------------- | ------ | - | ---- | - | ------ | -
|                                                                            |  | Three Months Ended September 30, |       
|                                                                            |  | 2004                             |        |   | 2003 |  
|Revenues                                                                    |  | $                                | 8,149  |   |      | $ | 6,680  |  
|Operating expenses:                                                         |  |                                  |        |   |      |   |        |  
|Cost of services (exclusive of items shown separately below)                |  |                                  | 3,675  |   |      |   | 2,152  |  
|Selling, general and administrative expense excluding stock related expense |  |                                  | 3,872  |   |      |   | 3,786  |  
|Stock related expense for selling, general, and administrative matters      |  |                                  | 130    |   |      |   | 89     |  
|Impairment of property, plant and equipment                                 |  |                                  | 129    |   |      |   |       |  
|Depreciation and amortization                                               |  |                                  | 2,192  |   |      |   | 2,223  |  
|                                                                            |  |                                  |        |   |      |   |        |  
|Total operating expenses                                                    |  |                                  | 9,998  |   |      |   | 8,250  |  
|                                                                            |  |                                  |        |   |      |   |        |  
|Loss from operations                                                        |  |                                  | (1,849 | ) |      |   | (1,570 | )
|Interest income                                                             |  |                                  | 18     |   |      |   | 11     |  
|Interest expense                                                            |  |                                  | (462   | ) |      |   | (553   | )
|                                                                            |  |                                  |        |   |      |   |        |  
|Net loss                                                                    |  | $                                | (2,293 | ) |      | $ | (2,112 | )
|                                                                            |  |                                  |        |   |      |   |        |  
|Net loss per sharebasic and diluted                                        |  | $                                | (0.04  | ) |      | $ | (0.05  | )
|Weighted average common shares outstandingbasic and diluted                |  |                                  | 51,019 |   |      |   | 38,663 |  



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



19



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##### Table of Contents

FIBERNET TELECOM GROUP, INC.



CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS



(UNAUDITED)



(DOLLARS IN 000S)



|                                                                                          |  |                                 |         |   |      |   |         |  
|----------------------------------------------------------------------------------------- |  | ------------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                          |  | Nine Months Ended September 30, |        
|                                                                                          |  | 2004                            |         |   | 2003 |  
|Cash flows from operating activities:                                                     |  |                                 |         |   |      |   |         |  
|Net loss                                                                                  |  | $                               | (15,902 | ) |      | $ | (15,278 | )
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |  |                                 |         |   |      |   |         |  
|Depreciation and amortization                                                             |  |                                 | 6,800   |   |      |   | 6,602   |  
|Stock related expense                                                                     |  |                                 | 389     |   |      |   | 89      |  
|Loss on early extinguishment of debt, non-cash portion                                    |  |                                 |         |   |      |   | 8,899   |  
|Capitalized accrued interest on notes payable                                             |  |                                 |         |   |      |   | 648     |  
|Impairment of property, plant and equipment                                               |  |                                 | 9,603   |   |      |   |        |  
|Impairment of goodwill                                                                    |  |                                 | 2,309   |   |      |   |        |  
|Decrease (increase) in restricted cash                                                    |  |                                 | 463     |   |      |   | (2,333  | )
|Other non-cash items                                                                      |  |                                 | 802     |   |      |   | 725     |  
|Change in assets and liabilities:                                                         |  |                                 |         |   |      |   |         |  
|Increase in accounts receivable                                                           |  |                                 | (246    | ) |      |   | (659    | )
|Decrease in prepaid expenses                                                              |  |                                 | 103     |   |      |   | 226     |  
|(Increase) decrease in other assets                                                       |  |                                 | (1,003  | ) |      |   | 6       |  
|Increase (decrease) in accounts payable                                                   |  |                                 | 1,201   |   |      |   | (420    | )
|(Decrease) increase in accrued expenses                                                   |  |                                 | (1,124  | ) |      |   | 36      |  
|Increase in deferred revenues                                                             |  |                                 | 942     |   |      |   | 926     |  
|                                                                                          |  |                                 |         |   |      |   |         |  
|Cash provided by (used in) operating activities                                           |  |                                 | 4,337   |   |      |   | (533    | )
|                                                                                          |  |                                 |         |   |      |   |         |  
|Cash flows from investing activities:                                                     |  |                                 |         |   |      |   |         |  
|Acquisition of Gateway Colocation                                                         |  |                                 | (382    | ) |      |   |        |  
|Capital expenditures                                                                      |  |                                 | (2,250  | ) |      |   | (1,775  | )
|                                                                                          |  |                                 |         |   |      |   |         |  
|Cash used in investing activities                                                         |  |                                 | (2,632  | ) |      |   | (1,775  | )
|                                                                                          |  |                                 |         |   |      |   |         |  
|Cash flows from financing activities:                                                     |  |                                 |         |   |      |   |         |  
|Payment of financing costs of debt financings                                             |  |                                 | (297    | ) |      |   | (363    | )
|Payment of financing costs of equity financings                                           |  |                                 | (520    | ) |      |   | (810    | )
|Repayment of capital lease obligation                                                     |  |                                 |        |   |      |   | (85     | )
|Repayment of notes payable                                                                |  |                                 | (7,225  | ) |      |   |        |  
|Proceeds from issuance of equity securities                                               |  |                                 | 8,000   |   |      |   | 3,500   |  
|                                                                                          |  |                                 |         |   |      |   |         |  
|Cash (used in) provided by financing activities                                           |  |                                 | (42     | ) |      |   | 2,242   |  
|                                                                                          |  |                                 |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                                      |  |                                 | 1,663   |   |      |   | (66     | )
|Cash and cash equivalents at beginning of period                                          |  |                                 | 3,488   |   |      |   | 3,788   |  
|                                                                                          |  |                                 |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                                |  | $                               | 5,151   |   |      | $ | 3,722   |  
|                                                                                          |  |                                 |         |   |      |   |         |  
|Supplemental disclosures of cash flow information:                                        |  |                                 |         |   |      |   |         |  
|Interest paid                                                                             |  | $                               | 580     |   |      | $ | 274     |  
|Non-cash financing activities:                                                            |  |                                 |         |   |      |   |         |  
|Conversion of accrued interest into notes payable                                         |  | $                               |        |   |      | $ | 385     |  
|Conversion of notes payable into common stock                                             |  | $                               |        |   |      | $ | 13,382  |  
|Common stock issued for acquisition of Gateway Colocation                                 |  | $                               | 4,565   |   |      | $ |        |  
|Warrants issued for lease amendments                                                      |  | $                               | 1,963   |   |      | $ |        |  



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



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##### Table of Contents

FIBERNET TELECOM GROUP, INC.



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



(UNAUDITED)



1. ORGANIZATION AND OPERATIONS



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



FiberNet is a holding company that owns all of the outstanding
common stock of FiberNet Operations, Inc., a Delaware corporation and an intermediate level holding company, and 96.386% of the outstanding membership interests of Devnet L.L.C. (Devnet), a Delaware limited liability company. FiberNet
Operations, Inc. owns 3.614% of Devnet all of the outstanding common stock of FiberNet Telecom, Inc., a Delaware corporation. FiberNet Telecom, Inc. owns all of the outstanding membership interests of Local Fiber, LLC (Local Fiber), a
New York limited liability company, and all of the outstanding membership interests of FiberNet Equal Access, LLC (Equal Access), also a New York limited liability company. The Company conducts its primary business operations through its
operating subsidiaries, Devnet, Local Fiber and Equal Access.



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



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



The Company believes that the completion of the transactions that constituted its recapitalization, as discussed in Note 6 of the Companys
consolidated financial statements included in its Annual Report on Form 10-K/A for the year ended December 31, 2003, as filed with the Securities and Exchange Commission on July 9, 2004, significantly enhanced its liquidity and improved its
financial position. Under FiberNets current operating plan, it does not anticipate requiring any additional external sources of capital to fund its operations in the coming year. The Company does not have any off-balance sheet financing
arrangements, nor does it anticipate entering into any.



2. SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES



Basis of Presentation



The condensed consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries, FiberNet Operations, Inc., Devnet, FiberNet Telecom, Inc., Equal Access and Local Fiber. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the
instructions to Form 10-Q and, therefore, do not include all information and footnotes necessary for a fair presentation of financial position, results of operations, and cash flows in conformity with accounting principles generally accepted in the
United States of America. However, in the opinion of management, all adjustments consisting of normal recurring accruals necessary for a fair presentation of the operating results have been included in the condensed consolidated financial
statements.



These condensed consolidated financial statements
should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Companys Annual Report on Form 10-K/A for the year ended December 31, 2003, as filed with the Securities and Exchange
Commission on July 9, 2004.



All significant inter-company
balances and transactions have been eliminated.



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##### Table of Contents

Use of Estimates



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



Cash and Cash
Equivalents



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



Restricted Cash



Restricted cash is invested in highly liquid investments with an original maturity of three months or less when purchased. The carrying amount
approximates fair value because of the short maturity of the instruments. The Company has a restricted cash account used as collateral to secure the funding obligations for a portion of its outstanding letters of credit, which are in lieu of cash
security deposits for real estate leases. The restricted cash can be substituted by a letter of credit.



Property, Plant and Equipment



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



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



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



Impairment of Long-Lived Assets



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



Revenue Recognition



FiberNet generates
revenues from selling network capacity and related services to other communications service providers. The Company recognizes revenues when earned as services are provided throughout the life of each contract with a customer. The majority of the
Companys revenues are generated on a monthly recurring basis under contracts of various lengths, ranging from one month to fifteen years. Revenue is recognized over the service contract period for all general services. If the Company
determines that collection of a receivable is not reasonably assured, it defers the revenue and recognizes it at the time collection becomes reasonably assured, which is generally upon receipt of payment. Deferred revenues consist primarily of
payments received in advance of revenue being earned under the service contracts. All deferred revenues that will not be earned in the next 12 months have been classified as long-term.



Revenues are derived from four general types of services:



On-net transport services. FiberNets transport services include the offering of broadband circuits on its metropolitan
transport networks and FiberNet in-building networks (FINs). Over the Companys metropolitan transport networks, it can provision circuits from one of its carrier point facilities to another carrier point facility or to an on-net
building via an interconnection with its FIN in that building. The Company can also provision circuits vertically between floors in a carrier point facility or an on-net building.



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##### Table of Contents

Off-net transport services. In 2003, the Company initiated a new type of transport service offering to
provide its customers with circuits on networks that it does not own. The Company sells this connectivity to its customers by purchasing the underlying circuits from other wholesale telecommunications carriers.



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



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



As of September 30, 2004 and 2003 the Company had one reciprocal agreement. The services provided and obtained through this
agreement were priced at fair market value as of the date of the agreement and are included in revenues and cost of services in the accompanying condensed consolidated statements of operations. The Company recorded revenues from this reciprocal
agreement for transport services in the amount of approximately $0.4 million for the nine months ended September 30, 2004 and 2003. The Company leased colocation facilities under this agreement. The total amount expensed for services rendered under
the reciprocal agreement for each of the nine months ended September 30, 2004 and 2003 was approximately $0.4 million.



Fair Value of Financial Instruments



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



Goodwill



Cost in excess of net assets of an acquired business, principally goodwill, is accounted for under Statement of Financial Accounting Standards
(SFAS) No. 142, Goodwill and Other Intangible Assets (SFAS No. 142). SFAS No. 142 requires that goodwill and certain intangible assets resulting from business combinations entered into prior to June 30, 2001 no
longer be amortized, but instead be reviewed for recoverability. The Company performs its annual impairment test in December. The Company also tests for impairment if an event occurs that is more likely than not to reduce the fair value of the
Company below its book value.



The Company continues to be a
single reporting unit entity, as the acquisition of Gateway Colocation was an asset purchase and was integrated into the Companys operations.



Other Intangible Assets



Other intangible assets include the value allocated to customer contracts acquired. Other intangible assets are amortized over their useful lives, which
are the terms of the related contracts.



Deferred Charges



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



Earnings Per Share



Basic earnings per share have been computed using the weighted average number of shares outstanding during the period.
Diluted earnings per share are computed by including the dilutive effect on common stock that would be issued assuming conversion of stock options, warrants and other dilutive securities. Dilutive options, warrants and other securities did not have
an effect on the computation of diluted earnings per share for the nine months and the three months ended September 30, 2004 and September 30, 2003, as they were anti-dilutive due to the fact that the Company was in a loss position for the
respective periods.



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##### Table of Contents

Concentration of Credit Risk



The Company had concentration of credit risk in its customer base. The Company performs ongoing credit evaluations of its
customers respective financial condition. As of September 30, 2004, no customer accounted for over 10% of the Companys total accounts receivable, and as of December 31, 2003, one customer accounted for 12.2% of the Companys total
accounts receivable.



For the three and nine months ended
September 30, 2004 and 2003, there were no individual customers that accounted for over 10% of the Companys total revenue, excluding revenues recognized in connection with the Companys arbitration award during the nine months ended
September 30, 2004.



The Company continuously monitors
collections and payments from its customers and maintains allowances for doubtful accounts based upon its historical experience and any specific customer collection issues that are identified. While such credit losses have historically been within
the Companys expectations, there can be no assurance that the Company will continue to experience the same level of credit losses that it has in the past. A significant number of the Companys customers have filed for bankruptcy or are
otherwise in financial distress. A significant change in the liquidity or financial position of any one of these customers or a further deterioration in the economic environment or telecommunications industry, in general, could have a material
adverse impact on the collectability of the Companys accounts receivable and its future operating results, including a reduction in future revenues and additional allowances for doubtful accounts.



As of September 30, 2004, the Company had an allowance for doubtful accounts
of $0.7 million. During the nine months ended September 30, 2004, the Company wrote off approximately $28,000 in the allowance for doubtful accounts and recovered approximately $24,000 due to the sale of securities received as a result of the
bankruptcy of a former customer, and there were no charges to bad debt expense. During the nine months ended September 30, 2003, the Company wrote off approximately $0.3 million in the allowance for doubtful accounts, and there were no charges to
bad debt expense.



Equity Incentive Plan



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



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



|                                                                                                                             |  |                                |         |   |                                 |   |         |      |  |   |        |   |  |   |        |  
|---------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ------------------------------- | - | ------- | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                                                             |  | Nine Months EndedSeptember 30, |         |   | Three Months EndedSeptember 30, |  
|(in thousands, except per share data)                                                                                        |  | 2004                           |         |   | 2003                            |   |         | 2004 |  |   | 2003   |  
|(unaudited)                                                                                                                  |  |                                |         |   |                                 |   |         |      |  |   |        |  
|Net loss, as reported                                                                                                        |  | $                              | (15,902 | ) |                                 | $ | (15,278 | )    |  | $ | (2,293 | ) |  | $ | (2,112 | )
|Deduct: Total stock-based employee compensation expense determined under fair value based method, net of related tax effects |  |                                | (404    | ) |                                 |   | (3,104  | )    |  |   | (134   | ) |  |   | (855   | )
|                                                                                                                             |  |                                |         |   |                                 |   |         |      |  |   |        |   |  |   |        |  
|Pro forma net loss                                                                                                           |  | $                              | (16,306 | ) |                                 | $ | (18,382 | )    |  | $ | (2,427 | ) |  | $ | (2,967 | )
|Net loss per share:                                                                                                          |  |                                |         |   |                                 |   |         |      |  |   |        |   |  |   |        |  
|As reported: Basic and diluted                                                                                               |  | $                              | (0.32   | ) |                                 | $ | (0.42   | )    |  | $ | (0.04  | ) |  | $ | (0.05  | )
|Pro forma: Basic and diluted                                                                                                 |  | $                              | (0.33   | ) |                                 | $ | (0.51   | )    |  | $ | (0.05  | ) |  | $ | (0.08  | )



The fair value of each
option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants in September 30, 2004 and 2003: risk-free interest rates of 4.18%, expected dividend yields of 0%, expected
life of six years to expiration and expected volatility of 357%. The Company issued its options in 2003 and 2004 at fair market value.



On July 30, 2003, the Company issued 4.7 million shares of restricted stock and 0.4 million stock options at an exercise price of $1.13 per share to
employees and directors under its Equity Incentive Plan. During 2004 and 2003, 0.1 million shares and 0.3 million shares of restricted stock, respectively, were returned to the Company as the result of employee terminations prior to vesting. All
shares of restricted stock vest on the tenth anniversary of the grant date, and the stock options vest in three equal annual installments,



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commencing on the issuance date, subject to the terms and conditions of the Equity Incentive Plan. In accordance with
FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation (FIN No. 44), the deferred compensation is being amortized on a straight-line basis over the vesting period.



During the nine months ended September 30, 2004, the Company granted 0.1
million shares of restricted stock to employees with a weighted average price of $1.67 per share and 13,300 stock options with a weighted average exercise price of $1.42 per share.



Accounting for Income Taxes



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



Accounting for Derivative Instruments



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



Reclassifications



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



Segment Reporting



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



Revenues were generated by providing transport, colocation and communications access management services to customers. The
Company recognized $14.7 million in on-net transport service revenues for the nine months ended September 30, 2004. Off-net transport service revenues for the nine months ended September 30, 2004 were $2.5 million. Revenues from colocation and other
services were $4.7 million for the nine months ended September 30, 2004, and revenues from communications access management services were $1.8 million for the nine months ended September 30, 2004. The Company also recognized $2.7 million in revenues
in the nine months ended September 30, 2004 due to an award from an arbitration proceeding, in which it was the prevailing claimant.



Recent Accounting Pronouncements



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



3. PROPERTY, PLANT AND EQUIPMENT



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



|                                     |  |                    |         |   |                   |   |         |  
|------------------------------------ |  | ------------------ | ------- | - | ----------------- | - | ------- | -
|                                     |  | September 30, 2004 |         |   | December 31, 2003 |  
|Computer software                    |  | $                  | 227     |   |                   | $ | 200     |  
|Computer equipment                   |  |                    | 416     |   |                   |   | 256     |  
|Leasehold improvements               |  |                    | 31      |   |                   |   | 30      |  
|Office equipment and furniture       |  |                    | 146     |   |                   |   | 146     |  
|Network equipment and infrastructure |  |                    | 105,336 |   |                   |   | 113,858 |  
|                                     |  |                    |         |   |                   |   |         |  
|Subtotal                             |  |                    | 106,156 |   |                   |   | 114,490 |  
|Accumulated depreciation             |  |                    | (31,215 | ) |                   |   | (27,532 | )
|                                     |  |                    |         |   |                   |   |         |  
|Property, plant and equipment, net   |  | $                  | 74,941  |   |                   | $ | 86,958  |  
|                                     |  |                    |         |   |                   |   |         |  



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Depreciation expense on property, plant and equipment was $6.7 million and $6.6 million for the nine months ended
September 30, 2004 and 2003, respectively. Depreciation expense on property, plant and equipment was $2.2 million for the three months ended September 30, 2004 and 2003.



4. ACQUISITION OF GATEWAY COLOCATION



On January 30, 2004, the Company completed the acquisition of the operating assets of gateway.realty.new_jersey.llc, also known as Gateway Colocation.
Gateway Colocation operated a 49,000 square foot communications hub and colocation facility located at 165 Halsey Street in Newark, New Jersey. The transaction was an acquisition of assets treated as a business combination subject to purchase
accounting. The purchase agreement includes an earn-out payment based upon the achievement of certain financial objectives with respect to the revenues generated by the facility. More specifically, the earn-out payment will
be based on the gross revenues, on an annualized basis, for a particular month designated by Gateway Colocation during the twenty-four month period immediately subsequent to closing. The earn-out payment, if payable, will be paid in
shares of the Companys common stock. However, the issuance of such additional shares, in the aggregate with the shares of common stock issued at closing, will not exceed 19.9% of the issued and outstanding shares of common stock of the Company
as of the closing date without first receiving stockholder approval. FiberNet filed a registration statement with the Securities and Exchange Commission which was declared effective on April 14, 2004 covering the resale of the shares issued at
closing, and has agreed to file a registration statement with respect to the resale of shares issued, if any, pursuant to the terms of the earn-out provision. As of September 30, 2004, there were no additional shares required under the
earn-out provision. In connection with the closing of the acquisition, Oskar Brecher, a founder of Gateway Colocation, was appointed to the board of directors of the Company.



In connection with the acquisition, the Company paid $432,000 in cash (including acquisition costs of approximately
$262,000), and on January 30, 2004 issued to Gateway Colocation 2.9 million shares of common stock with fair value of approximately $4.6 million on the date issued. The acquisition was accounted for under the purchase method of accounting. The
assets acquired were recorded at their estimated fair values as determined by the Company based on information currently available and on current assumptions about future operations. Pro forma financial statements were not presented as the
acquisition was not deemed significant.



The Company recorded
$2.3 million of goodwill as a result of this acquisition. A summary of the allocation of the total transaction consideration is as follows (in thousands):



|                                |  |   |      
|------------------------------- |  | - | -----
|Total Transaction Consideration |  | $ | 4,972
|Less assets acquired:           |  |   |      
|Property, plant and equipment   |  |   | 2,370
|Other intangible assets         |  |   | 486  
|Other assets                    |  |   | 334  
|Plus liabilities assumed:       |  |   |      
|Accrued expenses                |  |   | 198  
|Deferred revenues               |  |   | 329  
|                                |  |   |      
|Goodwill                        |  | $ | 2,309
|                                |  |   |      



In June 2004, the
Companys settlement agreement with a dark fiber provider required it to record an impairment to property, plant and equipment. Per SFAS No. 144, Impairment and Disposal of Long Lived Assets, this asset impairment required the
Company to perform a test for impairment of goodwill under FASB Statement No. 142, Goodwill and Other Intangible Assets. As such, the Company performed a test for recoverability of goodwill from the acquisition of Gateway Colocation, and
determined that goodwill was impaired and recorded a $2.3 million impairment.



5. SIGNIFICANT EVENTS



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



In connection with the
Investor Purchase Agreement, the Company entered into a Registration Rights Agreement with the investors, dated as of January 30, 2004, which required the Company to file a registration statement with the Securities and Exchange



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Commission with respect to the resale of (i) the shares of common stock issued to the investors and (ii) the shares of
common stock underlying the warrants issued to the investors. These shares were included in a registration statement that was declared effective on April 14, 2004.



In connection with the consummation of both the acquisition described in Note 4 and equity financing described above, the
Company entered into certain transactions with the lenders under its credit facility. The Company and the lenders executed an eleventh amendment to the credit agreement, pursuant to which, among other things, the lenders consented to the
above-referenced transactions. The eleventh amendment also revised the automatic reductions of the commitments underlying the credit facility that are required on a quarterly basis beginning on March 31, 2004. Expressed as a percentage of the
aggregate outstanding commitments, the automatic reductions were revised to a total of 8% in 2004, 40% in 2005, 48% in 2006 and 4% at maturity on March 31, 2007. As of September 30, 2004, the Company had satisfied the entire 8% of the mandatory
reduction of commitments for 2004. In addition, the eleventh amendment also incorporated adjustments to the financial covenants of the credit facility. As a condition to the lenders entering into the eleventh amendment, the Company agreed to reduce
the exercise price of certain previously issued outstanding warrants held by the lenders to purchase approximately 379,230 shares of common stock from $3.60 per share to $0.001 per share, which were immediately exercised by the lenders. The Company
compared the value of the warrants prior to repricing with the value of the warrants after the repricing using the Black-Scholes option pricing model and determined that there was no material difference in value. Therefore the re-pricing of warrants
had no impact on the Companys condensed consolidated financial statements.



Unrelated to any transactions discussed above, during the nine months ended September 30, 2004, various investors exercised an aggregate of 249,000 warrants.



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



On March 10, 2004, the Company was notified that it prevailed as the claimant
in an arbitration proceeding regarding a breach of contract. FiberNet was awarded approximately $2.7 million in cash, payment of which was received on April 9, 2004. Of the total award payment, $2.4 million related to payment for services previously
provided and earned, and the Company recognized this amount as revenues in the nine months ended September 30, 2004. The remaining $0.3 million was for the reimbursement of expenses incurred in connection with the proceeding. The Company has
recorded this reimbursement as a reversal of previously accrued expenses included in selling, general and administrative expenses in 2003.



Also in connection with this arbitration award, the Company recognized an additional $0.3 million in revenues that were previously deferred. The Company
did not recognize revenues related to this arbitration proceeding or the disputed contract in prior periods as the collectability of amounts due under the contract was in doubt.



On April 13, 2004, the Company repaid $1.6 million of outstanding revolving loan indebtedness, which is available to be
redrawn in the future subject to compliance with the terms of the credit agreement. As of September 30, 2004, the Company had $5.5 million of available borrowing capacity and $0.4 million of availability to issue letters of credit under the credit
facility, again subject to compliance with the terms of the credit agreement.



On May 17, 2004 the Company settled a dispute with a dark fiber provider that had filed for bankruptcy, which resulted in the impairment of previously purchased dark fiber miles. The Company agreed to concede its
claim to 364 unutilized dark fiber miles, or 36.4% of the total dark fiber acquired from this provider in December 1999 for $34.8 million. The Company also agreed to pay $750,000 to settle a trade payable dispute with this provider, for which the
Company had accrued $1.1 million as a liability. As a result, the Company recorded an impairment of $9.5 million due to the write-off of $12.7 million of dark fiber included in network infrastructure, $2.8 million of related accumulated depreciation
and a $0.4 million reduction in accrued liabilities from this settlement for charges for network infrastructure that were previously capitalized and impaired.



On June 15, 2004, the Company recorded a one-time termination charge of $0.4 million related to the cancellation of a fifteen-year lease commitment for
unutilized space at a carrier hotel.



On September 1, 2004, the
Company amended its lease agreements for facilities at 60 Hudson Street in New York City. The amendments include a reduction in the license fee to 12.0% of revenues, and an increase in the total annual rent amount from $2.1 million to $3.3 million.
In conjunction with the amendment, the Company issued 2,549,858 warrants with an exercise price of $0.01 and a term of five years. The fair value of the warrants as of September 1, 2004 was approximately $2.0 million, using the Black-Scholes option
pricing model with the following assumptions used as of September 1, 2004: risk-free interest rates of 3.32%, expected dividend yields of 0%, expected life of five years to expiration and expected volatility of 357%. In accordance with



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Emerging Issues Task Force Issue (EITF) 00-18 Accounting Recognition for Certain Transactions involving
Equity Instruments Granted to Other Than Employees the fair value of the warrants was recorded as deferred rent (a contra-equity) to be amortized into cost of services over the life of the lease.



In the quarter ended September 30, 2004, the Company did not renew two of its
off-net property leases. As a result, the Company abandoned the assets associated with these two properties. As a result, the Company recorded an impairment of $0.1 million due to the write-off of $0.2 million of network infrastructure and $0.1
million of related accumulated depreciation.



6. RESTATEMENT



Subsequent to the issuance of its condensed consolidated financial
statements for the quarter ended March 31, 2004, the Company determined that the loss on early extinguishment of debt should have been classified in other expenses rather than operating expenses in its consolidated statement of operations. This
reclassification resulted in a reduction of loss from operations of $9.0 million for the nine months ended September 30, 2003.



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