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                       SECURITIES AND EXCHANGE COMMISSION
                            Washington, D. C. 20549

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

                                   FORM 10-K

[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
   OF 1934
                  For the Fiscal Year ended December 31, 1999

                                       OR

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

                  For the transition period from      to

                       Commission file number: 000-26103

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

                              CAIS INTERNET, INC.
             (Exact name of registrant as specified in its charter)

        Delaware
         1255 22nd Street, N.W., Fourth Floor, Washington, D.C.  20037
                                                             52-2066769
    (State or other                                      (I.R.S. Employer)
    jurisdiction of                                     Identification No.)
    incorporation or
     organization)
              (Address of principal executive offices) (Zip Code)



       Registrant's telephone number, including area code: (202) 715-1300

          Securities registered pursuant to Section 12(b) of the Act:

                                     None.

          Securities registered pursuant to Section 12(g) of the Act:

                              Title of each class
                     Common Stock, par value $.01 per share

  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 than the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]

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

  Based on the closing sale price of our common stock on March 15, 2000, the
aggregate market value of common stock held by nonaffiliates of the Registrant
was $244,154,000

  The number of shares of the Registrant's common stock outstanding as of March
15, 2000 was 23,130,015.

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<PAGE>

                              CAIS INTERNET, INC.

                                   FORM 10-K
               For the Fiscal Year Period Ended December 31, 1999

                                     INDEX

<TABLE>
<CAPTION>
                                                                                                  Page
                                                                                                  ----
<S>       <C>                                                                                     <C>
PART I
Item 1.   Business...............................................................................   3
Item 2.   Properties.............................................................................  14
Item 3.   Legal Proceedings......................................................................  14
Item 4.   Submission of Matters To a Vote of Security Holders....................................  14

PART II

Item 5.   Market for Registrant's Common Equity and Related Stockholder Matters..................  15
Item 6.   Selected Financial Data................................................................  17
Item 7.   Management's Discussion and Analysis of Financial Condition and Results of Operations..  19
Item 7A.  Quantitative and Qualitative Disclosures About Market Risk.............................  29
Item 8.   Financial Statements and Supplementary Data............................................  30
Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...  57

PART III

Item 10.  Directors and Executive Officers of the Registrant.....................................  57
Item 11.  Executive Compensation.................................................................  57
Item 12.  Security Ownership of Certain Beneficial Owners and Management.........................  57
Item 13.  Certain Relationships and Related Transactions.........................................  57

PART IV

Item 14.  Exhibits, Financial Statements and Reports on Form 8-K.................................  57
</TABLE>

Signatures....................................................................60

Exhibits......................................................................61

                                       2
<PAGE>

                                    PART I

Item 1. Business

  This Annual Report on Form 10-K contains forward-looking statements within
the meaning of Section 21E of the Securities Exchange Act of 1934, as amended,
and Section 27A of the Securities Act of 1933, as amended. For this purpose,
any statements contained herein that are not statements of historical fact may
be deemed to be forward-looking statements. Without limiting the foregoing,
the words "believes," "anticipates," "plans," "expects" and similar
expressions are intended to identify forward-looking statements. The important
factors discussed below under the caption "Risk Factors," among others, could
cause actual results to differ materially from those indicated by forward-
looking statements made herein and presented elsewhere by management from time
to time. Such forward-looking statements represent management's current
expectations and are inherently uncertain. Investors are warned that actual
results may differ from management's expectations.

  This Annual Report on Form 10-K contains trademarks of the Registrant and
its affiliates, and may contain trademarks, trade names and service marks of
other parties. References to "CAIS" or the "Registrant" are to CAIS Internet,
Inc. and its subsidiaries.

Overview

  We are a nationwide provider of broadband Internet access solutions. We
offer cost-effective, broadband Internet access and content solutions to
hotels and multi-family properties utilizing our tier-one, nationwide Internet
network and several proprietary technologies. Our proprietary technologies for
the hotel and multi-family markets include the patented OverVoice technology,
IPORT server software and the CAIS broadband portal. We use our Internet
kiosk's product IPORT PTS, to deliver broadband Internet access and content to
public venues, such as airports, retail centers, hotel lobbies and cruise
ships. To maximize use of our network, we also offer always-on, broadband
Internet access to commercial and residential customers through our digital
subscriber line service, "HyperDSL," in major metropolitan areas throughout
the U.S. Our goal is to become a leader in the provision of broadband Internet
access, content, software and systems.

  As of December 31, 1999, we had contracts to offer Internet access in
approximately 9,800 hotels and 1.3 million rooms through master agreements
with Hilton Hotels Corporation, John Q. Hammons Hotels, Inc., Carlson
Hospitality Worldwide, Staybridge Suites, Cendant Corporation, and Prime
Hospitality Corporation, Bass Hotels & Resorts, as well as trial agreements
with Starwood, Hyatt, Promus, and others. To date, we have installed high
speed Internet access in 125 hotels covering 24,000 rooms including properties
such as the Waldorf-Astoria, Westin Peachtree Plaza and the Palmer House-
Chicago. We also had master agreements for approximately 600 multi-family
properties covering 175,000 apartment units through agreements with OnePoint
Communications, Town & Country Trust, Tarragon Realty and United Dominion. We
also have trial agreements with Equity Residential, Charles E. Smith, Avalon
Bay and Insignia. To date we have installed approximately 9 multi-family
properties covering 3,500 apartment units.

  We provide broadband Internet access solutions in markets where broadband
Internet access has previously been uneconomical. We deploy highly cost-
effective proprietary technology that allows us to provide broadband Internet
access economically in such markets. We use our OverVoice technology to
simultaneously transmit voice and data over a single traditional copper
telephone line at speeds of up to 175 times those of 56.6k dial-up modems. We
use this technology to convert existing copper telephone wiring into a secure,
broadband Internet network and provide Internet connections to all rooms or
units within a hotel or multi-family residence without costly end-user
equipment or modems. A CAIS Internet customer is able to have both always-on,
broadband Internet access and complete use of the telephone at the same time
over one traditional telephone line. OverVoice technology is inexpensive to
produce and install relative to competing technologies, so we are able to
provide always-on, broadband Internet access in hotels and multi-family
properties in a highly cost-effective manner.


                                       3
<PAGE>

  Our IPORT server software is a broadband provisioning system which provides
hotels and multi-family properties with Internet access connections together
with "plug and play" automatic provisioning, automatic billing, credit card
authorization and quality of service features including the ability to support
Virtual Private Networks and offer secured network access for users. Our
Business Anywhere centers, which have been installed to date in over 100
hotels nationwide, provide a variety of automated business services as well as
facilitate broadband Internet access. Our IPORT PTS Internet kiosks enable us
to offer broadband Internet access to the common areas of hotels, multi-family
properties and other public venues, including airports, retail centers and
cruise ships. Our current customers for IPORT PTS kiosks include US West, GTE,
TCG, Pacific Bell, Royal Caribbean Cruise Lines, Park and View and Mail Boxes
etc.

  To complete the customer experience when going online with a CAIS broadband
access service, we offer the CAIS broadband portal. The CAIS portal not only
interfaces with the customer to manage the server's billing and bandwidth
access management, but is also designed to direct customers to proprietary
content when logging on at a CAIS-serviced hotel guest room or apartment home.

  We believe that our broadband portal for the hospitality market offers a
targeted demographic for media-rich content partners, advertisers and e-
commerce companies, enabling them to access millions of sets of business
travelers' eyeballs. The portal will also complete the customer experience of
convenience, speed and maximum utility of going online with CAIS Internet
through this aggregated offering of broadband media, e-commerce and
information resources. We believe that expanding the portal puts CAIS in a
unique market leadership position to control access to what we expect will be
the widest viewed portal in hotels and apartment buildings. We generate
advertising and e-commerce revenues through our own sales efforts as well as
the efforts of our content partners. We share a percentage of that revenue
with our hotel chain and multifamily REIT partners.

  To maximize use of our network backbone, we also offer always-on, broadband
Internet access to small-to-medium sized business, telecommuters, and
residential customers through our digital subscriber line service, HyperDSL,
in major metropolitan areas throughout the U.S. These users typically make up
our daytime network traffic. We provide our HyperDSL service in conjunction
with Covad Communications, Bell Atlantic, and Rhythms Corporation. We believe
digital subscriber line technology currently represents the most economical
always-on, broadband Internet solution for commercial customers. In addition,
we believe that digital subscriber line technology, used in conjunction with
OverVoice, will provide a highly cost-effective Internet solution for single-
family residences requiring multiple points of access. We intend to continue
the roll-out of HyperDSL as we expand our network to numerous layer
metropolitan areas nationwide. We expect to have points of presence in at
least 37 cities by the end of 2000. We are continually evaluating new partners
in different regions of the U.S. for the provision of digital subscriber line
services.

Industry Background

  Currently, most individuals access the Internet from home or while traveling
by using a dial-up service. Due to the inconveniences of dial-up Internet
service, most businesses prefer an always-on, broadband Internet connection,
such as a T-1. However, ordering T-1s for hotel meetings takes provisioning
time and is not always immediately available for hotel meeting rooms. Until
recently, broadband Internet access has been generally unavailable to most
users at home or while traveling due to the cost and difficulty of
implementing such service.

  We believe that Internet users have grown accustomed to the broadband
Internet access at work and therefore are increasingly seeking cost-effective
options for broadband access at home and while traveling. As a result, we
believe demand is ever increasing for broadband public networking, also called
visitor-based networks. Visitor-based networks are broadband Internet access
networks available to the public for a fee. Examples of visitor-based networks
include networks for hotels, resorts, and convention centers, as well as
kiosks for airports, shopping centers, cruise ships and truck stops.

  We believe that increased demand and evolving technology make the hotel,
multi-family residences and other public venues increasingly attractive
markets for always-on, broadband Internet access. The economies of scale in
these markets create the opportunity to price always-on, broadband Internet
access services at levels

                                       4
<PAGE>

comparable to, and in some cases better than, current dial-up services. In
addition, many property owners believe that broadband Internet access is an
attractive amenity that can enhance other revenue streams such as rental rates
and occupancy within a given property. Many major hotel chains and multi-
family property owners are currently evaluating alternative solutions to meet
the need for faster Internet connections and simultaneous voice and data
transmission.


  We believe that the domestic hotel segment represents a significant market
opportunity. We estimate that as of December 31, 1997, there were 49,000 hotel
properties with a total of 3.8 million hotel rooms nationwide. In the top
twenty-five hotel markets, we estimate that there were more than 7,775
properties with a total of approximately 1.2 million rooms. We are also
targeting the domestic multi-family property market. As of 1998, approximately
31% of the U.S. population, lived in multi-family properties and there were
over nine million apartment units in buildings with 50 or more units.

Business Strategy

  Our goal is to become a leader in the provisioning of broadband Internet
access, content, software and systems across large new markets worldwide. The
following are key elements of our business strategy to achieve this objective:

  Deploy Visitor-based and Multi-family Networks Nationwide. We are deploying
our broadband Internet solutions through our strategic alliances with Unisys,
Qwest, Nortel and Cisco. As of March 15, 2000, we have contracts to offer
Internet access in 10,400 hotels and apartment buildings. Additionally, CAIS
is accelerating its deployment with the CAIS Nationwide Provisioning Alliance.
The CAIS NPA involves agreements with Bell Atlantic, BellSouth, U S WEST, GTE
and SBC Communications. We are also deploying our IPORT PTS Internet kiosks,
which enable Internet access in the common areas of hotels, multi-family
properties and other public venues, including airports, retail centers and
cruise ships.

  Attract End-Users via Ease-of-Use and Increased Demand Creation. As CAIS
Internet visitor-based networks become widely available, we believe travelers
and apartment residents will expect broadband access to the Internet in their
hotel rooms and other visitor-based locations. To promote awareness of our
services, we jointly market nationally with our hotel partners. We believe
that to increase demand for these services, it is imperative for end users to
be able to access the Internet quickly and easily. In addition, we believe
that offering compelling content specifically designed for broadband
connections through our CAIS broadband portal is very important for increasing
demand.

  Continue to Expand "Best Solution" Product Suite. We provide broadband
Internet access solutions in markets where broadband Internet has previously
been uneconomical. We deploy highly cost-effective proprietary technology
which allows us to provision broadband Internet access economically in such
markets. We intend to continue expanding our service and product offerings
through internal research and development, and by acquiring complementary
businesses and technologies.

  Provide Superior Customer Service & Support. We believe customer service and
support is a cornerstone to our success. We maintain a separate division
dedicated solely to servicing the customer. We believe that our customer
service division will enable us to increase usage of our services by existing
customers and attract new customers.

  Expand our Internet Backbone. We operate a tier one, state of the art,
nationwide network to guarantee our customers top quality service. Through our
arrangements with Qwest, we will provide OC-12 and OC-3 capacity over a
redundant, broadband nationwide network to points of presence in 37 U.S.
cities. We provide Internet access to customers outside of these 37 cities
through third party network providers, such as UUNet, PSINet, BBN, and others.
We intend to continue to evaluate strategic relationships and acquisitions
that will allow us to further expand this network.

  Capitalize on Operating Leverage. We believe that our ability to deliver
high quality Internet services with low capital investment and low overhead
gives CAIS a significant long-term advantage over providers of competing
services. In our hotel and multi-family properties, we use our proprietary
technology to share a single broadband Internet connection among many multiple
users. As we drive usage by hotel guests and multi-family tenants in these
properties we enjoy significant operating leverage due to the fixed nature of
our operating costs.


                                       5
<PAGE>

Risk Factors

  Our performance may be difficult to evaluate since we have had a limited
operating history during which we have incurred significant net losses,
experienced negative cash flows and accumulated a significant deficit.

  Our limited historical operating data may make it more difficult for you to
evaluate our performance. We incurred a loss from continuing operations and
negative cash flows from operations for the year ended December 31, 1998 in
the amounts of approximately $12.3 million and $3.2 million, respectively, and
a loss from continuing operations and negative cash flows from operations for
the year ended December 31, 1999 in the amounts of approximately $52.4 million
and $15.3 million, respectively. We had a stockholders' deficit of
approximately $14.8 million on December 31, 1998, and a stockholders' equity
of approximately $112.0 million on December 31, 1999.

  We believe that we will incur further losses in the future, in part due to
expenses incurred in connection with the continued roll-out of our network,
marketing and sales organizations and the introduction of new services. We
also expect that operations in new target markets will experience losses until
we establish an adequate customer base. However, we cannot assure you that
after incurring these additional losses and expenses:

  .  there will be an increase in revenues;

  .  we will gain profits in future operating periods; or

  .  we will have sufficient cash available to meet continuing losses and/or
     necessary capital expenditures.

  Our continued growth and expansion will place substantial burdens on our
resources and personnel.

  Our business strategy depends in large part on our ability to rapidly deploy
OverVoice and our other technology platforms. This growth will increase our
operating complexity as well as the level of responsibility for both existing
and new management personnel. As a result, in order to manage our growth, we
must, among other things:

  .  continue to implement and improve our operational, financial and
     management information systems, including our billing, accounts
     receivable and payables tracking, fixed assets and other financial
     management systems;

  .  hire and train additional qualified personnel; and

  .  continue to expand and upgrade our network infrastructure.

  We also expect that demands on our network infrastructure and technical
support resources will increase rapidly as our customer base continues to
grow. We may therefore experience difficulties meeting a high demand for
services in the future. We cannot assure you that our infrastructure,
technical support or other resources will be sufficient to facilitate this
growth. As we strive to increase network utilization, there will be additional
demands on our customer support, sales and marketing resources. Competition
for qualified employees is intense and salaries are escalating very quickly.
In addition, the process of locating such personnel with the combination of
skills and attributes required to carry out our strategy is often lengthy.

  We may need additional capital, which we may not be able to obtain.

  We intend to rapidly enhance and develop our network and continue a broad-
based roll-out of OverVoice and our other technology platforms in order to
attain our business goals. We will need to seek additional financing to carry
out our growth and operating plans. We may not be able to raise cash on terms
acceptable to us or at all. Financings may be on terms that are dilutive or
potentially dilutive to our stockholders. If financing is insufficient or
unavailable, we will have to modify our growth and operating plans, which may
negatively affect our ability to expand our network and facilities and offer
additional services, and may adversely affect our growth and our ability to
repay our outstanding indebtedness.

                                       6
<PAGE>

  Future sales of our common stock could have a negative impact on the market
price of our common stock and our ability to make future stock offerings.

  Sales of a substantial number of shares of common stock in the public
market, or the appearance that such shares are available for sale, could
adversely affect the market price of our common stock and could impair our
ability to raise funds in future stock offerings. As of December 31, 1999
there were 22,595,565 shares of common stock outstanding.

  A third party could be prevented from acquiring your shares of stock at a
premium to the market price because of our anti-takeover provisions.

  There are provisions in our certificate of incorporation and by-laws that
make it more difficult for a third party to acquire, or attempt to acquire,
control of CAIS Internet, even if a change in control would result in the
purchase of your shares at a premium to the market price.

  These provisions include:

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

  .  the authority to issue "blank check" preferred stock;

  .  eliminating the ability of stockholders to act by written consent;

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

  .  an advance notice procedure for stockholder proposals to be brought
     before meetings of our stockholders; and
  .  requiring a super-majority stockholder vote to effect certain
     amendments.

  In addition, the Delaware General Corporation Law may also discourage
takeover attempts that have not been approved by our Board of Directors.

  We are required to pay ongoing royalties to Inline to use the OverVoice
technology, and any failure to do so, or otherwise meet our obligations to
Inline, could cause us to lose our exclusive right to use the OverVoice
technology.

  We are required to pay Inline Connection Corporation royalties ranging
between 3.0% and 5.5% of net sales of the OverVoice technology. In the rare
cases where we do not provide the Internet access or own the OverVoice
equipment installed, this percentage may be as high as 70.0%. If we sublicense
the patents and pending patent applications relating to the OverVoice
technology to a third party, we are required to pay Inline a percentage of the
income received from the sublicense. Additionally, we had minimum annual
royalty payments $150,000 in 1999 and increasing to $250,000 during the term
of the agreement. If we fail to pay the minimum payments, or otherwise breach
our agreement with Inline, we will lose our exclusive right to use the
OverVoice technology in hotels and multi-family properties which would
eliminate our ability to offer many of our key services.

  Technological change and evolving industry standards may render our services
noncompetitive, unnecessary or obsolete.

  Our future success will depend, in part, on our ability to: (1) offer
services that address the increasingly sophisticated and varied needs of our
current and prospective customers, and (2) respond to technological advances
and emerging industry standards and practices on a timely and cost-effective
basis. Internet access operations are characterized by:

  .  rapidly changing and unproven technology;

  .  evolving industry standards;

  .  changing customer needs; and

                                       7
<PAGE>

  .  numerous competitive services and product offerings.

  We cannot assure you that:

  .  future advances in technology will be beneficial to, or compatible with,
     our business;

  .  we will be able to incorporate such advances on a cost-effective or
     timely basis; or

  .  our services will be necessary and cost-effective as a result of such
     advances.

  Although we intend to support emerging standards, we cannot assure you that
industry standards will be established, or that, if established, we will be
able to conform to the new standards in a timely fashion or maintain a
competitive position in the market. In addition, future products, services or
technologies developed by others may render our services noncompetitive,
unnecessary or obsolete.

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

  We operate in a highly competitive environment for each of our lines of
business and we believe that competition is increasing. We may not be able to
compete effectively, especially against established industry competitors with
greater marketplace presence and financial resources than ours. The
competitive environments for our different lines of business are as follows:

  OverVoice. The major groups of competitors in the business of providing high
speed Internet access to hotels and multi-family properties include:

  .  local exchange carriers;

  .  other digital subscriber line providers;

  .  cable TV companies and other providers using cable modems; and

  .  installation firms that upgrade existing wiring.

  Many of these competitors have extensive marketplace presence and greater
technological and financial resources than we do.

  The OverVoice technology also competes with technologies using other
transmission media, such as coaxial cable, wireless facilities and fiber optic
cable. If telecommunications service providers, hotels, multi-family
properties or single family residences install any of these alternative
transmission media, demand for OverVoice may decline.

  CAIS Internet. Our principal competitors include other major providers such
as UUNET Technologies, Inc., PSINet Inc., BBN (a GTE subsidiary), and other
providers of always-on high speed Internet access including digital subscriber
line services, T-1 and wireless access. To a lesser extent, we also compete
for always-on and dial-up access and web services business with smaller,
regional Internet service providers and cable companies that operate in the
same geographic markets that we serve. Because the Internet services market
has no substantial barriers to entry, we expect that competition will continue
to intensify. Eventually, we expect some form of a market consolidation to
occur, with those Internet service providers that furnish the most value-added
solutions ultimately surviving.

  CAIS Software Solutions, Inc. Our principal competitors include other
providers of self-automated subscriber management systems and kiosk software
that could challenge the private label sale of our IPORT server and kiosk
software solutions. We compete for business with cable, digital subscriber
line and wireless providers in the deployment of access solutions to multiple
users. Our IPORT software automates and creates subscriber management systems
for customer service billing, pay-per-use ordering, work order management, and
portal sales and marketing functions. Some potential customers for our server
and kiosk products may have existing contracts with our competitors, or may
sell their server and kiosk software as part of a competitor's bundled
solution in the hotel and apartment community marketplace.

  Business Anywhere Centers and Internet Kiosks. There are currently two major
competitors in the marketplace providing automated business center services.
Based on the published information, Business Anywhere has the most number of
multi-purpose business center placements in business class hotels than any of

                                       8
<PAGE>

our competitors. Our two key competitors utilize the traditional technology of
individual credit card swipes hard wired to each machine. The major drawbacks
to our competitors' technology are the high cost of equipment service and
upgrading and the high initial capital cost.

  As a result of increased competition and vertical and horizontal integration
in the industry, we could encounter significant pricing pressure which could
cause us to significantly reduce the average selling price of some of our
products and services. We might not be able to offset the effects of any such
price reductions with an increase in the number of our customers, higher
revenue from enhanced services, cost reductions or otherwise. Market
consolidation could result in increased price and other competition in these
industries. Increased price or other competition could result in erosion of
our market share and could have a material adverse effect on our financial
condition. We cannot assure you that we will have the financial resources,
technical expertise or marketing and support capabilities to continue to
compete successfully.

  If we do not meet our obligations to deliver high speed Internet access
solutions to our customers according to schedule, our reputation will be
harmed and our revenues may be affected.

  As of December 31, 1999, we had entered into agreements to provide high
speed Internet access services in approximately 9,800 hotels and 600 multi-
family properties. Our ability to meet the installation schedule in our
agreements is critical to our success and to our ability to generate revenues.
We depend on outside suppliers and vendors to install our technology in
buildings, as well as on telecommunications service providers, to install our
technology in buildings, as well as on telecommunications service providers,
to install our technology and provide services to our customers. If we fail to
install our technology or provide service on a timely basis as required by our
customer agreements, whether or not such failure is outside of our control,
our ability to market our Internet access and content solutions and,
accordingly, our services would be harmed.

  We incur significant up-front costs to install our technology, which we may
not be able to recover; our agreements do not contain any minimum use
requirements, and some of our contracts are not exclusive.

  We have incurred, and will continue to incur, significant up-front costs
installing OverVoice and our other technology platforms in hotels and multi-
family properties. There is no guarantee that we will be able to recover such
costs.

  Because our trial and long-term agreements for both hotels and multi-family
properties generally do not contain any minimum use requirements, there is no
minimum payout that we can expect to receive. Furthermore, some of our
agreements do not require hotel owners and operators to offer our services
exclusively. As a result owners and operators could offer services that
compete with ours.

  If we fail to adequately protect our intellectual property rights or face a
claim of intellectual property infringement by a third party, we could lose
our intellectual property rights or be liable for significant damages.

  Our competitive advantage depends on certain domestic and foreign patents
and patent applications relating to the OverVoice technology that we license
from and jointly own with Inline Connection Corporation, as well as our
patented IPORT and Business Anywhere Center technology. Our success relies
substantially on our ability to protect our patented technology, both
domestically and abroad. We face two major risks in connection with our
intellectual property rights:

  (1) Others may infringe on our intellectual property rights, resulting in:

  .  lack of competitiveness in the market;

  .  expense of time and resources to protect our patents; and

  .  dilution of the brand value of our service.

  (2) Although we do not believe this to be the case, we may infringe others'
patents, resulting in:

  .  significant expense in defending our technology, even in the case of a
     frivolous suit;

                                       9
<PAGE>

  .  requirement to pay damages; and

  .  costly and potentially impracticable redesign of our technology.

  Because we depend upon our suppliers and have sole and limited sources of
supply for certain products and services, we are vulnerable to service
interruptions and increased costs of services.

  We depend substantially on telecommunications services providers and we are
unable to control the prices for these services. For example, in order to
provide Internet access and other on-line services to our customers, we lease
long distance fiber optic telecommunications lines from national
telecommunications services providers.

  Certain of our suppliers, including regional Bell operating companies and
competitive local exchange carriers, are currently subject to various price
constraints, including tariff controls, which may change in the future. In
addition, pending regulatory proposals may affect the prices they charge us.
These regulatory changes could result in increased prices for products and
services. This could reduce the profit margin for our services or require us
to increase the prices which we charge our customers, which could reduce the
demand for our services.

  We do not manufacture our proprietary OverVoice equipment, such as wall
jacks and the OverVoice DeskJack; rather, we depend on third parties to
manufacture and supply it. Any interruption in these manufacturers' operations
could adversely affect our ability to meet our customers' requirements, which
could cause them to use our competitors' services.

  We rely on other companies to supply our network infrastructure, some of
which may compete directly with us or enter into arrangements with our
competitors.

  We rely on other companies to supply our network infrastructure (including
telecommunications services and networking equipment) which, in the quantities
and quality we require, is available only from sole or limited sources. We
are, therefore, vulnerable to the possibility that our suppliers may:

  .  compete directly with us;

  .  enter into exclusive arrangements with our competitors; or

  .  stop selling their products or components to us at commercially
     reasonable prices, or at all.

  The Internet relies on the exchange of traffic over a network of networks
that is owned and operated by many parties. We currently exchange traffic with
other Internet service providers with whom we maintain relationships. These
exchange agreements are not regulated and may be changed. If they become
regulated, modified or are altogether terminated, we may have to find
alternate, more expensive means to exchange traffic, or we may not be able to
do so, which could limit our ability to offer services in a particular market
or increase the cost of our services, which could reduce the demand for these
services.

  A system failure could cause interruptions in the services we provide to our
customers.

  Our operations depend upon our ability to protect our network against damage
from acts of nature, power failures, telecommunications failures and similar
events. Because we lease our lines from long-distance telecommunications
companies, Internet providers, the regional Bell operating companies and
competitive local exchange carriers, we depend upon those companies for
physical repair and maintenance of those lines. Despite the precautions we and
our telecommunications providers take, the occurrence of a natural disaster,
fire, electrical outage or other unanticipated problems at one of our
facilities may cause interruptions in the services we provide. Such
interruptions in operations could limit our ability to meet our customers'
requirements and reduce the demand for our services.

  Viruses, break-ins and other security breaches could cause interruptions,
delays or a cessation of the services we provide to our customers.

                                      10
<PAGE>

  Despite the implementation of network security measures, the core of our
Internet network infrastructure is vulnerable to computer viruses, break-ins
and similar disruptive problems. We may experience future interruptions in
service as a result of the accidental or intentional actions of Internet
users, current and former employees or others. Unauthorized use could also
potentially jeopardize the security of confidential information stored in our
computer systems and the computer systems of our customers. Although we intend
to continue to implement security measures to prevent this, these measures
have occasionally been circumvented in the past, and the possibility exists
that the measures we implement will be circumvented in the future. In
addition, eliminating such viruses and remedying such security problems may
cause interruptions, delays or cessation of service to our customers. If our
security measures fail, we may lose subscribers or be sued, resulting in
additional expenses and reduced profitability. We do not carry any insurance
against these risks because it is unavailable at a reasonable cost.

  The loss of our key personnel, or failure to hire additional personnel,
could harm our business because we would lose experienced personnel and new
skilled personnel are in short supply and command high salaries.

  Our success depends in significant part upon the continued service and
performance of our senior management personnel and other employees who possess
longstanding industry relationships and technical knowledge of our operations.
While we do not maintain any "key person" insurance, we have entered into
employment agreements with key employees. Our future success also depends on
our ability to attract, train, retain and motivate highly skilled personnel.
To date, we have successfully attracted and retained qualified, high-level
personnel; we have not had to devote significant time and resources recruiting
such personnel; and personnel turnover has not affected our development
efforts. However, competition for qualified, high-level telecommunications
personnel is intense and we cannot assure you that we will be able to continue
to attract and retain such talent. The loss of the services of one or more of
our key individuals, or the failure to attract and retain additional key
personnel, could limit our ability to market our services, manage our growth
and develop and achieve our business objectives.

  Because we are an internet service provider, we may become subject to
application of telecommunications laws to services provided over the internet.

  As an Internet service provider, we are not currently subject to direct
regulation by the Federal Communications Commission ("FCC"). Nevertheless,
Internet-related regulatory policies are continuing to develop and vigorous
public debates regarding the costs and benefits of regulating the Internet
have emerged in federal, state and local legislative, executive and regulatory
agency forums. It is possible that we could be exposed to regulation as a
telecommunications service provider in the future. For example, the FCC has
stated its intention to consider whether to regulate voice and fax telephony
services provided over the Internet as "telecommunications" even though
Internet access itself would not be regulated; and the FCC recently initiated
a Notice of Inquiry to examine this issue. The FCC is also considering whether
such Internet-based telephone service should be subject to universal service
support obligations, or pay carrier access charges on the same basis as
traditional telecommunications companies.

  Local telephone companies assess access charges to long distance companies
for the use of the local telephone network to originate and terminate long
distance calls, generally on a per-minute basis. Access charges have been a
matter of continuing dispute, with long distance companies complaining that
the rates are substantially in excess of cost, and local telephone companies
arguing that access rates are justified to subsidize lower local rates for end
users and other purposes. Both local and long distance companies, however,
contend that Internet-based telephony should be subject to these charges. We
have no current plans to install gateway equipment and offer telephony, and so
we do not believe we would be directly affected by these developments.
However, we cannot predict whether these debates will cause the FCC to
reconsider its current policy of not regulating Internet service providers.

  A decision by Congress or the FCC to regulate Internet telephony or Internet
access services may limit the growth of the Internet, increase our cost of
doing business or increase our legal exposure, any of which could cause our
revenues to decrease.

                                      11
<PAGE>

  A governmental body could impose sales and other taxes on the provision of
our services, which could increase our costs of doing business.

  A number of federal, state and local government officials have asserted the
right or indicated a willingness to impose taxes on Internet-related services
and commerce, including sales, use and access taxes. We cannot accurately
predict whether the imposition of any such taxes would materially increase our
costs of doing business or limit the services we provide.

  We may be liable for information sent through our network.

  As an Internet service provider, we may be liable for content and
communications provided by third parties and carried over, or hosted on, our
facilities. Because the law of Internet service provider liability is
uncertain and in a constant state of change, our actual exposure for third-
party content cannot be predicted.

  One area of potential liability is copyright and trademark infringement. We
may be found liable for third-party communications that infringe a trademark
or copyright, and we are obligated to comply with the requirements of the
Digital Millennium Copyright Act concerning responses to claims of copyright
infringement.

  We also may be liable for obscene, indecent or otherwise offensive
communications carried over our facilities. Although the Communications
Decency Act, enacted in 1996, was found by the courts to be unconstitutional
as applied to indecent speech, in 1998 the Congress passed another statute
intended to prohibit indecent communications over the Internet. That more
recent statute was declared to be unconstitutional, but a federal court of
appeals is hearing a pending challenge to that decision. Depending upon the
outcome of that proceeding, we may be exposed to potential liability for
indecent material carried over our facilities.

  We also are required to comply with state and federal privacy requirements,
including the Electronic Communications Privacy Act ("ECPA") and the
Children's Online Privacy Protection Act ("COPPA"). The ECPA imposes
limitations on the interception, disclosure and use of communications
transmitted over and stored on our facilities. COPPA, and the Federal Trade
Commission rules implementing that statute, requires us to safeguard personal
information that we know to be transmitted to our website by children under
13.

  We also are subject to federal and state laws that regulate the advertising
and sale of certain products and services over the Internet. In addition to
existing statutes of this kind, such as state statutes that prohibit
advertisement of gambling, a number of bills are pending in the Congress and
state legislatures that would prohibit or regulate particular marketing
practices (such as the transmission of unsolicited commercial email) or the
advertisement or sale of certain goods and services. We cannot predict the
impact of these potential laws upon our business.

  While no one has ever filed a claim against us concerning content carried
over our service, someone may file a claim of that type in the future and may
be successful in imposing liability on us. If that happens, we may have to
spend significant amounts of money to defend ourselves against these claims
and, if we are not successful in our defense, the amount of damages that we
will have to pay may be significant. Any costs that we incur as a result of
defending these claims or the amount of liability that we may suffer if our
defense is not successful could materially adversely affect our profitability.

  If, as the law in this area develops, we may decide to take steps to reduce
our exposure to for information carried on, stored on or disseminated through
our network. This may require us to spend significant amounts of money for new
equipment and may also require us to discontinue offering certain of our
products or services or modify existing arrangements to mitigate potential
liability.

  We may not be able to protect our trademarks which could hamper our ability
to market our products and services.

  Our success is dependent in part on recognition of our name and trademarks,
such as "CAIS," "OverVoice", IPORT and "Business Anywhere" and pending
trademarks, such as "DeskJack." We intend to protect and defend our name,
servicemarks and trademarks in the United States and internationally. We
achieved

                                      12
<PAGE>

federal registration for several of our trademarks, including the mark CAIS,
and filed for federal trademark protection for a number of other marks which
we use or intend to use, for example "DeskJack." However, we cannot assure you
that:

  .  our efforts to protect our proprietary rights in the United States or
     abroad will be successful;

  .  our use of our trademarks and servicemarks will be free from legal
     challenges; or

  .  we will have sufficient funds to withstand such challenges or claims,
     regardless of their merit.

  If we are unable to protect our proprietary rights, it could seriously
affect our ability to market our products and services. In addition, legal
challenges to our proprietary rights could lead to a substantial diversion of
our limited resources.

  Our executive officers and directors, as a group, control CAIS Internet.

  At December 31, 1999, our executive officers and directors, as a group,
beneficially own or control approximately 42% of the shares of our common
stock on a fully diluted basis. Consequently, as a practical matter, our
executive officers and directors, as a group, are able to control all matters
requiring approval by our stockholders, including the election of our Board of
Directors, management policy and all fundamental corporate actions, including
mergers, substantial acquisitions and dispositions of assets.

Failure to obtain Year 2000 compliance could cause an interruption in, or a
failure of, our normal business activities and operations.

  The term "Year 2000 issue" is a general term used to describe the various
problems that may result from the improper processing of dates and date-
sensitive calculations by computers and other machinery as the year 2000 is
approached, reached and passed. Our failure to correct a material Year 2000
problem could result in an interruption in, or a failure of, our normal
business activities or operations. Prior to December 31, 1999, the Company
made custom coding enhancements and other necessary modifications to its
mission-critical internal business systems, as well as to other internal
business systems. We believe that such internal systems are now Year 2000
compliant. We continue to assess the impact of Year 2000 issues on our
internal computer, operational and financial systems, and to review with our
key vendors and suppliers and the compliance of their systems with Year 2000
processing requirements. We currently believe that our most likely worst case
scenario related to the Year 2000 is associated with potential concerns with
our customers' and suppliers' Internet operations. The failure of such parties
to ensure Year 2000 compliance could lead to decreased Internet usage and the
delay or inability to obtain necessary data communication and
telecommunication capacity. These factors could result in delay or loss of
revenue, interruption of network services, cancellation of customer contracts,
diversion of development resources, damage to CAIS Internet's reputation and
litigation costs. Please see "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Impact of the Year 2000 Issue"
for a more detailed discussion of the impact of the Year 2000 issue.

Our results of operations and financial condition may be adversely affected if
we do not successfully integrate future acquisitions into our operations.

   In order to respond to the competitive pressures of the broadband access
services industry and support our intended growth, we intend to continue to
focus on acquiring, or making significant investments in, additional
companies, products and technologies that complement our business. Since our
initial public offering in May 1999, we have completed four such acquisitions.
We do not have any present understanding, nor are we having any discussions,
relating to any significant acquisition. Our ability to compete effectively
and support our intended growth may be adversely affected if we are not able
to identify suitable acquisition candidates or investments or acquire
companies or make investments on acceptable terms or at acceptable times. In
addition, acquiring companies, products, services or technologies involves
many potential difficulties and risks, including:


  .  difficulty in assimilating them into our operations;

  .  disruption of our ongoing business and distraction of our management and
     employees;

                                      13
<PAGE>

  .  negative effects on reported results of operations due to acquisition-
     related charges and amortization of acquired technology and other
     intangibles; and

  .  potential dilutive issuances of equity or equity-linked securities.

These potential difficulties and risks could adversely affect our ability to
realize the intended benefits of an acquisition and could result in
unanticipated expenses and disruptions in our business, which could harm our
financial results and condition.

Item 2. Properties

  The Company's headquarters are in Washington, D.C. where it leases
approximately 39,000 square feet under a ten year lease which expires in
February 2009. The Company also leases:

  .  approximately 40,000 square feet of office space for sales and customer
     support functions in Arlington, Virginia,

  .  approximately 24,000 square feet of office space for CAISSoft operations
     in San Diego, California,

  .  approximately 10,000 square feet of office space for technical
     operations in McLean, Virgina,

  .  approximately 5,000 square feet of office space for Business Anywhere
     operations in Irvine, California.

  The Company also leases or is otherwise provided with the right to utilize
space in various geographic locations for network operations. The Company
believes that these facilities are adequate for its current needs and that
suitable additional space, should it be needed, will be available to
accommodate expansion of its operations on commercially reasonable terms.

Item 3. Legal Proceedings

  The Company, one of its principal officers and the corporate inventor of
OverVoice (the "Corporate Inventor") were named as defendants in a federal
civil action filed in the Eastern District of New York in September 1998. The
plaintiff alleged patent infringement, unfair competition, breach of contract
and related claims. On January 24, 1999, the parties in this litigation signed
a Settlement Agreement (the "Settlement"). Under the terms of the Settlement,
the Company agreed to pay the plaintiff $500,000 as follows: $250,000 upon
dismissal of this action, $150,000 on or before July 1, 1999, and $100,000 on
or before July 1, 2000. The Company also issued the plaintiff 25,000 shares of
common stock and agreed to issue additional shares if the 25,000 shares,
multiplied by the price at which shares are issued in this offering, does not
equal or exceed $250,000. In exchange, the plaintiff also agreed to modify
their exclusive license agreement with the Corporate Inventor to a
nonexclusive agreement. As a result, the Company now has the right to install
the OverVoice technology in single family residences and food establishments.
Along with the cash settlement, the Company expensed the fair value of the
25,000 shares of common stock issued together with the fair value of the
commitment to issue additional shares contingent on the offering price in the
accompanying statement of operations for the year ended December 31, 1998. The
Company also granted the plaintiff the right to purchase an additional 25,000
shares of common stock at the offering price in any IPO. The fair value of
this right was nominal.

  On March 25, 1999, the Company filed a patent infringement lawsuit against
LodgeNet Entertainment Corp. ("LodgeNet") in Maryland U.S. District Court. The
complaint charged LodgeNet with infringement of one of the OverVoice patents,
which is directed to the delivery of high-speed audio and video signals over
active telephone wiring. On September 15, 1999 the Company and LodgeNet
entered into a settlement agreement, and on September 16, 1999 the Company
submitted a Stipulation of Dismissal of the lawsuit, under terms satisfactory
to the Company.

  The Company is not a party to any lawsuit or proceeding which, in the
opinion of its management, is likely to have a material adverse effect on its
business, financial condition or results of operation.

Item 4. Submission Of Matters To A Vote Of Security Holders.

  None.

                                      14
<PAGE>

                                    PART II

Item 5. Market For Registrant's Common Equity And Related Stockholder Matters.

  The common stock of CAIS has been traded on the Nasdaq National Market
(Nasdaq Symbol: CAIS) since the completion of our initial public offering on
May 20, 1999. Prior to that date, there was no public market for our common
stock. The following table presents for the periods indicated the high and low
closing sales of our common stock, as reported by the Nasdaq National Market.
<TABLE>
<CAPTION>
                                                                   Price Range
                                                                    of Common
                                                                      Stock
                                                                  -------------
                                                                   High   Low
                                                                  ------ ------
<S>                                                               <C>    <C>
Fiscal Year Ended December 31, 1999
  Second Quarter (from May 20, 1999)............................. $22.13 $10.63
  Third Quarter.................................................. $22.75 $11.00
  Fourth Quarter................................................. $39.13 $10.69
</TABLE>

  On March 9, 2000, the closing price of our common stock as reported on the
Nasdaq National Market was $30.63 per share. As of March 9, 2000, there were
approximately 140 holders of record of our common stock.

Dividends

  We have never paid or declared any cash dividends on our common stock. We
currently expect to retain future earnings, if any, to finance the growth and
development of our business, including potential acquisitions. Therefore, we
do not anticipate paying cash dividends in the foreseeable future, except as
required pursuant to the terms of our convertible preferred stock owned by
Qwest.

Recent Sales of Unregistered Securities

  In the year ended December 31, 1999, the Company granted stock options to
employees to purchase approximately 1,347,000 shares at exercise prices
ranging from $4.31 to $16.50 per share under the Company's Incentive Stock
Option plan. The Company also converted Atcom options to CAIS options to
purchase approximately 842,000 shares under the Company's Incentive Stock
Option Plan at exercise prices ranging from $0.36 to $12.02 per share.
Additionally, the Company granted options to executives to purchase 1,010,000
shares at exercise prices ranging from $4.31 to $13.50 per share.

  On June 3, 1999, the Company issued 66,500 shares of common stock to Hilton
Hotels Corporation in connection with the companies' agreement on a digital
entertainment fund to jointly pursue the development of future guest and
meeting room digital entertainment solutions in Hilton properties.

  In September 1999, the Company issued 2,493,383 and 121,704 shares of common
stock in connection with the acquisitions of Atcom Inc. ("Atcom") and Business
Anywhere USA, Inc. ("Business Anywhere"), respectively.

  In September 1999, the Company issued 125,000 shares of Series C Preferred
Stock to U.S. Telesource, Inc., an affiliate of Qwest Communications
Corporation ("Qwest") for total gross proceeds of $15,000,000. The Series C
Preferred Stock ranks prior to the Company's common stock with respect to
dividends and rights upon liquidation, dissolution, or winding up of the
Company. Each holder of Series C Preferred Stock is entitled: (i) to receive,
when, as and if declared by the Company's Board of Directors, cumulative
dividends of $10.20 per annum per share; (ii) to a liquidation preference
equal to the sum of $120.00 per share, plus any accrued but unpaid dividends;
(iii) to the number of votes equal to the number of whole shares of Common
Stock into which all of the shares of Series C Preferred Stock held by such
holder are convertible; and (iv) to certain demand and piggyback registration
rights. Subject to certain limitations, each share of Series C Preferred Stock
is convertible, at the option of the holder, into such number of fully paid
and nonassessable shares of common stock at the ratio of ten common shares for
each share of Series C Preferred Stock. The Company shall redeem (i) up to
41,667 shares of the Series C Preferred Stock by the second anniversary of the
date of issuance of the Series C Preferred Stock; and (ii) the remaining
shares of the Series C Preferred Stock upon the third anniversary of the date
of issuance of the Series C Preferred Stock.

  In connection with the Series C Preferred Stock, the Company issued warrants
to Qwest to purchase 500,000 shares of common stock at an exercise price of
$12.00 per share. The warrants have been valued at their

                                      15
<PAGE>

estimated fair value of $7.70 per share (or approximately $3,851,000 in the
aggregate) based upon a Black-Scholes valuation model. The fair value of the
warrants has been recorded as a dividend on preferred stock. The warrants
expire on October 28, 2002.

  On December 20, 1999, the Company entered into a Preferred Stock Purchase
Agreement ("Purchase Agreement") between CII Ventures LLC, an affiliate of the
private investment firm Kohlberg Kravis Roberts & Co. (KKR). Under the
Purchase Agreement, KKR, through its affiliate, will make a strategic
investment of up to $200 million in the Company.), CII Ventures will purchase
$100 million of the Company's Series D convertible participating preferred
stock ("Series D Shares"). The Series D Shares will be convertible into common
stock of the Company, with an initial conversion price of $16.50 per share,
subject to adjustment. The Purchase Agreement also includes a one-year option
for CII Ventures to purchase up to an additional $100 million of Series E
convertible participating preferred stock ("Series E Shares"). The Series E
Shares are convertible into the Company's common stock, with an initial
conversion price of $20.00 per share, subject to adjustment. Based on the
Company's capitalization at December 31, 1999, the investment by KKR in the
Series D Shares would represent a 16 percent fully diluted capital interest in
the Company. Upon the exercise of the option for the Series E Shares, the
investment by KKR in the Series D and Series E Shares would represent a 26
percent fully diluted capital interest in the Company. The holders of the
Series D and Series E Shares will be entitled to receive dividends, payable in
additional Series D Shares and Series E Shares, respectively, at a rate of 6
percent per annum compounded quarterly. The Company issued approximately
5,577,000 Series D Shares in February 2000.


  On January 26, 2000, the Company entered an agreement with Bass to provide
the Company's services to approximately 2,750 properties and 400,000 rooms.
The Company will pay contract rights to individual hotels at a rate of $25 per
room when a hotel contracts for service. Additionally, the Company will
contribute up to approximately $2.2 million in marketing and technology
development funds. The Company issued 63,000 warrants to Bass effective
February 1, 2000 at an exercise price of $40.01 per share.

  On March 15, 2000, CAIS Software Solutions, Inc., a wholly owned subsidiary
of the Company, entered into an agreement to purchase the contracts,
intellectual property, and certain other assets of QuickATM, LLC ("QuickATM")
for a purchase price of $500,000 in cash, and $1,250,000 in the Company's
common stock. The Company issued approximately 40,000 shares of common stock
valued at $31.10 per share.

  On March 20, 2000, the Company also entered into an agreement with 3Com
Corporation ("3Com") for the issuance of 20,000 shares of Series G Preferred
Stock for total gross proceeds of $20 million. The Series G Shares are
initially convertible into approximately 556,000 shares of CAIS common stock.
The Company also agreed to purchase $10 million of 3Com equipment over the
next year. The closing of the agreement is subject to the negotiation of a
definitive commercial and marketing agreement and apporoval under the Hart-
Scott-Rodino Antitrust Improvement Act of 1976.

Initial Public Offering

  Our initial public offering ("IPO") was effected through a Registration
Statement on Form S-1 (File No. 333-72769) that was declared effective by the
SEC on May 19, 1999, and pursuant to which we sold an aggregate of 6,842,100
shares of our common stock, including 842,100 shares pursuant to the exercise
of the underwriters' over-allotment option. The amount of net proceeds to the
Company from the IPO was approximately $118,233,000.

  As of December 31, 1999, we had used the net proceeds from our IPO as
follows:

<TABLE>
<CAPTION>
                                                                  (in thousands)
   <S>                                                            <C>
   Capital expenditures and network infrastructure...............    $42,183
   General corporate purposes....................................     17,004
   Sales and marketing...........................................     11,800
   Repay indebtedness............................................      7,000
   Redeem Series B preferred stock...............................      3,000
   Repay debt to discontinued operations.........................      2,100
   Research and development......................................      1,525
                                                                     -------
                                                                     $84,612
                                                                     =======
</TABLE>


                                      16
<PAGE>

Item 6. Selected Financial Data

  The following selected financial data should be read in conjunction with the
Consolidated Financial Statements and Notes to the Consolidated Financial
Statements and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" appearing elsewhere in this 10-K. The selected
financial data for the fiscal years ended December 31, 1996, 1997, 1998 and
1999 are derived from CAIS Internet's financial statements, which have been
audited by Arthur Andersen LLP, independent public accountants and included
elsewhere in this 10-K. The selected financial data for the period from
January 1, 1996 through May 10, 1996 are derived from Capital Area Internet
Service, Inc.'s financial statements which have been audited by Arthur
Andersen LLP, independent public accountants. The selected financial data for
the fiscal year ended December 31, 1995 are derived from unaudited financial
statements. The unaudited financial statements include all adjustments,
consisting of normal recurring accruals, which CAIS Internet considers
necessary for a fair presentation of the financial position and results of
operations for these periods. The financial data set forth for the periods
ended, or as of dates, on or prior to May 10, 1996 reflect the results of
operations of Capital Area prior to its acquisition by CAIS, Inc. and are
captioned as "predecessor." The historical financial data subsequent to May
10, 1996 reflect the results of operations of CAIS Internet's continuing
operations. In February 1999, CAIS Internet completed the spin-off of Cleartel
Communications, Inc. and for financial reporting purposes has accounted for
Cleartel Communications, Inc.'s results as discontinued operations.
Accordingly, the results of operations for Cleartel Communications, Inc. have
been excluded from the selected financial data below. The operating results
for the period ended December 31, 1999 are not necessarily indicative of the
results to be expected for any future period. Also, the operating results for
interim periods are not necessarily indicative of the results that might be
expected for the entire year.

  In 1999, the Company increased its capital expenditures and sales and
marketing programs for its hospitality and multi-family networks, and DSL
services. Additionally, the Company acquired Atcom (which was renamed CAIS
Software Solutions Inc.) and Business Anywhere. These activities affect the
comparability of the financial data and statements over time. The following
selected consolidated financial and operating data are qualified by and should
be read in conjunction with our more detailed Consolidated Financial
Statements and notes thereto and the discussion under "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included in
Part II, Items 7 and 8 of this Form 10-K.

                                      17
<PAGE>

              SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
                   (in thousands, except per share amounts)

<TABLE>
<CAPTION>
                               Predecessor                      Successor
                         ------------------------ ----------------------------------------
                                                   Inception
                                      Period from   (May 11,
                                       January 1     1996)
                          Year Ended    1996 to     through     Year Ended December 31,
                         December 31,   May 10,   December 31, ---------------------------
                             1995        1996         1996      1997      1998      1999
                         ------------ ----------- ------------ -------  --------  --------
                         (unaudited)
<S>                      <C>          <C>         <C>          <C>      <C>       <C>
Statements of
 Operations Data:
Net revenue............     $2,240      $1,287      $ 2,410    $ 4,556  $  5,315  $ 10,784
Cost of revenues.......        697         323          834      2,010     3,118     9,689
Operating costs and
 expenses:
  Selling, general and
   administrative......        514         339        2,126      5,329    10,434    39,693
  Research and
   development.........        --          --           --         221       223     1,593
  Depreciation and
   amortization........         82          42          631      1,117     1,270     7,666
  Fair value of stock
   issued to
   third party.........        --          --           --         --        --        723
  Non-cash
   compensation........        --          --           --         616     1,426     4,892
                            ------      ------      -------    -------  --------  --------
    Total operating
     costs and
     expenses..........        596         381        2,757      7,283    13,353    54,567
                            ------      ------      -------    -------  --------  --------
Loss from operations...        947         583       (1,181)    (4,737)  (11,156)  (53,472)
Net interest income
 (expense).............         (3)          2         (212)      (288)   (1,101)    1,035
                            ------      ------      -------    -------  --------  --------
Loss from continuing
 operations(1).........      $ 944       $ 585      $(1,393)   $(5,025) $(12,257) $(52,437)
                            ======      ======      =======    =======  ========  ========
Basic and diluted loss
 per share from
 continuing
 operations(1).........                             $ (0.14)   $ (0.52) $  (1.24) $  (3.10)
                                                    =======    =======  ========  ========
Weighted average shares
 outstanding--basic and
 diluted...............                               9,648      9,648     9,869    16,937
                                                    =======    =======  ========  ========
<CAPTION>
                         December 31,                          December 31,
                         ------------             ----------------------------------------
                             1995                     1996      1997      1998      1999
                         ------------             ------------ -------  --------  --------
                         (unaudited)
<S>                      <C>          <C>         <C>          <C>      <C>       <C>
Balance Sheet Data:
  Cash and cash
   equivalents.........     $  113                  $    73    $   149  $     95  $ 17,120
  Short-term
   investments.........        --                       --         --        --     16,501
  Working capital
   (deficit)...........        454                   (3,755)    (6,440)   (9,374)  (18,335)
  Total assets.........        997                   12,841     14,320    14,521   186,951
  Preferred stock......        --                       --         --        --     15,319
  Put warrants.........        --                       --         --        --      1,267
  Long-term debt, less
   current portion.....        --                     4,863      4,110    10,767       --
  Stockholders' equity
   (deficit)...........        748                   (3,412)    (5,996)  (14,761)  112,030
</TABLE>
--------
(1) Excludes an extraordinary loss on early extinguishment of debt for the
year ended December 31, 1999 of $551,000 or $(.03) per share.

                                      18
<PAGE>

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

  The following discussion should be read in conjunction with the Consolidated
Financial Statements and the Notes thereto contained elsewhere in this report.

  The cautionary statements set forth below and elsewhere in this Report
identify important risks and uncertainties that could materially adversely
affect our business, financial condition, results of operations or prospects.

Overview

  The Company is a nationwide provider of broadband Internet access solutions.
The Company operates two business segments: the visitor-based and multi-family
networks segment provides high-speed Internet access and content solutions for
hotels, apartment communities and other public areas using its patented
OverVoice solution and IPORT server software; and the Internet services
segment provides high-speed Internet access and content solutions for
businesses and consumers, DSL services using HyperDSL lines, always-on access
solutions for ISPs and businesses, and web hosting and other Internet
services. The Company operates a clear-channel Internet and ATM network, and
currently peers with public and private partners, and at national exchange
points MAE East, MAE East ATM, MAE West, and AADS. The Company entered into an
agreement with Qwest to expand the Company's network to 38 metropolitan areas
across the United States.

  During the years ended December 31, 1997, 1998 and 1999, the Company derived
a majority of its revenue from the sale of various Internet services,
including always-on Internet access services, web hosting and domain
registration services and, to a lesser extent, dial-up Internet access. During
the third quarter of 1999, the Company began to increase its visitor-based and
multi-family networks revenues, as it began to install its services in various
hotels and apartment communities, and acquire complementary businesses. The
Company incurred significant costs and devoted substantial resources
associated with the research, development and deployment of its visitor-based
and multi-family networks services. The costs included equipment, contract
labor for surveys and the actual property installation, and Internet bandwidth
and local loop connection charges. The Company capitalizes the costs of
installations in hotels and apartment buildings, including equipment and
labor.

  Through its bandwidth purchase in the Qwest IRU, the Company has made a
significant investment in its nationwide network infrastructure. The Company's
business plan will require substantial capital to fully develop, deploy, and
to fund start-up losses. The Company also plans to devote considerable sales
and marketing resources to the sale of its services in hotels and apartment
communities and its DSL services in the commercial and residential markets.
The Company plans to continue to expand its research and development
activities to develop new products and services to be offered using its
patented OverVoice and IPORT technologies.

  The Company's nationwide deployment of its services, and the expansion of
its network, will result in increased cost of revenues, selling, general and
administrative expenses and capital expenditures. The Company's ability to
generate positive cash flow from operations and achieve profitability is
dependent upon its ability to successfully expand its customer base for
visitor-based and multi-family networks and other services and achieve further
operating efficiencies. The Company might not be able to achieve or sustain
revenue growth, positive cash flow or profitability in the future.

Key Developments in the Year Ended December 31, 1999

  Initial Public Offering. In May 1999, the Company sold approximately 6.8
million shares of common stock, and raised gross proceeds of approximately
$130 million.

  New Long Term Networks Contracts and Buildout. As of December 31, 1999, the
Company signed hospitality and multi-family master agreements for the
provision of its services in approximately 10,400 buildings and 1.5 million
rooms/units, and installed its services in approximately 134 buildings and
27,500 rooms/units.

                                      19
<PAGE>

  Nortel Networks Partnership and Financing. On June 4, 1999, the Company
entered into a $30 million credit facility with Nortel Networks, and agreed to
utilize certain Nortel equipment in the Company's OverVoice hotel contracts.
The two companies are also working together to develop new technology
solutions to leverage the Company's patented OverVoice technology.

  Cisco Systems Partnership and Financing. On June 30, 1999, the Company
entered into a $50 million credit facility with Cisco Systems Capital
Corporation, and agreed to utilize certain Cisco equipment in the Company's
Internet backbone and OverVoice apartment community contracts. The two
companies are also working together to develop new technology solutions to
leverage the Company's patented OverVoice technology.

  Overnet Partnership. On June 10, 1999, the Company entered into a strategic
relationship with Overnet, a privately held company looking to develop
opportunities using the Company's OverVoice technology in Korea. Overnet has
entered into partnership agreements with three major Korean telecommunications
companies: Korea Informatics Telesis (a subsidiary of Korea Telecom); S1
Corporation (a subsidiary of Samsung); and Dreamline Corporation.

  Qwest investment and bandwidth purchase. In September 1999, Qwest
Communications Corporation ("Qwest") invested $15 million in the Company and
in the form of Series C Preferred Stock. Qwest also received warrants to
purchase 500,000 shares of the Company's common stock at $12.00 per share.
Additionally, the Company and Qwest entered into a twenty-year IRU agreement.
The Company purchased approximately $44 million of capacity on Qwest's fiber
network. The Qwest capacity will support the delivery of the Company's network
services up to 38 metropolitan areas by April 2000. The Company also committed
to purchase $10 million of Qwest's communications services over five years.
The IRU agreement terminates the Company's $100 million commitment in the
parties' June 1998 Memorandum of Understanding.

  Acquisition -- CAIS Software Solutions, Inc. (formerly Atcom, Inc.). The
Company acquired Atcom, Inc. ("Atcom") (subsequently renamed CAIS Software
Solutions, Inc.) in September 1999 to combine the Company's OverVoice hardware
technology with Atcom's IPORT server software and kiosk products to deliver
high speed Internet access solutions to hotels, apartment communities and
public areas, including shopping centers, airports, travel plazas and lobbies
and common areas.

  Acquisition -- Business Anywhere. The Company acquired Business Anywhere
USA, Inc. ("Business Anywhere") in September 1999 to expand its public area
services portfolio. Business Anywhere centers are self-operated, self-
contained units that offer most business services to travelers, including
round-the-clock access to printers, fax machines, copiers, and PCs with
Internet connectivity. The services are activated by touch-screen, and are
remotely monitored.

  Unisys. The Company entered into an alliance with Unisys Corporation
("Unisys") to accelerate a full range of Unisys installation, maintenance, and
end-user and network support services for CAIS Internet's solutions in hotels
and apartment communities. The partnership mobilizes a global workforce of
Unisys field operations, project managers and installers to install more than
200 hotel and apartment properties, or 60,000 units, per month.

  Portal. The Company introduced the hospitality industry's inaugural,
customized, Content Portal--and announced its plans to deliver the CAIS Portal
to guests at hotels under master agreement to deliver high speed Internet
access with the broadband company.

Business Segments

  Visitor-based and Multi-family Networks. The Company delivers high-speed
Internet access and content solutions to hotels, apartment communities and
other public areas across existing telephone lines at speeds up to 175 times
faster than 56K dial-up modems. As of December 31, 1999 the Company had master
contracts to install its services in approximately 10,400 properties and 1.5
million units/rooms.

                                      20
<PAGE>

  Internet Services. The primary services in the Company's Internet Services
segment include business digital subscriber line (HyperLan DSL), always-on
access and web hosting:

  HyperDSL Services: In 1999 the Company has initiated its roll-out of a new
  always-on, high-speed Internet access service using DSL technology under
  the name HyperLan DSL. The Company partners with Covad Communications Group
  to provide this service to small and medium-sized businesses. During the
  year ended December 31, 1999, the Company began to offer HyperLan DSL
  services in 13 U.S. metro areas. The Company intends to enter additional
  markets in 2000 as it expands its network with Qwest.

  High-Speed Always-On Access and Other Services: The Company provides
  dedicated Internet access to businesses and other Internet providers,
  including T-1, fractional T-1, DS-3 and fractional DS-3 services. The
  Company also provides web hosting and colocation services. In addition, the
  Company provides dial-up and other narrowband connectivity services which
  are not marketed generally.

Statements of Operations

  The Company records revenues for all services when the services are provided
to customers. Amounts for services billed in advance of the service period and
cash received in advance of revenues earned are recorded as unearned revenues
and recognized as revenue when earned. Upfront charges in connection with
service contracts are recognized ratably over the contract period. Customer
contracts for Internet access and web hosting services are typically for
periods ranging from one month to three years. Internet access services
typically require the customer to purchase equipment and pay for the related
installation fees. Revenues from equipment sales are recorded when delivery of
the related equipment is accepted by the customer. Dial-up access customers
typically subscribe to service on a monthly or annual basis.

  Cost of revenues include recurring expenses for the long haul bandwidth
lease and local interconnection charges from national and local fiber
providers. It also includes wholesale DSL resale charges, equipment costs and
amortization of DSL install and equipment charges incurred in connection with
term contracts.

  Research and development costs include internal research and development
activities and external product development agreements.

  Selling, general and administrative expenses are incurred in the areas of
sales and marketing, customer support, network operations and maintenance,
engineering, research and development, accounting and administration. Selling,
general and administrative expenses will increase over time as the Company's
operations, including the nationwide deployment of hotel and multi-family
services and the expansion of its HyperDSL services, increase. In addition,
significant levels of marketing activity may be necessary for the Company to
build or increase its customer base among hotel guests and apartment residents
to a significant enough size in a particular building or market. Any such
increased marketing efforts may have a negative effect on earnings.

  Operating results for any period are not necessarily indicative of results
for any future period. Also, the operating results for interim periods are not
necessarily indicative of the results that might be expected for the entire
year.

Year Ended December 31, 1999 Compared to Year Ended December 31, 1998

  Net revenues. Net revenues for the year ended December 31, 1999 increased
103% to approximately $10,784,000 from approximately $5,315,000 for the year
ended December 31, 1998. Net revenues increased primarily due to an increase
of approximately $3,383,000 in visitor-based and multi-family network revenues
(of which approximately $2,174,000 of the increase was for equipment sales),
$1,038,000 in DSL revenues, $743,000 Internet access services, and $304,000 in
web hosting services. The increases were due to an increase in the number of
properties and customers for these services, and the acquisitions of Atcom and
Business Anywhere.

                                      21
<PAGE>

  Cost of revenues. Cost of revenues for the year ended December 31, 1999
totaled approximately $9,689,000 or 90% of net revenues, compared to
approximately $3,118,000 or 59% of net revenues for the year ended December
31, 1998. This increase resulted primarily from increases of approximately
$1,833,000 in charges for visitor-based and multi-family network direct
equipment sales, $1,296,000 in visitor-based and multi-family network charges
for bandwidth and network installation, $2,253,000 in additional nationwide
bandwidth, and $1,129,000 in DSL charges for customer connectivity, equipment
and installation.

  Selling, general and administrative. Selling, general and administrative
expenses for the year ended December 31, 1999 totaled approximately
$39,693,000 or 368% of net revenues, compared to approximately $10,434,000 or
196% of net revenues for the year ended December 31, 1998. This increase
resulted primarily from increases of $3,906,000 related to visitor-based and
multi-family network payroll, $8,453,000 related to Internet services payroll,
$1,810,000 related to visitor-based and multi-family network costs (e.g.
marketing and professional fees and expenses), and $15,090,000 in advertising
and other sales, marketing and administrative expenses.

  Research and development. Research and development for the year ended
December 31, 1999 totaled approximately $1,593,000 or 15% of net revenues,
compared to approximately $223,000, or 4% of net revenues for the year ended
December 31, 1998. This increase resulted from the inclusion of research and
development labor costs incurred by CAISSoft after acquisition and various
development projects related to new hotel/multi-family services and products.

  Depreciation and amortization. Depreciation and amortization totaled
approximately $7,666,000 for the year ended December 31, 1999, compared to
approximately $1,270,000 for the year ended December 31, 1998. This increase
resulted from an increase of $1,273,000 in depreciation of capital assets to
support the expansion of the Company's network, $810,000 related to the
amortization of purchased contract rights from visitor-based and multi-family
network partners, and $4,313,000 related to the amortization of goodwill and
intangibles as a result of acquisitions.

  Fair value of stock issued to third party for services. Fair value of stock
issued to a third party for services totaled approximately $723,000 for the
year ended December 31, 1999. There was no comparable expense for the year
ended December 31, 1998.

  Non-cash compensation. Non-cash compensation totaled approximately
$4,892,000 for the year ended December 31, 1999, compared to approximately
$1,426,000 for the year ended December 31, 1998. This increase resulted from
the acceleration of deferred compensation charges that occurred as a result of
the IPO, and from the amortization of deferred compensation related to
additional stock options granted in 1999.

  Interest income (expense), net. Interest income (expense), net totaled
income of approximately $1,035,000 for the year ended December 31, 1999,
compared to expense of approximately $1,101,000 for the year ended December
31, 1998. This income total was attributable primarily to interest income
earned from the proceeds of the IPO, offset by interest expense and the
amortization of financing costs related to the Company's financing agreements.

  Loss from continuing operations. Loss from continuing operations totaled
approximately $52,437,000 for the year ended December 31, 1999, compared to
approximately $12,257,000 for the year ended December 31, 1998, due to the
foregoing factors.

  Income (loss) from discontinued operations. Loss from discontinued
operations totaled approximately $340,000 for the year ended December 31,
1999, compared to income of approximately $671,000 for the year ended ended
December 31, 1998. The decrease in loss amount for 1999 is attributable to the
spin-off of Cleartel at February 12, 1999.

  Extraordinary item--early extinguishment of debt. Extraordinary item--early
extinguishment of debt totaled approximately $551,000 for the year ended
December 31, 1999. This charge was related to the write-off of unamortized
debt discount and deferred financing fees associated with the repayment of the
$7 million loan from an investment banking firm. There were no extraordinary
items for the year ended December 31, 1998.


                                      22
<PAGE>

Year Ended December 31, 1998 Compared to Year Ended December 31, 1997

  Net revenues. Net revenues for the year ended December 31, 1998 increased
17% to approximately $5,315,000, compared to approximately $4,556,000 for the
year ended December 31, 1997. Net revenues increased primarily due to an
increase of $747,000 resulting from the sale of Internet access services and
an increase of $237,000 from the sale of web hosting services. Both of these
increases were due to an increase in the number of customers for these
services. This increase in net revenues was offset by a decrease in consulting
revenues from $159,000 in 1997 to zero in 1998.

  Cost of revenues. Cost of revenues for the year ended December 31, 1998
totaled approximately $3,118,000 or 59% of net revenues, compared to
approximately $2,010,000 or 44% of net revenues for the year ended December
31, 1997. This increase resulted primarily from an increase of $944,000 due to
the purchase of additional nationwide bandwidth and the expansion to new
geographic locations. CAIS Internet also incurred bandwidth and local
connection charges of $102,000 in 1998 for the deployment of visitor-based and
multi-family networks in trial properties. There was no OverVoice related cost
of revenues for 1997.

  Selling, general and administrative. Selling, general and administrative
expenses for the year ended December 31, 1998 totaled approximately
$10,434,000 or 196% of net revenues, compared to approximately $5,329,000 or
117% of net revenues for the year ended December 31, 1997. This increase
resulted primarily from increases of $910,000 attributable to Internet
services payroll, $1,671,000 related to Internet services administrative
costs, $2,177,000 related to visitor-based and multi-family network costs
(e.g., payroll, market trials and marketing and professional fees and
expenses) and $347,000 for professional fees relating to the October 1998
reorganization.

  Research and development. Research and development for the year ended
December 31, 1998 totaled approximately $223,000 or 4% of net revenues,
compared to approximately $221,000 or 5% of net revenues for the year ended
December 31, 1997.

  Depreciation and amortization. Depreciation and amortization totaled
approximately $1,270,000 for the year ended December 31, 1998, compared to
approximately $1,117,000 for the year ended December 31, 1997. This increase
was attributable primarily to the purchase of capital equipment necessary to
support the expansion of CAIS Internet's network.

  Non-cash compensation. Non-cash compensation totaled approximately
$1,426,000 for the year ended December 31, 1998, compared to approximately
$616,000 for the year ended December 31, 1997. This increase reflects
amortization of deferred compensation for an entire year in 1998 compared to a
partial year in 1997.

  Interest income (expense), net. Interest expense totaled approximately
$1,101,000 for the year ended December 31, 1998, compared to approximately
$288,000 for the year ended December 31, 1997. This increase was attributable
primarily to interest on indebtedness incurred, including amortization of
financing costs relating to our credit agreement with ING (U.S.) Capital LLC.

  Loss from continuing operations. Loss from continuing operations totaled
approximately $12,257,000 for the year ended December 31, 1998, compared to
approximately $5,025,000 for the year ended December 31, 1997, due to the
foregoing factors.

  Income (loss) from discontinued operations. Loss from discontinued
operations totaled $671,000 for the year ended December 31, 1998, compared to
income of approximately $1,923,000 for the year ended December 31, 1997. This
decrease in earnings resulted primarily from a reduction in net revenues
generated from operator assisted telephone calls.


                                      23
<PAGE>

Quarterly Results

  The following tables set forth certain unaudited quarterly financial data,
and such data expressed as a percentage of revenue, for the eight quarters
ended December 31, 1999. In the opinion of management, the unaudited financial
information set forth below has been prepared on the same basis as the audited
financial information included elsewhere herein and includes all adjustments,
consisting only of normal recurring adjustments, necessary to present fairly
the information set forth. The operating results for any quarter are not
necessarily indicative of results for any future period.

<TABLE>
<CAPTION>
                                                    Quarter Ended
                          ------------------------------------------------------------------------
                                       1998                                 1999
                          ----------------------------------  ------------------------------------
                          Mar 31   Jun 30   Sep 30   Dec 31   Mar 31   Jun 30    Sep 30    Dec 31
                          -------  -------  -------  -------  -------  -------  --------  --------
                                      (in thousands, except per share amounts)
<S>                       <C>      <C>      <C>      <C>      <C>      <C>      <C>       <C>
Net revenues(1).........  $ 1,242  $ 1,325  $ 1,357  $ 1,391  $ 1,609  $ 1,811  $  2,682  $  4,682
                          -------  -------  -------  -------  -------  -------  --------  --------

Cost of revenues........      717      750      776      875    1,050    1,518     2,558     4,563
Operating expenses......    2,704    2,819    3,201    4,629    4,533    9,538    16,080    24,416
                          -------  -------  -------  -------  -------  -------  --------  --------
Loss from operations....   (2,179)  (2,244)  (2,620)  (4,113)  (3,974)  (9,245)  (15,956)  (24,297)
                          -------  -------  -------  -------  -------  -------  --------  --------

Net interest income
 (expense)..............      (82)     (92)    (295)    (632)    (677)      85       992       635
                          -------  -------  -------  -------  -------  -------  --------  --------
Loss from continuing
 operations.............   (2,261)  (2,336)  (2,915)  (4,745)  (4,651)  (9,160)  (14,964)  (23,662)

Income (loss) from
 discontinued
 operations.............      154      211     (249)    (787)    (340)     --        --        --
                          -------  -------  -------  -------  -------  -------  --------  --------
Loss before
 extraordinary item.....   (2,107)  (2,125)  (3,164)  (5,532)  (4,991)  (9,160)  (14,964)  (23,662)
Extraordinary item--
 early extinguishment of
 debt...................      --       --       --       --       --      (551)      --        --
                          -------  -------  -------  -------  -------  -------  --------  --------
Net loss................   (2,107)  (2,125)  (3,164)  (5,532)  (4,991)  (9,711)  (14,964)  (23,662)
Dividends and accretion
 on preferred stock.....      --       --       --       --      (171)    (179)   (3,851)     (319)
                          -------  -------  -------  -------  -------  -------  --------  --------
Net loss attributable to
 common stockholders....  $(2,107) $(2,125) $(3,164) $(5,532) $(5,162) $(9,890) $(18,815) $(23,981)
                          =======  =======  =======  =======  =======  =======  ========  ========

Basic and diluted loss
 per share(2):
 Continuing operations,
  less dividends on
  preferred stock.......  $ (0.23) $ (0.23) $ (0.29) $ (0.48) $ (0.48) $ (0.65) $  (0.91) $  (1.06)
 Discontinued
  operations............     0.01     0.02    (0.03)   (0.08)   (0.04)     --        --        --
 Extraordinary item.....      --       --       --       --       --     (0.04)      --        --
                          -------  -------  -------  -------  -------  -------  --------  --------
 Total..................  $ (0.22) $ (0.21) $ (0.32) $ (0.56) $ (0.52) $ (0.69) $  (0.91) $  (1.06)
                          =======  =======  =======  =======  =======  =======  ========  ========
Basic and diluted
 weighted-average shares
 outstanding............    9,648    9,888    9,966    9,966    9,990   14,307    20,586    22,519
                          =======  =======  =======  =======  =======  =======  ========  ========
</TABLE>

--------
(1) Approximately $1,610,000 of net revenues for the quarter ended December
    31, 1999 represent equipment sales.
(2) Since there are changes in the weighted average number of shares
    outstanding each quarter, the sum of the loss per share by quarter does
    not equal the loss per share for 1998 and 1999.

                                      24
<PAGE>

<TABLE>
<CAPTION>
                                                 Quarter Ended
                            --------------------------------------------------------------
                                       1998                            1999
                            ------------------------------  ------------------------------
                            Mar 31  Jun 30  Sep 30  Dec 31  Mar 31  Jun 30  Sep 30  Dec 31
                            ------  ------  ------  ------  ------  ------  ------  ------
<S>                         <C>     <C>     <C>     <C>     <C>     <C>     <C>     <C>
Net revenues..............    100 %   100 %   100 %   100 %   100 %   100 %   100 %   100 %
                             ----    ----    ----    ----    ----    ----    ----    ----

Cost of revenues..........     58 %    56 %    57 %    63 %    65 %    84 %    95 %    98 %
Operating expenses........    217 %   213 %   236 %   333 %   282 %   527 %   600 %   521 %
                             ----    ----    ----    ----    ----    ----    ----    ----
Loss from operations......   (175)%  (169)%  (193)%  (296)%  (247)%  (511)%  (595)%  (519)%

Net interest income
 (expense)................     (7)%    (7)%   (22)%   (45)%   (42)%     5 %    37 %    14 %
                             ----    ----    ----    ----    ----    ----    ----    ----
Loss from continuing
 operations...............   (182)%  (176)%  (215)%  (341)%  (289)%  (506)%  (558)%  (505)%

Income (loss) from
 discontinued operations..     12 %    16 %   (18)%   (57)%   (21)%   --      --      --
                             ----    ----    ----    ----    ----    ----    ----    ----
Loss before extraordinary
 item.....................   (170)%  (160)%  (233)%  (398)%  (310)%  (506)%  (558)%  (505)%
Extraordinary item--early
 extinguishment of debt...    --      --      --      --      --      (30)%   --      --
                             ----    ----    ----    ----    ----    ----    ----    ----
Net loss..................   (170)%  (160)%  (233)%  (398)%  (310)%  (536)%  (558)%  (505)%
Dividends and accretion on
 preferred stock..........    --      --      --      --      (11)%   (10)%  (144)%    (7)%
                             ----    ----    ----    ----    ----    ----    ----    ----
Net loss attributable to
 common stockholders......   (170)%  (160)%  (233)%  (398)%  (321)%  (546)%  (702)%  (512)%
                             ====    ====    ====    ====    ====    ====    ====    ====
</TABLE>

  Our quarterly operating results have fluctuated and will continue to
fluctuate from period to period depending upon such factors as:

  .  the installation of our hospitality and multi-family properties,

  .  the success of our efforts and of our hospitality and multi-family
     partners to sell our services in installed buildings,

  .  the success of our efforts to expand our DSL and traditional Internet
     customer base, and to sell enhanced and value added services to existing
     customers,

  .  the timing of acquisitions,

  .  changes in and the timing of expenditures relating to the continued
     expansion of our network,

  .  the delivery of bandwidth from our global network providers,

  .  the development of new services, and

  .  changes in pricing policies by us or our competitors.

  In view of the significant historical growth of our operations, we believe
that period-to-period comparisons of our financial results should not be
relied upon as an indication of future performance and that we may experience
significant period-to-period fluctuations in operating results in the future.
We expect to focus in the near term on building and increasing our property
and customer base and increasing our network utilization both through internal
growth and through acquisitions which may require us from time to time to
increase our expenditures for personnel, marketing, network infrastructure and
the development of new services.

Liquidity and Capital Resources

  Prior to the IPO, the Company financed its operations with various debt and
private equity placements. During the year ended December 31, 1998, the
Company's continuing operations were also financed in part from operating
profits and cash flows generated from its now discontinued operation
(Cleartel). Net cash provided by (used in) operating activities for the years
ended December 31, 1997, 1998 and 1999 was approximately $692,000,
$(3,208,000) and $(15,329,000), respectively. Cash used in operating
activities in each period was primarily affected by the net losses caused by
increased costs relating to the Company's expansion in infrastructure and
personnel and sales and marketing activities for its Internet-related
businesses.

  In May 1999, the Company completed the IPO of its common stock. The Company
sold 6,842,100 shares (including the over-allotment option) of common stock
for approximately $130 million, yielding net proceeds to the Company of
approximately $118.2 million after deducting underwriting discounts and
commissions and other fees and expenses. The Company used approximately $12
million of the net proceeds to repay indebtedness and redeem shares of Series
B cumulative mandatory redeemable convertible preferred stock.

                                      25
<PAGE>

  At the completion of the IPO, the Company converted 2,827,168 shares of
Series A convertible preferred stock into an equal number of common shares. In
addition, the Company redeemed 745,645 Series B Shares for cash totaling
$3,000,000 (plus accrued interest of $104,000), and converted the remaining
Series B Shares into 81,946 shares of common stock.

  In September 1999, the Company issued to Qwest 125,000 shares of Series C
Preferred Stock, which is initially convertible into 1,250,000 shares of
common stock for total gross proceeds of $15,000,000. It also issued warrants
to acquire 500,000 shares of the Company's common stock at an exercise price
of $12.00 per share. The Company incurred approximately $40,000 of offering
costs paid to third parties. The Series C Preferred Stock ranks prior to the
Company's common stock with respect to dividends and rights upon liquidation,
dissolution, or winding up of the Company. Each holder of Series C Preferred
Stock is entitled: (i) to receive, when, as and if declared by the Company's
Board of Directors, cumulative dividends of $10.20 per annum per share; (ii)
to a liquidation preference equal to the sum of $120.00 per share, plus any
accrued but unpaid dividends; (iii) to the number of votes equal to the number
of whole shares of common stock into which all of the shares of Series C
Preferred Stock held by such holder are convertible; and (iv) to certain
demand and piggyback registration rights. Subject to certain limitations, each
share of Series C Preferred Stock is convertible, at the option of the holder,
into such number of fully paid and nonassessable shares of common stock at the
ratio of ten common shares for each share of Series C Preferred Stock. The
Company shall redeem (i) up to 41,667 shares of the Series C Preferred Stock
by the second anniversary of the date of issuance of the Series C Preferred
Stock; and (ii) the remaining shares of the Series C Preferred Stock upon the
third anniversary of the date of issuance of the Series C Preferred Stock.

  Approximately $3.9 million of the proceeds received were allocated to the
value of the warrants to acquire 500,000 shares of the Company's common stock
at $12.00 per share. The warrants have been valued at their estimated fair
value of $7.70 per share (or approximately $3,851,000 in the aggregate) based
on the Black-Scholes valuation model. The warrants expire on October 28, 2002.

  As the Series C Preferred Stock is immediately convertible into common
stock, the discount on the preferred stock (as a result of the allocation of
proceeds to the warrants) was fully accreted on the date of issuance and is
reflected as a dividend on preferred stock in the accompanying financial
statements.

  The Company and Nortel Networks, Inc. ("Nortel Networks") entered into a
five-year, $30 million equipment financing line of credit, dated as of June 4,
1999, and several amendments. As of December 31, 1999, the Company had
borrowed approximately $2.7 million under this credit facility. Borrowings
outstanding as of December 31, 1999 incur interest expense at rates ranging
from 10.3 to 10.9 percent. The facility requires the Company to meet certain
financial covenants including revenue targets and leverage and debt service
ratios. In addition, on April 1, 1999, the Company and Nortel Networks entered
into an agreement to purchase $10 million of Nortel equipment by April 1,
2000. The Company will be subject to a reduction in its purchase discount
percentages after that date if its annual purchases do not exceed $10 million
for the year ended April 1, 2001 and $9.9 million for the year ended April 1,
2002. The remaining commitment as of December 31, 1999 was $5.3 million for
the initial April 1, 2000 deadline.

  The Company and Cisco Systems Capital Corporation entered into a three-year,
$50 million equipment financing line of credit, dated as of June 30, 1999, and
several amendments. Under the facility, $50 million is available during the
first two years of the facility provided the Company meets certain financial
performance requirements. The line of credit bears interest at an annual rate
equal to the three-month LIBOR plus 6.0%. The facility requires the Company to
meet certain financial covenants including EBITDA targets, revenue targets and
leverage ratios. Borrowings under the facility are secured by a first priority
lien in all assets of the Company, other than its property securing the Nortel
facility, in which assets Cisco will have a second priority lien. As of
December 31, 1999, the Company had not borrowed under this credit facility.
The Company obtained a waiver from Cisco for financial covenant violations as
of December 31, 1999. Subsequent to year-end, the Company and Cisco amended
the financial covenants of this agreement for the remainder of the term of
this facility.

  On December 20, 1999, the Company entered into a Preferred Stock Purchase
Agreement ("Purchase Agreement") between CII Ventures LLC, an affiliate of the
private investment firm Kohlberg Kravis Roberts &

                                      26
<PAGE>

Co. (KKR). Under the Purchase Agreement, KKR, through its affiliate, will make
a strategic investment of up to $200 million in the Company. CII Ventures will
purchase $100 million of the Company's Series D convertible participating
preferred stock ("Series D Shares"). The Series D Shares will be convertible
into common stock of the Company, with an initial conversion price of $16.50
per share, subject to adjustment. The Purchase Agreement also includes a one-
year option for CII Ventures to purchase up to an additional $100 million of
Series E convertible participating preferred stock ("Series E Shares"). The
Series E Shares are convertible into the Company's common stock, with a
conversion price of $20.00 per share, subject to adjustment. Based on the
Company's capitalization at December 31, 1999, the investment by KKR in the
Series D Shares would represent a 16 percent fully diluted capital interest in
the Company. Upon the exercise of the option for the Series E Shares, the
investment by KKR in the Series D and Series E Shares would represent a 26
percent fully diluted capital interest in the Company. The holders of the
Series D and Series E Shares will be entitled to receive dividends, payable in
additional Series D and Series E shares, at a rate of 6 percent per annum
compounded quarterly.

  Under a Stockholders Agreement, KKR has certain rights to board
representation, stock registration, and must consent with respect to certain
corporate actions by the Company, including share issuances and mergers and
other business combinations, subject to certain exceptions.

  As of December 31, 1999, the Company had cash and cash equivalents, and
short-term investments of approximately $33.6 million. In February 2000, the
Company received a investment of $73.9 million of the initial $100 million
from KKR in Series D shares for net proceeds of $67.7 million, and expects to
receive the remaining $26.1 million of Series D shares in May 2000 for net
proceeds of $25.0 million, after approval of the additional shares at a
special meeting of the Company's stockholders. In addition to the KKR option
for the $100 million investment in Series E shares in 2001, the Company may
require additional financing to meet its anticipated cash needs over the next
several years, and is actively exploring alternatives for such financing. If
such sources of financing are insufficient or unavailable, or if the Company
experiences shortfalls in anticipated revenues or increases in anticipated
expenses, the Company would curtail the planned roll-out of its services and
reduce marketing and development activities.

  The Company from time to time engages in discussions involving potential
business acquisitions. Depending on the circumstances, the Company may not
disclose material acquisitions until completion of a definitive agreement. The
Company may determine to raise additional debt or equity capital to finance
potential acquisitions and/or to fund accelerated growth. Any significant
acquisitions or increases in the Company's growth rate could materially affect
the Company's operating and financial expectations and results, liquidity and
capital resources.

Impact of the Year 2000 Issue

  Many computer programs were been written using two digits rather than four
to define the applicable year. This posed a problem at the end of the century
because these computer programs may have recognized a date using "00" as the
year 1900 rather than the year 2000. This, in turn, could result in major
system failures or miscalculations, and is generally referred to as the "Year
2000 issue." The Company's failure to correct a material Year 2000 problem
could result in an interruption in, or a failure of, the Company's normal
business activities and operations.

  Prior to December 31, 1999, the Company made custom coding enhancements and
other necessary modifications to its mission-critical internal business
systems, as well as to other internal business systems. We believe that such
internal systems are now Year 2000 compliant.

  During the year ended December 31, 1999, the Company spent approximately
$72.9 million for capital expenditures related to the upgrade and continuing
build-out of its technical operations and network. The Company believes that
all of this equipment is Year 2000 compliant. In addition, the Company
acquired a new billing and customer care system as part of its business
strategy, which the Company believes is Year 2000 compliant. If the Company
uncovers the need for additional expenditures related to Year 2000, it may
have a material adverse effect on the Company's business, financial condition
or results of operations.

                                      27
<PAGE>

  To date, the Company has not experienced any material problems attributable
to the inability to recognize dates beginning with the Year 2000 in its
products, equipment, services, systems, or internal systems or those of our
external suppliers. Although the Company believes that it has successfully
modified its products, equipment, services, and systems as necessary to be
Year 2000 compliant, it cannot be sure that its operations do not contain
undetected errors or defects associated with Year 2000 functions that may
result in material costs to us. Its business could suffer if we fail to make
its operations Year 2000 compliant in time.

  The Company currently believes that its most likely, worst case scenario
related to the Year 2000 issue is associated with potential concerns with its
partners' and suppliers' Internet operations. To the extent that one or more
of these third parties experience Year 2000 problems, which would lead to
decreased Internet usage and the delay or inability to obtain necessary data
communication and telecommunication capacity, the Company's network and
services could be adversely affected.

  The Company cannot guarantee that it will be able to timely and successfully
modify its products, services and systems to comply with Year 2000
requirements. Any failure to do so could have a material adverse effect on the
Company's operating results. Furthermore, despite the aforementioned testing
performed by the Company and its vendors, the Company's products, services and
systems may contain undetected errors or defects associated with Year 2000
date functions. In the event any material errors or defects are not detected
and fixed, or third parties cannot timely provide the Company with products,
services or systems that meet the Year 2000 requirements, the Company's
operating results could be materially adversely affected. Known or unknown
errors or defects that affect the operation of the Company's products,
services or systems could result in delay or loss of revenue, interruption of
network services, cancellation of customer contracts, diversion of development
resources, damage to the Company's reputation and litigation costs. The
Company cannot guarantee that these or other factors relating to Year 2000
compliance issues will not have a material adverse effect on the Company's
business.

Subsequent Events

  On January 26, 2000, the Company entered an agreement with Bass to provide
the Company's services to approximately 2,750 hotel properties and 400,000
hotel rooms. The Company will pay contract rights to individual hotels at a
rate of $25 per room when a hotel contracts for service. Additionally, the
Company will contribute up to approximately $2.2 million in marketing and
technology development funds. In connection with this agreement, the Company
issued 63,000 warrants to Bass effective February 1, 2000 with an exercise
price of $40.01 per share.

  On February 9, 2000, the Company announced that it had entered into an
agreement with Mid-America to provide the Company's services to approximately
35,000 apartment homes in 110 apartment communities. The Company paid Mid-
America approximately $778,000 for contract rights for installation and
marketing.

  On February 28, 2000, the Company announced that it had completed the sale
of $73.9 million of Series D convertible participating preferred stock on
February 25, 2000 to an affiliate of KKR. Under a Purchase Agreement dated as
of December 20, 1999, KKR will purchase an additional $26.1 million of Series
D Shares after approval of the Company's stockholders. In conjunction with the
initial purchase of the Series D Shares, two KKR nominees joined the Company's
Board of Directors and KKR was granted a one-year option to purchase $100
million of Series E Shares. The issuance of the Series E Shares pursuant to
the option also is subject to the approval of the Company's stockholders. Upon
the exercise of the option for the Series E Shares, KKR will have the right to
elect an additional director on the Company's Board of Directors.

  On March 15, 2000, CAIS Software Solutions, Inc., a wholly owned subsidiary
of the Company, entered into an agreement to purchase the contracts,
intellectual property, and certain other assets of QuickATM, LLC ("QuickATM")
for a purchase price of $500,000 in cash, and $1,250,000 in the Company's
common stock. The Company issued approximately 40,000 shares of common stock
valued at $31.10 per share.

                                      28
<PAGE>

  On March 20, 2000, the Company also entered into an agreement with 3Com
Corporation ("3Com") for the issuance of 20,000 shares of Series G Preferred
Stock for total gross proceeds of $20 million. The Series G shares are
initially convertible into approximately 556,000 shares of CAIS common stock.
The Company also agreed to purchase $10 million of 3Com equipment over the
next year. The closing of the agreement is subject to the negotiation of a
definitive commercial and marketing agreement and approval under the Hart-
Scott-Rodino Antitrust Improvements Act of 1976.

Item 7a. Quantitative And Qualitative Disclosures About Market Risk

  The Company has limited exposure to financial market risks, including
changes in interest rates. At December 31, 1999, the Company had short-term
investments of approximately $16.5 million. These short-term investments
consist of highly liquid investments in debt obligations of highly rated
entities with maturities of between 91 and 270 days. These investments are
subject to interest rate risk and will fall in value if market interest rates
increase. The Company expects to hold these investments until maturity, and
therefore expects to realize the full value of these investments, even though
changes in interest rates may affect their value prior to maturity. If
interest rates decline over time, this will result in a reduction of our
interest as our cash is reinvested at lower rates.

  At December 31, 1999, the Company had notes payable in the aggregate amount
of $2.7 million. A change of interest rates would affect its obligations under
these agreements. Increases in interest rates would increase the interest
expense associated with future borrowings and borrowings under its equipment
financing agreements.

                                      29
<PAGE>

Item 8. Financial Statements And Supplementary Data

                         Index to Financial Statements

<TABLE>
<CAPTION>
                                                                           Page
                                                                           ----
<S>                                                                        <C>
1. Financial Statements:

  Report of Independent Public Accountants................................  31

  Consolidated Balance Sheets as of December 31, 1998 and 1999............  32

  Consolidated Statements of Operations for the years ended December 31,
   1997, 1998 and 1999....................................................  33

  Consolidated Statements of Changes in Stockholders' (Deficit) Equity for
   the years ended December 31, 1997, 1998 and 1999.......................  34

  Consolidated Statements of Cash Flows for the years ended December 31,
   1997, 1998 and 1999....................................................  36

  Notes to Consolidated Financial Statements..............................  37
</TABLE>

                                       30
<PAGE>

                   Report of Independent Public Accountants

To CAIS Internet, Inc. and subsidiaries
(formerly CGX Communications, Inc.):

  We have audited the accompanying consolidated balance sheets of CAIS
Internet, Inc. (a Delaware corporation, formerly CGX Communications, Inc.) and
subsidiaries, as of December 31, 1999 and 1998, and the related consolidated
statements of operations, changes in stockholders' (deficit) equity, and cash
flows for each of the three years in the period ended December 31, 1999. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

  In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of CAIS Internet, Inc. and subsidiaries, as of December 31, 1999 and 1998, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1999, in conformity with
generally accepted accounting principles in the United States.

                                          Arthur Andersen LLP

Vienna, Virginia
March 6, 2000 (except with respect to
the matters discussed in Note 15 to the
consolidated financial statements,
which are indicated to have occurred
subsequent to March 6, 2000, as to
which the date is March 20, 2000).


                                      31
<PAGE>

                              CAIS INTERNET, INC.

                          CONSOLIDATED BALANCE SHEETS

                      (in thousands, except share amounts)

<TABLE>
<CAPTION>
                                                              December 31,
                                                            ------------------
                                                              1998      1999
                                                            --------  --------
<S>                                                         <C>       <C>
Current Assets
  Cash and cash equivalents...............................  $     95  $ 17,120
  Short-term investments..................................       --     16,501
  Accounts receivable, net of allowance for doubtful
   accounts of $137 and $249, respectively................       648     3,090
  Prepaid expenses and other current assets...............       228     2,571
  Current assets of discontinued operations...............     8,170       --
                                                            --------  --------
    Total current assets..................................     9,141    39,282
Property and equipment, net...............................     2,638    90,476
Deferred offering costs...................................       237       --
Deferred debt financing costs, net........................       292     1,499
Intangible assets and goodwill, net.......................       277    51,059
Receivable from officers..................................       --        450
Other assets..............................................       --      4,185
Non-current assets of discontinued operations.............     1,936       --
                                                            --------  --------
    Total assets..........................................  $ 14,521  $186,951
                                                            ========  ========
Current liabilities
  Accounts payable and accrued expenses...................  $  4,396  $ 53,779
  Notes payable...........................................       --      2,680
  Obligations under capital lease.........................       --        312
  Payable to discontinued operations......................     5,342       --
  Unearned revenues.......................................       572       846
  Current liabilities of discontinued operations..........     8,205       --
                                                            --------  --------
    Total current liabilities.............................    18,515    57,617
Loan, net of unamortized debt discount of $511 and $0,
 respectively.............................................     6,183       --
Notes payable to related parties, net of current portion..     1,983       --
Other long-term liabilities...............................       --        718
Long-term liabilities of discontinued operations..........     2,601       --
                                                            --------  --------
    Total liabilities.....................................    29,282    58,335
                                                            --------  --------
Series C cumulative mandatory redeemable convertible
 preferred stock; 125,000 shares authorized, issued and
 outstanding as of December 31, 1999 (aggregate
 liquidation preference of $15,319).......................       --     15,319
                                                            --------  --------
Put warrants..............................................       --      1,267
                                                            --------  --------
Commitments and contingencies (Note 12)
Stockholders' (deficit) equity
  Common stock, $0.01 par value; 100,000,000 shares
   authorized; 9,965,505 and 22,608,331 shares issued and
   9,965,505 and 22,595,565 shares outstanding,
   respectively...........................................       100       226
  Additional paid-in capital..............................     7,794   188,569
  Warrants outstanding....................................     1,226    13,234
  Deferred compensation...................................    (2,888)   (2,673)
  Treasury stock, 12,766 shares of common stock...........       --       (150)
  Accumulated deficit.....................................   (20,993)  (87,176)
                                                            --------  --------
    Total stockholders' (deficit) equity .................   (14,761)  112,030
                                                            --------  --------
    Total liabilities and stockholders' (deficit) equity
     .....................................................  $ 14,521  $186,951
                                                            ========  ========
</TABLE>

   The accompanying notes are an integral part of these consolidated balance
                                    sheets.

                                       32
<PAGE>

                              CAIS INTERNET, INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS

                    (in thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                    Years Ended December 31,
                                                    ---------------------------
                                                     1997      1998      1999
                                                    -------  --------  --------
<S>                                                 <C>      <C>       <C>
Net revenues:
  Equipment.......................................  $   146  $     72  $  2,186
  Services........................................    4,410     5,243     8,598
                                                    -------  --------  --------
    Total net revenues............................    4,556     5,315    10,784
                                                    -------  --------  --------
Cost of revenues:
  Equipment.......................................      120        58     1,833
  Services........................................    1,890     3,060     7,856
                                                    -------  --------  --------
    Total cost of revenues........................    2,010     3,118     9,689
                                                    -------  --------  --------
Operating expenses:
  Selling, general and administrative.............    5,329    10,434    39,693
  Research and development........................      221       223     1,593
  Depreciation and amortization...................    1,117     1,270     7,666
  Fair value of stock issued to third party for
   services.......................................      --        --        723
  Non-cash compensation...........................      616     1,426     4,892
                                                    -------  --------  --------
    Total operating expenses......................    7,283    13,353    54,567
                                                    -------  --------  --------
Loss from operations..............................   (4,737)  (11,156)  (53,472)
Interest income (expense), net:
  Interest income.................................        2       --      2,419
  Interest expense................................     (290)   (1,101)   (1,384)
                                                    -------  --------  --------
    Total interest income (expense), net..........     (288)   (1,101)    1,035
                                                    -------  --------  --------
Loss from continuing operations before income
 taxes............................................   (5,025)  (12,257)  (52,437)
Provision for income taxes........................      --        --        --
                                                    -------  --------  --------
Loss from continuing operations...................   (5,025)  (12,257)  (52,437)
Income (loss) from discontinued operations........    1,923      (671)     (340)
                                                    -------  --------  --------
Loss before extraordinary item....................   (3,102)  (12,928)  (52,777)
Extraordinary item--early extinguishment of debt..      --        --       (551)
                                                    -------  --------  --------
Net loss..........................................   (3,102)  (12,928)  (53,328)
Dividends and accretion on preferred stock........      --        --     (4,520)
                                                    -------  --------  --------
Net loss attributable to common stockholders......  $(3,102) $(12,928) $(57,848)
                                                    =======  ========  ========
Basic and diluted earnings (loss) per share:
  Loss attributable to common stockholders before
   discontinued operations and extraordinary
   item...........................................  $  (.52) $  (1.24) $  (3.37)
  Discontinued operations.........................      .20      (.07)     (.02)
  Extraordinary item..............................      --        --       (.03)
                                                    -------  --------  --------
    Total.........................................  $  (.32) $  (1.31) $  (3.42)
                                                    =======  ========  ========
Basic and diluted weighted-average shares
 outstanding......................................    9,648     9,869    16,937
                                                    =======  ========  ========
</TABLE>

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

                                       33
<PAGE>

                              CAIS INTERNET, INC.

      CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' (DEFICIT) EQUITY

              For the Years Ended December 31, 1997, 1998 and 1999
                                 (in thousands)

<TABLE>
<CAPTION>
                            Redeemable Convertible Preferred Stock
                         -------------------------------------------------
                            Series A          Series B         Series C
                         ----------------  ---------------  --------------
                                                                             Put
                         Shares   Amount   Shares  Amount   Shares Amount  Warrants
                         ------  --------  ------  -------  ------ ------- --------
<S>                      <C>     <C>       <C>     <C>      <C>    <C>     <C>
December 31, 1996.......    --   $    --     --    $   --     --   $   --   $  --
 Unearned compensation
  pursuant to issuance
  of stock options......    --        --     --        --     --       --      --
 Amortization of
  unearned
  compensation..........    --        --     --        --     --       --      --
 Distributions declared
  to equity holders.....
 Net loss...............    --        --     --        --     --       --      --
                         ------  --------  -----   -------   ----  -------  ------
December 31, 1997.......    --        --     --        --     --       --      --
 Shares issuable upon
  settlement............    --        --     --        --     --       --      --
 Distributions declared
  to equity holders.....
 Capital contribution...    --        --     --        --     --       --      --
 Issuance of common
  stock.................    --        --     --        --     --       --      --
 Warrants issued in
  connection with loan..    --        --     --        --     --       --      --
 Amortization of
  unearned
  compensation..........    --        --     --        --     --       --      --
 Net loss...............    --        --     --        --     --       --      --
                         ------  --------  -----   -------   ----  -------  ------
December 31, 1998.......    --        --     --        --     --       --      --
 Issuance of common
  stock and options in
  connection with
  litigation
  settlement............    --        --     --        --     --       --      --
 Issuance of Series A,
  Series B and Series C
  Preferred Stock, net
  of offering costs of
  $175 and amounts
  allocated to
  warrants..............  2,827     3,209  1,120     4,557    125   11,149     --
 Capital contribution...    --        --     --        --     --       --      --
 Distribution of
  Cleartel net assets...    --        --     --        --     --       --      --
 Initial public offering
  gross proceeds, net of
  underwriting discounts
  and commissions and
  other IPO fees and
  expenses..............    --        --     --        --     --       --      --
 Accrued dividends on
  preferred shares and
  accretion of
  discount..............    --        246    --        104    --       319     --
 Accretion of Series A
  and Series C Preferred
  Stock warrant and
  issuance costs........    --      8,292    --        --     --     3,851     --
 Conversion of Series A
  and Series B Preferred
  Stock and accrued
  dividend to common
  stock................. (2,827)  (11,747)  (374)   (1,557)   --       --      --
 Redemption of Series B
  Preferred Stock.......    --        --    (746)   (3,104)   --       --      --
 Issuance of common
  stock to third party..    --        --     --        --     --       --      --
 Issuance of put
  warrants..............    --        --     --        --     --       --    1,267
 Unearned compensation
  pursuant to issuance
  of stock options......    --        --     --        --     --       --      --
 Amortization of
  unearned
  compensation..........    --        --     --        --     --       --      --
 Issuance of common
  stock for
  acquisitions..........    --        --     --        --     --       --      --
 Exercise of stock
  options...............    --        --     --        --     --       --      --
 Treasury stock.........    --        --     --        --     --       --      --
 Net loss...............    --        --     --        --     --       --      --
                         ------  --------  -----   -------   ----  -------  ------
December 31, 1999.......    --   $    --     --    $   --     125  $15,319  $1,267
                         ======  ========  =====   =======   ====  =======  ======
</TABLE>

                                                                     (Continued)

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


                                       34
<PAGE>

                              CAIS INTERNET, INC.

      CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' (DEFICIT) EQUITY

              For the Years Ended December 31, 1997, 1998 and 1999
                                 (in thousands)

<TABLE>
<CAPTION>
                                                Stockholders' (Deficit) Equity
                         -----------------------------------------------------------------------------
                         Common Stock
                         ------------  Additional
                                        Paid-in    Warrants     Deferred   Treasury  Accum.
                         Shares   Par   Capital   Outstanding Compensation  Stock   Deficit    Total
                         ------- ----- ---------- ----------- ------------ -------- --------  --------
<S>                      <C>     <C>   <C>        <C>         <C>          <C>      <C>       <C>
December 31, 1996.......   9,648 $  97  $  1,300    $   --      $   --      $ --    $ (4,809) $ (3,412)
 Unearned compensation
  pursuant to issuance
  of stock options......     --    --      4,930        --       (4,930)      --         --        --
 Amortization of
  unearned
  compensation..........     --    --        --         --          616       --         --        616
 Distributions declared
  to equity holders.....     --    --        --         --          --        --         (98)      (98)
 Net loss...............     --    --        --         --          --        --      (3,102)   (3,102)
                         ------- -----  --------    -------     -------     -----   --------  --------
December 31, 1997.......   9,648    97     6,230        --       (4,314)      --      (8,009)   (5,996)
 Shares issuable upon
  settlement............     --    --        250        --          --        --       ----        250
 Distributions declared
  to equity holders.....     --    --        --         --          --        --         (56)      (56)
 Capital contribution...     --    --        317        --          --        --         --        317
 Issuance of common
  stock.................     317     3       997        --          --        --         --      1,000
 Warrants issued in
  connection with loan..     --    --        --       1,226         --        --         --      1,226
 Amortization of
  unearned
  compensation..........     --    --        --         --        1,426       --         --      1,426
 Net loss...............     --    --        --         --          --        --     (12,928)  (12,928)
                         ------- -----  --------    -------     -------     -----   --------  --------
December 31, 1998.......   9,965   100     7,794      1,226      (2,888)      --     (20,993)  (14,761)
 Issuance of common
  stock and options in
  connection with
  litigation
  settlement............      25   --        --         --          --        --         --        --
 Issuance of Series A,
  Series B and Series C
  Preferred Stock, net
  of offering costs of
  $175 and amounts
  allocated to
  warrants..............     --    --        --      12,008         --        --         --     12,008
 Capital contribution...     --    --      1,083        --          --        --         --      1,083
 Distribution of
  Cleartel net assets...     --    --        --         --          --        --         (43)      (43)
 Initial public offering
  gross proceeds, net of
  underwriting discounts
  and commissions and
  other IPO fees and
  expenses..............   6,842    68   118,165        --          --        --         --    118,233
 Accrued dividends on
  preferred shares and
  accretion of
  discount..............     --    --        --         --          --        --        (669)     (669)
 Accretion of Series A
  and Series C Preferred
  Stock warrant and
  issuance costs........     --    --        --         --          --        --     (12,143)  (12,143)
 Conversion of Series A
  and Series B Preferred
  Stock and accrued
  dividend to common
  stock.................   2,909    29    13,275        --          --        --         --     13,304
 Redemption of Series B
  Preferred Stock.......     --    --        --         --          --        --         --        --
 Issuance of common
  stock to third party..      67     1       722        --          --        --         --        723
 Issuance of put
  warrants..............     --    --        --         --          --        --         --        --
 Unearned compensation
  pursuant to issuance
  of stock options......     --    --      4,677        --       (4,677)      --         --        --
 Amortization of
  unearned
  compensation..........     --    --        --         --        4,892       --         --      4,892
 Issuance of common
  stock for
  acquisitions..........   2,615    26    42,461        --          --        --         --     42,487
 Exercise of stock
  options...............     185     2       392        --          --        --         --        394
 Treasury stock.........     --    --        --         --          --       (150)       --       (150)
 Net loss...............     --    --        --         --          --        --     (53,328)  (53,328)
                         ------- -----  --------    -------     -------     -----   --------  --------
December 31, 1999 ......  22,608 $ 226  $188,569    $13,234     $(2,673)    $(150)  $(87,176) $112,030
                         ======= =====  ========    =======     =======     =====   ========  ========
</TABLE>

                                                                     (Concluded)

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

                                       35
<PAGE>

                              CAIS INTERNET, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

                                 (in thousands)

<TABLE>
<CAPTION>
                                                   Years Ended December 31,
                                                   ---------------------------
                                                    1997      1998      1999
                                                   -------  --------  --------
<S>                                                <C>      <C>       <C>
Cash flows from operating activities:
 Net loss......................................... $(3,102) $(12,928) $(53,328)
 Adjustments to reconcile net loss to net cash
  provided by (used in) operating activities:
 Non-cash compensation pursuant to stock
  options.........................................     616     1,426     4,892
 Amortization of debt discount and deferred
  financing costs.................................     --        555       864
 Extraordinary item--early extinguishment of
  debt............................................     --        --        551
 Loss on disposal of fixed assets.................      63       --        --
 Fair value of shares issued to third party for
  services........................................     --        --        723
 Depreciation and amortization....................   1,117     1,270     7,666
 Depreciation and amortization of discontinued
  operations......................................     668       519        58
 Changes in operating assets and liabilities, net
  of effect of acquisitions:
  Accounts receivable, net........................    (104)     (182)   (2,112)
  Prepaid expenses and other current assets.......     (46)     (149)   (2,286)
  Other assets....................................     --        --     (1,211)
  Accounts payable and accrued liabilities........     380     2,986    31,935
  Payable to discontinued operations..............   2,755     1,047    (3,892)
  Unearned revenues...............................     147       116       274
  Shares issuable upon settlement.................     --        250       --
  Other long-term liabilities.....................     --        --        610
  Changes in operating assets and liabilities of
   discontinued operations........................  (1,802)    1,882       (73)
                                                   -------  --------  --------
   Net cash provided by (used in) operating
    activities....................................     692    (3,208)  (15,329)
                                                   -------  --------  --------
Cash flows from investing activities:
 Purchases of property and equipment..............    (556)   (1,435)  (72,916)
 Purchases of property and equipment of
  discontinued operations.........................    (551)     (387)      (14)
 Purchases of restricted investments..............     --        --       (160)
 Purchases of short-term investments..............     --        --    (16,501)
 Cash paid for acquisitions, net of cash
  acquired........................................     --        --     (1,394)
 Investment in equity holdings....................     --        --     (2,574)
 Payment of visitor-based and multi-family network
  contract rights.................................     --        --    (11,795)
 Net payments received (advanced) on notes
  receivable......................................     129      (265)     (570)
 Net payments received on related party accounts
  receivable......................................     180       317       --
                                                   -------  --------  --------
   Net cash used in investing activities..........    (798)   (1,770) (105,924)
                                                   -------  --------  --------
Cash flows from financing activities:
 Net (repayments) borrowings under receivables-
  based credit facility of discontinued
  operations......................................    (211)   (1,451)      313
 Borrowings under notes payable...................     --        --      2,680
 Borrowings under Loan............................     --      7,000       --
 Repayments under Loan............................     --        --     (7,000)
 Borrowings under long-term debt..................     600       --        --
 Repayments under long-term debt..................    (367)   (2,000)      --
 Borrowings under notes payable--related parties..     675     1,000     1,000
 Repayments under notes payable--related parties..    (162)     (107)      --
 Principal payments under capital lease
  obligations.....................................    (337)     (173)      (11)
 Payment of loan commitment, debt financing, and
  offering costs..................................     (16)     (345)     (442)
 Net proceeds from issuance of Series A Preferred
  Stock...........................................     --        --     11,365
 Redemption of Series B Preferred Stock...........     --        --     (3,104)
 Net proceeds from issuance of Series C Preferred
  Stock and warrants..............................     --        --     15,000
 Net proceeds from initial public offering........     --        --    118,233
 Proceeds from issuance of common stock...........     --      1,000       394
 Repurchase of common stock.......................     --        --       (150)
                                                   -------  --------  --------
   Net cash provided by financing activities......     182     4,924   138,278
                                                   -------  --------  --------
Net increase (decrease) in cash and cash
 equivalents......................................      76       (54)   17,025
Cash and cash equivalents, beginning of period....      73       149        95
                                                   -------  --------  --------
Cash and cash equivalents, end of period.......... $   149  $     95  $ 17,120
                                                   =======  ========  ========
</TABLE>

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

                                       36
<PAGE>

                              CAIS INTERNET, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Business Description:

Overview

  CAIS Internet, Inc. (the "Company") is a nationwide provider of broadband
Internet access solutions. The Company operates two business segments: the
visitor-based and multi-family networks segment provides high-speed Internet
access and content solutions for hotels, apartment communities and other
public areas using its patented OverVoice solution and IPORT server software;
and the Internet services segment provides high-speed Internet access and
content solutions for businesses and consumers, including digital subscriber
line ("DSL") services using HyperDSL lines, always-on access solutions for
ISPs and businesses, and web hosting and other Internet services.

Organization

  CAIS Internet, Inc. was incorporated under the name CGX Communications, Inc.
("CGX") as a "C" corporation in Delaware in December 1997 to serve as a
holding company for two operating entities, CAIS, Inc., a Virginia "S"
Corporation, and Cleartel Communications Limited Partnership ("Cleartel"), a
District of Columbia limited partnership. The Company completed a
reorganization in October 1998 such that CAIS and Cleartel became wholly owned
subsidiaries of the Company. In February 1999, the Company spun-off Cleartel
to the Company's stockholders (see Note 3) and changed its name from CGX
Communications, Inc. to CAIS Internet, Inc. The Company's headquarters are in
Washington, D.C.

Initial Public Offering

  In May 1999, the Company completed an initial public offering of its common
stock (the "IPO"). The Company sold 6,842,100 shares (including the over-
allotment option), yielding net proceeds to the Company of approximately
$118.2 million, after deducting underwriting discounts and commissions and
other fees and expenses of approximately $11.8 million. The Company used
approximately $12 million of the net proceeds in the second quarter of 1999 to
repay indebtedness and redeem shares of Series B cumulative mandatory
redeemable convertible preferred stock.

Risks and Other Important Factors

  The Company has devoted substantial resources to the buildout of its
networks and the expansion of its marketing programs. As a result, the Company
has experienced operating losses and negative cash flows. These operating
losses and negative cash flows are expected to continue for additional periods
in the future. There can be no assurance that the Company will become
profitable or generate positive cash flows.

  As of December 31, 1999, the Company had cash and cash equivalents, and
short-term investments of approximately $33.6 million. In February 2000, the
Company issued $73.9 million of convertible preferred stock pursuant to a
December 1999 stock purchase agreement for net proceeds of approximately $67.7
million (see Note 10). In May 2000, the Company expects to issue an additional
$26.1 million of convertible preferred stock pursuant to the same stock
purchase agreement for net proceeds of $25.0 million, upon receiving
stockholder approval for such issuances. The Company expects that it will seek
additional financing to meet its planned capital expenditures over the next
year. If such sources of financing are insufficient or unavailable, or if the
Company experiences shortfalls in anticipated revenues or increases in
anticipated expenses, the Company would curtail the planned roll-out of its
services and reduce marketing and research and development activities.

  The Company is subject to various risks in connection with the operation of
its business. These risks include, but are not limited to, regulations,
dependence on effective billing and information systems, intense competition
and rapid technological change. The Company's future plans are substantially
dependent on the

                                      37
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

successful roll-out of its visitor-based and multi-family networks. Net
revenues generated from visitor-based and multi-family networks were
approximately $3,417,000 for the year ended December 31, 1999. There can be no
assurance that the Company will be successful in its roll-out of services nor
can there be any assurance that the Company will be successful in defending
its related patent rights. Many of the Company's competitors are significantly
larger and have substantially greater financial, technical, and marketing
resources than the Company.

2.  Summary of Significant Accounting Policies:

Consolidated Financial Statements

  The consolidated statements include the results of the Company and its
wholly-owned subsidiaries. These results include CAIS, Inc. for all periods
presented, and CAIS Software Solutions ("CAISSoft") formerly known as Atcom,
Inc. ("Atcom") and Business Anywhere USA, Inc. ("Business Anywhere") for the
period from their respective acquisition dates in September, 1999 through
December 31, 1999. All significant inter-company transactions and accounts
have been eliminated.

  In February 1999, the Company spun-off its operator and long-distance
services subsidiary, Cleartel, to its stockholders as a non-cash distribution
(See Note 3). The spin-off has been presented as discontinued operations and,
accordingly, the Company has presented its financial statements for all
periods prior to that date in accordance with Accounting Principles Board
("APB") Opinion No. 30. All expenses related to members of senior management
who continued with the Company are included within loss from continuing
operations.

Use of Estimates

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

Revenue Recognition

  The Company records revenues for all services when the services are provided
to customers. Amounts for services billed in advance of the service period and
cash received in advance of revenues earned are recorded as unearned revenues
and recognized as revenue when earned. Upfront charges in connection with
service contracts are recognized ratably over the contract period. Customer
contracts for Internet access and web hosting services are typically for
periods ranging from one month to three years. Internet access services
typically require the customer to purchase equipment and pay for the related
installation fees. Revenues from equipment sales are recorded when delivery of
the related equipment is accepted by the customer. Dial-up access customers
typically subscribe to service on a monthly or annual basis.

Cost of revenues

  Cost of revenues include recurring expenses for the long haul bandwidth
lease and local interconnection charges from national and local fiber
providers. It also includes wholesale DSL resale charges, equipment costs and
amortization of DSL install and equipment charges incurred in connection with
term contracts.

Research and Development costs

  Research and development costs include internal research and development
activities and external product development agreements. Research and
development costs are expensed as incurred, and were approximately $221,000,
$223,000 and $1,593,000 for the years ended December 31, 1997, 1998 and 1999,
respectively.

                                      38
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Non-cash compensation

  The Company accounts for its stock option plan under APB Opinion No. 25,
"Accounting for Stock Issued to Employees." The Company has adopted SFAS No.
123, "Accounting for Stock-Based Compensation," for disclosure purposes. The
Company has recognized non-cash compensation expense on certain stock options
granted to management (see Note 10).

Fair Value of Financial Instruments

  The carrying amounts for current assets and liabilities, other than the
current portion of notes payable to related parties, approximate their fair
value due to their short maturities. The fair value of notes payable to
related parties cannot be reasonably and practicably estimated due to the
unique nature of the related underlying transactions and terms (see Note 9).
However, given the terms and conditions of these instruments, if these
financial instruments were with unrelated parties, interest rates and payment
terms could be substantially different than the currently stated rates and
terms.

Cash and Cash Equivalents and Short-Term Investments

  The Company considers all short-term investments with original maturities of
90 days or less to be cash equivalents. Cash equivalents consist primarily of
commercial paper and money market accounts that are available on demand.
Short-term investments consist of investment-grade commercial paper with
original maturities greater than 90 days. The carrying amounts of cash and
cash equivalents and short-term investments in the accompanying consolidated
balance sheets approximates fair value.

Long-lived assets

  Long-lived assets and identifiable assets to be held and used are reviewed
for impairment whenever events or changes in circumstances indicated that the
carrying amount should be addressed. Impairment is measured by comparing the
carrying value to the estimated undiscounted future cash flows expected to
result from the use of the assets and their eventual dispositions. The Company
considers expected cash flows and estimated future operating results, trends,
and other available information in assessing whether the carrying value of the
assets is impaired. The Company believes that no such impairment existed as of
December 31, 1998 and 1999.

  The Company's estimates of anticipated net revenues, the remaining estimated
lives of tangible and intangible assets, or both, could be reduced
significantly in the future due to changes in technology, regulation,
available financing, or intense competition. As a result, the carrying amount
of long-lived assets could be reduced materially in the future.

Property and Equipment

  Property and equipment is stated at historical cost net of accumulated
depreciation and amortization. Depreciation is provided using the straight-
line method over the estimated useful lives of the assets ranging from three
to five years, or for leasehold improvements, the life of the lease, if
shorter. Costs of additions and improvements are capitalized and repairs and
maintenance are charged to expense as incurred. Upon sale or retirement of
property and equipment, the costs and related accumulated depreciation are
eliminated from the accompanying consolidated balance sheets, and any
resulting gain or loss is reflected in the accompanying consolidated
statements of operations.

Income Taxes

  Until the Company's reorganization in October 1998, the federal income tax
obligations of CAIS and Cleartel were passed through to their respective
subchapter S shareholders and partners. Cleartel was subject to state
unincorporated business franchise taxes on any profits in the District of
Columbia.

                                      39
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  The Company accounts for federal, state and local income taxes in accordance
with SFAS No. 109, "Accounting for Income Taxes." Under SFAS No. 109, deferred
tax assets and liabilities are computed based on the difference between the
financial statement and income tax bases of assets and liabilities using the
enacted marginal tax rate. SFAS No. 109 requires that a net deferred tax asset
be reduced by a valuation allowance if, based on the weight of available
evidence, it is more likely than not that some portion or all of the net
deferred tax asset will not be realized.

Net Loss Per Share

  SFAS No. 128, "Earnings Per Share," requires dual presentation of basic and
diluted earnings per share on the face of the statements of operations. Basic
earnings per share excludes dilution and is computed by dividing income or
loss available to common shareholders by the weighted-average number of common
shares outstanding for the period. Diluted earnings per share reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the entity.

  Options to purchase approximately 2,034,000, 2,946,000 and 5,736,000 shares
of common stock in 1997, 1998 and 1999, respectively and warrants to purchase
approximately 390,000 and 1,715,000 shares of common stock in 1998 and 1999,
respectively, were excluded from the computation of diluted loss per share.
Additionally, Series C preferred shares equivalent conversion to 1,250,000
shares of common stock as of December 31, 1999 were excluded from the
computation of diluted loss per share in 1999. The options, warrants and
preferred shares have been excluded from the computation of diluted loss per
share as their inclusion would have an anti-dilutive effect on loss per share.

Comprehensive Income

  Statement of Financial Accounting Standards ("SFAS") No. 130 "Reporting of
Comprehensive Income", requires "comprehensive income" and the components of
"other comprehensive income" to be reported in the financial statements and/or
notes thereto. Since the Company does not have any components of "other
comprehensive income", reported net income is the same as "comprehensive
income" for the years ended December 31, 1997, 1998 and 1999.

Recently Adopted Accounting Pronouncements

  In July 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
No. 133 is effective for fiscal years beginning after December 31, 2000, and
its purpose is to replace existing pronouncements with a single, integrated
accounting framework for derivatives and hedging activities. The Company has
not yet evaluated the effect of this standard on the financial statements.

  In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 98-1, "Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use." It provides
guidance on accounting for costs of computer software developed or obtained
for internal use. It is effective for fiscal years beginning after December
15, 1998, for projects in progress and prospectively, with earlier application
encouraged. The Company has adopted this standard which had no significant
impact on its financial statements to date.

Excess of Cost over Net Assets Acquired (Goodwill)

  Goodwill and other intangibles were recorded as a result of the acquisitions
by the Company of Capital Area Internet Service, Inc. ("Capital Area") in May
1996, and of Atcom and Business Anywhere in September

                                      40
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

1999. Goodwill and acquired intangibles are amortized on a straight-line basis
over three years. Amortization of goodwill and intangibles was approximately
$821,000 for both of the years ended December 31, 1997 and 1998, and
$5,133,000 for the year ended December 31, 1999. Goodwill with respect to the
Capital Area acquisition was fully amortized in May 1999.

Concentration of Credit Risk

  Financial instruments that potentially subject the Company to concentrations
of credit risk consist principally of trade accounts receivable. For trade
accounts receivable, the risk is limited due to the large number of customers,
the dispersion of those customers across many industries and geographic
regions, and the ability to terminate access on delinquent accounts.

Visitor-based and Multi-family Network Contract Rights

  The Company made up-front contract payments to certain contract partners in
connection with entering into long-term master agreements for visitor-based
and multi-family networks in 1999. These contracts give the Company various
installation and marketing rights to provide high-speed Internet services to
customers in hotels and apartment buildings. The net total balance of these
contract rights was approximately $11,153,000 as of December 31, 1999 and is
included in intangible assets in the accompanying consolidated balance sheets.
The contract rights are amortized over the term of the agreements, ranging
from five to seven years. Amortization expense for the year ended December 31,
1999 was approximately $642,000.

Supplemental Cash Flow Information

  The following represents supplemental cash flow information for the years
ended December 31, 1997, 1998 and 1999 (in thousands):

<TABLE>
<CAPTION>
                                                                Years Ended
                                                                December 31,
                                                              ----------------
                                                              1997 1998  1999
                                                              ---- ---- ------
   <S>                                                        <C>  <C>  <C>
   Cash paid for interest expense of continuing operations... $246 $412 $1,221
                                                              ==== ==== ======
   Cash paid for interest expense of discontinued
    operations............................................... $870 $791 $   31
                                                              ==== ==== ======
   Equipment acquired under capital leases of continuing
    operations............................................... $--  $--  $  312
                                                              ==== ==== ======
   Equipment acquired under capital leases of discontinued
    operations............................................... $--  $228 $  --
                                                              ==== ==== ======
</TABLE>


                                      41
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

3. Spin-off/Discontinued Operations:

  On February 12, 1999, the Company completed a spin-off of Cleartel, its
operator and long-distance services subsidiary, pursuant to which ownership of
Cleartel was transferred to the Company's stockholders. The Company
distributed all of the shares of common stock to its stockholders on a pro
rata basis, and the holders of options to acquire the Company's stock and
warrants were granted stapled rights to acquire shares in Cleartel. For
financial reporting purposes, the Company has presented the results of
operations for Cleartel as discontinued operations. A summary of the statement
of the assets and liabilities of discontinued operations are as follows (in
thousands):

<TABLE>
<CAPTION>
                                                              Date of Spin-Off
                                            December 31, 1998 February 12, 1999
                                            ----------------- -----------------
                                                                 (Unaudited)
<S>                                         <C>               <C>
Balance Sheets
Cash.......................................      $    21           $    1
Accounts receivable, net of allowance for
 doubtful accounts of $1,450 and $1,395,
 respectively..............................        2,224            2,129
Notes receivable, current..................          530              437
Advances receivable from CAIS..............        5,342            4,941
Prepaid expenses and other assets..........           53               59
                                                 -------           ------
  Total current assets.....................        8,170            7,567
Property and equipment, net of accumulated
 depreciation of $3,142 and $3,201,
 respectively..............................        1,305            1,260
Notes receivable, net of current portion...          607              632
Other noncurrent assets....................           24               27
                                                 -------           ------
  Total assets.............................      $10,106           $9,486
                                                 =======           ======
Accounts payable and accrued liabilities...      $ 5,410           $4,827
Borrowings under receivable-based
 financing.................................        2,714            3,027
Current portion of capital leases..........           81               77
                                                 -------           ------
  Total current liabilities................        8,205            7,931
Notes payable to related party.............        2,100            1,450
Accrued interest to related party..........          411              --
Capital leases, net of current portion.....           69               62
Other liabilities..........................           21              --
                                                 -------           ------
  Total liabilities........................       10,806            9,443
                                                 -------           ------
Owners' (deficit) equity...................         (700)              43
                                                 -------           ------
  Total liabilities and owners' (deficit)
   equity..................................      $10,106           $9,486
                                                 =======           ======
Statement of Changes in Owners' (Deficit)
 Equity
Beginning owners' deficit, December 31,
 1998......................................                        $ (700)
Conversion of related party debt to
 equity....................................                         1,083
Net loss...................................                          (340)
                                                                   ------
Ending owners' equity, February 12, 1999...                        $   43
                                                                   ======
</TABLE>


                                      42
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  A summary of results for the discontinued operations are as follows (in
thousands):

<TABLE>
<CAPTION>
                                                   Years Ended December 31,
                                                   ----------------------------
                                                     1997      1998     1999
                                                   --------  --------  --------
   <S>                                             <C>       <C>       <C>
   Statements of Operations:
   Net revenues................................... $ 33,959  $ 27,424  $ 2,340
   Operating expenses:
     Cost of revenues.............................   19,319    17,880    1,748
     Selling, general, and administrative.........   11,158     8,996      796
     Depreciation and amortization................      668       519       58
                                                   --------  --------  -------
       Total operating expenses...................   31,145    27,395    2,602
                                                   --------  --------  -------
   Income (loss) from operations..................    2,814        29     (262)
   Interest expense, net..........................      783       734       78
                                                   --------  --------  -------
   Income (loss) before taxes.....................    2,031      (705)    (340)
   (Provision) benefit for state taxes............     (108)       34      --
                                                   --------  --------  -------
   Net income (loss).............................. $  1,923  $   (671) $  (340)
                                                   ========  ========  =======
</TABLE>

  The results above for the year ended December 31, 1999 reflect the
operations of Cleartel through February 12, 1999, the effective date of the
spin-off.

  Income (loss) related to discontinued operations reflect those revenues and
expenses directly incurred by Cleartel and allocations of shared corporate
costs based primarily on methodologies established by management between the
Company and Cleartel to reflect the cost sharing agreement between both
companies.

  Through the date of the spin-off of Cleartel in February 1999, profits and
cash flows from Cleartel were used to finance operating losses at the Company.
This obligation of the Company as of February 12, 1999, was approximately
$4,941,000 and was reduced to $1,991,000 in February 1999 upon cash payments
of $1,500,000 and the Company's assumption of related party debt totaling
$1,450,000 from Cleartel. The remaining obligation and additional transactions
after the spin-off date were paid to Cleartel in May 1999.

  During the years ended December 31, 1997, 1998 and 1999, the Company and
Cleartel shared certain support services such as bookkeeping, information
systems, and advertising and marketing support. After the spin-off of Cleartel
in February 1999, the Company provided these services at cost plus a fixed
percentage until Cleartel replaced those services with its own services in
1999. Amounts charged for services are included as an offset to the respective
operating expenses in the accompanying statements of operations. A summary of
these transactions is as follows (in thousands, unaudited):

<TABLE>
<CAPTION>
                                                    Years Ended December 31,
                                                   --------------------------
                                                     1997     1998     1999
                                                   -------- -------- --------
   <S>                                             <C>      <C>      <C>
   Bookkeeping, MIS, advertising, and marketing
    support....................................... $    302 $    227 $    141
   Office lease................................... $    161 $    164 $     40
</TABLE>

4. Acquisitions

  In September 1999, the Company acquired the outstanding shares of Atcom
(which it renamed CAIS Software Solutions) for a purchase price of
approximately $42,565,000 including direct aquisition costs of $1,578,000. The
Company issued approximately 2,493,000 shares of common stock valued at $12.38
per share, and options to acquire approximately 842,000 shares of common stock
valued at approximately $10,131,000 based on the Black-Scholes valuation
model. The acquisition was accounted for under the purchase method of

                                      43
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

accounting for business combinations, and accordingly, the operating results
of CAIS Software Solutions have been included in the Company's consolidated
financial statements from the date of acquisition. The purchase price was
allocated as follows: tangible assets, principally cash, accounts receivable
and property and equipment of approximately $3,163,000; assumed liabilities of
approximately $2,481,000; and intangible assets including intellectual
property of approximately $6,344,000, management resources of approximately
$4,493,000, contracts of approximately $7,036,000 and goodwill of
approximately $24,010,000. The intangible assets including goodwill are being
amortized over three years.

  In September 1999, the Company acquired Business Anywhere for a purchase
price of approximately $200,000 in cash and $1,500,000 in the Company's common
stock. The Company issued approximately 122,000 shares of common stock valued
at $12.33 per share. The Company will issue $1,000,000 in additional common
stock at each of the first and second annual anniversaries of the transaction
based upon the fair market value of the stock at that time, provided Business
Anywhere meets certain revenue targets. The Company also incurred
approximately $94,000 for direct acquisition costs. The acquisition was
accounted for under the purchase method of accounting for business
combinations, and accordingly, the operating results of Business Anywhere have
been included in the Company's consolidated financial statements from the date
of acquisition. The purchase price was allocated as follows: tangible assets,
principally cash, accounts receivable and property and equipment of
approximately $658,000; assumed liabilities of approximately $687,000; and
intangible assets including contracts of approximately $1,762,000 and goodwill
of approximately $61,000. The intangible assets including goodwill are being
amortized over three years.

  The following pro forma results give effect to the foregoing acquisitions as
if such transactions had been consummated on January 1 of each of the periods
presented (in thousands, except per share amounts):

<TABLE>
<CAPTION>
                                                              1998      1999
                                                            --------  --------
   <S>                                                      <C>       <C>
   Net revenues............................................ $  7,479  $ 12,578
   Net loss................................................ $(30,173) $(66,094)
   Basic and diluted loss per share........................ $  (2.42) $  (3.53)
</TABLE>

5. Accounts Payable and Accrued Expenses

  Accounts payable and accrued expenses consist of the following (in
thousands):

<TABLE>
<CAPTION>
                                                                  December 31,
                                                                 --------------
                                                                  1998   1999
                                                                 ------ -------
   <S>                                                           <C>    <C>
   Accounts payable............................................. $3,412 $34,058
   Accrued salaries and vacation................................    186   2,487
   Accrued legal settlement.....................................    500     --
   Accrued equipment financing fees.............................    --    1,014
   Accrued Qwest Indefeasible Right of Use......................    --   14,521
   Other........................................................    298   1,699
                                                                 ------ -------
                                                                 $4,396 $53,779
                                                                 ====== =======
</TABLE>


                                      44
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

6. Property and Equipment:

  Property and equipment consists of the following (in thousands):

<TABLE>
<CAPTION>
                                                               December 31,
                                                              ---------------
                                                               1998    1999
                                                              ------  -------
   <S>                                                        <C>     <C>
   Internet backbone equipment............................... $1,287  $14,841
   Hospitality and multi-family equipment and installation
    costs....................................................    802   25,138
   Computer hardware and software............................    384    5,338
   Office furniture and fixtures.............................    747    1,877
   Leasehold improvements....................................    207    1,666
   Qwest Indefeasible Right of Use...........................    --    44,042
                                                              ------  -------
                                                               3,427   92,902
   Less: Accumulated depreciation and amortization...........   (789)  (2,426)
                                                              ------  -------
                                                              $2,638  $90,476
                                                              ======  =======
</TABLE>

7. Financing and Debt:

Extinguishment of Debt

  In September 1998, the Company entered into a $7 million loan facility (the
"Loan") with an investment banking firm. In connection with the Loan, the
Company issued the investment banking firm warrants to acquire 3 percent of
the fully diluted outstanding shares of common stock of the Company or 390,000
shares at September 4, 1998. The warrants have an exercise price of $0.01 per
share and expire on the tenth anniversary after issuance, or September 4,
2008. The warrants fully vested upon closing of the Loan and include certain
anti-dilution provisions. The fair value of the warrants, totaling
approximately $1,226,000, or $3.14 per share, is classified as a component of
additional paid-in capital as of December 31, 1998. The warrants were valued
using a Black-Scholes option pricing model with the following assumptions:
risk-free interest rate of 4.55 percent, no dividend yield, expected life of
10 years and expected volatility of 70 percent.

  The Company recorded debt discount costs of $1,226,000 attributable to the
redeemable warrants issued and other direct financing costs in connection with
the Loan. The $7 million loan was repaid in full from net proceeds from the
IPO. Upon the early extinguishment of the Loan in May 1999, the Company
recognized an extraordinary charge of $551,000 related to the write-off of the
unamortized debt discount and deferred financing costs.

Equipment Financing

  The Company and Nortel Networks, Inc. ("Nortel Networks") entered into a
five-year, $30 million equipment financing line of credit, dated as of June 4,
1999, and several amendments. As of December 31, 1999, the Company had
borrowed approximately $2.7 million under this credit facility. Borrowings
outstanding as of December 31, 1999 incur interest expense at rates ranging
from 10.3 to 10.9 percent. The facility requires the Company to meet certain
financial covenants including revenue targets and leverage and debt service
ratios. In addition, on April 1, 1999, the Company and Nortel Networks entered
into an agreement to purchase $10 million of Nortel equipment by April 1,
2000. The Company will be subject to a reduction in its purchase discount
percentages after that date if its annual purchases do not exceed $10 million
for the year ended April 1, 2001 and $9.9 million for the year ended April 1,
2002. The remaining commitment as of December 31, 1999 was $5.3 million for
the initial April 1, 2000 deadline.

                                      45
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  The Company and Cisco Systems Capital Corporation entered into a three-year,
$50 million equipment financing line of credit, dated as of June 30, 1999, and
several amendments. Under the facility, $50 million is available during the
first two years of the facility provided the Company meets certain financial
performance requirements. The line of credit bears interest at an annual rate
equal to the three-month LIBOR plus 6.0%. The facility requires the Company to
meet certain financial covenants including EBITDA targets, revenue targets and
leverage ratios. Borrowings under the facility are secured by a first priority
lien in all assets of the Company, other than its property securing the Nortel
facility, in which assets Cisco will have a second priority lien. As of
December 31, 1999, the Company had not borrowed under this credit facility.
The Company obtained a waiver from Cisco for financial covenant violations as
of December 31, 1999. Subsequent to year-end, the Company and Cisco amended
the financial covenants of this agreement for the remainder of the term of
this facility.

  Deferred debt financing costs represent direct financing costs incurred in
connection with entering into the equipment financing agreements. The Company
accrued debt financing costs of approximately $1.3 million as of December 31,
1999 in connection with completing the Nortel and Cisco lines of credit. The
deferred debt financing costs are being amortized over the terms of the
equipment financing agreements and are included in interest expense. The
amortization was approximately $95,000 for the year ended December 31, 1999.

8. Bank Loan and Interest Rate Swap:

  In connection with the acquisition of Capital Area on May 10, 1996, the
Company obtained a $2,000,000 loan from a bank (the "Bank Loan"). Interest on
the Bank Loan accrued at a rate of prime plus one and one-half percent (9.75
percent at that date), with payments on a five-year amortization schedule and
a maturity date of May 10, 1999. The Bank Loan was guaranteed by one of the
principal stockholders of the Company and was secured by investments from
another principal stockholder of the Company.

  On October 17, 1996, CAIS entered into an interest rate swap transaction
with the bank, and refinanced the remaining principal balance of approximately
$1,833,000 at that time into a new promissory note. Interest on the refinanced
note was based on the LIBOR rate, plus 2 percent. The bank also entered into a
hedging transaction to control fluctuation in the LIBOR rate, which had the
effect of converting the variable interest rate on the Bank Loan into a fixed
rate of 8.65 percent as of December 31, 1996.

  On December 5, 1997, CAIS again refinanced the Bank Loan to increase the
principal balance outstanding at that time of $1,400,000 to the original
$2,000,000, thus netting CAIS $600,000 in cash proceeds. In addition, the
maturity date of the refinanced Bank Loan and the swap agreement was extended
to December 10, 2000.

  On September 4, 1998, the entire Bank Loan principal and interest and
interest rate swap totaling $1,782,000 was paid off with proceeds from the
Loan (see Note 7). The amount of interest expense incurred related to the Bank
Loan was $137,000 and $151,000 for the years ended December 31, 1997 and 1998,
respectively.

9. Transactions with Related Parties:

Notes Payable to Related Parties

  Notes payable to related parties of $1,515,000 and $1,983,000 as of December
31, 1997 and 1998, respectively, consist of notes payable to stockholders with
interest accruing at annual rates of 10 to 13 percent. In February 1999,
related party notes totaling $4,433,000, including the $1,983,000 outstanding
as of December 31, 1998, the $1,450,000 assumed from Cleartel, and the
$1,000,000 borrowed in 1999, were converted into Series B Cumulative Mandatory
Redeemable Convertible Preferred Stock (see Note 10).


                                      46
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  Interest expense of approximately $131,000, $128,000 and $14,000 was
incurred during the years ended December 31, 1997, 1998 and 1999,
respectively, related to related party loans.

  In January 1999, a principal stockholder lent $1,000,000 to the Company
under a note which accrued interest quarterly at 10 percent with principal due
on the earlier of thirty days after the closing date of the IPO or March 31,
2000. As described above, the note was converted into Series A cumulative
mandatory redeemable convertible preferred stock in February 1999.

Related Party Leases

  During the years ended December 31, 1997 and 1998 and the first two months
of 1999, the Company leased a building in Washington D.C. for their corporate
headquarters from a stockholder. Rent expense of $180,000 was incurred for
this lease for each of the years ended December 31, 1997 and 1998, and $23,000
for the year ended December 31, 1999.

Receivable from Officers

  In June 1999, the Company advanced a $400,000 unsecured loan to one of its
executives. The loan bears interest at a rate of 7 percent per annum, with the
interest payable quarterly, and the principal amount due three years from the
date of the loan. In December 1999, the Company advanced a $50,000 unsecured
loan to one of its executives. The loan bears interest at a rate of 7 percent
per annum, with the interest payable quarterly, and the principal amount due
three years from the date of the loan.

Treasury Stock

  The Company purchased approximately 13,000 shares of its common stock at
fair market value from a former shareholder of Atcom and current officer of
the Company. The shares are currently being held by the Company.

10. Stockholders' (Deficit) Equity:

Common Stock

  On April 22, 1998, an individual invested $1,000,000 in the Company in
exchange for approximately 317,000 shares of common stock. Since the Company
had not yet been reorganized, the investor received a 2.439 percent equity
interest in CAIS and Cleartel, subject to any future corporate restructurings.

  In February 1999, the Company increased its authorized common stock from
25,000,000 to 100,000,000 shares of common stock.

Initial Public Offering

  In May 1999, the Company completed an initial public offering of its common
stock (the "IPO"). The Company sold 6,842,100 shares (including the over-
allotment option), yielding net proceeds to the Company of approximately
$118.2 million, after deducting underwriting discounts and commissions and
other fees and expenses of approximately $11.8 million. The Company used
approximately $12 million of the net proceeds in the second quarter of 1999 to
repay indebtedness and redeem shares of Series B cumulative mandatory
redeemable convertible preferred stock.


                                      47
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Convertible Preferred Stock and Warrants

  In February 1999, the Company authorized the issuance of up to 25,000,000
shares of preferred stock, par value $0.01 per share. Of these authorized
shares, 2,827,168 shares have been designated as Series A Convertible
Preferred Stock, par value $0.01 per share (the "Series A Shares") and
1,119,679 shares have been designated as Series B Cumulative Mandatory
Redeemable Convertible Preferred Stock, par value $0.01 per share (the "Series
B Shares").

  In February 1999, after the Spin-off, the Company issued 2,827,168 Series A
Shares to an entity controlled by a director of the Company and to a related
party to the investment banking firm that provided the Loan to the Company for
total gross proceeds of $11,500,000, of which $1,500,000 was used to pay
amounts due to Cleartel. The shares automatically converted into common stock
upon the IPO. The Series A Shares were entitled to a liquidation preference
equal to $11,500,000, plus a return of 8 percent per annum thereon, and all
accrued but unpaid dividends thereon. The Company also issued to the
purchasers of the Series A Shares, warrants to purchase a number of shares of
common stock equal to 3.0% of the total number of shares outstanding on a
fully diluted basis at the close of the IPO. The warrants have an exercise
price of $19.00 per share of common stock at the IPO, and vested upon the IPO.
The warrants expire in May 2004. The warrants were valued at $8,157,000 using
the Black-Scholes option pricing model.

  In February 1999, after the Spin-off, the Company issued 1,119,679 Series B
Shares to stockholders of the Company, in exchange for indebtedness, including
accrued interest, totaling $4,557,000 payable by the Company to the
stockholders. Upon consummation of the IPO, the Company redeemed for cash
$3,000,000 of the face amount of the Series B Shares, plus accrued dividends
of $104,000, and converted the remaining Series B shares into 81,946 shares of
common stock.

  On April 23, 1999, in connection with an amendment to the Company's master
agreement with a hotel customer (the "Customer") to provide the Company with
exclusive rights and to extend the contract term, the Company issued warrants
to the Customer to purchase 66,667 shares of common stock at an exercise price
of $0.01 per share, as an additional contribution by the Company in support of
the Customer's marketing of the Company's services. The warrants have been
valued at their estimated fair value of $19.00 per share (or approximately
$1,267,000 in the aggregate) based upon a Black-Scholes valuation model. The
fair value of the warrants has been recorded as an intangible asset and is
being amortized over the expected benefit life of the five year contract term.
In connection with the warrants, the Customer received certain demand and
incidental registration rights. The warrants expire on April 23, 2004. The
Customer has a put option to sell all of the warrants (or shares of the
Company issued pursuant to the exercise of the warrants) back to the Company
at $19.00 per share. The put option expires ninety days following the earlier
of: (1) the effective date of the first registration statement that includes
any warrant shares for resale and (2) the date on which the Customer may sell
all of the warrant shares within a three-month period pursuant to the 1933
Securities Act Rule 144. Due to the existence of the put rights, the value
ascribed to the warrants will not be included within stockholders' equity
until the put option expires.

  In September 1999, the Company issued 125,000 shares of Series C Cumulative
Mandatory Redeemable Convertible Preferred Stock (the "Series C Preferred
Stock") and warrants to acquire 500,000 shares of the Company's common stock
at $12.00 per share to Qwest Communications Corporation ("Qwest") for total
gross proceeds of $15,000,000. The Series C Preferred Stock ranks prior to the
Company's common stock with respect to dividends and rights upon liquidation,
dissolution, or winding up of the Company. Each holder of Series C Preferred
Stock is entitled: (i) to receive, when, as and if declared by the Company's
Board of Directors, cumulative dividends of $10.20 per annum per share; (ii)
to a liquidation preference equal to the sum of $120.00 per share, plus any
accrued but unpaid dividends; (iii) to the number of votes equal to the number
of whole shares of Common Stock into which all of the shares of Series C
Preferred Stock held by such holder are

                                      48
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

convertible; and (iv) to certain demand and piggyback registration rights.
Subject to certain limitations, each share of Series C Preferred Stock is
convertible, at the option of the holder, into such number of fully paid and
nonassessable shares of common stock at the ratio of ten common shares for
each share of Series C Preferred Stock. The Company shall redeem (i) up to
41,667 shares of the Series C Preferred Stock by September 2001; and (ii) the
remaining shares of the Series C Preferred Stock by September 2002.

  Approximately $3.9 million of the proceeds received were allocated to the
value of the warrants to acquire 500,000 shares of the Company's common stock
at $12.00 per share. The warrants have been valued at their estimated fair
value of $7.70 per share based on the Black-Scholes valuation model. The
warrants expire on October 28, 2002.

  As the Series C Preferred Stock is immediately convertible into common
stock, the discount on the preferred stock (as a result of the allocation of
proceeds to the warrants) was fully accreted on the date of issuance and is
reflected as a dividend on preferred stock in the accompanying financial
statements.

  On December 20, 1999, the Company entered into a Preferred Stock Purchase
Agreement ("Purchase Agreement") between CII Ventures LLC, an affiliate of the
private investment firm Kohlberg Kravis Roberts & Co. (KKR). Under the
Purchase Agreement, KKR, through its affiliate, will make a strategic
investment of up to $200 million in the Company. Under a), CII Ventures will
purchase $100 million of the Company's Series D convertible participating
preferred stock ("Series D Shares"). The Series D Shares will be convertible
into common stock of the Company, with an initial conversion price of $16.50
per share, subject to adjustment. The Purchase Agreement also includes a one-
year option for CII Ventures to purchase up to an additional $100 million of
Series E convertible participating preferred stock ("Series E Shares"). The
Series E Shares are convertible into the Company's common stock, with a
conversion price of $20.00 per share, subject to adjustment. The holders of
the Series D and Series E Shares will be entitled to receive dividends,
payable in additional shares, at a rate of 6 percent per annum compounded
quarterly.

  Under the executed Stockholders Agreement, KKR has certain rights to board
representation, stock registration and must consent with respect to certain
corporate actions by the Company, including share issuances and mergers and
other business combinations, subject to certain exceptions.

Executive Stock Options

  During 1997, the Company issued stock options to two members of executive
management as part of their four-year employment contracts. Since the Company
had not yet been reorganized at the time of the grants, the executives
received options to purchase equal interests in CAIS, Inc. and Cleartel. In
February 1997, one of the members of executive management received options to
acquire approximately 301,000 shares of common stock at an exercise price of
$1.19 per share. One-third of these options vested at May 20, 1999 on the date
of the IPO, while the remaining two-thirds vest at the end of year four of the
employment contract. In September 1997, another member of executive management
received options to acquire approximately 1,733,000 shares of common stock at
an exercise price of $0.97 per share. Approximately 97,000 options fully
vested on April 1, 1999. Of the remaining 1,636,000 options, 75 percent vested
at May 20, 1999 on the date of the IPO, while the remaining 25 percent vest at
the end of employment year four.

  As a result of these grants and several other executive management grants,
the Company recorded deferred compensation of approximately $9,607,000 to be
amortized over the vesting period relating to these options. The amount of
deferred compensation was based upon the difference between the estimated fair
market value of the Company at the date of the grants and the applicable
exercise prices. Accordingly, the Company amortized $616,000, $1,426,000 and
$4,892,000 for the years ended December 31, 1997, 1998, and 1999,
respectively, in the consolidated statements of operations.

                                      49
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Employee Stock Option Plan

  On March 24, 1998, the Company's stockholders approved the 1998 Equity
Incentive Plan (the "Stock Option Plan"). In February 1999, the Stock Option
Plan was amended and currently provides for the grant of both incentive and
nonstatutory stock options to eligible employees and consultants of the
Company. The Stock Option Plan initially reserved 1,500,000 shares of common
stock for issuance; in November 1999, the number of reserved shares was
increased to 5,000,000. Options granted under the Stock Option Plan must have
an exercise price of no less than fair market value of the Company's common
stock at the date of grant and expire ten years after grant date. As of
December 31, 1998 and 1999, approximately 912,000 and 2,689,000 shares,
respectively, were outstanding under the Stock Option Plan. The stock options
outstanding under the Stock Option Plan generally vest over three to four year
periods.

  A summary of the Company's aggregate stock option activity and related
information under the Stock Option Plan and the Executive Stock Options is as
follows (in thousands, except per share prices):

<TABLE>
<CAPTION>
                            Year Ended         Year Ended       Year Ended
                           December 31,      December 31,      December 31,
                               1997              1998              1999
                         ----------------- ----------------- -----------------
                                 Weighted-         Weighted-         Weighted-
                                  Average           Average           Average
                                 Exercise          Exercise          Exercise
                         Options   Price   Options   Price   Options   Price
                         ------- --------- ------- --------- ------- ---------
<S>                      <C>     <C>       <C>     <C>       <C>     <C>
Options outstanding at
 beginning of period....  2,034    $1.00    2,034    $1.00    2,946    $1.00
Granted.................    --       --       960     3.13    3,200     8.24
Exercised...............    --       --       --       --       185     2.17
Forfeited...............    --       --        48     3.07      225     3.40
                          -----    -----    -----    -----    -----    -----
Options outstanding at
 end of period..........  2,034    $1.00    2,946    $1.66    5,736    $5.35
                          =====    =====    =====    =====    =====    =====
Options exercisable at
 end of period..........    --     $ --       --     $ --     2,397    $1.65
                          =====    =====    =====    =====    =====    =====
</TABLE>


                                      50
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  Exercise prices for options outstanding under the Stock Option Plan and for
the Executive Stock Options as of December 31, 1999 are as follows:

<TABLE>
<CAPTION>
                          Number of Options         Weighted-            Weighted-
                             Outstanding        Average Remaining     Average Exercise
Range of Exercise Prices   (in thousands)   Contractual Life in Years      Price
------------------------  ----------------- ------------------------- ----------------
<S>                       <C>               <C>                       <C>
$0.36--$0.91............          490                 7.19                 $0.68
$0.97--$0.97............        1,733                 7.69                  0.97
$0.99--$1.69............          529                 8.17                  1.40
$3.07--$3.07............          653                 8.29                  3.07
$4.31--$4.31............          623                 9.15                  4.31
$11.50--$12.19..........          825                 9.53                 11.95
$13.06--$13.50..........          280                 9.85                 13.42
$13.87--$13.88..........           45                 9.91                 13.88
$14.19--$14.19..........          110                 9.68                 14.19
$16.50--$16.50..........          448                 9.96                 16.50
                                -----                 ----                 -----
$0.36--$16.50...........        5,736                 8.52                 $5.35
                                =====                 ====                 =====
</TABLE>

  The Company has elected to account for stock and stock rights in accordance
with APB Opinion No. 25, "Accounting for Stock Issued to Employees" and has
adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-
Based Compensation."

  Had compensation cost for the Company's employee stock options been
determined based on fair value at the grant date, consistent with the
provisions of SFAS No. 123, the Company's net loss from continuing operations
and loss per share from continuing operations would have been (in thousands,
except per share data):

<TABLE>
<CAPTION>
                                                   1997      1998      1999
                                                  -------  --------  ---------
   <S>                                            <C>      <C>       <C>
   Loss from continuing operations pro forma..... $(5,298) $(12,814) $(54,439)
   Basic and diluted loss per share from
    continuing operations pro forma.............. $ (0.55) $  (1.30) $  (3.21)
</TABLE>

  The fair value of options granted in the years ended December 31, 1997, 1998
and 1999 were estimated at the date of grant using a Black-Scholes option
pricing model with the following weighted-average assumptions: risk-free
interest rates of 5.68, 4.55 and 5.59, percent, respectively, no dividend
yield, weighted-average expected lives of the options ranging from 3 to 4
years, and expected volatility of 70 percent for 1997 and 1998 grants, and 88
percent for 1999 grants.

  The weighted-average fair value of options granted during the year ended
December 31, 1997, 1998 and 1999 was $2.64, $1.75 and $3.69, respectively. For
purposes of pro forma disclosures, the estimated fair value of the options is
amortized to expense over the estimated service period. The options granted in
1997 were granted below fair market value, while options granted in 1998 and
most of those granted in 1999 were granted at fair market value.

11. Income Taxes:

  Until the Company's Reorganization in October 1998, all earnings and losses
were passed through to the individual equity holders. At December 31, 1999,
the Company had net operating loss carryforwards of approximately $41,267,000
for income tax purposes that expire through 2019. Net operating loss
carryforwards are subject to review and possible adjustment by the Internal
Revenue Service and may be limited in the event of changes in ownership
pursuant to Section 382 of the Internal Revenue Code.


                                      51
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  Significant components of the Company's net deferred tax asset as of
December 31, 1998 and 1999 are as follows (in thousands):

<TABLE>
<CAPTION>
                                                                 December 31,
                                                                ---------------
                                                                 1998    1999
                                                                ------  -------
<S>                                                             <C>     <C>
Deferred tax assets:
Net operating loss carryforwards............................... $1,582  $16,507
Unearned stock compensation....................................    817    2,774
Allowance for doubtful accounts................................    635      106
Book over tax goodwill.........................................    190      702
Accrued vacation...............................................     56      178
Other deferred tax assets......................................    154       54
                                                                ------  -------
  Total deferred tax assets....................................  3,434   20,321
Deferred tax liabilities:
Basis differences attributable to purchase accounting              --   (11,628)
Tax over book depreciation.....................................    (84)    (975)
                                                                ------  -------
Net deferred tax asset.........................................  3,350    7,718
Valuation allowance for net deferred tax assets................ (3,350)  (7,718)
                                                                ------  -------
                                                                $  --   $   --
                                                                ======  =======
</TABLE>

  The Company has determined that the net deferred tax assets as of December
31, 1998 and 1999 do not satisfy the recognition criteria set forth in SFAS
No. 109. Accordingly, a valuation allowance was recorded against the
applicable net deferred tax assets.

12. Commitments and Contingencies:

Leases

  The Company leases office space under noncancellable operating leases, one
of which was from a related party (see Note 9). The Company entered into a new
lease in 1999 for office space for its corporate headquarters. The lease term
commenced in February 1999 for a period of ten years. The initial base annual
rent is approximately $861,000 per year with annual rent escalations of 2
percent each year thereafter. The Company recognizes rental expense on a
straight-line basis over the lease term based on the total lease commitment,
including escalations. Other long-term liabilities as of December 31, 1999
primarily reflect the value of leasehold improvements in the Washington, DC
location paid for by the landlord.

  The new building is approximately 45% owned by one of the principal
stockholders of the Company and his wife. The Company believes that the terms
of the lease, including the rental rate, are at least as favorable to the
Company as those which could have been negotiated with an unaffiliated third
party.

  In October 1999, the Company entered into a ten year lease for 14,500 square
feet in Arlington, Virginia for its sales and customer support staff. This
lease was amended to 52,000 square feet in early 2000.

  The Company's subsidiaries, CAISSoft and Business Anywhere, which were
acquired in September 1999, are currently leasing office space to house their
operations. CAISSoft leases approximately 24,000 square feet of office space
in San Diego, California, while Business Anywhere leases approximately 5,000
square feet in Irvine, California.


                                      52
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  Total rental expense for operating leases, including related party rent, was
approximately $300,000, $329,000 and $1,434,000 for the years ended December
31, 1997, 1998 and 1999, respectively.

  Minimum future lease payments at December 31, 1999 are as follows (in
thousands):

<TABLE>
<CAPTION>
                                                                       Operating
                                                                        Leases
                                                                       ---------
   <S>                                                                 <C>
   2000...............................................................  $ 3,387
   2001...............................................................    3,689
   2002...............................................................    3,500
   2003...............................................................    3,196
   2004 and thereafter................................................   15,089
                                                                        -------
                                                                        $28,861
                                                                        =======
</TABLE>

Capital Lease

  The Company leases certain office equipment under a noncancelable capital
lease entered into during 1999. Equipment capitalized under the lease as of
December 31, 1999 was approximately $500,000. Future minimum payments for the
capital lease as of December 31, 1999 were approximately $324,000 for the year
ending December 31, 2000, including interest of approximately $12,000.

License and Royalty Agreement

  In November 1996, the Company and the corporate inventor of OverVoice (the
"Corporate Inventor") entered into a license agreement that provided the
Company with an option to acquire an exclusive license to use, make, sub-
license or sell the OverVoice technology, subject only to certain geographical
and pre-existing contract limitations described in the license agreement. The
Company paid $50,000 for this option and an additional $50,000 when it
exercised its option to acquire the license in April 1997. Unless the Company
terminates the license agreement, it will remain in effect until the lapse of
the last patent existing at the time of the agreement or any additional
patents filed during the term. Following the exercise of the option, the
Company agreed to expend up to $200,000 for research and development efforts
to design and build a system that incorporated the patented technology, and to
hire the individual inventor of OverVoice ("Individual Inventor") for a two
year consulting contract.

  The license agreement calls for royalties to be paid to the Corporate
Inventor equal to a variable percentage of net revenues, depending both upon
the specific type of service provided and the total annual revenue from all
services. The royalty percentage for services in which the Company is an
active participant either by selling proprietary equipment or by selling
Internet services ranges up to 5.5%. In cases where the Company is an inactive
participant and merely sub-licenses its rights, the Corporate Inventor
receives a royalty percentage that ranges from 40-70%. Management plans to
remain an active participant in all or substantially all OverVoice activities
at this time.

  The Company had minimum annual royalty obligations to the Corporate Inventor
of $150,000 for 1999 and increasing to a maximum of $250,000 per year during
the term of the agreement, unless the license agreement is terminated at the
Company's option.

  In August 1997, the Corporate Inventor and the Company signed an amendment
that states that the Company would advance funds for approved expenses related
to patent applications. As of December 31, 1997, 1998 and 1999, respectively,
the Company has recorded notes receivables for patent fund advances totaling
$38,000, $82,000 and $120,000, respectively. These notes receivable balances
have been partially reserved in the accompanying consolidated balance sheets,
due to the minimum royalty obligations.

                                      53
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  In a January 1999 amendment, the Company and the Corporate Inventor agreed
to transfer 50% of the patent ownership to the Company.

Litigation

  The Company and the Corporate Inventor were named as defendants in a federal
civil action filed in the Eastern District of New York in September 1998. The
plaintiff alleged patent infringement, unfair competition, breach of contract
and related claims. On January 24, 1999, the parties in this litigation signed
a Settlement Agreement (the "Settlement"). Under the terms of the Settlement,
the Company agreed to pay the plaintiff $500,000 as follows: $250,000 upon
dismissal of this action, $150,000 on or before July 1, 1999, and $100,000 on
or before July 1, 2000. The Company also issued the plaintiff 25,000 shares of
common stock. In exchange, the plaintiff also agreed to modify their exclusive
license agreement with the Corporate Inventor to a nonexclusive agreement. As
a result, the Company now has the right to install the OverVoice technology in
single family residences and food establishments. Along with the cash
settlement, the Company expensed the fair value of the 25,000 shares of common
stock issued in the accompanying statement of operations for the year ended
December 31, 1998.

  On March 25, 1999, the Company filed a patent infringement lawsuit against
LodgeNet Entertainment Corp. ("LodgeNet") in Maryland U.S. District Court. The
complaint charged LodgeNet with infringement of one of the OverVoice patents,
which is directed to the delivery of high-speed audio and video signals over
active telephone wiring. On September 15, 1999 the Company and LodgeNet
entered into a settlement agreement, and on September 16, 1999 the Company
submitted a Stipulation of Dismissal of the lawsuit, under terms satisfactory
to the Company.

  The Company is not a party to any lawsuit or proceeding which, in the
opinion of its management, is likely to have a material adverse effect on its
business, financial condition or results of operation.

Network Capacity

  The Company and Qwest entered into a twenty-year Indefeasible Right of Use
("IRU") agreement, dated as of September 28, 1999. The Company purchased
approximately $44 million of capacity on Qwest's fiber network, of which
approximately $14.5 million is included in accrued expenses in the
accompanying consolidated balance sheets as of December 31, 1999. The Qwest
capacity will support the delivery of the Company's network services to 38
metropolitan areas across the United States. The Company also committed to
purchase $10 million of Qwest's communications services over five years. The
IRU agreement terminated the Company's $100 million commitment in the parties'
June 1998 Memorandum of Understanding.

13. Segment Reporting:

  The Company has two reportable segments: visitor-based and multi-family
networks ("Networks") and Internet Services (see Note 1). Networks includes
operations related to the Company's provision of broadband Internet services
to hospitality and multi-family properties and also the Company's wholly-owned
subsidiaries, CAIS Software Solutions and Business Anywhere. Internet Services
includes the operations related to the Company's provision of its DSL
services, web hosting, dial up and traditional Internet connectivity
solutions. The accounting principles of the segments are the same as those
applied in the consolidated condensed financial statements. Since Networks is
a new segment, its revenues and costs are being reported on an incremental
basis without any allocations of corporate overhead. Interest is allocated
based upon the respective percentage of losses before interest of the two
segments. The evaluation of the Networks segment's performance is based on the
accumulation of revenues and specific costs identified to Networks operations.


                                      54
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  The following is a summary of information about each of the Company's
reportable segments that is used by the Company to measure the segment's
operations (in thousands):

<TABLE>
<CAPTION>
                                                 Year Ended December 31, 1997
                                                --------------------------------
                                                Internet
                                                Services  Networks  Consolidated
                                                --------  --------  ------------
<S>                                             <C>       <C>       <C>
Revenues....................................... $  4,556  $    --     $  4,556
Depreciation and amortization..................    1,117       --        1,117
Interest income (expense), net.................     (244)      (44)       (288)
Segment losses.................................   (4,247)     (778)     (5,025)
Segment assets.................................    1,615       --        1,615
Expenditures for segment assets................      556       --          556
<CAPTION>
                                                 Year Ended December 31, 1998
                                                --------------------------------
                                                Internet
                                                Services  Networks  Consolidated
                                                --------  --------  ------------
<S>                                             <C>       <C>       <C>
Revenues....................................... $  5,278  $     37    $  5,315
Depreciation and amortization..................    1,263         7       1,270
Interest income (expense), net.................     (778)     (323)     (1,101)
Segment losses.................................   (8,667)   (3,590)    (12,257)
Segment assets.................................    2,404       882       3,286
Expenditures for segment assets................    1,537     1,272       2,809
<CAPTION>
                                                 Year Ended December 31, 1999
                                                --------------------------------
                                                Internet
                                                Services  Networks  Consolidated
                                                --------  --------  ------------
<S>                                             <C>       <C>       <C>
Revenues....................................... $  7,367  $  3,417    $ 10,784
Depreciation and amortization..................    1,463     6,203       7,666
Interest income (expense), net.................      688       347       1,035
Segment losses.................................  (34,844)  (17,593)    (52,437)
Segment assets.................................   66,208    79,788     145,996
Expenditures for segment assets................   52,370    37,782      90,152
</TABLE>

  Approximately $12,000 and $2,174,000 of Internet Service and Networks
revenues, respectively, for the year ended December 31, 1999 represent
equipment sales.

  The following is a reconciliation of the reportable segments' losses and
assets to the Company's consolidated totals (in thousands):

<TABLE>
<CAPTION>
                                                   Years Ended December 31,
                                                   ---------------------------
                                                    1997      1998      1999
                                                   -------  --------  --------
<S>                                                <C>      <C>       <C>
Losses
Total losses for reportable segments.............. $(5,025) $(12,257) $(52,437)
Income (loss) from discontinued operations........   1,923      (671)     (340)
Extraordinary item................................     --        --       (551)
                                                   -------  --------  --------
Consolidated net loss............................. $(3,102) $(12,928) $(53,328)
                                                   =======  ========  ========
</TABLE>


                                      55
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

<TABLE>
<CAPTION>
                                                                December 31,
                                                              ----------------
                                                               1998     1999
                                                              ------- --------
   <S>                                                        <C>     <C>
   Assets
   Total assets for reportable segments...................... $ 3,286 $145,996
   Total current assets, excluding reportable segment
    assets...................................................   8,493   39,006
   Deferred financing and offering costs, net................     529    1,499
   Intangible assets and goodwill, net.......................     277      --
   Receivable from officers..................................     --       450
   Noncurrent assets of discontinued operations..............   1,936      --
                                                              ------- --------
   Consolidated total assets................................. $14,521 $186,951
                                                              ======= ========
</TABLE>

Major Customer and Geographical Information

  For the year ended December 31, 1999, a kiosk terminal customer in the U.S.
represented 13 percent and 14 percent of the Company's consolidated net
revenues and cost of revenues, respectively. Substantially all net revenues
were earned from customers in the United States.

14. Regulatory Matters

  At the present time, ISPs like the Company are not subject to direct
regulation by the Federal Communications Commission ("FCC") even though they
provide Internet access through transmission over public telephone lines.
However, as the growth of the Internet industry continues, there has been
considerable discussion and debate about whether the industry should be
subjected to regulation. This regulation could include universal service
subsidies for local telephone services and enhanced communications systems for
schools, libraries and certain health care providers. Local telephone
companies could be allowed to charge ISPs for the use of their local telephone
network to originate calls, similar to charges currently assessed on long
distance telecommunications companies. In addition, many state and local
government officials have asserted the right or indicated a willingness to
impose taxes on Internet-related services and commerce, including sales, use
and excise taxes.

15. Subsequent Events

  On January 26, 2000, the Company entered an agreement with Bass to provide
the Company's services to approximately 2,750 properties and 400,000 rooms.
The Company will pay contract rights to individual hotels at a rate of $25 per
room when a hotel contracts for service. Additionally, the Company will
contribute up to approximately $2.2 million in marketing and technology
development funds. The Company issued 63,000 warrants to Bass effective
February 1, 2000 with an exercise price of $40.01 per share.

  On February 9, 2000, the Company announced that it had entered into an
agreement with Mid-America to provide the Company's services to approximately
35,000 apartment homes in 110 apartment communities. The Company paid Mid-
America approximately $778,000 for contract rights for installation and
marketing.

  On March 15, 2000, CAIS Software Solutions, Inc., a wholly owned subsidiary
of the Company, entered into an agreement to purchase the contracts,
intellectual property, and certain other assets of QuickATM, LLC ("QuickATM")
for a purchase price of $500,000 in cash, and $1,250,000 in the Company's
common stock. The Company issued approximately 40,000 shares of common stock
valued at $31.10 per share.

                                      56
<PAGE>

                              CAIS INTERNET, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  On March 20, 2000, the Company also entered into an agreement with 3Com
Corporation ("3Com") for the issuance of 20,000 shares of Series G Preferred
Stock for total gross proceeds of $20 million. The Series G Shares are
initially convertible into approximately 556,000 shares of CAIS common stock.
The Company also agreed to purchase $10 million of 3Com equipment over the
next year. The closing of the agreement is subject to the negotiation of a
definitive commercial and marketing agreement and apporoval under the Hart-
Scott-Rodino Antitrust Improvement Act of 1976.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

  Not applicable.

                                   PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

  The information required by Item 10 is incorporated by reference to our
Proxy Statement to be used in connection with our 2000 Annual Meeting of
Shareholders and to be filed with the Securities and Exchange Commission (the
"Commission") within 120 days after fiscal year end.

ITEM 11. EXECUTIVE COMPENSATION

  The information required by Item 11 is incorporated by reference to our
Proxy Statement to be used in connection with our 2000 Annual Meeting of
Shareholders and to be filed with the Commission.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

  The information required by Item 12 is incorporated by reference to our
Proxy Statement to be used in connection with our 2000 Annual Meeting of
Shareholders and to be filed with the Commission.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

  The information required by Item 13 is incorporated by reference to our
Proxy Statement to be used in connection with our 2000 Annual Meeting of
Shareholders and to be filed with the Commission.

                                    PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K


                                      57
<PAGE>

Report of Independent Public Accountants

To CAIS Internet, Inc. and subsidiaries
(formerly CGX Communications, Inc.):

  We have audited, in accordance with generally accepted auditing standards in
the United States, the consolidated financial statements of CAIS Internet,
Inc. (a Delaware corporation, formerly CGX Communications, Inc.) and
subsidiaries included in this Form 10-K and have issued our report thereon
dated March 6, 2000 (except with respect to the matters discussed in Note 15
to the consolidated financial statements, which are indicated to have occurred
subsequent to March 6, 2000, as to which the date is March 20, 2000). Our
audits were made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The schedule listed in Item 14 is the
responsibility of the Company's management and is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part
of the basic financial statements. This schedule has been subjected to the
auditing procedures applied in the audits of the basic financial statements
and, in our opinion, fairly states, in all material respects, the financial
data required to be set forth therein in relation to the basic financial
statements taken as a whole.

Vienna, Virginia
March 6, 2000

a. Documents filed as a part of this report.

1. Financial Statements

See Index to Financial Statements on page 30.

2. Financial Statement Schedules

                                  SCHEDULE II

                       VALUATION AND QUALIFYING ACCOUNTS

                 YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999

                                (in thousands)

<TABLE>
<CAPTION>
                                                          Balance at  Charged to                Balance at
                                                         Beginning of Costs and                   End of
                                   Description               Year      Expenses  Deductions (a)    Year
                         ------------------------------- ------------ ---------- -------------- ----------
<S>                      <C>                             <C>          <C>        <C>            <C>
1997.................... Allowance for doubtful accounts     $137        $106        $ (64)        $179
1998.................... Allowance for doubtful accounts      179          80         (122)         137
1999.................... Allowance for doubtful accounts      137         552         (440)         249
</TABLE>

(a) Represents amounts written off as uncollectible.

                                      58
<PAGE>

3. Exhibits

  See Index to Exhibits on page 61.

b. Reports on Form 8-K.

  On September 17, 1999, the Company filed a Current Report on Form 8-K with
respect to the acquisition of Atcom on September 2, 1999. On November 12,
1999, the Company filed an amendment on Form 8-K/A for the purpose of
including financial statements and pro forma financial information with
respect to such acquisition.

  On December 27, 1999, the Company filed a Current Report on Form 8-K which
included as an Exhibit the Company's press release dated December 21, 1999
announcing that it had signed a definitive agreement with an affiliate of
Kohlberg Kravis Roberts & Co. (KKR), a private investment firm in New York,
under which KKR, through its affiliate, will make a strategic investment of up
to $200 million in the Company.

  On March 7, 2000, the Company filed a Current Report on Form 8-K which
included as an Exhibit the Company's press release dated February 28, 2000
announcing it had completed the sale of $73.9 million of Series D convertible
preferred stock to the KKR affiliate. An additional $26.1 million of Series D
convertible preferred stock will be sold upon receipt of shareholder approval
of the issuance of the shares.

                                      59
<PAGE>

                                   SIGNATURE

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

                                          CAIS Internet, Inc.

<TABLE>
<CAPTION>
              Signature                         Capacity                 Date
              ---------                         --------                 ----

<S>                                    <C>                        <C>
     /s/ Ulysses G. Auger, II          Chairman of the Board and    March 21, 2000
______________________________________  Chief Executive Officer
         Ulysses G. Auger, II           (Principal Executive
                                        Officer)

        /s/ Barton R. Groh             Chief Financial Officer      March 21, 2000
______________________________________  (Principal Financial and
            Barton R. Groh              Accounting Officer)

      /s/ S. Theodore Ammon            Director                     March 21, 2000
______________________________________
          S. Theodore Ammon

    /s/ Ulysses G. Auger, Sr.          Director                     March 21, 2000
______________________________________
        Ulysses G. Auger, Sr.

   /s/ William M. Caldwell, IV         Director                     March 21, 2000
______________________________________
       William M. Caldwell, IV

     /s/ Vernon Fotheringham           Director                     March 21, 2000
______________________________________
         Vernon Fotheringham

    /s/ James H. Greene, Jr.           Director                     March 21, 2000
______________________________________
         James H. Greene, Jr.
       /s/ Richard F. Levin            Director                     March 21, 2000
______________________________________
           Richard F. Levin

     /s/ Alexander Navab, Jr.          Director                     March 21, 2000
______________________________________
         Alexander Navab, Jr.
</TABLE>


                                       60
<PAGE>

                              CAIS INTERNET, INC.

                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
 Exhibit
   No.    Description
 -------- -----------
 <C>      <S>
    *2.1  Agreement of Merger among the Company, CAIS, Inc. and CGX2 Merger
          Corp., dated October 2, 1998.
  ***2.2  Amended and Restated Agreement and Plan of Merger, dated as of August
          4, 1999, by and among the Registrant, CIAM Corp., and Atcom, Inc.
  ***2.3  Amendment No. 1 to the Amended and Restated Agreement and Plan of
          Merger, dated as of September 1, 1999, by and among the Registrant,
          CIAM Corp., Atcom, Inc.
     2.4  Agreement and Plan of Merger, dated as of September 7, 1999, by and
          among the Company, Business Anywhere, USA, Inc., and CIBA Merger
          Corporation., Kim Kao and Amy Hsiao
    *3.2  Certificate of Incorporation: Restated Certificate of Incorporation
          of the Company incorporated by reference to Exhibit 3.1 to the
          Registration Statement.
    *3.4  By-Laws: Amended and Restated By-Laws of the Company incorporated by
          reference to Exhibit 3.2 to the Registration Statement.
    *4.1  Specimen Common Stock Certificate.
    *4.2  Warrant Agreement by and among CAIS Internet, Inc., CAIS, Inc.,
          Cleartel Communications, Inc. and ING (U.S.) Capital Corporation,
          Inc., dated September 4, 1998.
 ****4.3  Certificate of Designation of Series C Preferred Stock of CAIS
          Internet, Inc.
    *4.4  Common Stock Warrant, among CAIS Internet, Inc. and Chancery Lane,
          L.P., dated February 19, 1999.
    *4.5  Common Stock Warrant, among CAIS Internet, Inc. and CAIS-Sandler
          Partners, L.P., dated February 19, 1999.
    *4.6  Common Stock Warrant, among CAIS Internet, Inc. and Hilton Hotels
          Corporation, dated April 22, 1999.
    *4.7  Warrant Agreement, among CAIS Internet, Inc. and Hilton Hotels
          Corporation, dated April 22, 1999.
 ****4.8  Common Stock Warrant, among CAIS Internet, Inc. and U.S. Telesource,
          Inc., dated as of October 27, 1999
 ****4.9  Certified Certificate of Amendment of Certificate of Designation of
          Series filed in Delaware.
     4.10 Form of Certificate of Designation of Series D Preferred Stock of
          CAIS Internet, Inc.
     4.11 Form of Certificate of Designation of Series E Preferred Stock of
          CAIS Internet, Inc.
     4.12 Common Stock Warrant Agreement among CAIS Internet, Inc. and Bass
          Hotels & Resorts, Inc. dated February 1, 2000.
 p* 10.1  Agreement for Cooperative Use of Communication Patents, Purchase of
          an Option to Obtain Intellectual Property Rights, among Inline
          Connection Corporation and CAIS, Inc., dated November 5, 1996.
  * 10.2  Letter Agreement Extending Option Period provided in the Agreement
          for Cooperative Use of Communication Patents, among Inline Connection
          Corporation and CAIS, Inc., dated February 28, 1997.
</TABLE>

                                       61
<PAGE>

<TABLE>
<CAPTION>
 Exhibit
   No.    Description
 -------- -----------
 <C>      <S>
  * 10.3  Letter Exercising Option Pursuant to Agreement for Cooperative Use of
          Communication Patents, among Inline Connection Corporation and CAIS,
          Inc., dated April 4, 1997.
  * 10.4  Amended and Restated Employment Agreement, among CAIS, Inc. and Evans
          K. Anderson, dated June 3, 1997.
  * 10.5  Deed of Lease, among Ramay Family Partnership and CAIS, Inc., dated
          July 28, 1997.
  * 10.6  Letter Amendment Agreement to Agreement for Cooperative Use of
          Communication Patents, among Inline Connection Corporation and CAIS,
          Inc., dated August 1, 1997.
  * 10.7  Amended and Restated Employment Agreement, among CAIS, Inc. and
          William M. Caldwell, IV, dated September 8, 1997.
  * 10.8  Letter Amendment Agreement to Agreement for Cooperative Use of
          Communication Patents, among Inline Connection Corporation and CAIS,
          Inc., dated October 21, 1997.
  * 10.9  CAIS Internet Services Agreement, among CAIS, Inc. and Hongkong
          Telecom, dated October 24, 1997.
  * 10.10 Collaboration on IPORT Market Trial Agreement, among CAIS, Inc. and
          Microsoft Corporation, dated February 18, 1998.
  * 10.11 Investment Agreement, among the Company, CAIS, Inc. and R. Theodore
          Ammon, dated April 22, 1998.
  * 10.12 Credit Agreement by ING (U.S.) Capital LLC to the Company, CAIS, Inc.
          and certain of the Company's affiliates, dated September 4, 1998.
 p* 10.13 CAIS IPORT Integrator License Agreement, among CAIS and ATCOM, Inc.
          d/b/a ATCOM/INFO dated September 10, 1998.
  * 10.14 Exchange Agreement, among the Company, the limited partners of
          Cleartel LP, Cleartel, Inc. and the shareholders of Cleartel, Inc.,
          dated October 2, 1998.
  * 10.15 Assignment and Assumption Agreement and Release, among the Company,
          CAIS, Inc. and William M. Caldwell, IV, dated October 2, 1998.
  * 10.16 Assignment and Assumption Agreement and Release, among the Company,
          CAIS, Inc. and Evans K. Anderson, dated October 2, 1998.
  * 10.17 Employment Agreement, among the Company and Laura Neuman, dated June
          29, 1998.
  * 10.18 Letter Amendment Agreement to Agreement for Cooperative Use of
          Communication Patents, among Inline Connection Corporation and CAIS,
          Inc., dated March 4, 1998.
  * 10.19 Deed of Lease, among Ramay Family Partnership and CAIS, Inc., dated
          May 28, 1998.
 p* 10.20 Marketing Associate Solution Alliance Agreement, among CAIS, Inc. and
          Unisys Corporation, dated November 11, 1998.
  * 10.21 Office Building Lease for 1255 22nd Street, among 1255 22nd Street
          Associates Limited Partnership and the Company, dated November 21,
          1998.
 p* 10.22 Master License Agreement for High Speed Internet Service, among
          Hilton Hotels Corporation and CAIS, Inc., dated December 23, 1998.
 p* 10.23 Marketing/Administration Fund and Incentive Agreement, among Hilton
          Hotels Corporation and CAIS, Inc., dated December 23, 1998.
  * 10.24 Application Transfer for Inline PCT Serial No. PCT/US97/12045, among
          Inline Connection Corporation and CAIS, Inc., dated January 6, 1999.
</TABLE>

                                       62
<PAGE>

<TABLE>
<CAPTION>
 Exhibit
   No.    Description
 -------- -----------
 <C>      <S>
  * 10.25 Assignment of USSN 08/893,403 and PCT/US97/12045, among Inline
          Connection Corporation and CAIS, Inc., dated January 6, 1999.
  * 10.26 Settlement Agreement, among CAIS, Inc. and Terk Technologies Corp.,
          dated January 24, 1999.
  * 10.27 Letter Amendment Agreement to Agreement for Cooperative Use of
          Communication Patents among Inline Connection Corporation and CAIS,
          Inc., dated January 26, 1999.
  * 10.28 Assignment of 50% of Certain Patent Properties, among Inline
          Connection Corporation and CAIS, Inc., dated January 26, 1999.
  * 10.29 Assignment of Certain Trademarks, among Cleartel Communications, Inc.
          and CAIS, Inc., dated February 9, 1999.
  * 10.30 The Company's Amended and Restated 1998 Equity Incentive Plan, dated
          February 12, 1999.
  * 10.31 Amendment No. 1 to Credit Agreement by ING (U.S.) Capital LLC to the
          Company, CAIS, Inc. and certain of the Company's affiliates for
          $7,000,000, dated February 12, 1999.
 p* 10.32 Agreement for High Speed Internet Access Service in Multiple Dwelling
          Units, among CAIS, Inc. and OnePoint Communications Corp., dated
          February 19, 1999.
  * 10.33 Series A Preferred Stock and Warrant Purchase Agreement, among CAIS
          Internet, Inc., Chancery Lane, L.P. and CAIS-Sandler Partners, L.P.,
          dated February 19, 1999.
  * 10.34 Stockholders Agreement among CAIS Internet, Inc., Chancery Lane, L.P.
          and CAIS-Sandler Partners, L.P., dated February 19, 1999.
  * 10.35 Amendment to Amended and Restated Employment Agreement, among the
          Company, CAIS, Inc. and Evans K. Anderson, dated February 22, 1999.
  * 10.36 Amendment to Amended and Restated Employment Agreement, among the
          Company, CAIS, Inc. and William M. Caldwell, IV, dated February 22,
          1999.
 ** 10.37 Global Purchase Agreement between CAIS, Inc. and Nortel Networks,
          Inc., dated April 1, 1999.
 p* 10.38 First Amendment to Master License Agreement, among Hilton Hotels
          Corporation, CAIS Internet, Inc. and CAIS, Inc. dated April 23, 1999.
 p* 10.39 First Amendment to Marketing/Administration Fund and Incentive
          Agreement, among Hilton Hotels Corporation and CAIS, Inc., dated
          April 23, 1999.
  * 10.40 Letter Agreement for the Hilton Hotel Digital Entertainment Fund,
          among Hilton Hotels Corporation and CAIS Internet, Inc., dated April
          23, 1999.
 ** 10.41 Credit Agreement by and among CAIS, Inc. and Nortel Networks Inc.,
          dated June 4, 1999.
 ** 10.42 Guaranty Agreement by the Company in favor of Nortel Networks Inc.,
          dated June 4, 1999.
 ** 10.43 Security Agreement by and among CAIS, Inc. and Nortel Networks Inc.,
          dated June 4, 1999.
 ** 10.44 Security Agreement by and among the Company and Cisco Systems Capital
          Corporation, dated June 30, 1999.
 ** 10.45 Security Agreement by and among CAIS, Inc. and Cisco Systems Capital
          Corporation, dated June 30, 1999.
 ** 10.46 Guaranty Agreement by the Company in favor of Cisco Systems Capital
          Corporation, dated June 30, 1999.
 ** 10.47 Credit Agreement by and among CAIS, Inc. and Cisco Systems Capital
          Corporation, dated June 30, 1999.
</TABLE>

                                       63
<PAGE>

<TABLE>
<CAPTION>
  Exhibit
    No.     Description
 ---------- -----------
 <C>        <S>
  *** 10.48 Registration Rights and Lock-Up Agreement, dated as of August 4,
            1999, by and among the Registrant and the shareholders of Atcom,
            Inc. listed therein.
 **** 10.49 First Amendment to Credit Agreement, made and entered into
            effective September 7, 1999 by and among the Company and Nortel
            Networks, Inc.
      10.51 Registration Rights and Lock-Up Agreement by and among the
            Registrant, Kim Kao and Amy Hsiao, dated as of September 7, 1999.
 **** 10.52 Series C Preferred Stock Purchase Agreement between CAIS Internet,
            Inc. and U.S. Telesource, Inc. dated September 29, 1999
 **** 10.53 First Amendment, dated October 27, 1999, to Registration Rights and
            Lock-Up Agreement dated September 29, 1999.
      10.54 Form of First Amendment, dated December 2, 1999, to Credit
            Agreement by and among CAIS, Inc. and Cisco Systems Capital
            Corporation, dated June 30, 1999.
      10.55 Form of First Amendment to Guaranty, dated as of December 2, 1999,
            between CAIS Internet, Inc. and Cisco Stytems Capital Corporation.
      10.56 Borrower Consent for First Amendment to Guaranty Dated December 2,
            1999 By and Between CAIS, Inc. and Cisco Systems Capital
            Corporation.
      10.57 Preferred Stock Purchase Agreement between CAIS, Inc. and CII
            Ventures LLC, dated as of December 20, 1999.
      10.58 Voting Agreement between CII Ventures LLC and certain holders of
            the Registrant's common stock, dated as of December 20, 1999.
      10.59 Form of Office Lease by and between CAIS, Inc. and Ames Center,
            L.C., dated      , 1999.
      10.60 Form of Amendment to Office Lease by and between CAIS, Inc. and
            Ames Center, L.C., dated November 18, 1999.
      10.61 Second Amendment to Office Lease by and between CAIS, Inc. and Ames
            Center, L.C., dated March 1, 2000.
      10.62 Form of Stockholders Agreement between the Registrant and CII
            Ventures LLC, dated as of      , 2000.
      10.63 Asset Purchase Agreement between the Registrant, CAIS Software
            Solutions, Inc., and QuickATM, dated March 15, 2000.
      10.64 Form of Registration Rights Agreement, dated as of March 15, 2000
            by and among the Registrant and QuickATM, Inc.
      10.65 Form of Bill of Sale, Assignment and Assumption Agreement as of
            March 15, 2000 by and between CAIS Software Solutions, Inc. and
            QuickATM, LLC.
      10.66 Second Amendment, dated March 20, 2000, to Credit Agreement by and
            among CAIS, Inc. and Cisco Systems Capital Corporation, dated June
            30, 1999.
    * 21.1  List of Subsidiaries.
      23.1  Consent of Arthur Andersen LLP
      27.1  Financial Data Schedule.
 **** 99.1  Financial Statements of Atcom, Inc.
 **** 99.2  Unaudited Pro Forma Condensed Combined Financial Information.
</TABLE>
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*   Incorporated by reference from the Registration Statement on Form S-1 of
    the Registrant (Registration No. 333-72769) filed with the Commission on
    May 19, 1999, as amended.
p   Portions of this Exhibit have been omitted pursuant to a request for
    confidential treatment and filed separately with the SEC.

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<PAGE>

   ** Incorporated by reference from the Registrant's quarterly report on Form
      10-Q filed with the Commission on August 16, 1999.
  *** Incorporated by reference from the Registrant's current report on Form 8-K
      filed with the Commission on September 17, 1999.
 **** Incorporated by reference from the Registrant's amended current report on
      Form 8-K/A filed with the Commission on November 12, 1999.
***** Incorporated by reference from the Registrant's quarterly report on 10-Q
      filed with the Commission on November 15, 1999.

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