--------------------------------------------------------------------------------
                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                  ------------

                                    FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 1999

                             OR

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

For the transition period from                   to
                               ------------------  --------------------

COMMISSION FILE NUMBER:  333-50475

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

            DELAWARE                                  22-3545325
 (State or other jurisdiction           (I.R.S. Employer Identification No.)
 of incorporation or organization)

                            1545 ROUTE 206, SUITE 300
                          BEDMINSTER, NEW JERSEY 07921
          (Address, including zip code, of principal executive offices)

                                 (908) 470-2100
              (Registrant's telephone number, including area code)

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

         Indicate  the  number of  shares  outstanding  of each of the  issuer's
classes of common stock, as of the latest practicable date.

               CLASS                                  OUTSTANDING
               -----                                  -----------
         Common Stock, par value $0.01                852,676 shares,
         per share.                                   as of  November 12, 1999

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



<PAGE>


                           KMC TELECOM HOLDINGS, INC.

                                      INDEX


PART I.     FINANCIAL INFORMATION                                       PAGE NO.
-------     ---------------------                                       --------

ITEM 1.    Financial Statements

           Unaudited Condensed Consolidated Balance Sheets,
              December 31, 1998 and September 30, 1999......................   2

           Unaudited Condensed Consolidated Statements of Operations,
              Three Months Ended September 30, 1998 and 1999
              and Nine Months Ended September 30, 1998 and 1999 ............   3

           Unaudited Condensed Consolidated Statements of Cash Flows,
              Nine Months Ended September 30, 1998 and 1999.................   4

           Notes to Unaudited Condensed Consolidated Financial Statements...   5

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

ITEM 3.    Quantitative and Qualitative Disclosures About Market Risk.......  21

PART II.  OTHER INFORMATION
--------  -----------------

ITEM 1.    Legal Proceedings................................................  22

ITEM 2.    Changes in Securities and Use of Proceeds........................  22

ITEM 3.    Defaults Upon Senior Securities..................................  22

ITEM 4.    Submission of Matters to a Vote of Security Holders..............  22

ITEM 5.    Other Information................................................  22

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

SIGNATURES..................................................................  24






<PAGE>
                         PART I - FINANCIAL INFORMATION


                           KMC TELECOM HOLDINGS, INC.
                 UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>

<S>                                                                                <C>              <C>
                                                                                    DECEMBER 31,      SEPTEMBER 30,
                                                                                        1998              1999
                                                                                   ---------------  ------------------

ASSETS
Current assets:
   Cash and cash equivalents....................................................       $   21,181          $   21,207
   Restricted investments.......................................................                -              37,125
   Accounts receivable, net of allowance for doubtful accounts of $350 and
      $2,095 in 1998 and 1999, respectively                                                 7,539              23,810
   Prepaid expenses and other current assets....................................            1,315               1,076
                                                                                   ---------------  ------------------


Total current assets............................................................           30,035              83,218
Investments held for future capital expenditures................................           27,920              75,000
Long term restricted investments................................................                -              68,348
Networks and equipment, net.....................................................          224,890             426,782
Intangible assets, net..........................................................            2,829               2,985
Deferred financing costs, net...................................................           20,903              40,045
Other assets....................................................................            4,733               1,118
                                                                                   ---------------  ------------------


                                                                                       $  311,310         $   697,496
                                                                                   ===============  ==================

LIABILITIES,   REDEEMABLE  AND   NONREDEEMABLE   EQUITY   (DEFICIENCY)   Current
liabilities:
   Accounts payable.............................................................       $   21,052          $   33,232
   Accrued expenses.............................................................           10,374              49,109
   Notes payable................................................................                -             125,000
                                                                                   ---------------  ------------------
Total current liabilities.......................................................           31,426             207,341
Notes payable...................................................................           41,414                   -
Senior discount notes payable...................................................          267,811             292,161
Senior notes payable............................................................                -             275,000
                                                                                   ---------------  ------------------
Total liabilities...............................................................          340,651             774,502
Commitments and contingencies
Redeemable equity:
   Senior  redeemable,  exchangeable,  PIK preferred  stock,  par value $.01 per
      share;  authorized:  -0- shares in 1998, 630 shares in 1999; shares issued
      and outstanding:
        Series E, - 0 - shares in 1998 and 63 shares in 1999 ($62,681
        liquidation preference).................................................                -              48,130
        Series F, - 0 - shares in 1998 and 43 shares in 1999 ($42,599
        liquidation preference).................................................                -              39,143
  Redeemable  cumulative  convertible  preferred stock, par value $.01 per share
      499 shares authorized; shares issued and outstanding:
        Series A, 124 shares in 1998 and 1999 ($12,380 liquidation preference)..           30,390              50,813
        Series C, 175 shares in 1998 and 1999 ($17,500 liquidation preference)..           21,643              30,727
   Redeemable common stock, 224 shares issued and outstanding...................                               27,459
                                                                                           22,305
   Redeemable common stock warrants.............................................              674              11,664
                                                                                   ---------------  ------------------


Total redeemable equity.........................................................           75,012             207,936
                                                                                   ---------------  ------------------
Nonredeemable equity (deficiency):
   Common stock, par value  $.01 per share; 3,000 shares authorized, 614 shares
      and 629 shares issued and outstanding in 1998 and 1999, respectively......                                    6
                                                                                                6
   Additional paid-in capital...................................................           13,750                   -
   Unearned compensation........................................................          (5,824)             (6,227)
   Accumulated deficit..........................................................        (112,285)           (278,721)

                                                                                   ---------------  ------------------
Total nonredeemable equity (deficiency).........................................        (104,353)           (284,942)
                                                                                   ---------------  ------------------

                                                                                       $  311,310         $   697,496
                                                                                   ===============  ==================
</TABLE>

                             See accompanying notes.

                                       2
<PAGE>




                           KMC TELECOM HOLDINGS, INC.

            UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>

                                                                THREE MONTHS ENDED                   NINE MONTHS ENDED
                                                                   SEPTEMBER 30,                       SEPTEMBER 30,
                                                         ----------------------------------  ---------------------------------
<S>                                                      <C>               <C>               <C>               <C>
                                                              1998              1999              1998              1999
                                                         ----------------  ----------------  ----------------  ---------------
Revenue................................................        $   6,250         $   15,572       $   13,588       $    42,284
Operating expenses:
   Network operating costs.............................           10,658             31,154           24,577            75,209
   Selling, general and administrative.................            6,081             14,956           15,301            41,680
   Stock option compensation expense...................              398            (6,961)            6,594            13,240
   Depreciation and amortization.......................            3,142              7,593            5,198            19,230
                                                          ----------------  ----------------  ----------------  ---------------
      Total operating expenses.........................           20,279             46,742           51,670           149,359
                                                          ----------------  ----------------  ----------------  ---------------

Loss from operations...................................          (14,029)                            (38,082)        (107,075)
                                                                                   (31,170)
Other expense..........................................                 -                 -                 -          (4,297)
Interest income........................................
                                                                    5,330             3,980            10,349            7,035
Interest expense.......................................          (11,407)          (21,834)          (25,970)         (47,848)
                                                          ----------------  ----------------  ----------------  ---------------
Net loss...............................................          (20,106)          (49,024)          (53,703)        (152,185)

Dividends and accretion on redeemable preferred stock..           (4,117)             1,330          (14,157)         (42,085)
                                                          ----------------  ----------------  ----------------  ---------------
Net loss applicable to common shareholders.............       $  (24,223)       $ ( 47,694)       $  (67,860)      $ (194,270)
                                                          ================  ================  ================  ===============



Net loss per common share..............................       $   (28.91)       $   (55.93)       $   (81.94)      $  (228.20)
                                                          ================  ================  ================  ===============


Weighted average number of common shares outstanding.            837,876           852,676           828,181          851,321
                                                          ================  ================  ================  ===============

</TABLE>

                                                      See accompanying notes.




                                       3
<PAGE>




                           KMC TELECOM HOLDINGS, INC.

            UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>

                                                                                          NINE MONTHS ENDED
                                                                                            SEPTEMBER 30,
                                                                                   ---------------------------------
<S>                                                                                <C>              <C>
                                                                                        1998             1999
                                                                                   ---------------  ----------------

OPERATING ACTIVITIES
Net loss........................................................................      $  (53,703)       $ (152,185)
Adjustments to reconcile net loss to net cash used in operating activities:
   Depreciation and amortization................................................            5,198            19,230
   Non-cash interest expense....................................................           22,774            40,174
   Non-cash stock option compensation expense...................................            6,593            13,240
   Changes in assets and liabilities:
      Accounts receivable.......................................................          (3,941)          (16,271)
      Prepaid expenses and other current assets.................................            (354)               239
      Other assets..............................................................            (584)             1,065
      Accounts payable..........................................................          (2,653)            14,707
      Accrued expenses..........................................................            3,571            12,585
      Due from affiliate........................................................             (47)                 -
                                                                                   ---------------  ----------------
Net cash used in operating activities...........................................         (23,146)          (67,216)
                                                                                   ---------------  ----------------

INVESTING ACTIVITIES
Construction of networks and purchases of equipment.............................         (90,938)         (216,508)
Acquisitions of franchises, authorizations and related assets...................          (1,100)           (1,221)
Deposit on purchases of equipment...............................................          (3,055)                 -
Purchases of investments, net...................................................         (90,000)          (47,080)
                                                                                   ---------------  ----------------
Net cash used in investing activities...........................................        (185,093)         (264,809)
                                                                                   ---------------  ----------------

FINANCING ACTIVITIES
Repayment of notes payable......................................................         (20,801)                 -
Proceeds from issuance of preferred stock and related warrants, net of issuance
   costs........................................................................                -            91,235
Proceeds from issuance of common stock and warrants, net of issuance costs .....           10,000                 -
Proceeds from exercise of stock options.........................................                -               333
Proceeds from issuance of senior discount notes, net of issuance costs..........          236,369                 -
Proceeds from issuance of senior notes, net of issuance costs and purchase of
   portfolio of restricted investments..........................................                -           159,942
Proceeds from senior secured credit facility, net of issuance costs.............                -            82,770
Issuance costs of Lucent facility...............................................                -           (2,229)
Dividends on preferred stock of subsidiary......................................            (592)                 -
                                                                                   ---------------  ----------------
Net cash provided by financing activities.......................................          224,976           332,051
                                                                                   ---------------  ----------------

Net increase in cash and cash equivalents.......................................           16,737                26
Cash and cash equivalents, beginning of period..................................           15,553            21,181
                                                                                   ---------------  ----------------

Cash and cash equivalents, end of period........................................        $  32,290         $  21,207
                                                                                   ===============  ================

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest, net of amounts capitalized............         $  3,274         $   5,751
                                                                                   ===============  ================
</TABLE>

                             See accompanying notes.


                                       4
<PAGE>



                           KMC TELECOM HOLDINGS, INC.

         NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

                               SEPTEMBER 30, 1999

1.   BASIS OF PRESENTATION AND ORGANIZATION

         KMC Telecom Holdings, Inc. and its subsidiaries,  KMC Telecom Inc., KMC
Telecom II, Inc., KMC Telecom III, Inc., KMC Telecom of Virginia,  Inc., and KMC
Investments,  Inc.  are  collectively  referred  to herein as the  Company.  All
significant  intercompany  accounts and  transactions  have been  eliminated  in
consolidation.

         On July 1, 1999, the Company  acquired all of the membership  interests
of KMC  Services  LLC from  Harold  N.  Kamine,  the  Chairman  of our  Board of
Directors,  for nominal  consideration.  KMC  Services LLC was formed to provide
services to the Company and its customers,  initially offering a leasing program
for equipment physically installed at a customer's premises. The acquisition was
accounted for as a combination of entities under common control,  and no changes
were  made  to  the  historical   cost  basis  of  KMC  Services  LLC's  assets.
Accordingly, during the second quarter of 1999, the Company reduced the carrying
value of its $709,000 loan  receivable  from KMC Services LLC to an amount equal
to the value of KMC  Services  LLC's net  assets at the  acquisition  date.  KMC
Services LLC has been consolidated with the Company since July 1, 1999.

         The unaudited  condensed  consolidated  financial  statements have been
prepared in accordance with generally accepted accounting principles for interim
financial  reporting.  Accordingly,  they do not include certain information and
note disclosures required by generally accepted accounting principles for annual
financial  reporting  and  should  be read in  conjunction  with  the  financial
statements  and notes  thereto of KMC Telecom  Holdings,  Inc. as of and for the
year ended December 31, 1998.

         The unaudited  interim  financial  statements  reflect all  adjustments
which management  considers  necessary for a fair presentation of the results of
operations for these periods.  The results of operations for the interim periods
are not necessarily indicative of the results for the full year.

         The balance  sheet of KMC Telecom  Holdings,  Inc. at December 31, 1998
was derived from the audited consolidated balance sheet at that date.


2.   INVESTMENTS HELD FOR FUTURE CAPITAL EXPENDITURES

         The Company has  designated  certain  amounts as  investments  held for
future capital expenditures. As of September 30, 1999, the Company's investments
held for future capital  expenditures  consisted of cash equivalents  (bank term
deposits and  commercial  paper with  maturities  of less than 90 days) of $69.8
million and debt securities (US government  obligations and commercial bonds due
within 1 year) of $5.2 million.  All debt securities have been designated by the
Company as  held-to-maturity.  Accordingly,  such securities are recorded in the
accompanying  financial statements at amortized cost. At September 30, 1999, the
carrying value of such held-to-maturity debt securities  approximated their fair
value.



                                       5
<PAGE>




3.   NETWORKS AND EQUIPMENT

         Networks and equipment are comprised of the following (in thousands):

                                               DECEMBER 31,      SEPTEMBER 30,
                                                   1998               1999
                                            -----------------  -----------------
Fiber optic systems......................    $        99,502          $ 138,577
Telecommunications equipment.............            115,769            162,011
Furniture and other......................              7,340             19,209
Leasehold improvements...................              1,177              1,555
Construction-in-progress.................             11,770            132,703
                                            -----------------  -----------------
                                                     235,558            454,055
Less accumulated depreciation............            (10,668)           (27,273)
                                            -----------------  -----------------
                                             $       224,890          $ 426,782
                                            =================  =================


         Costs  capitalized  during the  development  of the Company's  networks
include amounts incurred related to network engineering, design and construction
and capitalized  interest.  Capitalized  interest related to the construction of
the networks for the nine months ended  September  30, 1998 and 1999 amounted to
$2.9 million and $3.5 million, respectively.


4.   INTANGIBLE ASSETS

         Intangible assets are comprised of the following (in thousands):

                                               DECEMBER 31,      SEPTEMBER 30,
                                                   1998               1999
                                              ----------------  ----------------
Franchise costs..........................      $        1,690        $    1,672
Authorizations and rights-of-way.........               1,455             1,965
Building access agreements and other.....               1,062               697
                                              ----------------  ----------------
                                                        4,207             4,334
Less accumulated amortization............              (1,378)           (1,349)
                                              ----------------  ----------------
                                               $        2,829        $    2,985
                                              ================  ================



5.   ACCRUED EXPENSES

         Accrued expenses are comprised of the following (in thousands):

                                                   DECEMBER 31,    SEPTEMBER 30,
                                                       1998            1999
                                                  --------------  --------------
Accrued compensation...........................   $      4,138        $  10,721
Deferred revenue...............................          1,187            2,934
Accrued costs related to financing activities..            380            8,423
Accrued interest payable.......................            162           17,502
Accrued cost of sales..........................            565            2,549
Other accrued expenses.........................          3,942            6,980
                                                  ============== ===============
                                                  $     10,374        $  49,109
                                                  ============== ===============


                                       6
<PAGE>


6.   LUCENT LOAN AND SECURITY AGREEMENT

LUCENT LOAN AND SECURITY AGREEMENT

         KMC Telecom III entered into a Loan and Security Agreement (the "Lucent
Facility") dated February 4, 1999 with Lucent Technologies Inc. ("Lucent") which
provides  for  borrowings  to  be  used  to  fund  the  acquisition  of  certain
telecommunications  equipment and related expenses. The Lucent Facility provides
for an  aggregate  commitment  of up to $600  million,  of which $250 million is
currently  available to purchase Lucent products.  Further,  up to an additional
$350 million will be available upon (a) additional lenders  participating in the
Lucent Facility and making  commitments to make loans so that Lucent's aggregate
commitment does not exceed $250 million and (b) the Company  satisfying  certain
other  requirements,  the most  significant of which is KMC Holdings raising and
contributing  at least $300  million in high  yield debt or equity  (other  than
disqualified  stock) to KMC Telecom  III.  The Lucent  Facility  places  certain
restrictions  upon KMC Telecom  III's ability to purchase  non-Lucent  equipment
with  proceeds  from such  facility.  At September 30, 1999, no amounts had been
borrowed under the Lucent Facility.

         Interest on  borrowings  under the Lucent  Facility is charged,  at the
option of KMC  Telecom  III,  at a floating  rate of LIBOR plus the  "Applicable
LIBOR Margin",  or at an alternative  base rate plus the  "Applicable  Base Rate
Margin" (as defined).  Such margins will be increased by 0.25% until KMC Telecom
III and its  subsidiaries  have completed  systems in fourteen  markets.  If KMC
Telecom III defaults on any payment due under the Lucent Facility,  the interest
rate will  increase  by four  percentage  points.  If any other event of default
shall occur,  the interest  rate will be  increased  by two  percentage  points.
Interest on each LIBOR loan is payable on each LIBOR  interest  payment  date in
arrears and interest on each base rate loan is payable quarterly in arrears. KMC
Telecom  III must pay an annual  commitment  fee on the  unused  portion  of the
Lucent Facility of 1.25%.

         Loans borrowed under the Lucent Facility amortize in amounts based upon
the following  percentages of the aggregate  amount of the loans drawn under the
Lucent Facility:

                       PAYMENT DATES                        AMORTIZATION
            --------------------------------------       -------------------

            May 1, 2002 - February 1, 2003               2.5% per quarter
            May 1, 2003 - February 1, 2006               5.0% per quarter
            May 1, 2006 - February 1, 2007               7.5% per quarter

         KMC Holdings has unconditionally guaranteed the repayment of up to $250
million  under the  Lucent  Facility  when such  repayment  is due,  whether  at
maturity, upon acceleration, or otherwise. KMC Telecom III Holdings, Inc., which
owns the shares of KMC  Telecom III and is  wholly-owned  by KMC  Holdings,  has
pledged the shares of KMC Telecom III to Lucent to collateralize its obligations
under the guaranty.  In addition,  KMC Telecom III has pledged all of its assets
to Lucent.

         The Lucent  Facility  contains  a number of  affirmative  and  negative
covenants  including,  among others,  covenants  restricting  the ability of KMC
Telecom III to consolidate or merge with any person, sell or lease assets not in
the ordinary course of business, sell or enter into any long term leases of dark
fiber,  redeem  stock,  pay  dividends  or make any  other  payments  (including
payments  of   principal  or  interest  on  loans)  to  KMC   Holdings,   create
subsidiaries, transfer any permits or licenses, or incur additional indebtedness
or act as  guarantor  for the  debt of any  other  person,  subject  to  certain
conditions.

         KMC Telecom III is required to comply with certain  financial tests and
maintain certain  financial  ratios,  including,  among others, a ratio of total
debt to contributed capital, certain minimum revenues, maximum EBITDA losses and


                                       7
<PAGE>


minimum EBITDA, maximum capital expenditures and minimum access lines, a maximum
total  leverage  ratio, a minimum debt service  coverage  ratio, a minimum fixed
charge coverage ratio and a maximum  consolidated  leverage ratio. The covenants
become more  restrictive upon the earlier of (i) July 1, 2002 and (ii) after KMC
Telecom III achieves positive EBITDA for two consecutive fiscal quarters.

         Failure to satisfy any of the financial  covenants  will  constitute an
event of default under the Lucent Facility,  permitting the lenders to terminate
the commitment and/or accelerate payment of outstanding indebtedness. The Lucent
Facility also includes other  customary  events of default,  including,  without
limitation,   a   cross-default   to  other  material   indebtedness,   material
undischarged  judgments,  bankruptcy,  loss of a material  franchise or material
license,  breach of representations  and warranties,  a material adverse change,
and the occurrence of a change of control.

  WAIVER AND AMENDMENTS TO FINANCIAL COVENANTS

         The Company  obtained a waiver of  compliance,  for the  quarter  ended
September 30, 1999,  with certain  financial  covenants  (related to revenue and
EBITDA)  contained in the Senior Secured  Credit  Facility (for a description of
the Senior Secured Credit Facility,  see Note 6 of the Notes to the Consolidated
Financial  Statements in the  Company's  Annual Report on Form 10-K for the year
ended December 31, 1998).  In addition,  the EBITDA covenant was amended for the
fourth quarter of 1999 to a level which the Company expects to achieve.

         The Company has received a signed  commitment  from Lucent to refinance
the existing  Lucent  Facility  upon terms which would  involve the provision of
additional  funding to the Company and the resetting of the financial  covenants
for periods after the fourth quarter of 1999.  The Company is currently  engaged
in  discussions  with the agents for the lenders under the Senior Secured Credit
Facility  which  presently  contemplate  comparable  amendments to the financial
covenants in the Senior Secured Credit Facility. The Company believes that these
negotiations  will lead to  definitive  agreements  during the first  quarter of
2000. If, however,  the Company is not successful in completing the negotiations
as presently  contemplated  and amending the  financial  covenants in the Senior
Secured Credit Facility and the Lucent  Facility,  the Company is likely to fail
to  comply  with  one or more of the  covenants  presently  contained  in  those
facilities for the quarter ended March 31, 2000,  which failure,  unless waived,
would constitute a default under those credit facilities. Given that, as of this
date, the Company has not yet signed  definitive  agreements with Lucent and the
agents for the lenders under the Senior Secured Credit Facility implementing the
foregoing  refinancings,  under applicable financial accounting  standards,  the
Company was required to reclassify the $125 million outstanding at September 30,
1999 under the Senior  Secured  Credit  Facility as current  liabilities  in the
accompanying balance sheet. If, as expected,  the Company successfully completes
the  contemplated  refinancings of the Senior Secured Credit Facility and Lucent
Facility  prior to the issuance of its financial  statements  for the year ended
December  31,  1999,  the  applicable  accounting  standards  will  permit it to
classify the amounts  outstanding  under the Senior Secured  Credit  Facility as
long-term debt in its balance sheet as of December 31, 1999. A covenant  default
under the  Senior  Secured  Credit  Facility  or the Lucent  Facility  is not an
automatic default under the Company's other outstanding  indebtedness but, under
certain circumstances, may become one, depending upon the actions of the lenders
under the Senior Secured Credit Facility and Lucent Facility.


7.   INTEREST RATE SWAP AGREEMENT

         The Company has entered  into an interest  rate swap  agreement  with a
commercial  bank to  reduce  the  impact of  changes  in  interest  rates on its
outstanding  variable rate debt. The agreement  effectively  fixes the Company's
interest rate on the $125 million of outstanding  variable rate borrowings under


                                       8
<PAGE>


the Senior  Secured  Credit  Facility due 2007. The interest rate swap agreement
terminates in April 2004.  The Company is exposed to credit loss in the event of
nonperformance by the other party to the interest rate swap agreement.  However,
the Company does not anticipate nonperformance by the counterparty.


8.   PREFERRED STOCK AND WARRANT ISSUANCES

SERIES E PREFERRED STOCK

         On  February  4, 1999,  the Company  issued  25,000  shares of Series E
Senior  Redeemable,  Exchangeable,  PIK Preferred Stock (the "Series E Preferred
Stock")  to  Newcourt  Commercial  Finance  Corporation   ("Newcourt  Finance"),
generating  aggregate  gross proceeds of $22.9  million.  On April 30, 1999, the
Company issued an additional 35,000 shares of Series E Preferred Stock for gross
proceeds  of $25.9  million.  The  Series E  Preferred  Stock has a  liquidation
preference  of $1,000  per share  and an annual  dividend  equal to 14.5% of the
liquidation  preference,  payable quarterly.  On or before January 15, 2004, the
Company may pay dividends in cash or in additional fully paid and  nonassessable
shares of Series E Preferred  Stock.  After January 15, 2004,  dividends must be
paid in cash,  subject to certain  conditions.  Unpaid  dividends  accrue at the
dividend rate of the Series E Preferred Stock,  compounded  quarterly.  On April
15,  1999 and July 15,  1999,  the Company  issued 695 shares and 1,986  shares,
respectively,  of Series E  Preferred  Stock to pay the  dividends  due for such
periods.

         The Series E  Preferred  Stock must be  redeemed  on  February 1, 2011,
subject to the legal  availability  of funds  therefor,  at a redemption  price,
payable in cash, equal to the liquidation  preference  thereof on the redemption
date, plus all accumulated and unpaid dividends to the date of redemption. After
April 15, 2004,  the Series E Preferred  Stock may be  redeemed,  in whole or in
part, at the option of the Company,  at a redemption  price equal to 110% of the
liquidation  preference  of the Series E  Preferred  Stock plus all  accrued and
unpaid dividends to the date of redemption.  The redemption price declines to an
amount equal to 100% of the liquidation preference as of April 15, 2007.

         In  addition,  on or prior to April 15,  2002,  the Company may, at its
option,  redeem up to 35% of the  aggregate  liquidation  preference of Series E
Preferred  Stock with the proceeds of sales of its capital stock at a redemption
price equal to 110% of the  liquidation  preference on the redemption  date plus
accrued and unpaid dividends.

         The holders of Series E Preferred  Stock have voting  rights in certain
circumstances.  Upon the occurrence of a change of control,  the Company will be
required to make an offer to repurchase the Series E Preferred Stock for cash at
a purchase price of 101% of the liquidation  preference  thereof,  together with
all accumulated and unpaid dividends to the date of purchase.

         The Series E Preferred  Stock is not  convertible.  The Company may, at
the sole  option of the Board of  Directors  (out of funds  legally  available),
exchange  all,  but not less than all,  of the  Series E  Preferred  Stock  then
outstanding,  including any shares of Series E Preferred Stock issued as payment
for  dividends,  for a new  series of  subordinated  debentures  (the  "Exchange
Debentures") issued pursuant to an exchange debenture indenture.  The holders of
Series  E  Preferred  Stock  are  entitled  to  receive  on the date of any such
exchange,  Exchange Debentures having an aggregate principal amount equal to (i)
the total of the  liquidation  preference  for each share of Series E  Preferred
Stock  exchanged,  plus (ii) an amount equal to all accrued but unpaid dividends
payable on such share.

SERIES F PREFERRED STOCK

         On  February  4, 1999,  the Company  issued  40,000  shares of Series F
Senior  Redeemable,  Exchangeable,  PIK Preferred Stock (the "Series F Preferred
Stock") to Lucent and Newcourt Finance,  generating  aggregate gross proceeds of


                                       9
<PAGE>


$38.9  million.  The Series F Preferred  Stock has a  liquidation  preference of
$1,000  per  share  and an  annual  dividend  equal to 14.5% of the  liquidation
preference,  payable  quarterly.  The  Company may pay  dividends  in cash or in
additional fully paid and  nonassessable  shares of Series F Preferred Stock. On
April 15, 1999 and July 15,  1999,  the Company  issued  1,112  shares and 1,486
shares,  respectively,  of Series F Preferred Stock to pay the dividends due for
such period.

         The Series F Preferred  Stock may be redeemed at any time,  in whole or
in part,  at the option of the Company,  at a redemption  price equal to 110% of
the  liquidation  preference on the redemption date plus an amount in cash equal
to all accrued and unpaid  dividends  thereon to the redemption  date.  Upon the
occurrence of a change of control, the Company will be required to make an offer
to purchase the Series F Preferred Stock for cash at a purchase price of 101% of
the  liquidation  preference  thereof,  together with all accumulated and unpaid
dividends to the date of purchase.

         The  holders of Series F  Preferred  Stock  have  voting  rights  under
certain circumstances.

         Upon the  earlier  of (i) the date that is sixty days after the date on
which the  Company  closes an  underwritten  primary  offering  of at least $200
million of its Common  Stock,  pursuant to an effective  registration  statement
under the  Securities  Act or (ii) February 4, 2001,  any  outstanding  Series F
Preferred Stock will  automatically  convert into Series E Preferred Stock, on a
one for one basis.

         The Company may, at the sole option of the Board of  Directors  (out of
funds legally  available),  exchange all, but not less than all, of the Series F
Preferred  Stock then  outstanding,  including  any shares of Series F Preferred
Stock issued as payment for dividends,  for Exchange Debentures.  The holders of
Series  F  Preferred  Stock  are  entitled  to  receive  on the date of any such
exchange,  Exchange Debentures having an aggregate principal amount equal to (i)
the total of the  liquidation  preference  for each share of Series F  Preferred
Stock  exchanged,  plus (ii) an amount equal to all accrued but unpaid dividends
payable on such share.

WARRANTS

         In  connection  with the  February  4, 1999  issuances  of the Series E
Preferred  Stock and the Series F  Preferred  Stock,  warrants  to  purchase  an
aggregate  of 24,660  shares of Common  Stock were sold to Newcourt  Finance and
Lucent.  The  aggregate  gross  proceeds  from the sale of  these  warrants  was
approximately  $3.2 million.  These  warrants,  at an exercise price of $.01 per
share, are exercisable from February 4, 2000 through February 1, 2009.

         In  addition,   the  Company  also   delivered  to  the  Warrant  Agent
certificates  representing  warrants to purchase an aggregate  of an  additional
107,228  shares  of Common  Stock at an  exercise  price of $.01 per share  (the
"Springing  Warrants").  The Springing  Warrants may become  issuable  under the
circumstances described in the following paragraph.

         If the Company  fails to redeem all shares of Series F Preferred  Stock
prior to the date (the "Springing Warrant Date") which is the earlier of (i) the
date  that is  sixty  days  after  the  date on  which  the  Company  closes  an
underwritten  primary  offering  of at least $200  million  of its Common  Stock
pursuant to an effective registration statement under the Securities Act or (ii)
February  4,  2001,  the  Warrant  Agent is  authorized  to issue the  Springing
Warrants to the Eligible  Holders (as defined in the warrant  agreement)  of the
Series E and Series F Preferred Stock. In the event the Company has redeemed all
outstanding  shares of Series F Preferred  Stock prior to the Springing  Warrant
Date,  the  Springing  Warrants  will not be issued and the  Warrant  Agent will
return the certificates to the Company.  To the extent the Company exercises its
option to exchange all of the Series F Preferred  Stock for Exchange  Debentures
prior to the  Springing  Warrant Date,  the  Springing  Warrants will not become
issuable.  Therefore,  as the  future  issuance  of the  Springing  Warrants  is


                                       10
<PAGE>


entirely  within the control of the Company and the likelihood of their issuance
is deemed to be remote, no value has been ascribed to the Springing Warrants.

         In connection with the April 30, 1999 issuance of additional  shares of
the Series E Preferred Stock, warrants to purchase an aggregate of 60,353 shares
of Common Stock were issued to Newcourt  Finance and First Union.  The aggregate
gross proceeds from the sale of these warrants was  approximately  $9.1 million.
These warrants,  at an exercise price of $.01 per share,  are  exercisable  from
February 4, 2000 through February 1, 2009.


9. SERVICE REVENUES

         The Company provides on-net switched and dedicated services and resells
switched  services  previously  purchased  from  the  incumbent  local  exchange
carrier.   On-net  services  include  both  services   provided  through  direct
connections  to our own  networks  and  services  provided by means of unbundled
network elements leased from the incumbent local exchange carrier.

         The Company's service revenues consist of the following (in thousands):


                         THREE MONTHS ENDED              NINE MONTHS ENDED
                            SEPTEMBER 30,                  SEPTEMBER 30,
                      --------------------------    ----------------------------
                        1998            1999           1998            1999
                      ----------     -----------    -----------    -------------
On-net..............   $ 2,125        $ 9,693        $ 4,240         $ 23,992
Resale..............     4,125          5,879          9,348           18,292
                      ----------     -----------    -----------    -------------
Total...............   $ 6,250        $15,572       $ 13,588         $ 42,284
                      ==========     ===========    ===========    =============


10.  COMMITMENTS AND CONTINGENCIES

PURCHASE COMMITMENTS

         As of  September  30,  1999,  the Company has  outstanding  commitments
aggregating    approximately    $92.8   million    related   to   purchases   of
telecommunications equipment and fiber optic cable and its obligations under its
agreements with certain suppliers.

ARBITRATION AWARD

         During the second quarter of 1999, the company  recorded a $4.3 million
charge to other expense in connection with an unfavorable arbitration award. The
net amount due under the terms of the award was paid in full in June 1999.

REDEMPTION RIGHTS

         Pursuant  to  a  stockholders  agreement,   certain  of  the  Company's
stockholders  and warrant  holders have "put rights"  entitling them to have the
Company repurchase their preferred and common shares and redeemable common stock
warrants for the fair value of such securities if no Liquidity Event (defined as
(i) an initial public offering with gross proceeds of at least $40 million, (ii)
the sale of substantially all of the stock or assets of the Company or (iii) the
merger or consolidation of the Company with one or more other  corporations) has
taken  place by the later of (x) October 22, 2003 or (y) 90 days after the final
maturity date of the Senior  Discount Notes.  The  restrictive  covenants of the


                                       11
<PAGE>


Senior Discount Notes limit the Company's ability to repurchase such securities.
All of the  securities  subject to such "put rights" are presented as redeemable
equity in the accompanying balance sheets.

         The redeemable preferred stock,  redeemable common stock and redeemable
common stock  warrants,  which are subject to the  stockholders  agreement,  are
being  accreted up to their fair market  values from their  respective  issuance
dates to their  earliest  potential  redemption  date  (October  22,  2003).  At
September 30, 1999, the aggregate  redemption value of the redeemable equity was
approximately $235 million,  reflecting per share redemption amounts of $897 for
the Series A Preferred Stock, $352 for the Series C Preferred Stock and $185 for
the redeemable common stock and redeemable common stock warrants.


11.  NET LOSS PER COMMON SHARE

         The following  table sets forth the  computation of net loss per common
share-basic (in thousands, except share and per share amounts):
<TABLE>
<CAPTION>

                                                               THREE MONTHS ENDED                  NINE MONTHS ENDED
                                                                  SEPTEMBER 30,                      SEPTEMBER 30,
                                                        ----------------------------------  ---------------------------------
<S>                                                     <C>               <C>               <C>               <C>
                                                             1998              1999              1998              1999
                                                        ----------------  ----------------  ----------------  ---------------
Numerator:
   Net loss..........................................      $   (20,106)      $   (49,024)      $   (53,703)     $  (152,185)

Dividends and accretion on redeemable preferred stock           (4,117)            1,330           (14,157)         (42,085)
                                                        ----------------  ----------------  ----------------  ---------------
   Numerator for net loss per common share - basic...      $   (24,223)      $  ( 47,694)      $   (67,860)     $  (194,270)
                                                        ================  ================  ================  ===============

Denominator:
     Denominator for net loss per common share -
   weighted average number of common shares
   outstanding..........................................       837,876           852,676           828,181          851,321
                                                        ================  ================  ================  ===============


Net loss per common share - basic....................      $   (28.91)       $   (55.93)       $   (81.94)     $   (228.20)
                                                        ================  ================  ================  ===============
</TABLE>


         Options and  warrants to purchase an  aggregate  of 373,135 and 483,273
shares of common  stock were  outstanding  as of  September  30,  1998 and 1999,
respectively,  but a  computation  of diluted net loss per common  share has not
been presented, as the effect would be anti-dilutive.


12.  LOUISIANA RECIPROCAL REVENUE

         During 1998 and the first nine  months of 1999 the  Company  recognized
revenue which it believed was due from  incumbent  local  exchange  carriers for
terminating  local traffic of Internet  service  providers  (ISPs).  The Company
determined to recognize  this revenue  because,  based upon all of the facts and
circumstances  known  at the  time,  including  numerous  state  public  service
commission and state and federal court  decisions  upholding  competitive  local
exchange carriers'  entitlement to reciprocal  compensation for such calls, that
realization  of those  amounts was  reasonably  assured.  On October  13,  1999,
however,  the Louisiana  Public Service  Commission  ruled that local traffic to
ISPs in Louisiana is not eligible for  reciprocal  compensation.  As a result of
that  ruling,  the  Company  determined  that it could no longer  conclude  that
realization  of amounts  attributable  to  termination of local calls to ISPs in
Louisiana was  reasonably  assured.  Accordingly,  an adjustment was recorded to
reduce revenue in the 1999 Third Quarter,  which reversed all reciprocal revenue
recognized  related to ISP traffic in Louisiana  for the entire year of 1998 and
the first nine months of 1999. The adjustment amounted to $4.4 million, of which



                                       12
<PAGE>


$1.1  million  relates  to the year ended  December  31,  1998 and $3.3  million
relates to the nine months ended September 30, 1999.

         The  Company  has been  advised  by its  regulatory  counsel  that this
decision  appears  to be well  out of the  mainstream  on the  issue.  To  date,
Louisiana  is the only state  which has  rendered  a  decision,  pursuant  to an
existing  agreement,  that has permitted an incumbent local exchange  carrier to
use a competitive local exchange carriers'  facilities to complete calls without
compensation  to the  competitive  local exchange  carrier.  Thirty-three  other
states have ruled that the  originating  carrier must compensate the terminating
carrier for such use.  Many of these  decisions  have been affirmed by state and
federal  courts on appeal and none have been  reversed.  The Company  intends to
appeal the decision to the appropriate authority.




                                       13
<PAGE>


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

         THIS FORM 10-Q CONTAINS FORWARD-LOOKING  STATEMENTS WHICH INVOLVE RISKS
AND  UNCERTAINTIES.  THE COMPANY'S ACTUAL RESULTS MAY DIFFER  SIGNIFICANTLY FROM
THE  RESULTS  DISCUSSED  IN  THE  FORWARD-LOOKING   STATEMENTS.   THE  FOLLOWING
DISCUSSION   SHOULD  BE  READ  IN  CONJUNCTION  WITH  THE  UNAUDITED   CONDENSED
CONSOLIDATED  FINANCIAL  STATEMENTS,   INCLUDING  THE  NOTES  THERETO,  INCLUDED
ELSEWHERE IN THIS FORM 10-Q.


RESULTS OF OPERATIONS

As a result of the development and rapid growth of the Company's business during
the periods presented, the period-to-period comparisons of the Company's results
of operations are not necessarily meaningful and should not be relied upon as an
indication of future performance.

                THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO
                      THREE MONTHS ENDED SEPTEMBER 30, 1998

         REVENUE. Revenue increased from $6.3 million for the three months ended
September  30, 1998 (the "1998 Third  Quarter")  to $15.6  million for the three
months ended  September  30, 1999 (the "1999 Third  Quarter").  This increase is
primarily  attributable  to the fact that we  derived  revenues  from 23 markets
during  the 1999 Third  Quarter  compared  to 11  markets  during the 1998 Third
Quarter.  During  1998 and the first nine months of 1999 we  recognized  revenue
which we believed  was due to us from  incumbent  local  exchange  carriers  for
terminating local traffic of Internet service providers (ISPs). We determined to
recognize  this revenue  because we  concluded,  based upon all of the facts and
circumstances  known to us at the time,  including numerous state public service
commission and state and federal court  decisions  upholding  competitive  local
exchange carriers'  entitlement to reciprocal  compensation for such calls, that
realization  of those  amounts was  reasonably  assured.  On October  13,  1999,
however,  the Louisiana  Public Service  Commission  ruled that local traffic to
ISPs in Louisiana is not eligible for  reciprocal  compensation.  As a result of
that ruling,  we determined that we could no longer conclude that realization of
amounts  attributable  to  termination  of local calls to ISPs in Louisiana  was
reasonably assured.  Accordingly, we recorded an adjustment to reduce revenue in
the 1999 Third Quarter, which reversed all reciprocal revenue recognized related
to ISP  traffic  in  Louisiana  for the  entire  year of 1998 and the first nine
months of 1999. The adjustment  amounted to $4.4 million,  of which $1.1 million
relates to the year ended December 31, 1998 and $3.3 million relates to the nine
months ended September 30, 1999.

         Excluding  the  effect of the  adjustment,  revenue  for the 1999 Third
Quarter would have been $20.0 million, including $4.7 million of revenue related
to reciprocal  compensation.  With the  exception of our two Louisiana  systems,
which are  affected by the  Louisiana  Public  Service  Commission's  reciprocal
compensation  decision,  each of our systems that  generated  revenue during the
1998 Third  Quarter  generated  higher  revenue  during the 1999 Third  Quarter.
Excluding  the effect of the  adjustment,  our two systems  located in Louisiana
also generated higher revenue during the 1999 Third Quarter than during the 1998
Third Quarter.

         Revenue for the 1998 Third Quarter and 1999 Third Quarter included $4.2
million  and $5.9  million,  respectively,  of revenue  derived  from  resale of
switched services and an aggregate of $2.1 million and $9.7 million  (including,
after giving effect to the $4.4 million  adjustment for Louisiana,  $0.3 million
of revenue  related to reciprocal  compensation  during the 1999 Third Quarter),
respectively,  of revenue derived from on-net special  access,  private line and
switched services.


                                       14
<PAGE>


         Although  incumbent local exchange  carriers,  such as BellSouth,  have
generally  withheld  payments  of amounts  due for  reciprocal  compensation  to
competitive  local  exchange  carriers such as the Company for calls to ISPs and
disputed the  entitlement of competitive  local exchange  carriers to reciprocal
compensation  for such calls in  jurisdictions  other than Louisiana as well, we
have  determined  to continue  to  recognize  amounts  due to us for  reciprocal
compensation  for such calls in  jurisdictions  other than Louisiana  because we
have  concluded,  based  upon  all of the  facts  and  circumstances,  including
numerous state public service  commission and state and federal court  decisions
upholding   competitive  local  exchange  carriers'  entitlement  to  reciprocal
compensation  for such calls,  that  realization  of such amounts is  reasonably
assured.

         NETWORK  OPERATING COSTS.  Network operating costs increased from $10.7
million in the 1998 Third  Quarter to $31.2  million in the 1999 Third  Quarter.
This  increase of $20.5  million was due primarily to the increase in the number
of  markets  in which we  operated  in the 1999 Third  Quarter  and the  related
increases of $5.0 million in personnel  costs,  $4.8 million in costs associated
with providing resale services and leasing  unbundled  network element services,
$2.5 million in consultant and professional services related costs, $1.8 million
in  contracted  network  support  costs,  $1.4  million in  reciprocal  expense,
$700,000 in  telecommunications  costs,  $700,000 in  facility  costs,  and $3.6
million in other direct operating costs.

         Costs associated with providing  on-net switched  services were greater
than revenue  generated from on-net switched services because we hired personnel
and staffed local offices prior to generating  revenue and obtaining  sufficient
revenue volume to cover such fixed operating costs.

         Costs  associated with providing  resale services were greater than the
revenues  generated from these services because of narrow discounts  provided by
the incumbent local exchange carriers and because initial  installation  charges
by the incumbent local exchange  carrier to us are greater than our installation
charges to our customers. Initially, resale has been used as an interim strategy
for us to  create a  backlog  of  customers  to be  transitioned  to our  on-net
switched facilities as our own switches become commercially operational.  We now
have  switches in commercial  operation in 23 markets.  We are in the process of
transitioning the majority of our resale customers to on-net switched  services,
but this can be a time-consuming task.

         SELLING,  GENERAL AND  ADMINISTRATIVE  EXPENSES.  Selling,  general and
administrative  expenses  increased from $6.1 million for the 1998 Third Quarter
to $15.0  million for the 1999 Third  Quarter.  This  increase  of $8.9  million
resulted  primarily  from  increases of $6.4 million in  personnel  costs,  $1.2
million in professional costs (consisting primarily of legal costs), $800,000 in
travel related expenses and $100,000 in advertising  costs, along with increases
in  other   marketing   and  general  and   administrative   costs   aggregating
approximately $400,000.

         STOCK OPTION COMPENSATION EXPENSE. Stock option compensation expense, a
non-cash charge,  decreased from $398,000 for the 1998 Third Quarter to a credit
of $7.0 million for the 1999 Third  Quarter.  This decrease  primarily  resulted
from a decrease in the estimated fair value of the Company's Common Stock.

         DEPRECIATION AND  AMORTIZATION.  Depreciation and amortization  expense
increased  from $3.1 million for the 1998 Third  Quarter to $7.6 million for the
1999 Third Quarter primarily as a result of depreciation expense associated with
the greater  number of networks in  commercial  operation  during the 1999 Third
Quarter.

         INTEREST EXPENSE.  Interest expense increased from $11.4 million in the
1998 Third  Quarter to $21.8  million in the 1999 Third  Quarter.  The  increase
resulted primarily from the issuance of the Senior Notes in May 1999, additional
accretion on the Senior Discount Notes and increased interest charges related to
higher  borrowings  under  the  Senior  Secured  Credit  Facility.  The  Company


                                       15
<PAGE>


capitalized  interest related to network  construction  projects of $1.5 million
during the 1998 Third Quarter and $2.2 million during the 1999 Third Quarter.

         NET LOSS. For the reasons  stated above,  net loss increased from $20.1
million for the 1998 Third Quarter to $49.0 million for the 1999 Third Quarter.

                NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO
                      NINE MONTHS ENDED SEPTEMBER 30, 1998

         REVENUE. Revenue increased from $13.6 million for the nine months ended
September 30, 1998 (the "1998 Nine Months") to $42.3 million for the nine months
ended  September 30, 1999 (the "1999 Nine  Months").  This increase is primarily
attributable to the fact that we derived revenue from 23 markets during the 1999
Nine Months compared to 11 markets during the 1998 Nine Months.  During 1998 and
the first nine months of 1999 we recognized revenue which we believed was due to
us from incumbent local exchange carriers for terminating local traffic of ISPs.
We determined to recognize this revenue because we concluded,  based upon all of
the facts and circumstances  known to us at the time,  including  numerous state
public  service  commission  and state and  federal  court  decisions  upholding
competitive local exchange carriers' entitlement to reciprocal  compensation for
such calls, that realization of those amounts was reasonably assured. On October
13, 1999,  however,  the Louisiana  Public Service  Commission  ruled that local
traffic to ISPs in Louisiana is not eligible for reciprocal  compensation.  As a
result of that  ruling,  we  determined  that we could no longer  conclude  that
realization  of amounts  attributable  to  termination of local calls to ISPs in
Louisiana  was  reasonably  assured.  Accordingly,  we recorded an adjustment to
reduce revenue in the 1999 Third Quarter,  which reversed all reciprocal revenue
recognized  related to ISP traffic in Louisiana  for the entire year of 1998 and
the first nine months of 1999. The adjustment amounted to $4.4 million, of which
$1.1  million  relates  to the year ended  December  31,  1998 and $3.3  million
relates to the nine months ended September 30, 1999.

         Excluding  the  effect  of the  adjustment,  revenue  for the 1999 Nine
Months would have been $46.7 million,  including $9.2 million of revenue related
to reciprocal  compensation.  Each of our systems that generated  revenue during
the 1998 Nine Months generated higher revenue during the 1999 Nine Months.

         Revenue  for the 1998 Nine Months and 1999 Nine  Months  included  $9.4
million  and $18.3  million,  respectively,  of revenue  derived  from resale of
switched services and an aggregate of $4.2 million and $24.0 million (including,
after giving effect to the $4.4 million  adjustment for Louisiana,  $4.8 million
of revenue  related to  reciprocal  compensation  during the 1999 Nine  Months),
respectively,  of revenue derived from on-net special  access,  private line and
switched services.

         Although  incumbent local exchange  carriers,  such as BellSouth,  have
generally  withheld  payments  of amounts  due for  reciprocal  compensation  to
competitive  local  exchange  carriers such as the Company for calls to ISPs and
disputed the  entitlement of competitive  local exchange  carriers to reciprocal
compensation  for such calls in  jurisdictions  other than Louisiana as well, we
have  determined  to continue  to  recognize  amounts  due to us for  reciprocal
compensation  for such calls in jurisdictions  other than Louisiana,  because we
have  concluded,  based  upon  all of the  facts  and  circumstances,  including
numerous state public service  commission and state and federal court  decisions
upholding   competitive  local  exchange  carriers'  entitlement  to  reciprocal
compensation  for such calls,  that  realization  of such amounts is  reasonably
assured.

         NETWORK  OPERATING COSTS.  Network operating costs increased from $24.6
million in the 1998 Nine Months to $75.2  million in the 1999 Nine Months.  This
increase of $50.6  million was due  primarily  to the  increase in the number of
markets in which we operated  in the 1999 Nine Months and the related  increases
of $13.4  million in personnel  costs,  $12.4 million in costs  associated  with
providing resale services and leasing unbundled  network element services,  $5.4
million in contracted  network  support  costs,  $5.1 million in consultant  and


                                       16
<PAGE>


professional  services related costs, $2.7 million in reciprocal  expense,  $1.8
million in facility costs,  $1.5 million in  telecommunications  costs, and $8.3
million in other direct operating costs.

         SELLING,  GENERAL AND  ADMINISTRATIVE  EXPENSES.  Selling,  general and
administrative expenses increased from $15.3 million for the 1998 Nine Months to
$41.7 million for the 1999 Nine Months.  This increase of $26.4 million resulted
primarily  from increases of $15.6 million in personnel  costs,  $4.0 million in
professional costs (consisting primarily of legal costs), $2.4 million in travel
related  expenses,  and $400,000 in advertising  costs,  along with increases in
other marketing and general and administrative  costs aggregating  approximately
$4.0 million.

         STOCK OPTION COMPENSATION EXPENSE. Stock option compensation expense, a
non-cash  charge,  increased from $6.6 million for the 1998 Nine Months to $13.2
million for the 1999 Nine  Months.  This  increase  primarily  resulted  from an
increase in the estimated fair value of the Company's Common Stock.

         DEPRECIATION AND  AMORTIZATION.  Depreciation and amortization  expense
increased  from $5.2  million for the 1998 Nine Months to $19.2  million for the
1999 Nine Months primarily as a result of depreciation  expense  associated with
the  greater  number of networks in  commercial  operation  during the 1999 Nine
Months.

         OTHER EXPENSE.  During the second quarter of 1999, the Company recorded
a $4.3  million  charge  to other  expense  in  connection  with an  unfavorable
arbitration  award.  The net amount due under the terms of the award was paid in
full in June 1999.

         INTEREST EXPENSE.  Interest expense increased from $26.0 million in the
1998 Nine Months to $47.8 million in the 1999 Nine Months. The increase resulted
primarily  from  the  issuance  of the  Senior  Notes  in May  1999,  additional
accretion on the Senior Discount Notes,  and increased  interest charges related
to higher  borrowings  under the Senior  Secured  Credit  Facility.  The Company
capitalized  interest related to network  construction  projects of $2.9 million
during the 1998 Nine Months and $3.5 million during the 1999 Nine Months.

         NET LOSS. For the reasons  stated above,  net loss increased from $53.7
million for the 1998 Nine Months to $152.2 million for the 1999 Nine Months.

LIQUIDITY AND CAPITAL RESOURCES

         We have  incurred  significant  operating and net losses as a result of
the development  and operation of our networks.  We expect that such losses will
continue as we emphasize  the  development,  construction  and  expansion of our
networks and build our customer  base.  As a result,  there will not be any cash
provided by operations in the near future and we will need to fund the expansion
of our networks.  We have financed our operating losses and capital expenditures
with  equity  invested  by our  founders,  preferred  stock  placements,  credit
facility borrowings, the 12 1/2% Senior Discount Notes and 13 1/2% Senior Notes.

         On May 24, 1999, we issued $275.0 million in aggregate principal amount
of 13 1/2%  Senior  Notes  due 2009.  Approximately  $104.1  million  of the net
proceeds of this  offering  were used to purchase a portfolio  of U.S.  treasury
securities  that have been  pledged to secure the first six  scheduled  interest
payments on these notes.

         In  February  1999,  we issued  PIK  Preferred  Stock and  warrants  to
purchase  common  stock for  aggregate  gross  proceeds of $65.0  million to two
purchasers.  In April 1999, we issued  additional  shares of PIK Preferred Stock
and warrants to purchase common stock to one additional  purchaser for aggregate
gross proceeds of $35.0 million.


                                       17
<PAGE>


         In February 1999, our subsidiary which owns the 14 additional  networks
currently under  development,  entered into a secured vendor financing  facility
with Lucent Technologies Inc. Under this Lucent Facility, our subsidiary will be
permitted to borrow, subject to certain conditions, up to an aggregate of $600.0
million,   primarily  for  the  purchase  from  Lucent  of  switches  and  other
telecommunications equipment.  Currently, $250.0 million is available under this
facility.  The balance of $350.0  million  will become  available  only upon (a)
additional  lenders agreeing to participate in the facility so that Lucent's own
aggregate  commitment  does  not  exceed  $250.0  million  and (b)  the  Company
satisfying  certain other  requirements,  the most  significant  of which is the
Company  raising,  and  contributing to the subsidiary,  at least $300.0 million
from the sale of high yield debt or equity. As of September 30, 1999 the Company
had no borrowings outstanding under this facility.

         Net cash provided by financing  activities  from  borrowings and equity
issuances was $332.1  million for the nine months ended  September 30, 1999. Our
net cash used in operating and investing  activities  was $332.0 million for the
nine months ended September 30, 1999.

         We made capital expenditures of $218.5 million in the nine months ended
September 30, 1999. We currently plan to make additional capital expenditures of
approximately $132.0 million during the remainder of 1999. Continued significant
capital  expenditures are expected to be made thereafter.  The majority of these
expenditures is expected to be made for network construction and the purchase of
switches and related  equipment to facilitate  the offering of our services.  In
addition,  we expect to continue to incur  operating  losses while we expand our
business and build our customer base. Actual capital  expenditures and operating
losses will depend on numerous factors, including the nature of future expansion
and acquisition opportunities and factors beyond our control, including economic
conditions,   competition,  regulatory  developments  and  the  availability  of
capital.

         At  September  30,  1999,  the  Company  had  outstanding   commitments
aggregating  approximately  $92.8 million related to the purchase of fiber optic
cable  and  telecommunications   equipment  as  well  as  engineering  services,
principally under the Company's agreements with Lucent Technologies Inc.

         At September 30, 1999, the Company had $125.0  million of  indebtedness
outstanding under the Senior Secured Credit Facility,  and had $125.0 million in
borrowing capacity  available under the Senior Secured Credit Facility,  subject
to  certain  conditions.  On the same  date,  the  Company  had no  indebtedness
outstanding  under the  Lucent  Facility  and had $250.0  million  in  borrowing
capacity available thereunder.

         We obtained a waiver of compliance, for the quarter ended September 30,
1999, with certain financial covenants (related to revenue and EBITDA) contained
in the Senior  Secured Credit  Facility.  In addition,  the EBITDA  covenant was
amended for the fourth quarter of 1999 to a level which we expect to achieve.

         We have  received a signed  commitment  from  Lucent to  refinance  the
existing  Lucent  Facility  upon terms which  would  involve  the  provision  of
additional  funding to the Company and the resetting of the financial  covenants
for  periods  after the fourth  quarter  of 1999.  We are  currently  engaged in
discussions  with the agents for the  lenders  under the Senior  Secured  Credit
Facility  which  presently  contemplate  comparable  amendments to the financial
covenants  in  the  Senior  Secured  Credit  Facility.  We  believe  that  these
negotiations  will lead to  definitive  agreements  during the first  quarter of
2000.  If,  however,  we are not successful in completing  the  negotiations  as
presently  contemplated  and  amending  the  financial  covenants  in the Senior
Secured Credit Facility and the Lucent Facility,  it is likely that we will fail
to  comply  with  one or more of the  covenants  presently  contained  in  those
facilities for the quarter ended March 31, 2000,  which failure,  unless waived,
would  constitute a default under those credit  facilities.  A covenant  default
under the  Senior  Secured  Credit  Facility  or the Lucent  Facility  is not an
automatic  default under our other  outstanding  indebtedness but, under certain


                                       18
<PAGE>


circumstances,  may become one,  depending upon the actions of the lenders under
the Senior Secured Credit Facility and Lucent Facility.

         We  believe  that  our  cash,   investments  held  for  future  capital
expenditures  and borrowings  available under our Senior Secured Credit Facility
and the Lucent Facility,  will be sufficient to meet our liquidity needs through
the completion of the 14 additional  networks  currently  under  development and
anticipated  to be completed in the first half of 2000,  although we can give no
assurance  in this regard.  Thereafter  we will  require  additional  financing.
However,  in the event that our plans  change,  the  assumptions  upon which our
plans are based prove  inaccurate,  we expand or accelerate our business plan or
we determine to  consummate  acquisitions,  the  foregoing  sources of funds may
prove  insufficient  to complete all of the networks,  and we may be required to
seek additional financing sooner than we currently expect. Additional sources of
financing  may  include  public  or  private  equity or debt  financings  by the
Company, capitalized leases and other financing arrangements.

         We can give no assurance that additional financing will be available to
us or, if available, that it can be obtained on a timely basis and on acceptable
terms. Failure to obtain such financing could result in the delay or abandonment
of some or all of our development and expansion plans and  expenditures.  Such a
failure could also limit our ability to make principal and interest  payments on
our indebtedness  and meet our dividend and redemption  obligations with respect
to our  preferred  stock.  The  Company has no working  capital or other  credit
facility  under  which it may  borrow  for  working  capital  and other  general
purposes.  We can give no assurance that such financing will be available to the
Company in the future or that, if such  financing  were  available,  it would be
available on terms and conditions acceptable to the Company.

YEAR 2000 COMPLIANCE

         Similar to all  businesses,  we may be  affected  by the  inability  of
certain computer software to distinguish  between the years 1900 and 2000 due to
a  commonly-used  programming  convention.  Unless such programs are modified or
replaced  prior to January 1, 2000,  calculations  based on date  arithmetic  or
logical operations performed by such programs may be incorrect. In addition, the
Senior Secured Credit  Facility and the Lucent Facility impose certain Year 2000
compliance obligations on the Company.

         Management's  plan to address the effect of the Year 2000 issue focuses
on the following areas:  applications  systems (including our billing system and
financial  software),  infrastructure  (including personal computers and servers
used throughout the Company),  and other third party business partners,  vendors
and  suppliers.  Management's  analysis  and review of these areas is  comprised
primarily of the following phases: developing an inventory of hardware, software
and  embedded  chips;  assessing  the  degree to which  each  area is  currently
compliant  with Year 2000  requirements;  performing  renovations,  repairs  and
replacements as needed to attain compliance;  testing to ensure compliance; and,
developing  a  contingency  plan for each area if our initial  efforts to attain
compliance are either unsuccessful or untimely.

         Management completed the inventory and assessment phases of the project
during the fourth quarter of 1998. The renovation,  repair and replacement phase
and the testing  phase have  commenced;  however,  we expect to  continue  these
phases throughout 1999.

         Further, we have completed the initial  installation and are continuing
the process of implementing new billing software systems,  operational  software
systems  and  financial  and  personnel   software   systems.   Although   these
implementations  were made  necessary by the  expansion of our business and were
not directly  related to Year 2000  issues,  they have enabled us to utilize new
software for these  purposes  which the  respective  suppliers have certified as
Year 2000 compliant.


                                       19
<PAGE>


         Costs  incurred  to date have  primarily  consisted  of labor  from the
redeployment  of existing  information  services and operational  resources.  We
expect to spend  approximately  $150,000 for these Year 2000 compliance  efforts
which will be  expensed as  incurred.  This amount does not include the costs of
the new billing  software,  operational  software and  financial  and  personnel
software  systems which we are  implementing as a result of the expansion of our
business.

         If the  software  applications  of the local  exchange  carriers,  long
distance  carriers  or others  on whose  services  we  depend or with  which our
systems interact are not Year 2000 compliant,  it could affect our systems which
could have a material  adverse effect on our business,  financial  condition and
results of operations.

         Although  we  do  not   presently   anticipate   a  material   business
interruption as a result of the Year 2000 issue,  the worst case scenario if all
of our Year 2000  efforts  fail  would  result in a daily  loss of  revenues  of
approximately $250,000 calculated based upon our current revenues.




























                                       20
<PAGE>








ITEM 3.       QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

          Market risks  relating to the Company's  operations  result  primarily
from  changes in interest  rates.  The  substantial  majority  of the  Company's
long-term debt bears interest at a fixed rate. However, the fair market value of
the fixed rate debt is  sensitive to changes in interest  rates.  The Company is
subject to the risk that market  interest  rates will  decline and the  interest
expense  due under the fixed  rate debt will  exceed  the  amounts  due based on
current  market  rates.  The  Company has  entered  into an  interest  rate swap
agreement  with a  commercial  bank to reduce the impact of changes in  interest
rates on its outstanding variable rate debt. The agreement effectively fixes the
Company's  interest  rate on the  $125  million  of  outstanding  variable  rate
borrowings  under the Senior Secured Credit Facility due 2007. The interest rate
swap agreement terminates in April 2004.

         The  following   table   provides   information   about  the  Company's
significant  financial  instruments  that are  sensitive  to changes in interest
rates (in millions):

<TABLE>
<CAPTION>

                                                 Fair                Future Principal Payments
                                                  Value on
<S>                                              <C>         <C>   <C>    <C>   <C>   <C>   <C>           <C>
                                                 September   1999  2000   2001  2002  2003  Thereafter    Total
                                                 30, 1999
                                                -------------------------------------------------------------------

Long-Term Debt
Fixed Rate:
Senior Discount Notes,
  Interest payable at 12 1/2%,
   Maturing 2008                                   $ 282.2      -     -     -      -     -     $ 292.3    $ 292.3

Senior Notes,
  Interest payable at 13 1/2 %,
   Maturing 2009                                     275.0      -     -     -      -     -       275.0      275.0


Interest Rate Swap Derivative:
 Variable to fixed
   Senior Secured Credit Facility
   Pay rate at September 30, 1999 - 9.113%(a)
   Receive rate at September 30, 1999 - 6.075%       125.0      -     -     -    0.6   0.8       123.6      125.0
                                                -------------------------------------------------------------------

Total                                              $ 682.2      -     -     -    $.6   $.8     $ 690.9    $ 692.3
                                                ===================================================================
</TABLE>


(a) Pay  interest  rate is  based on a  variable  rate,  which at the  Company's
option,  is  determined  by either a base rate or LIBOR,  plus,  in each case, a
specified margin.


                                       21
<PAGE>


                           PART II - OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS.

         For a discussion  of an  arbitration  proceeding  between the Company's
subsidiary,  KMC Telecom,  Inc.  and Wang  Laboratories,  Inc. (as  successor to
I-Net, Inc.) see Item 3 of the Company's Annual Report on Form 10-K for the year
ended  December 31, 1998 and Item 1 of the  Company's  Quarterly  Report on Form
10-Q for the quarter ended June 30, 1999.

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.

         (a)   EXHIBITS

         4.1      First  Supplemental  Indenture  dated as of May 24, 1999 among
                  KMC Telecom Holdings,  Inc., KMC Telecom  Financing,  Inc. and
                  The Chase Manhattan  Bank, as Trustee,  to the Indenture dated
                  as of January 29, 1998 between KMC Telecom Holdings,  Inc. and
                  The Chase Manhattan Bank, as Trustee.

         4.2      Indenture dated as of May 24, 1999 among KMC Telecom Holdings,
                  Inc.,  KMC Telecom  Financing,  Inc.  and The Chase  Manhattan
                  Bank, as Trustee,  including specimen of KMC Telecom Holdings,
                  Inc.'s 13 1/2% Senior Notes due 2009.

         4.3      Purchase  Agreement  dated  May 19,  1999  among  KMC  Telecom
                  Holdings,  Inc. and Morgan Stanley & Co. Incorporated,  Credit
                  Suisse First Boston  Corporation,  First Union Capital Markets
                  Corp., CIBC World Markets Corp., BancBoston Robertson Stephens
                  Inc. and Wasserstein Perella Securities, Inc.

         4.4      Collateral Pledge and Security Agreement made and entered into
                  as of May 24, 1999 by KMC Telecom Financing,  Inc. in favor of
                  The Chase Manhattan Bank, as Trustee.

         4.5      Registration  Rights  Agreement  dated May 19,  1999 among KMC
                  Telecom Holdings,  Inc. and Morgan Stanley & Co. Incorporated,
                  Credit  Suisse First Boston  Corporation,  First Union Capital
                  Markets Corp., CIBC World Markets Corp.,  BancBoston Robertson
                  Stephens Inc. and Wasserstein Perella Securities, Inc.

         27.1     Financial Data Schedule.


                                       22
<PAGE>


         (b)   REPORTS ON FORM 8-K

         No  reports on Form 8-K were filed by the  Company  during the  quarter
         ended September 30, 1999.





















                                       23
<PAGE>



                                   SIGNATURES

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

DATED:    November 12, 1999



                                           KMC TELECOM HOLDINGS, INC.
                                                   (Registrant)



                                           By: /S/        MICHAEL A. STERNBERG
                                               -------------------------------
                                           Michael A. Sternberg
                                           President and Chief Executive Officer
                                           (Principal Executive Officer)



                                           By: /S/          JAMES D. GRENFELL
                                               -------------------------------
                                           James D. Grenfell
                                           Executive Vice President, Chief
                                           Financial Officer and Secretary
                                           (Principal Financial Officer)












                                       24
<PAGE>



EXHIBIT INDEX

         NO.      DESCRIPTION

         4.1      First  Supplemental  Indenture  dated as of May 24, 1999 among
                  KMC Telecom Holdings,  Inc., KMC Telecom  Financing,  Inc. and
                  The Chase Manhattan  Bank, as Trustee,  to the Indenture dated
                  as of January 29, 1998 between KMC Telecom Holdings,  Inc. and
                  The Chase Manhattan Bank, as Trustee.

         4.2      Indenture dated as of May 24, 1999 among KMC Telecom Holdings,
                  Inc.,  KMC Telecom  Financing,  Inc.  and The Chase  Manhattan
                  Bank, as Trustee,  including specimen of KMC Telecom Holdings,
                  Inc.'s 13 1/2% Senior Notes due 2009.

         4.3      Purchase  Agreement  dated  May 19,  1999  among  KMC  Telecom
                  Holdings,  Inc. and Morgan Stanley & Co. Incorporated,  Credit
                  Suisse First Boston  Corporation,  First Union Capital Markets
                  Corp., CIBC World Markets Corp., BancBoston Robertson Stephens
                  Inc. and Wasserstein Perella Securities, Inc.

         4.4      Collateral Pledge and Security Agreement made and entered into
                  as of May 24, 1999 by KMC Telecom Financing,  Inc. in favor of
                  The Chase Manhattan Bank, as Trustee.

         4.5      Registration  Rights  Agreement  dated May 19,  1999 among KMC
                  Telecom Holdings,  Inc. and Morgan Stanley & Co. Incorporated,
                  Credit  Suisse First Boston  Corporation,  First Union Capital
                  Markets Corp., CIBC World Markets Corp.,  BancBoston Robertson
                  Stephens Inc. and Wasserstein Perella Securities, Inc.

         27.1     Financial Data Schedule.