Use these links to rapidly review the documentALLEGIANCE TELECOM, INC. AND SUBSIDIARIES FORM 10-Q INDEX

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UNITED
STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-Q

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

For the Quarterly Period Ended March 31, 2002.

or

|o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15() OF THE
SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the transition period from
 to

Commission file number 0-24509

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Allegiance Telecom, Inc.

(Exact
name of registrant as specified in its charter)

Delaware

75-2721491(State or other jurisdiction
of incorporation or organization)

(IRS Employer Identification No.)


9201 North Central Expressway
Dallas, Texas 75231(Address of principal executive offices) (Zip Code) (214) 261-7100(Registrant's telephone number, including area code)

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

As
of May 13, 2002, the registrant has 116,433,946 shares of common stock, par value $0.01 per share outstanding.

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ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES  FORM 10-Q INDEX



|PART I. FINANCIAL INFORMATION
|-----------------------------
|Item 1.                      
|                             
|                             
|                             
|                             
|Item 2.                      
|Item 3.                      
|PART II. OTHER INFORMATION   
|Item 1.                      
|Item 2.                      
|Item 3.                      
|Item 4.                      
|Item 5.                      
|Item 6.                      
|                             

2

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PART I. FINANCIAL INFORMATION

ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES        CONDENSED CONSOLIDATED BALANCE SHEETS  (Dollars in thousands, except per share amounts)

|                                           |                                                                                                                                                                                                                 | March 31,
2002                                    |           | December 31,
2001 |          
|------------------------------------------ | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------- | --------- | ----------------- | ---------
|
|Current Assets:                            |                                                                                                                                                                                                                 |                                                   |           |                   |          
|                                           | Cash and cash equivalents                                                                                                                                                                                       |                                                   | $         | 302,608           |          
|                                           | Short-term investments                                                                                                                                                                                          |                                                   |           | 57,448            |          
|                                           | Accounts receivable, net                                                                                                                                                                                        |                                                   |           | 149,238           |          
|                                           | Prepaid expenses and other current assets                                                                                                                                                                       |                                                   |           | 14,500            |          
|                                           |                                                                                                                                                                                                                 |                                                   |           |                   |          
|                                           |                                                                                                                                                                                                                 | Total current assets                              |           |                   | 523,794  
|Property and equipment, net                |                                                                                                                                                                                                                 |                                                   | 1,014,771 |                   |          
|Deferred debt issuance costs, net          |                                                                                                                                                                                                                 |                                                   | 18,140    |                   |          
|Long-term investments, restricted          |                                                                                                                                                                                                                 |                                                   | 954       |                   |          
|Goodwill, net                              |                                                                                                                                                                                                                 |                                                   | 110,820   |                   |          
|Other assets                               |                                                                                                                                                                                                                 |                                                   | 57,008    |                   |          
|                                           |                                                                                                                                                                                                                 |                                                   |           |                   |          
|                                           |                                                                                                                                                                                                                 | Total assets                                      |           | $                 | 1,725,487
|                                           |                                                                                                                                                                                                                 |                                                   |           |                   |          
|Current liabilities:                       |                                                                                                                                                                                                                 |                                                   |           |                   |          
|                                           | Accounts payable                                                                                                                                                                                                |                                                   | $         | 61,373            |          
|                                           | Accrued liabilities and other current liabilities                                                                                                                                                               |                                                   |           | 116,801           |          
|                                           |                                                                                                                                                                                                                 |                                                   |           |                   |          
|                                           |                                                                                                                                                                                                                 | Total current liabilities                         |           |                   | 178,174  
|Long-term debt                             |                                                                                                                                                                                                                 |                                                   | 1,034,479 |                   |          
|Other long-term liabilities                |                                                                                                                                                                                                                 |                                                   | 14,348    |                   |          
|Commitments and contingencies (see Note 9) |                                                                                                                                                                                                                 |                                                   |           |                   |          
|Stockholders' equity:                      |                                                                                                                                                                                                                 |                                                   |           |                   |          
|                                           | Preferred stock, $.01 par value, 1,000,000 shares authorized, no shares issued or outstanding at March 31, 2002 and December 31, 2001                                                                           |                                                   |           |                  |          
|                                           | Common stock, $.01 par value, 150,000,000 shares authorized, 116,298,215 and 115,542,354 shares issued and 115,970,720 and 115,214,859 shares outstanding at March 31, 2002 and December 31, 2001,
respectively |                                                   |           | 1,163             |          
|                                           | Additional paid-in capital                                                                                                                                                                                      |                                                   |           | 1,798,761         |          
|                                           |                                                                                                                                                                                                                 | Common stock in treasury, at cost, 327,495 shares |           |                   | (45      
|                                           | Common stock warrants                                                                                                                                                                                           |                                                   |           | 1,877             |          
|                                           | Deferred compensation                                                                                                                                                                                           |                                                   |           | (470              | )        
|                                           | Accumulated deficit                                                                                                                                                                                             |                                                   |           | (1,302,800        | )        
|                                           |                                                                                                                                                                                                                 |                                                   |           |                   |          
|                                           |                                                                                                                                                                                                                 | Total stockholders' equity                        |           |                   | 498,486  
|                                           |                                                                                                                                                                                                                 |                                                   |           |                   |          
|                                           |                                                                                                                                                                                                                 | Total liabilities and stockholders' equity        |           | $                 | 1,725,487
|                                           |                                                                                                                                                                                                                 |                                                   |           |                   |          

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

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ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES        CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS  (Dollars in thousands, except per share amounts)

|                                                                 |                                        | Three Months Ended March 31, |            
|---------------------------------------------------------------- | -------------------------------------- | ---------------------------- | -----------
|
|
|Revenues                                                         |                                        | $                            | 162,095    
|Operating expenses:                                              |                                        |                              |            
|                                                                 | Network                                |                              |            
|                                                                 | Selling, general and administrative    |                              |            
|                                                                 | Depreciation and amortization          |                              |            
|                                                                 | Management ownership allocation charge |                              |            
|                                                                 | Non-cash deferred compensation         |                              |            
|                                                                 |                                        |                              |            
|                                                                 |                                        | Total operating expenses     |            
|                                                                 |                                        |                              |            
|                                                                 |                                        | Loss from operations         |            
|Other income (expense):                                          |                                        |                              |            
|                                                                 | Interest income                        |                              |            
|                                                                 | Interest expense                       |                              |            
|                                                                 |                                        |                              |            
|                                                                 |                                        | Total other income (expense) |            
|Net loss                                                         |                                        | $                            | (112,590   
|                                                                 |                                        |                              |            
|Net loss per share, basic and diluted                            |                                        | $                            | (0.97      
|                                                                 |                                        |                              |            
|Weighted average number of shares outstanding, basic and diluted |                                        |                              | 115,727,554
|                                                                 |                                        |                              |            

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

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ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES        CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS  (Dollars in Thousands)

|                                                                       |                                                                                            | Three Months Ended March 31,                                                     |                                                    
|---------------------------------------------------------------------- | ------------------------------------------------------------------------------------------ | -------------------------------------------------------------------------------- | ---------------------------------------------------
|
|
|Cash flows from operating activities:                                  |                                                                                            |                                                                                  |                                                    
|                                                                       | Net loss                                                                                   |                                                                                  | $                                                  
|                                                                       | Adjustments to reconcile net loss to cash used in operating activities                    |                                                                                  |                                                    
|                                                                       |                                                                                            | Depreciation and amortization                                                    |                                                    
|                                                                       |                                                                                            | Provision for uncollectible accounts receivable                                  |                                                    
|                                                                       |                                                                                            | Accretion of investments                                                         |                                                    
|                                                                       |                                                                                            | Accretion of Series B and 127/8% notes                                           |                                                    
|                                                                       |                                                                                            | Amortization of deferred debt issuance costs                                     |                                                    
|                                                                       |                                                                                            | Amortization of management ownership allocation charge and deferred compensation |                                                    
|                                                                       | Changes in assets and liabilities, net of effects of acquisitions                         |                                                                                  |                                                    
|                                                                       |                                                                                            | Increase in accounts receivable                                                  |                                                    
|                                                                       |                                                                                            | (Increase) decrease in prepaid expenses and other current assets                 |                                                    
|                                                                       |                                                                                            | Increase in other assets                                                         |                                                    
|                                                                       |                                                                                            | Increase (decrease) in accounts payable                                          |                                                    
|                                                                       |                                                                                            | Increase in accrued liabilities and other current liabilities                    |                                                    
|                                                                       |                                                                                            |                                                                                  |                                                    
|                                                                       |                                                                                            |                                                                                  | Net cash provided by (used in) operating activities
|Cash flows from investing activities:                                  |                                                                                            |                                                                                  |                                                    
|                                                                       | Purchases of property and equipment                                                        |                                                                                  |                                                    
|                                                                       | Capitalized interest                                                                       |                                                                                  |                                                    
|                                                                       | Purchases of subsidiaries, net of cash acquired                                            |                                                                                  |                                                    
|                                                                       | Purchases of investments                                                                   |                                                                                  |                                                    
|                                                                       | Proceeds from sale of investments                                                          |                                                                                  |                                                    
|                                                                       |                                                                                            |                                                                                  |                                                    
|                                                                       |                                                                                            |                                                                                  | Net cash used in investing activities              
|Cash flows from financing activities:                                  |                                                                                            |                                                                                  |                                                    
|                                                                       | Proceeds from issuance of common stock, net                                                |                                                                                  |                                                    
|                                                                       | Payments on capital lease obligations                                                      |                                                                                  |                                                    
|                                                                       | Other                                                                                      |                                                                                  |                                                    
|                                                                       |                                                                                            |                                                                                  |                                                    
|                                                                       |                                                                                            |                                                                                  | Net cash provided by (used in) financing activities
|                                                                       |                                                                                            |                                                                                  |                                                    
|Decrease in cash and cash equivalents                                  |                                                                                            |                                                                                  | (71,476                                            
|Cash and cash equivalents, beginning of period                         |                                                                                            |                                                                                  | 374,084                                            
|                                                                       |                                                                                            |                                                                                  |                                                    
|Cash and cash equivalents, end of period                               |                                                                                            | $                                                                                | 302,608                                            
|                                                                       |                                                                                            |                                                                                  |                                                    
|Supplemental disclosure of cash flow information:                      |                                                                                            |                                                                                  |                                                    
|                                                                       | Cash paid for interest                                                                     |                                                                                  | $                                                  
|Supplemental disclosure of noncash investing and financing activities: |                                                                                            |                                                                                  |                                                    
|                                                                       | Assets acquired under capital lease obligations                                            |                                                                                  | $                                                  
|                                                                       | Fair value of assets acquired in business acquisitions                                     |                                                                                  |                                                    
|                                                                       | Liabilities assumed in business acquisitions                                               |                                                                                  |                                                    
|                                                                       | Common stock issued for business acquisitions (242,968 and 2,416,628 shares, respectively) |                                                                                  |                                                    

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

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ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  Three Months Ended March 31, 2002 and March 31, 2001  (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 in major metropolitan areas across the United States. Allegiance Telecom, Inc. and its subsidiaries are generally 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. The Company is currently operational in all 36 target markets.
These markets include Atlanta, Austin, 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, Ontario/Riverside, Orange County, Philadelphia, Phoenix, Pittsburgh, Portland, Sacramento, St. Louis, San Antonio, San Diego, San Francisco, San Jose, Seattle,
Tampa, Washington, D.C., West Palm Beach/Boca Raton and White Plains.

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
it 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 as well as other revenues, 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 it will be able to do so or that it will ever operate
profitably.

Expenses
are expected to exceed revenues in each of the Company's markets 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 Company has prepared the accompanying unaudited condensed consolidated financial statements 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 Company's audited financial statements as of and for the year ended December 31, 2001. 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, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002.

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

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3. Business Combinations:

Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, "Business Combinations." This
statement addresses financial accounting and reporting for business combinations. Adoption of this statement is required for all business combinations consummated after June 30, 2001. All of
the Company's prior business combinations have been accounted for under the purchase method of accounting. Therefore, the adoption of this statement did not have a material impact on the Company's
business acquisition model.

In
June 2001, the Financial Accounting Standards Board also issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets." This
statement will (1) require that goodwill balances no longer be amortized but rather assessed for impairment at least annually and (2) expand the classifications of other intangible
assets, as well as the expected useful lives of these assets. Adoption of this statement was required as of January 1, 2002, as well as for all purchase business combinations initiated after
June 30, 2001. In accordance with Statement of Financial Accounting Standards No. 142, management will perform an initial valuation enterprise-level goodwill prior to the end of the
second quarter of 2002. Management does not anticipate that an impairment of the Company's enterprise goodwill exists as of January 1, 2002 or that the valuation will have a material impact on
the Company's financial position.

The
table below shows the impact of the amortization recognized in prior periods for intangibles that are no longer amortized after the adoption of Statement of Financial Accounting
Standards No. 142:

Three Months Ended March 31,2002

2001Reported net loss

$
(112,590
)
$
(96,340
)Add back: Goodwill amortization





12,175Add back: Acquired workforce amortization





345Adjusted net loss

$
(112,590
)
$
(83,820
)Basic and diluted net loss per share:Reported net loss per share

$
(0.97
)
$
(0.87
)Goodwill amortization





0.11Acquired workforce amortization





Adjusted net loss per share

$
(0.97
)
$
(0.76
)


Business Acquisitions

During the first quarter of 2002, the Company did not consummate any acquisitions. However, during that quarter, the Company paid contingent consideration totaling
$1,303, consisting of 242,968 shares of its common stock as provided in the merger agreements with Jump.Net, Inc. (acquired in 2000) and Coast to
Coast Telecommunications, Inc. (acquired in 2001). The consideration paid during the first quarter of 2002 was included in accrued liabilities at December 31, 2001. There is no
additional consideration payable under any of the Company's acquisition agreements other than Coast to Coast Telecommunications, Inc. and JumpNet, Inc.

In
connection with the Company's integration plan for the acquired businesses, it has recorded additional goodwill to establish reserves for certain costs, including the termination of
acquired redundant network elements, closure of acquired duplicate facilities, and severance of certain employees. If the Company does not utilize the full extent of the established reserves for their
intended purposes, the reserves are reversed to goodwill in accordance with accounting principles generally accepted in the United States.

4. Property and Equipment:

Property and equipment includes network equipment, land, leasehold improvements, software, office equipment, furniture and fixtures and
construction-in-progress. These assets are stated at cost, which includes

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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, 2002 and 2001,
$2,811 and $4,656, 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, 2002 and December 31, 2001, consisted of the following:

March 31,
2002

December 31,
2001

Useful Lives
(In Years)Network equipment

$
927,407

$
869,011

2-20Land


9,365


9,164

Leasehold improvements


134,668


134,618

7-10Software


124,693


114,553

3Office equipment and other


38,398


36,824

2-5Furniture and fixtures


17,705


17,715

7Property and equipment, in service


1,252,236


1,181,885Less: Accumulated depreciation


(408,219
)

(350,460
)Property and equipment, in service, net


844,017


831,425Construction-in-progress


170,754


184,825Property and equipment, net

$
1,014,771

$
1,016,250


5. Other Assets:

Other assets consisted of the following:

March 31,
2002

December 31,
2001Acquired intangibles

$
62,800

$
66,148Long-term deposits


5,739


4,040Inventory


9,491


6,827Other


6,114


6,231Total other assets


84,144


83,246Less: Accumulated amortization


(27,136
)

(18,520
)Other assets, net

$
57,008

$
64,726


Acquired
intangibles consist of acquired customer lists obtained in connection with business acquisitions. These assets are being amortized over their estimated useful lives of one to
three years using the straight-line method. During the first quarter of 2002, the Company reclassified the value of the acquired workforce intangibles to goodwill in accordance with
Statement of Financial Accounting Standards No. 142. (See Note 3)

Inventory
consists of equipment purchased and being staged for deployment in the Company's network. These inventories will be classified as property and equipment when the equipment is
deployed.

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6. Accrued Liabilities and Other Current Liabilities:

Accrued liabilities and other current liabilities consisted of the following:

March 31,
2002

December 31,
2001Accrued employee compensation and benefits

$
15,268

$
10,314Accrued network expenses


34,551


40,313Business acquisition costs


16,124


15,657Accrued taxes


5,896


8,171Accrued interest expense


10,888


4,103Deferred revenue


22,680


3,088Other


11,394


7,442Accrued liabilities and other current liabilities

$
116,801

$
89,088


7. Long-Term Debt:

Long-term debt consisted of the following:

March 31,
2002

December 31,
2001Series B 113/4% notes, face amount $445,000 due February 15, 2008; effective interest rate of 12.21%; at accreted value

$
397,308

$
385,765127/8% senior notes, face amount $205,000 due May 15, 2008; effective interest rate of 13.24%; at accreted value


201,938


201,852Senior secured credit facilities due December 31, 2006; average interest rate of 6.17% and 6.28%, respectively


350,000


350,000Capital lease obligations, net of current portion


85,233


75,567Long-term debt

$
1,034,479

$
1,013,184




In February 2000, the Company closed on $500 million of senior secured credit facilities ("Credit Facilities"). The Credit Facilities consist of a
$350 million seven-year revolving credit facility and a $150 million two-year delayed draw term loan facility. The Credit Facilities are available, subject to
satisfaction of certain terms and conditions, to provide 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 the Company's leverage ratio, which is approximately the
London Interbank Offered Rate (LIBOR) plus 3.25%. The current commitment fee on the unused portion of the Credit Facilities is 0.75% per annum, paid quarterly.

As
of March 31, 2002, there were $200,000 and $150,000 of borrowings outstanding under the seven-year revolving credit facility and the two-year delayed
draw term loan facility, respectively, all of which are classified as long-term debt.

The
Credit Facilities carry certain restrictive covenants that, among other things, limit the Company's ability to incur indebtedness, create liens, engage in sale-leaseback
transactions, pay dividends or make distributions in respect of capital stock, redeem capital stock, make investments or certain other restricted payments, sell assets, issue or sell stock of certain
subsidiaries, engage in transactions with stockholders or affiliates, effect a consolidation or merger and require the Company to maintain certain operating and financial performance measures. The
Company was in compliance with all such restrictive covenants at March 31, 2002.

8. Capitalization:

During the three months ended March 31, 2002, 512,893 shares of common stock were issued under the Company's stock-based compensation plans for proceeds of
$1,243.

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9. Commitments and Contingencies:

The Company has entered into various operating lease agreements, with expirations through 2015, for office space, equipment and network facilities. Future minimum
lease obligations related to the Company's operating leases as of March 31, 2002 are as follows:

2002

$
22,2812003


30,4102004


28,6132005


28,2142006


26,117Thereafter


97,656


Total
rent expense for the three months ended March 31, 2002 and 2001, was $8,578 and $8,191, 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 $350,000 purchase commitment. In July 2001, this agreement was amended to extend the term to six years. Under the amended agreement,
the Company must complete purchases totaling $100,000 by December 31, 2000, an aggregate of $160,000 of purchases by September 30, 2001, an aggregate of $210,000 by December 31,
2002, an aggregate of $257,000 by December 31, 2003, an aggregate of $304,000 by December 31, 2004, and the full $350,000 of aggregate purchases on or before December 31, 2005. If
the Company does not meet the required purchase milestones, the Company will be required to provide cash settlement in an amount equal to the shortfall. During the term of the contract, such cash
settlements may be applied to future purchases during the commitment period. As of March 31, 2002, the Company has completed cumulative purchases totaling $169,615. In 2002, Lucent waived
$50,000 of the $210,000 purchase commitment for 2002 in exchange for a purchase commitment by the Company of approximately $13,100 of telecommunications equipment. Thus, the remaining commitment under
this agreement is approximately $130,000.

10

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

Overview

Allegiance Telecom, Inc. is a leading competitive provider of integrated telecommunications in major metropolitan areas across the United States.
Allegiance Telecom, Inc. is generally referred to in this Management's Discussion and Analysis of Financial Condition and Results of Operations as "we" or "our company". We offer an integrated
set of telecommunications services including local, long distance, data and web hosting 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. We completed our network rollout during 2001, with all 36 targeted markets operational as of
March 31, 2002, as follows: Atlanta, Austin, Baltimore, Boston, Chicago, Cleveland, Dallas, Denver, Detroit, Fort Lauderdale, Fort Worth, Houston, Long Island, Los Angeles, Miami,
Minneapolis/St. Paul, New York, Northern New Jersey, Oakland, Ontario/Riverside CA, Orange County, Philadelphia, Phoenix, Pittsburgh, Portland, Sacramento, St. Louis, San Antonio, San Diego, San
Francisco, San Jose, Seattle, Tampa, Washington, D.C., West Palm Beach/Boca Raton and White Plains NY.

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 primary 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, 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 arrangement 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 through our own network. 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

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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 table below provides selected key
operational data for the periods ended, each on a cumulative basis:

As of March 31,2002

2001Markets served

36

29Number of switches deployed

31

27Central office colocations

815

687Net lines installed

1,139,400

733,900Sales force employees

1,632

1,471Total employees

4,096

3,834


RESULTS OF OPERATIONS  Three Months Ended March 31, 2002 Compared With Three Months Ended March 31, 2001

Revenues

During the first quarter of 2002 and 2001, we generated revenues of approximately $162.1 million and $105.9 million, respectively. Revenues
have
increased 53.1% compared to first quarter 2001. This increase in revenues is attributable to an increase in the number of customers and the number of lines installed. Revenue growth during 2002 will
depend on our ability to add new customers in a competitive market place, retain existing customers and manage churn, increase customer usage and sell additional services to our existing customers. We
believe that managing our customer churn may be one of our bigger challenges. We expect that customer churn will average approximately 2% to 3% per month, which means that approximately 2% to 3% of
our total number of lines installed would discontinue our service each month. However, in the first quarter of 2002 and fourth quarter of 2001, we experienced churn rates in excess of 2% to 3% per
month, partly due to an increase in churn for our end user retail customers. See the discussion of customer churn under the caption "Liquidity and Capital Resources" below.

Local
voice service revenues for the quarters ended March 31, 2002 and 2001 were $89.2 million and $73.0 million, respectively. Local voice service revenues as a
percent of total revenues has decreased from
68.9% for the three months ended March 31, 2001 to 55.0% for the three months ended March 31, 2002. Local voice service revenues consisted of:



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 and due to lower rates as mandated by the FCC and certain states.
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, 2002 and 2001 were $10.7 million and $5.4 million, respectively. Long distance service revenues as a
percent of total revenues has increased from 5.1% for the three months ended March 31, 2001 to 6.6% for the three months ended March 31, 2002. We reduced our pricing of long distance
services during 2000 and 2001 to respond to competitive pressures and we anticipate long distance pricing to continue at historically low levels given the current competitive environment. A benefit of
this

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reduced pricing was an increase in the number of customers selecting us as their long distance provider. These increased volumes are primarily responsible for the increase in our long distance
revenues. Although these reduced prices decrease our margins on a percentage basis, we anticipate that an increasing share 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, 2002 and 2001 were
$62.2 million and $27.5 million, respectively. Data revenues as a percent of total revenues has increased from 26.0% for the three months ended March 31, 2001 to 38.4% for the
three months ended March 31, 2002. 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 Integrated Access Service 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.

The
rate of growth in our data revenues, however, is subject to uncertainties and negative trends. We believe that the demand for high-end web hosting services has decreased
in response to a general economic slowdown. Moreover, an over capacity of data center space has decreased prices for these high-end services. These high-end services include
dedicated hosting services where we provide the customer with a dedicated computer server in our data centers and colocation services where we provide data center space and services for a customer
which locates its own computer server on our premises. We do not believe that these trends are having a material impact on shared hosting services where customers share a computer server with several
other customers. We believe these shared services are sold less on the basis of price and more on the basis of customer service and ease of use of the underlying software platform which enables the
customer to configure and manage its web site.

Similarly,
the services we offer to network service providers who provide dial-up Internet access services is also experiencing the effects of over capacity and decreased
demand. 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 was amended on September 29, 2000, December 29, 2000 and December 31, 2001. This contract established Genuity as our largest customer. For the three months ended
March 31, 2002 and 2001, revenues from the Genuity contract were $14.4 million and $6.8 million, respectively. Genuity accounted for 8.9% and 6.4% of our total revenues for the
quarters ended March 31, 2002 and 2001, respectively, and 23.2% and 24.7% of our data revenues for the same periods. We anticipate that Genuity will continue to be our largest customer for the
foreseeable future. The contract term expires on December 31, 2006. Under this agreement, Genuity committed to pay us an aggregate of $550.8 million over the term of the contract,
subject to our performance under the contract and the other terms and conditions of the contract. We recognized $5 million of revenue in each of the years 2000 and 2001 upon our delivery of
certain network configuration elements of the contract. For the remainder of the contract value, we recognize revenue under the contract on a pro rata basis over the contract term and based on our
delivery of the required network capacity to Genuity pursuant to the contract. The contract contains specific provisions that decrease Genuity's purchase commitment, including but not limited to,
Genuity experiencing a business downturn. Although we believe our relationship with Genuity and Genuity's liquidity remains strong, many other network service providers who provide dial-up
Internet access services have either gone out of business or materially reduced their offerings and their demand for the services of companies like our company who provide the local services necessary
to connect dial-up customers to the Internet. If Genuity were to experience financial trouble, decrease their commitment in accordance with the contract or otherwise terminate this
contract, this could have a material adverse affect on our revenues.

Notwithstanding
these trends and uncertainties, we believe the demand by end-user small and medium sized business customers for dedicated access to the Internet and for an
efficient way to establish and maintain a web presence through shared hosting remains strong. Indeed, our Integrated Access Service which delivers high-speed, "always on" Internet access
and allows multiple voice, data and Internet combinations over a single access line remains our fastest growing product offering. In the first quarter 2002, Integrated Access Service represented 34.8%
of our net lines installed for that quarter. We believe that customer churn rates (the rate at which customers disconnect their service with us) for this type of service is less than that of our local
phone service. One of the challenges we face in this area is and continues to be building the provisioning processes and resources

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necessary to meet this demand. At March 31, 2002, we had approximately 20,700 lines in backlog for this type of service and we are increasing our efforts to process these orders more quickly.

With
this anticipated increase in demand for dedicated Internet access and shared hosting services, 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. We believe that
investment capital for many of these providers is either unavailable or very difficult to obtain and, as a result, has created some attractive opportunities for us to acquire customers through
acquisitions. Our ability to take advantage of these opportunities, however, is dependent on the market value of our common stock and access to capital, because we use our stock and cash as
consideration for acquisitions.

Lines Sold and Lines Installed

For the quarters ended March 31, 2002 and 2001, we sold 210,000 lines and 165,900 lines, respectively, an increase of 26.6%. For the same periods,
 we
installed 124,400 net lines and 126,200 net lines, respectively. "Lines sold" by us represents the number of lines for which customers have placed orders with us to provide services and "lines
installed" represents the lines sold that are now being used to provide our services. Net lines installed during the first quarter of 2002 were lower than expected, primarily due to customer account
churn. We have established programs to further improve and streamline processes to reduce future churn. See the discussion of customer churn under the caption "Liquidity and Capital Resources" below.

The
services we provide over our own network 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 network as of March 31, 2002 and 2001, representing approximately 95% of our revenues as of March 31, 2002, and we expect this level of facilities-based service to remain
constant over time.

We
have continued to have sales of lines in excess of our ability to install them and place them into service, particularly with respect to customers purchasing T-1 level
services. During the fourth quarter of 2001, we reorganized and expanded our T-1 provisioning operations and centralized them in Dallas. Although we have seen an increased level of
productivity in these operations since the reorganization, the process of moving and expanding these operations had a negative impact on our ability to install T-1 level service lines
during the fourth quarter of 2001. This reorganization and expansion had a continued negative effect on the installation of T-1 based services in the first quarter of 2002.

Network Expenses

For the quarters ended March 31, 2002 and 2001, network expenses were $82.1 million and $51.2 million, respectively. Network expenses
as a
percentage of total revenues increased from 48.4% for the three months ended March 31, 2001 to 50.6% for the three months ended March 31, 2002. The increase in network expense is
consistent with the deployment of our networks and initiation and growth of our services during 2001. While there can be no assurance that we will be successful in creating operating efficiencies, we
expect to continue to control costs and that network expenses as a percentage of total revenues will remain near current levels during 2002.

Gross
margin has decreased from 51.6% for the quarter ended March 31, 2001 to 49.4% for the quarter ended March 31, 2002. Gross margin is calculated as revenues less
network expenses, divided by revenues. We expect our gross margins to improve as our revenues increase and as we realize cost efficiencies in our network expenses.

Network
expenses include:



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Network
expenses do not include an allocation of our depreciation or amortization expenses.

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. In areas of low density and traffic and for most of the local loop lines that we lease, we depend on the incumbent local exchange carriers to provide us with these
lines. In areas of high density and traffic, in addition to the incumbent carriers, we believe that in many instances there are other carriers from whom we can lease high-capacity lines to
connect our switch to our transmission gear and that we can generally lease those lines at lower prices than the prices charged by the incumbent local exchange carriers.

We
expect that our network costs 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 develop our 36 markets, we will continue to generate operating losses.

In
constructing switching and transmission equipment for a new market, we capitalized 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 began to carry revenue-producing traffic. Typically, the recurring charges for
one to three months were 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 are a variable cost that 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 space owned or leased by other parties, including locating our equipment in 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 and connect additional markets to our Internet network.

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Selling, General and Administrative Expenses

Selling, general and administrative expenses increased to $101.8 million for the quarter ended March 31, 2002 from $84.6 million for
the
quarter ended March 31, 2001, primarily due to headcount growth, the addition of new markets and growth of our customer base. Selling, general and administrative expenses as a percentage of
total revenues decreased from 79.9% for the quarter ended March 31, 2001 to 62.8% for the quarter ended March 31, 2002. This decrease is partially due to an increase in our total
revenues and the achievement of certain economies of scale as we have grown the 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, investor and media relations, insurance, professional fees and bad debt expense. The number of employees increased to
4,096 as of March 31, 2002, from 3,834 as of March 31, 2001. As of March 31, 2002, the sales force, including sales managers and sales administrators, had grown to 1,632 from
1,471 as of March 31, 2001. As we expanded our company, ongoing selling, general and administrative expenses increased. We expect these expenses to level off and decrease as we focus on
operating our existing 36 markets and not on expanding into new markets.

Management Allocation Charges and Deferred Compensation Expenses

We amortized $0.2 million of the deferred management ownership allocation charge, a non-cash charge to income, for the quarter ended
March 31, 2001. 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 was fully amortized as
of March 31, 2001.

For
the quarters ended March 31, 2002 and 2001, we recognized $0.5 million and $5.9 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 stock options granted to certain employees under our
1997 stock option plan and 1998 stock incentive plan.

Depreciation

During the quarters ended March 31, 2002 and 2001, depreciation expense was $57.8 million and $36.4 million, respectively. Such
increase was
consistent with the continued deployment of our networks and initiation of services in new markets during 2001.

Amortization of Purchased Intangibles

In connection with the acquisitions completed since inception, we assigned an aggregate of $62.8 million of the purchase price to customer lists.
These
intangible assets are being amortized over their estimated useful lives of one to three years. For the quarters ended March 31, 2002 and 2001, we recorded $10.3 million and
$2.3 million of amortization of customer lists, respectively.

On
January 1, 2002, we adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets." SFAS 142 (1) requires that
goodwill balances no longer be amortized and (2) expands the classifications of other intangible assets, as well as the expected useful lives of these assets. Prior to the adoption of
SFAS 142, we recognized amortization on the goodwill recorded in connection with our business acquisitions. The expense associated with amortization of goodwill in the quarter ended
March 31, 2001 was $12.2 million. Additionally, prior to the adoption of SFAS 142, we assigned an aggregate of $3.3 million to acquired workforces. We recorded
$0.4 million of amortization of these intangible assets during the quarter ended March 31, 2001. The

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acquired workforce intangibles are no longer being amortized and the net book value of these intangibles was reclassified as goodwill on January 1, 2002 upon the adoption of SFAS 142.

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.

We
are required to assess our enterprise-level goodwill under the provisions of Statement of Financial Accounting Standards No. 142. As outlined in the authoritative literature,
our assessment of whether our goodwill has been impaired will be based on relatively sophisticated valuation analysis completed by experienced professionals and valuation experts. We will perform the
valuation at least annually, with the first valuation to be completed before the end of the second quarter. We do not anticipate that an impairment of our enterprise goodwill exists as of
March 31, 2002 or that the valuation will have a material impact on our financial position.

Interest Expense and Interest Income

For the quarters ended March 31, 2002 and 2001, interest expense was $24.1 million and $16.0 million, respectively. The increase in
interest
expense is primarily due to the interest expense associated with the draw down of $350 million of our senior secured credit facility in September 2001. Interest expense reflects the
accretion of the 113/4% notes and related amortization of the original issue discount, the amortization of the original issue discount on the 127/8% notes, and the
interest charges and amortization of deferred debt issuance costs related to our $500 million senior secured credit facilities. The amount of interest capitalized for the quarters ended
March 31, 2002 and 2001 was $2.8 million and $4.7 million, respectively.

Interest
income for the quarters ended March 31, 2002 and 2001 was $1.7 million and $7.0 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 semi-annual payments of
interest through May 2001 on the 127/8% notes. Interest income during quarter ended March 31, 2001 is greater than for the quarter ended March 31, 2002 because we
had additional cash invested in interest-bearing instruments and because interest rates have declined over the past year.

Net Losses and Adjusted EBITDA Losses

Our net loss for the quarters ended March 31, 2002 and 2001, after amortization of the non-cash management ownership allocation charge and
amortization of deferred compensation, was $112.6 million and $96.3 million, respectively.

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 $21.8 million and $30.0 million for quarters ended March 31,
2002 and 2001, 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 $0.5 million and $6.1 million for the quarters ended March 31, 2002 and 2001, respectively.

We
expect to continue to experience operating losses as a result of our development and growth of our business. However, we expect to turn EBITDA positive during the latter part of
2002.

LIQUIDITY AND CAPITAL RESOURCES

As of March 31, 2002, we had approximately $360.1 million of unrestricted cash and short-term investments, compared with
$399.3 million of unrestricted cash and short-term investments as of December 31, 2001. The 10% decrease during the quarter is primarily due to the funding of our operating
losses and capital expenditures of $39.8 million, partially offset by cash generated from working capital, operations and investments.

As
of March 31, 2002 and December 31, 2001, we had approximately $1,034.5 million and $1,013.2 million of long-term indebtedness (including debt
under our senior credit facilities, two series of bonds, and capital lease obligations). We do not have any off-balance sheet financing arrangements, special purpose entities or asset
securitizations.

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Our
existing cash and short-term investment balances will decline further during fiscal 2002. However, our financing plan has been predicated on the pre-funding
of each market's expansion to positive free cash flow. We believe that we have raised the capital necessary to build and operate our network in each of our 36 markets to the point at which operating
cash flow from the market is sufficient to fund its ongoing operating costs and capital expenditures. We also believe that our existing cash on hand, together with an additional $150 million
available under our 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. None of our existing financing arrangements, described below in more detail, have any credit rating downgrade triggers that would
accelerate the maturity dates of our debt. However, a downgrade in our credit rating could adversely affect our ability to renew existing, or obtain access to new, credit facilities in the future and
could increase the cost of such facilities.

We
cannot assure you that our estimates for required funding are accurate. We may need 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. Our common stock closed at $1.20 on May 10, 2002; with our stock trading at these levels, it is unlikely that we
will be able to seek funding from the public equity markets. In addition, in light of adverse developments in the general economy and specifically the telecommunications industry, it may be extremely
difficult to obtain vendor financing, bank financing or other public/private funding necessary to continue funding our business. The actual amount and timing of future capital requirements may differ
materially from our estimates as a result of, among other things:



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



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. Decreased
demand for our services, as noted above, could adversely impact our liquidity. Customer demand for our services depends in part on our ability to efficiently and timely switch customers from their
prior carrier to our service, respond to customer service and billing issues and provide quality service. Our financial projections are based on forecasts of, among other things, customer demand and
customer churn, i.e. the rate at which customers discontinue our service. We expect that customer churn will range between approximately 2% and 3% per month, which means that approximately 2% to 3%

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of our total number of lines installed would discontinue our service each month. Customers leave our service for a variety of reasons, including but not limited to, the customer: (a) leaving
our service area, (b) going out of business, (c) being unhappy with our service, (d) leaving for better pricing, and (e) needing a different telecom solution that we do not
provide. Churn is difficult to forecast and remains one of the specific challenges that
we are focusing on for 2002. We believe our churn rate is trending up due to a number of factors, including so called "win back" programs of the incumbent carriers and recession-induced customer
financial difficulties. We have responded to this trend with aggressive customer retention initiatives and our general shift to lower churn integrated service offerings. We can provide no assurances,
however, that these or other efforts will allow us to reverse this negative trend in customer churn.

In
addition, decreased customer demand may also stem from uncertainty of the industry in which we compete. Many of our competitors have declared bankruptcy, de-listed from
the public securities markets and/or identified financing problems. Some of our potential customers as well as current customers have expressed concerns about our financial stability, in light of the
general economy and the telecommunications industry in general. Customer perception will have an impact on our ability to attract and retain customers.

For
the quarters ended March 31, 2002 and 2001, we made capital expenditures of $39.8 million and $115.8 million, respectively. As of March 31, 2002, we had
transmission equipment colocated in 815 central offices. Pursuant to our business plan, we expect to use approximately $214 million to $240 million for capital expenditures in 2002. We
expect to fund our capital expenditures with available cash and future cash flow.

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. In July 2001, we amended this agreement to extend the term to six years. Under the amended agreement, we
must complete purchases totaling $100 million by December 31, 2000, an aggregate of $160 million of purchases by September 30, 2001, an aggregate of $210 million by
December 31, 2002, an aggregate of $257 million by December 31, 2003, an aggregate of $304 million by December 31, 2004, and the full $350 million of
aggregate purchases on or before December 31, 2005. If we do not meet the required purchase milestones, we will be required to provide cash settlement in an amount equal to the shortfall.
During the term of the contract, such shortfall payments may be applied to future purchases during the next succeeding year. We exceeded the required purchase milestones for 2000 and 2001. As of
March 31, 2002, we have completed cumulative purchases under this contract totaling approximately $169.6 million. In 2002, Lucent waived $50 million of the $210 million
purchase commitment for 2002 in exchange for a purchase commitment by us of approximately $13.1 million of telecom equipment. Thus, our remaining commitment is approximately
$130 million.

We
have purchased dedicated fiber rings in 24 of our markets. As of March 31, 2002, we had dedicated fiber rings in operation in 21 markets including Austin, Boston, Chicago,
Dallas, Denver, Ft. Worth, Houston, Long Island, Los Angeles, New York City, Northern New Jersey, Philadelphia, Phoenix, Pittsburgh, Portland, San Antonio, San Diego, St. Louis, Seattle, Washington,
D.C., and White Plains. 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. As of March 31, 2002, our total costs have been $160 million, and our budget to complete the remaining fiber rings for which we have commitments is approximately
$151 million, which will be incurred over several periods ending in 2022. We plan to fund this cost with our available cash and future cash flow.

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The
following summarizes future financial commitments at March 31, 2002 and the effect such obligations are expected to have on our liquidity and cash flow in future periods:

|                                        |                                  | Payments due by Period
|--------------------------------------- | -------------------------------- | ----------------------
|
|Long-term debt(1)(2):                   |                                  |                       
|                                        | 113/4% and 127/8% notes          |                       
|                                        |                                  | Principal payments    
|                                        |                                  | Interest payments     
|                                        | Senior secured credit facilities |                       
|                                        |                                  | Principal payments    
|                                        |                                  | Interest and fees     
|Capital lease obligations(3)            |                                  |                       
|Operating leases                        |                                  |                       
|Other material long-term obligations(3) |                                  |                       
|                                        |                                  |                       
|Total contractual cash obligations      |                                  | $                     

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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 113/4% senior
discount note and one redeemable warrant. Net proceeds of approximately $240.7 million were received from that offering. The 113/4% notes have a principal amount at maturity of
$445.0 million and an effective interest rate of 12.21%. The 113/4% notes mature on February 15, 2008. From and after February 15, 2003, interest on such notes will
be payable semi-annually in cash at the rate of 113/4% per annum. The accretion of original issue discount will cause an increase in indebtedness from March 31, 2002
to February 15, 2003 of $47.7 million.

We
raised net proceeds of approximately $124.8 million in our offering of the 127/8% senior discount notes early in the third quarter of 1998. The
127/8% notes mature on May 15, 2008. Interest on these notes is payable in cash semi-annually, commencing November 15, 1998. The 127/8% notes
were sold at less than par, resulting in an effective rate of 13.24%, and the value of the 127/8% 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, $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, 2002 to May 15, 2008 of $3.1 million.

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.

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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 our prior $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. During the third quarter of 2001, we drew
$200.0 million under the revolving credit facility due December 31, 2006 and $150.0 million under the delayed draw term loan due December 31, 2006. Interest on amounts
drawn is variable, based on leverage ratios, and is currently the 6-month London Interbank Offered Rate + 3.25%, or 5.53% per annum; this interest rate will remain fixed
until September 19, 2002.

The
additional $150.0 million of revolving credit facility is 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. The current commitment fee on the unused portion of these credit facilities is 0.75% per annum, paid quarterly. The senior credit agreement contains certain representations, warranties
and covenants, including many financial covenants. Financial covenants from this credit agreement for fiscal year 2002 are summarized below.

Minimum
quarterly revenue covenants for 2002 are as follows:

Quarter Ended

Minimum Quarterly RevenueMarch 31, 2002

$155 millionJune 30, 2002

$180 millionSeptember 30, 2002

$200 millionDecember 31, 2002

$220 million


Our
ratio of Senior Secured Debt to the aggregate Annualized Pre-Overhead EBITDA cannot exceed 6:00 to 1:00 as of the last day of any quarter. Our ratio of Senior Secured
Debt to Total Capitalization cannot exceed 0.35 to 1.00. Our ratio of Consolidated Total Debt to Total Capitalization cannot exceed 0.60 to 1.00. (Capitalized terms used in this paragraph have
the meanings from our credit agreement). Our credit agreement also contains financial covenants for fiscal year 2003 and beyond.

Our
failure to comply with the covenants, including the failure to comply with any of the above described financial covenants, and restrictions contained in our financing agreements
could lead to default under the terms of these agreements. If such a default occurs, our lenders could declare all amounts borrowed immediately due and payable. In addition, lenders under our
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.

At
March 31, 2002, we were in compliance with all covenants and other requirements set forth in our senior credit agreement and indentures. Based on our budgeted projections, we
believe we will meet the above financial covenants contained in our senior credit agreement for year 2002. However, the margin for performance below these covenants is relatively narrow and even a
relatively small decrease in our growth or cash flow from operations could cause a default under our senior credit agreement.

We
believe that the risk related to potential defaults under our financing agreements has increased due to the financial failures and difficulties of other communications companies. We
believe that these events have caused many lenders to be even more reluctant to waive defaults or otherwise restructure credit arrangements.

CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been
prepared in
accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and

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assumptions about the effect of matters that are inherently uncertain. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues and expenses and disclosure of
contingent assets and liabilities that exist at the date of our financial statements. While we believe our estimates are appropriate, actual results can, and often do, differ from those estimates.

Our
critical accounting policies are discussed below. Each of these areas involves complex situations and a high degree of judgment either in the application and interpretation of
existing literature or in the development of estimates that impact our financial statements.

Revenue Recognition

We recognize revenue in accordance with all applicable generally accepted accounting principles including SEC Staff Accounting Bulletin No. 101,
"Revenue
Recognition in Financial Statements" (SAB 101), which provides additional guidance on revenue recognition as well as criteria for when revenue is realized and earned and related costs are
incurred. The application of SAB 101 requires management's judgment on the amount and timing of revenue recognition. Should changes in conditions cause management to determine the revenue
recognition criteria are not met for certain future transactions, revenue recognized for any reporting period could be adversely affected.

The
assessment of collectibility is particularly critical in determining whether or not revenue should be recognized. A portion of our revenue is for reciprocal compensation generated
by calls placed to Internet service providers who are our customers. In addition, a portion of our revenue is access charge revenue for connecting our voice service customers to their selected long
distance carriers for outbound calls or for delivering inbound long distance traffic to our voice service customers. Our ability to earn local reciprocal compensation revenues and access revenues is
the subject of numerous regulatory and legal challenges. Until these issues are ultimately resolved, our policy is to recognize these revenues only when realization is reasonably assured.

Accounts Receivable

A considerable amount of judgment is required in assessing the ultimate realization of our accounts receivable. We evaluate the collectibility of our
accounts
receivable based on a combination of factors. We recognize allowances for doubtful accounts based on the length of time the receivables are past due, the current business environment and our
historical experience. In circumstances where we are aware of a specific customer's or carrier's inability to meet its financial obligations to us, we record a specific allowance against amounts due,
to reduce the net recognized receivable to the amount we reasonably believe will be collected. If the financial condition of our customers or carriers were to deteriorate or if economic conditions
worsened, additional allowances may be required in the future.

Goodwill and Intangibles

We have significant intangible assets related to goodwill and other acquired intangibles. The determination of related estimated useful lives and
whether or not
these assets are impaired involves significant judgment by management. We periodically evaluate acquired businesses for potential impairment indicators. Our judgments regarding the existence of
impairment are based on market conditions, legal factors and operational performance of our acquired businesses. Future events could cause us to conclude that goodwill associated with our acquired
businesses is impaired. Any resulting impairment loss could have a significant impact on our financial condition and results of operations.

Network Expenses

The recognition of network expense and the related liabilities for network expense requires certain estimates and assumptions to be made by
management. Our
accruals for unbilled leased network facilities, network access charges, and equipment colocation charges are based on circuit counts, estimated usage, and active colocation sites. Additionally, our
accrual includes charges invoiced by carriers which are probable network expenses but have not yet been paid due to rate or volume disputes with other carriers. Should changes in conditions or facts
cause us to revise our estimates, our financial condition and results of operations could be significantly impacted.

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Other Matters

We do not have any of the following:



NEW ACCOUNTING PRONOUNCEMENTS

We continually monitor and revise our accounting policies as developments occur. The following recently issued accounting pronouncements may impact
the future
presentation of our financial condition and results of operations.

In
June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, "Business Combinations." This statement addresses
financial accounting and reporting for business combinations. Adoption of this statement is required for all business combinations consummated after June 30, 2001. All of our prior business
combinations have been accounted for under the purchase method of accounting. Therefore, the adoption of this statement did not have a material impact on our business acquisition model or our results
of operations.

In
June 2001, the Financial Accounting Standards Board also issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets." This
statement will (1) require that goodwill balances no longer be amortized but rather assessed for impairment at least annually and (2) expand the classifications of other intangible
assets, as well as the expected useful lives of these assets. Adoption of this statement is required as of January 1, 2002, as well as for all purchase business combinations initiated after
June 30, 2001. We will perform an initial valuation enterprise-level goodwill during the second quarter of 2002 and do not anticipate that an impairment of our enterprise goodwill exists as of
March 31, 2002 or that the valuation will have a material impact on our financial position.

In
June 2001, the Financial Accounting Standards Board also issued Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations." This
statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. Our adoption
of this statement did not have a material effect on our financial position or results of operations.

In
August 2001, the Financial Accounting Standards Board also issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." This Statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. Adoption of this statement is required for
fiscal years beginning after December 15, 2001. Our adoption of this statement did not have a material effect on our financial position or results of operations.

FORWARD-LOOKING STATEMENTS

Certain statements in this report 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, the

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risks discussed below as well as our ability to do the following in a timely manner, at reasonable costs and on satisfactory terms and conditions:



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

The expansion and development of our business and the deployment of our networks, systems and services will require significant capital and other
expenditures, a
substantial portion of which will need to be incurred before the realization of significant revenue from these activities. We have incurred net losses every year since we began operations. We will
continue to have significant operating losses and our adjusted EBITDA will continue to be negative while we develop and expand our business and until we establish a sufficient revenue-generating
customer base. We have experienced increasing operating losses and negative adjusted EBITDA as we have expanded our operations. 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 (used in) operations determined in accordance with generally accepted accounting principles. For the quarter ended March 31, 2002, we had net operating losses and net losses
applicable to common stock of $112.6 million and negative adjusted EBITDA of approximately $21.8 million.

We
typically do not expect to achieve positive adjusted EBITDA in any market until at least our third year of operation in 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.

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

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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. Since 1997, the company has invoiced AT&T approximately $42 million in
aggregate for switched access services, a majority of which remains unpaid by AT&T pursuant to AT&T's dispute of certain of the switched access charges. 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 Telecommunications Act of 1996 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, or the actual outcome of our lawsuit. Given
the uncertainty regarding the collection from AT&T of unpaid invoices for switched access services, we have recognized revenue for only the portion of switched access invoices for which we believe
realization is reasonably assured. If we 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.

In
a separate action to collect unpaid access charges brought by several other competitive carriers against AT&T and Sprint, the federal district court in Alexandria, Virginia referred
two related issues to the FCC for decision. Although we are not a party to this lawsuit, the issues are substantially the same as those in dispute in our lawsuit against AT&T. Pursuant to the
referral, AT&T and Sprint asked the FCC to determine (1) whether any statutory or regulatory constraints prevent an interexchange carrier from declining access services or from terminating
access services previously ordered or constructively ordered and if not (2) what steps interexchange carriers must take either to avoid ordering access or to cancel service after ordering or
constructively ordering. On October 22, 2001, the FCC issued a Declaratory Ruling in response to AT&T's and Sprint's requests in which it held that where a CLEC's tariffed charges for access
service were presumptively reasonable at the time service was offered, interexchange carriers such as AT&T and Sprint cannot refuse to exchange traffic with the CLEC. At all times relevant in our
collection action against AT&T, access tariffs filed by non-dominant carriers such as Allegiance were presumptively lawful and reasonable. AT&T has appealed the FCC's Declaratory Ruling to
the U.S. Court of Appeals for the District of Columbia Circuit. We can provide no assurances that the outcome of this appeal will be in our favor, that the delay caused by the appeal will not have a
material adverse effect on us or that, even if we are successful on the appeal, the result will not be subject to further appeal by AT&T.

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

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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 revenues 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.

Enactment into Law of the Tauzin-Dingell Bill in its Current Form Would Adversely Affect Our Business

On February 27, 2002, the U.S. House of Representatives passed H.R. 1542, the Tauzin-Dingell bill, by a 273-157 vote. The current
Telecommunications Act requires the incumbent carriers to lease access to their high-speed networks to their competitors at wholesale rates. Under the Tauzin-Dingell bill, competitors are
still able to purchase access to unbundled copper loops and to lease access to the incumbent carriers' high-speed networks. However, the bill classifies high-speed services as
"nondominant," which would relieve the incumbents of the obligation to price such access at cost-based rates. The bill also enables the incumbent carriers potentially to limit competitors'
access to their networks, by eliminating the obligation to provide unbundled access to certain technologies, including fiber lines and packet switches, and to provide colocation space within remote
terminals. Finally, the bill allows the regional Bell companies to immediately enter the long distance market for data without first demonstrating that their local voice markets are open to
competition. Because no action has yet been taken on the bill in the Senate, we cannot predict whether the bill or any amendments to the bill will actually become law. If the bill is passed as
currently written, this will have a material adverse affect on our business.

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 of 1996, 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 reasonably assured. In addition, the per
minute compensation rates the FCC established for calls to Internet service providers under new interconnection agreements are significantly lower than the reciprocal compensation rates under our
previous agreements. These reductions in 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 decision issued May 3, 2002, the U.S. Court of
Appeals for the District of Columbia Circuit remanded for

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further proceedings, but did not vacate, the FCC's Order on remand, holding that the section of the Act on which the FCC relied did not support its conclusion that Internet service provider traffic
is not subject to reciprocal compensation. 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.

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 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 and service customers,
initiate,
implement and track customer orders and achieve operating efficiencies. We are in the process of introducing a new billing platform across our geographic markets. Although we are taking steps to
manage the implementation of the new system and we believe that the new system will enhance our ability to accurately and efficiently bill for our services, we cannot assure you that the transition to
the new billing system will be implemented without any adverse impact on our business. We believe this new billing system will be more effective and accurate in delivering the quality billing
functions that we need. Since our inception, we have also been engaged in developing and integrating our essential information systems consisting of our billing system, our sales order entry system,
our customer
implementation system and our switch information systems. This is a challenging project because these systems were developed by different vendors and must be coordinated through custom software and
integration processes. Our sales, line count and other core operating and financial data are generated by these systems and the accuracy of this data depends on the quality and progress of the system
integration project. Although we have made significant progress in our system integration efforts, we have not completed it and we have experienced and expect to experience negative adjustments to our
financial and operating data as we complete this effort. These adjustments have not had a material adverse effect on our financial or operating data to date but until we complete the entire project we
cannot assure you that any such adjustments arising out of our systems integration efforts will not have a material adverse effect in the future. In addition, if we are unable to develop, acquire and
integrate our operations and financial systems, our customers could experience delays in connection of service, billing issues and/or lower levels of client service. We also cannot assure you that any
of our systems will be successfully implemented on a timely basis or at all or will perform as expected because:



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We Are Dependent on Many Vendors and Suppliers and Their Financial Difficulties May Adversely Affect Our Business

We depend on many vendors and suppliers to conduct our business. For example, we purchase our network assets from equipment manufacturers and other
suppliers and
we lease fiber and other circuits from other carriers as well as from companies which construct these network elements for resale. Many of these third parties have experienced substantial financial
difficulties in recent months, in some cases leading to bankruptcies and liquidations. In particular, the providers of fiber for our metropolitan fiber rings as well as our long-haul fiber
routes have experienced financial difficulties, including difficulty in raising the necessary capital to complete fiber construction projects. The financial difficulties of these companies could have
a material adverse affect on our business and prospects.

Our Financial Results Could Be Adversely Affected By Customer Churn and the Financial Difficulties of Our Customers

We expect customer churn will average approximately 2% to 3% per month, which means that approximately 2% to 3% of our total number of lines installed
would
discontinue our service each month. However, our ability to retain our customers and control our churn rate is dependent on a number of factors, including (a) our ability to provide quality
service, customer care and accurate and timely billing, (b) our ability to offer competitive pricing and overcome so called "win-back" programs offered by our competitors,
(c) our ability to timely meet the needs and demands of our customers, (d) our ability to properly incentivize our sales force to build strong customer relationships and (e) the
economic viability of our customers (see the discussion in the following paragraph). We can make no assurances that our customer churn rates will not increase. If our customer churn rates increase or
are higher than expected, this could have a material adverse affect on our business and prospects.

We
provide services to small and medium-sized businesses as well as network service providers. Many of these businesses have experienced substantial financial difficulties in recent
months, in some cases leading to bankruptcies and liquidations. The financial difficulties of these companies could have a material adverse affect on our financial results if we are unable to collect
revenues from these customers. In addition, among other things, we believe companies in financial difficulty are less likely to expand their operations and related demand for communications services
and to migrate from dial-up Internet connections to more advanced dedicated connections such as those that we offer.

The Financial Difficulties of Other Competitive Communications Providers Could Adversely Affect Our Financial Results

Many competitive local exchange carriers and other emerging communications providers have experienced substantial financial difficulties over the past
year, in
some cases leading to bankruptcies and liquidations. The financial difficulties of these companies could reflect poorly on our own financial stability, may diminish our ability to obtain further
capital and may adversely affect the willingness of potential customers to move their communications services to an emerging carrier like Allegiance Telecom. Moreover, we have experienced efforts by
established carriers to promote this problem and suggest to their customers that they should not risk placing their communications services in the hands of an emerging carrier. We believe these
concerns are unfounded in our case and that raising these concerns with respect to Allegiance Telecom is inappropriate. We vigorously respond to illegal attempts by other carriers to spread false
information about our financial stability. We have a lawsuit pending against AT&T in the Federal District Court in the District of Columbia regarding this practice.

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

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 under our credit facilities, together with our cash on hand, will be sufficient to
pre-fund our business plan. However, we will only be able to borrow additional funds under these credit facilities if we are in compliance with the financial covenants and other conditions
in our credit agreement. In the event we cannot borrow all of the funds committed under these credit facilities or if our estimates of capital requirements and revenues are inaccurate, we may need to
access alternative sources of capital, reduce or delay

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capital expenditures, sell assets, refinance or restructure our debt and/or modify our business plan, 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 may need to access additional debt financing to fund our business plan, including utilization of
our credit
facilities. At March 31, 2002, we had $1,034 million of outstanding long-term indebtedness.

This
level of debt could:



Our
ability to repay or refinance our debt obligations will depend on our future financial and operational performance. 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:



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. In addition, under our credit agreement, we have granted a security interest in substantially all of our and our subsidiaries' assets. As a
result of these restrictions and encumbrances, 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

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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 default under the terms of these agreements. The
financial covenants under our credit agreement require us, among other things, to achieve certain levels of revenue and earnings before interest, taxes, depreciation and amortization. Although our
current business plan is formulated to achieve these levels of performance, the margin for performance below these covenant levels is relatively narrow and even a relatively small decrease in our
growth or cash flow from operations could cause a default under this agreement. If such a default occurs under the credit agreement or if a default occurs under our other financing agreements, 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 believe that the risk related to potential defaults under our financing agreements has
increased due to the financial failures and difficulties of other communications companies. We believe that these events have caused many lenders to be even more reluctant to waive defaults or
otherwise restructure credit arrangements.

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 113/4% notes and 101% of the principal amount of the 127/8% notes, plus
any accrued and unpaid interest to the date of repurchase. Our credit facilities provide 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.

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 of
1996 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 has granted approval to Verizon to provide
in-region long distance service in New York, Connecticut, Massachusetts, Rhode Island and Pennsylvania and to SBC Communications to provide in-region long distance service in
Texas, Oklahoma, Missouri, Arkansas and Kansas. Verizon has applications pending with the FCC to provide in-region long distance service in New Jersey and Maine and BellSouth has an
application pending to provide such service in Georgia and Louisiana. 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.

The
regional Bell operating companies have been fined numerous times by both federal and state authorities for their failure to comply with applicable telecommunications laws and
regulations. We do not believe these fines have had any meaningful impact on the anticompetitive practices of many of these companies and in fact believe that these practices are increasing in most of
our markets. We attempt to enforce our rights against these incumbent monopolies but often times the remedies are inadequate to change their anticompetitive practices and in any event provide us with
little or no recovery of the damages we have suffered as a result of these practices. Moreover, efforts by us to enforce our rights against these companies may further diminish the level of
cooperation we receive from them. 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

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meet our requirements, for example, because of (1) labor shortages, (2) work stoppages or (3) disruption caused by mergers or other organizational changes or terrorist attacks,
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, went into effect on July 31, 2001, as of which date
carriers were required to 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 are still 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. As of January 2002, carriers were 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:



In
addition, with respect to competitive access services, such as special access services as opposed to switched access services, the FCC recently granted 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.

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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 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 granted approval to provide in-region long distance service to Verizon in New York, Connecticut,
Massachusetts, Rhode Island and Pennsylvania and to SBC Communications in Texas, Oklahoma, Missouri, Arkansas 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 Verizon 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.

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. As noted
above, as of July 31, 2001 and January 2002, we were prohibited from filing tariffs with the FCC for domestic interstate and international long distance service respectively and were
required to cancel any such tariffs on file as of those dates.

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, service quality 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.

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

The Telecommunications Act of 1996 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, access
to unbundled network elements 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 of 1996 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.

The
United States Supreme Court vacated an 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. The FCC also stated its intention to
review every three years the unbundling obligations of incumbent local exchange carriers. The FCC's order was appealed and that appeal is still pending before the U.S. Court of Appeals for the
District of Columbia Circuit. While these court and FCC proceedings were pending, we entered into interconnection agreements with a number of 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 December 20, 2001, the FCC issued a notice of proposed rulemaking to commence its triennial review of the incumbent local exchange
carriers' unbundling obligations. We cannot predict the outcome of that proceeding.

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 cost (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 agreed to review the Eighth Circuit's decision and the Eighth Circuit in turn stayed issuance of the mandate vacating the
TELRIC rules pending the Supreme Court's decision. In a decision issued May 13, 2002, the Supreme Court reversed the Eighth Circuit's invalidation of TELRIC as a methodology for setting rates
under the Act and upheld the FCC's rules.

On
February 15, 2002, the FCC released a Notice of Proposed Rulemaking requesting comment on the future regulatory treatment of wireline broadband Internet access services. The
FCC has tentatively concluded that when an entity provides wireline broadband Internet access over its own transmission facilities, the service should be
classified as an information service, rather than a telecommunications service. If the FCC adopts this conclusion wire-line broadband Internet access services provided by incumbent
carriers would be subject to substantially less

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regulation. Allegiance purchases unbundled transmission facilities from incumbent carriers to provide our own broadband Internet access service. While we cannot predict the outcome of this
proceeding, any curtailment of the incumbent carriers' unbundling obligations for the transmission component of broadband Internet access services could materially increase our costs and adversely
affect our ability to compete effectively with the incumbent carriers' broadband Internet access products.

Our Past and Future Acquisitions May Be Difficult To Integrate, Disrupt Our Business, Dilute Our Stockholders and Divert Management Attention

We have acquired a number of companies as part of our business plan, especially companies that provide Internet services. We expect to acquire or
invest in
additional businesses that we believe could complement or expand our business, augment our market coverage, enhance our service offerings or that may otherwise offer other opportunities. We may
encounter problems with the assimilation of acquired businesses, including, among others:



We
can make no assurances that we will be able to successfully integrate acquired businesses or operations that we have acquired or that we may acquire in the future. In addition, we
may not achieve the anticipated benefits from our acquisitions. If we fail to achieve the anticipated benefits from such acquisitions, we may incur increased expenses and experience a shortfall in our
anticipated revenues and we may not obtain a satisfactory return on our investment.

Our Stock Has Been Extremely Volatile

Our stock has experienced significant price and volume fluctuations, often times due to factors beyond our control. In recent months, for example, our
stock price
has decreased significantly because different institutional stockholders have decided to sell their position in our company, in some cases due to their own financial difficulties and requirements to
satisfy margin loan requirements. Given that our stock is thinly traded, sales by even a single large stockholder can materially decrease our market price. The market price for our common stock may
continue to be subject to wide fluctuations in response to a variety of other factors, including but not limited to the following, some of which are beyond our control:



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Future Sales of Our Stock by Existing Stockholders May Adversely Affect Our Stock Price

As of March 31, 2002, we had 115,970,720 shares of common stock outstanding and 28,508,201 shares of common stock reserved for issuance upon
exercise of
outstanding stock options and warrants. Many of our outstanding shares are "restricted securities" under the federal securities laws, and such shares are or will be eligible for sale subject to
restrictions as to timing, manner, volume, notice and the availability of current public information regarding Allegiance. Sales of substantial amounts of stock in the public market, or the perception
that sales could occur, could depress the prevailing market price for our stock. Sales of substantial amounts of stock in the public market may also make it more difficult for us to sell equity
securities or equity-related securities in the future at a time and price that we deem appropriate.

Anti-Takeover Provisions in Our Charter and Bylaws Could Limit Our Share Price and Delay a Change of Management

Our charter and bylaws contain provisions that could make it more difficult or even prevent a third party from acquiring Allegiance without the
approval of our
incumbent board of directors. In addition, our credit facilities and some of our other agreements may discourage a change in control.

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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 and senior credit facilities. 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.

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 2002, based on the estimated average 2001 earned rate on investments, is $9.8 million. Assuming
a 100-basis-point drop in the estimated average rate, we would be exposed to a $2.3 million reduction in interest income for the year. The following table illustrates this impact on
a quarterly basis:

|                                                                                                    |  | Quarter Ending
|--------------------------------------------------------------------------------------------------- |  | --------------
|
|
|Estimated average investments                                                                       |  | $             
|Estimated average interest earned at the average rate of 4.06% for the year ended December 31, 2001 |  | $             
|Estimated impact of interest rate drop                                                              |  | $             

Our
outstanding long-term debt consists both of long-term, fixed rate notes, not subject to interest rate fluctuations, and our senior secured credit facilities.
Borrowings under our senior secured credit facilities incur interest at a variable rate, based on leverage ratios, and is currently the London Interbank Offered Rate + 3.25%. On
March 19, 2002, our borrowing rate was adjusted to 5.53% per annum and this interest rate will remain fixed until September 2002. Therefore, we will not be exposed to market risk related
to rate fluctuations during the first three quarters of 2002.

During
the fourth quarter of 2002, we will be exposed to market risk related to market changes in the London Interbank Offered Rate and other market indexes. Based on our current level
of debt, the impact of a 100-basis-point increase in our average interest rate would cause an increase in interest expense during 2002 of $1.0 million.

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PART II. OTHER INFORMATION

ITEM 1.Legal Proceedings

Not applicable.

ITEM 2.Changes in Securities and Use of Proceeds

Not applicable.

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



|Exhibit
Number |  | Description                                                                                
|-------------- |  | -------------------------------------------------------------------------------------------
|11.1           |  | Statement regarding computation of per share loss for the three months ended March 31, 2002
|11.2           |  | Statement regarding computation of per share loss for the three months ended March 31, 2001

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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:                     
|                    |  |                         
|                    |  | By:                     
|                    |  |                         
|Dated: May 14, 2002 |  |                         

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INDEX TO EXHIBITS

|Exhibit
Number |  | Description                                                                                
|-------------- |  | -------------------------------------------------------------------------------------------
|11.1           |  | Statement regarding computation of per share loss for the three months ended March 31, 2002
|11.2           |  | Statement regarding computation of per share loss for the three months ended March 31, 2001

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