<PAGE>

    As filed with the Securities and Exchange Commission on August 13, 1999
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------

                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

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

                                   FORM 10-Q

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

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

                 For the Quarterly Period Ended June 30, 1999

                       Commission file number 333-49397

                       Focal Communications Corporation
            (Exact name of registrant as specified in its charter)

               Delaware                              36-4167094
       (State of incorporation)         (IRS Employer Identification Number)

                             200 N. LaSalle Street
                                  Suite 1100
                               Chicago, IL 60601
                   (Address of principal executive offices)

                                (312) 895-8400
                        (Registrant's telephone number)

   Indicate by check mark whether the registrant (1) has filed all reports to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or required 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

   The number of shares outstanding of the issuer's common stock, as of August
2, 1999:

     Common stock ($.01 par value)                59,074,555 shares

-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
<PAGE>

                                     INDEX

<TABLE>
<CAPTION>
                                                                            Page
                                                                            ----
<S>                                                                         <C>
PART I--FINANCIAL INFORMATION

  Item 1. Financial Statements (Unaudited).................................   4

    Consolidated Statements of Operations for the Three months ended June
     30, 1999 and 1998, and the Six months ended June 30, 1999 and 1998....   4

    Consolidated Balance Sheets as of June 30, 1999 and December 31, 1998..   5

    Consolidated Statements of Cash Flows for the Six months ended June 30,
     1999 and 1998.........................................................   6

    Condensed Notes to Unaudited Interim Consolidated Financial Statements.   7

  Item 2. Management's Discussion and Analysis of Financial Condition and
   Results of Operations...................................................  14

  Item 3. Quantitative and Qualitative Disclosures About Market Risk.......  20

PART II--OTHER INFORMATION

  Item 1. Legal Proceedings................................................  21

  Item 2. Changes in Securities and Use of Proceeds........................  21

  Item 3. Defaults Upon Senior Securities..................................  21

  Item 4. Submission of Matters to a Vote of Security Holders..............  21

  Item 5. Other Information................................................  22

  Item 6. Exhibits and Reports on Form 8-K.................................  22

SIGNATURES.................................................................  23
</TABLE>

                                       2
<PAGE>

               INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

   We have made statements in this Report on Form 10-Q that are not historical
facts. These "forward-looking statements" can be identified by the use of
terminology such as "believes," "expects," "may," "will," "should" or
"anticipates" or comparable terminology. These forward-looking statements
include, among others, statements concerning:

  . Our business strategy

  . Our anticipation of potential revenues from designated markets or
    customers

  . Statements regarding the growth of our business

  . The markets for our services and products

  . Forecasts of when we will enter particular markets or begin offering
    particular services

  . Our anticipated capital expenditures and funding requirements

  . Anticipated regulatory developments

   These statements are only predictions. You should be aware that these
forward-looking statements are subject to risks and uncertainties, including
financial, regulatory developments, industry growth and trend projections,
that could cause actual events or results to differ materially from those
expressed or implied by the statements. The most important factors that could
affect these statements or prevent us from achieving our stated goals include,
but are not limited to, our failure to:

  . Prevail in legal and regulatory proceedings regarding reciprocal
    compensation for Internet-related calls or changes to laws and
    regulations that govern reciprocal compensation

  . Successfully expand our operations into new geographic markets on a
    timely and cost-effective basis

  . Successfully introduce and expand our data and voice service offerings on
    a timely and cost effective basis

  . Respond to competitors in our existing and planned markets

  . Execute and renew interconnection agreements with incumbent carriers on
    terms satisfactory to us

  . Maintain our agreements for transport facilities

  . Maintain acceptance of our services by new and existing customers

  . Attract and retain talented employees

  . Obtain and maintain any required governmental authorizations, franchises
    and permits, all in a timely manner, at reasonable costs and on
    satisfactory terms and conditions

  . Respond effectively to regulatory, legislative and judicial developments

  . Manage administrative, technical or operational issues presented by our
    expansion plans

  . Address Year 2000 remediation issues

                                       3
<PAGE>

                         PART I--FINANCIAL INFORMATION

Item 1. Financial Statements

               FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                             For the three months        For the six months
                                 ended June 30             ended June 30
                            ------------------------  -------------------------
                               1999         1998          1999         1998
                            -----------  -----------  ------------  -----------
<S>                         <C>          <C>          <C>           <C>
REVENUES..................  $30,326,843  $ 8,078,043  $ 56,330,740  $13,180,491
EXPENSES:
  Customer service and
   network operations.....   14,985,677    2,787,055    25,354,996    4,613,948
  Selling, general and
   administrative.........    6,918,976    1,964,160    12,584,872    3,271,785
  Depreciation and
   amortization...........    4,937,767    1,115,398     8,964,517    2,006,269
  Non-cash compensation
   expense................      811,471      325,000     2,371,047      650,000
                            -----------  -----------  ------------  -----------
    Total operating
     expenses.............   27,653,891    6,191,613    49,275,432   10,542,002
                            -----------  -----------  ------------  -----------
OPERATING INCOME..........    2,672,952    1,886,430     7,055,308    2,638,489
                            -----------  -----------  ------------  -----------
OTHER INCOME (EXPENSE):
  Interest income.........    1,213,681    2,064,813     2,519,763    3,080,715
  Interest expense........   (5,880,845)  (4,534,642)  (11,284,429)  (6,643,794)
                            -----------  -----------  ------------  -----------
                             (4,667,164)  (2,469,829)   (8,764,666)  (3,563,079)
                            -----------  -----------  ------------  -----------
LOSS BEFORE INCOME TAXES..   (1,994,212)    (583,399)   (1,709,358)    (924,590)
PROVISION FOR INCOME
 TAXES....................     (307,685)         --       (307,685)         --
                            -----------  -----------  ------------  -----------
NET LOSS..................  $(2,301,897) $  (583,399) $ (2,017,043) $  (924,590)
                            ===========  ===========  ============  ===========
BASIC AND DILUTED NET LOSS
 PER SHARE OF COMMON
 STOCK....................  $     (0.05) $     (0.01) $      (0.05) $     (0.02)
                            ===========  ===========  ============  ===========
BASIC AND DILUTED WEIGHTED
 AVERAGE NUMBER OF SHARES
 OF COMMON STOCK
 OUTSTANDING..............   44,111,000   44,153,500    44,037,515   44,153,500
                            ===========  ===========  ============  ===========
</TABLE>

                                       4
<PAGE>

               FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS

                      June 30, 1999 and December 31, 1998

<TABLE>
<CAPTION>
                       ASSETS                        June 30, 1999  December 31, 1998
                       ------                        -------------  -----------------
<S>                                                  <C>            <C>
CURRENT ASSETS:
  Cash and cash equivalents......................... $ 86,264,781     $126,041,001
  Short-term investments............................   18,546,258        7,959,940
  Accounts receivable, net of allowance for doubtful
   accounts of $3,900,000, and $1,189,000 at June
   30, 1999 and December 31, 1998, respectively.....   20,253,166        9,792,532
  Other current assets..............................    2,736,849          843,793
                                                     ------------     ------------
      Total current assets..........................  127,801,054      144,637,266
FIXED ASSETS, at cost:..............................  157,393,924       76,119,650
  Less--Accumulated depreciation and amortization...   14,504,605        6,146,530
                                                     ------------     ------------
    Fixed assets, net...............................  142,889,319       69,973,120
  Other Non-Current Assets, net.....................    4,874,623        4,963,894
                                                     ------------     ------------
                                                     $275,564,996     $219,574,280
                                                     ============     ============
<CAPTION>
        LIABILITIES AND STOCKHOLDERS' EQUITY
        ------------------------------------
<S>                                                  <C>            <C>
CURRENT LIABILITIES:
  Accounts payable.................................. $ 14,088,218     $  8,365,470
  Accrued liabilities...............................    4,819,599        1,941,377
  Income taxes payable..............................          --         4,055,000
  Current maturities of long-term debt..............    6,358,392        2,887,036
                                                     ------------     ------------
      Total current liabilities.....................   25,266,209       17,248,883
LONG-TERM DEBT, net of current maturities...........  227,833,131      182,408,757
OTHER NONCURRENT LIABILITIES........................    1,835,344          588,228
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
  Common stock, $.01 par value, 100,000,000 shares
   authorized and 49,108,430 and 48,687,000 issued
   and outstanding at June 30, 1999 and December 31,
   1998, respectively...............................      491,084          486,870
Additional paid-in capital..........................   37,447,357       34,927,448
Deferred compensation...............................   (3,941,612)      (4,736,432)
Accumulated deficit.................................  (13,366,517)     (11,349,474)
                                                     ------------     ------------
      Total stockholders' equity....................   20,630,312       19,328,412
                                                     ------------     ------------
                                                     $275,564,996     $219,574,280
                                                     ============     ============
</TABLE>

                                       5
<PAGE>

               FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                    For the six months ended
                                                             June 30
                                                    --------------------------
                                                        1999          1998
                                                    ------------  ------------
<S>                                                 <C>           <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net loss......................................... $ (2,017,043) $   (924,590)
  Adjustments to reconcile net loss to net cash
   provided by operating activities--
    Depreciation and amortization..................    8,964,517     2,006,269
    Non-cash compensation expense..................    2,371,047       650,000
    Amortization of discount on senior discount
     notes.........................................   10,052,307     6,596,702
    Provision for losses on accounts receivable....    2,711,000       829,000
    Changes in operating assets and liabilities--
      Accounts receivable..........................  (13,171,634)   (6,352,630)
      Related-party receivables....................          --         34,883
      Other current assets.........................   (2,277,373)     (293,545)
      Accounts payable and accrued liabilities.....    8,600,970     1,316,252
      Income taxes payable.........................   (4,055,000)          --
      Other non-current liabilities................    1,247,116       179,484
                                                    ------------  ------------
        Net cash provided by operating activities..   12,425,907     4,041,825
                                                    ------------  ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Capital expenditures.............................  (60,053,334)  (20,394,824)
  Change in short-term investments.................  (10,586,318)          --
                                                    ------------  ------------
        Net cash used in investing activities......  (70,639,652)  (20,394,824)
                                                    ------------  ------------
CASH FLOW FROM FINANCING ACTIVITIES:
  Loan origination fees............................     (132,854)          --
  Proceeds from issuance of long-term debt.........   19,094,356   143,910,756
  Payments on long-term debt.......................   (1,471,873)   (3,536,886)
  Proceeds from the issuance of common stock.......      947,896    13,800,000
                                                    ------------  ------------
        Net cash provided by financing activities..   18,437,525   154,173,870
                                                    ------------  ------------
NET INCREASE (DECREASE) IN CASH AND CASH
 EQUIVALENTS.......................................  (39,776,220)  137,820,871
CASH AND CASH EQUIVALENTS, beginning of period.....  126,041,001     2,256,552
                                                    ------------  ------------
CASH AND CASH EQUIVALENTS, end of period........... $ 86,264,781  $140,077,423
                                                    ============  ============
</TABLE>

                                       6
<PAGE>

               FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

                     CONDENSED NOTES TO UNAUDITED INTERIM
                       CONSOLIDATED FINANCIAL STATEMENTS

                Three months and six months ended June 30, 1999

1. Basis of Presentation

   Except as otherwise required by the context, references in this Form 10-Q
to "Focal", "we", "us", or "our" refer to the combined businesses of Focal
Communications Corporation and all of its subsidiaries. The accompanying
unaudited interim consolidated financial statements reflect all adjustments,
consisting of normal recurring accruals, which we believe are necessary to
present fairly the financial position, results of operations, and cash flows
for Focal for the respective periods presented. Certain information and
footnote disclosures normally included in the annual financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to the rules and regulations of the Securities
and Exchange Commission for Form 10-Q. These unaudited interim consolidated
financial statements should be read in conjunction with our Annual Report on
Form 10-K for the year ended December 31, 1998, filed on March 31, 1999, as
amended by Form 10-K/A filed on April 7, 1999. The consolidated balance sheet
at December 31, 1998 included herein was derived from our audited consolidated
financial statements, but does not include all disclosures required under
generally accepted accounting principles.

   In connection with our August 2, 1999 initial public offering of common
stock (Note 12), our Board of Directors and stockholders authorized: (1) a
recapitalization of our existing Class A common stock, Class B common stock,
and Class C common stock into a single class of common stock; (2) an increase
in the number of authorized shares of common stock to 100,000,000 and the
authorization of 2,000,000 shares of preferred stock; and (3) a 500 for-one
stock split. All shares of common stock outstanding and per share amounts have
been restated to reflect our recapitalization and stock split for all periods
presented.

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

2. Risks and Uncertainties

   Reciprocal compensation payments are amounts paid by one carrier to send
particular traffic to another carrier's network. Reciprocal compensation is
currently a significant component of our total revenues representing
approximately 75%, 72%, and 71% of our total revenues for 1998 and the six and
three month periods ended June 30, 1999, respectively.

   Ameritech is disputing its obligation to pay the reciprocal compensation
owed to us. This dispute was ruled on in favor of Focal by the Illinois
Commerce Commission in March 1998, and by a federal court in July 1998, and
most recently in June 1999 by the Seventh Circuit Court of Appeals.
Substantially all of the disputed amounts have been collected. There is a risk
that prior decisions and any future appeal regarding the settlement of this
dispute in favor of Focal could be revisited, which could allow the carrier to
obtain a refund of prior reciprocal compensation payments. In addition, Bell
Atlantic has notified us that they intend to reduce the reciprocal
compensation rate in New York on a prospective basis beginning on July 1,
1999. We are vigorously challenging this matter before the New York Public
Utility Commission ("NYPUC"). A determination by the NYPUC in favor of Bell
Atlantic to reduce the future reciprocal compensation rate in New York may
have a future material adverse effect on us and our results of operations.

   As a result of several trends in our business and the current regulatory
environment, we expect revenues from reciprocal compensation to decline as a
percentage of total revenues. A reduction in or elimination of revenues
attributable to reciprocal compensation which is not offset by increases in
other revenues generated by us may have a material adverse effect on us and
our results of operations.

                                       7
<PAGE>

               FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

                     CONDENSED NOTES TO UNAUDITED INTERIM
                CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


3. Property and Equipment

   Property and equipment consists of the following:

<TABLE>
<CAPTION>
                                                 June 30,
                                                   1999      December 31, 1998
                                               ------------  -----------------
                                               (Unaudited)
      <S>                                      <C>           <C>
      Building and improvements............... $  2,350,000     $ 2,350,000
      Communications Network..................   68,977,102      44,774,965
      Construction in progress................   39,780,968      15,103,564
      Computer Equipment......................    6,285,313       3,503,512
      Leasehold Improvements..................   15,454,394       8,577,724
      Furniture and fixtures..................    3,230,235       1,790,596
      Motor vehicles..........................       94,973          19,289
      Assets under capital lease..............   21,220,939             --
                                               ------------     -----------
                                                157,393,924      76,119,650
      Less--Accumulated Depreciation and
       Amortization                             (14,504,605)     (6,146,530)
                                               ------------     -----------
                                               $142,889,319     $69,973,120
                                               ============     ===========
</TABLE>

4. Debt

   Long-term debt consists of the following:

<TABLE>
<CAPTION>
                                               June 30, 1999 December 31, 1998
                                               ------------- -----------------
                                                (Unaudited)
      <S>                                      <C>           <C>
      12.125% senior discount notes due 2008,
       net of unamortized discount of
       $93,844,708 and $103,897,016 at June
       30, 1999 and December 31, 1998,
       respectively........................... $176,155,292    $166,102,984
      Secured equipment term loan, maximum
       borrowing level at $50,000,000.........   36,815,292      19,192,809
      Obligation under capital lease..........   21,220,939             --
                                               ------------    ------------
                                                234,191,523     185,295,793
      Less--current maturities................    6,358,392       2,887,036
                                               ------------    ------------
                                               $227,833,131    $182,408,757
                                               ============    ============
</TABLE>

   We utilize a secured equipment term loan (the "Facility") from a third
party with a maximum borrowing level of $50,000,000. The Facility provides
for, among other things, equipment drawdowns through December 30, 1999, and
requires repayment based on 60 equal monthly installments of principal and
interest for each drawdown. All drawdowns under the Facility bear interest at
the five-year swap rate percent plus additional basis points, as defined in
the Facility. Total drawdowns of $36,815,292 and $19,192,809 were outstanding
under the Facility as of June 30, 1999 and December 31, 1998, respectively.
The Facility provides for certain restrictive financial and nonfinancial
covenants. Among other things, these covenants require the maintenance of
minimum cash flow and revenue levels. We were in compliance with these
covenants as of December 31, 1998 and June 30, 1999.

   On May 24, 1999, we entered into an agreement for the acquisition of dark
fiber transport capacity for a minimum of 2,500 fiber miles (Note 6). The term
of the agreement is 20 years with a renewal option, as defined. The total
minimum commitment is approximately $53.3 million over the lease term. This
agreement has been recorded as property under capital lease and the assets and
obligation under capital lease has been recorded at the present value of the
minimum lease payments totaling $21,220,939 as of June 30, 1999.

                                       8
<PAGE>

               FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

                     CONDENSED NOTES TO UNAUDITED INTERIM
                CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


5. Loss Per Share

   SFAS No. 128 "Earnings Per Share," requires us to calculate our earnings
per share based on basic and diluted earnings per share, as defined. Basic
earnings per common share are based on the weighted average number of shares
of common stock outstanding for the period. This calculation excludes certain
unvested shares of common stock held by executives of the Company. Diluted
earnings per common share are adjusted for the assumed exercise of dilutive
stock options and unvested shares of common stock. Since the adjustments
required for the calculation of diluted weighted average common shares
outstanding are anti-dilutive, this calculation has been excluded from the
loss per share calculation for the three and six months ended June 30, 1999
and 1998. Under the requirements of SFAS No. 128 our basic and diluted
weighted average number of shares outstanding for the three and six months
ended June 30, 1999 and 1998 is as follows:

<TABLE>
<CAPTION>
                                       Three      Three       Six        Six
                                       Months     Months     Months     Months
                                       Ended      Ended      Ended      Ended
                                      June 30,   June 30,   June 30,   June 30,
                                        1999       1998       1999       1998
                                     ---------- ---------- ---------- ----------
<S>                                  <C>        <C>        <C>        <C>
Basic Weighted Average Number of
 Common Shares Outstanding.........  44,111,000 44,153,500 44,037,515 44,153,500
Dilutive Stock Options and Unvested
 Common Shares.....................   8,149,648  6,671,863  7,873,410  6,702,500
                                     ---------- ---------- ---------- ----------
Dilutive Weighted Average Number of
 Common Shares Outstanding.........  52,260,648 50,825,363 51,910,925 50,856,000
                                     ========== ========== ========== ==========
</TABLE>

6. Commitments and Contingencies

   Under the terms of various short- and long-term contracts and agreements,
we are obligated to make payments for office rents and for leasing components
of our communications network through 2019. The office rent contracts provide
for certain scheduled increases and for possible escalation of basic rentals
based on a change in the cost of living or on other factors. We expect to
enter into other contracts for additional components of our communications
network, office space, other facilities, equipment and maintenance services in
the future.

   A summary of such fixed commitments at June 30, 1999 is as follows:

<TABLE>
<CAPTION>
             Year                            Amount
             ----                         ------------
             <S>                          <C>
             1999........................ $ 22,979,241
             2000........................   19,987,804
             2001........................   23,574,238
             2002........................   25,299,279
             2003........................   25,340,529
             Thereafter..................   86,986,492
                                          ------------
                 Total................... $204,167,583
                                          ============
</TABLE>

   On April 28, 1999, we signed an agreement with a carrier for the
acquisition of indefeasible rights of use for dark fiber transport capacity
for a minimum of 8,300 fiber miles. The term of the agreement is 20 years and
the total minimum commitment is approximately $17.9 million.

   On May 4, 1999, we signed an agreement with another carrier for the lease
of fiber transport capacity for a five year term and a minimum commitment of
$70 million. We have committed to $10 million in year one; $13.2 million in
year 2; and $15.6 million for each of the remaining three years of the
agreement.

                                       9
<PAGE>

               FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

                     CONDENSED NOTES TO UNAUDITED INTERIM
                CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


   On May 24, 1999, we entered into an agreement for the acquisition of dark
fiber transport capacity for a minimum of 2,500 fiber miles. This capacity
purchase was financed through a capital lease arrangement with the carrier.
The total minimum commitment is approximately $53.3 million over the lease
term and the present value of the minimum lease payments totaling $21,220,939
has been recorded as assets and an obligation under capital lease as of June
30, 1999.

7. Stock Options

   We have chosen to account for stock based compensation using the intrinsic
value method prescribed in Accounting Principals Board Opinion("APB") No. 25,
"Accounting for Stock Issued To Employees." We have determined the pro forma
net loss and net loss per share for the three and six months ended June 30,
1999 as if compensation expense had been recorded for options granted under
the fair value method described in SFAS No. 123, "Accounting for Stock-Based
Compensation."

   We utilize the Black-Scholes option pricing model to estimate the fair
value of options at the date of grant. If we had adopted SFAS No. 123, pro
forma net loss and pro forma basic and diluted net loss per share of common
stock would have been approximately $(2,809,000) and $(0.06); and $(3,034,000)
and $(0.07) for the three and six months ended June 30, 1999, respectively.

   The Black-Scholes option model estimated the weighted average fair value at
the date of grant of options granted for the six months ended June 30, 1999 to
be approximately $2.11 per option. Principal assumptions used in applying the
Black-Scholes model were as follows:

<TABLE>
<CAPTION>
                                          For the six
                                          months ended
                                            June 30,
                                              1999
                                          ------------
             <S>                          <C>
             Risk-free interest rates....  5.6%-6.7%
             Expected life...............   5 years
             Expected volatility......... 41.7%-142.0%
             Expected dividend yield.....      -
                                          ============
</TABLE>

   The following summarizes option activity:

<TABLE>
<CAPTION>
                                                                      Weighted
                                               Shares of              Average
                                                Common     Exercise   Exercise
                                                 Stock      Prices     Price
                                               ---------  ----------- --------
      <S>                                      <C>        <C>         <C>
      Outstanding at December 31, 1998........ 3,595,000  $0.58-$3.00  $2.18
      Activity for the six months ended June
       30, 1999:
        Options Granted....................... 1,150,500    3.15-3.73   3.47
        Options Exercised.....................  (271,250)   0.58-3.00   1.75
        Options Canceled......................   (53,250)   3.00-3.73   3.17
                                               ---------  -----------  -----
      Outstanding at June 30, 1999............ 4,421,000  $0.58-$3.73  $2.53
                                               =========  ===========  =====
</TABLE>

                                      10
<PAGE>

               FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

                     CONDENSED NOTES TO UNAUDITED INTERIM
                CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


   The following table summarizes information about fixed stock options
outstanding at June 30, 1999:

<TABLE>
<CAPTION>
                          Options Outstanding              Options Exercisable
                   -------------------------------------  -----------------------
                                  Weighted
                                   Average     Weighted                 Weighted
       Range of                   Remaining    Average                  Average
       Exercise      Options     Contractual   Exercise     Options     Exercise
        Prices     Outstanding      Life        Price     Exercisable    Price
       --------    -----------   -----------   --------   -----------   --------
      <S>          <C>           <C>           <C>        <C>           <C>
      $0.58-0.67      771,250        8.1        $0.62       246,563      $0.61
      $2.10-3.73    3,649,750        9.3         2.93       268,250       2.65
                    ---------        ---        -----       -------      -----
                    4,421,000        9.0        $2.53       514,813      $1.67
                    ---------        ---        -----       -------      -----
</TABLE>

8. Equity Transactions

   During the first quarter and second quarter of 1999, we granted 517,000 and
633,500 stock options to employees and directors, respectively. Giving effect
to our initial public equity offering (Note 12), the fair market value of our
common stock exceeded the exercise price of the options granted. We also sold
150,000 shares of common stock to a director during the first quarter of 1999,
which was retrospectively determined to be at a price below the fair market
value. Total non-cash compensation related to these transactions of
approximately $7,610,000 will be recognized, of which $985,000 was recorded
during the first quarter of 1999, and $6,625,000 will be ratably charged to
operations over the four-year vesting period of the options. Non-cash
compensation expense totaling approximately $811,000 and $2,371,000 has been
recorded for the three and six months ended June 30, 1999, respectively.

   On July 1, 1999, employees were granted 820,500 stock options. Giving
effect to our initial public equity offering, the fair market value of our
common stock exceeded the exercise price of the options granted. Total non-
cash compensation related to this grant of approximately $5,314,000 will be
ratably charged to operations over the four-year vesting period of the options
beginning in the third quarter of 1999. In addition, during the second quarter
of 1999, we granted 1,221,500 stock options to employees that were contingent
upon the closing of our initial public equity offering, which occurred on
August 2, 1999. The fair market value of our common stock on the date of the
initial public offering exceeded the exercise price of these options. Total
non-cash compensation of approximately $8,631,000 will be ratably charged to
our operations over the four-year vesting period of the options beginning in
the third quarter of 1999.

9. Income Taxes

   We recorded a provision for income taxes totaling $307,685 for the three
and six months ended June 30, 1999, which is based on our estimate of the
effective tax rate expected to be applicable for the full year. The effective
tax rate of 18% for the six months ended June 30, 1999 differs from the
statutory rate principally because our income tax obligation is based on
alternative minimum tax requirements.

10. Supplemental Disclosure of Cash Flow Information

   Cash paid for interest and non-cash investing and financing activities for
the six months ended June 30, 1999 is as follows:

<TABLE>
<CAPTION>
                                                                    Six Months
                                                                       Ended
                                                                     June 30,
                                                                       1999
                                                                    -----------
      <S>                                                           <C>
      Cash paid during the period for interest..................... $   931,266
      Fixed assets acquired under capital lease.................... $21,220,939
      Payments made under capital leases........................... $       --
      Cash paid for income taxes................................... $ 1,602,000
</TABLE>


                                      11
<PAGE>

               FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

                     CONDENSED NOTES TO UNAUDITED INTERIM
                CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

11. Segment Information

   In 1998, we adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." We are organized primarily on the basis
of strategic geographic operating segments that provide telecommunications
services in each respective geographic region. All of our geographic operating
segments have been aggregated into one reportable segment, "Communications
Services," as of and for the periods ended June 30, 1999 and 1998, and
December 31, 1998.

   Our chief operating decision maker views earnings before interest, taxes,
depreciation and amortization ("EBITDA") as the primary measure of profit and
loss. The following represents information about revenues and EBITDA (which
excludes non-cash compensation), total assets and capital expenditures for the
Communications Services reportable segment as of and for the year ended
December 31, 1998 and for the six months ended June 30, 1999:

<TABLE>
<CAPTION>
                                                          June 30,    December
                                                            1999      31, 1998
                                                         ----------- -----------
      <S>                                                <C>         <C>
      Revenues.......................................... $56,330,740 $43,531,846
      EBITDA............................................  17,831,543  15,161,031
      Total assets...................................... 150,128,600  73,436,768
      Capital expenditures..............................  60,053,334  64,229,247
</TABLE>

   The following reconciles total segment EBITDA to consolidated net loss
before income taxes for the six months ended June 30, 1999 and 1998:

<TABLE>
<CAPTION>
                                                      Six months   Six months
                                                        ended         ended
                                                       June 30,     June 30,
                                                         1999         1998
                                                     ------------  -----------
      <S>                                            <C>           <C>
      Total EBITDA for reportable segment........... $ 17,831,543  $ 5,013,233
      Corporate EBITDA..............................      559,329      281,525
      Depreciation and amortization.................   (8,964,517)  (2,006,269)
      Interest expense..............................  (11,284,429)  (6,643,794)
      Interest income...............................    2,519,763    3,080,715
      Non-cash compensation expense.................   (2,371,047)    (650,000)
                                                     ------------  -----------
          Loss before income taxes.................. $ (1,709,358) $  (924,590)
                                                     ============  ===========
</TABLE>

   The following reconciles segment total assets to consolidated total assets
as of June 30, 1999 and December 31, 1998:

<TABLE>
<CAPTION>
                                                        June 30,   December 31,
                                                          1999         1998
                                                      ------------ ------------
      <S>                                             <C>          <C>
      Total assets for reportable segment............ $150,128,600 $ 73,436,768
      Cash and short-term investments................  104,811,039  133,307,515
      Other current assets...........................    2,210,431    1,125,124
      Fixed assets, net..............................   13,540,304    6,740,979
      Other noncurrent assets........................    4,874,622    4,963,894
                                                      ------------ ------------
          Total consolidated assets.................. $275,564,996 $219,574,280
                                                      ============ ============
</TABLE>

                                      12
<PAGE>

               FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

                     CONDENSED NOTES TO UNAUDITED INTERIM
                CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


   We currently only operates in the United States. Revenues by major customer
for the six months ended June 30, 1999 and 1998, are as follows:

<TABLE>
<CAPTION>
                                                       Six months
                                                          ended     Six months
                                                        June 30,       ended
                                                          1999     June 30, 1998
                                                       ----------- -------------
      <S>                                              <C>         <C>
      Revenues from major customer A.................. $27,547,943  $8,639,978
      Revenues from major customer B..................  13,057,827   1,290,398
</TABLE>

12. Subsequent Events

   On August 2, 1999, we raised approximately $119,000,000 of net proceeds in
an initial public offering ("IPO") of our common stock. We sold 9,950,000
shares of our common stock at a price of $13 per share. Pursuant to the terms
of the underwriting agreement among us and our underwriters, the underwriters
may elect to purchase an additional 1,492,500 shares of our common stock
solely to cover over-allotments, if any. The underwriters have until August
27, 1999 to exercise this option. In connection with the IPO, our Board of
Directors and stockholders authorized: (1) a recapitalization of our existing
Class A common stock, Class B common stock, and Class C common stock into a
single class of common stock; (2) an increase in the number of authorized
shares of common stock to 100,000,000 and the authorization of 2,000,000
shares of preferred stock; and (3) a 500 for-one stock split.

                                      13
<PAGE>

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

Overview

   General. We provide data, voice and colocation services to large,
communications-intensive users in major cities. We began operations in 1996
and initiated service first in Chicago in May 1997. We currently serve a total
of 13 markets, which encompass a total of 34 metropolitan statistical areas,
or MSAs, and plan to serve 16 markets, or 42 MSAs, by the end of 1999 and 20
markets, or 50 MSAs, by the end of 2000. We believe our market expansion will
allow us to reach a critical mass of geographic coverage and service
capability for our target customer base of communications-intensive users. As
of June 30, 1999, we sold 133,536 access lines, of which 106,749 were
installed and in service.

   Our operating results are expected to change over the next 15 months as a
result of several trends in our business and in the regulatory environment.
First, we anticipate that the mix of lines we sell will shift from being
dominated by ISP customer lines to being more evenly balanced among ISP,
corporate and VAR customer lines due to expanded marketing efforts. Second, we
expect our revenues from and margin on ISP lines to decline as our
interconnection agreements in each state in which we operate come up for
renewal. In connection with these trends, we intend to emphasize the sale of
new products that leverage our network to maximize revenues per line and
operating margins. These products include high-speed remote access to the
Internet and LANs connected via DSL technology. Third, our continued expansion
may result in negative operating cash flows and operating losses for a period
of time. If this occurs, we expect to again produce positive operating cash
flows once these trends stabilize and operating activities in our newer
markets are established and mature. If, however, these trends do not stabilize
or our operating activities are not established or do not mature as expected,
we may continue to sustain negative operating cash flows and net losses.

   Revenue. Our revenue is comprised of monthly recurring charges, usage
charges and initial, non-recurring charges. Monthly recurring charges include
the fees paid by our customers for lines in service, additional features on
those lines, and colocation space. Monthly recurring charges are derived only
from end user customers. Usage charges consist of fees paid by end users for
each call made, fees paid by the ILEC and other CLECs as reciprocal
compensation, and access charges paid by the IXCs for long distance traffic
that we originate and terminate. Non-recurring revenues are typically derived
from fees charged to install new customer lines.

   We earn reciprocal compensation revenue for calls made by customers of
another local exchange carrier to our customers. Conversely, we incur
reciprocal compensation expense to other local exchange carriers for calls by
our customers to their customers. Reciprocal compensation has historically
been a significant component of our total revenue due to the preponderance of
inbound applications utilized by our customers. Reciprocal compensation
represented approximately 75% of total revenues in 1998 and approximately 72%
and 71% of total revenues for the six and three months ended June 30, 1999,
respectively.

   We expect the proportion of revenues represented by reciprocal compensation
to substantially decrease in the future as a result of the expiration and
subsequent renegotiation of our existing interconnection agreements with the
ILECs and as a result of our focus on increasing the percentage of our lines
that are sold to non-ISP customers. We expect the most significant impact of
the reduction in reciprocal compensation to occur when our existing
interconnection agreement with Ameritech Illinois, which expires during the
fourth quarter of 1999, is renegotiated. Although we expect to renew our
existing interconnection agreements on satisfactory terms, we expect that the
new agreements will result in lower negotiated interconnection rates for
future reciprocal compensation. Revenues from reciprocal compensation could
also decline as a result of adverse judicial or regulatory determinations.

   Operating Expenses. Our operating expenses are categorized as customer
service and network operations, selling, general and administrative,
depreciation and amortization, and non-cash compensation expense. Settlement
costs are a significant portion of customer service and network operations
expense and are comprised of leased transport charges and reciprocal
compensation payments. Leased transport charges are the lease payments we make
for the use of fiber transport facilities connecting our customers to our
switches and for our

                                      14
<PAGE>

connection to the ILECs' and other CLECs' networks. Our strategy of initially
leasing rather than building our own fiber transport facilities has resulted
in our cost of service being a significant component of total costs. To date,
we have been successful in negotiating lease agreements that match the
duration of our customer contracts, thereby allowing us to avoid the risk of
incurring expenses associated with transport facilities that are not being
used by revenue generating customers.

   Historically, leasing rather than building our transport network has
resulted in capital expenditures which we believe are lower than those of
CLECs of similar size that own their fiber networks. Our capital expenditures
have been driven by customer service demands and projected near-term revenue
streams from our established markets. In addition, we believe that the
percentage of these "success-based" capital expenditures is higher than those
of fiber-based CLECs. In contrast, we incur operating expenses for leased
facilities that are proportionately higher than those incurred by fiber-based
CLECs. The margin impact of these higher, anticipated operating expenses is
expected to be mitigated, in part, by a higher revenue per line, which we
anticipate as a result of our focus on communications-intensive users.

   As contemplated by our business plan, in April and May 1999 we entered into
a number of agreements to own fiber transport capacity as well as continue to
lease transport facilities for combined minimum commitments of $98.6 million
over five years and $42.6 million over the next fifteen years. These
commitments will result in increased operating expenses for future periods,
which we believe should be more than offset by future revenues associated with
new services made possible, in part, by these agreements.

   Other customer service and network operations expense consists of the costs
of operating our network and the costs of providing customer care activities.
Major components include wages, rent, power, equipment maintenance, supplies
and contract employees.

   Selling, general and administrative expense consists of sales force
compensation and promotional expenses as well as the cost of corporate
activities related to regulatory, finance, human resources, legal, executive,
and other administrative activities. We expect our selling, general and
administrative expense to be lower as a percentage of revenue than that of our
competitors because we have relatively high sales productivity associated with
our strategy of serving communications-intensive customers. These customers
generally utilize a large number of switched access lines relative to the
average business customer, resulting in more revenue per sale. Further, fewer
sales representatives are required to service the relatively smaller number of
communications-intensive customers in a given region.

   We record monthly non-cash compensation expense related to shares issued to
some of our executive officers in November 1996, in connection with the
September 30, 1998 amendments to vesting agreements with some of our executive
officers, in connection with stock options granted to employees and directors
during the first and second quarters of 1999, and shares issued to a director
during the first quarter of 1999. We will continue to record non-cash
compensation expense in future periods relating to these events through the
third quarter of 2003 (See Note 8 to our Unaudited Interim Consolidated
Financial Statements).

                                      15
<PAGE>

Quarterly Results

   The following table sets forth unaudited financial, operating and
statistical data for each of the specified quarters of 1998 and 1999. The
unaudited quarterly financial information has been prepared on the same basis
as our Consolidated Financial Statements and, in our opinion, contains all
normal recurring adjustments necessary to fairly state this information. The
operating results for any quarter are not necessarily indicative of results
for any future period.

<TABLE>
<CAPTION>
                                         1998                            1999
                          ------------------------------------  ------------------------
                            Second       Third       Fourth        First       Second
                           Quarter      Quarter      Quarter      Quarter      Quarter
                          ----------  -----------  -----------  -----------  -----------
<S>                       <C>         <C>          <C>          <C>          <C>
Revenues................  $8,078,043  $12,755,293  $17,596,062  $26,003,897  $30,326,843
EBITDA..................  $3,326,828  $ 4,348,713  $ 6,393,913  $ 9,968,682  $ 8,422,190
Lines Sold to Date......      30,385       41,316       68,184       85,329      133,536
Lines Installed to
 Date(1)................      24,357       33,188       52,011       70,572      106,749
Estimated Data Lines (%
 of Installed lines)....          81%          69%          71%          71%          72%
Lines on Switch (%).....         100%         100%         100%         100%         100%
ILEC Central Offices
 Interconnected.........         249          297          340          443          771
ILEC Central Office
 Colocations in Service
 or Under Development...         --           --           --            23           58
Average Monthly Revenue
 Per Line...............        $139         $148         $138         $141         $114
Quarterly Minutes of use
 switched (in millions).         683        1,039        1,444        2,033        2,657
Markets in Operation....           2            6           10           12           13
MSAs Served.............           6           13           29           31           34
Switches Operational....           2            4            6            7            9
Focal Customer
 Colocation Space in
 Service (Sqr. Ft.).....       2,938        9,882       23,302       29,282       41,081
Capital Expenditures
 ($mil).................         $13          $24          $21          $24          $57(2)
Employees...............         131          186          233          312          418
</TABLE>
-------
(1) Does not include approximately 12,000 access lines in Boston, which are
    being managed by us on behalf of Level 3 Communications, as a result of
    our purchase of Level 3's switch in January of 1999. These lines are
    expected to eventually migrate to Level 3's network.
(2) Includes approximately $21 million of assets acquired under a capital
    lease during the second quarter of 1999.

Three Months Ended June 30, 1999 Compared to Three Months Ended June 30, 1998

   Our total revenues for the three months ended June 30, 1999 were $30.3
million compared to $8.1 million for the three months ended June 30, 1998.
This $22.2 million increase is primarily due to our generation of revenues
from several markets, including Chicago and New York during the second quarter
of 1999 compared to revenues being generated from only two markets, Chicago
and New York, in the second quarter of 1998. Also contributing to our revenue
increase is that the number of lines we installed during the second quarter of
1999 exceeded the lines installed in the comparable period of 1998 by
approximately 26,000 lines. Customer service and network operations expenses
totaled $15.0 million for the second quarter of 1999 compared to $2.8 million
for the second quarter of 1998. This $12.2 million increase resulted from our
rapid expansion into new markets and related costs for leased facilities,
usage settlements, customer care and operational personnel, equipment
maintenance and other operating expenses. Selling, general and administrative
expenses also increased by $4.9 million, from $2.0 million during the three
months ended June 30, 1998 to $6.9 million during the most recent three month
period as a result of our rapid expansion. Similarly, depreciation and
amortization increased from $1.1 million to $4.9 million in the comparative
periods. This increase of $3.8 million is a result of a significant increase
in the level of fixed assets we put into service between July 1, 1998 and June
30, 1999. Non-cash compensation expense was $0.8 million for the second
quarter of 1999 compared to $0.3 million for the second quarter of 1998. The
increase of $0.5 million in non-cash compensation expense is the result of the
September 30, 1998 amendments of vesting agreements with some of our executive
officers and stock options granted to employees and directors during the first
and second quarters of 1999.

   Interest income decreased from $2.1 million in the second quarter of 1998,
to $1.2 million in the comparable period of 1999. This $0.9 million decrease
is due to our utilization of approximately $35.3 million of our cash, cash
equivalents, and short-term investments for planned capital and operations
requirements. Interest expense increased

                                      16
<PAGE>

from $4.5 million in the second quarter of 1998 to $5.9 million in the second
quarter of 1999. This $1.4 million increase is due to an additional $0.6
million of amortization of our Notes and $0.8 million of interest expense on
our secured equipment term loan that we entered into during December 1998.
Interest on the Notes is not payable in cash until August 2003.

   We incurred U.S income tax expense of $0.3 million for the second quarter
of 1999 due to the application of the alternative minimum income tax. We
incurred no income tax expense during the second quarter of 1998. We had a net
loss of $2.3 million in the second quarter of 1999 compared to a net loss of
$0.6 million in the comparable period of 1998. This $1.7 million of additional
losses in the second quarter of 1999 is a direct result of our planned
expansion into 16 markets by the end of 1999.

Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998

   Our total revenues for the first half of 1999 were $56.3 million compared
to $13.2 million for the first half of 1998. This increase of $43.1 million is
primarily due to our generation of revenues from several markets, including
Chicago and New York during the first half of 1999 compared to revenues being
generated from only two markets, Chicago and New York, in the comparable
period of 1998. Also contributing to our increase in revenues is the
installation of approximately 55,000 lines during the first half of 1999,
which exceeded the lines installed in the comparable period of 1998 by
approximately 38,000 lines. Customer service and network operations expense
was $4.6 million in the six months ended June 30, 1998 and $25.4 million
during the most recent six-month period. The $20.8 million increase resulted
from our rapid expansion into new markets. Selling, general and administrative
expense increased by $9.3 million to $12.6 million for the first half of 1999
as a result of our planned expansion. Similarly, depreciation and amortization
increased from $2.0 million to $9.0 million in the comparative periods. This
increase of $7.0 million is a result of a significant increase in the level of
fixed assets put into service in the first half of 1999 compared to the first
half of 1998. Non-cash compensation expense was $2.4 million for the first
half of 1999 compared to $0.7 million for comparable period in 1998. This $1.7
million increase in non-cash compensation expense is the result of the
September 30, 1998 amendments of vesting agreements with some of our executive
officers, stock options granted to employees and directors during the first
and second quarters of 1999, and stock issued to a director during the first
quarter of 1999.

   Interest income decreased from $3.1 million in the six months ended June
30, 1998 to $2.5 million in the six months ended June 30, 1999. This decrease
of $0.6 million is due to our utilization of our cash, cash equivalents, and
short-term investments for our planned capital and operations requirements.
Interest expense increased from $6.6 million in the first half of 1998 to
$11.3 million in the first half of 1999. This increase of $4.7 million is due
to an additional $3.5 million of amortization of our Notes and $1.2 million of
interest expense on our secured equipment term loan that we entered into
during December 1998.

   We incurred U.S income tax expense of $0.3 million for the first half of
1999 due to the application of the alternative minimum income tax. We incurred
no income tax expense during the first half of 1998. We had a net loss of $2.0
million for the first six months of 1999 compared to a net loss of $0.9
million in the comparable period of 1998. This $1.1 million of additional
losses in the first half of 1999 is a direct result of our planned expansion
into 16 markets by the end of 1999.

Liquidity and Capital Resources

   We intend to continue to increase our coverage of major U.S. cities by
expanding our services to three additional markets in 1999 and another four
markets in 2000. This business plan contemplates that we expand our existing
networks and services, deploy our own fiber capacity in a majority of our
markets and fund our initial operating losses. We will require significant
capital to fund the purchase and installation of telecommunications switches,
equipment, infrastructure and fiber facilities and/or long-term rights to use
fiber transport capacity. The implementation of this plan requires significant
capital expenditures, a substantial portion of which will be incurred before
significant related revenues from our new markets are expected to be realized.

                                      17
<PAGE>

These expenditures, together with associated early operating expenses, may
result in our having substantial negative operating cash flow and substantial
net operating losses for the foreseeable future, including in 1999 and 2000.
Although we believe that our cost estimates and the scope and timing of our
build-out are reasonable, we cannot assure you that actual costs or the timing
of the expenditures, or that the scope and timing of our build-out, will be
consistent with current estimates.

   Our capital expenditures were approximately $60.1 million for the first
half of 1999, primarily reflecting capital spending for the build-out of 17 of
20 of our markets, including the $7.7 million acquisition of network assets
and associated infrastructure from Level 3 Communications for our Boston
market. We estimate that our capital expenditures in connection with our
business plan will be approximately $90 million for the remainder of 1999. The
1999 expenditures are expected to be made primarily for the build-out of
additional markets, the expansion of our existing markets and services,
including high-speed data services, and the purchase of local fiber transport
capacity in a majority of our markets. In addition, during May 1999 we entered
into a capital lease arrangement with a carrier for the acquisition of dark
fiber transport capacity. We have recorded $21.2 million of assets under
capital lease relating to this agreement during second quarter of 1999.

   We estimate that the implementation of our business plan, as currently
contemplated, including the remaining 1999 capital expenditures previously
described, operating losses in newer markets and working capital needs will be
funded through the fourth quarter of 2000 with cash, cash equivalents and
short-term investments currently on hand, borrowing capacity under our $50
million equipment term loan facility (described below), anticipated cash flows
from future operations and the net proceeds received of approximately $119
million from our initial public offering that was completed on August 2, 1999.

   Our expectations of our future capital requirements and cash flows from
operations are based on current estimates. If our plans or assumptions change
or prove to be inaccurate, we may be required to seek additional sources of
capital or seek additional capital sooner than currently anticipated. We may
also choose to raise additional capital to take advantage of favorable
conditions in the capital markets.

   Net cash provided by operating activities for the first half of 1999 was
$12.4 million, an increase of $8.4 million from the same period in 1998. This
increase is primarily the result of a $7.0 million increase in depreciation
and amortization, a $1.7 million increase in non-cash compensation expense, an
additional $3.5 million of amortization of our Notes, and a $7.3 million
increase in accounts payable and accrued liabilities, which was offset by
increased accounts receivable of $4.9 million and income taxes paid totaling
$4.1 million. Net cash used in investing activities was $70.6 million for the
first half of 1999 compared to $20.4 million in the first half of 1998. This
increase of $50.2 million is primarily the result of our expansion into new
markets, which resulted in capital expenditures that exceeded the capital
expenditures of the first half of 1998 by $39.7 million, and our short-term
investments changed by $10.6 million in the first half of 1999. Short-term
investments primarily consist of debt securities, which typically mature
between three months and one year. Net cash provided by financing activities
for the first six months of 1999 was $18.4 million, a decrease of $135.8
million from the first six months of 1998. This decrease is primarily the
result of our receipt of $144.1 million in net proceeds from the issuance of
Notes during the first half of 1998.

   Our $50 million equipment term loan facility with NTFC Capital Corporation
provides that NTFC will make term loans to us in an aggregate principal amount
of up to $50 million. These loans are to be used solely for the purchase of
telecommunications equipment and related software licenses. To secure the
loans, we have granted NTFC a security interest in the assets acquired with
the loans. Loans must be repaid over a five-year period from the date of the
borrowing, which must be on or prior to December 31, 1999. Principal and
interest payments are due monthly, and interest accrues based on the five-year
swap rate, plus additional basis points. Interest will accrue at a lower rate
if we meet specified financial tests. As of June 30, 1999, we had $36.8
million outstanding under this term loan facility.

   We have historically incurred net losses and have an accumulated deficit of
$11.3 million as of December 31, 1998 and $13.4 million as of June 30, 1999.
We initially funded a large portion of our future

                                      18
<PAGE>

operating losses and capital expenditures through the 1998 offering of the
Notes and by other financings. On February 18, 1998, we received $150 million
in gross proceeds from the sale of the Notes. The Notes will accrete to an
aggregate stated principal amount of $270 million by February 15, 2003. As of
June 30, 1999, the principal amount of the Notes had accreted to approximately
$176.2 million. No interest is payable on the Notes prior to August 15, 2003.
Thereafter, cash interest will be payable semi annually on August 15 and
February 15 of each year. On August 2, 1999, we raised net proceeds of
approximately $119 million in an initial public offering in which we sold
9,950,000 shares of our common stock at a price of $13 per share.

Impact of the Year 2000 Issue

   The year 2000 issue results from computer programs being written using two
digits rather than four to define the year. Any of our computer programs or
systems, or those of our suppliers, that have date-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in a system failure or miscalculation causing disruption of
operations, including, among other things:

  . A temporary inability to process transactions

  . A temporary inability to send invoices

  . A temporary inability to engage in normal business activities

  . Interruptions of customer service

   Our Year 2000 compliance program can be divided into several phases. These
phases include:

  . Assessing our material information systems and hardware for Year 2000
    readiness

  . Assessing the Year 2000 readiness of third parties with whom we have
    significant business relationships and on whose systems and hardware we
    rely

  . Contingency planning

   As part of our internal assessment phase, we examined our material
information systems, including our DMS-500 SuperNode central office switches,
and other related hardware to determine whether these systems and hardware are
Year 2000 compliant. However, we have not nor do we plan to identify, validate
as compliant or remediate integrated circuits in any other systems or
hardware. We have received assurances from all of our major software and
hardware vendors that the products we use are Year 2000 compliant in all
material respects and will function adequately after December 31, 1999.

   Our services are also dependent on network systems and transport facilities
maintained by other carriers, including ILECs and IXCs. We are in the process
of assessing the Year 2000 compliance status of other carriers with whom we
have material relationships. Our assessment relies, without any independent
verification, on the statements and assumptions underlying the statements
these carriers have made in their periodic reports filed with the Securities
and Exchange Commission. The risks associated with the failure of these
carriers' systems or transport facilities include potential interruption of
service, including blocked calls and delayed call completion. Interruptions of
this type would heavily impact our customers and, if prolonged, could have a
material adverse effect on our business, financial condition or results of
operations.

   Because we currently lease 100% of our transport facilities, we are
dependent on the availability of fiber transport facilities owned by other
carriers. There are few, if any, contingency measures we can take if Year 2000
problems cause these carriers' facilities to fail. We lease transport
facilities from multiple carriers in each market in which we operate in an
attempt to provide redundancy and diversity in service. However, we cannot
assure you that there will not be multiple network failures in a particular
market. If our transport vendors experience facilities failures, our business
may be disrupted and we may suffer a material adverse effect.

   We have completed our Year 2000 compliance program and incurred
approximately $0.3 million in remediation expenditures. All of these costs
have been expensed as they were incurred. We intend to continue

                                      19
<PAGE>

our Year 2000 compliance assessment of our software. If it comes to our
attention that any of our software is not Year 2000 compliant, we intend to
develop an action plan and further assess the risks of non-compliance and the
resources that would be required to resolve the problem. We also intend to
develop contingency plans to the extent we believe those plans would be
useful.

   Based on our completion of our internal Year 2000 compliance program, we
believe that our planning is adequate to secure Year 2000 readiness of our
critical systems. Nevertheless, Year 2000 readiness is subject to a number of
risks and uncertainties, some of which, like the readiness of other carriers
upon whom we rely, are out of our control. We are not able to predict all the
factors that could cause actual results to differ materially from our current
expectations about Year 2000 readiness. The cost of our Year 2000 compliance
program is based upon our management's best estimate. At this time, we believe
that the major risks associated with an inability of our systems or software
to process Year 2000 data correctly or a system failure or miscalculation
causing a disruption of business activities or interruptions in customer
service. If we, or third parties with whom we have significant business
relationships, fail to achieve Year 2000 readiness with respect to critical
systems, there could be a material adverse effect on our business, financial
condition or results of operations.

   The discussions under "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contain forward-looking statements. Our
future performance is subject to a number of risks and uncertainties that
could cause actual results to differ substantially from our projections. See
"Information Regarding Forward-looking Statements" on page 3 of this report.

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

   We are exposed to minimal market risks. We manage sensitivity of our
results of operations to these risks by maintaining a conservative investment
portfolio, which primarily consists of debt securities, typically maturing
within one year, and entering into long-term debt obligations with appropriate
pricing and terms. We do not hold or issue derivative, derivative commodity or
other financial instruments for trading purposes. Financial instruments held
for other than trading purposes do not impose a material market risk on us.

   We are exposed to interest rate risk, as additional debt financing is
periodically needed due to the large operating losses and capital expenditures
associated with establishing and expanding our network coverage. The interest
rate that we will be able to obtain on debt financing will depend on market
conditions at that time, and may differ from the rates we have secured on our
current debt.

   While all of our long-term debt bears fixed interest rates, the fair market
value of our fixed rate long-term debt is sensitive to changes in interest
rates. We have no cash flow or earnings exposure due to market interest rate
changes for our fixed long-term debt obligations. The table below provides
additional information about our Notes.

<TABLE>
<CAPTION>
                                 As of June 30, 1999
       ------------------------------------------------------------------------
      Expected                                                       Average
      Maturity                                        Fixed Debt  Interest Rate
      --------                                       ------------ -------------
       <S>                                           <C>          <C>
       1999......................................... $        --        --
       2000.........................................          --        --
       2001.........................................          --        --
       2002.........................................          --        --
       2003.........................................          --        --
       Thereafter...................................  270,000,000    12.125%
                                                     ------------    ------
                                                     $270,000,000    12.125%
                                                     ============    ======
       Fair Market Value............................ $150,525,000
                                                     ============
</TABLE>

                                      20
<PAGE>

                          PART II--OTHER INFORMATION

Item 1. Legal and Administrative Proceedings

   With the exception of the matters discussed in our December 31, 1998 Annual
Report on Form 10-K, filed on March 31, 1999, as amended by Form 10-K/A filed
on April 7, 1999 and the matters discussed below, we are not aware of any
material litigation against us. In the ordinary course of our business, we are
involved in a number of regulatory proceedings before various state
commissions and the FCC.

   We have received notice from Bell Atlantic that it intends to reduce the
reciprocal compensation rate in the New York market from July 1, 1999 on a
going forward basis, which we are vigorously challenging before the New York
Public Utility Commission. We have also been informed by Bell Atlantic that
they intend to withhold a portion of reciprocal compensation payments in the
Philadelphia market.

Item 2. Changes in Securities and Use of Proceeds

   (a) On July 31, 1999, we filed an Amended and Restated Certificate of
Incorporation with the Secretary of State of the State of Delaware that (i)
authorized us to issue up to 100,000,000 shares of common stock, par value
$.01 per share ("common stock"), and up to 2,000,000 shares of Preferred
stock, par value $.01 per share and (ii) automatically converted each
outstanding share of our Class A common stock, Class B common stock and Class
C common stock into 500 shares of common stock. Accordingly, the holders of
shares of Class A common stock, Class B common stock and Class C common stock
are now entitled to the rights of common stock. Holders of common stock are
entitled to one vote per share on all matters to be voted on by stockholders
generally, including the election of directors. Holders of common stock will
be entitled to receive dividends, if any, declared from time to time by our
Board of Directors out of funds legally available for dividends. If Focal is
liquidated, dissolved or wound-up, holders of common stock will share
proportionately in all assets available for distribution. However, dividend
and distribution rights of holders of common stock will be subject to the
rights of any holders of preferred stock that may be authorized by the Board
of Directors and issued from time to time. The holders of common stock have no
preemeptive or conversion rights. The common stock does not have cumulative
voting rights. As a result, the holder or holders of more than half of the
shares of common stock voting for the election of directors can elect all
directors being elected at that time. There are no redemption or sinking fund
provisions applicable to the common stock. As of August 2, 1999, there were
59,074,555 shares of common stock and no shares of preferred stock
outstanding.

   (b) Not applicable.

   (c) During the second quarter of 1999, we issued an aggregate of 235,125
shares of common stock to our employees upon the exercise of stock options
granted under our Amended and Restated 1997 Nonqualified Stock Option Plan for
an aggregate purchase price of $404,045. No underwriter was engaged in
connection with these sales, and these sales were exempt from registration
under the Securities Act of 1933, as amended (the "Securities Act") pursuant
to Section 4(2) of the Securities Act, as a transaction not involving any
public offering, or Rule 701 under the Securities Act, as a sale of securities
pursuant to certain compensatory benefit plans.

   (d) Not applicable.

Item 3. Defaults Upon Senior Securities

   Not applicable.

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

   Pursuant to a written consent of our stockholders dated June 30, 1999,
effected in accordance with the General Corporation Law of the State of
Delaware, our stockholders re-elected all eight of our directors, who are
Robert C. Taylor, Jr., John R. Barnicle, James E. Crawford, III, John A.
Edwardson, Paul J. Finnegan, Richard D. Frisbie, James N. Perry, Jr. and
Paul G. Yovovich, and ratified the appointment of Arthur Andersen LLP as our
independent public accountant for the 1999 fiscal year.

                                      21
<PAGE>

   Pursuant to a written consent of our stockholders dated July 23, 1999,
effected in accordance with the General Corporation Law of the State of
Delaware, our stockholders voted to: (i) approve our Amended and Restated
Certificate of Incorporation, (ii) approve our Amended and Restated Bylaws,
(iii) approve our 1998 Equity and Performance Incentive Plan and (iv) approve
our 1998 Equity Plan for Non-Employee Directors.

   Holders of approximately 98.6% of the common stock outstanding consented to
the actions referred to above. The remaining holders of shares of common stock
were notified of the actions in accordance with the General Corporation Law of
the State of Delaware.

Item 5. Other Information

   Not applicable.

Item 6. Exhibits and Reports on Form 8-K

   (a) Exhibits

<TABLE>
<CAPTION>
 Exhibit
 Number                            Exhibit Description
 -------  ---------------------------------------------------------------------
 <C>      <S>
  3.1     Form of Amended and Restated Certificate of Incorporation.
          (Incorporated by reference to Exhibit No. 3.3 of the Company's
          registration statement on Form S-1 (No. 333-77995), as amended (the
          "S-1"))
  3.2     Form of Amended and Restated By-Laws. (Incorporated by reference to
          Exhibit No. 3.5 of the S-1)
  4.1     Amendment No. 4 to Stockholders Agreement with Madison Dearborn
          Capital Partners, L.P., Frontenac VI, L.P., Battery Ventures III,
          L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty and Robert C.
          Taylor, Jr., dated as of May 21, 1999. (Incorporated by reference to
          Exhibit No. 4.27 of the S-1)

 10.1     Amendment No. 1 to Loan and Security Agreement with NTFC Capital
          Corporation dated as of April 15, 1999. (Incorporated by reference to
          Exhibit No. 10.25 of the S-1)

 10.2     IRU Agreement dated April 28, 1999, by and between Focal Financial
          Services, Inc. and Level 3 Communications, LLC. (Incorporated by
          reference to Exhibit No. 10.55 of the S-1)

 10.3     Private Line Service Agreement, dated May 4, 1999, between Focal
          Communications Corporation and WorldCom Technologies, Inc.
          (Incorporated by reference to Exhibit No. 10.56 of the S-1)

 10.4     Fiber Optic Network leased Fiber Agreement between Metromedia Fiber
          Network Services, Inc. and Focal Financial Services, Inc. dated as of
          May 24, 1999. (Incorporated by reference to Exhibit No. 10.57 of the
          S-1)

 10.5     Amendment to 1997 Nonqualified Stock Option Plan (amended and
          restated as of August 21, 1998), dated as of May 21, 1999.
          (Incorporated by reference to Exhibit No. 10.58 of the S-1)
 27.1     Financial Data Schedule
</TABLE>

   (b) Reports on Form 8-K

   The Company did not file any current reports on Form 8-K during the quarter
ended June 30, 1999.

                                      22
<PAGE>

                                  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.

                                          Focal Communications Corporation

                                              /s/ Robert C. Taylor, Jr.
                                          _____________________________________
                                                 Robert C. Taylor, Jr.,
                                              President and Chief Executive
                                               Officer(Authorized Officer)

Date: August 13, 1999

                                                /s/ Joseph A. Beatty
                                          _____________________________________
                                                    Joseph A. Beatty,
                                           Executive Vice President and Chief
                                              Financial Officer (Principal
                                                   Financial Officer)

Date: August 13, 1999

                                               /s/ Gregory J. Swanson
                                          _____________________________________
                                                   Gregory J. Swanson,
                                            Controller (Principal Accounting
                                                        Officer)

Date: August 13, 1999

                                      23
<PAGE>

<TABLE>
<CAPTION>
 Exhibit
 Number              Exhibit Description                      Location
 -------  -----------------------------------------   -------------------------
 <C>      <S>                                         <C>
  3.1     Form of Amended and Restated Certificate    Incorporated by reference
          of Incorporation. (Incorporated by
          reference to Exhibit No. 3.3 of the
          Company's registration statement on Form
          S-1 (No. 333-77995), as amended (the "S-
          1"))
  3.2     Form of Amended and Restated By-Laws.       Incorporated by reference
          (Incorporated by reference to Exhibit No.
          3.5 of the S-1)
  4.1     Amendment No. 4 to Stockholders Agreement   Incorporated by reference
          with Madison Dearborn Capital Partners,
          L.P., Frontenac VI, L.P., Battery
          Ventures III, L.P., Brian F. Addy, John
          R. Barnicle, Joseph Beatty and Robert C.
          Taylor, Jr., dated as of May 21, 1999.
          (Incorporated by reference to Exhibit No.
          4.27 of the S-1)

 10.1     Amendment No. 1 to Loan and Security        Incorporated by reference
          Agreement with NTFC Capital Corporation
          dated as of April 15, 1999. (Incorporated
          by reference to Exhibit No. 10.25 of the
          S-1)

 10.2     IRU Agreement dated April 28, 1999, by      Incorporated by reference
          and between Focal Financial Services,
          Inc. and Level 3 Communications, LLC.
          (Incorporated by reference to Exhibit No.
          10.55 of the S-1)

 10.3     Private Line Service Agreement, dated May   Incorporated by reference
          4, 1999, between Focal Communications
          Corporation and WorldCom Technologies,
          Inc. (Incorporated by reference to
          Exhibit No. 10.56 of the S-1)

 10.4     Fiber Optic Network leased Fiber            Incorporated by reference
          Agreement between Metromedia Fiber
          Network Services, Inc. and Focal
          Financial Services, Inc. dated as of May
          24, 1999. (Incorporated by reference to
          Exhibit No. 10.57 of the S-1)

 10.5     Amendment to 1997 Nonqualified Stock        Incorporated by reference
          Option Plan (amended and restated as of
          August 21, 1998), dated as of May 21,
          1999. (Incorporated by reference to
          Exhibit No. 10.58 of the S-1)
 27.1     Financial Data Schedule                     Filed herewith
</TABLE>


                                       24