<PAGE>   1

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                UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

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

                                   FORM 10-Q
      [X]       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001.

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

            FOR THE TRANSITION PERIOD FROM           TO           .

                        COMMISSION FILE NUMBER: 0-24509

                            ALLEGIANCE TELECOM, INC.
             (Exact name of registrant as specified in its charter)

<TABLE>
<S>                                             <C>
                  DELAWARE                                       75-2721491
        (State or other jurisdiction                            (IRS Employer
      of incorporation or organization)                      Identification No.)
</TABLE>

                         9201 NORTH CENTRAL EXPRESSWAY
                              DALLAS, TEXAS 75231
              (Address of principal executive offices) (Zip Code)

                                 (214) 261-7100
              (Registrant's telephone number, including area code)

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

     As of April 26, 2001, the registrant has 113,396,784 shares of common
stock, par value $0.01 per share outstanding.

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<PAGE>   2

                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

                                FORM 10-Q INDEX

<TABLE>
<CAPTION>

<S>                                                           <C>
PART I. FINANCIAL INFORMATION
  Item 1. Financial Statements
     Condensed Consolidated Balance Sheets as of March 31,
      2001 and December 31, 2000............................    2
     Condensed Consolidated Statements of Operations for the
      three months ended March 31, 2001 and 2000............    3
     Condensed Consolidated Statements of Cash Flows for the
      three months ended March 31, 2001 and 2000............    4
     Notes to Condensed Consolidated Financial Statements...    5
  Item 2. Management's Discussion and Analysis of Financial
     Condition and Results of Operations....................   10
  Item 3. Quantitative and Qualitative Disclosures about
     Market Risk............................................   26
PART II. OTHER INFORMATION
  Item 1. Legal Proceedings.................................   28
  Item 2. Changes in Securities and Use of Proceeds.........   28
  Item 3. Defaults Upon Senior Securities...................   28
  Item 4. Submission of Matters to a Vote of Security
     Holders................................................   28
  Item 5. Other Information.................................   28
  Item 6. Exhibits and Reports on Form 8-K..................   28
  Signatures................................................   29
</TABLE>

                                        1
<PAGE>   3

                         PART I. FINANCIAL INFORMATION

                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

                     CONDENSED CONSOLIDATED BALANCE SHEETS
                  (DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                               MARCH 31,    DECEMBER 31,
                                                                 2001           2000
                                                              -----------   ------------
                                                              (UNAUDITED)
<S>                                                           <C>           <C>
                                         ASSETS

Current assets:
  Cash and cash equivalents.................................  $  234,206     $  396,103
  Short-term investments....................................     262,758        261,856
  Short-term investments, restricted........................      13,129         12,952
  Accounts receivable, net..................................     111,133         93,803
  Prepaid expenses and other current assets.................       8,415          5,563
                                                              ----------     ----------
          Total current assets..............................     629,641        770,277
Property and equipment, net.................................     846,752        744,903
Deferred debt issuance costs, net...........................      22,521         23,710
Long-term investments, restricted...........................         829            829
Goodwill, net...............................................     114,648        100,184
Other assets................................................      40,292         28,936
                                                              ----------     ----------
          Total assets......................................  $1,654,683     $1,668,839
                                                              ==========     ==========

                          LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
  Accounts payable..........................................  $   64,722     $   80,814
  Accrued liabilities and other current liabilities.........      85,071         58,256
                                                              ----------     ----------
          Total current liabilities.........................     149,793        139,070
Long-term debt..............................................     576,303        566,312
Other long-term liabilities.................................       7,348          4,972
Commitments and contingencies
Stockholders' equity:
  Preferred stock -- $.01 par value, 1,000,000 shares
     authorized, no shares issued or outstanding at March
     31, 2001 and December 31, 2000.........................          --             --
  Common stock -- 113,020,934 and 110,392,114 shares issued
     and 112,693,439 and 110,064,619 outstanding at March
     31, 2001 and December 31, 2000, respectively...........       1,130          1,104
  Common stock in treasury, at cost, 327,495 shares at March
     31, 2001 and December 31, 2000.........................         (45)           (45)
  Common stock warrants.....................................       1,877          1,877
  Additional paid-in capital................................   1,779,080      1,730,652
  Deferred compensation.....................................      (6,067)       (16,531)
  Deferred management ownership allocation charge...........          --           (175)
  Accumulated deficit.......................................    (854,736)      (758,397)
                                                              ----------     ----------
          Total stockholders' equity........................     921,239        958,485
                                                              ----------     ----------
          Total liabilities and stockholders' equity........  $1,654,683     $1,668,839
                                                              ==========     ==========
</TABLE>

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

                                        2
<PAGE>   4

                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
           (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                                  THREE MONTHS ENDED
                                                                       MARCH 31,
                                                              ---------------------------
                                                                  2001           2000
                                                              ------------   ------------
                                                                      (UNAUDITED)
<S>                                                           <C>            <C>
Revenues....................................................  $    105,874   $     47,161
Operating Expenses:
  Network...................................................        51,228         27,120
  Selling, general and administrative.......................        84,622         47,991
  Depreciation and amortization.............................        51,309         21,354
  Management ownership allocation charge....................           175          2,416
  Non-cash deferred compensation............................         5,933          2,010
                                                              ------------   ------------
          Total operating expenses..........................       193,267        100,891
                                                              ------------   ------------
          Loss from operations..............................       (87,393)       (53,730)
Other income (expense):
  Interest and other income.................................         7,048         13,454
  Interest expense..........................................       (15,995)       (20,994)
                                                              ------------   ------------
          Total other income (expense)......................        (8,947)        (7,540)
Net loss....................................................  $    (96,340)  $    (61,270)
                                                              ============   ============
Net loss per share, basic and diluted.......................  $      (0.87)  $      (0.59)
                                                              ============   ============
Weighted average number of shares outstanding, basic and
  diluted...................................................   110,731,142    104,095,622
                                                              ============   ============
</TABLE>

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

                                        3
<PAGE>   5

                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                THREE MONTHS ENDED
                                                                    MARCH 31,
                                                              ----------------------
                                                                2001         2000
                                                              ---------   ----------
                                                                   (UNAUDITED)
<S>                                                           <C>         <C>
Cash Flows from Operating Activities:
  Net loss..................................................  $ (96,340)  $  (61,270)
  Adjustments to reconcile net loss to cash used in
     operating activities --
     Depreciation and amortization..........................     51,309       21,354
     Provision for uncollectible accounts receivable........      4,501        4,431
     Accretion of investments...............................     (1,950)        (611)
     Accretion of Series B and 12 7/8% Notes................     10,372        9,257
     Amortization of deferred debt issuance costs...........      1,189        6,535
     Amortization of management ownership allocation charge
      and deferred compensation.............................      6,108        4,426
  Changes in assets and liabilities --
     Increase in accounts receivable........................    (19,345)     (19,437)
     Increase in prepaid expenses and other current
      assets................................................     (2,075)      (4,554)
     (Increase) decrease in other assets....................     (1,791)       1,264
     (Decrease) increase in accounts payable................    (16,218)      14,630
     Increase in accrued liabilities and other current
      liabilities...........................................     28,415        8,053
                                                              ---------   ----------
          Net cash used in operating activities.............    (35,825)     (15,922)
Cash Flows from Investing Activities:
  Purchases of property and equipment.......................   (120,483)    (102,529)
  Purchases of subsidiaries, net of cash acquired...........     (8,165)          --
  Purchases of investments..................................   (188,563)      (6,876)
  Proceeds from sale of investments.........................    189,435       17,500
                                                              ---------   ----------
          Net cash used in investing activities.............   (127,776)     (91,905)
Cash Flows from Financing Activities:
  Deferred debt issuance costs..............................         --      (11,831)
  Proceeds from issuance of common stock, net...............      2,591      721,602
  Purchase of treasury stock................................         --          (40)
  Payments on capital lease obligations.....................     (1,056)        (591)
  Other.....................................................        169          (51)
                                                              ---------   ----------
          Net cash provided by financing activities.........      1,704      709,089
                                                              ---------   ----------
Net (decrease) increase in cash and cash equivalents........   (161,897)     601,262
Cash and cash equivalents, beginning of period..............    396,103      502,234
                                                              ---------   ----------
Cash and cash equivalents, end of period....................  $ 234,206   $1,103,496
                                                              =========   ==========
Supplemental disclosures of cash flow information:
  Cash paid for interest....................................  $     594   $    1,261
Supplemental disclosure of noncash investing and financing
  activities:
  Assets acquired under capital lease obligations...........  $     372   $    2,088
  Fair value of assets acquired in business acquisitions....     34,009           --
  Liabilities assumed in business acquisitions..............      1,429           --
  Common stock issued for business acquisitions (2,416,628
     shares)................................................     50,225           --
</TABLE>

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

                                        4
<PAGE>   6

                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
              THREE MONTHS ENDED MARCH 31, 2001 AND MARCH 31, 2000
           (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
                                  (UNAUDITED)

1. GENERAL

     Allegiance Telecom, Inc., an integrated communications provider, was
incorporated on April 22, 1997, as a Delaware corporation, for the purpose of
providing voice, data and Internet services to small- to medium-sized businesses
in major metropolitan areas across the United States. Allegiance Telecom, Inc.
and its subsidiaries are referred to herein as the "Company."

     The Company's business plan is focused on offering services in 36 of the
largest metropolitan areas in the United States. As of March 31, 2001, the
Company is operational in 29 markets: Atlanta, Baltimore, Boston, Chicago,
Cleveland, Dallas, Denver, Detroit, Fort Lauderdale, Fort Worth, Houston, Long
Island, Los Angeles, Miami, Minneapolis/St. Paul, New York City, Northern New
Jersey, Oakland, Orange County, Philadelphia, Phoenix, St. Louis, San Antonio,
San Diego, San Francisco, San Jose, Seattle, Tampa and Washington, D.C.

     The Company's success will be affected by the challenges, expenses and
delays encountered in connection with the formation of any new business, and the
competitive environment in which the Company operates. The Company's performance
will further be affected by its ability to assess and access potential markets,
implement interconnection and colocation with the facilities of incumbent local
exchange carriers, lease adequate trunking capacity from and otherwise develop
efficient and effective working relationships with incumbent local exchange
carriers and other carriers, obtain peering agreements with Internet service
providers, collect interexchange access and reciprocal compensation charges,
purchase and install switches in additional markets, implement efficient
operations support systems and other back office systems, develop and retain a
sufficient customer base and attract, retain and motivate qualified personnel.
The Company's networks and the provisioning of telecommunications services are
subject to significant regulation at the federal, state and local levels. Delays
in receiving required regulatory approvals or the enactment of new adverse
regulation or regulatory requirements may have a material adverse effect upon
the Company. Although management believes that the Company will be able to
successfully mitigate these risks, there is no assurance that the Company will
be able to do so or that the Company will ever operate profitably.

     Expenses are expected to exceed revenues in each market in which the
Company offers service until a sufficient customer base is established. It is
anticipated that obtaining a sufficient customer base will take several years,
and positive cash flows from operations are not expected in the near future.

2. BASIS OF PRESENTATION

     The accompanying unaudited condensed consolidated financial statements have
been prepared by the Company in accordance with accounting principles generally
accepted in the United States for interim financial information and are in the
form prescribed by the Securities and Exchange Commission in instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. The interim
unaudited financial statements should be read in conjunction with the audited
financial statements of the Company as of and for the year ended December 31,
2000. In the opinion of management, all adjustments (consisting only of normal
recurring adjustments) considered necessary for a fair presentation have been
included. Operating results for the three months ended March 31, 2001 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2001.

     Certain amounts in the prior period's condensed consolidated financial
statements have been reclassified to conform to the current period presentation.

                                        5
<PAGE>   7
                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

      NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. ACQUISITIONS

     During the three months ending March 31, 2001, the Company acquired all of
the outstanding stock of Adgrafix Corporation and certain assets of HarvardNet,
Inc. The aggregate purchase price for these acquisitions was $53,588, consisting
of $4,132 in cash and 2,366,793 shares of the Company's common stock. The excess
of the purchase price over the fair value of the net assets acquired has been
recorded as goodwill of $21,008.

     The merger agreement with Adgrafix Corporation provides for additional
contingent consideration payable in cash and shares of the Company's common
stock effective six months following the closing date. The contingent
consideration is based on the satisfaction of certain conditions, including the
maintenance of certain minimum recurring revenues. Based on information
available at March 31, 2001, the contingent consideration is expected to be
approximately $4,981 (consisting of $249 cash and approximately 231,235 shares
of the Company's common stock). If such contingent consideration becomes due and
payable, such additional purchase price will result in the recording of a
corresponding amount of goodwill.

     Each of the acquisitions discussed above were accounted for using the
purchase method of accounting; accordingly, the net assets and results of
operations of the acquired companies have been included in the Company's
consolidated financial statements since the acquisition dates. The purchase
price of the acquisitions was allocated to assets acquired, including identified
intangible assets, and liabilities assumed, based on their respective estimated
fair values at acquisition. The Company's purchase price allocation of the
acquisitions made in 2001 is preliminary, subject to post-acquisition due
diligence of the acquired entities, and may be adjusted as additional
information is obtained.

     During the three months ending March 31, 2001, the Company distributed
contingent consideration totaling $4,802, consisting of $4,033 in cash, of which
$1,873 was included in accrued liabilities at December 31, 2000, and 49,835
shares of the Company's common stock as provided in the merger agreements with
the following businesses acquired during 2000: InterAccess Co., Virtualis
Systems, Inc. and Jump.Net, Inc. There is no additional consideration payable
under the merger agreement with InterAccess Co. The merger agreements with
Virtualis Systems, Inc. and Jump.Net, Inc. provide for additional contingent
consideration of approximately $8,141 (consisting of $6,446 cash and
approximately 74,782 shares of the Company's common stock) based on the
satisfaction of certain conditions.

     During March 2001, the Company moved forward with its integration plan for
Virtualis Systems, Inc. Part of the plan included severance packages for a group
of identified employees. In compliance with generally accepted accounting
principles in the United States, the Company has recorded additional goodwill as
of March 31, 2001 related to severance activity.

                                        6
<PAGE>   8
                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

      NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

4. PROPERTY AND EQUIPMENT

     Property and equipment includes network equipment, leasehold improvements,
software, office equipment, furniture and fixtures and construction-in-progress.
These assets are stated at cost, which includes direct costs and capitalized
interest and are depreciated over their respective useful lives using the
straight-line method. During the three months ended March 31, 2001 and 2000,
$4,656 and $2,524, respectively, of interest expense was capitalized related to
network construction-in-progress. Repair and maintenance costs are expensed as
incurred.

     Property and equipment at March 31, 2001 and December 31, 2000, consisted
of the following:

<TABLE>
<CAPTION>
                                                   MARCH 31,   DECEMBER 31,   USEFUL LIVES
                                                     2001          2000        (IN YEARS)
                                                   ---------   ------------   ------------
<S>                                                <C>         <C>            <C>
Network equipment................................  $ 587,407    $ 569,410          3-7
Leasehold improvements...........................    100,903       98,788         3-10
Software.........................................     81,294       63,435            3
Office equipment.................................     27,489       24,528          2-3
Furniture and fixtures...........................     14,290       13,879          3-5
                                                   ---------    ---------
Property and equipment, in service...............    811,383      770,040
Less: Accumulated depreciation...................   (198,704)    (162,279)
                                                   ---------    ---------
          Property and equipment, in service,
            net..................................    612,679      607,761
Construction-in-progress.........................    234,073      137,142
                                                   ---------    ---------
          Property and equipment, net............  $ 846,752    $ 744,903
                                                   =========    =========
</TABLE>

5. OTHER ASSETS

     Other assets consisted of the following:

<TABLE>
<CAPTION>
                                                              MARCH 31,   DECEMBER 31,
                                                                2001          2000
                                                              ---------   ------------
<S>                                                           <C>         <C>
Acquired intangibles........................................   $40,271      $28,171
Long-term deposits..........................................     4,202        3,917
Other.......................................................     3,887        2,231
                                                               -------      -------
Total other assets..........................................    48,360       34,319
Less: Accumulated amortization..............................    (8,068)      (5,383)
                                                               -------      -------
          Other assets, net.................................   $40,292      $28,936
                                                               =======      =======
</TABLE>

     Acquired intangibles consist of acquired workforces and customer lists
obtained in connection with business acquisitions. These assets are being
amortized over their estimated useful lives of three years using the
straight-line method.

                                        7
<PAGE>   9
                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

      NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

6. ACCRUED LIABILITIES AND OTHER CURRENT LIABILITIES

     Accrued liabilities and other current liabilities consisted of the
following:

<TABLE>
<CAPTION>
                                                              MARCH 31,   DECEMBER 31,
                                                                2001          2000
                                                              ---------   ------------
<S>                                                           <C>         <C>
Accrued employee compensation and benefits..................   $12,431      $ 5,915
Accrued network expenses....................................     8,748       12,410
Business acquisition costs..................................     5,250        4,461
Accrued taxes...............................................     5,717        5,797
Accrued interest expense....................................    11,773        5,216
Deferred revenue............................................    31,788       13,488
Other.......................................................     9,364       10,969
                                                               -------      -------
          Accrued liabilities and other current
            liabilities.....................................   $85,071      $58,256
                                                               =======      =======
</TABLE>

7. LONG-TERM DEBT:

     Long-term debt consisted of the following:

<TABLE>
<CAPTION>
                                                              MARCH 31,   DECEMBER 31,
                                                                2001          2000
                                                              ---------   ------------
<S>                                                           <C>         <C>
Series B 11 3/4% Notes, face amount $445,000 due February
  15, 2008; effective interest rate of 12.21%; at accreted
  value.....................................................  $353,056      $342,758
12 7/8% Senior Notes, face amount $205,000 due May 15, 2008;
  effective interest rate of 13.24%; at accreted value......   201,613       201,539
Capital lease obligations, net of current portion...........    21,634        22,015
                                                              --------      --------
          Long-term debt....................................  $576,303      $566,312
                                                              ========      ========
</TABLE>

8. CAPITALIZATION

     During the three months ended March 31, 2001, 210,694 shares of common
stock were issued under the Company's stock-based compensation plans for
proceeds of $2,591.

9. COMMITMENTS AND CONTINGENCIES:

     The Company has entered into various operating lease agreements, with
expirations through 2013, for office space, equipment and network facilities.
Future minimum lease obligations related to the Company's operating leases as of
March 31, 2001 are as follows:

<TABLE>
<S>                                                          <C>
2001.......................................................  $14,711
2002.......................................................   20,121
2003.......................................................   20,444
2004.......................................................   19,208
2005 and thereafter........................................   96,196
</TABLE>

     Total rent expense for the three months ended March 31, 2001 and 2000, was
$8,191 and $3,098, respectively.

     In April 2000, the Company executed a procurement agreement with Lucent
Technologies, Inc. for a broad range of advanced telecommunications equipment,
software and services. This agreement contains a three-year $350 million
purchase commitment. The Company must complete purchases totaling $80 million by
December 31, 2000, an aggregate of $180 million of purchases by December 31,
2001, and the full

                                        8
<PAGE>   10
                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

      NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

$350 million of aggregate purchases on or before December 31, 2002. The Company
exceeded the required purchase milestone at December 31, 2000. As of March 31,
2001, the Company has completed cumulative purchases totaling $114,776. If the
Company does not meet the required intermediate purchase milestones, the Company
will be required to provide cash settlement in an amount equal to the shortfall.
Such cash settlements may be applied to future purchases during the commitment
period. If the Company does not purchase $350 million of products and services
from Lucent and its affiliates by December 31, 2002, the Company will be
required to provide cash settlement in an amount equal to the cumulative
shortfall.

                                        9
<PAGE>   11

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

OVERVIEW

     Allegiance Telecom, Inc. is a leading competitive provider of
telecommunications services to small- to medium-sized businesses in major
metropolitan areas across the United States. We offer an integrated set of
telecommunications services including local, long distance, data and a full
suite of Internet services. Our principal competitors are incumbent local
exchange carriers, such as the regional Bell operating companies, as well as
other integrated communications providers.

     Our business plan covers 36 of the largest metropolitan areas in the United
States. Our network rollout has proceeded on schedule, with 29 markets
operational as of March 31, 2001, consisting of Atlanta, Baltimore, Boston,
Chicago, Cleveland, Dallas, Denver, Detroit, Fort Lauderdale, Fort Worth,
Houston, Long Island, Los Angeles, Miami, Minneapolis/St. Paul, New York City,
Northern New Jersey, Oakland, Orange County, Philadelphia, Phoenix, St. Louis,
San Antonio, San Diego, San Francisco, San Jose, Seattle, Tampa and Washington,
D.C. We are on track to add the seven remaining markets by the end of 2001. We
believe we have successfully raised the projected capital required to build our
networks and operate in each of these markets to the point at which projected
operating cash flow from the market is sufficient to fund its projected
operating costs and capital expenditures.

     We were formed in 1997 by a management team of industry veterans to take
advantage of the opportunity for facilities-based local communications
competition created by the Telecommunications Act of 1996. Since we formed our
company, we have focused on building a reliable nationwide network based on
proven technologies, a strong nationwide direct sales force and efficient
information processing systems to support our operations. We believe that by
doing so we have positioned ourselves to compete effectively with the incumbent
carriers, most of whom do not address our customers with direct sales efforts
and are burdened by legacy operations support systems.

     We use multiple technologies and a mixture of leased and owned facilities
at the edge of the communications network so that we can most effectively serve
our customer base where it is physically located. We install state-of-the-art
voice and data aggregation and switching equipment in the central offices or
"hubs" of the existing local incumbent carrier's networks. These central offices
connect directly to customers through the "local loop," which consists of the
existing copper wire and fiber running from the central offices to each customer
location. The local loop is owned by the incumbent carriers but can be leased by
competitive carriers under the terms of the Telecommunications Act of 1996. Our
local loop presence provides us with a flexible platform for delivering
traditional voice and data access services to our end-user customers. We connect
our central office locations to our main switching center in each market by
either leasing additional network elements from the incumbent carriers and other
providers on a short-term basis or by using dedicated fiber on a long-term
basis. We have increasingly focused on dedicated fiber because of the growth of
our customer base and traffic volume and the increased availability of this
fiber throughout the major metropolitan areas in the United States.

     As we have developed our local networks to service end-user customers, we
have also attempted to capitalize on our expertise and investment at the edge of
the network by maximizing the use of our network assets. In building a
nationwide network to serve end-user customers, we have fixed costs in many
assets that are underutilized during those times of day when our small- to
medium-sized business customers are not placing or receiving as many voice and
data calls. We have taken advantage of this underutilization by providing
network solutions to other service providers, primarily the leading national
providers. These national network providers also have end-user customers but do
not have the facilities and expertise to directly access these customers through
the local loop. Many of these providers focus on the residential Internet access
market. The traffic patterns in that market generally complement those of our
end-user business customers, making this business an incremental revenue
opportunity that leverages our fixed network costs.

     The other way we try to serve our customers and leverage our focus on the
small- to medium-sized business end users is by providing innovative
applications of existing technologies. An example is our Integrated Access
Service which delivers high-speed, "always on" Internet access and allows
multiple voice,

                                        10
<PAGE>   12

data and Internet combinations over a single access line. In addition, we have
developed electronic commerce products designed to help these customers market
their products and services online, improve communication and collaboration and
increase productivity. While these types of products and solutions are readily
available to larger business customers that can afford to devote the resources
necessary to develop and customize them internally, we believe that smaller
business customers are demanding easy to use electronic commerce solutions that
allow them, with minimal design and development costs, to market products online
and increase their own productivity.

     We and many financial analysts evaluate the growth of our business by
focusing on various operational data in addition to financial data. Within each
of our metropolitan markets, we have located our equipment in the central
offices of the established telephone companies. This practice is commonly
referred to as a colocation. The number of colocations that we have indicates
the number of different local geographic areas that we can serve within each of
our markets. Once we are colocated in a central office, we can then begin
offering service to all of the customers that have local loop connections to
that central office. "Lines installed" represents the lines sold that are now
being used by us to provide our services. Although the number of lines we
service for each customer varies significantly, our primary focus is on the
small- to medium-sized business customer. Over 90% of our customers have 20
lines or less. We plan to continue to focus on the small- to medium-sized
business customer and expect that the number of lines per customer will remain
at 20 or less for the vast majority of our customers. The number of customers
set forth below represents that number of customers for whom we have installed
lines. The table below provides these and other selected key operational data
for the quarters ended, each on a cumulative basis:

<TABLE>
<CAPTION>
                                                  MARCH 31,   MARCH 31,
                                                    2001        2000
                                                  ---------   ---------
<S>                                               <C>         <C>
Markets served..................................        29          20
Number of switches deployed.....................        27          16
Central office colocations......................       687         395
Lines installed.................................   733,900     314,300
Customers.......................................   120,500      27,600
Sales force employees...........................     1,471         905
Total employees.................................     3,834       2,038
</TABLE>

RESULTS OF OPERATIONS -- THREE MONTHS ENDED MARCH 31, 2001 COMPARED WITH THREE
MONTHS ENDED MARCH 31, 2000

     During the first quarter of 2001 and 2000, we generated revenues of
approximately $105.9 million and $47.2 million, respectively. The increase in
revenue is attributable to an increase in number of customers and the number of
lines installed. For the quarters ended March 31, 2001 and 2000, we sold 165,900
lines and 95,600 lines, and installed 126,200 lines and 72,600 lines,
respectively. "Lines sold" by us represents the number of lines for which
customers have placed orders with us to provide services. The services we
provide over our own switches generate higher margins than services provided by
other carriers that are resold by us. Over 90% of our installed lines were
provided over our own switches, representing approximately 93% of our revenues
as of March 31, 2001, and we expect this level of facilities-based service to
remain constant over time. Gross margin has increased from approximately 42.5%
for the quarter ended March 31, 2000 to approximately 51.6% for the quarter
ended March 31, 2001. Gross margin is calculated as revenues less network
expenses, divided by revenues. We expect our gross margins to continue to
improve as our revenues increase and as we realize cost efficiencies in our
network expenses.

     Local voice service revenues for the quarters ended March 31, 2001 and 2000
were $73.0 million and $39.0 million, respectively. Local voice service revenues
as a percent of total revenues has decreased from approximately 83% for the
quarter ended March 31, 2000 to approximately 69% for the quarter ended March
31, 2001. Local voice service revenues consisted of:

     - the monthly recurring charge for basic local voice service;

     - usage-based charges for local and toll calls in certain markets;

                                        11
<PAGE>   13

     - charges for services such as call waiting and call forwarding;

     - certain non-recurring charges, such as set-up charges for additional
       lines for an existing customer; and

     - interconnection revenues from switched access charges to long distance
       carriers and reciprocal compensation charges to other local carriers.

     Components of our local voice service revenues are subject to various
federal and state regulations and to disputes and uncertainties. We expect local
voice service revenues to continue to decrease as a percent of total revenues,
as a result of the resolution of certain of these regulatory disputes and
uncertainties. Specifically, we expect and have modified our business plans to
anticipate a decrease in switched access revenues and reciprocal compensation
revenues. See the discussion under "Risk Factors," which contains a detailed
discussion of the risks and uncertainties associated with our local voice
revenues.

     Long distance service revenues for the quarters ended March 31, 2001 and
2000 were $5.4 million and $1.7 million, respectively. Long distance service
revenues as a percent of total revenues has increased from approximately 3% for
the quarter ended March 31, 2000 to approximately 5% for the quarter ended March
31, 2001. We reduced our pricing of long distance services during 2000 to
respond to competitive pressures and we anticipate long distance pricing to
continue at historically low levels given the current competitive environment.
Although these reduced prices decrease our margins, we anticipate that more of
our local service customers will purchase long distance service from us at our
current pricing levels and through our continuing effort to promote the benefits
of purchasing local, long distance and data services from a single provider.

     Data revenues, including revenues generated from Internet access, Web
hosting and high-speed data services, for the quarters ended March 31, 2001 and
2000 were $27.5 million and $6.5 million, respectively. Data revenues as a
percent of total revenues has increased from approximately 14% for the quarter
ended March 31, 2000 to approximately 26% for the quarter ended March 31, 2001.
We expect data revenues to continue to increase as a percent of total revenues
(a) as we expand our data services offerings to existing local and long distance
voice customers, (b) as we increase our offerings of packaged services that
combine voice and data services which we market as the Allegiance Telecom Total
Communications Options and (c) as more small and medium-sized businesses turn to
the Internet to enhance their productivity. We also believe that the continuing
evolution of communications networks will promote the integration of voice and
data services over the same facilities, thereby further increasing the
availability of data offerings.

     During 2000, we signed a long-term contract to provide data services to
Genuity Solutions, Inc., a network services provider and operator of a
nationwide Internet network. This contract establishes Genuity as our largest
customer.

     We have had discussions, and will continue to have discussions in the
foreseeable future, concerning potential acquisitions of Internet service
providers, Web hosting and data services providers, and other providers of
telecommunications and Internet services. During the quarter ended March 31,
2001, we acquired the stock of Adgrafix Corporation and certain assets of
HarvardNet, Inc., both Internet-based, Web-hosting applications specialists. We
have utilized the purchase method of accounting for these acquisitions.
Accordingly, we have recognized the revenues earned since the closing of each of
these acquisitions in our condensed consolidated statement of operations for the
period ended March 31, 2001.

     For the quarters ended March 31, 2001 and 2000, network expenses were $51.2
million and $27.1 million, respectively. The increase in network expenses is
consistent with the deployment of our networks and initiation and growth of our
services. Network expenses included:

     - the cost of leasing local loop lines which connect our customers to our
       network;

     - the cost of leasing high-capacity digital lines that interconnect our
       network with the networks of the incumbent local exchange carriers;

     - the cost of leasing high-capacity digital lines that connect our
       switching equipment to our transmission equipment located in the central
       offices of the incumbent local exchange carrier;

                                        12
<PAGE>   14

     - the cost of expanding our network to additional colocation sites within a
       market;

     - the cost of completing local and long distance calls originated by our
       customers;

     - the cost of leasing space in incumbent local exchange carrier central
       offices for colocating our transmission equipment; and

     - the cost of leasing our nationwide Internet network.

     The costs to lease local loop lines and high-capacity digital lines from
the incumbent local exchange carriers vary by carrier and are regulated by state
authorities under the Telecommunications Act of 1996. We believe that in many
instances there are multiple carriers in addition to the incumbent local
exchange carriers from whom we can lease high-capacity lines and that we can
generally lease those lines at lower prices than are charged by the incumbent
local exchange carriers. We expect that the costs associated with these leases
will increase with customer volume and will be a significant part of our ongoing
cost of services.

     When we open new markets, we incur significant general and administrative
expenses and network expenses before we begin to generate revenue from
operations. Many of the network expenses, such as for transport facilities and
colocation rent and power charges, are fixed costs that we do not recover until
we build up a sufficient volume of traffic from customers. Consequently, as we
continue to open new markets throughout 2001, we will continue to generate
operating losses and do not expect to generate positive cash flow from
operations until some time in 2002.

     In constructing switching and transmission equipment for a new market, we
capitalize as a component of property and equipment only the non-recurring
charges associated with our initial network facilities and the monthly recurring
costs of those network facilities until the switching equipment begins to carry
revenue-producing traffic. Typically, the recurring charges for one to three
months are capitalized. We generally expense the monthly recurring costs
resulting from the growth of existing colocation sites, and the costs related to
expansion of the network to additional colocation sites in operational markets
as we incur these charges.

     We incur "reciprocal compensation" costs in providing both voice and data
services and expect reciprocal compensation costs to be a major portion of our
cost of services. We must enter into an interconnection agreement with the
incumbent local exchange carrier in each market to make widespread calling
available to our customers. These agreements typically set the cost per minute
to be charged by each party for the calls that are exchanged between the two
carriers' networks. Generally, a carrier must compensate another carrier when a
local call by the first carrier's customer terminates on the other carrier's
network. These reciprocal compensation costs will grow as our customers'
outbound calling volume grows.

     The cost of securing long distance service capacity is a variable cost that
increases in direct relationship to increases in our customer base and increases
in long distance calling volumes. We believe that these costs, measured as a
percentage of long distance revenues, will be relatively consistent from period
to period. However, we do expect period-over-period growth in the absolute cost
of such capacity, and that the cost of long distance capacity will be a
significant portion of our cost of long distance services.

     We install voice and data aggregation and switching equipment in the
central offices of local incumbent exchange carriers' networks. We incur rent
and utility charges in leasing this space. These costs will increase as we
expand to additional colocation sites and increase the capacity of our existing
colocations.

     We have developed a national Internet data network by connecting our
markets with leased high-capacity digital lines. The costs of these lines will
increase as we increase capacity to address customer demand, open new markets
and connect additional markets to our Internet network.

     Selling, general and administrative expenses increased to $84.6 million for
the quarter ended March 31, 2001 from $48.0 million for the quarter ended March
31, 2000, primarily due to the growth of our business. Selling, general and
administrative expenses include salaries and related personnel costs,
administration and facilities costs, sales and marketing costs, customer care
and billing costs, and professional fees. The number of employees increased to
3,834 as of March 31, 2001, from 2,038 as of March 31, 2000. As of March 31,
2001, the sales force, including sales managers and sales administrators, had
grown to 1,471 from 905 as of
                                        13
<PAGE>   15

March 31, 2000. As we continue to grow in terms of number of markets, customers
and employees, we expect that ongoing selling, general and administrative
expenses will increase.

     We amortized $0.2 million and $2.4 million of the deferred management
ownership allocation charge, a non-cash charge to income, for the quarters ended
March 31, 2001 and 2000, respectively. Our original private equity fund
investors and original management team investors owned 95.0% and 5.0%,
respectively, of the ownership interests of Allegiance Telecom, LLC, an entity
that owned substantially all of our outstanding capital stock prior to our
initial public offering of common stock. As a result of that offering, the
assets of Allegiance Telecom, LLC, which consisted almost entirely of such
capital stock, were distributed to the original fund investors and management
investors in accordance with the Allegiance Telecom, LLC limited liability
company agreement. This agreement provided that the equity allocation between
the fund investors and management investors would be 66.7% and 33.3%,
respectively, based upon the valuation implied by the initial public offering.
We recorded the increase in the assets of Allegiance Telecom, LLC allocated to
the management investors as a $193.5 million increase in additional paid-in
capital. This transaction was recorded during the third quarter of 1998. Of this
charge, we recorded $122.5 million as a non-cash, non-recurring charge to
operating expense and $71.0 million as a deferred management ownership
allocation charge. This deferred charge has been fully amortized as of March 31,
2001.

     For the quarters ended March 31, 2001 and 2000, we recognized $5.9 million
and $2.0 million, respectively, of amortization of deferred compensation
expense. Such deferred compensation was recorded in connection with membership
units of Allegiance Telecom, LLC sold to certain management employees and
options granted to certain employees under our 1997 stock option plan and 1998
stock incentive plan.

     During the quarters ended March 31, 2001 and 2000, depreciation expense was
$36.4 million and $18.0 million, respectively. Such increase was consistent with
the deployment of our networks and initiation of services in 29 markets by March
31, 2001.

     In connection with the acquisitions completed to date, we assigned an
aggregate of $40.3 million of the purchase price to customer lists and
workforces. We also recorded an aggregate of $154.2 million of goodwill. Each of
these intangible assets is being amortized over their estimated useful lives of
three years. For the quarters ending March 31, 2001 and 2000, we recorded $12.2
million and $2.8 million of amortization for goodwill and $2.7 million and $0.5
million of amortization of customer lists and workforces, respectively. Our
purchase price allocation for the acquisitions made in 2001 is subject to post
acquisition due diligence of the acquired entities and may be adjusted as
additional information is obtained.

     For the quarters ended March 31, 2001 and 2000, interest expense was $16.0
million and $21.0 million, respectively. Interest expense reflects the accretion
of the 11 3/4% notes and related amortization of the original issue discount,
the amortization of the original issue discount on the 12 7/8% notes, and the
amortization of deferred debt issuance costs related to our $500 million senior
secured credit facilities. Unamortized deferred debt issuance costs of $5.9
million related to the $225 million revolving credit facility were charged to
interest expense during first quarter 2000, upon termination of the $225 million
revolving credit facility and completion of the $500 million senior secured
credit facilities. The amount of interest capitalized for the quarters ended
March 31, 2001 and 2000 was $4.7 million and $2.5 million, respectively.
Interest income for the quarters ended March 31, 2001 and 2000 was $7.0 million
and $13.5 million, respectively. Interest income results from the investment of
short-term investments, cash and cash equivalents and from U.S. government
securities, which we purchased and placed in a pledge account to secure the
semiannual payments of interest through May 2001 on the 12 7/8% notes. Interest
income during the quarter ended March 31, 2000 is greater than for the quarter
ended March 31, 2001 because we had additional cash invested in interest-bearing
instruments as a result of our February 2000 equity offering. Additionally,
during the quarter ended March 31, 2001, we recorded an impairment loss against
interest income related to investment securities deemed to have a permanent
decline in fair value.

     Our net loss for the quarters ended March 31, 2001 and 2000, after
amortization of the non-cash management ownership allocation charge and
amortization of deferred compensation, was $96.3 million and $61.3 million,
respectively.

                                        14
<PAGE>   16

     Many securities analysts use the measure of earnings before deducting
interest, taxes, depreciation and amortization, also commonly referred to as
"EBITDA" as a way of measuring the performance of a company. EBITDA is not
derived pursuant to generally accepted accounting principles, and therefore
should not be construed as an alternative to operating income (loss), as an
alternative to cash flows from operating activities, or as a measure of
liquidity. We had adjusted EBITDA losses of approximately $30.0 million and
$28.0 million for quarters ended March 31, 2001 and 2000, respectively. In
calculating adjusted EBITDA, we also exclude the non-cash charges to operations
for the management ownership allocation charge and deferred compensation expense
totaling $6.1 million and $4.4 million for the quarters ended March 31, 2001 and
2000, respectively.

     We expect to continue to experience operating losses and negative adjusted
EBITDA as a result of our development and market expansion activities. We
typically do not expect to achieve positive adjusted EBITDA in any market until
at least its third year of operation.

LIQUIDITY AND CAPITAL RESOURCES

     Our financing plan is predicated on the pre-funding of each market's
expansion to positive free cash flow. By using this approach, we avoid being in
the position of seeking additional capital to fund a market after we have
already made a significant capital investment in that market. We believe that by
raising all required capital prior to making any commitments in a market, we can
raise capital on more favorable terms and conditions.

     We do not begin to develop a new market until we have raised the capital
that we project to be necessary to build and operate our network in the market
to the point at which operating cash flow from the market is sufficient to fund
its ongoing operating costs and capital expenditures. We believe that all of our
36 target markets are now fully funded in this manner. We also believe that our
existing cash on hand, together with cash from our committed $500 million of
senior secured credit facilities, are sufficient to fully fund our operations,
planned capital investments and debt service requirements until such time as we
have positive cash flow from operations on a consolidated basis to fund these
items.

     We may decide to seek additional capital in the future to expand our
business. Sources of additional financing may include vendor financing, bank
financing and/or the private or public sale of our equity or debt securities. We
cannot assure you, however, that such financing will be available at all or on
terms acceptable to us, or that our estimate of additional funds required is
accurate. The actual amount and timing of future capital requirements may differ
materially from our estimates as a result of, among other things:

     - the cost of the development of our networks in each of our markets;

     - a change in or inaccuracy of our development plans or projections that
       leads to an alteration in the schedule or targets of our roll-out plan;

     - the extent of price and service competition for telecommunications
       services in our markets;

     - the demand for our services;

     - regulatory and technological developments, including additional market
       developments and new opportunities in our industry;

     - an inability to borrow under our new credit facilities; and

     - the consummation of acquisitions.

     Our cost of rolling out our networks and operating our business, as well as
our revenues, will depend on a variety of factors, including:

     - our ability to meet our roll-out schedules;

     - our ability to negotiate favorable prices for purchases of equipment;

                                        15
<PAGE>   17

     - our ability to develop, acquire and integrate the necessary operations
       support systems and other back office systems;

     - the number of customers and the services for which they subscribe;

     - the nature and penetration of new services that we may offer; and

     - the impact of changes in technology and telecommunication regulations.

As such, actual costs and revenues may vary from expected amounts, possibly to a
material degree, and such variations are likely to affect our future capital
requirements.

     For the quarters ended March 31, 2001 and 2000, we made capital
expenditures of $120.5 million and $102.5 million, respectively. We also used
capital during these periods to fund our operations.

     In April 2000, we executed a procurement agreement with Lucent
Technologies, Inc. for a broad range of advanced telecommunications equipment,
software and services. This agreement contains a three-year $350 million
purchase commitment. We must complete purchases totaling $80 million by December
31, 2000, an aggregate of $180 million of purchases by December 31, 2001, and
the full $350 million of aggregate purchases on or before December 31, 2002. If
we do not meet the required intermediate purchase milestones, we will be
required to provide cash settlement in an amount equal to the shortfall. Such
payments may be applied to future purchases during the commitment period. If we
do not purchase $350 million of products and services from Lucent and its
affiliates by December 31, 2002, we will be required to provide cash settlement
in an amount equal to the shortfall. We exceeded the required purchase milestone
at December 31, 2000. As of March 31, 2001, we have completed cumulative
purchases under this contract totaling approximately $114.8 million. Pursuant to
our business plan, we expect to incur approximately $350 million of capital
expenditures in 2001, which includes the Lucent capital expenditure requirement
for 2001.

     We have purchased dedicated fiber rings in 24 of our markets. As of March
31, 2001, we had three dedicated fiber rings in operation, one each in New York,
Dallas and Houston. The cost of these rings includes both the amounts we pay to
the fiber ring provider as well as the cost of the electronic equipment that we
purchase and install on the rings to make them operational. Our total costs to
date have been $155.0 million, and our budget to complete the fiber rings for
which we have commitments is approximately $259.0 million, which will be
incurred over several periods ending in 2020. We plan to fund this cost with our
available cash.

     As of March 31, 2001, we had approximately $497.0 million of unrestricted
cash and short-term investments. In addition, $13.1 million of restricted U.S.
government securities have been placed in a pledge account to fund interest
payments on our 12 7/8% notes through May 2001.

     On February 28, 2000, a three-for-two stock split of our common stock was
effected in the form of a 50% dividend to shareholders of record on February 18,
2000. All references to the number of common shares and per share amounts have
been restated to reflect the stock split for the periods presented.

     On February 3, 1998, we raised gross proceeds of approximately $250.5
million in an offering of 445,000 units, each unit consisting of one 11 3/4%
senior discount note and one redeemable warrant. Net proceeds of approximately
$240.7 million were received from that offering. The 11 3/4% notes have a
principal amount at maturity of $445.0 million and an effective interest rate of
12.21%. The 11 3/4% notes mature on February 15, 2008. From and after February
15, 2003, interest on such notes will be payable semiannually in cash at the
rate of 11 3/4% per annum. The accretion of original issue discount will cause
an increase in indebtedness from March 31, 2001 to February 15, 2003 of $91.9
million.

     We completed the initial public offering of our common stock and the
offering of the 12 7/8% senior discount notes early in the third quarter of
1998. We raised net proceeds of approximately $137.8 million from our initial
public offering of common stock and approximately $124.8 million from the
offering of these notes. The 12 7/8% notes mature on May 15, 2008. Interest on
these notes is payable in cash semiannually, commencing November 15, 1998. The
12 7/8% notes were sold at less than par, resulting in an effective rate of
13.24%, and the value of the 12 7/8% notes is being accreted, using the
effective interest method, from the $200.9 million gross proceeds realized at
the time of the sale to the aggregate value at maturity,
                                        16
<PAGE>   18

$205.0 million, over the period ending May 15, 2008. The accretion of original
issue discount will cause an increase in indebtedness from March 31, 2001 to May
15, 2008 of $3.4 million. In connection with the sale of the 12 7/8% notes, we
purchased U.S. government securities for approximately $69.0 million and placed
them in a pledge account to fund interest payments for the first three years the
12 7/8% notes are outstanding. The first interest payment was made in November
1998. Such U.S. government securities are reflected in the balance sheet as of
March 31, 2001, at an accreted value of approximately $13.1 million, which is
classified as a current asset.

     On April 20, 1999, we completed the public offering of 17,739,000 shares of
our common stock at a price of $25.33 per share, raising gross proceeds of
$449.4 million. After underwriters' fees and other expenses, we realized net
proceeds of approximately $430.3 million. On April 28, 1999, the underwriters of
this offering exercised an option to purchase an additional 3,302,100 shares of
common stock at the same price per share. As a result, we raised an additional
$83.6 million of gross proceeds and $80.3 million of net proceeds, at that time.

     On February 2, 2000, we completed the public offering of 9,900,000 shares
of our common stock at a price of $70.00 per share, raising gross proceeds of
$693.0 million. After underwriters' fees and other expenses, we realized net
proceeds of approximately $665.6 million. On February 29, 2000, the underwriters
of this offering exercised an option to purchase an additional 803,109 shares of
common stock at the same price per share. As a result, we raised an additional
$56.2 million of gross proceeds and $54.1 million of net proceeds.

     In February 2000, we closed on $500.0 million of new senior secured credit
facilities, which replaced the $225 million revolving credit facility. These new
senior secured credit facilities consist of a $350.0 million revolving credit
facility and a $150.0 million delayed draw term loan facility. These credit
facilities are available, subject to satisfaction of certain terms and
conditions, to provide purchase money financing for network build-out, including
the cost to develop, acquire and integrate the necessary operations support and
back office systems, as well as for additional dark fiber purchases and central
office colocations. Interest on amounts drawn is variable, based on leverage
ratios, and is expected to be the London Interbank Offered Rate + 3.25%. The
initial commitment fee on the unused portion of these credit facilities will be
1.5% per annum, paid quarterly and will be reduced based upon usage. These
credit facilities contain certain representations, warranties, covenants and
events of default customary for credit of this nature and otherwise agreed upon
by the parties.

FORWARD-LOOKING STATEMENTS

     Certain statements in this Management's Discussion and Analysis of
Financial Condition and Results of Operations constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995, and we intend that such forward-looking statements be subject to the
safe harbors created by this law. You generally can identify these statements by
our use of forward-looking words such as "plans," "estimates," "believes,"
"expects," "may," "will," "should" or "anticipates" or the negative or other
variations of such terms or comparable terminology, or by discussion of strategy
that involve risks and uncertainties. We often use these types of statements
when discussing our plans and strategies, our anticipation of revenues from
designated markets, and statements regarding the development of our businesses,
the markets for our services and products, our anticipated capital expenditures,
operations support systems or changes in regulatory requirements and other
statements contained in this report regarding matters that are not historical
facts.

     We caution you that these forward-looking statements are only predictions
and estimates regarding future events and circumstances. We cannot assure you
that we will achieve the future results reflected in these statements. The risks
we face that could cause us not to achieve these results include, but are not
limited to, our ability to do the following in a timely manner, at reasonable
costs and on satisfactory terms and conditions:

     - successfully market our services to current and new customers;

     - interconnect with and develop cooperative working relationships with
       incumbent local carriers;

                                        17
<PAGE>   19

     - develop efficient operations support systems and other back office
       systems (including, but not limited to, provisioning and billing);

     - successfully and efficiently transfer new customers to our networks and
       access new geographic markets;

     - identify, finance, complete and integrate suitable acquisitions;

     - borrow under our credit facilities or borrow under alternative financing
       sources;

     - install new switching facilities and other network equipment;

     - electronically interface with incumbent local carriers; and

     - obtain leased fiber optic line capacity, rights-of-way, building access
       rights and any required governmental authorizations, franchises and
       permits.

     Regulatory, legislative and judicial developments could also cause actual
results to differ materially from the future results reflected in such
forward-looking statements. You should consider all of our subsequent written
and oral forward-looking statements only in light of such cautionary statements.
You should not place undue reliance on these forward-looking statements and you
should understand that they represent management's view only as of the dates we
make them.

RISK FACTORS

     We Anticipate Having Future Operating Losses and Negative EBITDA as We
     Continue to Expand Our Business and Enter into New Markets

     The expansion and development of our business and the deployment of our
networks, systems and services will require significant capital expenditures, a
substantial portion of which will need to be incurred before the realization of
sufficient revenue. We expect that we will have future operating losses and that
our future adjusted EBITDA will be negative while we develop and expand our
business and until we establish a sufficient revenue-generating customer base.
Adjusted EBITDA represents earnings before interest, income taxes, depreciation
and amortization, management allocation charges and non-cash deferred
compensation. Adjusted EBITDA should not be construed as a substitute for
operating income (loss) or cash flow from operations determined in accordance
with generally accepted accounting principles. For the quarter ended March 31,
2001, we had net operating losses and net losses applicable to common stock of
$96.3 million and negative adjusted EBITDA of approximately $30.0 million. We
typically do not expect to achieve positive adjusted EBITDA in any market until
at least our third year of operation of that market. We can make no assurances
that we will achieve or sustain profitability or generate sufficient operating
income or adjusted EBITDA to meet our working capital, capital expenditure and
debt service requirements, and if we are unable to do so, this would have a
material adverse effect on our business, financial condition and results of
operations.

     We Could Lose Revenue if Calls to Internet Service Providers Are Treated As
     Long Distance Interstate Calls

     We earn "reciprocal compensation" revenue by terminating on our network,
local calls that originate on another carrier's network. We believe that under
the Telecommunications Act other local exchange carriers should have to
compensate us when their customers place calls to Internet service providers who
are our customers. Most incumbent local carriers disagree. A majority of our
reciprocal compensation revenues are from calls to our customers that are
Internet service providers. Regulatory decisions providing that other carriers
do not have to compensate us for these calls could limit our ability to service
this group of customers profitably and could have a material adverse effect on
us. Given the uncertainty as to whether reciprocal compensation should be
payable in connection with calls to Internet service providers, we recognize
such revenue only when realization of it is certain, which in most cases is upon
receipt of cash. In addition, we anticipate that the per minute reciprocal
compensation rate we receive from incumbent local carriers under our new
interconnection agreements will be lower than it was under our previous
agreements. These reductions

                                        18
<PAGE>   20

in reciprocal compensation will have a material adverse effect on us if we are
unable to offset them with other revenues.

     The obligation to pay reciprocal compensation does not extend to long
distance interstate calls. The FCC in its Declaratory Ruling of February 26,
1999, determined that Internet service provider traffic is interstate for
jurisdictional purposes, but also determined that its current rules neither
require nor prohibit the payment of reciprocal compensation for such calls. In
the absence of a federal rule, the FCC determined that state commissions have
authority to interpret and enforce the reciprocal compensation provisions of
existing interconnection agreements and to determine the appropriate treatment
of Internet service provider traffic in arbitrating new agreements. The Court of
Appeals for the District of Columbia Circuit issued a decision on March 24,
2000, vacating the Declaratory Ruling. The court held that the FCC had not
adequately explained its conclusion that calls to Internet service providers
should not be treated as "local" traffic. On April 27, 2001, the FCC issued its
Order on remand from the Court of Appeals and concluded that it had erred in its
analysis of Internet traffic in the Declaratory Ruling. In that Order, the FCC
categorized such traffic as "information access" and held that it is not subject
to reciprocal compensation obligations. Nonetheless, it established an interim,
transitional recovery mechanism pursuant to which Internet service provider
traffic will continue to be compensated, but at rates declining over a period of
three years. In a companion Notice of Proposed Rulemaking released April 27,
2001, the FCC initiated a rulemaking to examine all forms of intercarrier
compensation, including reciprocal compensation, and sought comment on the
feasibility of adopting a bill-and-keep approach to such compensation.
Federally-mandated reductions in reciprocal compensation will have a material
adverse affect on us if we are unable to offset them with other revenues.
Additional disputes over the appropriate treatment of Internet service provider
traffic are expected.

     The Regulation of Access Charges Involves Uncertainties, and the Resolution
     of These Uncertainties Could Adversely Affect Our Business

     We earn "access charge" revenue by connecting our voice service customers
to their selected long distance carriers for outbound calls or by delivering
inbound long distance traffic to our voice service customers. Our interstate
access charges were filed largely mirroring those used by the National Exchange
Carrier Association (NECA), an association of independent local exchange
carriers and our state access charges were generally set the same as those of
state associations similar to NECA or of individual incumbent carriers operating
in other areas within the same state. These charges are generally higher than
those charged by the larger carriers operating in the same areas because these
large carriers have many more customers and therefore have lower per unit costs.
Access charges are intended to compensate the local exchange carrier for the
costs incurred in originating and terminating long distance calls on its network
and we believe our access charges are appropriately set at levels approximately
the same as those of the smaller carriers. Access charge levels in general, and
those charged by smaller carriers in particular, are subject to various disputes
and are under review by the FCC.

     AT&T has challenged the switched access rates of Allegiance and other
carriers and has withheld some or all payments for the switched access services
that they continue to receive. AT&T has asserted that they have not ordered
switched access service from us and/or that our charges for switched access
services are higher than those of the larger carriers serving the same territory
and are therefore unjust and unreasonable. AT&T has refused to pay us any
originating access charges at our tariffed rates. Given the uncertainty as to
whether such amounts will ultimately be paid to Allegiance by AT&T, we recognize
such access revenues only when realization of it is certain. On March 30, 2000,
we filed a lawsuit against each of AT&T and Sprint in the Federal District Court
of the District of Columbia requesting that such parties pay us for outstanding
interstate and intrastate access charges. AT&T and Sprint filed counterclaims
against us alleging that our access charges fail to comply with the Telecom Act
because they are unjust and unreasonable. We have settled this dispute with
Sprint and in doing so have reached an agreement with respect to access charges
payable by them for originating and terminating calls on our local networks.
Although we believe we will ultimately receive payment from AT&T for the amounts
owed to us by them, we cannot provide any assurance as to the amount of payments
that we will ultimately receive, the actual outcome of the FCC proceedings or
our lawsuit or the positions various states will take on the similar issue of
intrastate switched access rates. If we

                                        19
<PAGE>   21

do not receive payment from AT&T for interstate and intrastate access charges
that we believe are owed to us, this will have a material adverse effect on us
unless we are able to offset this access revenue with other revenues. In
addition, our switched access rates will have to be adjusted to comply with
future decisions of the FCC or state commissions and these adjustments could
have a material adverse effect on us.

     On July 5, 1999, the FCC issued a ruling to address the issue of
competitive carrier access charges in the context of a complaint filed by MGC
Communications, Inc. (now known as Mpower Communications), a carrier that had
not been receiving payments from AT&T. In that ruling, the FCC stated that "AT&T
is liable to MGC, at MGC's tariffed rate, for the originating access service
that it received . . ." The FCC indicated that AT&T had no obligation to
purchase access from MGC based on the arguments that MGC had made, but the FCC
also made clear that there may be other requirements that could limit AT&T's
ability to not purchase such access from a competitive local carrier. In
response to that FCC decision, AT&T filed a Petition for Review with the FCC,
which was denied on December 28, 1999. The FCC is also reviewing the switched
access rate level issue and related matters in its Access Charge Reform docket.
In this docket, the FCC has requested comment as to whether long distance
carriers, also known as "interexchange carriers," may refuse to purchase
switched access services from particular carriers. We are an active participant
in that proceeding. On April 19, 2001, the FCC issued a press release stating
that it will soon initiate a rulemaking to examine all forms of intercarrier
compensation including access charges, and that it will consider the feasibility
of adopting a bill-and-keep approach to such compensation. Federally-mandated
reductions in access charges could have a material adverse affect on us. On
April 27, 2001, the FCC issued a Report and Order in the Access Charge Reform
docket addressing competitive local exchange carrier access charge rates. The
FCC established safe harbor benchmark rates that decrease over three years to
the rates charged by incumbent local exchange carriers. The FCC stated that
interexchange carriers must pay the benchmark rates for access services they
receive or face suit in federal court. On April 27, 2001, the FCC also released
a Notice of Proposed Rulemaking through which it proposes to examine all forms
of intercarrier compensation including access charges, and seeks comment on the
feasibility of adopting a bill-and-keep approach for all such compensation.
Federally-mandated reductions in access charges could have a material adverse
affect on us if we are unable to offset them with other revenues.

     On May 31, 2000, the FCC approved a proposal made by a coalition of the
largest incumbent local carriers, AT&T and Sprint, to restructure interstate
access charges. Pursuant to the proposal, certain incumbent carriers, designated
as "price cap" incumbent local carriers, are required to reduce their interstate
access rates to targeted levels approved by the FCC or submit cost studies to
justify different rates. We anticipate that implementation of the FCC's decision
will lead to an industry-wide reduction in interstate access rates, even by
those carriers that are not bound by the decision, including smaller carriers.
Reduction in interstate access rates will have a material adverse effect on us
unless we are able to offset the access revenue with other revenues.

     Several states, including Colorado, Maryland, Massachusetts, Missouri, New
Jersey, New York, Texas, Virginia and Washington, have proposed or required that
access charges of competitive local carriers be limited to those charged by
incumbent local carriers operating in the same area as the competitive local
carriers with respect to calls originating or terminating in such area, except
where the competitive carrier in question can establish that its costs justify a
higher access rate through a formal cost proceeding. We believe that it is
possible that other states will enact similar requirements. We also believe,
however, that it is more likely that many states will use the same approach for
intrastate long distance as the FCC ultimately decides to use for interstate
long distance.

     Our Success Depends on Our Key Personnel and We May Not Be Able to Replace
     Key Executives Who Leave

     We are managed by a small number of key executive officers, most notably
Royce J. Holland, our Chairman and Chief Executive Officer, who is widely
recognized as one of the pioneers in managing providers of competitive local
exchange services. The loss of services of one or more of these key individuals,
particularly Mr. Holland, could materially and adversely affect our business and
our prospects. Most of our executive officers do not have employment agreements,
and we do not maintain key person life insurance for any of our
                                        20
<PAGE>   22

executive officers. The competition for qualified personnel in the
telecommunications industry is intense. For this reason, we cannot assure you
that we will be able to hire or retain necessary personnel in the future.

     We Are Dependent on Effective Billing, Customer Service and Information
     Systems and We May Have Difficulties in Developing These Systems

     Sophisticated back office information and processing systems are vital to
our growth and our ability to monitor costs, bill customers, initiate, implement
and track customer orders and achieve operating efficiencies. We cannot assure
you that these systems will be successfully implemented on a timely basis or at
all or will perform as expected because:

     - we have and will likely continue to have difficulties in getting products
       and services from our vendors delivered in a timely and effective manner,
       at acceptable costs and at the service and performance level required;

     - we may fail to adequately identify all of our information and processing
       needs;

     - our processing or information systems may fail or be inadequate;

     - we may not be able to effectively integrate such products or services;

     - we may fail to upgrade systems as necessary; and

     - third party vendors may cancel or fail to renew license agreements that
       relate to these systems.

     Under Certain Circumstances We May Need Additional Capital to Expand Our
     Business and Increase Revenue

     We may need additional capital to fund capital expenditures, working
capital, debt service and cash flow deficits during the period in which we are
expanding and developing our business and deploying our networks, services and
systems. We believe that the borrowings expected to be available under our
credit facilities, together with our cash on hand, will be sufficient to
pre-fund our expanded business plan. However, we will only be able to borrow
under these credit facilities if we are in compliance with the financial
covenants and other conditions. In the event we cannot borrow under these credit
facilities or if our estimates of capital requirements are inaccurate, we may
need to access alternative sources of capital. If we are unable to do so we may
not be able to expand as we expect, which may have an adverse effect on us.

     The actual amount and timing of our future capital requirements may differ
materially from our estimates as a result of financial, business and other
factors, many of which are beyond our control, as well as prevailing economic
conditions.

     Our Substantial Indebtedness Could Make Us Unable to Service Indebtedness
     and Meet Our Other Requirements and Could Adversely Affect Our Financial
     Health

     We have a significant amount of debt outstanding and plan to access
additional debt financing to fund our expanded business plan, including under
our credit facilities. On March 31, 2001, we had $576.3 million of outstanding
indebtedness.

     This level of debt could:

     - impair our ability to obtain additional financing for working capital,
       capital expenditures, acquisitions or general corporate purposes;

     - require us to dedicate a substantial portion of our cash flow from
       operations to the payment of principal and interest on our indebtedness,
       thereby reducing the funds available for the growth of our networks;

     - place us at a competitive disadvantage with those of our competitors who
       do not have as much debt as we do;

                                        21
<PAGE>   23

     - impair our ability to adjust rapidly to changing market conditions; and

     - make us more vulnerable if there is a downturn in general economic
       conditions or in our business.

     We cannot assure you that we will be able to meet our working capital,
capital expenditure and debt service requirements and if we are unable to do so,
this could have a material adverse effect on our business, financial condition
and results of operations.

     Limitations Imposed by Restrictive Covenants Could Limit How We Conduct
     Business and a Default Under Our Indentures and Financing Agreements Could
     Significantly Impact Our Ability to Repay Our Indebtedness

     Our indentures and our credit facilities contain covenants that restrict
our ability to:

     - incur additional indebtedness;

     - pay dividends and make other distributions;

     - prepay subordinated indebtedness;

     - make investments and other restricted payments;

     - enter into sale and leaseback transactions;

     - create liens;

     - sell assets; and

     - engage in certain transactions with affiliates.

     Our current and future financing arrangements contain and will continue to
contain similar or more restrictive covenants, as well as other covenants that
will require us to maintain specified financial ratios and satisfy financial
tests. As a result of these restrictions, we are limited in how we conduct
business and we may be unable to raise additional debt or equity financing to
operate during general economic or business downturns, to compete effectively or
to take advantage of new business opportunities. This may affect our ability to
generate revenues and make profits. Without sufficient revenues and cash, we may
not be able to pay interest and principal on our indebtedness.

     Our failure to comply with the covenants and restrictions contained in our
indentures and other financing agreements could lead to a default under the
terms of these agreements. If such a default occurs, the other parties to such
agreements could declare all amounts borrowed and all amounts due under other
instruments that contain provisions for cross-acceleration or cross-default due
and payable. In addition, lenders under our current and future financing
arrangements could terminate their commitments to lend to us. If that occurs, we
cannot assure you that we would be able to make payments on our indebtedness,
meet our working capital or meet our capital expenditure requirements, or that
we would be able to find additional alternative financing. Even if we could
obtain additional alternative financing, we cannot assure you that it would be
on terms that are favorable or acceptable to us.

     We May Not Have the Funds Necessary to Finance the Change of Control Offer
     Which May Be Required By Our Financing Agreements

     Our indentures provide that upon a change of control, each note holder will
have the right to require us to purchase all or a portion of such holder's
notes. We would be required to purchase the notes at a purchase price of 101% of
the accreted value of the 11 3/4% notes and 101% of the principal amount of the
12 7/8% notes, plus any accrued and unpaid interest to the date of repurchase.
Our credit facilities provides that upon a change of control, we may be required
to repay all of our obligations under these credit facilities. It is possible
that we will not have sufficient funds at that time to repurchase our notes or
repay any debt outstanding under our credit facilities.

                                        22
<PAGE>   24

     If We Do Not Interconnect with and Maintain Efficient Working Relationships
     with Our Primary Competitors, the Incumbent Local Carriers, Our Business
     Will Be Adversely Affected

     Many new carriers, including us, have experienced difficulties in working
with the incumbent local carriers with respect to initiating, interconnecting,
and implementing the systems used by these new carriers to order and receive
unbundled network elements and wholesale services and locating the new carriers'
equipment in the offices of the incumbent local carriers. As a new carrier, we
must coordinate with incumbent local carriers so that we can provide local
service to customers on a timely and competitive basis. The Telecommunications
Act created incentives for regional Bell operating companies to cooperate with
new carriers and permit access to their facilities by denying such companies the
ability to provide in-region long distance services until they have satisfied
statutory conditions designed to open their local markets to competition. The
FCC recently granted approval to Verizon to provide in-region long distance
service in New York and Massachusetts and to SBC Communications to provide
in-region long distance service in Texas, Oklahoma and Kansas. Other regional
Bell operating companies in our markets may petition and receive approval from
the FCC to offer long distance services. These companies may not be
accommodating to us once they are permitted to offer long distance service. If
we cannot obtain the cooperation of a regional Bell operating company in a
region, whether or not it has been authorized to offer long distance service or
a regional Bell operating company otherwise fails to meet our requirements, for
example, because of labor shortages, work stoppages or disruption caused by
mergers or other organizational changes, our ability to offer local services in
such region on a timely and cost-effective basis will be adversely affected.

     The Need to Move from Tariffs to Individual Contracts for Domestic
     Interstate and International Long Distance Services May Increase Our Costs

     In a decision issued April 28, 2000, the United States Court of Appeals for
the District of Columbia affirmed the FCC's 1996 order that prohibits the filing
of tariffs for domestic interstate long distance service. The FCC's order, which
had been stayed by the Court pending its decision, goes into effect on July 31,
2001, as of which date carriers must cancel all interstate domestic long
distance tariffs on file with the FCC and file no new tariffs for such service.
Although the FCC will not accept interstate long distance tariffs for filing
after July 31, 2001, carriers will still be required to maintain and make
available to the public upon request the rates, terms and conditions applicable
to their domestic long distance services. In the absence of retail tariffs, we
will be required to memorialize our legal relationship with our long distance
customers by some other means, such as individual contracts setting forth the
rates, terms and conditions of service. Negotiating individual contracts in this
manner is likely to increase our cost of providing domestic interstate long
distance services. In an order issued March 16, 2001, the FCC ruled that
carriers likewise are prohibited from filing tariffs for international long
distance service. Within nine months of the effective date of the FCC's order,
carriers will be required to cancel all international long distance tariffs on
file with the FCC and file no new tariffs for such service.

     Our Principal Competitors for Local Services, the Incumbent Local Carriers,
     and Potential Additional Competitors, Have Advantages that May Adversely
     Affect Our Ability to Compete with Them

     The telecommunications industry is highly competitive. Many of our current
and potential competitors in the local market have financial, technical,
marketing, personnel and other resources, including brand name recognition,
substantially greater than ours, as well as other competitive advantages over
us. In each of the markets targeted by us, we will compete principally with the
incumbent local carrier serving that area. These incumbent local carriers enjoy
advantages that may adversely affect our ability to compete with them. Incumbent
local carriers are established providers of local telephone services to all or
virtually all telephone subscribers within their respective service areas.
Incumbent local carriers also have long-standing relationships with federal and
state regulatory authorities. FCC and state administrative decisions and
initiatives provide the incumbent local carriers with pricing flexibility for
their:

     - private lines, which are private, dedicated telecommunications
       connections between customers;

     - special access services, which are dedicated lines from a customer to a
       long distance company provided by the local phone company; and
                                        23
<PAGE>   25

     - switched access services, which refers to the call connection provided by
       the local phone company's switch between a customer's phone and the long
       distance company's switch.

     In addition, with respect to competitive access services, such as special
access services as opposed to switched access services, the FCC recently
approved incumbent local carriers increased pricing flexibility and deregulation
for such access services after certain competitive levels are reached. If the
incumbent local carriers are allowed by regulators to offer discounts to large
customers through contract tariffs, engage in aggressive volume and term
discount pricing practices for their customers, and/or seek to charge
competitors excessive fees for interconnection to their networks, competitors
such as us could be materially adversely affected. If future regulatory
decisions afford the incumbent local carriers increased pricing flexibility or
other regulatory relief, such decisions could also have a material adverse
effect on competitors such as us.

     We also face, and expect to continue to face, competition in the local
market from other current and potential market entrants, including long distance
carriers seeking to enter, reenter or expand entry into the local exchange
marketplace such as AT&T, WorldCom and Sprint, and from other competitive local
carriers, resellers, competitive access providers, cable television companies,
electric utilities, microwave carriers, wireless telephone system operators and
private networks built by large end users. In addition, the development of new
technologies could give rise to significant new competitors in the local market.

     Significant Competition in Providing Long Distance and Internet Services
     Could Reduce the Demand for and Profitability of Our Services

     We also face significant competition in providing long distance and
Internet services. Many of these competitors have greater financial,
technological, marketing, personnel and other resources than those available to
us.

     The long distance telecommunications market has numerous entities competing
for the same customers and a high average turnover rate, as customers frequently
change long distance providers in response to the offering of lower rates or
promotional incentives. Prices in the long distance market have declined
significantly in recent years and are expected to continue to decline. We face
competition from large carriers such as AT&T, WorldCom and Sprint and many
smaller long distance carriers. Other competitors are likely to include regional
Bell operating companies providing long distance services outside of their local
service area and, with the removal of regulatory barriers, long distance
services within such local service areas, other competitive local carriers,
microwave and satellite carriers and private networks owned by large end users.
The FCC has recently granted approval to provide in-region long distance service
to Verizon in New York and Massachusetts and to SBC Communications in Texas,
Oklahoma and Kansas and other regional Bell operating companies may petition and
be granted such approval in the future. We may also increasingly face
competition from companies offering local and long distance data and voice
services over the Internet. Such companies could enjoy a significant cost
advantage because they do not currently pay many of the charges or fees that we
have to pay.

     The Internet services market is highly competitive and there are limited
barriers to entry. We expect that competition will continue to intensify. Our
competitors in this market include Internet service providers, other
telecommunications companies, online service providers and Internet software
providers. Most of the regional Bell operating companies and GTE Corporation
operating units have announced plans to rapidly roll out DSL services. Some of
these entities, including SBC Communications, Qwest (formerly known as US West)
and Verizon, have already commenced deployment of DSL services in selected
markets and may in the future deploy DSL services on a widespread basis.

     Our Need to Comply with Extensive Government Regulation Can Increase Our
     Costs and Slow Our Growth

     Our networks and the provision of telecommunications services are subject
to significant regulation at the federal, state and local levels. Delays in
receiving required regulatory approvals or the enactment of new adverse
regulation or regulatory requirements may slow our growth and have a material
adverse effect upon us.

                                        24
<PAGE>   26

     The FCC exercises jurisdiction over us with respect to interstate and
international services. We must obtain, and have obtained through our
subsidiary, Allegiance Telecom International, Inc., prior FCC authorization for
installation and operation of international facilities and the provision,
including by resale, of international long distance services. Additionally, we
file publicly available tariffs detailing our services and pricing with the FCC
for both international and domestic long-distance services. As noted above, as
of July 31, 2001, we will be prohibited from filing tariffs with the FCC for
domestic interstate long distance service and will be required to cancel any
such tariffs on file as of that date. As of nine months from the effective date
of the FCC's March 16, 2001 order detariffing international services, we will be
prohibited from filing tariffs with the FCC for international long distance
service and will be required to cancel any such tariffs on file as of that date.

     State regulatory commissions exercise jurisdiction over us because we
provide intrastate services. We are required to obtain regulatory authorization
and/or file tariffs at state agencies in most of the states in which we operate.
If and when we seek to build our own network segments, local authorities
regulate our access to municipal rights-of-way. Constructing a network is also
subject to numerous local regulations such as building codes and licensing. Such
regulations vary on a city by city and county by county basis.

     Regulators at both the federal and state level require us to pay various
fees and assessments, file periodic reports, and comply with various rules
regarding the contents of our bills, protection of subscriber privacy, and
similar matters on an ongoing basis.

     We cannot assure you that the FCC or state commissions will grant required
authority or refrain from taking action against us if we are found to have
provided services without obtaining the necessary authorizations, or to have
violated other requirements of their rules and orders. Regulators or others
could challenge our compliance with applicable rules and orders. Such challenges
could cause us to incur substantial legal and administrative expenses.

     Deregulation of the Telecommunications Industry Involves Uncertainties, and
     the Resolution of These Uncertainties Could Adversely Affect Our Business

     The Telecommunications Act provides for a significant deregulation of the
domestic telecommunications industry, including the local exchange, long
distance and cable television industries. The Telecommunications Act remains
subject to judicial review and additional FCC rulemaking, and thus it is
difficult to predict what effect the legislation will have on us and our
operations. There are currently many regulatory actions underway and being
contemplated by federal and state authorities regarding interconnection pricing
and other issues that could result in significant changes to the business
conditions in the telecommunications industry. We cannot assure you that these
changes will not have a material adverse effect upon us.

     The Regulation of Interconnection with Incumbent Local Carriers Involves
     Uncertainties, and the Resolution of These Uncertainties Could Adversely
     Affect Our Business

     Although the incumbent local carriers are required under the
Telecommunications Act to unbundle and make available elements of their network
and permit us to purchase only the origination and termination services that we
need, thereby decreasing our operating expenses, such unbundling may not be done
as quickly as we require and may be priced higher than we expect. This is
important because we rely on the facilities of these other carriers to connect
to our high capacity digital switches so that we can provide services to our
customers. Our ability to obtain these interconnection agreements on favorable
terms, and the time and expense involved in negotiating them, can be adversely
affected by legal developments.

     A recent Supreme Court decision vacated a FCC rule determining which
network elements the incumbent local carriers must provide to competitors on an
unbundled basis. On November 5, 1999, the FCC released an order revising its
unbundled network element rules to conform to the Supreme Court's interpretation
of the law, and reaffirmed the availability of the basic network elements, such
as local loops, the connection from a customer's location to the established
telephone company, and dedicated transport, used by us. It is likely that this
order may be subject to further agency reconsideration and/or court review.
While these court and FCC proceedings were pending, we entered into
interconnection agreements with a number of
                                        25
<PAGE>   27

incumbent local carriers through negotiations or, in some cases, adoption of
another competitive local carrier's approved agreement. These agreements remain
in effect, although in some cases one or both parties may be entitled to demand
renegotiation of particular provisions based on intervening changes in the law.
However, it is uncertain whether any of these agreements will be so renegotiated
or whether we will be able to obtain renewal of these agreements on as favorable
terms when they expire.

     On July 19, 2000, in a decision on remand from the Supreme Court, the
United States Court of Appeals for the Eighth Circuit vacated certain of the
FCC's total element long run incremental (TELRIC) pricing rules. While
sustaining the FCC's use of a forward-looking incremental cost methodology to
set rates for interconnection and unbundled network elements, the Court rejected
the FCC's conclusion that the costs should be based on the use of the most
efficient technology currently available and the lowest cost network
configuration. Instead, the Court stated that the statute required that costs be
based on the use of the incumbent local carrier's existing facilities and actual
network equipment but that these costs should not be based on the historic costs
actually paid by such carrier for network elements. The Court also found that
the FCC erred in using avoidable, rather than actually avoided, costs to
calculate the wholesale discount for resale products. Interconnection and
unbundled network element rates set using the Court's methodology may be higher
than and the wholesale discounts set using the Court's methodology may be lower
than the comparable rates established using the FCC's methodology. The Supreme
Court has agreed to review the Eighth Circuit's decision and the Eighth Circuit
in turn has stayed issuance of the mandate vacating the TELRIC rules pending the
Supreme Court's decision. It is difficult to evaluate the potential impact of
this ruling on the prices we pay incumbent local carriers for unbundled network
elements until the Supreme Court rules. We believe that the pricing of unbundled
network elements approved by many state commissions and reflected in many of our
interconnection agreements is already materially in compliance with the standard
set forth in the Eighth Circuit's ruling. This ruling could have a material
adverse effect on us, however, if it is interpreted to authorize materially
higher charges for unbundled network elements than those prevailing in our
current interconnection agreements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Our investment policy is limited by our existing bond indentures. We are
restricted to investing in financial instruments with a maturity of one year or
less. The indentures require investments in high quality instruments, such as
obligations of the U.S. government or any agency thereof guaranteed by the
United States of America, money market deposits and commercial paper with a
rating of A1/P1.

     We are thus exposed to market risk related to changes in short-term U.S.
interest rates. We manage these risks by closely monitoring market rates and the
duration of our investments. We do not enter into financial or commodity
investments for speculation or trading purposes and are not a party to any
financial or commodity derivatives.

                                        26
<PAGE>   28

     Interest income earned on our investment portfolio is affected by changes
in short-term interest rates. We believe that we are not exposed to significant
changes in fair value because of our conservative investment strategy. However,
the estimated interest income for 2001, based on the estimated average 2000
earned rate on investments, is $28.5 million. Assuming a 100-basis-point drop in
the estimated average rate, we would be exposed to a $4.5 million reduction in
interest income for the year. The following table illustrates this impact on a
quarterly basis:

<TABLE>
<CAPTION>
                                                          QUARTER ENDING
                                          ----------------------------------------------
                                          MARCH     JUNE    SEPTEMBER   DECEMBER
                                           2001     2001      2001        2001     TOTAL
                                          ------   ------   ---------   --------   -----
                                                      (DOLLARS IN MILLIONS)
<S>                                       <C>      <C>      <C>         <C>        <C>
Estimated average investments...........  $577.5   $494.2    $401.5      $336.7      N/A
Estimated average interest earned at the
  average rate of 6.3% for the year
  ended December 31, 2000...............  $  9.1   $  7.8    $  6.3      $  5.3    $28.5
Estimated impact of interest rate
  drop..................................  $  1.4   $  1.2    $  1.0      $  0.9    $ 4.5
</TABLE>

     Our outstanding long-term debt consists principally of long-term, fixed
rate notes, not subject to interest rate fluctuations.

                                        27
<PAGE>   29

                           PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

     Not applicable.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

     On March 9, 2001, we acquired Adgrafix Corporation through a subsidiary
merger, and a portion of the consideration for Adgrafix was 876,258 shares of
our common stock. The shares issued in this transaction are subject to transfer
restrictions imposed by the securities laws which are noted on the stock
certificates. This transaction was exempt from registration under the Securities
Act pursuant to Regulation D of the Securities Act.

     On March 13, 2001, we acquired certain assets of HarvardNet, Inc., and a
portion of the consideration for these assets was 1,721,771 shares of our common
stock. The shares issued in this transaction are subject to transfer
restrictions imposed by the securities laws which are noted on the stock
certificates. This transaction was exempt from registration under the Securities
Act pursuant to Regulation D of the Securities Act.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

     Not applicable.

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

     Not applicable.

ITEM 5. OTHER INFORMATION

     Not applicable.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

     (a) The following exhibits are filed with this report and made a part
hereof.

<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
          11.1           -- Statement regarding computation of per share loss for the
                            three months ended March 31, 2001
          11.2           -- Statement regarding computation of per share loss for the
                            three months ended March 31, 2000
</TABLE>

                                        28
<PAGE>   30

                                   SIGNATURES

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

                                            ALLEGIANCE TELECOM, INC.

                                            By:    /s/ ROYCE J. HOLLAND
                                              ----------------------------------
                                              Name: Royce J. Holland
                                              Title:  Chairman and Chief
                                                Executive Officer

                                            By:     /s/ THOMAS M. LORD
                                              ----------------------------------
                                              Name: Thomas M. Lord
                                                Title: Executive Vice President
                                              and Chief
                                                  Financial Officer

Dated: May 1, 2001

                                        29
<PAGE>   31

                               INDEX TO EXHIBITS

<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
          11.1           -- Statement regarding computation of per share loss for the
                            three months ended March 31, 2001
          11.2           -- Statement regarding computation of per share loss for the
                            three months ended March 31, 2000
</TABLE>