<PAGE>

                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549

                                   FORM 10-K

                 Annual Report Pursuant to Section 13 or 15(d)
                    of the Securities Exchange Act of 1934

 For the fiscal year ended December 31, 2000   Commission File Number:  0-20763

                            McLeodUSA Incorporated

            (Exact name of registrant as specified in its charter)

         Delaware                                   42-1407240

         (State or other jurisdiction of            (I.R.S. Employer
         incorporation or organization)             Identification No.)

         McLeodUSA Technology Park
         6400 C Street SW, P.O. Box 3177
         Cedar Rapids, IA                           52406-3177
         (Address of principal executive offices)   (Zip Code)

      Registrant's telephone number, including area code:  (319) 364-0000

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

                                 Not applicable

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

                Class A common stock, par value $0.01 per share
           6.75% Series A preferred stock, par value $0.01 per share
                               (Title of Classes)

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 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 registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant, based upon the closing price of the
registrant's common stock as of March 22, 2001 is $4,098,027,509.*/

The number of shares outstanding of each of the registrant's classes of common
stock, as of the latest practicable date is:

          .  Class A common stock, par value $.01 per share, outstanding as of
             March 22, 2001: 611,775,451 shares

-------------------
*/ Solely for the purposes of this calculation, all directors and executive
officers of the registrant and all stockholders beneficially owning more than 5%
of the registrant's common stock that have representation on the registrant's
Board of Directors are considered to be affiliates.
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                       DOCUMENTS INCORPORATED BY REFERENCE

List hereunder the following documents incorporated by reference and the Part of
the Form 10-K into which the document is incorporated: Portions of the
definitive proxy statement for the Annual Meeting of Stockholders to be held on
May 30, 2001, to be filed within 120 days after the end of the registrant's
fiscal year, are incorporated by reference into Part III, Items 10-13 of this
Form 10-K.

                               TABLE OF CONTENTS

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       <S>                                                                                                   <C>
       PART I   Item 1.      Business  .....................................................................   1
                                 Overview...................................................................   1
                                 Recent Transactions........................................................   4
                                 McLeodUSA Business Strategy................................................   4
                                 Market Potential...........................................................   4
                                 Current Products and Services..............................................   6
                                 Network Facilities.........................................................  11
                                 Sales and Marketing........................................................  13
                                 Wireless Licenses..........................................................  14
                                 Competition................................................................  15
                                 Regulation.................................................................  19
                                 Risk Factors...............................................................  25
                                 Employees..................................................................  34
                                 Executive Officers ........................................................  34
                Item 2.      Properties.....................................................................  36
                Item 3.      Legal Proceedings..............................................................  37
                Item 4.      Submission of Matters to a Vote of Security Holders............................  38

       PART II  Item 5.      Market for Registrant's Common Equity and
                             Related Stockholder Matters....................................................  38
                Item 6.      Selected Financial Data........................................................  39
                Item 7.      Management's Discussion and Analysis of Financial
                             Condition and Results of Operations............................................  42
                Item 7A.     Quantitative and Qualitative Disclosures
                             About Market Risk..............................................................  52
                Item 8.      Financial Statements and Supplementary Data....................................  52
                Item 9.      Changes in and Disagreements with Accountants on
                             Accounting and Financial Disclosure............................................  52

       PART III Item 10.     Directors and Executive Officers of the Registrant.............................  52
                Item 11.     Executive Compensation.........................................................  52
                Item 12.     Security Ownership of Certain Beneficial Owners
                             and Management.................................................................  53
                Item 13.     Certain Relationships and Related Transactions.................................  53

       PART IV  Item 14.     Exhibits, Financial Statement Schedules, and
                             Reports on Form 8-K............................................................  53

       GLOSSARY.............................................................................................  66

       SIGNATURES...........................................................................................  69

       INDEX TO CONSOLIDATED FINANCIAL STATEMENTS...........................................................  F-1

       REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
       ON THE FINANCIAL STATEMENT SCHEDULES.................................................................  S-1
</TABLE>
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References in this Form 10-K to "we," "us," "our" and "McLeodUSA" mean McLeodUSA
Incorporated and our subsidiaries and predecessors, unless the context suggests
otherwise. Some of the statements contained in this Form 10-K discuss future
expectations, contain projections of results of operations or financial
condition or state other forward-looking information. These statements are
subject to known and unknown risks, uncertainties and other factors that could
cause the actual events to differ materially from those contemplated by the
statements. The forward-looking information is based on various factors and was
derived using numerous assumptions. In some cases, you can identify these so-
called "forward-looking statements" by our use of words such as "may," "will,"
"should," "expect," "plan," "anticipate," "believe," "estimate," "predict,"
"project," "intend" or "potential" or the negative of those words and other
comparable words. You should be aware that those statements only reflect our
predictions. Actual events or results may differ substantially. Important
factors that could cause actual events or results to be materially different
from the forward-looking statements include those discussed under the heading
"Business--Risk Factors" and throughout this Form10-K.

See the "Glossary" appearing at page66 for definitions of some of the terms used
in this Form 10-K.

                                    PART I

Item 1.  Business.


The following disclosure relating to our business is organized as follows:

     .  Overview
     .  Recent Transactions
     .  McLeodUSA Business Strategy
     .  Market Potential
     .  Current Products and Services
     .  Network Facilities
     .  Sales and Marketing
     .  Wireless Licenses
     .  Competition
     .  Regulation
     .  Risk Factors
     .  Employees
     .  Executive Officers

Overview

We provide integrated communications services, including local services, in 25
Midwest, Southwest, Northwest and Rocky Mountain states. We also provide long
distance and advanced data services in all 50 states. We are a facilities-based
telecommunications provider with, as of December 31, 2000, 396 ATM switches, 50
voice switches, approximately 1.1 million local lines and more than 10,700
employees. Our network is capable of transmitting integrated next-generation
data, Internet, video and voice services, reaching 800 cities and approximately
90% of the U.S. population. In the next 12 months, we plan to distribute 33
million telephone directories in 26 states, serving a population of 56 million.
McLeodUSA is a Nasdaq-100 company traded under the symbol "MCLD."

Our integrated communications services include local, long distance, Internet
access, data and voice mail services from a single company on a single bill. We
believe we are the first company

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in many of our markets to offer one-stop shopping for communications services
tailored to customers' specific needs.

Our core business is providing communications services in competition with
existing local telephone companies, including:

     .  local and long distance services

     .  dial and dedicated Internet access

     .  higher bandwidth Internet access services, such as digital subscriber
        line (DSL) and cable modem

     .  value-added services such as virtual private networks and web hosting
        bandwidth leasing and colocation services

     .  facilities and services dedicated to a particular customer's use

     .  telephone and computer sales, leasing, networking, service and
        installation

     .  other communications services, including video, cellular, operator,
        payphone, mobile radio and paging services

We also derive revenue from the following services related to our core business:

     .  sale of advertising in print and electronic telephone directories

     .  traditional local telephone company services in east central Illinois
        and southeast South Dakota

     .  telemarketing services

In most of our markets, we compete with the entrenched, traditional local phone
company by leasing its lines and switches. In many markets we provide local
services by using our own facilities and by leasing capacity from others. We
provide long distance services by using our own facilities and by leasing
capacity from others.

We are actively developing fiber optic communications networks in many of our
target local markets to carry additional communications traffic on our own
network. We are actively developing enhancements to our national network to
provide voice and data, local and long distance, narrow band and wide band, and
associated next-generation services to provide increased control and service
quality and a base for growth.

The following chronology highlights some of the important events in the
development of our business:

Date                                  Event
----                                  -----

November 1992             Began providing fiber optic maintenance services
                          for the Iowa Communications Network, a fiber optic
                          communications network that links many schools,
                          libraries and other public buildings in the State of
                          Iowa.

December 1993             Received regulatory approvals in Iowa and Illinois to
                          offer local service along with long distance service.

June 1996                 Completed our initial public offering of Class A
                          common stock.

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July 1996                 Acquired Ruffalo, Cody & Associates, Inc., a
                          telemarketing company.

September 1996            Acquired Telecom*USA Publishing Group, Inc., a
                          telephone directory company.

September 1997            Acquired Consolidated Communications Inc.
                          ("CCI"), a diversified telecommunications
                          company offering a variety of products and services,
                          including local exchange and long distance services
                          and telephone directory publishing.

February 1999             Acquired Talking Directories, Inc. and Info America
                          Phone Books, Inc., related companies publishing and
                          distributing telephone directories primarily in
                          Michigan and Northwestern Ohio.

March 1999                Acquired Dakota Telecommunications Group, Inc.
                          ("DTG"), a diversified communications company offering
                          a variety of products and services, including local
                          exchange, long distance and data services and cable
                          television operations.

                          Acquired Ovation Communications, Inc. ("Ovation"), a
                          diversified telecommunications company offering a
                          variety of products and services, including local and
                          network access, local and long distance telephone
                          services and Internet access, which facilitated
                          expansion into selected major metropolitan markets.

August 1999               Acquired Access Communications Holdings, Inc.
                          ("Access"), a telecommunications company providing
                          switch-based commercial and residential services,
                          including traditional long distance service and an
                          enhanced - 800# product.

September 1999            Completed the sale of our Series B and C Preferred
                          Stock to three Forstmann Little & Co. partnerships for
                          $1 billion.

March 2000                Acquired Splitrock Services, Inc. ("Splitrock"), a
                          facilities-based provider of advanced data
                          communications services.

May 2000                  Completed our Senior Secured Credit Facility in the
                          amount of $1.3 billion.

December 2000             Acquired CapRock Communications Corp. ("CapRock"),a
                          facilities-based integrated communications provider,
                          primarily to small and medium-sized business and
                          carrier customers in the Southwest.

Our principal executive offices are located at McLeodUSA Technology Park, 6400 C
Street SW, P.O. Box 3177, Cedar Rapids, Iowa 52406-3177, and our main phone
number is (319) 364-0000.

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Recent Transactions

In January 2001, we issued $750 million of our 11 3/8% Senior Notes due January
1, 2009 in an underwritten public offering. The offering was completed on
January 16, 2001 and resulted in total cash and available cash of $1.5 billion
as of that date.


McLeodUSA Business Strategy

We want to be the leading and most admired provider of communications services
in our markets.

The principal elements of our business strategy are to:

Provide integrated communications services. We believe we can rapidly penetrate
our target markets and build customer loyalty by providing an integrated product
offering to business and residential customers.

Build customer share through branding. We believe we will create and strengthen
brand awareness in our target markets by branding our communications services
with the trade name McLeodUSA in combination with the distinctive black-and-
yellow motif of our telephone directories.

Provide outstanding customer service. Our customer service representatives are
available 24 hours a day, seven days a week, to answer customer calls. Our
customer-focused software and systems allow our representatives immediate access
to our customer and network data, enabling a rapid and effective response to
customer requests.

Emphasize small and medium sized businesses. We primarily target small and
medium sized businesses because we believe we can rapidly capture customer share
by providing face-to-face business sales and strong service support to these
customers. We target small and medium-sized businesses in large metropolitan
areas as well as in second and third tier markets.

Expand our fiber optic communications network. We are strategically building a
state-of-the-art fiber optic communications network to deliver multiple services
and reduce operating costs.

Expand our intra-city fiber optic communications network. Within selected
cities, we plan to extend our network directly to certain customers' locations.
This will allow us to provide expanded services and reduce the expense of
leasing communications facilities from the existing local telephone company.

Explore acquisitions and strategic alliances. We plan to pursue acquisitions,
joint ventures and strategic alliances that expand or complement our business.

Leverage proven management team. Our executive management team consists of
veteran telecommunications managers who have successfully implemented similar
customer-focused telecommunications strategies in the past.

Market Potential

The communications industry is undergoing substantial changes due to statutory,
regulatory and technological developments; changes in the competitive landscape
and mergers and

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acquisitions in the industry. We believe that we are well positioned to take
advantage of these fundamental changes.

Wireline Services. The market for local exchange services consists of a number
of distinct service components, including:

     . local network services, which generally include basic dial tone, local
       area charges, enhanced calling features and private line services
       (dedicated for a customer's use between locations)
     . network access services, which consist of access provided by local
       exchange carriers to long distance communications network carriers short-
       haul long distance communications network services, which include
       intraLATA long distance calls and private lines
     . other varied services, including operator services, Internet access,
       calling cards, publication of "white page" and "yellow page" telephone
       directories and the sale of business telephone equipment

Industry sources have estimated that the 2000 aggregate U.S. revenues for local,
long distance, private line and data were approximately $200 billion. Of that
total, just over half is represented by local service revenue.

Before 1984, AT&T largely monopolized local and long distance telephone services
in the United States. In 1984, as the result of a court order approving a
settlement agreement in an antitrust action, AT&T was required to divest its
local telephone systems (the "Divestiture"). The Divestiture and subsequent
related proceedings divided the country into 201 Local Access and Transport
Areas ("LATAs"). As part of the Divestiture, AT&T's former local telephone
systems were organized into seven independent regional Bell operating companies.
The original seven regional Bell operating companies are now concentrated into
four large incumbent "MegaBells." Those companies have the authority to provide
local telephone service, local access service and intraLATA long distance
service, but cannot provide in-region interLATA service unless they demonstrate
that certain competitive conditions have been met. Opportunities to compete in
the local exchange market expanded substantially on February 8, 1996, when the
Telecommunications Act of 1996 was signed into law. The Telecommunications Act
of 1996 eliminated state legal barriers to local exchange competition and
required entrenched, traditional local exchange carriers to allow other
providers of telecommunications services to purchase elements of their local
communications network offerings and to interconnect with their communications
facilities and equipment. In addition, entrenched, traditional local exchange
carriers are obligated to provide local number portability and dialing parity
upon request and make their local services available for resale by competitors.
Entrenched, traditional local exchange carriers also are required to allow
competitors non-discriminatory access to poles, conduit space and other rights-
of-way.

We believe that these requirements are likely, when fully implemented, to
increase competition among providers of local communications services and
simplify the process of switching from entrenched, traditional local exchange
carrier services to those offered by competitive local exchange carriers. The
Telecommunications Act of 1996 also offers important benefits to the MegaBells,
however, such as the ability to provide interLATA long distance services under
specified conditions. The process of implementing the Telecommunications Act of
1996 is still incomplete, and important questions remain unresolved. In
addition, the MegaBells are promoting changes to the Telecommunications Act of
1996 which would be more favorable to them and less favorable to us. See "--
Regulation."

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A number of states have also taken additional regulatory and legislative action
to open local communications markets to various degrees of competition. We
expect that continuing pro-competitive regulatory changes, together with
increasing customer demand, will create more opportunities for competitive
service providers to introduce additional services, expand their networks and
address a larger customer base. We cannot provide any assurance however, that
government actions to implement local telephone competition will be as complete,
as favorable or as timely as we require to implement our business plans.

Wireless Services. Demand for wireless communications has grown rapidly over the
past decade. According to the Cellular Telecommunications Industry Association
("CTIA"), the number of wireless telephone subscribers nationwide has grown from
approximately 680,000 in 1986 to an estimated 97 million as of June 30, 2000,
with annual growth of approximately 27% from June 1999 through June 2000. We
believe that the demand for wireless communications will continue to grow
dramatically due to anticipated declines in costs of service, increased function
versatility, and increased awareness of the productivity, convenience and safety
benefits associated with such services. In addition, we expect future
competition between wireline local exchange carriers and wireless service
providers as "wireless local loop" technology and reduced wireless rates
facilitate migration of wireline minutes to wireless carriers. Communications
providers who do not develop wireless services themselves may determine it is
necessary to offer such services and may do so by entering into arrangements
with wireless service providers.

Current Products and Services

We derive most of our revenue from our core business of providing communications
services, including:

     . local and long distance services
     . dial and dedicated Internet access
     . higher bandwidth Internet access services, such as digital subscriber
       line (DSL) and cable modem
     . value-added services such as virtual private networks and web hosting
       bandwidth leasing and colocation services
     . facilities and services dedicated for a particular customer's use
     . telephone and computer sales, leasing, networking, service and
       installation
     . other communications services, including video, cellular, operator,
       payphone, mobile radio and paging services

We also derive revenue from the following services related to our core business:


     . sale of advertising in print and electronic telephone directories
     . traditional local telephone company services in east central Illinois and
       southeast South Dakota
     . telemarketing services

For the year ended December 31, 2000, we derived 74% of our total revenues from
our core business of providing local, long distance and related communications
services, 18% from the sale of advertising space in telephone directories, 6%
from traditional local telephone company services and 2% from telemarketing
services. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Overview."

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Integrated Communications Services

Overview. As of December 31, 2000, we provided service, on a retail basis, to
about 1.1 million local lines in our markets, primarily to small and medium
sized business customers in major metropolitan areas and in second and third
tier markets, and to residential customers in second and third tier markets.
Since beginning sales activities in January 1994, we have increased our revenue
from the sale of local and long distance telecommunications services from $4.6
million for the year ended December 31, 1994 to $716.2 million for the year
ended December 31, 2000.

As of December 31, 2000, we have received state regulatory approval to offer
local switched services using our own communications network facilities in
Arkansas, Arizona, Colorado, Florida, Idaho, Illinois, Indiana, Iowa, Kansas,
Louisiana, Michigan, Minnesota, Missouri, Montana, Nebraska, New Mexico, North
Dakota, Ohio, Oklahoma, Oregon, South Dakota, Tennessee, Texas, Utah,
Washington, Wisconsin and Wyoming. We intend to offer additional local switched
services using our own network facilities, either alone or in combination with
network elements purchased from existing telephone companies, in selected
markets in 25 states. We plan to expand these facilities-based services as our
communications network develops and our market penetration increases.

In certain locations, we enter the market by reselling standard retail business
services. This strategy allows us to aggressively capture customer share and
generate revenue in a market with little up-front cost in comparison to
establishing Centrex or other resold service, while we complete our own
communications network. We will move relatively quickly from a resale mode to
providing facilities-based services. In many other markets we have installed
facilities and are aggressively capturing customer share utilizing our own
switching facilities.

We use several platforms to aggressively capture customer share. We utilize
resale, facilities-based services, including both leased switch port and loop
combinations and our own switching facilities combined with leased loops and
direct build platforms. Our ability to use diverse platforms allow us to adapt
to meet customer needs and to select the most economically appropriate platform
to provide service in a particular market. Our communications network and
switching capacity is also designed to serve other wireline and wireless
carriers on a wholesale basis.

In order to provide local communications services to most of our business and
residential customers, we purchase switch port and local loop combinations
through various agreements with Qwest Communications, Inc. Depending on the
availability of certain platforms and the relative economics of each, we
purchase a variety of service platforms (resold Centrex or other local services,
and unbundled network elements, including local loops, and switch port and local
loop combinations) through various interconnection agreements with subsidiaries
of SBC Communications, Inc. Our providers bill us for all the lines assigned to
our customers and provide us with call detail reports, which enable us to verify
our customers' bills for both local and long distance service. Our Qwest
agreements protect us from unilateral rate increases until 2002 or 2003,
depending on the state. In most Qwest states, we believe that our local services
are superior to a standard business or residential telephone line in most
markets since we can offer features, such as three-way calling, consultation
hold and call transfer at no extra charge. Other custom calling features are
available at additional cost. Because we also purchase certain functionality
from our providers, our personnel have on-line access to their systems, allowing
us to efficiently make changes to our customers' services at a lower cost.

Our plans to provide local switched services using our own communications
network facilities will depend upon obtaining and maintaining favorable
interconnection agreements and terms for leasing network elements from existing
telephone companies. In August 1996, the FCC

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released a decision (the "Interconnection Decision") implementing the
interconnection portions of the Telecommunications Act of 1996. The
Interconnection Decision has been the subject of significant legal dispute. In
January 1999, the U.S. Supreme Court rejected challenges to the Interconnection
Decision and affirmed the authority of the FCC to establish rules governing
interconnection. Additional disputes regarding the Interconnection Decision
(including disputes concerning the constitutionality of the FCC's pricing rules)
and other related FCC actions are currently pending before both the FCC and the
U.S. Supreme Court. We cannot provide any assurance that we will succeed in
obtaining interconnection agreements on terms that would permit us to offer
local services using our own communications network facilities at profitable and
competitive rates. See "--Regulation."

The foregoing statements are forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995 and where we actually
provide such services will depend on factors such as:

     .  the outcome of the judicial proceedings regarding the Interconnection
        Decision
     .  technological, regulatory or other developments in our business
     .  changes in the competitive climate in which we operate
     .  the emergence of future opportunities

For a detailed description of the expansion of our fiber optic communications
network, see "--Network Facilities."

We have interconnection agreements with Qwest in all states where it is the
entrenched, traditional local service provider, with SBC (through its
subsidiaries) in all states where Ameritech or Southwestern Bell Telephone
Company is the entrenched, traditional local service provider and with Verizon
(through its GTE entities) and BellSouth in certain states. These agreements
allow us to resell services of these MegaBells and to connect our switching
equipment and facilities to their local loop connections to customers. In Cedar
Rapids and Marion, Iowa, Champaign, Illinois, and certain cities in southwest
Minnesota, southeast South Dakota and northwest Iowa, we provide competitive
communications services to some of our business and residential customers using
only our own switching equipment, communications network facilities and lines.

Long distance service is provided in some areas by purchasing communications
network capacity, in bulk, from national long distance carriers, and routing our
customers' long distance traffic over this capacity. In many of our local
footprint states, we carry the bulk of our long distance traffic on our own
network facilities.

Business Services. End-user business customers can obtain integrated services
and ancillary services, such as three-way calling and call transfer, directly
from us in each of the cities and towns in which we offer communications
services. Integrated business services include local and long distance services,
dial and dedicated Internet access, higher bandwidth Internet access services,
such as digital subscriber line (DSL) and cable modem, and value-added services
such as virtual private networks and web hosting.

We generally offer business customers our integrated local communications
services at prices that are similar to the published retail rates for basic
business service provided by the incumbent local exchange carrier. We offer our
business customers a flat rate or a negotiated rate for long distance service
consistent with their particular needs and within the guidelines of our filed
tariffs. These rates are not subject to increase for the duration of the term
selected by the customer.

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Furthermore, in some states, including states outside our target markets, we
offer business customers long distance service only, in order to enhance our
ability to attract business customers that have offices outside our target
markets.

Residential Services. We introduced our PrimeLine(R) service in 1996 and now
offer that service to residential customers in various cities and towns in
several selected states. Our traditional PrimeLine(R) service includes local and
long distance telephone service. In most areas, PrimeLine(R) service also
includes enhanced features such as three-way calling, call transfer and
consultation hold. Where these three additional features are included, we
generally price our basic PrimeLine(R) local service slightly higher than the
rates for basic local service offered by the incumbent local exchange carrier
since our basic PrimeLine(R) local service includes enhanced features that are
not typically provided as part of the incumbent local exchange carrier's basic
local service. Our customers can add voice mail, Internet access and travel card
services to their basic PrimeLine(R) service at incremental rates designed to be
no higher than separately purchasing these services from other companies. In an
increasing number of states, including Michigan, Illinois and Texas, we also
offer residential services by leasing local lines from the MegaBell and using
our local switching. We also have begun to offer residential service by using
unbundled switch ports combined with unbundled local loops in several states.

Network Services. Through McLeodUSA Information Services, Inc. we provide
advanced data communications services, which are non-regulated, on a wholesale
basis. These services include an array of Internet access and data
communications services delivered over our high capacity, facilities-based
nationwide network. Data services can include, among other things, dial and
dedicated Internet access, higher bandwidth Internet access, virtual private
networks and bandwidth leasing.

Dedicated Facilities and Services. We provide, on a private carrier basis, a
wide range of special access, private line and data services to long distance
carriers, government agencies, wireless service providers and cable television
and other end-user customers. These services include:

     .  Point of presence ("POP")-to-POP special access
     .  End-user/long distance carrier special access
     .  Private line services

POP-to-POP special access services provide telecommunications lines that link
the points of presence of one long distance carrier or the POPs of different
long distance carriers in a market, allowing these POPs to exchange
telecommunications traffic for transport to final destinations.

End-user/long distance carrier special access services provide
telecommunications lines that connect an end-user such as a large business to
the local POP of its selected long distance carrier.

Long distance carrier special access services provide telecommunications lines
that link a long distance carrier POP to the local central office. For example,
we furnish long distance carrier special access services to AT&T in 17 cities in
Illinois, Iowa, North Dakota and South Dakota.

Private line services provide telecommunications lines that connect various
locations of a customer's operation to transmit internal voice, video and/or
data traffic. We provide private line services by using our own communications
network facilities, leasing communications network facilities from other
telecommunications carriers, or using some combination of owned and leased
communications network facilities.

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Network Maintenance Services. The State of Iowa owns segments of a fiber optic
network used primarily for interactive distance learning, telemedicine and the
State's own long distance telephone and data traffic. The State leases from us
some of the connections to this fiber network. We also provide maintenance
services on the State's network segments on a 24-hour-per-day, 365-days-per-year
basis, that consist of alarm monitoring, repair services and cable location
services. We believe that the expertise in fiber optic maintenance we have
developed through the maintenance of the State's network has provided advantages
in maintaining our own communications network facilities.

Telephone Equipment and Computer Networking Services. Through McLeodUSA
Integrated Business Systems, Inc., we sell, lease, install and service telephone
systems, primarily to small and medium sized businesses in Iowa, Illinois,
Minnesota, South Dakota, North Dakota and Colorado. We also provide customized,
integrated solutions for computing networks in several states. Such services
typically include review of customer system requirements; selection, design and
planning of components and networks; and operating and network support services.
These services are available through our sales offices and at our e-commerce
site. In addition, we sell preconfigured equipment, which we send throughout the
United States with installation available. We believe these services provide
valuable expertise for and complement our communications services offerings,
giving us additional contact with the small and medium sized businesses we
target in marketing our communications services.

Video Services. We own and operate 37 cable television systems in southeastern
South Dakota, northwestern Iowa and southwestern Minnesota, many of which
provide cable television service in combination with high quality fiber-based
telecommunications services. We also have a franchise in Cedar Rapids, Iowa
pursuant to which we provide cable television service in combination with high
quality fiber-based telecommunications services. In addition, we own 85% of
Greene County Partners, Inc., a cable television company which provides cable
television services in several locations in Illinois and Michigan.

Other Communications Services. We provide pay telephone service, operator
services and paging services in some markets. In addition, we own a minority
interest in a partnership that provides cellular service in central Illinois.

Directory Services

In 2000, we published 234 proprietary "white page" and "yellow page" telephone
directory titles and distributed approximately 26.7 million copies of these
directories to local telephone subscribers in 26 states, including most of our
target markets. In addition, all of our proprietary directories are accessible
on the Internet. We also published 265 "white page" and "yellow page" telephone
directory titles for other companies and distributed approximately 3.9 million
copies of these directories to local telephone subscribers in 37 states and the
U.S. Virgin Islands. We will be phasing out the business of publishing
directories for other companies by the end of 2002 in order to focus all of our
publishing resources on our own directories. Our telephone directory services
generated 2000 revenues of nearly $250 million, primarily from the sale of
advertising space in the directories.

Our proprietary telephone directories serve as "direct mail" advertising because
they contain information on how to contact us and detailed product descriptions
and step-by-step instructions on the use of our telecommunications products. In
addition, we believe that our directories' distinctive black-and-yellow motif
combined with the trade name McLeodUSA strengthens brand awareness in our
markets. See "--Sales and Marketing."

                                       10
<PAGE>

Traditional Local Telephone Services

Through Illinois Consolidated Telephone Company ("ICTC") and Dakota Community
Telephone, Inc, we provide incumbent local exchange telephone service to
subscribers in central Illinois and southeast South Dakota.

As of December 31, 2000, ICTC operates in 37 exchanges, or service areas, the
largest of which are in Mattoon, Charleston, and Effingham, Illinois and had
approximately 94,000 local access lines in its existing service areas. ICTC
offers a broad range of local exchange services, including long distance carrier
access service, intraLATA toll service, local telephone service, local paging
service, national directory assistance, and equipment leasing. ICTC also offers
most of its local telephone subscribers custom calling features such as call
waiting, call forwarding, conference calling, speed dialing, caller
identification, and call blocking. The rates for these and other local exchange
services are regulated by the Illinois Commerce Commission and the FCC.
Provision of these services is offered over an ICTC owned and controlled network
consisting of 4 host and 33 remote central office switches.

As of December 31, 2000, Dakota Community Telephone served approximately 7,000
local service access lines in 9 telephone exchanges in southeastern South
Dakota. Dakota Community Telephone, Inc. provides a full range of communications
products and services, including local dial tone and enhanced services, local
private line and public telephone services, dedicated and switched data
transmission services, long distance telephone services, operator assisted
calling services, Internet access and related services.

Telemarketing Services

We provide direct marketing and telemarketing services for third parties, as
well as a variety of fund-raising services for colleges, universities and other
non-profit organizations throughout the United States. In addition to providing
telemarketing services for third parties, we use our telemarketing sales
personnel to sell communications services to small businesses and for sales of
our PrimeLine(R) residential services. See "--Sales and Marketing."

Network Facilities

As the entrenched, traditional local exchange carriers are compelled, by
regulatory changes and competitive forces, to unbundle their network components
and to permit resale of their network elements and products, we plan to continue
to provide our customers with a full range of communications services. We do
this by using a combination of our own communications network, the networks of
the incumbent local exchange carriers and the networks of other competitive
carriers.

As of December 31, 2000, we operated 21,600 route miles of fiber optic
communications network and expect to expand this fiber optic network to
approximately 30,000 route miles by the end of 2001. As of December 31, 2000,
more than 5,000 route miles are located within the cities we serve or plan to
serve. We are connected to over 1,200 buildings along our network. We will
decide whether to begin construction of fiber optic network within a market
based on various economic factors, including:

     .  the number of our customers in a market
     .  the anticipated operating cost savings associated with such construction
     .  any strategic relationships with owners of existing infrastructure
        (e.g., utilities and cable operators)

                                       11
<PAGE>

As of December 31, 2000, we had over 400 POPs providing voice and data services,
which we expect to expand to approximately 500 POPs by the end of 2001. As of
December 31, 2000, we had approximately 50 voice switches, 37 core ATM switches
and over 350 remote ATM switches, with plans to expand during 2001.

As part of our acquisition of Splitrock Services, Inc. in 2000, we acquired the
Splitrock broadband access network. The network is designed to provide coverage
of approximately 90% of the population of the United States and deploys
asynchronous transfer mode (ATM) switches at every core, hub and remote POP.
This network architecture enables us to serve as a broad-based provider of data
communications services through the creation of a platform that efficiently
delivers multiple services, such as Internet access, virtual private networks
and web hosting, across multiple protocols, including Internet Protocol, frame
relay and ATM. The flexibility inherent in this network design allows us to
expand our service offerings to provide fully integrated data, video and voice
services.

To further expand and enhance our network and service offerings, we have the
indefeasible rights to use dark fiber strands in a state-of-the-art fiber optic
network currently under construction by Level 3 Communications, LLC. This
nationwide fiber network covers over 15,000 route miles, with delivery in
segments starting in the first quarter of 2000 and continuing through 2001.
Combining this fiber optic network with the broadband access network we acquired
from Splitrock positions us to:

     .  deliver a broad array of end-to-end data communications services at the
        high level of quality and reliability increasingly demanded by customers
     .  significantly reduce network costs as a percentage of revenues by
        substituting the acquired bandwidth for existing leased circuit
        arrangements with various telecommunications carriers
     .  expand service offerings by providing bandwidth leasing services on a
        stand-alone basis or bundled with other services
     .  increase the reliability and redundancy of  the network
     .  increase the variety of service options and speeds available to
        customers

Our local and super-regional networks utilize Synchronous Optical Networking
(SONET) transport technology. We are installing backbone communications network
facilities that form a series of fiber optic "self-healing" SONET rings and
intra-city communications network facilities that provide access directly to
customer locations. These communications network facilities are intended to
enable us to provide local and long distance service using our own facilities in
our target market areas. Our communications networks are designed to support a
wide range of communications services, provide increased network reliability and
reduce costs. Our communications network consists of fiber optic cables, which
typically contain between 36 and 288 fiber strands, each of which is capable of
providing many telecommunications circuits. A single pair of fibers on our
network can transmit over 10,000,000 simultaneous voice conversations, whereas a
typical pair of copper wires can carry a maximum of 24 digitized simultaneous
voice conversations. We expect that continuing developments in dense wave
division multiplexing and optical equipment will increase the capacity of each
fiber, providing greater capacity at relatively low incremental cost.

Our nationwide fiber network will utilize intelligent technology for transport,
with more than 50 broadband mesh switches planned for installation in major U.S.
markets and at key network junctions in 2001 and 2002. We believe the nationwide
mesh transport network will provide national origination and termination
capabilities for customers within our existing CLEC regions. We believe this
will also provide us with the ability to offer enhanced private line products to
carriers and large businesses.

                                       12
<PAGE>

We plan to continue our commitment to developing underserved second and third
tier markets, as well as serving small and medium sized enterprises in major
metropolitan markets in our target market states, by offering high-quality local
services and nationwide data services. Additionally, we will increase our
carrier customer base, offering high-speed, enhanced private line products on a
nationwide basis. Our network facilities provide residential, enterprise and
carrier customers with local and long-haul voice and data communications
services on owned network infrastructure, offering increased quality and
reliability and a strong dedication to meeting customer requirements.

We have agreements with Alliant Energy, an electric utility and one of our
principal stockholders, and with MidAmerican, Wisconsin Electric Power Company,
and Canadian National Railroad (formerly Illinois Central Railroad) that allow
us to make use of those companies' rights-of-way, underground conduits,
distribution poles, transmission towers and building entrances in exchange for
rights by such companies to use capacity on our network. These agreements give
us access to rights-of-way in parts of Iowa, Illinois and Wisconsin for
installation of our wireline and wireless networks. We expect our access to
these rights-of-way to have a significant positive impact on our capital costs
for network construction and the speed with which we can construct our networks.
We believe that our strategic relationships with our electric utility
stockholders and other companies that own rights-of-way and infrastructure give
us a competitive advantage.

The foregoing statements are forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995 and the results of our
actual expansion efforts may be materially different, depending on a variety of
other factors, including:

     .  the availability of financing and regulatory approvals
     .  the number of potential customers in a target market
     .  the existence of strategic alliances or relationships
     .  the outcome of the judicial proceedings regarding the Interconnection
        Decision
     .  technological, regulatory or other developments in our business
     .  changes in the competitive climate in which we operate
     .  the emergence of future opportunities

Sales and Marketing

Marketing of our integrated communications services to small and medium sized
business customers is primarily conducted by direct sales personnel located in
branch sales offices throughout our target market. In addition, we use
telemarketers to market these services to smaller business customers and those
located in areas that are geographically remote. Sales activities in our branch
sales offices are organized and managed by region.

In 2000, we expanded our communications sales and marketing efforts in our
target market area which now consists of 25 states. We continue our efforts to
expand sales and marketing in all states where we are located. In addition, we
believe our strategic acquisitions have enhanced our sales and marketing efforts
and increased our penetration of existing markets. Acquisitions also help
accelerate our entry into new markets. At the end of 2000 we had sales offices
in 130 cities, compared to 110 sales offices at the end of 1999. In addition,
the sales team selling our core communications products to business customers
increased to 1,250 at the end of 2000 from 800 at the end of 1999.

Marketing of our PrimeLine(R) integrated communications services to residential
customers is conducted by inside sales representatives. The telemarketers
emphasize the PrimeLine(R)

                                       13
<PAGE>

integrated package of communications services and its flat-rate per minute
pricing structure for long distance service.

Our sales force is trained to emphasize our customer-focused sales and service,
including our 24-hours-per-day, 365-days-per-year customer service center. Our
employees answer customer service calls directly rather than requiring customers
to use an automated queried message system. We believe that our emphasis on a
single point of contact for meeting our customer's communications needs is very
appealing to our current and prospective customers. In addition, we have
deployed skills-based routing software designed to match incoming calls with
customer service representatives best trained to respond to the customer's
needs.

We have also developed and installed customer-focused software for providing
integrated communications services. This software permits us to provide our
customers one fully integrated monthly billing statement for local, long
distance, 800, international, voice mail, paging, Internet access and travel
card services, and additional services when available. We believe that our
customer-focused software platform is an important element in the marketing of
our communications services and gives us a competitive advantage in the
marketplace.

We use our telephone directories as direct mail advertising by including
detailed product descriptions and information about our communications products
in them. We believe that these telephone directories provide us with a long-term
marketing presence in the millions of households and businesses that receive
them. We also believe that combining our directories' distinctive black-and-
yellow motif with the trade name McLeodUSA strengthens brand awareness in all of
our markets.

Marketing of our wholesale network service is conducted by a dedicated sales
force whose efforts are enhanced by significant knowledge of, and contacts in,
the industry.

Marketing of space in our telephone directories is conducted by a direct sales
force and telephone sales force whose goal is to contact each business within a
directory's market.

The foregoing statements are forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995 and the results of our
actual expansion efforts may be materially different, depending on a variety of
other factors, including:

     .  the availability of financing and regulatory approvals
     .  the number of potential customers in a target market
     .  the existence of strategic alliances or relationships
     .  technological, regulatory or other developments in our business
     .  changes in the competitive climate in which we operate
     .  the emergence of future opportunities

Wireless Licenses

We currently do not offer wireless services, although we do own a minority
interest in a cellular telephone partnership serving parts of east central
Illinois, and are conducting fixed wireless trials in two of our markets. We own
27 "D" and "E" frequency block PCS licenses, each covering 10 MHz of radio
spectrum, in 25 markets covering areas of Illinois, Iowa, Minnesota, Nebraska
and South Dakota. Our PCS licenses encompass approximately 110,000 square miles
and a population of approximately 6.6 million. Our PCS licenses are subject to
revocation if we do not provide substantial services with them by April 2002. We
are in the process of selling two PCS licenses in adjoining markets in Iowa. We
are evaluating many

                                       14
<PAGE>

possible alternatives for our PCS licenses, including the potential sale of some
or all of the balance of our PCS licenses.

We also hold four WCS licenses covering Milwaukee, Wisconsin; Minneapolis/St.
Paul, Minnesota; Des Moines-Quad Cities, Iowa/Illinois and Omaha, Nebraska
covering approximately 15 million people. We believe the frequency blocks
covered by such licenses may allow us to provide fixed wireless services. We are
evaluating many possible alternatives for these licenses.

Additionally, the FCC awarded us 13 "A" and "B" block LMDS frequency licenses in
May 1999 covering 12 markets reaching approximately 2.8 million people.

As the wireline and wireless markets converge, we may be able to identify
opportunities to generate revenues from the wireless industry on both a retail
and a wholesale basis. On a retail basis, we may be able to enter into strategic
arrangements with both cellular and PCS companies on favorable economic terms to
allow us to offer wireless services as part of our integrated communications
services offerings. On a wholesale basis, these opportunities may include (1)
leasing tower sites to wireless providers, (2) connecting or transferring
wireless traffic through our communications network facilities and (3)
transporting wireless traffic using our fiber optic communications network to
interconnect wireless providers' cell sites or to connect such sites to either
our communications network facilities or to communications network facilities of
other providers of wireline services.

The statements in the foregoing paragraphs about wireless services are forward-
looking statements within the meaning of the Private Securities Litigation
Reform Act of 1995. These plans may be revised, and our actual wireless services
may differ materially from that indicated by our current plans, in each case as
a result of a variety of factors, including:

     .  the availability of financing and regulatory approvals
     .  the number of potential customers in a target market
     .  the existence of strategic alliances or relationships
     .  technological, regulatory or other developments in our business
     .  changes in the competitive climate in which we operate
     .  the emergence of future opportunities

See "--Risk Factors--We May Not Develop or Make a Profit from Wireless Services"
and "--Risk Factors--Developments in the Wireless Telecommunications Industry
Could Make it More Difficult for Us to Compete."

Competition

Wireline Competition. The communications services industry is highly
competitive. We face intense competition from entrenched, traditional local
exchange carriers, primarily the MegaBells, which currently dominate their
respective local telecommunications markets. Our long distance services also
compete with the services of hundreds of other companies in the long distance
marketplace in most states. The MegaBells are also becoming a dominant long
distance provider in states in which they have received authority to offer that
service. AT&T, WorldCom and Sprint currently dominate the long distance market.
Our local and long distance services also compete with the services of other
competitive local exchange carriers in some markets. Other competitors may
include cable television companies, competitive access providers, microwave and
satellite carriers, wireless telecommunications providers, and private networks
owned by large end-users. In addition, we compete with the MegaBells and other
local exchange carriers, numerous direct marketers and telemarketers, equipment
vendors and

                                       15
<PAGE>

installers, and telecommunications management companies with respect to portions
of our business. Many of our existing and potential competitors have financial
and other resources far greater than our own.

We believe that the distinction between the local and long distance markets is
eroding, and other competitors will begin to offer integrated communications
services similar to our own. For example, AT&T, WorldCom and Sprint have each
begun to offer local telecommunications services using their own network
facilities, network elements obtained from the entrenched, traditional local
exchange carriers, or the facilities of other parties. SBC has been granted
authority to offer in-region long distance service in Texas, Kansas and
Oklahoma. These and other companies currently hold state regulatory certificates
to offer local and long distance service in most states within our target
markets. We cannot provide any assurance that these firms, and others, will not
enter the markets or target the small and medium sized businesses where we focus
our sales efforts.

A continuing trend toward business combinations and strategic alliances in the
telecommunications industry may strengthen our competitors. For example,
Southwestern Bell acquired Ameritech in October 1999, WorldCom acquired MCI in
September 1998 and AT&T acquired Teleport Communications Group Inc. in July 1998
and Tele-Communications, Inc. in March 1999. In 2000 Qwest completed its
acquisition of U S West, and Bell Atlantic and GTE merged to form Verizon. These
or other alliances or combinations between our competitors could put us at a
significant competitive disadvantage.

In order to provide long distance service, we must obtain access to customers
through local network connections. Local exchange carriers, including both
McLeodUSA and the MegaBells provide access service for the origination and
termination of toll long distance traffic and interexchange private lines.
Historically, charges for such access service made up a significant percentage
of our overall cost of providing service when we were not a facilities-based
provider. The FCC and various states have made or are considering changes to
promote reductions in access rate levels and related issues involving support
for universal service and other public policy objectives. The impact of these
changes on us and our competitors is not yet clear. We could be adversely
affected if we are not adequately compensated when we provide access services,
if we incur high access costs where another carrier provider access services, or
if our competitors receive a disproportionate share of universal service
revenues. In addition, new Internet-based competitors continue to be exempt from
these charges and to the extent they are exempt from paying comparable access
fees, they could enjoy a significant cost advantage in this area.

The Telecommunications Act of 1996 requires payments by each carrier that
terminates local traffic to another carrier. This system of compensation is
referred to as reciprocal compensation. Because a number of our customers
typically receive more calls than they make, we may receive more reciprocal
compensation than we pay for calls which originate on our network. We expect the
FCC and some regulatory agencies to act on reciprocal compensation issues during
2001. However, during 2000 we entered into agreements with Qwest to eliminate
reciprocal compensation payments between us. These agreements eliminate the risk
of adverse impact from regulatory actions with respect to reciprocal
compensation in our states that are in Qwest's territory.

Upon expiration of existing interconnection agreements, new agreements must be
negotiated. Those agreements may address reciprocal compensation for ISP-bound
traffic, or such compensation may be addressed in other ways. It is likely that
rates of compensation for ISP-bound traffic will be lower in these new
agreements than under our existing agreements. As a result of this and
developments in the regulatory environment and trends in the industry, we

                                       16
<PAGE>

expect that the limited revenue we receive from reciprocal compensation (net of
reciprocal compensation payments we make) will significantly decline in the
future.

Recently, a U.S. District Court in Wisconsin dismissed several appeals of state
commission decisions involving, among other issues, the obligation to pay
reciprocal compensation. The Court dismissed the appeals in light of recent U.S.
Supreme Court decisions which sought to clarify when states may be sued in the
U.S. courts. Based on a reading of those decisions, the U.S. District Court
determined the Wisconsin Public Service Commission may not be sued in federal
court in connection with the Commission's enforcement of interconnection
agreements. The decisions have been appealed to the U.S. Court of Appeals for
the Seventh Circuit. If the ruling of the U.S. District Court in Wisconsin is
upheld, it would raise serious questions concerning how state commission action
approving and enforcing interconnection agreements may be reviewed.

We also depend on the entrenched, traditional local exchange carriers, primarily
the MegaBells, to provide our local telephone service (through access to local
communications network elements, termination service, local central office
switching, or through wholesale purchase of the local telephone services of such
carriers that we then resell to end-users). Any successful effort by the
incumbent local exchange carriers to deny or substantially limit our access to
their network elements or wholesale services would have a material adverse
effect on our ability to provide local telephone services. Although the
Telecommunications Act of 1996 imposes interconnection obligations on incumbent
local exchange carriers, we cannot provide any assurance that we will be able to
obtain access to their communications network elements or services at rates, and
on terms and conditions, that will permit us to offer local services at rates
that are both profitable and competitive.

The Telecommunications Act also contains provisions that affect various
"universal service" programs designed to promote the availability of
telecommunications services in various areas and for various market segments.
These programs provide assistance to schools, libraries, rural health care
providers, low-income subscribers, and subscribers living in high-cost areas,
for their purchase of various telecommunications related services. These
programs are funded through charges on providers of interstate
telecommunications services, although the amounts contributed may be recovered
through charges to our end-users. The current contribution rate for federal
universal service programs is 6.6827% of international and interstate end-user
telecommunications revenue.

We are unable to specify the amount of universal service contributions we will
be required to make in future years, or the extent of universal service programs
that will be in existence for areas served by rural and non-rural telephone
companies. Changes to universal service programs may increase or decrease the
level of support provided to various programs, and may change the level of
contribution we are required to make.

The Telecommunications Act of 1996 also provides the incumbent local exchange
carriers with new competitive opportunities. For example, under the
Telecommunications Act of 1996, the MegaBells will, upon the satisfaction of
various conditions, be able to offer interLATA long distance services to local
telephone service customers in their regions. In some states, including three
states in our footprint, the MegaBells have received approval to offer interLATA
long distance service. In many states, the MegaBells are actively engaged in
proceedings and other activities by which they are seeking approval to offer
interLATA long distance service. We believe that we have advantages over the
incumbent local exchange carriers in providing our telecommunications services,
including our management's prior experience in the competitive
telecommunications industry and our emphasis on marketing (primarily using a
direct sales force for sales to business customers and telemarketing for sales
to residential customers) and on responsive customer service. However, the
MegaBells may be allowed to offer interLATA

                                       17
<PAGE>

long distance services before their local exchange markets are completely open
to competition. Under such circumstances in particular, additional competition
from the entrenched, traditional local exchange carriers could have a material
adverse effect on our business, results of operations and financial condition.

The MegaBells are also actively seeking the assistance of policymakers to ease
the requirements of the Telecommunications Act of 1996. For example, legislation
was introduced in Congress during 2000 that would allow the MegaBells to offer
interLATA data services to their customers in their traditional local service
markets without meeting any requirements and without opening their local markets
to competition. They are also attempting to convince policy makers to reduce the
standards used to determine if they have complied with the Telecommunications
Act of 1996. If they are successful in any of these efforts, the additional
competition from the MegaBells combined with the lack of access to their local
networks would have a material adverse effect on our business.

Competition for local and special access telecommunications services is based
principally on price, quality, network reliability, customer service and service
features. We believe that our management expertise and emphasis on customer
service allows us to compete effectively with the incumbent local exchange
carriers in providing these services. In addition, our fiber optic
communications networks provide both diverse access routing and redundant
electronics, which design features are not widely deployed by the local exchange
carriers' networks. However, if the incumbent local exchange carriers,
particularly the MegaBells, charge alternative providers like us unreasonably
high fees for interconnection to their networks, significantly lower their rates
for local, access, and private line services, or offer significant volume and
term discount pricing options to their customers, we could be at a significant
competitive disadvantage.

In the future, an important element of providing competitive services may be the
ability to offer customers high-speed broadband local connections. The FCC
approved a MegaBell proposal that allows incumbent local exchange carriers to
offer these and other services through separate affiliates, in which case their
network elements for providing these services would not need to be made
available to us or other competitors. However, the District of Columbia
Appellate Court overturned the FCC decisions. AT&T has announced that it is
entering into arrangements with cable companies for the exclusive use of their
local networks for broadband telecommunications and several cable companies are
offering broadband Internet access over their network facilities. Currently, we
offer such broadband local access to our customers in limited areas in Cedar
Rapids and Marion, Iowa, Champaign, Illinois, southwest Minnesota, northwest
Iowa and southeast South Dakota. If we are unable to meet future demands of our
customers for broadband local access or other services on a timely basis at
competitive rates, we may be at a significant competitive disadvantage.

For more information about the regulatory environment in which we operate, see
"--Regulation."

Wireless Competition. The wireless telecommunications industry is experiencing
significant technological change, as evidenced by the increasing pace of
improvements in the capacity and quality of digital technology, the growth of
wireless data, shorter cycles for new products and enhancements, and changes in
consumer preferences and expectations. We believe the market for wireless
telecommunications services is likely to expand significantly as equipment costs
and service rates continue to decline, equipment becomes more convenient and
functional, wireless services become more diverse, technology improves and new
competitors enter the market. We also believe providers of wireless services
increasingly will offer, in addition to products that supplement a customer's
wireline communications like cellular telephone services in use today, wireline
replacement products that may result in wireless services

                                       18
<PAGE>

becoming the customer's primary mode of communication. Accordingly, we expect
competition in the wireless telecommunications business to be dynamic and
intense as a result of the entrance of new competitors and the development of
new technologies, products and services.

Competition with these or other providers of wireless telecommunications
services may be intense. Many of our competitors have substantially greater
financial, technical, marketing, sales, manufacturing and distribution resources
than our own and have significantly greater experience than us in testing new or
improved wireless telecommunications products and services. Some competitors,
particularly LMDS carriers, are expected to market other services, such as cable
television access, with their wireless telecommunications service offerings. We
do not currently offer wireless cable television access. In addition, several of
our potential wireless competitors are operating or planning to operate, through
joint ventures and affiliation arrangements, wireless telecommunications systems
that encompass most of the United States. We cannot provide any assurance that
we will be able to compete successfully in this environment or that new
technologies and products that are more commercially effective than our
technologies and products will not be developed. See "--Wireless Licenses."

Regulation

Overview. Our services are subject to federal, state and local regulation. The
FCC has jurisdiction over our facilities and services to the extent they are
used to provide, originate or terminate interstate or international common
carrier communications. State regulatory commissions retain jurisdiction over
the same facilities and services to the extent they are used to originate or
terminate intrastate common carrier communications. Local governments may
require us to obtain licenses, permits or franchises regulating use of public
rights-of-way necessary to install and operate our networks. In addition, the
licensing, construction, operation, sale and interconnection arrangements of
wireless telecommunications systems are regulated to varying degrees by the FCC.
The construction and operation of wireless systems also may be subject to state
and local regulation.

Through our subsidiaries, we hold various federal and state regulatory
authorizations. We often join other industry members in seeking regulatory
reform at the federal and state levels to open additional telecommunications
markets to competition.

Through our wholly-owned subsidiary McLeodUSA Network Services, we provide
competitive access services as a private carrier on a non-regulated basis. In
general, a private carrier is one that provides service to customers on an
individually negotiated contractual basis, as opposed to a common carrier that
provides service to the public on the basis of generally available rates, terms
and conditions. We believe that McLeodUSA Network Services' private carrier
status is consistent with applicable federal and state laws, as well as
regulatory decisions interpreting and implementing those laws. Should such laws
and/or regulatory interpretations change in the future to reclassify McLeodUSA
Network Services' regulatory status, we believe that compliance with such
reclassification would not have a material adverse effect on us.

Through our wholly-owned subsidiaries, we are also subject to federal and state
regulatory requirements, including, in some states, bonding requirements, due to
our direct marketing, telemarketing, fund-raising activities and sale of prepaid
calling cards.

Federal Regulation. The FCC classifies us as a non-dominant carrier. As a non-
dominant carrier, our interstate and international services are not subject to
material federal regulation. The FCC also imposes prior approval requirements on
transfers of control and assignments of radio licenses and operating
authorizations. The FCC has the authority to condition, modify, cancel,
terminate or revoke such licenses and authorizations for failure to comply with
federal

                                       19
<PAGE>

laws or the rules, regulations and policies of the FCC. The FCC may also impose
fines or other penalties for such violations. While we believe we are in
compliance with applicable laws and regulations, we cannot assure you that the
FCC or third parties will not raise issues with regard to our compliance.

The FCC's role with respect to local telephone competition arises principally
from the Telecommunications Act of 1996. The Telecommunications Act of 1996
preempts state and local laws to the extent that they prevent competitive entry
into the provision of any telecommunications service and gives the FCC
jurisdiction over important issues related to local competition. However, state
and local governments retain authority over significant aspects of the provision
of local telecommunications. The Telecommunications Act of 1996 imposes a
variety of new duties on local exchange carriers, including non-incumbent local
exchange carriers like us, in order to promote competition in local exchange and
access services. These duties include requirements to:

   .  complete calls originated by competing carriers on a reciprocal basis
   .  permit resale of services
   .  permit users to retain their telephone numbers when changing carriers
   .  provide competing carriers access to poles, ducts, conduits and
   .  rights-of-way at regulated prices

Entrenched, traditional local exchange carriers are also subject to additional
requirements. These duties include obligations of the incumbent local exchange
carriers to:

   .  interconnect their networks with competitors
   .  offer collocation of competitors' equipment at their premises
   .  make available elements of their networks (including network facilities,
      features and capabilities) on non-discriminatory, cost-based terms
   .  offer wholesale versions of their retail services for resale at discounted
      rates

Collectively, these requirements recognize that local exchange competition
depends upon cost-based and non-discriminatory interconnection with and use of
the traditional telephone company's local "loops". Failure to achieve such
interconnection arrangements could adversely impact us and other entities that
provide competitive local exchange services. Under the Telecommunications Act of
1996, incumbent local exchange carriers are required to negotiate in good faith
with carriers requesting any or all of the above arrangements. In addition, in
the Interconnection Decision and related actions the FCC has adopted more
specific rules to implement these requirements. The Interconnection Decision has
been the subject of significant legal dispute. In January 1999, the U.S. Supreme
Court rejected challenges to the Interconnection Decision and affirmed the
authority of the FCC to establish rules governing interconnection. Other
challenges to the Interconnection Decision and related rules remain pending in
various courts including the U.S. Supreme Court. We believe that additional
disputes regarding the Interconnection Decision and other related FCC actions
are likely.

The Telecommunications Act of 1996 also eliminates previous prohibitions on the
provision of interLATA long distance services by the MegaBells and the general
telephone operating companies. The MegaBells are permitted to provide interLATA
long distance service outside those states in which they provide local exchange
service ("out-of-region long distance service") upon receipt of any necessary
state and/or federal regulatory approvals that are otherwise applicable to the
provision of intrastate and/or interstate long distance service. Under the
Telecommunications Act of 1996, the MegaBells will be allowed to provide long
distance service within the regions in which they also provide local exchange
service ("in-region service") on a state-by-state basis upon specific approval
of the FCC and satisfaction of other conditions,

                                       20
<PAGE>

including a checklist of interconnection requirements intended to open local
telephone markets to competition. The FCC has found that Verizon's (f/k/a Bell
Atlantic) operations in the state of New York and SBC's operations in Texas,
Oklahoma and Kansas have met these requirements. If the FCC permits Qwest or SBC
to provide long distance service in additional states in their local service
regions before they meet our local interconnection needs, they would be able to
offer integrated local and long distance services and could have a significant
competitive advantage in marketing those services to their existing local
customers.

The Telecommunications Act of 1996 imposes restrictions on the MegaBells in
connection with their entry into the interLATA long distance services market.
Among other things, for the first three years (unless extended by the FCC) the
MegaBells must pursue such activities only through separate subsidiaries with
separate books and records, financing, management and employees. In addition,
affiliate transactions with these subsidiaries must be conducted on a non-
discriminatory basis.

In the future, an important element of providing competitive services may be the
ability to offer customers high-speed broadband local connections. The FCC
approved a MegaBell proposal that allows incumbent local exchange carriers to
offer these and other services through separate affiliates, in which case their
network elements for providing these services would not need to be made
available to us or other competitors. However, the District of Columbia
Appellate Court overturned the FCC decisions. AT&T has announced that it is
entering into arrangements with cable companies for the exclusive use of their
local networks for broadband telecommunications and several cable companies are
offering broadband Internet access over their network facilities. Currently, we
offer such broadband local access to our customers in limited areas in Cedar
Rapids and Marion, Iowa, Champaign, Illinois, southwest Minnesota, northwest
Iowa and southeast South Dakota. If we are unable to meet future demands of our
customers for broadband local access or other services on a timely basis at
competitive rates, we may be at a significant competitive disadvantage.

The FCC also regulates the interstate access rates charged by incumbent local
exchange carriers for the origination and termination of interstate long
distance traffic. Those access rates make up a significant portion of the cost
of providing long distance service. The FCC has implemented changes to its
interstate access rules that result in restructuring of the access charge system
and changes in access charge rate levels. These and related actions may reduce
access rates, and hence the cost of providing long distance service, especially
to business customers; but at the same time, access revenue received by local
carriers may decline. The impact of these new changes will not be known until
they are finalized and implemented over the next several years. The FCC has
adopted changes to the methodology by which access has been used in part to
subsidize universal telephone service and other public policy goals.
Telecommunications providers like us pay a fee calculated as a percentage of
their revenues to support these goals. The full implications of these charges
also remain uncertain and subject to change.

In addition, the FCC and the states are considering related questions regarding
the applicability of access charge and universal service fees to Internet
service providers. Currently, Internet service providers are not subject to
these expenses. Many incumbent local exchange carriers and other parties have
argued that this exemption unfairly advantages Internet service providers,
particularly when they provide data, voice or other services in direct
competition with conventional telecommunications providers.

In connection with its interconnection decisions, the FCC has granted local
exchange carriers additional flexibility in pricing their interstate, special
and switched access services on a central office specific basis. Under this
pricing scheme, local exchange carriers may establish pricing zones based on
access traffic density and charge different prices for central offices in

                                       21
<PAGE>

each zone. We anticipate that the FCC will grant local exchange carriers
increasing pricing flexibility as the number of interconnection agreements and
competitors increases. The potential impact of such pricing flexibility on us
and other competitors is unclear at this time.

With the exception of an alpha fixed wireless trial in Illinois, we do not
currently offer PCS services. However, we do own a minority interest in a
cellular telephone partnership serving parts of east central Illinois. We own 27
"D" and "E" block frequency PCS licenses in markets covering areas of Iowa,
Illinois, Minnesota, Nebraska and South Dakota. We own four WCS licenses in the
Major Economic Areas of Milwaukee, Wisconsin, Minneapolis/St. Paul, Minnesota,
Des Moines-Quad Cities, Iowa/Illinois and Omaha, Nebraska. We believe the
frequency blocks covered by our WCS licenses may allow us to provide fixed
wireless services. We also own 13 "A" and "B" block LMDS licenses. We are in the
processing of selling two PCS licenses in adjoining markets in Iowa. We are
evaluating many possible alternatives for our PCS licenses, including the
potential sale of some or all of our remaining existing PCS licenses. All
wireless licenses are subject to FCC regulation.

All PCS licenses are awarded for a ten-year period, at the end of which, absent
prior revocation or a violation of the FCC's rules by the licensee, they will be
renewed. As a PCS licensee, we are subject to "build-out" requirements which
require that specified levels of service be available by specified times, in our
case by April 2002. If we fail to meet these coverage requirements, we may be
subject to forfeiture of our PCS licenses.

PCS licenses permit use of radio spectrum that may be currently occupied by
fixed microwave systems. The existing licensees of such systems retain the right
to continue to operate their systems until 2005. To secure a sufficient amount
of unencumbered spectrum to operate a PCS system efficiently, we would need to
relocate many of these existing licensees. In an effort to balance the competing
interests of existing microwave users and newly authorized PCS licensees, the
FCC has adopted a transition plan to relocate such microwave operators to other
spectrum blocks. In addition, the FCC has imposed new universal service
requirements on wireless carriers, as well as new number portability and
enhanced "911" obligations on commercial mobile radio service providers
including PCS carriers, which would require us to invest in advanced technology
over the next few years.

Wireless systems are also subject to Federal Aviation Administration regulations
respecting the location, lighting and construction of transmitter towers and
antennas and may be subject to regulation under the National Environmental
Policy Act and the environmental regulations of the FCC. Wireless providers also
must satisfy a variety of FCC requirements relating to technical and reporting
matters. One such requirement is the coordination of proposed frequency usage
between adjacent systems. In addition, the height and power of base station
transmitting facilities and the type of signals they emit must fall within
specified parameters.

The Communications Act of 1934 requires the FCC's prior approval of the
assignment or transfer of control of a PCS or other radio license. In addition,
the FCC has established transfer disclosure requirements that require licensees
who transfer control of or assign a PCS license within the first three years to
file associated contracts for sale, option agreements, management agreements or
other documents disclosing the total consideration that the applicant would
receive in return for the transfer or assignment of its license. Non-controlling
interests in an entity that holds a PCS license or PCS system generally may be
bought or sold by U.S. companies or individuals without prior FCC approval, but
subsequent notice must be provided to the FCC.

The Telecommunications Act of 1996 imposes restrictions on investment in us by
foreign persons or corporations arising from our ownership of common carrier
radio licenses. However, these restrictions generally do not apply to investment
by nationals of member countries of the

                                       22
<PAGE>

World Trade Organization. We have no knowledge of any ownership by or
affiliation with foreign persons or telecommunications carriers in violation of
the Communications Act or the FCC's rules.

Through our wholly-owned subsidiaries, we are also subject to rules governing
telemarketing that have been promulgated by both the FCC and the Federal Trade
Commission. The FCC and FTC telemarketing rules prohibit telemarketers from
engaging in deceptive telemarketing practices and require that telemarketers
make specified disclosures.

State Regulation. We provide intrastate common carrier services and are subject
to various state laws and regulations. Most public utility commissions subject
providers such as us to some form of certification requirement, which requires
providers to obtain authority from the state public utility commission before
initiating service. In most states, we are also required to file tariffs setting
forth the terms, conditions and prices for services that are classified as
intrastate. We are required to update or amend these tariffs when we adjust our
rates or add new products, and are subject to various reporting and record-
keeping requirements in these states. Some states impose service quality
standards on our local service operations and require us to file reports showing
our performance in meeting those standards.

Many states also require prior approval for transfers of control of certified
carriers, corporate reorganizations, acquisitions of telecommunications
operations, assignment of carrier assets, carrier stock offerings and incurrence
by carriers of significant debt obligations. Certificates of authority can
generally be conditioned, modified, canceled, terminated or revoked by state
regulatory authorities for failure to comply with state law or the rules,
regulations and policies of state regulatory authorities. Fines or other
penalties also may be imposed for such violations. State utility commissions or
third parties could raise issues with regard to our compliance with applicable
laws or regulations which could have a material adverse effect on our business,
results of operations and financial condition.

We hold certificates of authority to offer local services using our own
communications network facilities in Arkansas, Arizona, Colorado, Florida,
Idaho, Illinois, Indiana, Iowa, Kansas, Louisiana, Michigan, Minnesota,
Missouri, Montana, Nebraska, New Mexico, North Dakota, Ohio, Oklahoma, Oregon,
South Dakota, Tennessee, Texas, Utah, Washington, Wisconsin and Wyoming, and to
resell the local services of the MegaBells in most of the markets they serve in
those states. We have applications pending for authority to offer local services
or plans to file such applications in the remaining states in the continental
United States.

We are also authorized to offer intrastate long distance service in the lower 48
states in the United States. We have obtained authority to offer long distance
service in such states, including states outside our target markets, because we
believe this capability will enhance our ability to attract business customers
that have offices outside of our target markets. We may also apply for authority
to provide services in all MegaBell exchanges in our target market states and,
in the future, in other states. While we expect and intend to obtain the
necessary regulatory authority in each jurisdiction where we plan to operate, we
cannot assure you that each respective agency will grant our request for
authority.

The Telecommunications Act of 1996 preserves the ability of states to impose
reasonable terms and conditions on the provision of intrastate service and other
related regulatory requirements. In the last several years, many states have
enacted broad changes in their telecommunications laws that authorize the entry
of competitive local exchange carriers and provide for new regulations to
promote competition in local and other intrastate telecommunications services.
The MegaBells have consistently promoted sweeping legislation that would, if
enacted, severely limit or altogether eliminate state regulatory oversight of
the MegaBells. As a general matter, we believe the states will play a key role
in the development of local exchange

                                       23
<PAGE>

competition. Consequently, we could face regulatory decisions that adversely
affect our ability to compete in particular states.

States also regulate the intrastate carrier access services of the incumbent
local exchange carriers. We are required to pay access charges to originate and
connect our intrastate long distance traffic when we are not using our own
facilities. We could be adversely affected by high access charges, particularly
to the extent that the incumbent local exchange carriers do not incur the same
level of costs with respect to their own intrastate long distance services. We
could also be adversely affected if we are not permitted to charge or are unable
to collect access charges from other long distance carriers to compensate us for
the use of our network. In a related development, states also will be developing
intrastate universal service charges parallel to the interstate universal
service charges created by the FCC. For example, some incumbent local exchange
carriers are proposing that states create funds that would be supported by
potentially large payments by firms such as us based on their total intrastate
revenues. Another state regulatory issue that could adversely affect our
business is the approval by some state regulatory agencies of extended local
area calling for incumbent local exchange carriers, converting otherwise
competitive intrastate toll service to local service. Our business could be
adversely affected by these or other developments.

We believe that, as the degree of intrastate competition increases, states will
offer the local exchange carriers increasing pricing flexibility. This
flexibility may present the local exchange carriers with an opportunity to
subsidize services that compete with our services with revenues generated from
non-competitive services, allowing incumbent local exchange carriers to offer
competitive services at prices below the cost of providing the service. We
cannot predict the extent to which this may occur or its impact on our business.

ICTC is subject to rate of return regulation by the Illinois Commerce
Commission. Under such regulation, ICTC is allowed to earn up to a fixed rate of
return on its equity. In the event that the Illinois Commerce Commission finds
that ICTC has exceeded its authorized rate of return on equity, ICTC could be
required to lower its customer rates or make refunds. While we believe the
Commission will not find that ICTC earned an excessive rate of return during the
current monitoring period, we cannot assure you that the Illinois Commerce
Commission will not, at some future date, find that ICTC has earned more than
its authorized rate of return or that such a finding would not have a material
adverse effect on us.

In addition, a substantial proportion of the revenues of ICTC and Dakota
Community Telephone, Inc. are derived from access charges imposed on long
distance carriers. Access charge rate structures and rate levels have been
reduced by recent regulatory changes, and further changes are possible. If such
revisions result in a reduction of revenues and gross margins of ICTC and Dakota
Community Telephone, it could have a material adverse effect on us.

Several of our subsidiaries also hold state and federal certificates and FCC
licenses in connection with the operation of wireless telecommunications
services and paging services.

Through our subsidiaries, we engage in various direct marketing, telemarketing
and fund-raising activities. Most states have laws and regulations that govern
these activities. In states that regulate such activities, several types of
restriction have been imposed, either singly or in combination.

Local Government Authorizations. We are required to obtain construction permits
and licenses or franchises to install and expand our fiber optic communications
networks using rights-of-way. Some local governments where we have installed or
anticipate constructing networks are proposing and enacting ordinances
regulating use of rights-of-way and imposing

                                       24
<PAGE>

various fees in connection with such use. In some instances we have negotiated
interim agreements to authorize installation of facilities pending resolution of
the fee issue. In many markets, the local exchange carriers do not pay
rights-of-way fees or pay fees that are substantially less than the fees we are
required to pay. To the extent that competitors do not pay the same level of
fees as us, we could be at a competitive disadvantage. We must also negotiate
and enter into franchise agreements with local governments in order to operate
our video services networks. We have franchises for our existing services, but
will need additional franchises in order to expand into additional markets. If
we fail to receive necessary permits or franchise agreements on commercially
reasonable terms or are unable to obtain or maintain right-of-way authorization
or license agreements, we could be materially adversely affected. If we lose a
right-of-way, we could be required to remove our facilities from the right-of-
way or abandon our network in place.

Risk Factors

In connection with the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, set forth below are cautionary statements
identifying important factors that could cause actual events or results to
differ materially from any forward-looking statements made by or on behalf of
us, whether oral or written. We wish to ensure that any forward-looking
statements are accompanied by meaningful cautionary statements in order to
maximize to the fullest extent possible the protections of the safe harbor
established in the Private Securities Litigation Reform Act of 1995.
Accordingly, any such statements are qualified in their entirety by reference
to, and are accompanied by, the following important factors that could cause
actual events or results to differ materially from our forward-looking
statements.

Fluctuations in the Market Price of Our Class A Common Stock May Make It More
Difficult for Us to Raise Capital.

The market price of our Class A common stock is extremely volatile and has
fluctuated over a wide range. These fluctuations may impair our ability to raise
capital by offering equity securities. The market price may continue to
fluctuate significantly in response to various factors, including:

   .  market conditions in the industry
   .  announcements or actions by competitors or by other companies in the
      competitive local exchange sector
   .  sales of large amounts of our Class A common stock in the public market or
      the perception that such sales could occur
   .  quarterly variations in operating results or growth rates
   .  changes in estimates by securities analysts
   .  regulatory and judicial actions
   .  general economic conditions

See "Market for Registrants' Common Equity and Related Stockholder Matters--
Price Range of Class A Common Stock."

Failure to Raise Necessary Capital Could Restrict Our Ability to Develop Our
Network and Services and Engage in Strategic Acquisitions.

We need significant capital to continue to expand our operations, facilities,
network and services. There can be no assurance that our capital resources will
permit us to fund our planned network deployment and operations or achieve
operating profitability. Failure to

                                       25
<PAGE>

generate or raise sufficient funds may require us to delay or abandon some of
our expansion plans or expenditures, which could harm our business and
competitive position.

As of December 31, 2000, based on our business plan, capital requirements and
growth projections as of that date, we estimated that we would require
approximately $1.5 billion through 2002 to fund our planned capital expenditures
and operating expenses. We expect to meet these funding needs through various
sources, including our existing cash balances, net proceeds from the sale of our
11 3/8% senior notes issued in January 2001, our existing lines of credit,
prospective sales of selected assets, exercises of outstanding options and cash
flow from future operations. Our estimated aggregate capital requirements
include the projected costs of:

   .  expanding our fiber optic communications network, including national and
      intra-city fiber optic networks
   .  adding voice and data switches
   .  expanding operations in existing and new markets
   .  funding general corporate expenses
   .  integrating acquisitions
   .  constructing, acquiring, developing or improving telecommunications assets

Our estimate of future capital requirements is a "forward-looking statement"
within the meaning of the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. The actual amount and timing of our future
capital requirements may differ substantially from our estimate due to factors
such as:

   .  strategic acquisition costs and effects of acquisitions on our business
      plan, capital requirements and growth projections
   .  unforeseen delays
   .  cost overruns
   .  engineering design changes
   .  changes in demand for our services
   .  regulatory, technological or competitive developments
   .  new opportunities

We expect to evaluate potential acquisitions, joint ventures and strategic
alliances on an ongoing basis. We may require additional financing if we pursue
any of these opportunities.

We may meet any additional capital needs by issuing additional debt or equity
securities or borrowing funds from one or more lenders. In addition, in the
event vendor financing arrangements are available on terms that allow rates of
return comparable to current capital projects and are otherwise favorable to us,
we may use such financing to accelerate or increment the development of our
national network. There can be no assurance that we will have timely access to
additional financing sources on acceptable terms. If we do not, we may not be
able to expand our markets, operations, facilities, network and services as we
intend.

See "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."

We Expect to Incur Significant Losses Over the Next Several Years.

If we do not become profitable in the future, we could have difficulty obtaining
funds to continue our operations. We have incurred net losses every year since
we began operations. Since January 1, 1995, our net losses applicable to common
stock have been as follows:

                                       26
<PAGE>

Period                     Amount
------                     ------

1995....................   $ 11.3 million
1996....................   $ 22.3 million
1997....................   $ 79.9 million
1998....................   $124.9 million
1999....................   $238.0 million
2000....................   $531.7 million

We expect to incur significant operating losses during the next several years
while we develop our business and expand our fiber optic communications
network.

We May Not Be Able to Successfully Integrate Acquired Companies into Our
Operations, Which Could Slow Our Growth.

The integration of acquired companies into our operations involves a number of
risks, including:

   .  difficulty integrating operations and personnel
   .  diversion of management attention
   .  potential disruption of ongoing business
   .  inability to retain key personnel
   .  inability to successfully incorporate acquired assets and rights into our
      service offerings
   .  inability to maintain uniform standards, controls, procedures and policies
   .  impairment of relationships with employees, customers or vendors

Failure to overcome these risks or any other problems encountered in connection
with acquisition transactions could slow our growth or lower the quality of our
services, which could reduce customer demand and adversely affect our business.

Continued Rapid Growth of Our Network, Service Offerings and Customer Base Could
Be Slowed if We Cannot Manage This Growth.

We have rapidly expanded and developed our network, service offerings and
customer base. This has placed and will continue to place significant demands on
our management, operational and financial systems and procedures and controls.
We may not be able to manage our anticipated growth effectively, which would
harm our business, results of operations and financial condition. Further
expansion and development will depend on a number of factors, including:

   .  cooperation of existing local telephone companies
   .  regulatory, legislative and other governmental developments
   .  changes in the competitive climate in which we operate
   .  development of customer billing, order processing and network management
      systems
   .  availability of financing
   .  technological developments
   .  availability of rights-of-way, franchises, building access and antenna
      sites
   .  existence of strategic alliances or relationships
   .  emergence of future opportunities

We will need to continue to improve our operational and financial systems and
our procedures and controls as we grow. We must also develop, train and manage
our employees.

                                       27
<PAGE>

Our High Level of Debt Could Limit Our Flexibility in Responding to Business
Developments and Put Us at a Competitive Disadvantage.

We have substantial debt, which could adversely affect us in a number of ways,
including:

   .  limiting our ability to obtain necessary financing in the future
   .  limiting our flexibility to plan for, or react to, changes in our business
   .  requiring us to use a substantial portion of our cash flow from operations
      to pay debt rather than for other purposes, such as working capital or
      capital expenditures
   .  making us more highly leveraged than some of our competitors, which may
      place us at a competitive disadvantage
   .  making us more vulnerable to a downturn in our business

As of December 31, 2000, we had $2.7 billion of long-term debt, including $2.1
billion of debt under our senior notes and $575 million under our senior secured
credit facilities with a syndicate of lenders ("Senior Secured Credit
Facilities"). We also had $1.0 billion of redeemable convertible preferred stock
and $2.8 billion of stockholders' equity. In January 2001, we added $750 million
of debt with the issuance of additional senior notes. As a result, we expect our
fixed charges to exceed our earnings for the foreseeable future.

See "Management's Discussion and Analysis of Financial Condition and Results
of Operations--Liquidity and Capital Resources."

Covenants in Debt Instruments Restrict Our Capacity to Borrow and Invest,
Which Could Impair Our Ability to Expand or Finance Our Operations.

The indentures governing the terms of our long-term debt and the agreements
governing our Senior Secured Credit Facilities impose operating and financial
restrictions. In addition, under the terms of our Senior Secured Credit
Facilities, we have granted a security interest in substantially all of our and
our subsidiaries' assets. These restrictions and encumbrances limit our
discretion in some business matters, which could make it more difficult for us
to expand, finance our operations or engage in other business activities that
may be in our interest. These restrictions limit or prohibit our ability to:

   .  incur additional debt
   .  pay dividends or make other distributions
   .  make investments or other restricted payments
   .  enter into sale and leaseback transactions
   .  pledge, mortgage or permit liens upon assets
   .  enter into transactions with affiliates
   .  sell assets
   .  consolidate, merge or sell all or substantially all of our assets

If we fail to comply with these restrictions, all of our long-term debt could
become immediately due and payable.

See "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."

                                       28
<PAGE>

   Our Ability to Pay Cash Dividends Is Restricted.

   We have never paid any cash dividends on shares of our Class A common stock.
   We do not anticipate paying any cash dividends on shares of our Class A
   common stock for the foreseeable future. The indentures governing our debt
   and our Senior Secured Credit Facilities restrict our ability to pay such
   cash dividends. Investors should therefore not expect that cash dividends
   will be paid on shares of our Class A common stock. In addition, you should
   be aware that shares of our Series A preferred stock and Series B preferred
   stock carry rights to receive a cumulative dividend before any cash dividend
   may be paid on shares of our Class A common stock. See "Market for
   Registrant's Common Equity and Related Shareholder Matters--Dividend Policy."

   Our Dependence on the MegaBells to Provide Most of Our Communications
   Services Could Make It Harder for Us to Offer Our Services at a Profit.

   The original seven regional Bell operating companies that resulted from the
   divestiture by AT&T in 1984 of its local telephone systems are now
   concentrated into four large incumbent "MegaBells." We depend on these
   MegaBells to provide most of our core local and some long distance services.
   Today, without using the communications facilities of these companies, we
   could not provide bundled local and long distance services to most of our
   customers. Because of this dependence, our communications services are highly
   susceptible to changes in the conditions for access to these facilities and
   to inadequate service quality provided by the MegaBells. Therefore, we may
   have difficulty offering our services on a profitable and competitive basis.

   Qwest Communications International Inc. (successor to U S WEST
   Communications, Inc.) and SBC Communications Inc. (including its wholly-owned
   subsidiary Ameritech Corporation) are our primary suppliers of local lines to
   our customers and communications services that allow us to transfer and
   connect calls. The communications facilities of our suppliers allow us to
   provide local service, long distance service and private lines dedicated to
   our customers' use. If these MegaBells or other companies deny or limit our
   access to their communications network elements or wholesale services, we may
   not be able to offer our communications services at profitable rates.

   Our plan to provide local service using our own communications network
   equipment also depends on the MegaBells. In order to interconnect our network
   equipment and other communications facilities to network elements controlled
   by the MegaBells, we must first negotiate and enter into interconnection
   agreements with them. Interconnection obligations imposed on the MegaBells by
   the Telecommunications Act of 1996 have been and continue to be subject to a
   variety of legal proceedings, the outcome of which could affect our ability
   to obtain interconnection agreements on acceptable terms. There can be no
   assurance that we will succeed in obtaining interconnection agreements on
   terms that would permit us to offer local services using our own
   communications network facilities at profitable and competitive rates.

   Actions by the MegaBells May Make it More Difficult for Us to Offer Our
   Communications Services.

   The MegaBells have pursued several measures that may make it more difficult
   for us to offer our communications services. For example, in 1998 and 1999,
   SBC/Ameritech assessed special construction charges to install service for
   customers when we leased a line from them. SBC/Ameritech did not assess
   comparable charges to retail customers that ordered service directly from
   SBC/Ameritech, which put us at a disadvantage.

                                       29
<PAGE>

   In addition, during 2000 Qwest filed proposals with the Iowa Utilities Board
   to reduce the retail prices charged by Qwest for various business services
   without a corresponding wholesale price reduction. If the Qwest proposals are
   approved, it could cause us to reduce prices and have the effect of reducing
   our margins on competitive local business services in Iowa.

   We have challenged or are challenging these actions before the FCC or
   applicable state public utility commissions. We cannot assure you we will
   succeed in our challenges to these or other actions by the MegaBells that
   would prevent or deter us from using their service or communications network
   elements. If the MegaBells successfully withdraw, limit our access to
   services or successfully charge us extraordinary costs in any location, we
   may not be able to offer communications services in those locations, which
   would harm our business.

   We anticipate that the MegaBells will continue to pursue legislation in
   states within our target market area to reduce state regulatory oversight
   over their rates and operations. If adopted, these initiatives could make it
   more difficult for us to challenge MegaBell actions in the future which could
   harm our business.

   The MegaBells are also pursuing federal legislative and regulatory
   initiatives to undermine the Telecom Act of 1996 requirement to open local
   networks. If successful, these initiatives could make it more difficult to
   offer services on a profitable and competitive basis.

   Competition in the Communications Services Industry Could Cause Us to Lose
   Customers and Revenue and Make It More Difficult for Us to Enter New Markets.

   We face intense competition in all of our markets. This competition could
   result in loss of customers and lower revenue for us. It could also make it
   more difficult for us to enter new markets.  Entrenched, traditional local
   telephone companies, including Qwest, SBC, BellSouth and Verizon, currently
   dominate their local communications markets. Three major competitors, AT&T,
   WorldCom and Sprint, dominate the long distance market. Hundreds of other
   companies also compete in the long distance marketplace. Many other
   companies, including AT&T, WorldCom and Sprint, also compete in the local and
   long distance marketplace.

   Other competitors may include cable television providers, providers of
   communications network facilities dedicated to particular customers,
   microwave and satellite carriers, wireless telecommunications providers,
   private networks owned by large end-users, municipalities, electrical
   utilities and telecommunications management companies.

   These and other firms may enter the markets where we focus our sales efforts,
   which may create downward pressure on the prices for our services and
   negatively affect our returns. Many of our existing and potential competitors
   have financial and other resources far greater than ours. In addition, the
   trend toward mergers and strategic alliances in the communications industry
   may strengthen some of our competitors and could put us at a significant
   competitive disadvantage.

   For additional information, see "--Competition."

   If the MegaBells Are Allowed to Offer Bundled Local and Long Distance
   Services in Our Markets, It Could Cause Us to Lose Customers and Revenue and
   Could Make It More Difficult for Us to Enter New Markets.

   Presently the MegaBells are prohibited from offering interLATA long distance
   services to customers in their regions until they have shown compliance with
   the Telecommunications Act of 1996.  The MegaBells are attempting to show
   compliance and are seeking authority to offer in-region interLATA long
   distance service. SBC has obtained such authority in Texas,

                                       30
<PAGE>

   Oklahoma and Kansas and has requests pending at the FCC for Missouri and
   Arkansas. Qwest has indicated its intention to seek authority in all 14
   states where it provides local service.

   The MegaBells are also seeking policy changes to reduce or eliminate the
   requirement that they open their local networks prior to offering interLATA
   services.

   If the MegaBells, which have resources far greater than ours, are authorized
   to bundle interLATA long distance service and local service in our markets
   before the MegaBell local markets are effectively open to competition, such
   an offering by the MegaBells could cause us to lose customers and revenues
   and make it more difficult for us to compete in those markets.

   We May Not Develop or Make a Profit from Wireless Services.

   Developing wireless services involves a high degree of risk and would impose
   significant demands on our management and financial resources. It could
   require us to, among other things, spend substantial time and money to
   acquire, build and test a wireless infrastructure and enter into roaming
   arrangements with wireless operators in other markets or enter into other
   sophisticated long-term agreements. Our business plan does not currently
   include funds for the development of wireless services.  To offer wireless
   services on a widespread basis, we would need to obtain additional funding by
   issuing additional debt or equity securities or by borrowing funds from one
   or more lenders. Our PCS licenses are subject to revocation if we fail to
   provide substantial service with them by April 2002.  We may decide not to
   include wireless services in our package of integrated communications
   services. We may decide to sell some or all of our remaining wireless
   licenses. Even if we do offer wireless services, we may not develop wireless
   services ourselves. Even if we spend substantial amounts to develop wireless
   services, we may not make a profit from wireless operations.

   Our ability to successfully offer wireless services will also depend on a
   number of factors beyond our control, including:

       .  changes in communications service rates charged by other companies
       .  changes in the supply and demand for wireless services due to
          competition with other wireline and wireless operators in the same
          geographic area
       .  changes in the federal, state or local regulatory requirements
          affecting the operation of wireless systems
       .  changes in wireless technologies that could render obsolete the
          technology and equipment we choose for our wireless services

   See "--Wireless Licenses."

   Developments in the Wireless Telecommunications Industry Could Make It More
   Difficult for Us to Compete.

   The wireless telecommunications industry is experiencing increasing
   competition and significant technological change.  These developments will
   make it more difficult for us to gain a share of the wireless communications
   market and are facilitating the migration of wireline minutes to wireless
   carriers. We could face additional competition from users of other wireless
   technologies including, but not limited to, unlicensed spectrum, satellites
   and lasers.

   Many of the wireless carriers have financial and other resources far greater
   than ours and have more experience testing new or improved products and
   services. In addition, several wireless competitors operate or plan to
   operate wireless telecommunications systems that

                                       31
<PAGE>

   encompass most of the United States, which could give them a significant
   competitive advantage.

   See "-- Competition--Wireless Competition."

   The Success of Our Communications Services Will Depend on Our Ability to Keep
   Pace with Rapid Technological Changes in Our Industry.

   Communications technology is changing rapidly. These changes influence the
   demand for our services. We need to be able to anticipate these changes and
   to develop and bring to market new and enhanced products and services quickly
   enough for the changing market. This will determine whether we can continue
   to increase our revenue and number of subscribers and remain competitive.

   The Loss of Key Personnel Could Weaken Our Technical and Operational
   Expertise, Delay Our Introduction of New Services or Entry into New Markets
   and Lower the Quality of Our Service.

   We may not be able to attract, develop, motivate and retain experienced and
   innovative personnel. There is intense competition for qualified personnel in
   our lines of business. The loss of the services of key personnel, or the
   inability to attract additional qualified personnel, could cause us to make
   less successful strategic decisions, which could hinder the introduction of
   new services or the entry into new markets. We could also be less prepared
   for technological or marketing problems, which could reduce our ability to
   serve our customers and lower the quality of our services. As a result, our
   financial condition could be adversely affected.

   Our future success depends on the continued employment of our senior
   management team, particularly Clark E. McLeod, our Chairman and Co-Chief
   Executive Officer, and Stephen C. Gray, our President and Co-Chief Executive
   Officer.

   Failure to Obtain and Maintain Necessary Permits and Rights-of-Way Could
   Delay Installation of Our Networks and Interfere with Our Operations.

   To obtain access to rights-of-way needed to install our fiber optic cable, we
   must reach agreements with state highway authorities, local governments,
   transit authorities, local telephone companies and other utilities,
   railroads, long distance carriers and other parties. The failure to obtain or
   maintain any rights-of-way could delay our planned network expansion,
   interfere with our operations and harm our business. For example, if we lose
   access to a right-of-way, we may need to spend significant sums to remove and
   relocate our facilities. See "--Regulation--Local Government Authorizations."

   Government Regulation May Increase Our Cost of Providing Services, Slow Our
   Expansion into New Markets and Subject Our Services to Additional Competitive
   Pressures.

   Our facilities and services are subject to federal, state and local
   regulations. The time and expense of complying with these regulations could
   slow down our expansion into new markets, increase our costs of providing
   services and subject us to additional competitive pressures. One of the
   primary purposes of the Telecommunications Act of 1996 was to open the local
   telephone services market to competition. While this has presented us with
   opportunities to enter local telephone markets, it also provides important
   benefits to the existing local telephone companies, such as the ability,
   under specified conditions, to provide out-of-region long distance service to
   customers in their respective regions. In addition, we need to obtain and

                                       32
<PAGE>

   maintain licenses, permits and other regulatory approvals in connection with
   some of our services. Any of the following could harm our business:


       .  failure to comply with federal and state tariff requirements
       .  failure to maintain proper federal, state and municipal certifications
          or authorizations
       .  failure to comply with federal, state or local laws and regulations
       .  failure to obtain and maintain required licenses and permits
       .  burdensome license or permit requirements to operate in public rights-
          of-way
       .  burdensome or adverse regulatory requirements
       .  delays in obtaining or maintaining required authorizations

   For additional information, see "--Regulation."

   Our Management and Principal Stockholders Have Significant Ownership and May
   Have Interests Different Than Those of Other Security Holders.

   As of December 31, 2000, Alliant Energy Corporation, M/C Investors L.L.C.,
   Media/Communications Partners III Limited Partnership, Richard Lumpkin and
   various trusts for the benefit of his family, Clark and Mary McLeod, and the
   directors and executive officers of McLeodUSA beneficially owned
   approximately 25% of our outstanding Class A common stock. These stockholders
   may have substantial influence over management policy and many corporate
   actions requiring a stockholder vote, including election of the board of
   directors.  Conflicts of interest may arise between the interests of these
   stockholders and our other  security holders. For example, the fact that
   these stockholders hold so much McLeodUSA Class A common stock could make it
   more difficult for a third party to acquire McLeodUSA. You should expect
   these stockholders may resolve any conflicts in their favor.

   Preferred Stockholders May Have Interests Which Compete with the Interests of
   Other Security Holders.

   Holders of our preferred stock have the ability to convert their shares into
   approximately 112 million shares of our Class A common stock. Potential
   conflicts of interest may arise among holders of our Class A common stock,
   holders of our preferred stock and the holders of our Senior Notes with
   respect to, among other things, the payment of dividends, conversion rights,
   asset dispositions or liquidation matters, and operation and financial
   decisions of our board of directors. In addition, the holders of our
   preferred stock have class voting rights on specified actions requiring
   stockholder approval.

   Holders of Series B preferred stock are entitled to receive, if declared by
   our board of directors, cumulative dividends at an annual rate of $127.273
   per share. Furthermore, during the 180-day period commencing on September 15,
   2009, the holders of our Series B preferred stock and Series C preferred
   stock have the right to cause us to redeem, in whole or in part, the
   outstanding shares of Series B preferred stock and Series C preferred stock.
   In addition, an agreement relating to these securities imposes certain
   conditions on the incurrence of indebtedness by us and our subsidiaries.
   Based on these rights, these preferred stockholders may have interests which
   compete with the interests of other security holders.

   Secondary Sales of our Class A Common Stock in the Public Market Could
   Adversely Affect our Stock Price.

   The market price of our Class A common stock may fluctuate or decline
   significantly in the future as a consequence of sales by either existing
   holders of our Class A common stock or

                                       33
<PAGE>

   existing holders of our preferred stock who convert their shares into shares
   of Class A common stock.

   As of December 31, 2000, there were outstanding:

       .  606,596,945 shares of our Class A common stock
       .  1,149,400 shares of our Series A preferred stock convertible into 29.6
          million shares of our Class A common stock
       .  400,000 shares of our Series B and Series C preferred stock
          convertible into 82.2 million shares of our Class A common stock, all
          of which are held by three partnerships affiliated with Forstmann
          Little & Co.
       .  options to purchase 128,810,103 shares of our Class A common stock
       .  144,012,216 million shares of our Class A common stock owned by
          Alliant Energy, M/C Investors, Media/Communications Partners III,
          Richard Lumpkin and various trusts for the benefit of his family,
          Clark and Mary McLeod, and the directors and executive officers of
          McLeodUSA, all of which are eligible for sale in the public market
          either in accordance with Rule 144 under the Securities Act of 1933 or
          otherwise
       .  options held by Alliant Energy to purchase 4,687,500 shares of our
          Class B common stock convertible into 4,687,500 shares of our Class A
          common stock

   Employees

   As of December 31, 2000, we had more than 10,700 employees. Approximately 450
   employees at our ICTC subsidiary are covered by a collective bargaining
   agreement which expires November 15, 2002. We believe that our future success
   will depend on our continued ability to attract and retain highly skilled and
   qualified employees. We believe that our relations with our employees are
   good.

   Executive Officers

   The following is a list of our executive officers as of March 16, 2001,
   together with biographical summaries of their experience. The ages of the
   persons set forth below are as of December 31, 2000.

<TABLE>
<CAPTION>
   Name                                      Age            Position(s) with Company
   ----                                      ---            ------------------------
   <S>                                       <C>       <C>
   Clark E. McLeod                            54       Chairman, Co-Chief Executive Officer and Director
   Stephen C. Gray                            42       President and Co-Chief Executive Officer; Director
   Richard A. Lumpkin                         65       Vice Chairman and Director
   Roy A. Wilkens                             57       President and Chief Executive Officer--Network
     Services; Director
   J. Lyle Patrick                            48       Group Vice President - Finance & Accounting;
     Chief Financial & Accounting Officer
   Arthur L. Christoffersen                   54       Group Vice President - Publishing Services
   Randall Rings                              38       Group Vice President, Chief Legal Officer and
                                                       Secretary
</TABLE>

   Clark E. McLeod.  Mr. McLeod  serves as Chairman and Co-Chief Executive
   Officer. He founded McLeodUSA and has served as Chairman, Chief Executive
   Officer and a director since its inception in June 1991. His previous
   business venture, Teleconnect, an Iowa-based long distance telecommunications
   company, was founded in January 1980. Mr. McLeod served as

                                       34
<PAGE>

   Chairman and Chief Executive Officer of Teleconnect from January 1980 to
   December 1988, and from December 1988 to August 1990, he served as President
   of Telecom*USA, the successor to Teleconnect following its merger with
   SouthernNet, Inc. in December 1988. By 1990, Telecom*USA had become America's
   fourth largest long distance telecommunications company with nearly 6,000
   employees. MCI purchased Telecom*USA in August 1990 for $1.25 billion. Mr.
   McLeod services on the board of directors of APAC Customer Services, Inc., a
   provider of customer relationship management services, and Terabeam
   Corporation, a Seattle-based provider of proprietary fiber-less optic
   services.

   Stephen C. Gray.  Mr. Gray serves as President and Co-Chief Executive
   Officer.  He has been a director since April 1993. Prior to joining McLeodUSA
   in 1992, Mr. Gray served from August 1990 to September 1992 as Vice President
   of Business Services at MCI, where he was responsible for MCI's local access
   strategy and for marketing and sales support of the Business Markets
   division. From February 1988 to August 1990, he served as Senior Vice
   President of National Accounts and Carrier Services for Telecom*USA, where
   his responsibilities included sales, marketing, key contract negotiations and
   strategic acquisitions and combinations. Before joining Telecom*USA, Mr. Gray
   held a variety of management positions with Williams Telecommunications
   Company, a long distance telephone company.

   Richard A. Lumpkin.  Mr. Lumpkin has served as Vice Chairman and a director
   since September 1997. Mr. Lumpkin was elected as an officer and a director
   pursuant to the requirements of the CCI Merger Agreement. Mr. Lumpkin served
   as Chairman and Chief Executive Officer of Consolidated Communications Inc.
   from 1990 to September 24, 1997, the date CCI was acquired by McLeodUSA. He
   continues to serve as Chairman, Chief Executive Officer and President of
   Illinois Consolidated Telephone Company ("ICTC"), a wholly-owned subsidiary.
   From its formation in 1984 to 1990, Mr. Lumpkin served as President of CCI.
   From 1968 to 1990, Mr. Lumpkin held various executive positions at ICTC,
   including Vice President of Operations and Treasurer. He is a director of
   Ameren Corporation, an electric utility holding company, First Mid-Illinois
   Bancshares, Inc., a bank holding company, and its wholly-owned subsidiary
   First Mid-Illinois Bank & Trust, a bank. Mr. Lumpkin is Chairman of the Board
   of Illuminet Holdings, Inc., formerly USTN Holdings, Inc., a
   telecommunications company.  He is also a former director and past president
   of the Illinois Telephone Association and the United States Telephone
   Association.

   Roy A. Wilkens.  Mr. Wilkens serves as President and Chief Executive Officer-
   -Network Services, having joined the Company in January 2000.  Mr. Wilkens
   has served as a director of McLeodUSA since June 1999. Mr. Wilkens was
   President of the Williams Pipeline Company when he founded WilTel Network
   Services as an operating unit of the Williams Companies, Inc., in 1985.   He
   was Chief Executive Officer of WilTel Network Services from 1985 to 1997. In
   1995, WilTel Network Services was acquired by LDDS Communications, which now
   operates under the name WorldCom. Mr. Wilkens served as Vice Chairman of
   WorldCom until his retirement in 1997. In 1992, Mr. Wilkens was appointed by
   President George Bush to the National Security Telecommunications Advisory
   Council. He also has served as chairman of both the Competitive
   Telecommunications Association (CompTel) and the National Telecommunications
   Network. Mr. Wilkens was a director of Splitrock Services, Inc. before its
   acquisition by McLeodUSA.  He was also a director of Williams Communication
   Group, Inc., a provider of services and products to communications companies,
   before he resigned his position in December 2000.  Mr. Wilkens is a director
   of The Management Network Group, Inc. (TMNG), a provider of consulting
   services to the telecommunications industry.

   J. Lyle Patrick.  Mr. Patrick was named Group Vice President and Chief
   Financial Officer in September 1998. Mr. Patrick served as Executive Vice
   President of Public Policy and Accounting from September 1997 to September
   1998 with responsibility for financial, billing

                                       35
<PAGE>

   and other administrative functions of McLeodUSA, as well as directing
   regulatory and legislative efforts with various state and national agencies.
   From 1988 until September 1997, Mr. Patrick was Vice President and Chief
   Financial Officer of Consolidated Communications Inc. Mr. Patrick is a
   Certified Public Accountant and was a partner with Arthur Andersen LLP for
   the 4 years prior to his tenure with CCI. Mr. Patrick is a past Chairman of
   the CompTel Board of Directors, the national competitive telecommunications
   association. He is a past Chairman of the Illinois Telecommunications
   Association Board of Directors, and has served on various committees as well
   as the Board of Directors of the United States Telephone Association.

   Arthur L. Christoffersen.  Mr. Christoffersen has served McLeodUSA as Group
   Vice President, Publishing Services since September 1997. He joined the
   Company as Executive Vice President, Publishing Services in September 1996
   when McLeodUSA acquired McLeodUSA Publishing. Mr. Christoffersen served as
   Chairman, President and Chief Executive Officer of McLeodUSA Publishing from
   November 1990, the date Mr. Christoffersen and other investors acquired
   McLeodUSA Publishing from MCI, and has continued to serve in that capacity
   following the acquisition of McLeodUSA Publishing by McLeodUSA. From December
   1987 to August 1990, Mr. Christoffersen served as Executive Vice President
   and Chief Financial Officer of Teleconnect and its successor, Telecom*USA.
   From 1975 to 1987, Mr. Christoffersen held a variety of management positions,
   including Executive Vice President of Life Investors, Inc., a diversified
   financial services company.

   Randall Rings.  Mr. Rings was named Group Vice President, Chief Legal Officer
   and Secretary in June 2000.  He served as Vice President, Secretary and
   General Counsel from March 1998 to June 2000. From May 1996 to March 1998, he
   served as General Counsel of McLeodUSA Publishing, where he was responsible
   for its legal, legislative and regulatory affairs. Prior to 1996, Mr. Rings
   served as an Associate Attorney at March & McMillan, P.C., with a diverse
   legal practice which included business planning, commercial litigation,
   employment and environmental law, and representation of electric and
   telephone cooperatives. From November 1988 to June 1992, he served as
   Corporate Counsel to the Association of Illinois Electric Cooperatives, where
   he acted as its chief legal officer and advised electric and telephone
   cooperatives throughout Illinois on corporate, tax, employment and other
   legal matters.

   Item 2.  Properties

   Our headquarters are located in Cedar Rapids, Iowa on 314 acres we own and on
   which we have developed an office complex known as McLeodUSA Technology Park.
   Our headquarters buildings consist of a one-story, 160,000 square foot office
   building; a two-story, 320,000 square foot office building which also houses
   some of our telephone switching and computer equipment; and a 36,000 square
   foot maintenance building and warehouse. The total cost of the construction
   of our headquarters buildings was approximately $35.6 million. We also own a
   60,000 square foot office building in Mattoon, Illinois and a 55,000 square
   foot office building in Sioux Falls, South Dakota.

   We also conduct business activities at many other locations, either leased or
   purchased. These include facilities throughout the country used in connection
   with the construction and operation of our network, including over 400 POP
   sites as of December 31, 2000. Our locations also include 130 sales offices
   in our 25 state target market as of December 31, 2000.

   The following are some of the principal facilities at which we have business
   operations: 115,000 square feet of office space at our former headquarters in
   downtown Cedar Rapids, Iowa, under leases expiring in 2005, and 33,000 square
   feet of other office space in downtown Cedar Rapids under a lease expiring in
   2010; 80,000 square feet of office space in St. Louis, Missouri under a lease
   expiring in 2009; 100,000 square feet of office and warehouse space in

                                       36
<PAGE>

   Des Moines, Iowa under a lease expiring in 2015; 56,000 square feet of office
   space in Salt Lake City, Utah under a lease expiring in 2010; 95,000 square
   feet of office space in Houston, Texas under a lease expiring in 2009; 86,000
   square feet of office space in Dallas, Texas under a lease expiring in 2007;
   and 80,000 square feet of office space in Tulsa, Oklahoma, which serves as
   the headquarters for our network operations, under a lease expiring in 2004.

   Item 3.  Legal Proceedings

   Several class action complaints have been filed in the United States District
   Court for the Northern District of Texas on behalf of all purchasers of
   CapRock common stock during the period April 28, 2000 through July 6, 2000.
   The lawsuits principally allege that prior to its merger with McLeodUSA
   CapRock made material misstatements or omissions of fact in violation of
   Section 10(b) of the Securities Exchange Act.  Consolidated with these claims
   are allegations that CapRock's June 2000 registration statement for a public
   offering of common stock contained materially false and misleading statements
   and omitted certain material information about CapRock in violation of
   Section 11 of the Securities Act. The named defendants in these lawsuits
   include CapRock and certain of its officers and directors. The plaintiffs in
   the lawsuits seek monetary damages and other relief. The defendants intend to
   file a motion to dismiss at the appropriate time. We believe that these
   lawsuits are without merit and intend to vigorously defend them.

   On October 6, 2000, a class action complaint was filed in the County Court at
   Law of Dallas County, Texas on behalf of CapRock stockholders. This complaint
   names as defendants CapRock and each member of its board of directors prior
   to the merger of CapRock and McLeodUSA and principally alleges that the
   directors violated fiduciary duties owed to CapRock stockholders in
   connection with entering into the merger agreement. The plaintiffs in the
   lawsuit seek unspecified monetary damages.  While plaintiffs also sought an
   injunction in their pleadings, no application for such an injunction was
   brought to the court. We believe that the lawsuit is without merit and intend
   to vigorously defend the lawsuit.

   We are not aware of any other material litigation against us. We do, however,
   have various legal proceedings pending against us or on our behalf.

   We are involved in numerous regulatory proceedings before various public
   utility commissions and the FCC, particularly in connection with actions by
   the MegaBells. For example, we have filed complaints in both Colorado and
   Iowa challenging the apparent practice by U S West (now Qwest) of installing
   service for its own retail customers quicker than it installs service for our
   customers when new facilities are required. The Iowa regulatory agency
   determined that Qwest was discriminating unfairly against us. We have also
   complained to three state commissions that the practice of SBC (through its
   subsidiary Ameritech) of charging us extra fees to install service for our
   customers when we lease a line was unfair because Ameritech did not attempt
   to assess the same extra charges to its retail customers. Two state agencies
   have ruled that Ameritech's charges were not proper. The third complaint is
   pending.

   We anticipate the MegaBells will also pursue legislation in states within our
   target market area to reduce state regulatory oversight over its rates and
   operations. If adopted, these initiatives could make it more difficult for us
   to challenge the MegaBells' actions in the future.

   We cannot assure you we will succeed in our challenges to these or other
   actions by the MegaBells that would prevent or deter us from successfully
   competing with the MegaBells. See "Business--Risk Factors--Our Dependence on
   Regional Bell Operating Companies to Provide Most of Our Communications
   Services Could Make it Harder for Us to Offer Our Services at a Profit" and
   "Business--Risk Factors-- Actions by U S WEST May Make it More Difficult for
   Us to Offer Our Communications Services."

                                       37
<PAGE>

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

   None.

                                    PART II

   Item 5.  Market for Registrant's Common Equity and Related Stockholder
   Matters.

   Price Range of Class A Common Stock

   Our Class A common stock is quoted on The Nasdaq Stock Market's National
   Market System under the symbol "MCLD". The following table sets forth for the
   periods indicated the high and low sales price per share of our Class A
   common stock as reported by The Nasdaq Stock Market.  Prices per share of
   McLeodUSA Class A common stock take into account the two-for-one stock split
   in the form of a stock dividend effective July 26, 1999 and the three-for-one
   stock split in the form of a stock dividend effective April 24, 2000.

<TABLE>
<CAPTION>
          1998                                                                     High          Low
          ----                                                                     ----          ---
       <S>                                                                       <C>           <C>
       First Quarter...........................................................  $ 7.729       $ 5.083
       Second Quarter..........................................................  $ 8.052       $ 6.333
       Third Quarter...........................................................  $ 6.688       $ 3.563
       Fourth Quarter..........................................................  $ 6.417       $ 2.542

         1999
         ----
       First Quarter...........................................................  $ 7.375       $ 5.063
       Second Quarter..........................................................  $10.319       $ 7.281
       Third Quarter...........................................................  $14.250       $ 7.542
       Fourth Quarter..........................................................  $21.125       $12.208

         2000
         ----
       First Quarter...........................................................  $35.938       $16.500
       Second Quarter..........................................................  $29.500       $13.688
       Third Quarter...........................................................  $25.125       $10.500
       Fourth Quarter..........................................................  $19.500       $11.500
</TABLE>

   On March 22, 2001, the last reported sale price of our Class A common stock
   on The Nasdaq Stock Market was $8.75 per share. On March 22, 2001, there were
   5,138 holders of record of our Class A common stock and no holders of record
   of our Class B common stock, $.01 par value per share.

   Dividend Policy

   We have never declared or paid any cash dividends on our Class A common stock
   and do not anticipate paying these dividends in the foreseeable future. The
   indentures that govern the terms of our Senior Notes and the Senior Secured
   Credit Facilities restrict our ability to pay cash dividends on our common
   stock. Future dividends, if any, will be at the discretion of our board of
   directors and will depend upon, among other things, our operations, capital
   requirements and surplus, general financial condition, contractual
   restrictions in financing agreements and such other factors as our board of
   directors may deem relevant. In addition, shares of our Series A preferred
   stock and Series B preferred stock carry rights to receive a cumulative
   dividend before any cash dividend may be paid on shares of our Class A common
   stock.  See "Management's Discussion and Analysis of Financial Condition and
   Results of Operations--Liquidity and Capital Resources."

                                       38
<PAGE>

   Recent Sales of Unregistered Securities

   During the fourth quarter of 2000, we did not offer or sell equity securities
   that were not registered under the Securities Act of 1933, as amended.

   Item 6.  Selected Financial Data.

   The following table sets forth selected consolidated financial data and
   should be read in conjunction with and is qualified by reference to
   "Management's Discussion and Analysis of Financial Condition and Results of
   Operations," our consolidated financial statements, the notes thereto and the
   other financial data contained elsewhere in this Form 10-K.

   The information in the following table reflects financial information for the
   following companies we have acquired:

                 Acquired Company                        Date Acquired
                 ----------------                        -------------

       MWR Telecom, Inc.                                April 28, 1995
       Ruffalo, Cody & Associates, Inc.                 July 15, 1996
       Telecom*USA Publishing Group, Inc.             September 20, 1996
       Consolidated Communications Inc.               September 24, 1997
       Ovation Communications, Inc.                     March 31, 1999
       Splitrock Services, Inc.                         March 30, 2000
       CapRock Communications Corp.                    December 7, 2000


   The operations statement data and other financial data in the table include
   the operations of these companies beginning on the dates they were acquired.
   The balance sheet data in the table include the financial position of these
   companies at the end of the periods presented, beginning with the period in
   which they were acquired.  These acquisitions affect the comparability of the
   financial data for the periods presented.

   The information in the table also reflects the following debt and equity
   securities that we have issued:


<TABLE>
<CAPTION>
                       Description of Securities                       Principal Amount                Date Issued
                       -------------------------                       ----------------                -----------
         <S>                                                           <C>                            <C>
         10 1/2% senior discount notes due March 1, 2007                 $500 million                 March 4, 1997
         9 1/4% senior notes due July 15, 2007                           $225 million                 July 21, 1997
         8 3/8% senior notes due March 15, 2008                          $300 million                March 10, 1998
         9 1/2% senior notes due November 1, 2008                        $300 million               October 30, 1998
         8 1/8% senior notes due February 15, 2009                       $500 million               February 22, 1999
         Series A preferred stock                                        $287 million                August 23, 1999
         Series B preferred stock                                        $687 million              September 15, 1999
         Series C preferred stock                                        $313 million              September 15, 1999
         Senior Secured Credit Facilities                                $575 million                 May 31, 2000
</TABLE>

   The following debt securities were issued in connection with our acquisition
   of CapRock in exchange for the cancellation of outstanding CapRock senior
   notes having the same principal amount and interest rate:

<TABLE>
<CAPTION>
               Description of Securities                             Principal Amount                  Date Issued
               -------------------------                             ----------------                  -----------
       <S>                                                             <C>                          <C>
       12% senior notes due July 15, 2008                                $150 million               December 14, 2000
       11 1/2% senior notes due May 1, 2009                              $210 million               December 14, 2000
</TABLE>

                                       39
<PAGE>

   The operations statement data and other financial data in the table include
   the effects of the issuances beginning on the dates the securities were
   issued. The balance sheet data in the table include the effects of these
   issuances at the end of the periods presented, beginning with the period in
   which they occurred.

   See "Note 16:  Subsequent Events" to Notes to Consolidated Financial
   Statements.

                                                 (table begins on the next page)

                                       40
<PAGE>

               Selected Consolidated Financial Data of McLeodUSA

                      (In thousands except per share data)

<TABLE>
<CAPTION>
                                                                        Year Ended December 31,
                                                     ------------------------------------------------------------
                                                       1996        1997         1998        1999          2000
                                                     --------    --------    ---------   ----------    ----------
<S>                                                  <C>         <C>         <C>         <C>           <C>
Operations Statement Data:
Revenue.........................................     $ 81,323    $267,886    $ 604,146   $  908,792    $1,396,704
                                                     --------    --------    ---------   ----------    ----------
Operating expenses:
 Cost of service................................       52,624     151,190      323,208      457,085       772,751
 Selling, general and
  administrative................................       46,044     148,158      260,931      392,687       563,189
 Depreciation and
  amortization..................................        8,485      33,275       89,107      190,695       409,623
 Other..........................................        2,380       4,632        5,575           --            --
                                                     --------    --------    ---------   ----------    ----------
 Total operating
  expenses......................................      109,533     337,255      678,821    1,040,467     1,745,563
                                                     --------    --------    ---------   ----------    ----------
Operating loss..................................      (28,210)    (69,369)     (74,675)    (131,675)     (348,859)
 Interest income (expense), Net.................        5,369     (11,967)     (52,234)     (94,244)     (103,580)
 Other income...................................          495       1,426        1,997        5,637          (425)
Income taxes....................................           --          --           --           --            --
                                                     --------    --------    ---------   ----------    ----------
Net loss before extraordinary charge............      (22,346)    (79,910)    (124,912)    (220,282)     (452,864)
Extraordinary charge for early
 extinguishment of debt.........................           --          --           --           --       (24,446)
                                                     --------    --------    ---------   ----------    ----------
Net loss........................................      (22,346)    (79,910)    (124,912)    (220,282)     (477,310)
Preferred stock dividends.......................           --          --           --      (17,727)      (54,406)
                                                     --------    --------    ---------   ----------    ----------
Loss applicable to common stock.................     $(22,346)   $(79,910)   $(124,912)  $ (238,009)   $ (531,716)
                                                     ========    ========    =========   ==========    ==========
Net loss per common share:
   Loss before extraordinary charge.............     $  (0.09)   $  (0.24)   $   (0.33)  $    (0.54)   $    (0.91)
   Extraordinary charge.........................           --          --           --           --         (0.04)
                                                     --------    --------    ---------   ----------    ----------
Loss per common share...........................     $  (0.09)   $  (0.24)   $   (0.33)  $    (0.54)   $    (0.95)
                                                     ========    ========    =========   ==========    ==========
Weighted average common
 Shares outstanding.............................      243,036     329,844      376,842      443,130       558,440
                                                     ========    ========    =========   ==========    ==========
</TABLE>

<TABLE>
<CAPTION>
                                                                          December 31,
                                                   ---------------------------------------------------------
                                                     1996        1997        1998        1999        2000
                                                   --------   ----------  ----------  ----------  ----------
<S>                                                <C>        <C>         <C>         <C>         <C>
Balance Sheet Data:
 Current assets................................    $224,401   $  517,869  $  793,192  $1,569,473  $  562,820
 Working capital (deficit).....................    $185,968   $  378,617  $  613,236  $1,272,794  $ (283,609)
 Property and equipment, net...................    $ 92,123   $  373,804  $  629,746  $1,270,032  $3,019,091
 Total assets..................................    $452,994   $1,345,652  $1,925,197  $4,203,147  $7,365,626
 Long-term debt................................    $  2,573   $  613,384  $1,245,170  $1,763,775  $2,732,190
 Redeemable convertible preferred
    stock......................................   $      --   $       --  $       --  $1,000,000  $1,000,000
 Stockholders' equity..........................    $403,429   $  559,379  $  462,806  $1,108,542  $2,756,144
</TABLE>

<TABLE>
<CAPTION>
                                                                         Year Ended December 31,
                                                   -------------------------------------------------------------
                                                     1996         1997         1998         1999         2000
                                                   --------     --------     --------     --------    ----------
                                                  (unaudited)  (unaudited)  (unaudited)  (unaudited)  (unaudited)
<S>                                               <C>          <C>          <C>          <C>          <C>
Other Financial Data:
Capital expenditures
Property, plant and equipment                      $ 79,845     $179,255     $289,923     $580,003    $1,239,350
Business acquisitions                              $ 93,937     $421,882     $ 49,737     $736,626    $2,350,004
EBITDA(1)                                          $(17,345)    $(31,462)    $ 20,007     $ 59,020    $   60,764
</TABLE>

------------------
(1)   EBITDA consists of operating loss before depreciation, amortization and
      other nonrecurring operating expenses.  We have included EBITDA data
      because it is a measure commonly used in the industry.  EBITDA is not a
      measure of financial performance under generally accepted accounting
      principles and should not be considered an alternative to net income as a
      measure of performance or to cash flows as a measure of liquidity.

                                       41
<PAGE>

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

     The following discussion and analysis should be read in together with our
     consolidated financial statements and the notes thereto and the other
     financial data appearing elsewhere in this Form 10-K.

     Overview

     We derive most of our revenue from our core business of providing
     communications services, including:

          .    local and long distance services
          .    dial and dedicated Internet access
          .    higher bandwidth Internet access services, such as digital
               subscriber line (DSL) and cable modem
          .    value-added services such as virtual private networks and web
               hosting
          .    bandwidth leasing and colocation services
          .    facilities and services dedicated for a particular customer's use
          .    telephone and computer sales, leasing, networking, service and
               installation
          .    other communications services, including video, cellular,
               operator, payphone, mobile radio and paging services

     We also derive revenue from the following services related to our core
     business:

          .    sale of advertising in print and electronic telephone directories
          .    traditional local telephone company services in east central
               Illinois and southeast South Dakota
          .    telemarketing services

     The table set forth below summarizes our percentage of revenues from these
     sources:

<TABLE>
<CAPTION>
                                                                                 Year Ended December 31,
                                                                     --------------------------------------------------
                                                                         2000               1999               1998
                                                                     -----------         ----------         -----------
     <S>                                                             <C>                  <C>                <C>
     Communications services....................................           74%                66%                   62%
     Telephone directory services...............................           18                 23                    24
     Local exchange services....................................            6                  9                    11
     Telemarketing services.....................................            2                  2                     3
                                                                         ----               ----                  ----
                                                                          100%               100%                  100%
                                                                         ====               ====                  ====
</TABLE>

     We provide integrated communications services, including local services, in
     25 Midwest, Southwest, Northwest and Rocky Mountain states. We also provide
     long distance and advanced data services in all 50 states. We are a
     facilities-based telecommunications provider with, as of December 31, 2000,
     396 ATM switches, 50 voice switches, approximately 1.1 million local lines
     and more than 10,700 employees. Our network is capable of transmitting
     integrated next-generation data, Internet, video and voice services,
     reaching 800 cities and approximately 90% of the U.S. population. In the
     next 12 months, we plan to distribute 33 million telephone directories in
     26 states, serving a population of 56 million. McLeodUSA is a Nasdaq-100
     company traded under the symbol "MCLD".

                                       42
<PAGE>

     Our principal operating expenses consist of cost of service; selling,
     general and administrative expenses ("SG&A"); and depreciation and
     amortization.  Cost of service primarily includes local services purchased
     from the MegaBells, costs to terminate the long distance calls of our
     customers through long distance carriers, and costs of printing and
     distributing telephone directories.  SG&A consists of sales and marketing,
     customer service and administrative expenses, including the costs
     associated with operating our communications network.  Depreciation and
     amortization include depreciation of our telecommunications network and
     equipment; amortization of goodwill and other intangibles related to our
     acquisitions; amortization expense related to the excess of estimated fair
     market value in aggregate of options over the aggregate exercise price of
     such options granted to some of our officers, other employees and
     directors; and amortization of one-time direct installation costs
     associated with transferring customers' local line service from the
     MegaBells to our local telecommunications service over the life of the
     customer contract.

     As we expand into new markets, both cost of service and SG&A will increase.
     We expect to incur cost of service and SG&A expenses before achieving
     significant revenues in new markets. Fixed costs related to leasing of
     central office facilities needed to provide telephone services must be
     incurred in most markets prior to generating revenue in new markets, while
     significant levels of marketing activity may be necessary in the new
     markets in order for us to build a customer base large enough to generate
     sufficient revenue to offset such fixed costs and marketing expenses.

     We have experienced operating losses since our inception as a result of
     efforts to build our customer base, develop and construct our
     communications network infrastructure, build our internal staffing, develop
     our systems and expand into new markets. We expect to continue to focus on
     increasing our customer base and geographic coverage and bringing our
     customer base onto our communications network. Accordingly, we expect that
     our cost of service, SG&A and capital expenditures will continue to
     increase significantly, all of which may have a negative impact on
     operating results.

     In addition, our projected increases in capital expenditures will continue
     to generate negative cash flows from construction activities during the
     next several years while we install and expand our fiber optic
     communications network. We may also be forced to change our pricing
     policies to respond to a changing competitive environment, and we cannot
     assure you that we will be able to maintain our operating margin. We cannot
     assure you that growth in our revenue or customer base will continue or
     that we will be able to achieve or sustain profitability or positive cash
     flows.

     We have generated net operating losses since our inception and,
     accordingly, have incurred no income tax expense. We have reduced the net
     deferred tax assets generated by these losses by a valuation allowance
     which offsets the net deferred tax asset due to the uncertainty of
     realizing the benefit of the tax loss carry forwards. We will reduce the
     valuation allowance when, based on the weight of available evidence, it is
     more likely than not that some portion or all of the deferred tax assets
     will be realized.

     For a description of other important factors relating to our business, see
     "Business - Risk Factors."

     Year Ended 2000 Compared with Year Ended 1999

     Total revenue increased from $908.8 million for the year ended December 31,
     1999 to $1,396.7 million for the year ended December 31, 2000, representing
     an increase of $487.9 million or 54%.  Revenue from the sale of
     communication services accounted for $433.2 million of this increase,
     including $102.3 million contributed by Splitrock, acquired on

                                       43
<PAGE>

     March 30, 2000, $8.2 million from the acquisition of CapRock on December 7,
     2000 and $88.0 million contributed by the inclusion of Dakota
     Telecommunications Group, Inc. ("DTG"), Ovation Communications, Inc., and
     Access Communications Holdings, Inc. for an entire year in 2000. The
     remaining increase of $234.7 million is attributed to the internal growth
     of competitive lines in service and customer base, which increased by
     approximately 314,000 lines or 54% and 86,700 customers or 43%,
     respectively. Local exchange services increased by $10.5 million over 1999,
     including $1.5 million contributed by DTG. Directory revenues increased
     $40.7 million from 1999 to 2000 due mainly to revenues from several
     individually insignificant directories acquired in 2000. Telemarketing
     revenues in 2000 increased $3.5 million when compared to 1999.

     Cost of service increased from $457.1 million for 1999 to $772.8 million
     for 2000, representing an increase of $315.7 million or 69%. The increase
     in the cost of service was due primarily to the growth in our communication
     services attributed to the increase in customers and lines in service.
     Cost of service includes local and long-distance services purchased from
     certain MegaBells and interexchange carriers, the cost of providing local
     exchange services to customers in ICTC's service area and the cost of
     operating our fiber optic communications networks.  The remaining increase
     is due to the acquisitions of Splitrock and CapRock, which contributed
     $103.0 million and $8.9 million, respectively, to the increase.  Cost of
     service as a percentage of revenues increased from 50% for 1999 to 55% for
     2000.  This increase is the result of the cost of service for Splitrock and
     CapRock, as a percentage of their revenues from the date of acquisition
     through year end, totaling 101%.  Our cost of sales after taking out
     Splitrock and CapRock remained fairly consistent with 1999 at 51%.

     SG&A increased from $392.7 million for the year ended December 31, 1999 to
     $563.2 million for the year ended December 31, 2000, an increase of $170.5
     million or 43%. The acquisitions of Ovation, DTG and Access in 1999 and
     Splitrock and CapRock in 2000 contributed $53.4 million to the increase.
     Our full-time equivalent employee base increased from approximately 8,100
     to 9,500 or 17% excluding Splitrock and CapRock.  As a percentage of total
     revenues, SG&A expenses decreased from 43% in 1999 to 40% in 2000.  Sales
     and marketing and customer support increased $85.6 million, including $4.2
     million contributed by Splitrock and CapRock, due to an increase in sales
     volume and customer base.  General and administrative expenses increased
     $84.9 million, including $19.3 million contributed by Splitrock and
     CapRock.  The increase in general and administrative expenses is attributed
     to the additional costs to support our growth.

     Depreciation and amortization expenses increased from $190.7 million for
     the year ended December 31, 1999 to $409.6 million for the year ended
     December 31, 2000, representing an increase of $218.9 million or 115%. This
     increase consisted of $121.9 million related to the acquisition of
     Splitrock, $12.2 million related to the acquisition of Ovation, DTG and
     Access in 1999 and $84.8 million due primarily to the growth of our
     communications network.

     Interest income increased from $42.6 million for the year ended December
     31, 1999, to $47.8 million in 2000. This increase resulted from a higher
     average investment balance during 2000.

     Gross interest incurred increased from $159.9 million for the year ended
     December 31, 1999 to $216.6 million in 2000.  This increase was primarily a
     result of an increase of $34.2 million related to the senior secured credit
     facility, $10.7 related to the debt assumed in the acquisitions of
     Splitrock and CapRock, $5.9 million for the inclusion of an additional
     month and a half of interest related to the 8 1/8% senior notes and a $4.2
     million increase in the accretion of interest on our 10 1/2% senior
     discount notes. Interest expense of approximately $65.2 million and $23.1
     million was capitalized as part of our construction of fiber optic
     communications network during 2000 and 1999, respectively.

                                       44
<PAGE>

     Net loss applicable to common shares increased from $238.0 million for the
     year ended December 31, 1999 to $531.7 million for the year ended December
     31, 2000, an increase of $293.7 million. This increase resulted primarily
     from the following five factors: (1) the expansion of our local and long
     distance services, which requires significant expenditures, a substantial
     portion of which is incurred before the realization of revenues; (2) the
     increased depreciation expense related to the construction and expansion of
     our communications networks and amortization of intangibles related to
     acquisitions; (3) net interest expense on indebtedness to fund market
     expansion, network development and acquisitions; (4) dividends on preferred
     stock issued and (5) an extraordinary charge on the extinguishment of debt.

     Year Ended 1999 Compared with Year Ended 1998

     Total revenue increased from $604.1 million for the year ended December 31,
     1998 to $908.8 million for the year ended December 31, 1999, representing
     an increase of $304.7 million or 50%.  The increase was due to the
     acquisitions completed in 1999 and 1998 as well as the increase in local
     and long distance customers.  Revenue from the sale of competitive
     telecommunications services accounted for $230.5 million of this increase,
     including $119.4 million contributed by Dakota Telecommunications Group,
     Inc., Ovation Communications, Inc., and Access Communications Holdings,
     Inc. which were acquired on March 5, 1999, March 31, 1999 and August 13,
     1999, respectively.  Local exchange services increased by $10.6 million
     over 1998, including $7.5 million contributed by DTG.  Directory revenues
     increased $64.3 million from 1998 to 1999 due mainly to revenues from new
     directories acquired in 1999.  Telemarketing revenues in 1999 decreased
     $0.7 million when compared to 1998.

     Cost of service increased from $323.2 million for 1998 to $457.1 million
     for 1999, representing an increase of $133.9 million or 41%.  This increase
     in cost of service was due primarily to the growth in our local and long
     distance communications services and to the acquisitions of DTG, Ovation
     and Access, which contributed an aggregate of $56.4 million to the
     increase.  Cost of service as a percentage of revenue decreased from 54%
     for 1998 to 50% for 1999, as a result of these acquisitions and as a result
     of reductions in the cost of providing local and long distance services as
     a percentage of local and long distance communications revenue, which
     decreased from 75% in 1998 to 65% in 1999.  This decrease was primarily due
     to the realization of benefits associated with new wholesale line cost rate
     agreements with the MegaBells and reduced long distance costs resulting
     from migration of over 84% of customer long distance traffic to our fiber
     optic communications network.

     SG&A increased from $260.9 million for the year ended December 31, 1998 to
     $392.7 million for the year ended December 31, 1999, an increase of $131.8
     million or 51%. The acquisitions of Talking Directories Inc. and Info
     America Phone Books, Inc. (collectively, "Talking Directories"), DTG,
     Ovation and Access contributed an aggregate of $82.6 million to the
     increase.  Also contributing to this increase were increased costs of $49.2
     million primarily related to expansion of selling, customer support and
     administration activities to support our growth.

     Depreciation and amortization expenses increased from $89.1 million for the
     year ended December 31, 1998 to $190.7 million for the year ended December
     31, 1999, representing an increase of $101.6 million or 114%. This increase
     consisted of $55.9 million related to the acquisitions of Talking
     Directories, DTG, Ovation and Access; and $45.7 million due primarily to
     the growth of our communications network.

     Other operating expenses in 1998 represented the amortization of
     capitalized costs associated with Consolidated Communications Directories
     in progress at the time we acquired CCI in 1997.  This amortization did not
     exist in 1999.

                                       45
<PAGE>

     Interest income increased from $26.0 million for the year ended December
     31, 1998, to $42.6 million in 1999. This increase resulted from a higher
     average investment balance during 1999 as a result of our 8 1/8%
     senior notes offering in February 1999 and from our preferred stock
     issuances in August and September 1999.

     Gross interest incurred increased from $88.9 million for the year ended
     December 31, 1998 to $159.9 million in 1999.  This increase was primarily a
     result of an increase in the accretion of interest on our 10 1/2% senior
     discount notes of $3.8 million and an increase of interest of $63.7 million
     as the result of the issuance of our 9 1/4% senior notes, 8 3/8%
     senior notes, 9 1/2% senior notes and 8 1/8% senior notes.  Interest
     expense of approximately $23.1 million and $8.1 million was capitalized as
     part of our construction of fiber optic communications network during 1999
     and 1998, respectively.  In addition, interest expense of approximately
     $2.6 million was capitalized as part of our operating facilities building
     construction and our software development in 1998, with no corresponding
     amount in 1999.

     Net loss applicable to common shares increased from $124.9 million for the
     year ended December 31, 1998 to $238.0 million for the year ended December
     31, 1999, an increase of $113.1 million. This increase resulted primarily
     from the following three factors: the expansion of our local and long
     distance services, which requires significant expenditures, a substantial
     portion of which is incurred before the realization of revenues; the
     increased depreciation expense related to the construction and expansion of
     our communications networks and amortization of intangibles related to
     acquisitions; and net interest expense on indebtedness to fund market
     expansion, network development and acquisitions.

     Liquidity and Capital Resources

     Our total assets increased from $4.2 billion at December 31, 1999 to $7.4
     billion at December 31, 2000, primarily due to the acquisitions of
     Splitrock and CapRock.  At December 31, 2000, our current liabilities of
     $846.4 million exceeded our current assets of $562.8 million, creating a
     working capital deficit of $283.6 million, which represents a decrease of
     $1,556.4 million from December 31, 1999, primarily the result of the use of
     the 1999 financings on the construction and expansion of our communications
     network.  At December 31, 1999, our current assets of $1,569.5 million
     exceeded our current liabilities of $296.7 million, providing working
     capital of $1,272.8 million.

     Net cash used in operating activities totaled $174.1 million for the year
     ended December 31, 2000 and $42.2 million for the year ended December 31,
     1999.  During the year ended December 31, 2000, cash for operating
     activities was used primarily to fund our net loss of $477.3 million for
     such period.  As a result of the expansion of our communications services,
     we also required cash to fund:

          .    growth in trade receivables of $63.4 million
          .    increases in deferred expenses of $9.1 million
          .    increase in other assets of $90.9 million
          .    decreases in accounts payable and accrued expenses of $83.0
               million

     These amounts were partially offset by:

          .    decrease in inventory of $3.3 million
          .    decreases in prepaid and other expenses of $63.2 million
          .    increases in deferred revenue of $11.0 million
          .    increases in customer deposits of $19.4 million
          .    cumulative non-cash expenses of $452.7 million

                                       46
<PAGE>

     During the year ended December 31, 1999, cash for operating activities was
     used primarily to fund our net loss of $220.3 million for such period.  We
     were also required in 1999 cash to fund the growth in accounts receivable,
     inventory, the increase in deferred expenses, and deferred line
     installation costs and the decrease in accounts payable and accrued
     expenses of $20.7 million, $12.7 million, $4.0 million, $27.2 million and
     $16.9 million, respectively, partially offset by a decrease in prepaid
     expenses and other of $10.2 million, increases in deferred revenues of
     $10.5 million, customer deposits of $9.3 million, and cumulative non-cash
     expenses of $229.6 million.

     Net cash used in investing activities totaled $394.6 million during the
     year ended December 31, 2000 and $1,550.9 million during the year ended
     December 31, 1999.  The expansion of our communications services,
     development and construction of our fiber optic communications networks,
     and other capital expenditures resulted in purchases of equipment, fiber
     optic cable and other property and equipment totaling $1,239.3 million and
     $599.7 million during the years ended December 31, 2000 and 1999,
     respectively.  We also used cash of $599.8 million to acquire available-
     for-sale securities during the year ended December 31, 2000, offset by
     proceeds from sales and maturation of available-for-sale securities of
     $1,469.0 million and $4.2 million dividends received from an equity
     investment.

     During the year ended December 31, 2000, we used an aggregate of $30.4
     million cash in addition to shares of our Class A common stock to acquire:

          .    the capital stock Splitrock Services, Inc. in March 2000
          .    the capital stock of CapRock Communications Corp. in December
               2000

     During the year ended December 31, 1999, we used an aggregate of $230.8
     million cash in addition to shares of our Class A common stock to acquire:

          .    the capital stock Talking Directories in February 1999
          .    the capital stock of Dakota Telecommunications Group, Inc. in
               March 1999
          .    the capital stock of Ovation Communications, Inc. in March 1999
          .    the capital stock of Access Communications in August 1999

     Net cash received from financing activities was $257.5 million during the
     year ended December 31, 2000.  Cash was primarily obtained from our senior
     secured credit facility in May 2000 of $565.6 million and the issuance of
     common stock totaling $64.5 million.  This was partially offset by our
     retirement of debt in July 2000 of $345.3 million and payment of preferred
     stock dividends of $26.3 million.  Net cash received from financing
     activities was $1,464.9 million during the year ended December 31, 1999,
     primarily as a result of our offering of 8 1/8% senior notes, our
     offering of Series B and Series C redeemable, convertible preferred stock,
     and our offering of Series A preferred stock.

     Recent Developments. On January 16, 2001, we completed a public offering of
     $750 million aggregate principal amount of our 11 3/8% Senior Notes
     due January 1, 2009 (the "January 2001 Senior Notes"), yielding net
     proceeds of approximately $734.3 million.  Interest on the January 2001
     Senior Notes will be payable in cash semi-annually in arrears on January 1
     and July 1 of each year, commencing July 1, 2001.

     2000 Financings. On May 31, 2000, we entered into $1.3 billion of Senior
     Secured Credit Facilities (together the "Credit Facilities") with a
     syndicate of financial institutions.  The credit facilities consist of (1)
     a seven year Senior Secured Revolving Facility with an aggregate principal
     amount of $450 million (the "Revolving Credit Facility"), (2) a seven year
     Senior Secured Multi-Draw Term Loan Facility with an aggregate principal
     amount of $275

                                       47
<PAGE>

     million ("Tranche A Term Facility"), and (3) an eight year single draw
     Senior Secured Term Loan with an aggregate principal amount of $575 million
     ("Tranche B Term Facility"). The Tranche A Term Facility provides for
     multiple ($50 million minimum) draws for the first 24 months of the
     agreement at which time any undrawn commitments expire. At December 31,
     2000, the Tranche B Term Facility was drawn in full and the balance of the
     Tranche A Term Facility and Revolving Credit Facility remained undrawn.

     The Credit Facilities are secured by (1) a first priority pledge of all the
     capital stock owned by us and by each subsidiary, and (2) a perfected first
     priority security interest in substantially all our tangible and intangible
     assets and, to the extent of $100 million, by the assets of each
     subsidiary.  In addition, telecommunications assets acquired with proceeds
     or refinanced from the Credit Facilities serve as collateral.

     Interest on the Credit Facilities is payable quarterly at LIBOR plus 1% to
     LIBOR plus 3.25% based on our debt rating.  At December 31, 2000, our
     interest rates were LIBOR plus 2.25% on the Revolving Facility and Tranche
     A Term Facility, and LIBOR plus 3.0% on the Tranche B Term Facility (9.21%
     at December 31, 2000).  A commitment fee of 0.5% to 1.0% per annum is
     charged on the undrawn portion of the commitment relating to the Revolving
     Facility and the Tranche A Term Facility.

     The Credit Facilities imposes operating and financial restrictions on us
     and our subsidiaries.  These restrictions affect, and in certain cases
     significantly limit or prohibit, among other things, our ability and the
     ability of our subsidiaries to incur additional indebtedness, pay dividends
     or make distributions in respect of capital stock, make other restricted
     payments, enter into sale and leaseback transactions, create liens upon
     assets, enter into transactions with affiliates or related persons, sell
     assets, or consolidate, merge or sell all or substantially all of their
     assets.  These covenants also require the maintenance of certain financial
     covenants and minimum access service lines. We cannot assure you that such
     covenants will not adversely affect our ability to finance our future
     operations or capital needs or to engage in other business activities that
     may be in our interests.

     On October 30, 2000, in conjunction with the acquisition of CapRock, we
     made an offer to exchange CapRock's $210 million 11 1/2% senior notes due
     May 1, 2009 and $150 million 12% senior notes due July 15, 2008 for our
     $210 million 11 1/2% senior notes due May 1, 2009 and $150 million 12%
     senior notes due July 15, 2008.  Interest on the 12% senior notes is
     payable in cash semi-annually in arrears on January 15 and July 15.
     Interest on the 11 1/2% senior notes is payable in cash semi-annually in
     arrears on May 1 and November 1.  The exchange offer was completed on
     December 14, 2000 at which time all of the CapRock senior notes were
     exchanged for McLeodUSA notes.

     1999 Financings.  On February 22, 1999, we completed an offering of $500
     million aggregate principal amount of our 8 1/8% senior notes in which
     we received net proceeds of approximately $485.8 million.  Interest on the
     8 1/8% senior notes is payable in cash semi-annually in arrears on
     February 15 and August 15.

     We issued one million shares of our Series A preferred stock, par value
     $.01 per shares ("Series A preferred stock"), on August 11, 1999 and an
     additional 150,000 shares on August 23, 1999.  Net proceeds from the
     financing amounted to approximately $277.3 million.  Holders of Series A
     preferred stock are entitled to receive cumulative dividends at an annual
     rate of 6.75% of the liquidation preference payable quarterly on each
     February 15, May 15, August 15 and November 15.  The quarterly dividend is
     $4.21875 per share, payable at our option in cash or shares of our Class A
     common stock.  Series A preferred stock is convertible at the option of its
     holder, unless previously redeemed, at any time, into shares of our Class A
     common stock at a conversion rate of 25.79979 shares of Class A common
     stock for each

                                       48
<PAGE>

     share of Series A preferred stock (representing a conversion price of $9.69
     per share of Class A common stock), subject to adjustment in certain
     events. In addition, if on or after August 15, 2002, the closing price of
     our Class A common stock has equaled or exceeded 135% of the conversion
     price for at least 20 out of 30 consecutive business days, we will have the
     option to convert all of the Series A preferred stock into Class A common
     stock at the then current conversion rate. The holders of the Series A
     preferred stock will not be entitled to any voting rights unless payments
     of dividends on the Series A preferred stock are in arrears and unpaid for
     an aggregate of six or more quarterly dividend payments.

     We issued on September 15, 1999 (the "Issue Date") 275,000 shares of Series
     B preferred stock, par value $.01 per share, ("Series B preferred stock")
     and 125,000 shares of Series C preferred stock, par value $.01 per share,
     ("Series C preferred stock" and together with the Series B preferred stock,
     the "Preferred Shares") through a private offering. Net proceeds from the
     financing amounted to approximately $1 billion.  The Preferred Shares are
     redeemable on a proportionally equal basis, in whole or in part, by us at
     any time following the seventh anniversary of the Issue Date; or by the
     holders within 180 days following the tenth anniversary of the Issue Date.
     The Preferred Shares are convertible on a proportionally equal basis, at
     the Series B holders option, in whole or in part at any time into Class A
     common stock.  Each share of Series B preferred stock is entitled to
     receive a quarterly dividend based on its liquidation preference.
     Dividends are cumulative and payable quarterly on March 31, June 30,
     September 30, and December 31.  If prior to the fifth anniversary of the
     Issue Date we pay a dividend on our Class A common stock, holders of the
     Preferred Shares shall be entitled to receive an equivalent dividend
     calculated on a common stock equivalent basis as if the Preferred Shares
     had been converted into Class A common stock.  Holders of Series B
     preferred stock are not entitled to voting rights other than the right to
     vote as a series for the election of two members to the Board of Directors.
     Board representation decreases as the outstanding shares of the Series B
     preferred stock decreases.  Holders of Series C preferred stock are not
     entitled to voting rights other than the right to vote as a series for the
     election of one observer to the Board of Directors.  Board representation
     decreases as the outstanding shares of the Series C preferred stock
     decreases.  The Series B and Series C preferred stock rank on a parity with
     the Series A preferred stock with respect to dividend rights and rights on
     liquidation.

     Senior Notes. Our 12% senior notes, 11 1/2% senior notes, 11 3/8% senior
     notes, 10 1/2% senior discount notes, 9 1/2% senior notes, 9 1/4% senior
     notes, 8 3/8% senior notes, and 8 1/8% senior notes (collectively, the
     "Senior Notes") are senior unsecured obligations of McLeodUSA ranking pari
     passu in right of payment with all other existing and future senior
     unsecured obligations of McLeodUSA and senior to all existing and future
     subordinated debt of McLeodUSA. The Senior Notes are effectively
     subordinated to all existing and future secured indebtedness of McLeodUSA
     and our subsidiaries to the extent of the value of the assets securing such
     indebtedness. The Senior Notes also are effectively subordinated to all
     existing and future third-party indebtedness and other liabilities of our
     subsidiaries.

     The indentures governing our Senior Notes impose operating and financial
     restrictions on our subsidiaries and us.  These restrictions affect, and in
     many cases significantly limit or prohibit, among other things, our and our
     subsidiaries' ability to:

          .    incur additional indebtedness
          .    pay dividends or make distributions in respect of our or our
               subsidiaries' capital stock
          .    redeem capital stock
          .    make other restricted payments
          .    enter into sale and leaseback transactions

                                       49
<PAGE>

          .    create liens upon assets
          .    enter into transactions with affiliates or related persons
          .    sell assets
          .    consolidate, merge or sell all or substantially all of our assets

     We cannot assure you that such covenants will not adversely affect our
     ability to finance our future operations or capital needs or to engage in
     other business activities that may be in our interests.

     Other.  We need significant capital to continue to expand our operations,
     facilities, network and services.  We cannot assure you that our capital
     resources will permit us to fund our planned network deployment and
     operations or achieve operating profitability.  Failure to generate or
     raise sufficient funds may require us to delay or abandon some of our
     expansion plans or expenditures, which could have a material adverse effect
     on our business, results of operations or financial condition.

     As of December 31, 2000, based on our business plan, capital requirements
     and growth projections as of that date, we estimate that we will require
     approximately $1.5 billion through 2002.  Our estimated aggregate capital
     requirements include the projected costs of:

          .    expanding our fiber optic communications network, including
               national and intra-city fiber optic networks
          .    adding voice, data and ATM switches
          .    expanding operations in existing and new markets
          .    funding general corporate expenses
          .    integrating acquisitions
          .    constructing, acquiring, developing or improving
               telecommunications assets

     The estimated costs and incremental capital needs associated with the
     acquisitions of Splitrock and CapRock are included in our estimated
     aggregate capital requirements.

     We expect to use the following, among other things, to address our capital
     needs:

          .    $450 million available under the Revolving Credit Facility
          .    $275 million available under the Tranche A Term Facility
          .    $750 million from the issuance of 11 3/8% senior notes on
               January 16, 2001
          .    additional issuances of debt or equity securities
          .    projected operating cash flow

     Our estimate of future capital requirements is a forward-looking statement
     within the meaning of the safe harbor provisions of the Private Securities
     Litigation Reform Act of 1995.  The actual amount and timing of our future
     capital requirements may differ substantially from our estimate due to
     factors such as:

          .    strategic acquisition costs and effects of acquisitions on our
               business plan,
          .    capital requirements and growth projections
          .    unforeseen delays
          .    cost overruns
          .    engineering design changes
          .    changes in demand for our services
          .    regulatory, technological or competitive developments
          .    new opportunities

                                       50
<PAGE>

     We expect to evaluate potential acquisitions, joint ventures and strategic
     alliances on an ongoing basis.  We may require additional financing if we
     pursue any of these opportunities.  Accordingly, we may need additional
     capital to continue to expand our markets, operations, facilities, network
     and services.

     We may meet any additional capital needs by issuing additional debt or
     equity securities or borrowing funds from one or more lenders.  We cannot
     assure you that we will have timely access to additional financing sources
     on acceptable terms.

     Failure to generate or raise sufficient funds may require us to delay or
     abandon some of our expansion plans or expenditures, which could have a
     material adverse effect on our business, results of operations or financial
     condition.  See "Business--Risk Factors--Failure to Raise Necessary Capital
     Could Restrict Our Ability to Develop Our Network and Services and Engage
     in Strategic Acquisitions."

     Market Risk

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

     Effects of New Accounting Standards

     Accounting for Derivative Instruments and Hedging Activities

     Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting
     for Derivative Instruments and Hedging Activities", as amended, is
     effective for fiscal years beginning after June 15, 2000.  SFAS No. 133
     establishes accounting and reporting standards for derivative instruments
     and hedging activities by requiring that entities recognize all derivatives
     as either assets or liabilities at fair market value on the balance sheet.
     The Company does not currently hold any derivative instruments or engage in
     hedging activities.  As such, the adoption of SFAS 133 as of January 1,
     2001, had no effect on the Company's operations.

     Revenue Recognition

     Effective January 1, 2000, pursuant to Securities and Exchange Commission
     Staff Accounting Bulletin No. 101 ("SAB No. 101"), we changed our
     accounting for certain activation and reactivation fees charged to our
     customers and for certain inducements paid to acquire new customers.  We
     now defer these fees and inducements and record the related revenue and
     reduction of revenue over the average customer contract periods rather than
     recording the revenues and charges when received or paid.  This change in
     accounting policy did not have a material effect on results of operations
     or financial position.

     Business Combinations and Intangible Assets--Accounting for Goodwill

     On February 14, 2001, the FASB issued an Exposure Draft "Business
     Combinations and Intangible Assets - Accounting for Goodwill." The Exposure
     Draft requires the use of a non-amortization approach to account for
     purchased goodwill and for separately recognized (non-goodwill) intangible
     assets that have an indefinite economic useful life. Under this approach,
     goodwill and intangibles would not be amortized, but would be written down
     and expensed against earnings only in periods in which the recorded value
     exceeds the fair value. We have not yet quantified the impacts of adopting
     the new Exposure Draft, but it could result in significant changes to
     amortization expense and the classification and recording of intangibles
     currently on the books, as well as any future acquisitions.

                                       51
<PAGE>

     Inflation

     We do not believe that inflation has had a significant impact on our
     consolidated operations.

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

     At December 31, 2000, we recorded our marketable equity securities at a
     fair value of $44.3 million.  These securities have exposure to price risk.
     A hypothetical ten percent adverse change in quoted market prices would
     amount to a decrease in the recorded value of investments of approximately
     $4.4 million.  We believe our exposure to market price fluctuations on all
     other investments is nominal due to the short-term nature of our investment
     portfolio.

     Substantially all of our long-term debt obligations are fixed rate
     obligations which do not expose us to material future earnings or cash flow
     exposure from changes in interest rates. We have $575 million of variable
     rate debt outstanding at December 31, 2000 under the Tranche B Term
     Facility.  If market interest rates average 1% more in 2001 than the rates
     during 2000, interest expense for 2001 would increase by $5.8 million.
     This amount was determined by calculating the effect of the hypothetical
     interest rate increase on our variable rate debt as if it were outstanding
     for an entire year and does not assume changes in our financial structure.

     Item 8.   Financial Statements and Supplementary Data.

     Our consolidated financial statements, including our consolidated balance
     sheets as of December 31, 2000 and 1999, consolidated statements of
     operations and comprehensive income for the years ended December 31, 2000,
     1999 and 1998, consolidated statements of stockholders' equity for the
     years ended December 31, 2000, 1999 and 1998, consolidated statements of
     cash flows for the years ended December 31, 2000, 1999 and 1998, and notes
     to our consolidated financial statements, together with a report thereon of
     Arthur Andersen LLP, dated January 29, 2001, are attached hereto as pages
     F-1 through F-30.

     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.

     Reference is made to the information set forth under the captions "Election
     of Directors - Information as to Nominees and Other Directors" and
     "Executive Compensation and Other Information - Section 16(a) Beneficial
     Ownership Reporting Compliance" appearing in our definitive Proxy Statement
     for the Annual Meeting of Stockholders to be held on May 30, 2001 (the
     "Proxy Statement"), to be filed within 120 days after the end of our fiscal
     year, which information is incorporated herein by reference.  Information
     required by this item with respect to executive officers is provided in
     Item 1 of this Form 10-K.  See "Business-Executive Officers."

     Item 11.  Executive Compensation.

     Reference is made to the information set forth under the captions "Election
     of Directors-Directors' Compensation" and "Executive Compensation and Other
     Information" appearing

                                       52
<PAGE>

     in the Proxy Statement to be filed within 120 days after the end of our
     fiscal year, which information is incorporated herein by reference.

     Item 12.  Security Ownership of Certain Beneficial Owners and Management.

     Reference is made to the information set forth under the caption "Stock
     Owned by Management" and "Principal Holders of Voting Securities" appearing
     in the Proxy Statement to be filed within 120 days after the end of our
     fiscal year, which information is incorporated herein by reference.

     Item 13.  Certain Relationships and Related Transactions.

     Reference is made to the information set forth under the caption "Executive
     Compensation and Other Information-Certain Transactions" appearing in the
     Proxy Statement to be filed within 120 days after the end of our fiscal
     year, which information is incorporated herein by reference.

                                    PART IV

     Item 14.  Exhibits, Financial Statement Schedules, and Reports on Form 8-K.

     (a)(1)    The following consolidated financial statements of McLeodUSA and
               report of independent public accountants are included in Item 8
               of this Form 10-K.

               Report of independent public accountants.

               Consolidated balance sheets as of December 31, 2000 and 1999.

               Consolidated statements of operations and comprehensive income
               for the years ended December 31, 2000, 1999 and 1998.

               Consolidated statements of stockholders' equity for the years
               ended December 31, 2000, 1999 and 1998.

               Consolidated statements of cash flows for the years ended
               December 31, 2000, 1999 and 1998.

               Notes to consolidated financial statements.

     (a)(2)    The following financial statement schedule is filed as part of
               this report and is attached hereto as pages S-1 and S-2.

     Report of Independent Public Accountants on the Financial Statement
     Schedule

     Schedule II -- Valuation and Qualifying Accounts.

     All other schedules for which provision is made in the applicable
     accounting regulations of the SEC either have been included in our
     consolidated financial statements or the notes thereto, are not required
     under the related instructions or are inapplicable, and therefore have been
     omitted.

     (a)(3) The following exhibits are either provided with this Form 10-K or
     are incorporated herein by reference:

                                       53
<PAGE>

<TABLE>
<CAPTION>
        Exhibit
        Number                                           Exhibit Description
        -------                                          -------------------
        <S>        <C>
          2.1      Agreement and Plan of Merger, dated as of January 7, 1999 among McLeodUSA Incorporated, Bravo
                   Acquisition Corporation, Ovation Communications, Inc. and certain stockholders of Ovation
                   Communications, Inc. (Filed as Exhibit 2.1 to current Report on Form 8-K, File No. 0-20763 (the
                   "January 1999 Form 8-K"), filed with the Commission on January 14, 1999 and incorporated herein
                   by reference).

          2.2      Amended and Restated Agreement and Plan of Merger, dated as of January 7, 1999, among McLeodUSA
                   Incorporated, McLeodUSA Publishing Company, Pubco Merging Co., Talking Directories, Inc. and
                   the stockholders of Talking Directories, Inc.  (Filed as Exhibit 4.8 to the Registration
                   Statement on Form S-3, file number 333-78561, and incorporated herein by reference).

          2.3      Amended and Restated Agreement and Plan of Merger, dated as of January 7, 1999 among McLeodUSA
                   Incorporated, McLeodUSA Publishing Company, Publication Merge Co., Info America Phone Books,
                   Inc. and certain stockholders of Info America Phone Books, Inc.   (Filed as Exhibit 4.9 to the
                   Registration Statement on Form S-3, file number 333-78561, and incorporated herein by
                   reference).

          2.4      Amended and Restated Agreement and Plan of Merger by and among McLeodUSA, Southside Acquisition
                   Corporation, Splitrock Services, Inc., Splitrock Holdings, Inc., and Splitrock Merger Sub dated
                   as of February 11, 2000.  (Filed as Exhibit 2.1 to Registration Statement on Form S-4, file
                   number 333-95941 (the "February 2000 Form S-4"), and incorporated herein by reference).

          2.5      Agreement and Plan of Merger by and among McLeodUSA Incorporated, Cactus Acquisition Corp. and
                   CapRock Communications Corp., dated as of October 2, 2000 (filed as Exhibit 2.1 to the Current
                   Report on Form 8-K of the CapRock Communications Corp., file No. 0-24581, filed with the SEC on
                   October 10, 2000 and incorporated herein by this reference).

          3.1      Amended and Restated Certificate of Incorporation of McLeod, Inc. (Filed as Exhibit 3.1 to
                   Registration Statement on Form S-1, File No. 333-3112 ("Initial Form S-1") and incorporated
                   herein by reference).

          3.2      Amended and Restated Bylaws of McLeod, Inc. (Filed as Exhibit 3.2 to Registration Statement on
                   Form S-1, File No. 333-13885 (the "November 1996 Form S-1"), and incorporated herein by
                   reference).

          3.3      Certificate of Amendment of Amended and Restated Certificate of Incorporation of McLeod Inc.
                   (Filed as Exhibit 3.3 to Registration Statement on Form S-4, File No. 333-27647 (the "July 1997
                   Form S-4") and incorporated herein by reference).

          3.4      Certificate of Amendment to the Amended and Restated Certificate of Incorporation of McLeodUSA
                   (filed as Exhibit 3.8 to the Quarterly Report on Form 10-Q, File No. 0-20763, filed with the
                   SEC on May 15, 2000 (the "May 2000 Form 10-Q", and incorporated herein by reference).
</TABLE>

                                       54
<PAGE>

<TABLE>
<CAPTION>
        Exhibit
        Number                                           Exhibit Description
        -------                                          -------------------
        <C>        <S>
          3.5      Certificate of Amendment to the Amended and Restated Certificate of Incorporation of McLeodUSA
                   (filed as Exhibit 3.9 to the Quarterly Report on Form 10-Q, File No. 0-20763, filed with the
                   SEC on August 14, 2000 (the "August 2000 Form 10-Q"), and incorporated herein by reference).

          3.6      Certificate of Change of Registered Agent and Registered Office of McLeodUSA Incorporated.
                   (Filed as Exhibit 3.4 to Annual Report on Form 10-K, File No. 0-20763, filed with the
                   Commission on March 6, 1998 (the "1997 Form 10-K") and incorporated herein by reference).

          3.7      Certificate of Designations of the 6.75% Series A preferred stock.  (Filed as Exhibit 3.1 to
                   Current Report on Form 8-K, file number 0-20763, filed with the Commission on August 9, 1999
                   and incorporated herein by reference).

          3.8      Certificate of Designations of the Series B preferred stock.  (Filed as Exhibit 3.6 to February
                   2000 Form S-4 and incorporated herein by reference).

          3.9      Certificate of Designations of the Series C preferred stock. (Filed as Exhibit 3.7 to February
                   2000 Form S-4 and incorporated herein by reference).


          4.1      Form of Class A Common Stock Certificate of McLeod, Inc. (Filed as Exhibit 4.1 to Initial Form
                   S-1 and incorporated herein by reference).

          4.2      Indenture dated March 4, 1997 between McLeod, Inc. and United States Trust Company of New York,
                   as Trustee, relating to the 10 1/2% Senior Discount Notes Due 2007 of McLeod, Inc. (Filed
                   as Exhibit 4.2 to Annual Report on Form 10-K, File No. 0-20763, filed with the Commission on
                   March 31, 1997 (the "1996 Form 10-K") and incorporated herein by reference).

          4.3      Initial Global 10 1/2% Senior Discount Note Due March 1, 2007 of McLeod, Inc., dated March
                   4, 1997. (Filed as Exhibit 4.3 to the 1996 Form 10-K and incorporated herein by reference).

          4.4      Form of Certificated 10 1/2% Senior Discount Note Due March 1, 2007 of McLeod, Inc. (Filed
                   as Exhibit 4.4 to the 1996 Form 10-K and incorporated herein by reference).

          4.5      Investor Agreement dated as of April 1, 1996 among McLeod, Inc., IES Investments Inc., Midwest
                   Capital Group Inc., MWR Investments Inc., Clark and Mary McLeod, and certain other
                   stockholders. (Filed as Exhibit 4.8 to Initial Form S-1 and incorporated herein by reference).

          4.6      Amendment No. 1 to Investor Agreement dated as of October 23, 1996 by and among McLeod, Inc.,
                   IES Investments Inc., Midwest Capital Group Inc., MWR Investments Inc., Clark E. McLeod and
                   Mary E. McLeod. (Filed as Exhibit 4.3 to the November 1996 Form S-1 and incorporated herein by
                   reference).

          4.7      Form of 10 1/2% Senior Discount Exchange Note Due 2007 of McLeodUSA Incorporated. (Filed
                   as Exhibit 4.8 to the July 1997 Form S-4 and incorporated herein by reference).
</TABLE>

                                       55
<PAGE>

<TABLE>
<CAPTION>
        Exhibit
        Number                                           Exhibit Description
        -------                                          -------------------
        <C>        <S>
          4.8      Indenture dated as of July 21, 1997 between McLeodUSA Incorporated and United States Trust
                   Company of New York, as Trustee, relating to the 9 1/4% Senior Notes Due 2007 of McLeodUSA
                   Incorporated. (Filed as Exhibit 4.9 to the July 1997 Form S-4 and incorporated herein by
                   reference).

          4.9      Form of Initial Global 9 1/4% Senior Note Due 2007 of McLeodUSA Incorporated. (Filed as
                   Exhibit 4.10 to the July 1997 Form S-4 and incorporated herein by reference).

         4.10      Form of 9 1/4% Senior Exchange Note Due 2007 of McLeodUSA Incorporated. (Filed as Exhibit
                   4.14 to the 1997 Form 10-K and incorporated herein by reference).

         4.11      Indenture dated as of March 16, 1998 between McLeodUSA Incorporated and United States Trust
                   Company of New York, as Trustee, relating to the 8 3/8% Senior Notes Due 2008 of McLeodUSA
                   Incorporated (Filed as Exhibit 4.15 to Registration Statement on Form S-4, File No. 333-52793
                   (the "May 1998 Form S-4") and incorporated herein by reference).

         4.12      Form of Global 8 3/8% Senior Note Due 2008 of McLeodUSA Incorporated (contained in the
                   Indenture filed as Exhibit 4.11).

         4.13      Stockholders' Agreement dated November 18, 1998 by and among McLeodUSA Incorporated; IES
                   Investments Inc.; Clark E. McLeod; Mary E. McLeod; and Richard A. Lumpkin and each of the
                   former shareholders of Consolidated Communications Inc. ("CCI") and certain permitted
                   transferees of the former CCI shareholders. (Filed as Exhibit 99.1 to the Current Report on
                   Form 8-K, File No. 0-20763, filed with the Commission on November 19, 1998 and incorporated
                   herein by reference).

         4.14      Indenture dated as of October 30, 1998 between McLeodUSA Incorporated and United States Trust
                   Company of New York, as Trustee, relating to the 9 1/2% Senior Notes Due 2008 of McLeodUSA
                   Incorporated (Filed as Exhibit 4.19 to Registration Statement on Form S-4, File No. 333-69621
                   (the "December 23, 1998 Form S-4") and incorporated herein by reference).

         4.15      Form of Global 9 1/2% Senior Note Due 2008 of McLeodUSA Incorporated (contained in the
                   Indenture filed as Exhibit 4.14).

         4.16      Stockholders' Agreement dated January 7, 1999 by and among McLeodUSA Incorporated, IES
                   Investments Inc., Clark E. McLeod, Mary E. McLeod, Richard A. Lumpkin, Gail Lumpkin, M/C
                   Investors L.L.C. and Media/Communications Partners III Limited Partnership.  (Filed as Exhibit
                   4.1 to the January 1999 Form 8-K and incorporated herein by reference).

         4.17      Indenture dated as of February 22, 1999 between McLeodUSA Incorporated and United States Trust
                   Company of New York, as Trustee, relating to the 8 1/8% Senior Notes Due 2009 of McLeodUSA
                   Incorporated.  (Filed as Exhibit 4.22 to the 1998 Form 10-K and incorporated herein by
                   reference).
</TABLE>

                                       56
<PAGE>

<TABLE>
<CAPTION>
        Exhibit
        Number                                           Exhibit Description
       --------                                          -------------------
       <C>         <S>
         4.18      Form of Global 8 1/8% Senior Note Due 2009 of McLeodUSA Incorporated (contained in the
                   Indenture filed as Exhibit 4.19).   (Filed as Exhibit 4.22 to the 1998 Form 10-K and
                   incorporated herein by reference).

         4.19      Form of 6.75% Series A preferred stock certificate.  (Filed as Exhibit 4.1 to Current Report on
                   Form 8-K, filed number 0-20763, filed with the Commission on August 9, 1999 and incorporated
                   herein by reference).

         4.20      Form of Series B preferred stock certificate.  (Filed as Exhibit 22 to the February 2000 Form
                   S-4 and incorporated herein by reference).

         4.21      Form of Series C preferred stock certificate.  (Filed as Exhibit 23 to the February 2000 Form
                   S-4 and incorporated herein by reference).

         4.22      Second Amended and Restated November 1998 Stockholders' Agreement dated December 17, 1999 by
                   and among certain Alliant Entities, Clark and Mary McLeod, Richard Lumpkin and certain CCI
                   Shareholders (filed as Exhibit 4.24 to Annual Report on Form 10-K, File No. 0-20763, filed with
                   the SEC on March 30, 2000 (the "1999 Form 10-K") and incorporated herein by reference).

         4.23      Second Amended and Restated January 1999 Stockholders' Agreement dated December 17, 1999 by and
                   among certain Alliant Entities, Clark and Mary McLeod, Richard Lumpkin, certain CCI
                   Shareholders and the M/C Stockholders (filed as Exhibit 4.25 to the 1999 Form 10-K and
                   incorporated herein by reference).

         4.24      Stockholders' Agreement dated as of March 30, 2000 by and among, McLeodUSA, Kwok Li and Linsang
                   Partners, LLC (filed as Exhibit 4.26 to the May 2000 Form 10-Q and incorporated herein by
                   reference).

         4.25      Third Amended and Restated November 1998 Stockholders' Agreement dated as of March 10, 2000 by
                   and among by and among certain Alliant Entities, Clark and Mary McLeod, Richard Lumpkin and
                   certain CCI Shareholders (filed as Exhibit 4.27 to the May 2000 Form 10-Q and incorporated
                   herein by reference).

         4.26      Third Amended and Restated January 1999 Stockholders' Agreement dated as of March 10, 2000 by
                   and among certain Alliant Entities, Clark and Mary McLeod, Richard Lumpkin, certain CCI
                   Shareholders and the M/C Stockholders (filed as Exhibit 4.28 to the May 2000 Form 10-Q and
                   incorporated herein by reference).

         4.27      Amendment No. 1 to Third Amended and Restated November 1998 Stockholders' Agreement, dated as
                   of July 7, 2000 (filed as Exhibit 4.29 to the Registration Statement on Form S-4, File No.
                   333-48248, filed with the SEC on October 19, 2000 (the "October 2000 Form S-4") and
                   incorporated herein by reference).

         4.28      Amendment No. 1 to Third Amended and Restated January 1999 Stockholders' Agreement, dated as of
                   July 7, 2000 (filed as Exhibit 4.30 to the October 2000 Form S-4 and incorporated herein by
                   reference).
</TABLE>

                                       57
<PAGE>

<TABLE>
<CAPTION>
        Exhibit
        Number                                           Exhibit Description
       --------                                          -------------------
       <C>         <S>
         4.29      Amended and Restated Stockholders' Agreement dated as of August 10, 2000, by and among
                   McLeodUSA Incorporated, Kwok Li and Linsang Partners, LLC (filed as Exhibit 4.31 to the October
                   2000 Form S-4 and incorporated herein by reference).

         4.30      Warrant Agreement dated as of July 29, 1998 by and between Harris Trust Company of New York
                   (formerly Bank of Montreal Trust Company) and Splitrock Services, Inc. (filed as Exhibit 10.12
                   to the Registration Statement on Form S-4 of Splitrock Services, Inc., File No. 333-61293,
                   filed with the SEC on August 12, 1998 and incorporated herein by reference).

         4.31      Form of Splitrock Warrant Certificate (filed as Exhibit 4.7 to Post-Effective Amendment No. 1
                   to the Registration Statement on Form S-1 of Splitrock Services, Inc., File No. 333-63001,
                   filed with the SEC on July 16, 1999 and incorporated herein by reference).

         4.32      First Supplemental Warrant Agreement by and between Splitrock Services, Inc. and Harris Trust
                   Company of New York, dated as of February 24, 2000 (filed as Exhibit 4.11 to Post-Effective
                   Amendment No. 1 on Form S-3 to the Registration Statement on Form S-1 of Splitrock Services,
                   Inc., File No. 333-63001, filed with the SEC on March 13, 2000 and incorporated herein by
                   reference).

         4.33      Second Supplemental Warrant Agreement by and between Splitrock Services, Inc., Splitrock
                   Holdings, Inc. and Harris Trust Company of New York, dated as of March 30, 2000 (filed as
                   Exhibit 4.37 to the May 2000 Form 10-Q and incorporated herein by reference).

         4.34      Third Supplemental Warrant Agreement by and between Splitrock Services, Inc., Splitrock
                   Holdings, Inc., McLeodUSA and Harris Trust Company of New York, dated as of March 30, 2000
                   (filed as Exhibit 4.38 to the May 2000 Form 10-Q and incorporated herein by reference).

         4.35      Credit Agreement dated as of May 31, 2000 (the "Senior Credit Agreement") among McLeodUSA,
                   various Lenders and The Chase Manhattan Bank, as Agent (filed as Exhibit 4.39 to the August
                   2000 Form 10-Q and incorporated herein by reference).

         4.36      Form of Promissory Note under the Credit Agreement dated as of May 31, 2000 among McLeodUSA,
                   various Lenders and The Chase Manhattan Bank, as Agent (filed as Exhibit 4.40 to the August
                   2000 Form 10-Q and incorporated herein by reference).

         4.37      First Amendment dated as of December 7, 2000 to the Senior Credit Agreement

         4.38      Second Amendment dated as of January 11, 2001 to the Senior Credit Agreement

         4.39      Form of Indenture between McLeodUSA and United States Trust Company of New York, as Trustee,
                   relating to the 12% Senior Notes Due 2008 of McLeodUSA (filed as Exhibit 4.43 to the October
                   2000 Form S-4 and incorporated herein by reference).
</TABLE>

                                       58
<PAGE>

<TABLE>
<CAPTION>
        Exhibit
        Number                                           Exhibit Description
       --------                                          -------------------
       <C>         <S>
         4.40      Form of Indenture between McLeodUSA and United States Trust Company of New York, as Trustee,
                   relating to the 11 1/2% Senior Notes Due 2009 of McLeodUSA (filed as Exhibit 4.44 to the
                   October 2000 Form S-4 and incorporated herein by reference).

         4.41      Senior Debt Securities Indenture, dated January 15, 2001, between McLeodUSA and United States
                   Trust Company of New York, as trustee (filed as Exhibit 4.1 to the Current Report on Form 8-K,
                   File No. 0-20763, filed with the SEC on January 18, 2001 and incorporated herein by reference).

         4.42      First Supplemental Indenture, dated January 15, 2001, between McLeodUSA and United States Trust
                   Company of New York as trustee (filed as Exhibit 4.2 to the Current Report on Form 8-K, File
                   No. 0-20763, filed with the SEC on January 18, 2001 and incorporated herein by reference).

         4.43      Form of global 11-3/8% senior note due 2009 (filed as Exhibit 3.1 to the Current Report on Form
                   8-K, File No. 0-20763, filed with the SEC on January 18, 2001 and incorporated herein by
                   reference).

         10.1      U S WEST Centrex Plus Service Rate Stability Plan dated October 15, 1993 between McLeod
                   Telemanagement, Inc. and U S WEST Communications, Inc. (Filed as Exhibit 10.26 to Initial Form
                   S-1 and incorporated herein by reference).

         10.2      U S WEST Centrex Plus Service Rate Stability Plan dated July 17, 1993 between McLeod
                   Telemanagement, Inc. and U S WEST Communications, Inc. (Filed as Exhibit 10.27 to Initial Form
                   S-1 and incorporated herein by reference).

         10.3      Ameritech Centrex Service Confirmation of Service Orders dated various dates in 1994, 1995 and
                   1996 between McLeod Telemanagement, Inc. and Ameritech Information Industry Services. (Filed as
                   Exhibit 10.28 to Initial Form S-1 and incorporated herein by reference).

         10.4      Lease Agreement dated as of December 28, 1993 between 2060 Partnership and McLeod
                   Telemanagement, Inc., as amended by Amendments First to Ninth dated as of July 3, 1994, March
                   25, 1994, June 22, 1994, August 12, 1994, September 12, 1994, September 20, 1994, November 16,
                   1994, September 20, 1995 and January 6, 1996, respectively. (Filed as Exhibit 10.29 to Initial
                   Form S- 1 and incorporated herein by reference).

         10.5      Lease Agreement dated as of May 24, 1995 between 2060 Partnership and McLeod Telemanagement,
                   Inc. (Filed as Exhibit 10.30 to Initial Form S-1 and incorporated herein by reference).

         10.6      Lease Agreement dated October 31, 1995 between I.R.F.B. Joint Venture and McLeod
                   Telemanagement, Inc. (Filed as Exhibit 10.31 to Initial Form S-1 and incorporated herein by
                   reference).
</TABLE>

                                       59
<PAGE>

<TABLE>
<CAPTION>
        Exhibit
        Number                                           Exhibit Description
       --------                                          -------------------
       <C>         <S>
         10.7      First Amendment to Lease Agreement dated as of November 20, 1995 between I.R.F.B. Joint Venture
                   and McLeod Telemanagement, Inc. (Filed as Exhibit 10.32 to Initial Form S-1 and incorporated
                   herein by reference).

         10.8      Master Right-of-Way Agreement dated July 27, 1994 between McLeod Network Services, Inc. and IES
                   Industries Inc. (Filed as Exhibit 10.34 to Initial Form S-1 and incorporated herein by
                   reference).

         10.9      Master Right-of-Way and Tower Use Agreement dated February 13, 1996 between IES Industries Inc.
                   and McLeod, Inc. (Filed as Exhibit 10.35 to Initial Form S-1 and incorporated herein by
                   reference).

        10.10      Settlement Agreement dated March 18, 1996 between U S WEST Communications, Inc. and McLeod
                   Telemanagement, Inc. (Filed as Exhibit 10.38 to Initial Form S-1 and incorporated herein by
                   reference).

        10.11      McLeod Telecommunications, Inc. 1992 Incentive Stock Option Plan. (Filed as Exhibit 10.40 to
                   Initial Form S-1 and incorporated herein by reference).

        10.12      McLeod, Inc. 1993 Incentive Stock Option Plan. (Filed as Exhibit 10.41 to Initial Form S-1 and
                   incorporated herein by reference).

        10.13      McLeod, Inc. 1995 Incentive Stock Option Plan. (Filed as Exhibit 10.42 to Initial Form S-1 and
                   incorporated herein by reference).

       *10.14      Telecommunications Services Agreement dated March 14, 1994 between WiITel, Inc. and McLeod
                   Telemanagement, Inc., as amended. (Filed as Exhibit 10.47 to Initial Form S-1 and incorporated
                   herein by reference).

        10.15      First Amendment to Agreement Regarding Support Agreement dated May 14, 1996 among McLeod, Inc.,
                   IES Diversified Inc. and IES Investments Inc. (Filed as Exhibit 10.50 to Initial Form S-1 and
                   incorporated herein by reference).

        10.16      First Amendment to Agreement Regarding Guarantee dated May 14, 1996 among McLeod, Inc., IES
                   Diversified Inc. and IES Investments Inc. (Filed as Exhibit 10.51 to Initial Form S-1 and
                   incorporated herein by reference).

        10.17      Forms of Employment, Confidentiality and Non-Competition Agreement between McLeod, Inc. and
                   certain employees of McLeod, Inc. (Filed as Exhibit 10.53 to Initial Form S-1 and incorporated
                   herein by reference).

        10.18      Form of Change-of-Control Agreement between McLeod, Inc. and certain employees of McLeod, Inc.
                   (Filed as Exhibit 10.54 to Initial Form S-1 and incorporated herein by reference).

        10.19      McLeod, Inc. 1996 Employee Stock Option Plan, as amended. (Filed as Exhibit 10.55 to the
                   November 1996 Form S-1 and incorporated herein by reference).
</TABLE>

                                       60
<PAGE>

<TABLE>
<CAPTION>
        Exhibit
        Number                                           Exhibit Description
       --------                                          -------------------
       <C>        <S>
        10.20      McLeod, Inc. Employee Stock Purchase Plan, as amended. (Filed as Exhibit 10.56 to the 1996 Form
                   10-K and incorporated herein by reference).

        10.21      Form of Indemnity Agreement between McLeod, Inc. and certain officers and directors of McLeod,
                   Inc. (Filed as Exhibit 10.57 to Initial Form S-1 and incorporated herein by reference).

        10.22      McLeod, Inc. Incentive Plan. (Filed as Exhibit 10.63 to the November 1996 Form S-1 and
                   incorporated herein by reference).

        10.23      Lease Agreement dated as of July 18, 1995 between 2060 Partnership, L.P. and TelecomHUSA
                   Publishing Company. (Filed as Exhibit 10.68 to the November 1996 Form S-1 and incorporated
                   herein by reference).

        10.24      Form of McLeod, Inc. Directors Stock Option Plan Option Agreement. (Filed as Exhibit 10.72 to
                   the November 1996 Form S-1 and incorporated herein by reference).

        10.25      Forms of McLeod, Inc. 1996 Employee Stock Option Plan Incentive Stock Option Agreement. (Filed
                   as Exhibit 10.73 to the November 1996 Form S-1 and incorporated herein by reference).

        10.26      Forms of McLeod, Inc. 1996 Employee Stock Option Plan Non-Incentive Stock Option Agreement.
                   (Filed as Exhibit 10.74 to the November 1996 Form S-1 and incorporated herein by reference).

        10.27      Ameritech Centrex Service Confirmation of Service Orders dated August 21, 1996 between McLeod
                   Telemanagement, Inc. and Ameritech Information Industry Services. (Filed as Exhibit 10.93 to
                   the 1996 Form 10-K and incorporated herein by reference).

       *10.28      Amended and Restated Program Enrollment Terms dated November 1, 1996 between WorldCom Network
                   Services, Inc. d/b/a WilTel and McLeod Telemanagement, Inc. (Filed as Exhibit 10.94 to Annual
                   Report on Form 10-K/A, File No. 0-20763, filed with the Commission on April 8, 1997 and
                   incorporated herein by reference).

        10.29      Letter Agreement dated April 15, 1997 between U S WEST Communications and McLeodUSA Network
                   Services, Inc. (Filed as Exhibit 10.1 to Quarterly Report on Form 10-Q, File No. 0-20763, filed
                   with the Commission on May 14, 1997 and incorporated herein by reference).

        10.30      Network Agreement dated April 7, 1997, between Wisconsin Power and Light Company and McLeodUSA
                   Telecommunications Services, Inc. (Filed as Exhibit 10.96 to the July 1997 Form S-4 and
                   incorporated herein by reference).

        10.31      Agreement dated July 7, 1997 between McLeodUSA Telecommunications Services, Inc. and U S WEST
                   Communications, Inc. (Filed as Exhibit 10.97 to the July 1997 Form S-4 and incorporated herein
                   by reference).
</TABLE>

                                       61
<PAGE>

<TABLE>
<CAPTION>
        Exhibit
        Number                                           Exhibit Description
       --------                                          -------------------
       <C>         <S>
        10.32      Interconnection Agreement Under Sections 251 and 252 of the Telecommunications Act of 1996
                   dated as of October 28, 1996 between Ameritech Information Industry Services and Consolidated
                   Communications Telecom Services Inc. (Filed as Exhibit 10.99 to the November 1997 Form S-4 and
                   incorporated herein by reference).

        10.33      Interconnection Agreement Under Sections 251 and 252 of the Telecommunications Act of 1996
                   dated as of July 17, 1997 between Ameritech Information Industry Services and Consolidated
                   Communications Telecom Services Inc. (Filed as Exhibit 10.100 to the November 1997 Form S-4 and
                   incorporated herein by reference).

        10.34      Supply Agreement dated February 26, 1990 and Amendment Number 4 to Supply Agreement dated
                   January 4, 1999 between Alcatel USA Marketing, Inc. and McLeodUSA Incorporated. (Filed as
                   Exhibit 10.51 to the 1998 Form 10-K and incorporated herein by reference).

        10.35      Stock Purchase Agreement dated as of August 30, 1999 by and between McLeodUSA Incorporated and
                   three Forstmann Little Partnerships.  (Filed as Exhibit 10.1 to Current Report on Form 8-K,
                   file number 0-20763, filed with the Commission on September 23, 1999 and incorporated herein by
                   reference).

        10.36      Employment Agreement dated January 7, 2000 between McLeodUSA Incorporated and Clark E. McLeod.
                   (Filed as Exhibit 99.2 to Current Report on Form 8-K, file number 0-20763, filed with the
                   Commission on February 3, 2000 and incorporated herein by reference).

        10.37      Employment Agreement dated January 7, 2000 between McLeodUSA Incorporated and Stephen C. Gray.
                   (Filed as Exhibit 99.3 to Current Report on Form 8-K, file number 0-20763, filed with the
                   Commission on February 3, 2000 and incorporated herein by reference).

        10.38      Employment Agreement dated January 7, 2000 between McLeodUSA Incorporated and Roy A. Wilkens.
                   (Filed as Exhibit 99.4 to Current Report on Form 8-K, file number 0-20763, filed with the
                   Commission on February 3, 2000 and incorporated herein by reference).

        10.39      McLeodUSA Incorporated Second Amended and Restated Directors Stock Option Plan.  (Filed as
                   Exhibit 4.1 to Registration Statement on Form S-8, file number 333-89361 and incorporated
                   herein by reference).

       *10.40      Network Agreement dated November 24, 1999 between Alliant Energy Companies and McLeodUSA
                   Telecommunications Services, Inc.  Filed as Exhibit 10.57 to the 1999 Form 10-K and
                   incorporated herein by reference.

       *10.41      Splitrock Full Service Agreement dated as of June 24, 1997 by and between Splitrock and Prodigy
                   Services Corporation. Filed as an exhibit to Splitrock's Registration Statement on Form S-4,
                   file no. 333-61293, and incorporated herein by reference.
</TABLE>

                                       62
<PAGE>

<TABLE>
<CAPTION>
       Exhibit
       Number                                           Exhibit Description
      --------                                          -------------------
       <C>         <S>
       *10.42      Amendment to Full Service Agreement between Splitrock and Prodigy dated May 18, 1999. Filed as
                   an exhibit to Splitrock's Registration Statement on Form S-1, file no. 333-97707, and
                   incorporated herein by reference.

       *10.43      Amended and Restated Full Service Agreement between Splitrock and Prodigy dated as of February
                   16, 2000. Filed as an exhibit to Splitrock's Quarterly Report on Form 10-Q, file no. 000-26827,
                   filed with the SEC on May 15, 2000 and incorporated herein by reference.

       *10.44      Cost Sharing National IRU Agreement effective April 26, 1999 by and between Level 3
                   Communications, LLC and Splitrock Services, Inc. Filed as an exhibit to Splitrock's
                   Registration Statement on Form S-1, file no. 333-97707, and incorporated herein by reference.

       *10.45      First Amendment to Cost Sharing National IRU Agreement by and between Level 3 Communications,
                   LLC and Splitrock. Filed as an exhibit to Splitrock's Registration Statement on Form S-1, file
                   no. 333-97707, and incorporated herein by reference.

       *10.46      Second Amendment to Cost Sharing National IRU Agreement by and between Level 3 Communications,
                   LLC and Splitrock Services, Inc. Filed as an exhibit to Splitrock's Quarterly Report on Form
                   10-Q, file no. 000-26827, filed with the SEC on May 15, 2000 and incorporated herein by
                   reference.

       *10.47      Third Amendment to Cost Sharing National IRU Agreement by and between Level 3 Communications,
                   LLC and Splitrock Services, Inc.. Filed as an exhibit to Splitrock's Quarterly Report on Form
                   10-Q, file no. 000-26827, filed with the SEC on May 15, 2000 and incorporated herein by
                   reference.

       *10.48      Fourth Amendment to Cost Sharing National IRU Agreement by and between Level 3 Communications,
                   LLC and Splitrock Services, Inc.  Filed as an exhibit to the McLeodUSA Quarterly Report on Form
                   10-Q, file no. 0-20763, filed with the SEC on August 14, 2000 and incorporated herein by
                   reference.

       *10.49      Fifth Amendment to Cost Sharing National IRU Agreement by and between Level 3 Communications,
                   LLC and Splitrock Services, Inc. Filed as an exhibit to the McLeodUSA Quarterly Report on Form
                   10-Q, file no. 0-20763, filed with the SEC on August 14, 2000 and incorporated herein by
                   reference.

       *10.50      Sixth Amendment to Cost Sharing National IRU Agreement by and between Level 3 Communications,
                   LLC and Splitrock Services, Inc. Filed as an exhibit to the McLeodUSA Quarterly Report on Form
                   10-Q, file no. 0-20763, filed with the SEC on November 13, 2000 and incorporated herein by
                   reference.

       *10.51      Seventh Amendment to Cost Sharing National IRU Agreement by and between Level 3 Communications,
                   LLC and Splitrock Services, Inc. Filed as an exhibit to the McLeodUSA Quarterly Report on Form
                   10-Q, file no. 0-20763, filed with the SEC on November 13, 2000 and incorporated herein by
                   reference.
</TABLE>

                                       63
<PAGE>

<TABLE>
<CAPTION>
       Exhibit
       Number                                           Exhibit Description
      --------                                          -------------------
      <C>          <S>
        10.52      McLeodUSA Incorporated 1996 Employee Stock Option Plan, as amended and restated, filed as
                   Exhibit A to the Company's definitive proxy statement filed with the Commission on April 26,
                   2000 and incorporated herein by reference.

        10.53      Interconnection Agreement Amendment Terms dated October 26, 2000 between McLeodUSA
                   Telecommunications Services, Inc. and Qwest Corporation

         11.1      Computation of Loss per common and common equivalent share.

         21.1      Subsidiaries of McLeodUSA Incorporated.

         23.1      Consent of Arthur Andersen LLP.
</TABLE>

_________________
*  Confidential treatment has been requested. The copy filed as an exhibit omits
   the information subject to the confidential treatment request.

         (b)   Reports on Form 8-K.

         On November 9, 2000 we filed a Current Report on Form 8-K to report our
         agreement with Qwest Communications International Inc., our Next
         Generation National Network and our slides presented at the McLeodUSA
         Investor and Analyst Conference and Webcast on November 8, 2000.

         On December 12, 2000 we filed a Current Report on Form 8-K to report
         the completion of our acquisition of CapRock.

         On  January 5, 2001 we filed a Current Report on Form 8-K to report our
         proposed offering of senior notes.

         On January 8, 2001 we filed a Current Report on Form 8-K to make
         available slides regarding our presentation at the Salomon Smith Barney
         Entertainment Media and Telecommunications Conference in Arizona on
         January 8, 2001.

         On January 18, 2001 we filed a Current Report on Form 8-K to report the
         sale of $750 million of our 11 3/8% senior notes due January 1, 2009.

         On February 21, 2001 we filed a Current Report on Form 8-K to make
         available various slides accompanying our February 21, 2001 Financial
         Guidance Conference Call.

         (c)   Exhibits.

         We hereby file as part of this Form 10-K the exhibits listed in the
         Index to Exhibits.

         (d)   Financial Statement Schedule

                                       64
<PAGE>

     The following financial statement schedule is filed herewith:

     Schedule II -- Valuation and Qualifying Accounts

     Schedules not listed above have been omitted because they are inapplicable
     or the information required to be set forth therein is provided in our
     consolidated financial statements or notes thereto.

                                       65
<PAGE>

                                    GLOSSARY

     Access--Telecommunications services that permit long distance carriers to
use local exchange facilities to originate and/or terminate long distance
service.

     Access to Rights-of-Way--Access to poles, ducts, conduits and other rights-
of-way.

     CAP (competitive access provider)--A company that provides its customers
with an alternative to the local exchange company for local transport of private
line and special access telecommunications services.

     Central offices--The switching centers or central switching facilities of
the local exchange companies.

     Collocation--The ability of a CAP such as McLeodUSA to connect its network
to the LEC's central offices. Physical collocation occurs when a CAP places its
network connection equipment inside the local exchange company's central
offices. Virtual collocation is an alternative to physical collocation by which
the local exchange company permits a CAP to connect its network to the local
exchange company's central offices on comparable terms, even though the CAP's
network connection equipment is not physically located inside the central
offices.

     Dedicated--Telecommunications service or capacity reserved for use by
particular customers.

     Dialing Parity--The ability of a competing local or toll service provider
to provide telecommunications services in such a manner that customers have the
ability to route automatically, without the use of any access code, their
telecommunications to the service provider of the customer's designation.

     Digital--A method of storing, processing and transmitting information
through the use of distinct electronic or optical pulses that represent the
binary digits 0 and 1. Digital transmission and switching technologies employ a
sequence of these pulses to represent information as opposed to the continuously
variable analog signal. The precise digital numbers minimize distortion (such as
graininess or snow in the case of video transmission, or static or other
background distortion in the case of audio transmission).

     ESMR--Enhanced Specialized Mobile Radio.  A technology that allows two-way
radio service with the capability to provide wireless voice telephone service to
compete against cellular service.

     FCC--Federal Communications Commission.

     Interconnection--Interconnection of facilities between or among local
exchange carriers, including potential physical collocation of one carrier's
equipment in the other carrier's premises to facilitate such interconnection.

     Interconnection Decision--The August 1996 order issued by the FCC
implementing the interconnection provisions of the Telecommunications Act of
1996.

     InterLATA--Telecommunications services originating in a LATA and
terminating outside of that LATA.

     IntraLATA--Telecommunications services originating and terminating in the
same LATA.

                                       66
<PAGE>

     LATA (local access and transport area)--A geographic area composed of
contiguous local exchanges, usually but not always within a single state. The
State of Iowa contains all or part of five LATAs; the State of Illinois contains
all or part of 17 LATAs. There are approximately 200 LATAs in the United States.

     LMDS--Local Multipoint Distribution System.  A method of distributing TV
signals to locations in a particular community.

     Local exchange--A geographic area determined by the appropriate state
regulatory authority in which calls generally are transmitted without toll
charges to the calling or called party.

     LEC (local exchange carrier)--A company providing local telephone services.

     Long distance carriers (interexchange carriers)--Long distance carriers
provide services between local exchanges on an interstate or intrastate basis. A
long distance carrier may offer services over its own or another carrier's
facilities.

     MegaBells--The four large incumbent telephone companies which remain after
a number of mergers involving the seven regional Bell operating companies into
which AT&Ts local telephone systems were divided in 1984.  The MegaBells are
Verizon, Bell South, SBC Communications and Qwest.

     Number portability--The ability of an end-user to change local exchange
carriers while retaining the same telephone number.

     PCS (personal communications services) - A high frequency digital
technology competitive with cellular.

     POPs (points of presence)--Locations where a long distance carrier has
installed transmission equipment in a service area that serves as, or relays
calls to, a network switching center of that long distance carrier.

     Private line--A dedicated telecommunications connection between end-user
locations.

     Public switched network--That portion of a local exchange company's network
available to all users generally on a shared basis (i.e., not dedicated to a
particular user). Traffic along the public switched network is generally
switched at the local exchange company's central offices.

     Public utility commission--A state regulatory body, established in most
states, which regulates utilities, including telephone companies providing
intrastate services.

     Reciprocal compensation--The same compensation to a new competitive local
exchange carrier for termination of a local call by the local exchange carrier
on the new competitor's network as the new competitor pays the local exchange
carrier for termination of local calls on the local exchange carrier's network.

     Resale--Resale by a provider of telecommunications services (such as a
local exchange carrier) of such services to other providers or carriers on a
wholesale or a retail basis.

     Route mile--The number of miles of the telecommunications path in which
fiber optic cables are installed.

     Self-healing ring--A self-healing ring is a network design in which the
network backbone consists of a continuous ring connecting a central hub facility
with one or more network nodes (such

                                       67
<PAGE>

as customer premises). Traffic is routed between the hub and each of the nodes
simultaneously in both a clockwise and a counterclockwise direction. In the
event of a cable cut or component failure along one of these paths, traffic will
continue to flow along the alternate path so no traffic is lost. In the event of
a catastrophic node failure, other nodes will be unaffected because traffic will
continue to flow along whichever path (primary or alternate) does not pass
through the affected node. The switch from the primary to the alternate path
will be imperceptible to most users.

     Special access services--The lease of private, dedicated telecommunications
lines or "circuits" along the network of a local exchange company or a CAP,
which lines or circuits run to or from the long distance carrier POPs. Examples
of special access services are telecommunications lines running between POPs of
a single long distance carrier, from one long distance carrier POP to the POP of
another long distance carrier or from an end-user to a long distance carrier
POP.

     Switch--A device that opens or closes circuits or selects the paths or
circuits to be used for transmission of information. Switching is a process of
interconnecting circuits to form a transmission path between users.

     Switched access transport services--Transportation of switched traffic
along dedicated lines between the local exchange company central offices and
long distance carrier POPs.

     Switched traffic--Telecommunications traffic along the public switched
network. This traffic is generally switched at the local exchange company's
central offices.

     Unbundled Access--Access to unbundled elements of a telecommunications
services provider's network, including network facilities, equipment, features,
functions and capabilities, at any technically feasible point within such
network.

     WCS (wireless communications services) - A wireless technology for
cellular, PCS and similar communications.

                                       68
<PAGE>

                                  SIGNATURES


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

                              McLEODUSA INCORPORATED

     March 29, 2001           By    /s/ Clark E. McLeod
                                    -------------------
                                    Clark E. McLeod
                                    Chairman and Co-Chief Executive Officer

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
     report has been signed below by the following persons on behalf of the
     registrant and in the capacities indicated as of March 29, 2001.

<TABLE>
     <S>                                                    <C>
     /s/ Clark E. McLeod                                    /s/ Richard A. Lumpkin
     ----------------------------------------------         -----------------------------------------------
     Clark E. McLeod, Chairman, Co-Chief Executive          Richard A. Lumpkin, Vice Chairman and Director
     Officer and Director (Principal Executive
     Officer)

     /s/ Stephen C. Gray                                    /s/ J. Lyle Patrick
     ----------------------------------------------         -----------------------------------------------
     Stephen C. Gray, President and Co-Chief                J. Lyle Patrick, Group Vice President-Finance
     Executive Officer; Director                            and Accounting and Chief Financial and
                                                            Accounting Officer (Principal Financial
                                                            Officer and Principal Accounting Officer

     /s/ Roy A. Wilkens                                     /s/ Thomas M. Collins
     ----------------------------------------------         -----------------------------------------------
     Roy A. Wilkens, President and Chief                    Thomas M. Collins, Director
      Executive Officer--Network Services;
      Director

     /s/ Robert J. Currey                                   /s/ Paul D. Rhines
     ----------------------------------------------         -----------------------------------------------
     Robert J. Currey, Director                             Paul D. Rhines, Director

     /s/ Peter H. O. Claudy                                 /s/ Anne K. Bingaman
     ----------------------------------------------         -----------------------------------------------
     Peter H. O. Claudy, Director                           Anne K. Bingman, Director

     /s/ Theodore J. Forstmann                              /s/ Erskine B. Bowles
     ----------------------------------------------         -----------------------------------------------
     Theodore J. Forstmann, Director                        Erskine B. Bowles, Director

     /s/ James E. Hoffman                                   /s/ Daniel R. Hesse
     ----------------------------------------------         -----------------------------------------------
     James E. Hoffman, Director                             Daniel R. Hesse, Director
</TABLE>

                                       69
<PAGE>

                  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
<S>                                                                                          <C>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
Report of Independent Public Accountants...................................................  F-2
Consolidated Balance Sheets as of December 31, 2000 and 1999...............................  F-3
Consolidated Statements of Operations and Comprehensive Income (Loss) for the years ended
  December 31, 2000, 1999 and 1998.........................................................  F-4
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2000,
  1999 and 1998............................................................................  F-5
Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999
  and 1998.................................................................................  F-6
Notes to Consolidated Financial Statements.................................................  F-7
</TABLE>

                                      F-1
<PAGE>

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To the Board of Directors and Stockholders of
McLeodUSA Incorporated:

     We have audited the accompanying consolidated balance sheets of McLeodUSA
Incorporated (a Delaware corporation) and subsidiaries as of December 31, 2000
and 1999, and the related consolidated statements of operations and
comprehensive income (loss), stockholders' equity, and cash flows for each of
the three years in the period ended December 31, 2000. These financial
statements are the responsibility of McLeodUSA Incorporated's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of McLeodUSA
Incorporated and subsidiaries as of December 31, 2000 and 1999, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2000 in conformity with accounting principles
generally accepted in the United States.

                                                  ARTHUR ANDERSEN LLP



Chicago, Illinois
January 29, 2001

                                      F-2
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES
                          CONSOLIDATED BALANCE SHEETS
                          (In millions, except shares)

<TABLE>
<CAPTION>
                                                                                                                  December 31,
                                                                                                             ----------------------
                                                                                                               2000          1999
                                                                                                             --------      --------
<S>                                                                                                          <C>           <C>
                                                               ASSETS
Current Assets
 Cash and cash equivalents.................................................................................  $    15.7    $  326.9
 Investment in available-for-sale securities...............................................................       64.7       934.1
 Trade receivables, net....................................................................................      354.0       183.8
 Inventory.................................................................................................       25.1        27.5
 Deferred expenses.........................................................................................       48.3        39.2
 Prepaid expenses and other................................................................................       55.0        58.0
                                                                                                             ---------    --------
   Total current assets....................................................................................      562.8     1,569.5
                                                                                                             ---------    --------

Property and Equipment
 Land and building.........................................................................................      118.4        85.1
 Telecommunications networks...............................................................................    1,841.2       635.9
 Furniture, fixtures and equipment.........................................................................      428.6       267.2
 Networks in progress......................................................................................    1,062.8       453.2
 Building in progress......................................................................................        5.1         1.2
                                                                                                             ---------    --------
                                                                                                               3,456.1     1,442.6
 Less accumulated depreciation.............................................................................      437.0       172.6
                                                                                                             ---------    --------
                                                                                                               3,019.1     1,270.0
                                                                                                             ---------    --------
Investments, Intangibles and Other Assets
 Other investments.........................................................................................       29.2        35.9
 Goodwill, net.............................................................................................    3,226.2       957.1
 Other intangibles, net....................................................................................      391.0       290.2
 Other.....................................................................................................      137.3        80.4
                                                                                                             ---------    --------
                                                                                                               3,783.7     1,363.6
                                                                                                             ---------    --------
Total Assets...............................................................................................  $ 7,365.6    $4,203.1
                                                                                                             =========    ========
                                                LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
 Current maturities of long-term debt......................................................................  $    27.3    $   14.5
 Accounts payable..........................................................................................      275.9       109.6
 Accrued payroll and payroll related expenses..............................................................       43.0        26.2
 Other accrued liabilities.................................................................................      393.8        92.2
 Deferred revenue, current portion.........................................................................       52.6        24.1
 Customer deposits.........................................................................................       53.8        30.1
                                                                                                             ---------    --------
   Total current liabilities...............................................................................      846.4       296.7
Long-Term Debt, less current maturities....................................................................    2,732.2     1,763.8
Deferred Revenue, less current portion.....................................................................       12.1        15.8
Other Long-term liabilities................................................................................       18.8        18.3
                                                                                                             ---------    --------
                                                                                                               3,609.5     2,094.6
                                                                                                             ---------    --------
Redeemable convertible preferred stock
 Preferred, Series B, redeemable, convertible, $.01 par value, authorized, issued and
   Outstanding 2000 275,000; 1999 275,000..................................................................      687.5       687.5
 Preferred, Series C, redeemable, convertible, $.01 par value, authorized, issued and
   Outstanding 2000 125,000; 1999 125,000..................................................................      312.5       312.5
                                                                                                             ---------    --------
                                                                                                               1,000.0     1,000.0
                                                                                                             ---------    --------
Stockholders' Equity
 Capital stock:
   Preferred, Series A, $.01 par value: authorized 1,150,000; issued and outstanding
     2000 1,149,400 shares; 1999 1,150,000 shares..........................................................         --          --
   Common, Class A, $.01 par value; authorized 2,000,000,000 shares; issued and
     outstanding 2000 606,596,945 shares and 1999 472,761,036 shares.......................................        6.1         4.8
   Common, Class B, convertible, $.01 par value; authorized 22,000,000 shares;
     issued and outstanding 2000 none; 1999 none...........................................................         --          --
 Additional paid-in capital................................................................................    3,749.7     1,523.5
 Accumulated deficit.......................................................................................   (1,027.1)     (494.5)
 Accumulated other comprehensive income....................................................................       27.4        74.7
                                                                                                             ---------    --------
                                                                                                               2,756.1     1,108.5
                                                                                                             ---------    --------
Total Liabilities and Stockholders' Equity.................................................................  $ 7,365.6    $4,203.1
                                                                                                             =========    ========
</TABLE>

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

                                      F-3
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES

     CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
                      (In millions, except per share data)

<TABLE>
<CAPTION>
                                                                                                       Year Ended December 31,
                                                                                                -----------------------------------
                                                                                                  2000          1999         1998
                                                                                                --------      --------      -------
<S>                                                                                             <C>           <C>           <C>
Revenue:
    Communications Services................................................................     $1,035.7      $  602.5      $ 372.0
    Local exchange services................................................................         88.9          78.4         67.8
    Directory..............................................................................        249.9         209.2        144.9
    Telemarketing..........................................................................         22.2          18.7         19.4
                                                                                                --------      --------      -------
         Total revenue.....................................................................      1,396.7         908.8        604.1

Operating expenses:
    Cost of service........................................................................        772.8         457.1        323.2
    Selling, general and administrative....................................................        563.2         392.7        260.9
    Depreciation and amortization..........................................................        409.6         190.7         89.1
    Other..................................................................................           --            --          5.6
                                                                                                --------      --------      -------
         Total operating expenses..........................................................      1,745.6       1,040.5        678.8
                                                                                                --------      --------      -------

         Operating loss....................................................................       (348.9)       (131.7)       (74.7)
                                                                                                --------      --------      -------

Nonoperating income (expense):
    Interest income........................................................................         47.8          42.6         26.0
    Interest (expense).....................................................................       (151.4)       (136.8)       (78.2)
    Other income (expense).................................................................         (0.4)          5.6          2.0
                                                                                                --------      --------      -------
         Total nonoperating expense........................................................       (104.0)        (88.6)       (50.2)
                                                                                                --------      --------      -------

         Loss before income taxes and extraordinary charge.................................       (452.9)       (220.3)      (124.9)

Income taxes...............................................................................           --            --           --
                                                                                                --------      --------      -------
         Loss before extraordinary charge..................................................       (452.9)       (220.3)      (124.9)
Extraordinary charge for early retirement of debt..........................................        (24.4)           --           --
                                                                                                --------      --------      -------
         Net loss..........................................................................       (477.3)       (220.3)      (124.9)
                                                                                                --------      --------      -------
Preferred stock dividend...................................................................        (54.4)        (17.7)          --
                                                                                                --------      --------      -------
         Net loss applicable to common shares..............................................     $ (531.7)     $ (238.0)     $(124.9)
                                                                                                ========      ========      =======

Lossper common share:
         Loss before extraordinary charge..................................................     $  (0.91)     $  (0.54)     $ (0.33)
         Extraordinary charge..............................................................        (0.04)           --           --
                                                                                                --------      --------      -------
         Loss per common share.............................................................     $  (0.95)     $  (0.54)     $ (0.33)
                                                                                                ========      ========      =======

Weighted average common shares outstanding.................................................        558.4         443.1        376.8
                                                                                                ========      ========      =======
Other comprehensive income (loss):
 Unrealized gains on securities:
  Unrealized holding gains (losses) arising during the
    period.................................................................................     $  (46.1)     $   83.4      $   3.0
  Less: Reclassification adjustment for losses (gains) included in
    net income.............................................................................         (1.2)         (7.0)        (2.2)
                                                                                                --------      --------      -------
         Total other comprehensive income (loss)...........................................        (47.3)         76.4          0.8
                                                                                                --------      --------      -------
         Comprehensive loss................................................................     $ (579.0)     $ (161.6)     $(124.1)
                                                                                                ========      ========      =======
</TABLE>

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

                                      F-4
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                  Years Ended December 31, 2000, 1999 and 1998
                          (In millions, except shares)

<TABLE>
<CAPTION>
                                                                                                          Accumulated
                                                                 Common Stock     Additional                  Other
                                                               -----------------   Paid-In    Accumulated Comprehensive
                                                               Class A   Class B   Capital      Deficit      Income         Total
                                                               -------   -------  ----------  ----------- -------------  -----------
<S>                                                            <C>      <C>       <C>         <C>         <C>            <C>
Balance, December 31, 1997.....................................    4.5        --       689.0       (131.6)     (2.5)       559.4
    Net loss...................................................     --        --          --       (124.9)       --       (124.9)
 Issuance of 1,353,785 shares of Class A
     common stock related to the exercise of stock options.....     --        --         3.7           --        --          3.7
 Issuance of 70,508 shares of Class A common
     stock in connection with the acquisition of NewCom
     Technologies, Inc. and NewCom OSP Services, Inc...........     --        --         3.2           --        --          3.2
 Issuance of 151,019 shares of Class A common stock   in
     connection with the acquisition of certain assets of
     Communications Cable-Laying Company, Inc..................     --        --         6.0           --        --          6.0
 Issuance of 70,672 shares of Class A common
     stock in connection with the acquisition of
     of Inlet, Inc.............................................     --        --         2.4           --        --          2.4
 Issuance of 82,602 shares of Class A common stock
     to participants in the 401(k) profit-sharing plans........     --        --         2.6           --        --          2.6
 Issuance of 132,893 shares of Class A common stock
     to participants in the Employee Stock Purchase Plan.......     --        --         3.7           --        --          3.7
 Amortization of compensation expense related to
     stock options.............................................     --        --         5.9           --        --          5.9
    Other comprehensive income.................................     --        --          --           --       0.8          0.8
                                                                  ----  --------    --------    ---------    ------     --------
Balance, December 31, 1998.....................................    4.5        --       716.5       (256.5)     (1.7)       462.8
    Net loss...................................................     --        --          --       (238.0)       --       (238.0)
 Issuance of 4,174,274 shares of Class A
     common stock related to the exercise of stock options.....     --        --        20.7           --        --         20.7
 Issuance of 25,397,456 shares of Class A common
     stock in connection with the acquisitions ................    0.3        --       487.7           --        --        488.0
 Issuance of 222,762 shares of Class A common stock
     to participants in the 401(k) profit-sharing plans........     --        --         4.9           --        --          4.9
 Issuance of 313,909 shares of Class A common stock
     to participants in the Employee Stock Purchase Plan.......     --        --         4.4           --        --          4.4
    Issuance of 1,150,000 shares of Series A preferred stock...     --        --       277.3           --        --        277.3
 Amortization of compensation expense related to
     stock options.............................................     --        --         6.9           --        --          6.9
 Issuance of 120,261 shares of Class A common stock to
     Series A preferred stockholders...........................     --        --         5.1           --        --          5.1
    Other comprehensive income.................................     --        --          --           --      76.4         76.4
                                                                  ----  --------    --------    ---------    ------     --------
Balance, December 31, 1999.....................................    4.8        --     1,523.5       (494.5)     74.7      1,108.5
  Net loss.....................................................     --        --          --       (531.7)       --       (531.7)
    Issuance of 23,162,175 shares of Class A
     common stock related to the exercise of stock options.....    0.2        --        52.0           --        --         52.2
    Issuance of 108,593,090 shares of Class A common
     stock in connection with the acquisitions ................    1.0        --     2,133.2         (0.9)       --      2,133.3
 Issuance of 208,229 shares of Class A  common stock
     to participants in the 401(k) profit-sharing plans........     --        --         3.9           --        --          3.9
  Issuance of 849,995 shares of Class A common stock
     to participants in the Employee Stock Purchase Plan.......    0.1        --        12.2           --        --         12.3
  Amortization of compensation expense related to
   stock options...............................................     --        --         5.5           --        --          5.5
  Issuance of 1,011,843 shares of Class A  common stock to
   Series A preferred stockholders.............................     --        --        19.4           --        --         19.4
  Other comprehensive income...................................     --        --          --           --     (47.3)       (47.3)
                                                                  ----  --------    --------    ---------    ------     --------
Balance, December 31, 2000.....................................   $6.1  $     --    $3,749.7    $(1,027.1)   $ 27.4     $2,756.1
                                                                  ====  ========    ========    =========    ======     ========
 </TABLE>

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

                                      F-5
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES


                     CONSOLIDATED STATEMENTS OF CASH FLOWS

                                 (In millions)

<TABLE>
<CAPTION>
                                                                                                   Year Ended December 31,
                                                                                              ---------------------------------
                                                                                                 2000        1999        1998
                                                                                              ---------   ---------    --------
<S>                                                                                           <C>         <C>          <C>
Cash Flows from Operating Activities
  Net loss................................................................................    $  (477.3)  $  (220.3)   $(124.9)
  Adjustments to reconcile net loss to net cash (used in)
   operating activities:
     Depreciation.........................................................................        211.4       105.6       53.3
     Amortization.........................................................................        198.2        85.1       34.7
     Accretion of interest on senior discount notes.......................................         43.1        38.9       35.1
     Changes in assets and liabilities, net of effects
      of acquisitions:
        (Increase) in trade receivables...................................................        (63.4)      (20.7)      (6.4)
        Decrease (Increase) in inventory..................................................          3.3       (12.7)      (8.2)
        (Increase) decrease in deferred expenses..........................................         (9.1)       (4.0)       0.9
        (Increase) decrease in prepaid expenses and other.................................         63.2        10.2      (34.3)
        (Increase) in other assets........................................................        (90.9)      (27.2)     (13.6)
        Increase (decrease) in accounts payable and
         accrued expenses.................................................................        (83.0)      (16.9)      32.2
        Increase in deferred revenue......................................................         11.0        10.5        4.6
        Increase in customer deposits.....................................................         19.4         9.3        4.1
                                                                                              ---------   ---------    -------
          Net cash used in operating activities...........................................       (174.1)      (42.2)     (22.5)
                                                                                              ---------   ---------    -------

Cash Flows from Investing Activities
  Purchase of property and equipment......................................................     (1,239.3)     (599.7)    (289.9)
  Available-for-sale securities:
     Purchases............................................................................       (599.8)   (1,247.3)    (607.4)
     Sales................................................................................        111.5       144.3      264.4
     Maturities...........................................................................      1,357.5       391.5      242.0
  Business acquisitions...................................................................        (30.4)     (230.8)     (27.8)
  Dividends received......................................................................          4.2          --         --
  Other...................................................................................          1.7        (8.9)      (5.2)
                                                                                              ---------   ---------    -------
          Net cash used in investing activities...........................................       (394.6)   (1,550.9)    (423.9)
                                                                                              ---------   ---------    -------

Cash Flows from Financing Activities
  Payments on contracts and notes payable.................................................           --       (26.2)     (11.1)
  Proceeds from long-term debt............................................................        565.6       485.8      583.9
  Payments on long-term debt..............................................................       (345.3)     (279.2)     (10.9)
  Net proceeds from issuance of common stock..............................................         64.5        18.0        7.7
  Net proceeds from preferred stock - Series A............................................           --       278.1         --
  Net proceeds from preferred stock - Series B and C......................................         (1.0)      998.7         --
  Payments of preferred stock dividends...................................................        (26.3)      (10.3)        --
                                                                                              ---------   ---------    -------
          Net cash provided by financing activities.......................................        257.5     1,464.9      569.6
                                                                                              ---------   ---------    -------

          Net increase (decrease) in cash and cash equivalents............................       (311.2)     (128.2)     123.2
Cash and cash equivalents:
  Beginning...............................................................................        326.9       455.1      331.9
                                                                                              ---------   ---------    -------
  Ending..................................................................................    $    15.7   $   326.9    $ 455.1
                                                                                              =========   =========    =======

Supplemental Disclosure of Cash Flow Information
  Cash payment for interest...............................................................    $   148.4   $   108.8    $  37.7
                                                                                              =========   =========    =======
Supplemental Schedule of Noncash Investing and Financing Activities
  Capital leases incurred for the acquisition of property and equipment...................    $    11.8   $    10.3    $   5.9
                                                                                              =========   =========    =======
</TABLE>

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

                                      F-6
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1.   Nature of Business and Significant Accounting Policies

Nature of business:  McLeodUSA Incorporated (the "Company") is incorporated in
Delaware and through its subsidiaries provides communications services to
customers nationwide. The Company's business is highly competitive and is
subject to various federal, state and local regulations.

     The Company derives most of its revenue from its core business of providing
     communication services, including:

          .    local and long distance services
          .    dial and dedicated Internet access
          .    higher bandwidth Internet access services, such as digital
               subscriber line (DSL) and cable modem
          .    value-added services such as virtual private networks and web
               hosting
          .    bandwidth leasing and colocation services
          .    facilities and services dedicated for a particular customer's use
          .    telephone and computer sales, leasing, networking, service and
               installation
          .    other communications services, including video, cellular,
               operator, payphone, mobile radio and paging services

     The Company also derives revenue from the following services related to our
     core business:

          .    sale of advertising in print and electronic telephone directories
          .    traditional local telephone company services in east central
               Illinois and southeast South Dakota
          .    telemarketing services

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

A summary of the Company's significant accounting policies is as follows:

Principles of consolidation:  The accompanying financial statements include
those of the Company and its subsidiaries, substantially all of which are
wholly-owned. All significant intercompany items and transactions have been
eliminated in consolidation.

Regulatory accounting:  Illinois Consolidated Telephone Company ("ICTC") and
Dakota Community Telephone, Inc., independent local exchange carriers (together
the "ILECs") and  wholly-owned subsidiaries of the Company, prepare their
financial statements in accordance with the provisions of Statement of Financial
Accounting Standards No. 71, "Accounting for the Effects of Certain Types of
Regulation" ("SFAS No. 71"). Management periodically reviews the criteria for
applying these provisions to determine whether continuing application of SFAS
No. 71 is appropriate.  Management believes that such criteria are still being
met and therefore has no current plans to change its method of accounting.

                                      F-7
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 1.   Nature of Business and Significant Accounting Policies--(Continued)

In analyzing the effects of discontinuing the application of SFAS No. 71,
management has determined that the useful lives of plant assets used for
regulatory and financial reporting purposes are consistent with generally
accepted accounting principles in the United States and therefore, any
adjustments to telecommunications plant would be immaterial, as would be the
write-off of regulatory assets and liabilities.

Cash and cash equivalents:  For purposes of reporting cash flows, the Company
considers all highly liquid debt instruments purchased with a maturity of three
months or less and all certificates of deposit, regardless of maturity, to be
cash equivalents.

Investments:   Management determines the appropriate classification of the
securities at the time they are acquired and evaluates the appropriateness of
such classifications at each balance sheet date. The Company has classified its
securities as available-for-sale. Available-for-sale securities are stated at
fair value, and unrealized holding gains and losses are reported as a component
of stockholders' equity. Realized gains and losses are determined on the basis
of the specific securities sold.

Trade receivables: Trade receivables include certain unbilled revenue from
installment contracts related to the publication of telephone directories and
recoverable costs not yet billed on network contracts. It is anticipated that a
substantial portion of all such amounts at December 31, 2000 and 1999 will be
collected within one year (see Note 2).

Inventory:   Inventory is carried principally at the lower of average cost or
market and consists primarily of new and reusable parts to maintain fiber optic
networks and parts and equipment used in the maintenance and installation of
telephone systems.  All inventory is classified as raw materials.

Property and equipment:  Property and equipment is stated at cost. Network in
progress includes construction costs, including interest, capitalized during the
construction and installation of fiber optic telecommunications networks.  These
costs are considered in progress  until the networks become operational at which
time the costs are reclassified as telecommunications network assets.  Interest
expense was also capitalized as part of the construction of the Company's
headquarters buildings and the development of the Company's software.

The ILECs' property and equipment for their regulated operations is summarized
as follows at December 31, 2000 (in millions):

<TABLE>
<S>                                                                               <C>
Telephone plant:
 In service....................................................................   $150.4
 Under construction............................................................      1.5
                                                                                  ------
                                                                                   151.9
 Less accumulated depreciation.................................................    (29.5)
                                                                                  ------
                                                                                  $122.4
                                                                                  ======
</TABLE>

When regulated property and equipment are retired, the original cost, net of
salvage, is charged against accumulated depreciation. The cost of maintenance
and repairs of property and equipment including the cost of replacing minor
items not constituting substantial betterments is charged to operating expense.


The provision for depreciation of regulated property and equipment is based upon
remaining life rates for property placed in service through 1980 and equal life
rates for property additions placed in

                                      F-8
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 1.   Nature of Business and Significant Accounting Policies--(Continued)

service after 1980. The regulated provision is equivalent to an annual composite
rate of 6.85% for 2000.

The provision for depreciation of nonregulated property and equipment is
recorded using the straight-line method based on the following estimated useful
lives:

                                                                         Years
                                                                       ---------
     Buildings......................................................     20-39
     Telecommunications networks....................................      5-15
     Furniture, fixtures and equipment..............................      2-10

The Company's telecommunications networks are subject to technological risks and
rapid market changes due to new products and services and changing customer
demand. These changes may result in changes in the estimated economic lives of
these assets.

Other investments: Other investments primarily includes approximately $20.8
million for a minority interest in a limited partnership which provides cellular
services to customers in east central Illinois. The Company follows the equity
method of accounting for this investment, which recognizes the Company's
proportionate share of the income and losses accruing to it under the terms of
its partnership agreement.

Goodwill: Goodwill resulting from the Company's acquisitions is being amortized
over a range of 15 to 30 years using the straight-line method and the
acquisitions are periodically reviewed for impairment based upon an assessment
of future operations to ensure that it is appropriately valued. Accumulated
amortization on goodwill totaled $185.4 million and $52.1 million at December
31, 2000 and 1999, respectively.

Other intangibles: Other intangibles consist of customer lists and noncompete
agreements related to the Company's acquisitions, line installation costs
incurred in the establishment of local access lines for customers and franchise
rights to provide cable services to customers in three Illinois counties and in
a Michigan city. The customer lists and noncompete agreements are being
amortized using the straight-line method over periods ranging from 3 to 15
years. The deferred line installation costs are being amortized using the
straight-line method over 36 to 60 months, which approximates the average lives
of residential and business customer contracts. The franchise rights are being
amortized using the straight-line method over periods ranging from 10 to 15
years. Accumulated amortization on the other intangibles totaled $113.0 million
and $60.7 million at December 31, 2000 and 1999, respectively.

Income tax matters: The Company recognizes deferred tax assets and liabilities
for the expected future tax consequences of events that have been included in
the financial statements or tax returns. Under this method, deferred tax assets
and liabilities are determined based on the difference between the financial
statement and tax bases of assets and liabilities using enacted tax rates in
effect for the year in which the differences are expected to reverse. Net
deferred tax assets are reduced by a valuation allowance when appropriate (see
Note 6). Deferred tax assets and liabilities are adjusted for the effects of
changes in tax laws and rates on the date of enactment.

Deferred revenue: Amounts received in advance under long-term leases of fiber
optic telecommunications networks are recognized as revenue on a straight-line
basis over the life of the leases.

                                      F-9
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 1.   Nature of Business and Significant Accounting Policies--(Continued)

Revenue recognition: Revenues for local and long-distance services are
recognized when subscribers use telecommunications services. The revenue from
long-term leases of fiber optic telecommunications networks is recognized over
the term of the lease. Base annual revenue for telecommunications network
maintenance is recognized on a straight-line basis over the term of the
contract. Additional services provided under these contracts are recognized as
the services are performed.

The ILECs' toll revenue is provided through a combination of billed carrier
access charges, traditional end-user billed toll revenues, interstate tariffed
subscriber line charges and ICTC's share of revenues and expenses from the non-
traffic sensitive pool administered by the National Exchange Carrier
Association.

The ILECs' prescribed rate of return on interstate access revenues for 2000
continues to be 11.25%, as it has been since the FCC's represcription order in
December 1990. The FCC's rate of return rules also establishes a maximum for the
overall interstate rate of return by allowing up to 0.25% over the prescribed
rate, and also establishes a maximum rate of return for each individual access
element by allowing up to 0.40% over the prescribed rate per element.

Fees from telemarketing contracts are recognized as revenue in the period the
services are performed.

Revenues from directories are recorded upon publication.

Customer deposits consist of cash received from customers at the time a sales
contract is signed. They are recorded as revenue when the related directory is
published or when the related service is performed.

Effective January 1, 2000, pursuant to Securities and Exchange Commission Staff
Accounting Bulletin No. 101 ("SAB No. 101"), the Company changed its accounting
for certain activation and reactivation fees charged to its customers and for
certain inducements paid to acquire new customers.  The Company now defers these
fees and inducements and records the related revenue and reduction of revenue
over the average customer contract periods rather than recording the revenues
and charges when received or paid.   This change in accounting policy did not
have a material effect on results of operations or financial position.

Cost of service and deferred expenses: Cost of service includes local and long-
distance services purchased from certain MegaBells and interexchange carriers,
the cost of providing local exchange services to customers in the ILEC's service
area and the cost of operating the Company's fiber optic telecommunications
networks. Cost of service also includes production costs associated with the
publication of directories and direct costs associated with telemarketing
services and the sale and installation of telephone systems.

Deferred expenses consist of production and selling costs on unpublished
directory advertising orders. They are expensed when the related directory is
published and the related revenue of the directory is recognized.

Key business suppliers: Qwest, Ameritech/SBC and Verizon are the Company's
primary suppliers of non-owned local central office switching and local lines.

Stock options issued to employees: The Company follows the provisions of SFAS
No. 123, Accounting for Stock-Based Compensation, which establishes a fair value
based method for the financial

                                      F-10
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 1.   Nature of Business and Significant Accounting Policies--(Continued)

reporting of its stock-based employee compensation plans. As permitted under
SFAS 123, the Company measures compensation using the intrinsic value based
method as prescribed by Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees. Under this method, compensation is measured as
the difference between the market value of the stock on the grant date, less the
amount required to be paid for the stock. The difference, if any, is charged to
expense over the vesting period of the options.

The estimated market value used for the stock options granted was determined on
a periodic basis by the Company's Board of Directors prior to the Company's
initial public offering on June 10, 1996. Subsequent to the Company's initial
public offering, the market value used for stock options granted is based upon
the closing price of the Class A common stock on the day before the grant date.

Stock options issued to nonemployees: The Company uses the Black-Scholes model
to determine the fair value of the stock options issued to nonemployees at the
date of grant. This amount is amortized to expense over the vesting period of
the options.

Loss per common share: Loss per common share has been computed using the
weighted average number of shares of common stock outstanding. All stock options
granted and the convertible preferred stock outstanding are anti-dilutive, and
therefore excluded from the computation of earnings per share. In the future,
the stock options and convertible preferred stock may become dilutive.

Fair value of financial instruments: The carrying amount of cash and cash
equivalents approximates fair value due to the short maturity of the
instruments. The fair value of the Company's long-term debt is estimated to be
$2.6 billion based on the quoted market rates for the same or similar issues or
the current rates offered to the Company for debt with similar maturities.

Common stock splits: On June 30, 1999, the Company announced a two-for-one stock
split in the form of a stock dividend on the Company's Class A common stock. The
record date for the stock split was July 12, 1999 and the distribution of the
additional shares took place on July 26, 1999. On February 29, 2000, the Company
announced a three-for-one stock split in the form of a stock dividend on the
Company's Class A common stock. The record date for the stock split was April 4,
2000 and the distribution of the additional shares took place on April 24, 2000.
All share data in the consolidated financial statements and notes to the
financial statements have been adjusted to reflect the stock splits.

Reclassifications: Certain items in the 1999 and 1998 consolidated financial
statements have been reclassified to be consistent with the presentation in the
2000 consolidated financial statements.

Note 2.   Trade Receivables

     The composition of trade receivables, net is as follows:

                                                               December 31
                                                          ---------------------
                                                           2000           1999
                                                          ------         ------
                                                               (In millions)

          Billed                                          $323.4         $165.7
          Unbilled                                         120.4           59.5
                                                          ------         ------
                                                           443.8          225.2
     Less allowance for doubtful accounts
      and discounts....................................    (89.8)         (41.4)
                                                          ------         ------
                                                          $354.0         $183.8
                                                          ======         ======

                                      F-11
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 3. Investments

At December 31, 2000, the Company held $18.3 million and $44.3 million in
corporate debt securities and marketable equity securities, respectively. At
December 31, 1999, the Company held $1,123.8 million, $23.0 million and $89.7
million in corporate debt securities, United States Government and governmental
agency securities and marketable equity securities, respectively. The Company
has classified these securities as available-for-sale, and at December 31, 2000
and 1999, the debt securities' amortized cost approximates fair value. The
marketable equity securities have been recorded at their fair market value at
December 31, 2000. The available-for-sale securities have been classified as
cash and cash equivalents, and investment in available-for-sale securities-
current, with $2.1 million and $60.5 million, respectively, being recorded in
each classification at December 31, 2000. Also reported in investments is $4.2
million of restricted cash held as collateral to support outstanding letters of
credit assumed under the Splitrock acquisition. At December 31, 1999, $302.4
million and $934.1 million, were recorded as cash and cash equivalents and
available-for-sale securities, respectively.

The contractual maturities of the available-for-sale securities of $18.3 million
and $1,237  million in 2000 and 1999, respectively, are due within one year.
Expected maturities will differ from contractual maturities because the issuers
of certain debt securities have the right to call or prepay their obligations
without any penalties. The amount classified as current assets on the
accompanying balance sheets represent the expected maturities of the debt
securities during the next year.

Note 4. Pledged Assets and Debt

On May 31, 2000, the Company entered into $1.3 billion of Senior Secured Credit
Facilities (together the "Credit Facilities") with a syndicate of financial
institutions. The credit facilities consist of (1) a seven year Senior Secured
Revolving Facility with an aggregate principal amount of $450 million (the
"Revolving Credit Facility"), (2) a seven year Senior Secured Multi-Draw Term
Loan Facility with an aggregate principal amount of $275 million ("Tranche A
Term Facility"), and (3) an eight year single draw Senior Secured Term Loan with
an aggregate principal amount of $575 million ("Tranche B Term Facility"). The
Tranche A Term Facility provides for multiple ($50 million minimum) draws for
the first 24 months of the agreement at which time any undrawn commitments
expire. At December 31, 2000, the Tranche B Term Facility was drawn in full and
the balance of the Tranche A Term Facility and Revolving Credit Facility
remained undrawn.

The Credit Facilities are secured by (1) a first priority pledge of all the
capital stock owned by the Company and by each subsidiary, and (2) a perfected
first priority security interest in substantially all of the Company's tangible
and intangible assets and, to the extent of $100 million, by the assets of each
subsidiary. In addition, telecommunications assets acquired with proceeds or
refinanced from the Credit Facilities serve as collateral.

Interest on the Credit Facilities is payable quarterly at LIBOR plus 1% to LIBOR
plus 3.25% based on the Company's debt rating. At December 31, 2000, the
Company's interest rates were LIBOR plus 2.25% on the Revolving Facility and
Tranche A Term Facility, and LIBOR plus 3.0% on the Tranche B Term Facility
(9.21% at December 31, 2000). A commitment fee of 0.5% to 1.0% per annum is
charged on the undrawn portion of the commitment relating to the Revolving
Facility and the Tranche A Term Facility. During 2000, the commitment fee on the
unused portion of the Credit Facilities was $4.2 million.

                                      F-12
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 4. Pledged Assets and Debt--(Continued)

Upon the acquisition of Splitrock Services, Inc., all of their 11.75% Senior
Notes due 2008 remained outstanding. The debt was recorded by the Company at
fair market value, as determined by quoted market prices on the date of
acquisition. On July 11, 2000 the Company completed its offer, commenced on May
31, 2000, to purchase all of the outstanding Splitrock Senior Notes. The Company
recognized an extraordinary charge of $24.4 million or $0.04 per share as a
result of the repurchase. The cost to repurchase the notes was the aggregate of
the principal amount of $260.9 million plus accrued interest and call premium of
$55.4 million.

On October 30, 2000, in conjunction with the CapRock Communications Corp.
acquisition, the Company made an offer to exchange (the "Exchange Offer")
CapRock's $210 million 11.5% Senior Notes due May 1, 2009 and $150 million 12%
Senior Notes due July 15, 2008 ("CapRock Senior Notes") for McLeodUSA. $210
million 11.5% Senior Notes due May 1, 2009 and $150 million 12% Senior Notes due
July 15, 2008 (together the "McLeodUSA Exchange Notes"). The Company filed a
registration statement with the SEC for the registration of the McLeodUSA Notes.
The Exchange Offer was completed on December 14, 2000, at which time all of the
CapRock Senior Notes were exchanged for the McLeodUSA Exchange Notes. Interest
on $210 million of the McLeodUSA Exchange Notes is payable in cash semi-annually
in arrears on May 1 and November 1, commencing May 1, 2001. Interest on $150
million of the McLeodUSA Exchange Notes is payable in cash semi-annually in
arrears on January 15 and July 15, commencing January 15, 2001. The McLeodUSA
Exchange Notes rank pari passu in right of payment with all existing and future
senior unsecured indebtedness of the Company and rank senior in right of payment
to all existing and future subordinated indebtedness.

The $210 million and $150 million CapRock Senior Notes were recorded by the
Company upon acquisition, net of discounts of $7.7 million and $1.2 million,
respectively. The fair market values were determined based upon quoted market
prices on the date of acquisition. The discount will be amortized as a component
of interest expense over the life of the senior notes to their $210 million and
$150 million face values by May 1, 2009 and July 15, 2008, respectively.

On February 22, 1999, the Company completed a private offering of its 8 1/8%
Senior Notes due February 15, 2009, for which the Company received net proceeds
of approximately $485.8 million. All of the February 1999 privately placed
Senior Notes were exchanged in July 1999 for publicly registered Senior Notes
having the same principal amount and interest rate. Interest on the February
1999 Senior Notes is payable in cash semi-annually in arrears on August 15 and
February 15. The February 1999 Senior Notes rank pari passu in right of payment
with all existing and future senior unsecured indebtedness of the Company and
rank senior in right of payment to all existing and future subordinated
indebtedness.

Covenants associated with most of the Company's debt impose operating and
financial restrictions on the Company and its subsidiaries. These restrictions,
among others, affect, and in certain cases significantly limit or prohibit the
ability of the Company and its subsidiaries to incur additional indebtedness,
pay dividends or make distributions in respect of the Company's or such
subsidiaries' capital stock, make other restricted payments, enter into sale and
leaseback transactions, create liens upon assets, enter into transactions with
affiliates or related persons, sell assets, or consolidate, merge or sell all or
substantially all of their assets. These covenants also require the maintenance
of certain financial covenants and minimum access service lines. These
conditions were satisfied as of December 31, 2000.

                                      F-13
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 4. Pledged Assets and Debt--(Continued)

     The Company's debt consisted of the following at December 31, 2000 and
1999:

<TABLE>
<CAPTION>
                                                                                         2000       1999
                                                                                       --------   --------
                                                                                            (In millions)
<S>                                                                                    <C>        <C>
Tranche B Term Facility, variable rate due May 30, 2008.........................       $  575.0   $     --
10 1/2% Senior Discount Notes due March 1, 2007.................................          443.9      400.8
9 1/4% Senior Notes due July 15, 2007...........................................          225.0      225.0
8 3/8% Senior Notes due March 15, 2008..........................................          300.0      300.0
9 1/2% Senior Notes due November 1, 2008........................................          300.0      300.0
8 1/8% Senior Notes due February 15, 2009.......................................          500.0      500.0
11 1/2% Senior Notes due May 1, 2009............................................          202.3         --
12% Senior Notes due July 15, 2008..............................................          148.8         --
Greene County Partners, Inc. senior notes due in quarterly payments of
$450,000 bearing interest at 6.35% and maturing in April 2001...................            9.9       11.7
ICTC Series K, 8.620% First Mortgage Bonds due September 2022 (A)...............           10.0       10.0
ICTC Series L, 7.050% First Mortgage Bonds due October 2013 (A).................           10.0       10.0
Capitalized Lease payable, due in various installments payments, bearing
  interest at 3.90% to 11.5%, with final payment due in December 2004...........           30.9       11.5
Note payable due in various annual installments, including
 interest at 8.25%, through 2006. Collateralized by publishing
  rights to purchased directories...............................................            0.5        0.5
Other long-term borrowings, due in various installments
 bearing interest at rates ranging from 0% to 9.75%
  through March 2004............................................................            3.1        3.5
Note Payable, bearing interest at 5%, due January, 2000.........................             --        4.6
Incentive compensation agreements, due in various
  estimated amounts plus interest at 6.0% through
  January 2001..................................................................            0.1        0.6
                                                                                       --------   --------
                                                                                        2,759.5    1,778.2
Less current maturities.........................................................           27.3       14.4
                                                                                       --------   --------
                                                                                       $2,732.2   $1,763.8
                                                                                       ========   ========
</TABLE>
________________________
(A) ICTC's first mortgage bonds are collateralized by substantially all real and
    personal property of the subsidiary. The bond indenture contains various
    provisions restricting, among other things, the payment of dividends and
    repurchase of its own stock. Early redemption of the Series K and Series L
    Bonds is permitted.


In 1996, the Company used a portion of the proceeds from the Company's initial
public offering to pay off all existing indebtedness under three line of credit
facilities, which were then canceled. Options to purchase shares of Class B
common stock, $.01 par value, of the Company were granted to a stockholder which
had guaranteed borrowings under two of the facilities. The Company used the
Black-Scholes model to determine the value of the options, which was
approximately $3.4 million, at the date of grant. This value was being amortized
over the vesting period of the options. Upon cancellation of the credit
facilities, the options' vesting schedule and amortization of the fair value of
the options were terminated. A total of 4,687,500 and 7,804,128 Class B common
stock options were outstanding at December 31, 2000 and December 31, 1999,
respectively.

                                      F-14
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 4. Pledged Assets and Debt--(Continued)

Principal payments required on the outstanding debt at December 31, 2000 are as
follows (in millions):


         2001                                            $   27.3
         2002                                                14.4
         2003                                                 4.5
         2004                                                 6.6
         2005                                                 5.8
         Later years..........................            2,700.9
                                                         --------
                                                         $2,759.5
                                                         ========

Note 5. Leases and Commitments

Leases: The Company leases certain of its office and network facilities under
noncancelable agreements which expire at various times through September 2022.
These agreements require various monthly rentals plus the payment of applicable
property taxes, maintenance and insurance. The Company also leases vehicles and
equipment under both operating and capital lease agreements which expire at
various times through January 2009 and require various monthly rentals.
Amortization on the capitalized assets is included in depreciation expense.
Interest rates are imputed at 3.9% to 11.5%.


The total minimum commitment at December 31, 2000 under the operating and
capital leases mentioned above is as follows (in millions):

                                                     Capital     Operating
                                                     Leases       Leases
                                                     ------       ------
2001............................................     $19.6       $ 37.6
2002............................................      13.8         29.9
2003............................................       0.7         33.7
2004............................................       0.1         31.7
2005............................................        --         25.3
Remaining.......................................        --         79.3
                                                     ------      -------
                                                      34.2        237.5
                                                                 =======
Less amount representing interest...............       3.3
                                                     ------
Present value of net minimum lease payments.....      30.9
Less current portion of obligations under
 capital leases.................................      16.5
                                                     -----
Long-term obligations under capital leases......      14.4
                                                     =====

The total rental expense included in the consolidated statements of operations
for 2000, 1999 and 1998 is approximately $59.1 million, $21.9 million, and $19.8
million, respectively, which also includes short-term rentals for office
facilities.

                                      F-15
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 5. Leases and Commitments--(Continued)

Alcatel: In January 1999 the Company entered into an agreement with Alcatel USA
Marketing, Inc. to purchase equipment, software and services for a total
commitment of $200 million over a six (6) year period. If McLeodUSA does not
meet the committed purchases on a cumulative annual basis, Alcatel retains the
right to renegotiate the applicable prices. If regulatory conditions
substantially prevent the Company from continuing to implement its current
network deployment plans, the Company has the option to request renegotiation of
unit prices based on revised quantities of products or to renegotiate unit
prices based on the quantities of products purchased to that time and cease any
further purchases of products.

Note 6. Income Tax Matters

Net deferred taxes consist of the following components as of December 31, 2000
and 1999:


                                                                2000       1999
                                                               ------     ------
                                                                 (In millions)
    Deferred tax assets:
      Net operating loss carryforwards....................     $586.1     $214.0
      Accruals and reserves not currently deductible......       48.3       35.9
      Deferred revenues...................................        8.9       11.3
      Intangibles and other assets........................        9.1        8.5
      Other...............................................       10.2        5.1
                                                               ------     ------
                                                                662.6      274.8
      Less valuation allowance............................      520.5      169.6
                                                               ------     ------
                                                                142.1      105.2
                                                               ------     ------
    Deferred tax liabilities:
      Property and equipment..............................       60.6       64.3
      Other investments...................................       21.3       15.9
      Differences in revenue recognition..................        3.9        9.6
      Deferred line installation cost.....................       43.5       11.9
      Other...............................................       12.8        3.5
                                                               ------     ------
                                                                142.1      105.2
                                                               ------     ------
                                                               $   --     $   --
                                                               ======     ======

A valuation allowance has been recognized to offset the related net deferred tax
assets due to the uncertainty of realizing the benefit of the loss
carryforwards. The Company has available net operating loss carryforwards
totaling approximately $1,357 million which expire in various amounts in the
years 2008 to 2020.

The income tax rate differs from the U. S. Federal income tax rate for 2000,
1999 and 1998 due to the following:

<TABLE>
<CAPTION>
                                                                           2000      1999     1998
                                                                           ----      ----     ----
     <S>                                                                   <C>      <C>      <C>
     "Expected" tax (benefit) rate.....................................    (35)%     (35)%    (35)%
     Percent increase (decrease) in income taxes resulting from:
     Change in valuation allowance.....................................      33        36       34
     Tax deductions due to exercises of incentive stock options........      (9)       (7)      (2)
     Goodwill amortization for stock purchases.........................      11         5        6
     Other.............................................................       0         1       (3)
                                                                           ----      ----     ----
                                                                             --%       --%      --%
                                                                           ====      ====     ====
</TABLE>

                                      F-16
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 7. Stock-based Compensation Plans

At December 31, 2000, the Company has various stock-based compensation plans
which are described below. Grants under the Company's stock option plans are
accounted for in accordance with Accounting Principles Board (APB) Opinion No.
25 and related Interpretations. The Company granted a total of 9,922,128 stock
options in January and February 1996 at an exercise price of $0.445 per share.
The estimated aggregate fair market value of these options at the date of grant
was later determined to exceed the aggregate exercise price by approximately
$9,190,000. Additionally, in September 1997, the Company granted a total of
8,813,670 stock options at an exercise price of $4.08 per share. The aggregate
fair market value of these options at the date of grant exceeded the aggregate
exercise price by approximately $15,790,000. As a result, the Company is
amortizing these amounts over the four-year vesting period of the options.
Compensation cost of $4,995,000, $6,629,000, and $5,820,000 has been charged to
income for the years ended December 31, 2000, 1999 and 1998, respectively, using
the intrinsic value based method as prescribed by APB No. 25. Had compensation
cost for all of the stock-based compensation plans been determined based on the
grant date fair values of awards granted during 2000, 1999 and 1998, as
prescribed by SFAS No. 123, reported net loss and loss per common share would
have been as follows (in millions, except per share data):



                                                              December 31,
                                                   -----------------------------
                                                     2000       1999      1998
                                                   -------    -------   --------
Pro forma net loss...............................  $(744.4)   $(307.6)  $(151.2)
Pro forma loss per common share..................    (1.33)     (0.69)    (0.40)

1992, 1993 and 1995 Incentive Stock Option Plans: The Company has reserved
4,144,608 shares of its Class A common stock, $.01 par value ("Class A common
stock"), for issuance to employees under the 1992, 1993 and 1995 Incentive Stock
Option Plans. Options outstanding under these plans were granted at prices equal
to the estimated fair market value on the dates of grant as determined by the
Company's Board of Directors. Under the 1992 and 1993 plans, all options granted
become exercisable at a rate of 25% per year, on a cumulative basis, and expire
seven years after the date of grant. Under the 1995 plan, all options, except
for options granted to the Company's chairman and chief executive officer,
become exercisable at a rate of 25% per year, on a cumulative basis, beginning
five years from the date of grant. The options granted to the Company's chairman
and chief executive officer vest at a rate of 20% per year on a cumulative
basis. All options granted under the 1995 plan expire ten years after the date
of grant. These plans have been superseded by the 1996 Employee Stock Option
Plan, and no future grants of options will be made under these plans.

1996 Employee Stock Option Plan: In 1997, the Company's stockholders approved an
amendment to the 1996 Employee Stock Option Plan to increase the number of Class
A common shares available under the plan to 225,000,000 shares from 27,150,000
shares. At December 31, 2000, after adjusting for option exercises, the Company
has reserved 206,610,493 shares of Class A common stock for issuance under the
plan, which supersedes the 1992, 1993 and 1995 Incentive Stock Option Plans. The
exercise price for incentive stock options granted under this plan is no less
than the fair market value, as defined in the Plan of the Company's Class A
common stock on the date of the grant (or 110% of the fair market value if the
grantee beneficially owns more than 10% of the outstanding Class A common
stock). The options granted expire ten years after the grant date (or five years
after the grant date if the grantee beneficially owns more than 10% of the
outstanding Class A common stock) and vest over periods determined by the
Compensation Committee. However, options will qualify as incentive stock options
only to the extent that the aggregate exercise price for options that become
first exercisable by an employee in any calendar year does not exceed $100,000.
The 1996 Plan will terminate in March 2006, unless terminated earlier by the
Board of Directors.

                                      F-17
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 7. Stock-based Compensation Plans(Continued)

In 2000, in connection with the Splitrock and CapRock acquisitions, the Company
substituted 9,051,372 options under the 1996 Employee Stock Option Plan for
options which were outstanding under Splitrock and CapRock option plans at the
time of acquisition. The options were converted to the Company's plan based on a
conversion ratio, which resulted in a different number of options and exercise
price than the options originally granted by Splitrock or CapRock, but retained
the same terms as the original grant, including the grant date, expiration date,
vesting schedule and total exercise cost.

Directors' Stock Option Plan:   The Company has reserved, after adjusting for
option exercises,  3,986,250 shares of Class A common stock for issuance under
the Directors' Plan to directors who are not officers or employees of the
Company. The Director's Plan was adopted and approved by the stockholders in
1993.  The Plan was amended and restated in 1996 to be a "formula" plan
providing for an automatic grant of options to eligible directors. In 1999 a
further amendment and restatement to the Plan was adopted and approved by
stockholders.  Under the Plan as currently amended and restated each eligible
director who commences service after the 1999 amendment and restatement will be
granted an initial option to purchase from 60,000 to 120,000 shares of Class A
common stock, such amount to be determined by the Board of Directors in its
discretion.  Each such eligible director also will be granted an additional
option to purchase up to 60,000 shares of Class A common stock after each
subsequent annual meeting of the stockholders.  In addition each eligible
director may receive discretionary options to purchase shares of Class A common
stock as may be determined by the Board of Directors in its discretion.
However, no more than an aggregate of 600,000 shares of Class A common stock may
be granted as discretionary options under the plan as currently amended and
restated.  Options granted under the Directors' Plan vest at a rate of 25% per
year, on a cumulative basis, and expire seven years after the date of grant (ten
years after the date of grant for options granted under the amended and restated
plan). However, upon a change in control of the Company as defined in the
Directors' Plan, all options will become fully exercisable. The Company has the
right to repurchase any Class A common stock issued pursuant to the exercise of
an option granted under this plan that is offered for sale to an individual who
is not an employee or director of the Company. The Directors' Plan will
terminate in March 2006, unless terminated earlier by the Board of Directors.

The fair value of each grant under the Company's stock option plans is estimated
at the grant date using the Black-Scholes option-pricing model with the
following weighted-average assumptions for grants in 2000, 1999 and 1998,
respectively: no expected dividends, risk-free interest rates of 6.36%, 6.26%
and 4.65%; price volatility of 90.52%, 68.44% and 59.39% and expected lives of 4
years for grants in 2000, 1999 and 1998.

Employee Stock Purchase Plan:   Under the stock purchase plan, employees may
purchase up to an aggregate of 6,000,000 shares of Class A common stock through
payroll deductions. Employees of the Company who have been employed more than 90
days and who are regularly scheduled to work more than 20 hours per week are
eligible to participate in the plan, provided that they own less than five
percent of the total combined voting power of all classes of stock of the
Company. The purchase price for each share will be determined by the
Compensation Committee, but may not be less than 85% of the closing price of the
Class A common stock on the first or last trading day of the applicable purchase
period, whichever is lower.  No employee may purchase in any calendar year Class
A common stock having an aggregate fair value in excess of $25,000 as determined
by the closing price of the Class A common stock on the first trading day of the
relevant purchase period or periods. Upon termination of employment, an employee
other than a participating employee who is subject to Section 16(b) under the
Securities Exchange Act of 1934, as amended, will be refunded all moneys in his
or her account and the employee's option to purchase shares will terminate. The
plan will terminate in March 2006, unless terminated earlier by the Board of
Directors. The Company

                                      F-18
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 7. Stock-based Compensation Plans(Continued)

implemented this plan effective February 1, 1997. Under the plan, the Company
sold 849,995 shares of Class A common stock in 2000, 941,727 shares in 1999 and
797,358 shares in 1998. The fair value of the employees' purchase rights was
calculated for disclosure purposes using the Black-Scholes model with the
following assumptions: an expected life of 6 months in 2000 and 12 months in
both 1999 and 1998; a risk-free interest rate of 6.36% in 2000, 6.26% in 1999
and 4.65% in 1998; expected volatility of 90.52% in 2000, 68.44% in 1999 and
59.39% in 1998; and no expected dividends. The weighted average fair value of
each purchase right granted in 2000 was $7.25, in 1999 was $6.05 and in 1998 was
$5.38.

A summary of the status of the Company's stock option plans as of and for the
years ended December 31, 2000, 1999 and 1998 is as follows (in thousands, except
price data):


<TABLE>
<CAPTION>
                                                                                                                 Weighted-
                                                                                                                  Average
                                                                                                                  Exercise
                                                                                                  Shares           Price
                                                                                              ---------------  --------------
<S>                                                                                           <C>              <C>
Outstanding at January 1, 1998.................................................................       63,648           $ 2.40
   Granted.....................................................................................       37,638             5.21
   Exercised...................................................................................       (8,238)            0.45
   Forfeited...................................................................................      (19,422)            5.98
                                                                                                     -------
Outstanding at December 31, 1998...............................................................       73,626             3.12
   Granted.....................................................................................       44,961             7.33
   Exercised...................................................................................      (12,483)            1.87
   Forfeited...................................................................................       (4,830)            5.36
                                                                                                     -------
Outstanding at December 31, 1999...............................................................      101,274             4.99
                                                                                                     -------
   Granted.....................................................................................       43,190            19.03
   Substituted and converted in connection with acquisitions...................................        9,051             9.55
   Exercised...................................................................................      (19,438)            2.61
   Forfeited...................................................................................       (7,176)           11.44
                                                                                                     -------
Outstanding at December 31, 2000...............................................................      126,901            10.08
                                                                                                     =======
</TABLE>



<TABLE>
<CAPTION>
                                                                                                   Number of Options
                                                                                        ---------------------------------------
                                                                                              2000            1999         1998
                                                                                           -------         -------      -------
<S>                                                                                     <C>         <C>             <C>
  Exercisable, end of year............................................................      31,938          21,279       16,656
                                                                                           =======         =======      =======
  Weighted-average fair value per option of options granted
          during the year.............................................................     $ 12.48         $  4.11      $  3.03
                                                                                           =======         =======      =======
</TABLE>

                                      F-19
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Note 7. Stock-based Compensation Plans(Continued)

Other pertinent information related to the options outstanding at December 31,
2000 is as follows:


<TABLE>
<CAPTION>
                                                      Options Outstanding                     Options Exercisable
                                        ------------------------------------------------   --------------------------
                                                        Weighted-
                                                         Average         Weighted-                          Weighted-
                                                        Remaining         Average                            Average
                                          Number       Contractual       Exercise             Number        Exercise
       Range Of Exercise Prices         Outstanding       Life             Price            Exercisable       Price
       ------------------------         -----------    -----------       ---------          -----------    ----------
<S>                                     <C>            <C>               <C>                <C>          <C>
$0.13 to $0.70........................    5,613,277       3.5             $ 0.45              4,600,777      $ 0.47
$0.71 to $2.96........................    9,649,745       6.1               2.89              3,066,702        2.74
$3.10 to $4.96........................   26,683,083       7.5               4.26             10,822,652        4.28
$5.02 to $7.50........................   25,905,303       8.0               6.30              6,465,261        6.11
$7.51 to $11.25.......................   13,969,322       8.5               8.25              3,490,235        8.32
$11.26 to $16.87......................    7,308,031       9.1              13.88              2,173,953       14.02
$17.25 to $17.54......................   24,587,479       3.9              17.52                 27,181       17.28
$17.55 to $20.46......................    9,656,333       9.2              20.42                165,950       18.28
$20.47 to $30.70......................    2,531,150       9.2              22.22                132,829       23.15
$30.71 to $124.48.....................      996,859       8.8              71.99                992,017       72.09
                                        -----------                                          ----------
                                        126,900,582       7.0             $10.08             31,937,557      $ 7.33
                                        ===========                                          ==========
</TABLE>

In addition, options to purchase shares of Class B common stock were granted to
a stockholder which had guaranteed borrowings under certain credit facilities
which were paid off with a portion of the proceeds from the Company's initial
public offering. Those options which are still held by the stockholder have an
exercise price of $0.2444 and were fully vested at December 31, 2000.

                                      F-20
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 8. Capital Stock Information and Stockholders' Agreements

Authorized Capital Stock.  Under the certificate of incorporation, the Company
has the authority to issue 2,034,000,000 shares of capital stock, consisting of
2,000,000,000 shares of  Class A common stock, par value $.01 per share;
22,000,000 shares of Class B common stock, par value $.01 per share; 2,000,000
shares of serial preferred stock, par value $.01 per share; and 10,000,000
shares of Class II serial preferred stock, par value $.001 per share.

Redeemable Convertible Preferred Stock:  Pursuant to a Stock Purchase Agreement
dated August 30, 1999 (the "Stock Purchase Agreement"), the Company issued on
September 15, 1999 (the "Issue Date") 275,000 shares of Series B preferred
stock, par value $.01 per share, ("Series B preferred stock") and 125,000 shares
of Series C preferred stock, par value $.01 per share, ("Series C preferred
stock" and together with the Series B preferred stock, the "Preferred Shares")
through a private offering. Net proceeds from the financing amounted to
approximately $1 billion.  The Preferred Shares are redeemable on a
proportionally equal basis, in whole or in part, by the Company at any time
following the seventh anniversary of the Issue Date, or by the holders within
180 days following the tenth anniversary of the Issue Date.  The Preferred
Shares are convertible on a proportionally equal basis, at the Series B holders
option, in whole or in part at any time into Class A Common Stock. Shares of
each series will have a liquidation preference of $2,500.00 per share plus
accrued and unpaid dividends, if any, and will be convertible into shares of the
Company's Class A common stock at a rate of (a) the liquidation preference
divided by (b) $36.50.  Each share of Series B preferred stock is entitled to
receive a quarterly dividend  of approximately $31.82.  Dividends are cumulative
and payable quarterly on March 31, June 30, September 30, and December 31.  If
prior to the fifth anniversary of the Issue Date the Company pays a dividend on
its Class A common stock, par value $.01 per share ("Class A common stock"),
holders of the Preferred Shares shall be entitled to receive an equivalent
dividend calculated on a common stock equivalent basis as if the Preferred
Shares had been converted into Class A common stock.  Holders of Series B
preferred stock are not entitled to voting rights other than the right to vote
as a series for the election of two additional members to the Board of
Directors.  Board representation decreases as the outstanding shares of the
Series B preferred stock decreases.  Holders of Series C preferred stock are not
entitled to voting rights other than the right to vote as a series for the
election of one observer to the Board of Directors.  Board representation
decreases as the outstanding shares of the Series C preferred stock decreases.
The Series B and Series C preferred stock rank on a parity with the company's
6.75% Series A cumulative convertible preferred stock, par value $.01 per share
(the "Series A preferred stock"), with respect to dividend rights and rights on
liquidation.

Cumulative Convertible Preferred Stock: The Company issued one million shares of
its Series A preferred stock on August 11, 1999 and an additional 150,000 shares
on August 23, 1999.  Holders of Series A preferred stock are entitled to receive
cumulative dividends at an annual rate of 6.75% of the liquidation preference
payable quarterly on each February 15, May 15, August 15 and November 15.  The
quarterly dividend is $4.21875 per share, payable at the Company's option in
cash or shares of its Class A common stock.  Series A preferred stock is
convertible at the option of its holder, unless previously redeemed, at any time
after the issue date, into shares of its Class A common stock at a conversion
rate of 25.79979 shares of Class A common stock for each share of Series A
preferred stock (representing a conversion price of $9.69 per share of Class A
common stock), subject to adjustment in certain events.  In addition, if on or
after August 15, 2002, the closing price of its Class A common stock has equaled
or exceeded 135% of the conversion price for at least 20 out of 30 consecutive
business days, the Company will have the option to convert all of the Series A
preferred stock into Class A common stock at the then current conversion rate.
The holders of the Series A preferred stock will not be entitled to any voting
rights unless payments of dividends on the Series A preferred stock are in
arrears and unpaid for an aggregate of six or more quarterly dividend payments.

                                      F-21
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 8. Capital Stock Information and Stockholders' Agreements

Stockholders' Agreements:  The Company has various agreements with significant
stockholders, which among other things, restrict the sale of equity securities
without the prior written consent of the Company and establish certain
representation on the board of directors for certain significant stockholders.
These Agreements terminate at various dates through December 31, 2002.

Note 9.  Change-of-Control Agreements

Change-of-Control Agreements: The Company has entered into change-of-control
agreements with certain executive employees, which provide for certain payments
in connection with termination of employment after a change of control (as
defined within the agreements) of the Company. The change-of-control agreements
terminate on December 31, 2006 unless a change of control occurs during the six-
month period prior to December 31, 2006, in which case the agreements terminate
on December 31, 2007. The agreements provide that if an executive terminates his
or her employment within six months after a change of control or if the
executive's employment is terminated within 24 months after a change of control
in accordance with the terms and conditions set forth in the agreements, the
executive will be entitled to certain benefits. The benefits include cash
compensation, immediate vesting of outstanding stock options and coverage under
the Company's group health plan.

Employment agreements with the Company's top three executive employees also
contain provisions relating to change of control.  These employment agreements,
which expire on January 7, 2003, provide that if the executive's employment is
terminated in connection with a change of control, whether by the executive or
by the Company or its successor, then the executive will be entitled to certain
severance benefits.  These benefits include foregone salary and other cash
compensation, immediate vesting of all outstanding options to purchase common
stock of the Company, and continuing coverage under the Company's group
insurance programs for the remainder of the term of the relevant employment
agreement.

Note 10. Retirement Plans and Postretirement Benefits

Illinois Consolidated Telephone Company ("ICTC"), a wholly-owned subsidiary of
the Company, maintains noncontributory defined pension and death benefit plans
covering substantially all of its hourly employees. The pension benefit formula
used in the determination of pension cost is based on the highest five
consecutive calendar years' base earnings within the last ten calendar years
immediately preceding retirement or termination. It is ICTC's policy to fund
pension costs as they accrue subject to any applicable Internal Revenue Code
limitations.

In addition to providing pension benefits, ICTC provides an optional retiree
medical program to its salaried and union retirees and spouses under age 65 and
life insurance coverage for the salaried retirees. All retirees are required to
contribute to the cost of their medical coverage while the salaried life
insurance coverage is provided at no cost to the retiree.

                                      F-22
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 10. Retirement Plans and Postretirement Benefit (Continued)

The change in benefit obligations and the change in plan assets for 2000 and
1999, and the components of net periodic benefit costs and the weighted-average
assumptions for 2000, 1999 and 1998, are as follows (in millions):


<TABLE>
<CAPTION>
                                                     Pension Benefits    Postretirement Benefits
                                                    ------------------  -------------------------
                                                       2000      1999          2000         1999
                                                     ------    ------         -----        -----
<S>                                                 <C>       <C>       <C>           <C>
Change in benefit obligations
-----------------------------
Benefit obligation at beginning of year..........    $ 41.3    $ 45.1         $ 5.5        $ 4.6
Service cost.....................................        .7        .8            .1           .1
Interest cost....................................       3.0       2.9            .4           .4
Benefits paid....................................      (2.1)     (2.8)          (.2)         (.2)
Actuarial gains..................................      ( .4)     (4.7)          (.2)          .6
                                                     ------    ------         -----        -----
Benefit obligation at end of year................    $ 42.5    $ 41.3         $ 5.6        $ 5.5
                                                     ======    ======         =====        =====

Change in plan assets
---------------------
Fair value of plan assets at beginning of
 year............................................    $ 54.4    $ 52.2         $  --        $  --

Actual return on plan assets......................      1.7       5.0            --           --
Employer contributions............................       --        --            .2           .2
Benefits paid....................................      (2.1)     (2.8)          (.2)         (.2)
                                                     ------    ------         -----        -----
Fair value of plan assets at end of year.........    $ 54.0    $ 54.4         $  --        $ --
                                                     ======    ======         =====        =====




Funded status ...................................    $ 11.5    $ 13.1         $(5.5)       $(5.5)
Unrecognized net actuarial gain..................     (16.7)    (18.6)         (3.0)        (3.0)
Unrecognized prior service cost..................       3.5       4.0          (1.9)        (2.0)
Unrecognized transition (asset) or
 obligation......................................       (.1)      (.1)          3.6          3.9
                                                     ------    ------         -----        -----
Accrued benefit cost.............................    $ (1.8)   $ (1.6)        $(6.8)       $(6.6)
                                                     ======    ======         =====        =====
</TABLE>


<TABLE>
<CAPTION>
                                             Pension Benefits       Postretirement Benefits
                                         ------------------------  --------------------------

                                           2000    1999     1998      2000     1999     1998
                                          -----   -----    -----     -----    -----    -----
<S>                                      <C>      <C>     <C>      <C>       <C>      <C>
Components of net
periodic benefit costs
----------------------
Service cost............................  $  .7   $  .8    $  .7     $  .1    $  .1    $  .1
Interest cost...........................    3.0     2.9      3.9        .4       .4       .4
Expected return on plan assets..........   (4.2)   (4.1)    (5.0)       --       --       --
Amortization of prior service
      costs.............................     .5      .5       .5       (.2)     (.2)     (.2)
Amortization of transitional
      obligation........................     --      --       --        .4       .4       .4
Recognized actuarial gain...............   (1.1)    (.9)    (1.7)      (.2)     (.1)     (.2)
                                          -----   -----    -----     -----    -----    -----
Net periodic benefit cost...............  $(1.1)  $ (.8)   $(1.6)    $  .5    $  .6    $  .5
                                          =====   =====    =====     =====    =====    =====

Weighted-average assumption
as of December 31
----------------------------
Discount rate...........................    7.5%    7.5%       7%      7.5%     7.5%       7%
Expected return on plan assets..........      8%      8%       8%       --       --       --
Rate of compensation increase...........      5%      5%       5%        5%       5%       5%
</TABLE>

                                      F-23
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 10. Retirement Plans an Postretirement Benefits (Continued)

The postretirement benefit obligation is calculated assuming that health-care
costs increased by 8.0% in 2000 and 7.5% in 2001, and that the rate of increase
thereafter (the health-care cost trend rate) will decline to 5% in 2006 and
subsequent years. The health-care cost trend rate has a significant effect on
the amounts reported for costs each year as well as on the accumulated
postretirement benefit obligation. For example, a one percentage point increase
each year in the health-care trend rate would have the following effects:


<TABLE>
<CAPTION>
                                            One Percentage            One Percentage
( in millions)                              Point Increase            Point Decrease
                                            ---------------           --------------
<S>                                         <C>                       <C>
Effect on total of service and
 interest cost components in 2000                $0.04                      $0.04


Effect on year-end 2000
 postretirement benefit obligations              $ 0.4                      $(0.4)
 </TABLE>

The weighted average discount rate used in determining the benefit obligation
was 7.5% in 2000.


The postretirement medical and life insurance benefit plans have been modified
effective January 1, 1998 to provide benefits only to employees meeting certain
age and years of service requirements as of January 1, 1998.


Prior to January 1, 2000, pension benefits for substantially all employees of
DTG were provided through the National Telephone Cooperative Association
Retirement and Security Program (a defined benefit plan) and Savings Plan (a
defined contribution plan) (together the "NTCA Plans").  On January 1, 2000,
employees of DTG were given the option of remaining in the NTCA Plans or joining
the Company's 401(k) profit-sharing plan.  Substantially all employees elected
to participate in the Company's 401(k) profit-sharing plan. The Company
continues to make annual contributions to the NTCA Plans equal to the amounts
accrued for pension expense on the remaining employees.  The Retirement and
Security Program is a multi-employer plan and the accumulated benefits and plan
assets are not determined or allocated separately by the individual employer.
The total pension costs for 2000 and 1999 were $33,000 and $393,000.


The Company also has various 401(k) profit-sharing plans available to eligible
employees. The Company contributed Company stock valued at approximately $3.9
million, $3.0 million and $2.0 million for the years ended December 31, 2000,
1999 and 1998, respectively.  An additional discretionary 1998 contribution of
stock valued at $1.5 million was also made.


In addition the Company has a nonqualified deferred compensation plan, which
allows selected employees to defer a portion of any compensation received. Those
deferred amounts are invested in various funds at December 31, 2000 to provide
assets and accumulated earnings to offset the deferred compensation amounts due
to the participating employees.

                                     F-24
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 11.   Acquisitions


Talking Directories, Inc. (Talking Directories) and Info America Phone Books,
Inc. (Info America): On February 10, 1999, the Company acquired Talking
Directories in exchange for 15.3 million shares of its Class A common stock.  In
a related and concurrent transaction, on February 10, 1999, the Company acquired
Info America in exchange for 7.2 million shares of its Class A common stock.
The Company also paid outstanding obligations of Talking Directories and Info
America of approximately $27 million.

Dakota Telecommunications Group, Inc. (DTG): On March 5, 1999, the Company
acquired DTG in exchange for approximately 5.7 million shares of its Class A
common stock, and the assumption of approximately $31 million in DTG debt.

Ovation Communications, Inc. (Ovation): On March 31, 1999, the Company acquired
Ovation in exchange for approximately 33.6 million shares of its Class A common
stock, and the payment of approximately $121.3 million in cash to the
stockholders of Ovation.  The total purchase price was approximately $310.2
million based on the average closing price of the Company's Class A common stock
five days before and after the date of the acquisition agreement.  The Company
also assumed approximately $105.6 million in Ovation debt.

Access Communications Holdings, Inc. (Access) and S.J. Investments Holdings,
Inc. (SJIH): On August 14, 1999, the Company acquired Access and SJIH in
exchange for approximately 11.6 million shares of its Class A common stock, and
the payment of $48.3 million in cash to the stockholders of Access and SJIH.
The Company also assumed approximately $96.7 million in Access and SJIH debt.

Splitrock Services, Inc. (Splitrock):  On March 30, 2000, the Company acquired
Splitrock pursuant to the Amended Plan of Merger dated February 11, 2000, in
exchange for approximately 93.2 million shares of Class A common stock.  The
total purchase price was approximately $2.3 billion based on the average closing
price of the Company's Class A common stock five days before and after January
6, 2000, the initial date of the Merger Agreement.  Approximately $261 million
in Splitrock debt remained outstanding after the closing.  This debt has been
paid off (Note 4).  The purchase price includes approximately $29.4 million of
direct acquisition costs.

CapRock Communications Corp. (CapRock):  On December 7, 2000, the Company
acquired CapRock pursuant to an Agreement and Plan of Merger, dated October 2,
2000, in exchange for approximately 15.0 million shares of Class A common stock.
The total purchase price was approximately $579 million based on average closing
price of the Company's Class A common stock for the ten trading days beginning
five days prior to October 2, 2000, the date the merger agreement was announced,
and ending four days after such announcement, plus the principal amount of
outstanding CapRock senior notes of $360 million.  The purchase includes
approximately $11 million of costs directly attributed to the merger.

                                     F-25
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 11. Acquisition--(Continued)

The following table summarizes the purchase price allocations for the Company's
business acquisitions (in millions):

<TABLE>
<CAPTION>
            Transaction Year:                                          2000            1999            1998
            -----------------                                        --------         -------           -----
            <S>                                                      <C>              <C>               <C>
            Cash purchase price...........................           $   30.4         $ 230.8           $27.8
            Acquisition costs.............................              112.2             8.7             0.2
            Contracts payable.............................                 --             3.0             9.3
            Option agreements.............................              103.3             0.8              --
            Promissory notes..............................               59.1            14.8             1.0
            Stock issued..................................            2,045.0           480.2            11.4
            Note received.................................                 --            (1.6)             --
                                                                     ----------------------------------------
                                                                     $2,350.0         $ 736.7           $49.7
                                                                     ========================================

            Working capital acquired, net.................           $  (88.1)        $ (16.4)          $(0.1)
            Fair value of other assets acquired...........              765.3           133.0            13.5
            Goodwill and other intangibles................            2,318.1           874.0            38.7
            Liabilities assumed...........................             (645.3)         (253.9)           (2.4)
                                                                     ----------------------------------------
                                                                     $2,350.0         $ 736.7           $49.7
                                                                     ========================================
</TABLE>

These acquisitions have been accounted for under the purchase method and the
results of operations are included in the consolidated financial statements
since the dates of acquisition.

The unaudited consolidated results of operations for the years ended December
31, 2000 and 1999 on a pro forma basis as though the above entities had been
acquired as of the beginning of the respective periods are as follows:

<TABLE>
<CAPTION>
                                                                               2000                1999
                                                                             --------            --------
      <S>                                                                    <C>                 <C>
                                                                                (In millions, except
                                                                                   per share data)
      Revenue.....................................................           $1,685.8            $1,273.7
      Net loss applicable to common shares........................             (616.9)             (351.2)
      Loss per common share.......................................              (1.04)              (0.62)
</TABLE>

The pro forma financial information is presented for informational purposes only
and is not necessarily indicative of the operating results that would have
occurred had the acquisitions been consummated as of the above dates, nor are
such operating results necessarily indicative of future operating results.

Note 12.   Related Party Transactions

The Company has entered into agreements with a stockholder that give certain
rights-of-way to the Company for the construction of its telecommunications
network in exchange for capacity on the network.

The Company provided and purchased services from various companies, the
principals of which are stockholders or directors of McLeodUSA Incorporated or
are affiliates.  Revenues from services provided totaled $6.1 million, $4.2
million and $3.7 million and services purchased, primarily rent, legal services
and database verification services, totaled $20.6 million, $5.0 million and $3.1
million for the years ended December 31, 2000, 1999 and 1998, respectively.

                                     F-26
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 12. Related Party Transactions--(Continued)

In December 1998, the Company entered into a split dollar arrangement for life
insurance policies owned by the McLeod Family 1998 Special Trust (the "Owner")
on the joint lives of Clark and Mary McLeod (the "McLeods").  The Owner agreed
to assign the policies to the Company as collateral for the premium payments.
No loans have been taken against these policies.  The premium payments paid by
the Company totaled $1.9 million in both 2000 and 1999.  The aggregate face
amount of the policies is $113 million.  The McLeod Family 1998 Special Trust is
sole owner and beneficiary of each policy.  The Company has agreed with Clark
and Mary McLeod that one of the principal reasons for entering into this
arrangement is to avoid the need for their heirs to liquidate their holdings of
Class A common stock at or soon after the death of one or both of them.  Clark
and Mary McLeod have agreed to restrictions on their ability to sell or
otherwise dispose of their shares of Class A common stock.  The Company also
paid premiums of $71,000 in both 2000 and 1999 for a universal life policy on
Clark and Mary McLeod with a face value of $13.5 million.  The Company is the
beneficiary of this policy.

Note 13.   Quarterly Data--(Unaudited)

  The following tables include summarized quarterly financial data for the years
ended December 31:

<TABLE>
<CAPTION>
                                                                                     Quarters
                                                            -----------------------------------------------------------
                                                                First         Second          Third         Fourth
                                                            -------------  -------------  -------------  -------------
                                                                      (In millions, except per share data)
<S>                                                         <C>            <C>            <C>            <C>
2000:
 Revenue.....................................................     $288.3        $ 331.8        $ 366.6        $ 410.0
 Operating loss..............................................      (42.6)        (101.5)         (98.5)        (106.3)
 Net loss....................................................      (58.5)        (125.7)        (152.2)        (140.9)
 Loss applicable to common shares............................      (72.1)        (139.3)        (165.8)        (154.5)
 Loss per common share.......................................      (0.15)         (0.24)         (0.28)         (0.26)

 1999:
 Revenue.....................................................     $181.1        $ 222.7        $ 241.1        $ 263.9
 Operating loss..............................................      (26.3)         (32.5)         (36.7)         (36.2)
 Net loss....................................................      (47.5)         (61.4)         (58.4)         (53.0)
 Loss applicable to common shares............................      (47.5)         (61.4)         (62.5)         (66.6)
 Loss per common share.......................................      (0.12)         (0.14)         (0.14)         (0.14)

 1998:
 Revenue.....................................................     $134.3        $ 155.7        $ 148.6        $ 165.5
 Operating loss..............................................      (20.8)         (17.3)         (21.3)         (15.3)
 Net loss....................................................      (30.3)         (29.8)         (33.0)         (31.8)
 Loss applicable to common shares............................      (30.3)         (29.8)         (33.0)         (31.8)
 Loss per common share.......................................      (0.08)         (0.08)         (0.09)         (0.08)
</TABLE>

                                     F-27
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Note 14:  Information by Business Segment

The Company operates predominantly in three reportable operating segments:  (1)
providing telecommunications and related services, such as local and long
distance service and expanding fiber optic network; (2) selling advertising
space in telephone directories, and publishing and distributing directories to
local area subscribers; and (3) providing end-to-end data communications.  These
business segments have separate management teams and infrastructures that offer
different products and services.

The acquisition of Splitrock on March 30, 2000 introduced our third business
segment, end-to-end data communications services.  Since the data segment was
not part of McLeodUSA prior to March 30, 2000, the table below does not reflect
any data activity in 1999 and 1998.

The Company evaluates the performance of its operating segments based on
earnings before interest, taxes, depreciation and amortization, excluding
general corporate expenses ("EBITDA").  The accounting policies of the
reportable segments are the same as those described in Note 1 of Notes to
Consolidated Financial Statements.  Intersegment transfers are accounted for on
an arm's length pricing basis.

Identifiable assets (excluding intersegment receivables) are the Company's
assets that are identified in each business segment.  Corporate assets primarily
include cash and cash equivalents, investments in available-for-sale securities,
administrative headquarters and goodwill recorded as a result of acquisitions.

In 2000, 1999 and 1998, no single customer or group under common control
represented 10% or more of the Company's sales.

                                     F-28
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Segment information for the years 2000, 1999 and 1998 was as follows (in
millions):

<TABLE>
<CAPTION>
                                   Telecommunications   Directory     Data    Corporate     Total
                                   -------------------  ----------  --------  ----------  ----------
<S>                                <C>                  <C>         <C>       <C>         <C>
2000
Revenues.......................              $1,040.5      $253.9    $102.3   $  --        $1,396.7
                                 ==================================================================

EBITDA.........................                  68.3        43.2     (20.1)      (30.6)       60.8
Depreciation and
  amortization.................                (187.8)      (32.4)    (38.8)     (150.6)     (409.6)
Interest Income................                   1.1          .6       1.1        45.0        47.8
Interest Expense...............                  (4.7)         --      (9.4)     (137.3)     (151.4)
Other..........................                   (.3)        (.1)      (.3)         .2         (.5)
                                 ------------------------------------------------------------------
Net Income (Loss)..............                (123.4)       11.3     (67.5)     (273.3)     (452.9)
                                 ==================================================================

Total assets...................               3,110.2       521.1     277.5     3,456.8     7,365.6
Capital expenditures...........               1,707.3        66.5      94.1     1,721.5     3,589.4

---------------------------------------------------------------------------------------------------
1999
Revenues.......................              $  697.5      $211.3       N/A   $      --    $  908.8
                                 ==================================================================

EBITDA.........................                  44.4        33.8       N/A       (19.2)       59.0
Depreciation and
  amortization.................                (117.8)      (30.0)      N/A       (42.9)     (190.7)
Interest Income................                   1.9          --       N/A        40.7        42.6
Interest Expense...............                  (6.4)        (.7)      N/A      (129.7)     (136.8)
Other..........................                   7.0         (.1)      N/A        (1.3)        5.6
                                 ------------------------------------------------------------------
Net Income (Loss)..............                 (70.9)        3.0       N/A      (152.4)     (220.3)
                                 ==================================================================

Total assets...................               1,729.6       441.3       N/A     2,032.2     4,203.1
Capital expenditures...........                 716.9       217.2       N/A       382.5     1,316.6

---------------------------------------------------------------------------------------------------
1998
Revenues.......................              $  459.2      $144.9       N/A   $  --        $  604.1
                                 ==================================================================

EBITDA.........................                  13.1        18.8       N/A       (11.9)       20.0
Depreciation and
  amortization.................                 (56.1)       (9.8)      N/A       (23.2)      (89.1)
Interest Income................                    .9          .1       N/A        25.0        26.0
Interest Expense...............                  (5.2)         --       N/A       (73.0)      (78.2)
Other..........................                  (4.0)        (.1)      N/A          .5        (3.6)
                                 ==================================================================
Net Income (Loss)..............                 (51.3)        9.0       N/A       (82.6)     (124.9)
                                 ==================================================================

Total assets...................                 684.7       199.7       N/A     1,040.8     1,925.2
Capital expenditures...........                 251.4        26.4       N/A        61.9       339.7
</TABLE>

                                     F-29
<PAGE>

                    McLEODUSA INCORPORATED AND SUBSIDARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 15:   Effects of New Accounting Standards

Accounting for Derivative Instruments and Hedging Activities

Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended, is effective for
fiscal years beginning after June 15, 2000.  SFAS No. 133 establishes accounting
and reporting standards for derivative instruments and hedging activities by
requiring that entities recognize all derivatives as either assets or
liabilities at fair market value on the balance sheet. The Company does not
currently hold any derivative instruments or engage in hedging activities. As
such, the adoption of SFAS 133 as of January 1, 2001 had no effect on the
Company's operations.

Business Combinations and Intangible Assets--Accounting for Goodwill


On February 14, 2001, the FASB issued an Exposure Draft "Business Combinations
and Intangible Assets - Accounting for Goodwill."  The Exposure Draft requires
the use of a non-amortization approach to account for purchased goodwill and for
separately recognized (non-goodwill) intangible assets that have an indefinite
useful economic life.  Under this approach, goodwill and intangibles would not
be amortized, but would be written down and expensed against earnings only in
periods in which the recorded value exceeds the fair value.  The Company has not
yet quantified the impacts of adopting the new Exposure Draft, but it could
result in significant changes to amortization expense and the classification and
recording of intangibles currently on the books, as well as any future
acquisitions.

Note 16:  Subsequent Events

$750 million 11 3/8% Senior Notes.

On January 16, 2001 the Company completed a public offering of $750 million
aggregate principal amount of its 11 3/8% Senior Notes due January 1, 2009
(the "January 2001 Senior Notes"), yielding net proceeds of approximately $734.3
million.  Interest on the January 2001 Senior Notes will be payable in cash
semi-annually in arrears on January 1 and July 1 of each year, commencing July
1, 2001.

                                     F-30

<PAGE>

                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Stockholders of
McLeodUSA Incorporated:

     We have audited, in accordance with auditing standards generally accepted
in the United States, the financial statements of McLeodUSA Incorporated
included in this Form 10-K, and have issued our report thereon dated January 29,
2001.  Our audit was made for the purpose of forming an opinion on those
statements taken as a whole.  The supplemental Schedule II--Valuation and
Qualifying Accounts ("Schedule II") is presented for purposes of complying with
the Securities and Exchange Commission's rules and is not part of the basic
financial statements.  The Schedule II has been subjected to the auditing
procedures applied in the audit 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.

                                               ARTHUR ANDERSEN LLP



Chicago, Illinois
January 29, 2001

                                      S-1
<PAGE>

                            MCLEODUSA INCORPORATED
               SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
                       Column A                           Column B               Column C               Column D      Column E
                                                                                 Additions
                                                                       -----------------------------
                                                           Balance         Charged        Charged                      Balance
                                                             at              to              to                          at
                                                          Beginning       Cost and         Other                       End of
                     Description                          of Period       Expenses        Accounts     Deductions      Period
                     -----------                          ---------       --------        --------     ----------      ------
<S>                                                     <C>            <C>              <C>           <C>           <C>
Year Ended December 31, 1998:
  Allowance for doubtful accounts
    and discounts                                        $ 11,951,000  $ 19,620,000(1)   $        --   $16,003,000   $ 15,568,000
  Valuation reserve on deferred tax assets............     29,532,000    49,024,000               --            --     78,556,000
                                                         ------------  ------------      -----------   -----------   ------------
                                                         $ 41,483,000  $ 68,644,000      $        --   $16,003,000   $ 94,124,000
                                                         ============  ============      ===========   ===========   ============
Year Ended December 31, 1999:
  Allowance for doubtful accounts
    and discounts                                        $ 15,568,000  $ 20,412,000(2)   $ 7,015,000   $ 1,580,000   $ 41,415,000
  Valuation reserve on deferred tax assets............     78,556,000    91,037,000               --            --    169,593,000
                                                         ------------  ------------      -----------   -----------   ------------
                                                         $ 94,124,000  $111,449,000      $ 7,015,000   $ 1,580,000   $211,008,000
                                                         ============  ============      ===========   ===========   ============
Year Ended December 31, 2000:
  Allowance for doubtful accounts
    and discounts                                        $ 41,415,000  $ 35,221,000(3)   $22,243,000   $ 9,122,000   $ 89,757,000
  Valuation reserve on deferred tax assets............    169,593,000   350,952,000               --            --    520,545,000
                                                         ------------  ------------      -----------   -----------   ------------
                                                         $211,008,000  $386,173,000      $22,243,000   $ 9,122,000   $610,302,000
                                                         ============  ============      ===========   ===========   ============
</TABLE>

__________________________________________________________
(1) Includes $15,000 of allowance for doubtful accounts and discounts related to
    acquisitions during the year.
(2) Includes $1,296,000 of allowance for doubtful accounts and discounts related
    to acquisitions during the year.
(3) Includes $5,753,000 of allowance for doubtful accounts and discounts related
    to acquisitions during the year.

                                      S-2
<PAGE>

                                 EXHIBIT INDEX
                                 -------------

4.37     First Amendment dated as of December 7, 2000 to the Senior Credit
         Agreement

4.38     Second Amendment dated as of January 11, 2001 to the Senior Credit
         Agreement

10.53    Interconnection Agreement Amendment Terms dated October 26, 2000
         between McLeodUSA Telecommunications Services, Inc. and Qwest
         Corporation

11.1     Computation of Loss per common and common equivalent share.

21.1     Subsidiaries of McLeodUSA Incorporated.

23.1     Consent of Arthur Andersen LLP.