<PAGE>   1
================================================================================


                       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, 1996

                                       OR

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

             FOR THE TRANSITION PERIOD                 TO
                                       ---------------    --------------------

             COMMISSION FILE NUMBER 0-20763



                                  MCLEOD, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)



                DELAWARE                                58-421407240
        (STATE OF INCORPORATION)              (IRS EMPLOYER IDENTIFICATION NO.)
                                              
                                              
         221 THIRD AVENUE S.E.,                             52401
      SUITE 500, CEDAR RAPIDS IOWA                       (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)       


                                  319-364-0000
                        (REGISTRANT'S TELEPHONE NUMBER,
                              INCLUDING AREA CODE)


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

   The number of shares outstanding of each class of the issuer's common stock
as of November 5, 1996:

<TABLE>
     <S>                    <C>                                                      <C>
     Common Stock Class A:  ($.01 par value)  . . . . . . . . . . . . . . . . . . .  30,923,589 shares

     Common Stock Class B:  ($.01 par value)  . . . . . . . . . . . . . . . . . . .  15,625,929 shares
</TABLE>

================================================================================





<PAGE>   2

                                     INDEX

<TABLE>
<CAPTION>
                                                                                                          Page
                                                                                                          ----
<S>                                                                                                       <C>
PART I.  FINANCIAL INFORMATION
-------  ---------------------
Item 1.  Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .        2
         Consolidated Balance Sheets, September 30, 1996 (unaudited) and
         December 31, 1995  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .        2
         Unaudited Consolidated Statements of Operations for the three and nine months             
         ended September 30, 1996 and 1995  . . . . . . . . . . . . . . . . . . . . . . . . . . . .        3
         Unaudited Consolidated Statements of Cash Flows for the nine months ended                 
         September 30, 1996 and 1995  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .        4
         Notes to Consolidated Financial Statements (unaudited)   . . . . . . . . . . . . . . . . .        5
Item 2.  Management's Discussion and Analysis of Financial Condition and                           
         Results of Operations  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .        7

PART II. OTHER INFORMATION
--------------------------
Item 1.  Legal Proceedings  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .       16
Item 6.  Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . . . .       17
Signatures  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .       19
</TABLE>





<PAGE>   3


                                   P A R T  I
                            FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
                         MCLEOD, INC. AND SUBSIDIARIES
                          CONSOLIDATED BALANCE SHEETS
                (AMOUNTS IN THOUSANDS, EXCEPT SHARE INFORMATION)
<TABLE>
<CAPTION>
                                                                                     SEPTEMBER 30,             DECEMBER 31,
                                                                                          1996                    1995*     
                                                                                    --------------            -------------
                                                                                       (Unaudited)
                                                              ASSETS
 <S>                                                                                      <C>                  <C>
 Current Assets
       Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . .          $ 38,758                 $    ---
       Investment in available-for-sale securities . . . . . . . . . . . . . . .            53,002                      ---
       Trade receivables, net (Note 2) . . . . . . . . . . . . . . . . . . . . .            24,828                    6,689
       Inventory (Note 2)  . . . . . . . . . . . . . . . . . . . . . . . . . . .             5,333                    2,639
       Deferred expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . .            15,608                      ---
       Prepaid expenses and other  . . . . . . . . . . . . . . . . . . . . . . .             9,034                      296
                                                                                          --------                 --------
                  TOTAL CURRENT ASSETS . . . . . . . . . . . . . . . . . . . . .           146,563                    9,624
                                                                                          --------                 --------
                                                                                                                   
 Property and Equipment                                                                                            
       Land  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .             2,263                      311
       Telecommunication networks  . . . . . . . . . . . . . . . . . . . . . . .            21,996                    7,696
       Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .            16,547                    6,101
       Networks in progress  . . . . . . . . . . . . . . . . . . . . . . . . . .            24,970                    3,115
                                                                                            ------                 --------
                                                                                            65,776                   17,223
       Less accumulated depreciation . . . . . . . . . . . . . . . . . . . . . .             4,382                    2,145
                                                                                          --------                 --------
                                                                                            61,394                   15,078
                                                                                          --------                 --------
                                                                                                                   
 Investments, Intangible and Other Assets                                                                          
       Investment in available-for-sale securities . . . . . . . . . . . . . . .            31,239                 
       Deferred line installation costs, net (Note 2)  . . . . . . . . . . . . .             1,869                    1,425
       Other intangibles, net (Note 2) . . . . . . . . . . . . . . . . . . . . .            81,449                    2,525
       Other   . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .             1,563                      334
                                                                                          --------                 --------
                                                                                           116,121                    4,284
                                                                                          --------                 --------
                                                                                          $324,077                 $ 28,986
                                                                                          ========                 ========
<CAPTION>                                                                                                          
                                               LIABILITIES AND STOCKHOLDERS' EQUITY
 <S>                                                                                      <C>                     <C>
 Current Liabilities                                                                                               
      Notes payable  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .             1,697                      ---
      Current maturities of long-term debt . . . . . . . . . . . . . . . . . . .             1,221                      ---
      Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . .            16,721                 $  5,832
      Checks issued not yet presented for payment  . . . . . . . . . . . . . . .               617                      919
      Accrued payroll and payroll related expenses . . . . . . . . . . . . . . .             4,464                    1,955
      Other accrued liabilities  . . . . . . . . . . . . . . . . . . . . . . . .             4,945                      857
      Deferred revenue, current portion  . . . . . . . . . . . . . . . . . . . .               928                      134
      Customer deposits  . . . . . . . . . . . . . . . . . . . . . . . . . . . .             9,348                       18
                                                                                          --------                 --------
                 TOTAL CURRENT LIABILITIES . . . . . . . . . . . . . . . . . . .            39,941                    9,715
                                                                                          --------                 --------
 Long-Term Debt, less current maturities  (Note 4) . . . . . . . . . . . . . . .             4,155                    3,600
                                                                                          --------                 --------
 Deferred Revenue, less current portion  . . . . . . . . . . . . . . . . . . . .             6,274                      713
                                                                                          --------                 --------
 Commitments                                                                                                       
 Stockholders' Equity                                                                                              
      Capital Stock  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .               ---                      ---
             Preferred, Class A, $5.50 par value; authorized 1,150,000 shares;                 
                   none outstanding  . . . . . . . . . . . . . . . . . . . . . .                                   
             Preferred, $.01 par value; authorized 2,000,000 shares, none                                          
                   issued; terms determined upon issuance  . . . . . . . . . . .               ---                      ---
             Common, Class A, $.01 par value; authorized 75,000,000 shares;                                        
                   outstanding 1995 16,387,081 shares; 1996 30,742,610 shares                  307                      164
             Common, Class B, convertible, $.01 par value; authorized                                              
                   22,000,000 shares; outstanding 1995 and 1996 15,625,929                                       
                   shares  . . . . . . . . . . . . . . . . . . . . . . . . . . .               156                      156
      Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . .           312,141                   40,117
      Accumulated deficit  . . . . . . . . . . . . . . . . . . . . . . . . . . .           (38,897)                 (25,479)
                                                                                          --------                 -------- 
                                                                                           273,707                   14,958 
                                                                                          --------                 --------
                                                                                          $324,077                 $ 28,986
                                                                                          ========                 ========
</TABLE>
* Condensed from audited financial statements.

                 See Notes to Consolidated Financial Statements





                                       2
<PAGE>   4


                         MCLEOD, INC. AND SUBSIDIARIES

                UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
                 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)


<TABLE>
<CAPTION>
                                                                THREE MONTHS ENDED                        NINE MONTHS ENDED
                                                                   SEPTEMBER 30,                            SEPTEMBER 30,          
                                                          ------------------------------          ------------------------------
                                                             1996                 1995               1996                 1995    
                                                          ----------         -----------          ----------         -----------    
 <S>                                                        <C>               <C>                   <C>                  <C>
 Revenue . . . . . . . . . . . . . . . . . . .               $19,091           $  8,019              $45,497             $19,438
                                                                                                                        
 Operating expenses:                                                                                                    
    Cost of service  . . . . . . . . . . . . .                12,969              5,044               31,693              12,672
    Selling, general and administrative  . . .                11,650              4,797               25,626              13,087
    Depreciation and amortization  . . . . . .                 2,161                466                4,734               1,229
                                                             -------           --------              -------            --------
       TOTAL OPERATING EXPENSES  . . . . . . .                26,780             10,307               62,053              26,988
                                                                                                                        
           OPERATING LOSS  . . . . . . . . . .                (7,689)            (2,288)             (16,556)             (7,550)
                                                                                                                        
 Nonoperating income (expense):                                                                                         
    Interest income  . . . . . . . . . . . . .                 2,899                 51                3,404                  79
    Interest expense . . . . . . . . . . . . .                   (23)              (205)                (544)               (693)
    Other  . . . . . . . . . . . . . . . . . .                   278                ---                  278                 ---
                                                             -------           --------              -------            --------
       TOTAL NONOPERATING INCOME (EXPENSE)                     3,154               (154)               3,138                (614)
                                                                                                                        
       LOSS BEFORE INCOME TAXES  . . . . . . .                (4,535)            (2,442)             (13,418)             (8,164)
 Income taxes  . . . . . . . . . . . . . . . .                   ---                ---                  ---                 ---
                                                             -------           --------              -------            --------
       NET LOSS  . . . . . . . . . . . . . . .               $(4,535)          $ (2,442)             (13,418)           $ (8,164)
                                                             =======           ========               ======             ======= 
                                                                                                                        
 Loss per common and common equivalent share                 $ (.10)           $  (0.07)             $ (0.33)            $ (0.22)
                                                             =======           ========              =======             =======
 Weighted average common and common 
 equivalent shares outstanding                                46,233             37,055               41,188              37,055
                                                              ======             ======               ======              ======
</TABLE>

                 See Notes to Consolidated Financial Statements





                                       3
<PAGE>   5


                         MCLEOD, INC. AND SUBSIDIARIES

                UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
                                                                                 NINE MONTHS        NINE MONTHS
                                                                                    ENDED              ENDED
                                                                                SEPTEMBER 30,      SEPTEMBER 30,
                                                                                    1996               1995    
                                                                               ----------------  ----------------
 <S>                                                                                <C>               <C>
 Cash Flows from Operating Activities
      Net Loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .         $ (13,418)          $ (8,164)
      Adjustments to reconcile net loss to net cash used in                                              
             operating activities:                                                                       
             Depreciation  . . . . . . . . . . . . . . . . . . . . . . . . .             2,243                882
             Amortization  . . . . . . . . . . . . . . . . . . . . . . . . .             2,832                791
             Changes in assets and liabilities, net of effects of purchase .                             
               business acquisitions (Note 5):                                                           
             (Increase) in trade receivables . . . . . . . . . . . . . . . .            (6,598)            (2,488)
             (Increase) in inventory . . . . . . . . . . . . . . . . . . . .            (2,694)              (152)
             (Increase) in deferred expenses . . . . . . . . . . . . . . . .              (730)               ---
             (Increase) in deferred line installation costs  . . . . . . . .              (842)              (661)
             Increase in accounts payable and accrued expenses . . . . . . .             4,095              1,888
             Increase in deferred revenue  . . . . . . . . . . . . . . . . .             6,354                 10
             Increase in customer deposits . . . . . . . . . . . . . . . . .             1,027                  9
             Other, net  . . . . . . . . . . . . . . . . . . . . . . . . . .            (2,727)              (188)
                                                                                     ---------           --------
                     NET CASH (USED IN) OPERATING ACTIVITIES . . . . . . . .           (10,458)            (8,073)
                                                                                     ---------           --------
 Cash Flows from Investing Activities                                                                    
      Purchases of available-for-sale securities . . . . . . . . . . . . . .          (123,012)               ---
      Proceeds from sale of available-for-sale securities  . . . . . . . . .            39,047                ---
      Purchase of property and equipment . . . . . . . . . . . . . . . . . .           (39,742)            (2,403)
      Business acquisitions (Note 5) . . . . . . . . . . . . . . . . . . . .           (78,868)               ---
      Deposit on PCS licenses  . . . . . . . . . . . . . . . . . . . . . . .            (4,889)               ---
      Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .              (950)              (349)
                                                                                     ---------           --------
                      NET CASH (USED IN) INVESTING ACTIVITIES                         (208,414)            (2,752)
                                                                                     ---------           --------
 Cash Flows from Financing Activities                                                                    
      Increase (decrease) in checks issued not yet presented for payment . .              (302)               286
      Proceeds from line of credit agreements  . . . . . . . . . . . . . . .            50,238             36,100
      Payments on line of credit agreements  . . . . . . . . . . . . . . . .           (52,441)           (39,600)
      Proceeds from long-term debt . . . . . . . . . . . . . . . . . . . . .             2,012                ---
      Payments on long-term debt . . . . . . . . . . . . . . . . . . . . . .                (8)               ---
      Net proceeds from issuance of common stock . . . . . . . . . . . . . .           258,131             14,000
      Reissuance of treasury stock . . . . . . . . . . . . . . . . . . . . .               ---                 39
                                                                                     ---------           --------
                     NET CASH PROVIDED BY FINANCING ACTIVITIES . . . . . . .           257,630             10,825
                                                                                     ---------           --------
                     NET INCREASE IN CASH AND CASH EQUIVALENTS . . . . . . .            38,758                ---
 Cash and cash equivalents:                                                                              
      Beginning  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .               ---                ---
                                                                                     ---------           --------
      Ending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .         $  38,758           $    ---
                                                                                     =========           ========
</TABLE>

                 See Notes to Consolidated Financial Statements





                                       4
<PAGE>   6
                         MCLEOD, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           (INFORMATION AS OF AND FOR THE THREE AND NINE MONTHS ENDED
                   SEPTEMBER 30, 1996 AND 1995 IS UNAUDITED)

NOTE 1:  BASIS OF PRESENTATION

  Interim Financial Information (unaudited):  The financial statements and
notes related thereto as of September 30, 1996, and for the three and nine
month periods ended September 30, 1996 and 1995, are unaudited, but in the
opinion of management include all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the Company's
financial position and results of operations.  The operating results for the
interim periods are not indicative of the operating results to be expected for
a full year or for other interim periods.  Not all disclosures required by
generally accepted accounting principles necessary for a complete presentation
have been included.  It is recommended that these consolidated condensed
financial statements be read in conjunction with the Registration Statement on
Form S-1 (File No. 333-13885) and all related amendments and exhibits
(including all financial statements and notes therein), initially filed by the
Company with the Securities and Exchange Commission on October 10, 1996.

NOTE 2:  SUPPLEMENTAL ASSET DATA

 The balance in trade receivables, net is composed of the following:
<TABLE>
<CAPTION>
                                                                  (Amounts in thousands)
                                                        SEPTEMBER 30, 1996       DECEMBER 31, 1995
                                                       --------------------     --------------------
       <S>                                                     <C>                          <C>
       Trade Receivables:
          Billed                                                $   21,129                  $6,908
          Unbilled                                                   7,172                     ---
                                                       --------------------     --------------------
                                                                $   28,301                  $6,908
       Allowance for doubtful accounts and discounts                (3,473)                   (219)
                                                       --------------------     --------------------
                                                                $   24,828                  $6,689
                                                       ====================     ====================
</TABLE>

   Inventory is carried principally at the lower of average cost or market and
consists primarily of new and reusable parts required to maintain and build
fiber optic networks.  Inventories of approximately $1.6 million used to
support a maintenance agreement are amortized on a straight-line basis over the
10-year life of the agreement.

   Deferred line installation costs are reflected net of accumulated
amortization of $916,000 and $518,000 as of September 30, 1996 and December 31,
1995, respectively.  Other intangibles are reflected net of accumulated
amortization of $575,000 and $117,000 as of September 30, 1996 and December 31,
1995, respectively.

NOTE 3:  OFFERINGS

   On June 14, 1996, the Company completed an initial public offering (the
"IPO") of its Class A Common Stock, par value $.01 per share ("Class A Common
Stock").  The Company issued 13,800,000 shares at an initial public offering
price of $20.00 per share.  The total proceeds from the IPO, net of
underwriting discounts and expenses, were approximately $258 million.  The
Company also filed a Registration Statement on Form S-1 (File No. 333-13885)
with the Securities and Exchange Commission on October 10, 1996 in connection
with a public offering of its Class A Common Stock to be completed during the
fourth quarter of 1996 (the "Current Offering").





                                       5
<PAGE>   7



NOTE 4:  SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
                                                                                (Amounts in thousands)

                                                                                    NINE MONTHS ENDED    
                                                                                       SEPTEMBER 30,
                                                                           ------------------------------------
                                                                                   1996            1995
                                                                           ------------------------------------
                                                                                       (UNAUDITED)
 <S>                                                                             <C>              <C>
 Supplemental Disclosure of Cash Flow information

       Cash payment for interest, net of interest
          capitalized 1996 $204,056; 1995 $61,914  . . . . . . . . . . . .         $   761         $      240
                                                                                   =======         ==========
 Supplemental Schedule of Noncash Investing and
       Financing Activities

       Accounts payable incurred for property and equipment  . . . . . . .         $ 5,172         $      141
                                                                                   =======         ==========
       Acquisition of MWR Telecom, Inc.
          Working capital acquired, net  . . . . . . . . . . . . . . . . .                         $      393
          Fair value of other assets acquired, principally
             fiber optic telecommunication networks  . . . . . . . . . . .                         $    5,298
          Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . .                              2,642
                                                                                                   ----------
          Stock issued . . . . . . . . . . . . . . . . . . . . . . . . . .                         $    8,332
                                                                                                   ==========
       Acquisition of Ruffalo, Cody & Associates, Inc. (Note 5)
          Cash purchase price  . . . . . . . . . . . . . . . . . . . . . .         $ 4,808
          Stock issued . . . . . . . . . . . . . . . . . . . . . . . . . .           8,945
          Options to purchase Class A common stock . . . . . . . . . . . .           3,911
          Less cash to be received upon exercise of options  . . . . . . .            (610)
                                                                                   -------
                                                                                   $17,054
                                                                                   =======
          Working capital acquired, net  . . . . . . . . . . . . . . . . .         $   758
          Fair value of other assets acquired, principally equipment . . .           1,068
          Intangibles  . . . . . . . . . . . . . . . . . . . . . . . . . .          15,228
                                                                                   -------
                                                                                   $17,054
                                                                                   =======
       Acquisition of Telecom*USA Publishing Group, Inc. (Note 5)
          Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .         $74,060
          Incentive Agreements . . . . . . . . . . . . . . . . . . . . . .           1,610
                                                                                   -------
                                                                                   $75,670
                                                                                   =======
          Working capital acquired, net  . . . . . . . . . . . . . . . . .         $ 8,475
          Fair value of other assets acquired, principally equipment . . .           4,405
          Intangibles  . . . . . . . . . . . . . . . . . . . . . . . . . .          64,126
          Liabilities assumed, principally long-term debt  . . . . . . . .          (1,336)
                                                                                   -------
                                                                                   $75,670
                                                                                   =======
</TABLE>


NOTE 5:  ACQUISITIONS

   Ruffalo, Cody & Associates, Inc. - On July 15, 1996, the Company consummated
an acquisition of Ruffalo, Cody & Associates, Inc. ("Ruffalo, Cody"), from the
shareholders of Ruffalo, Cody by means of a forward triangular merger pursuant
to an Agreement and Plan of Reorganization, dated as of July 12, 1996 (the
"Agreement"), by and among the Company, Ruffalo, Cody and certain shareholders
of Ruffalo, Cody.  Pursuant to the Agreement, (i) McLeod Merging Co., a newly
incorporated Iowa corporation and a wholly-owned subsidiary of the Company, was
merged with and into Ruffalo, Cody, with McLeod Merging Co. (which has been
renamed "Ruffalo, Cody & Associates, Inc.") being the surviving corporation,
(ii) the outstanding shares of Ruffalo, Cody common stock were converted into
the right to receive cash and/or shares of Class A Common Stock, and (iii) the
outstanding options to purchase shares of the Ruffalo, Cody common stock were
converted into options to purchase shares of Class A Common Stock (the
"Substitute Options").  Under the Agreement,





                                       6
<PAGE>   8


each issued and outstanding share of Ruffalo, Cody common stock was converted
into the right to receive a maximum of approximately 0.7 of a share of Class A
Common Stock.

   The Company agreed to purchase Ruffalo, Cody for a maximum aggregate
purchase price of approximately $19.9 million (based on the average market
price of the Class A Common Stock during the five business days before and
after the acquisition date).  The purchase price consisted of approximately
$4.9 million in cash, 474,807 shares of Class A Common Stock issuable upon
exchange for Ruffalo, Cody common stock, and 158,009 shares of Class A Common
Stock issuable upon the exercise of the Substitute Options.  On July 15, 1996,
the Company paid an aggregate of approximately $4.8 million in cash and issued
361,420 shares of Class A Common Stock to the shareholders of Ruffalo, Cody,
and granted to the Ruffalo, Cody option holders Substitute Options to purchase
158,009 shares of Class A Common Stock.  An additional $50,782 in cash and
113,387 shares of Class A Common Stock were placed into escrow and will be
delivered (if at all) to certain of the shareholders of Ruffalo, Cody over a
period of 18 months, contingent upon certain conditions relating to Ruffalo,
Cody's ongoing revenues from an agreement with a major long distance carrier to
provide telemarketing services.  The major long distance carrier has informed
Ruffalo, Cody that it intends to terminate this contract effective December 31,
1996.  The Company recorded the Ruffalo, Cody acquisition as a  purchase for
accounting purposes.

   Telecom*USA Publishing Group, Inc. - On September 20, 1996, the Company
acquired Telecom*USA Publishing Group, Inc. ("Telecom") pursuant to an
Agreement and Plan of Reorganization, dated as of August 15, 1996, between the
Company and Telecom.  Pursuant to this agreement, (i) Telecom was merged with
and into McLeod Reverse Merging Co., a newly incorporated Iowa corporation and
a wholly owned subsidiary of the Company, with Telecom as the surviving
corporation, (ii) each outstanding share of common stock, no par value, of
Telecom was converted into the right to receive $12.75 in cash, and (iii) all
outstanding non-vested options to purchase shares of Telecom common stock were
replaced with a deferred compensation program.

   This acquisition resulted in a total purchase price of approximately $75.7
million.  The purchase consisted of approximately $74.1 million in cash and an
additional amount currently estimated to be approximately $1.6 million
resulting from the Company entering into a deferred compensation program with
all holders of non-vested options to purchase shares of Telecom.  At the time
of the acquisition, Telecom had outstanding debt of approximately $6.6 million.
The Company recorded the Telecom acquisition as a purchase for accounting
purposes.


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

    Unless otherwise indicated, all dollar amounts in the following
Management's Discussion and Analysis of Financial Condition and Results of
Operations that exceed $1 million have been rounded to one decimal place and
all dollar amounts less than $1 million have been rounded to the nearest
thousand.

OVERVIEW

   The Company is a provider of integrated telecommunications services to small
and medium-sized businesses and, since June 1996, residential customers,
primarily in Iowa and Illinois.  The Company derives its telecommunications
revenue from (i) the sale of "bundled" local, long distance and other
telecommunications services to end users, (ii) telecommunications network
maintenance services, (iii) competitive access services, including special
access and private line services, and (iv) ancillary services, including direct
marketing and telemarketing services and the sale of advertising space in
telephone directories.  As of September 30, 1996, the Company served over
13,630 telecommunications customers in 68 cities and towns.

   The Company offers "one-stop" integrated telecommunications services,
including local, long distance, voice mail, paging and Internet access
services, tailored to the customer's specific needs.  For business customers,
this approach simplifies telecommunications procurement and management  and
makes available customized services, such as "least-cost" long distance pricing
and enhanced calling features, that might not otherwise be directly available 
to such customers on a cost-effective basis.  For residential customers, this
approach provides integrated local, long distance and other telecommunications
services, flat-rate long distance pricing and enhanced calling features as part
of the 



                                       7
<PAGE>   9
Company's basic PrimeLine(R) residential services.  The Company also
operates a competitive access provider that offers  a variety of special access
and private line services to 76 large businesses, institutional customers and
interexchange carriers.  In addition, the Company provides network maintenance
services for the State of Iowa's fiber optic network.

   The Company was formed on June 6, 1991 as McLeod Telecommunications, Inc.
It began operations in November of 1992, providing fiber optic maintenance
services for the State of Iowa's fiber optic network that links certain of the
State's schools, libraries and other public buildings (the "Iowa Communications
Network").  On August 1, 1993, the Company was reincorporated in the State of
Delaware.  McLeod Telemanagement, Inc., a wholly owned subsidiary of the
Company, received regulatory approvals in Iowa and Illinois to offer local and
long distance services in December 1993 and began providing such services in
January 1994.  In April 1995, July 1996 and September 1996, respectively, the
Company acquired MWR Telecom, Inc. ("MWR"), a competitive access provider in
Des Moines, Iowa, Ruffalo, Cody, a telemarketing company, and Telecom, a
publisher of telephone directories.

   The Company is organized as a holding company and operates through six
wholly owned subsidiaries.  Since September 1996, the Company's business has
been organized into four operational groups:   (i) Business Services, which
develops, markets and sells the Company's telecommunications services to
business customers; (ii) Consumer Services, which markets and sells the
Company's PrimeLine(R) service to residential customers and engages in various
direct marketing and telemarketing activities; (iii) Network Services, which
designs, constructs, and operates the Company's fiber optic network and engages
in the Company's network maintenance activities; and (iv) Publishing Services,
which publishes and distributes telephone directories.

   The Company is currently offering telecommunications services to business
and residential customers located primarily in Iowa and Illinois.  The Company
also offers long distance service in Omaha, Nebraska.  The Company intends to
begin sales of telecommunications services in a number of markets in Minnesota
and Wisconsin during the fourth quarter of 1996.  The Company plans to enter
markets in South Dakota and North Dakota in 1997.  Over the next several years,
depending on competitive and other factors, the Company also intends to offer
telecommunications services in Nebraska, Colorado, Wyoming, Montana, Utah and
Idaho.

    The statements in the foregoing paragraph about the Company's expansion
plans are "forward looking statements" within the meaning of the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995.  These
plans may be revised, and the Company's actual geographic expansion may differ
materially from that indicated by its current plans, in each case as a result
of a variety of factors, including:  (I) the availability of financing and
regulatory approvals; (ii) the number of potential customers in a target
market; (iii) the existence of strategic alliances or relationships; (iv)
technological,





                                       8
<PAGE>   10


regulatory or other developments in the Company's business; (v) changes in the
competitive climate in which the Company operates; and (vi) the emergence of
future opportunities.

   The Company believes it is the first telecommunications provider in most of
its current markets to offer "bundled" local, long distance and other
telecommunications services.  As a result, the Company believes that it is
well-positioned to take advantage of fundamental changes occurring in the
telecommunications industry resulting from the Telecommunications Act of 1996
(the "Telecommunications Act") and to challenge incumbent local carriers.  The
Company provides local service using existing telephone lines obtained from
incumbent local exchange carriers, which allows customers to switch to local
service provided by the Company without changing existing telephone numbers.
The Company provides long distance services by purchasing bulk capacity from a
long distance carrier.  Using the Company's sophisticated proprietary software,
known as Raterizer(R), each business customer receives the lowest long distance
rate available each month from among the pricing plans of AT&T Corp. ("AT&T"),
MCI Communications Corporation ("MCI") and Sprint Corporation that currently
are most popular with the Company's business customers, and, in certain cases,
rates specifically identified by a business customer and agreed to by the
Company.  The Company also provides paging and Internet access services.

   The Company has historically derived its telecommunications revenue from (i)
the sale of local and long distance telecommunications services to end users,
(ii) telecommunications network maintenance services and (iii) special access
and private line services. The Company also derives revenue from ancillary
services as a result of its acquisitions of Ruffalo, Cody and Telecom in July
1996 and September 1996, respectively.  The Company began deriving revenue from
direct marketing and telemarketing services on July 15, 1996, the date the
Company acquired Ruffalo, Cody.  The Company also began deriving revenue from
the sale of advertising space in telephone directories published by Telecom on
September 20, 1996, the date the Company acquired Telecom.  The table set forth
below summarizes the Company's percentage of revenues from these sources:


<TABLE>
<CAPTION>
                                                                                  NINE MONTHS ENDED
                                                                                    SEPTEMBER 30,
                                                                              ------------------------
                                                                                 1995        1996
                                                                              ----------   -----------
 <S>                                                                              <C>           <C>
 Local and long distance telecommunications services                                75%           63%
 Telecommunications network maintenance services                                    19%           10%
 Special access and private line services                                            6%           18%
 Ancillary services                                                                 ---            9%
                                                                              ----------   -----------
                                                                                   100%          100%
                                                                              ==========   ===========
</TABLE>


   The Company began offering "bundled" local and long distance services to
business customers in January 1994. At the end of 1995, the Company began
providing, on a test basis, long distance services to residential customers.
In June 1996, the Company began marketing and providing to residential
customers in Cedar Rapids, Iowa and Iowa City, Iowa an integrated package of
telecommunications services, marketed under the name PrimeLine(R), that
includes local and long distance service, voice mail, paging, Internet access
and travel card services.  The Company plans to continue its efforts to market
and provide local, long distance and other telecommunications services to
business customers and plans to accelerate its efforts to market its
PrimeLine(R) service to residential customers.  The Company believes its
efforts to market its integrated telecommunications services will be enhanced
by its July 1996 acquisition of Ruffalo, Cody, which specializes in direct
marketing and telemarketing services, including telecommunications sales, and
its September 1996 acquisition of Telecom, which publishes and distributes
"white page" and "yellow page" telephone directories in fifteen states in the
midwestern and Rocky Mountain regions of the United States, including most of
the Company's target markets.

   Because its revenue from network maintenance is derived almost exclusively
from the State of Iowa under a fiber optic maintenance contract for the Iowa
Communications Network (the "Iowa Communications Network Maintenance Contract")
and such revenue is expected to increase more slowly than the Company's other
types of revenue, the Company expects that revenue derived from network
maintenance services will continue to constitute a decreasing percentage of the
Company's revenue in the future.  Special access and private line services as a
percentage of the Company's total revenue increased in 1995 due to the revenue
generated by MWR, which was acquired in April 1995.  The percentage increase in
revenue from this source for the nine months ended September 30, 1996 was due
primarily to non-recurring  revenue from the construction, installation and
sale of  fiber optic networks and related equipment.  Excluding the revenue
from these projects





                                       9
<PAGE>   11


as well as the ancillary revenues the Company began deriving from the
acquisitions of Ruffalo, Cody and Telecom, the percentage of total revenues
from the Company's three historical sources would have been 77%, 12%, and 11%,
respectively.

   The Company's principal operating expenses consist of cost of service;
selling, general and administrative expenses ("SG&A"); and depreciation and
amortization.  Cost of service primarily includes local services purchased from
two Regional Bell Operating Companies, costs to terminate the long distance
calls of the Company's customers through an interexchange carrier, costs
associated with maintaining the Iowa Communications Network and costs
associated with operating the Company's network.  Cost of service also includes
the costs of printing and distributing the telephone directories published by
Telecom.  SG&A consists of selling and marketing, customer service and
corporate administrative expenses.  Depreciation and amortization include
depreciation of the Company's telecommunications network and equipment;
amortization of goodwill related to the Company's acquisition of MWR, Ruffalo,
Cody and Telecom; amortization expense related to the excess of estimated fair
market value in aggregate of certain options over the aggregate exercise price
of such options granted to certain officers, other employees, and directors;
and amortization of one-time installation costs associated with transferring
customers' local line service from the Regional Bell Operating Companies to the
Company's telemanagement service.

   As the Company expands into new markets, both cost of service and SG&A will
increase.  The Company expects to incur SG&A expenses prior to achieving
significant revenues in new markets.  Significant levels of marketing activity
may be necessary in new markets in order for the Company to build a customer
base large enough to generate sufficient revenue to offset such marketing
expenses.  In addition, SG&A may increase as a percentage of total revenue in
the short term after the Company enters a new market, because many of the fixed
costs of providing service in new markets are incurred before significant
revenue can be expected from those markets.

   The Company has experienced operating losses since its inception as a result
of efforts to build its customer base, develop and construct its network
infrastructure, build its internal staffing, develop its systems and expand
into new markets.  The Company expects to continue to focus on increasing its
customer base and geographic coverage. Accordingly, the Company expects that
its cost of service, SG&A and capital expenditures will continue to increase
significantly, all of which may have a negative impact on operating results.
The Company expects to incur significant operating losses and to generate
negative cash flows from operating and construction activities during the next
several years while it develops its business and installs and expands its fiber
optic network.  In addition, the Company may be forced to change its pricing
policies to respond to a changing competitive environment, and there can be no
assurance that the Company will be able to maintain its operating margin.
There can be no assurance that growth in the Company's revenue or customer base
will continue or that the Company will be able to achieve or sustain
profitability or positive cash flows.

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

THREE MONTHS ENDED SEPTEMBER 30, 1996 COMPARED WITH THREE MONTHS ENDED
SEPTEMBER 30, 1995

    Revenue increased from $8 million for the three months ended September 30, 
1995 to $19.1 million for the three months ended September 30, 1996, 
representing an increase of $11.1 million or 139%.  Revenue from the sale of 
local and long distance telecommunications services accounted for $5 million 
of this increase. There also was an increase of $1.9 million related to 
special access and  private line services.  Revenue from telecommunications     
network maintenance services for the three months ended September 30, 1996 was
$1.5 million, compared to $1.3 million for the third quarter of 1995, which
increase was primarily attributable to additional services provided to the
State of Iowa. The three months ended September 30, 1996 included ancillary
revenues of $4 million related to the acquisition of  Ruffalo, Cody in July
1996.

    Cost of service increased from $5 million for the three months ended
September 30, 1995, to $13 million for the three months ended September 30,
1996, representing an increase of $8 million or 157%.  This increase in cost of
service resulted primarily from increased costs required to provide the
increased levels of revenue noted above, including cost of service related to
Ruffalo, Cody acquired in July 1996.  Cost of service as a percentage of
telecommunication revenue increased from 63% for the three months ended
September 30, 1995 to 68% for the three months ended September 30, 1996.  





                                       10
<PAGE>   12
This increase was primarily a result of an increased number of higher
volume, price sensitive customers and increased local line costs associated
with expansion into new markets.

   SG&A increased from $4.8 million for the three months ended September 30,
1995 to $11.7 million for the three months ended September 30, 1996, an
increase of $6.9 million or 143%.  This increase was due to increased
compensation of $1.9 million resulting from selling and customer support 
activities, additional administrative personnel expenses of $1.1 million,
additional expenses of $1.6 million related to Ruffalo, Cody and Telecom, and
associated costs of $2.3 million required to handle the growth experienced
primarily in local and long distance services.

   Depreciation and amortization expenses increased from $466,000 for the three
months ended September 30, 1995 to $2.2 million for the three months ended
September 30, 1996, representing an increase of $1.7 million or 364%.  The
increase consisted of $567,000 of amortization expense related to the excess of
estimated fair market value in aggregate of certain options over the aggregate
exercise price of such options granted to certain officers, other employees and
directors; depreciation of $275,000 related to the additional fiber optic
network purchased and built during 1995 and the first nine months of 1996;
$82,000 resulting from the amortization of one-time installation costs
primarily associated with transferring customers' local line service from the
Regional Bell Operating Companies to the Company's telemanagement service;
$443,000 of depreciation related to capital costs associated with the growth of
the Company; and amortization of intangible assets of $329,000 related to the
Company's acquisitions.

   Interest income increased from $51,000 for the three-month period ended
September 30, 1995, to $2.9 million for the same period in 1996.  This increase
resulted from additional highly liquid interest-bearing investments made with a
portion of the proceeds from IPO.

   Interest expense decreased from $205,000 for the third quarter of 1995 to
$23,000 for the third quarter of 1996.  This decrease was primarily a result of
lower interest expense on reduced borrowings as a result of the Company's
payment of  the majority of the amounts outstanding under its lines of credit
with the First National Bank of Chicago (collectively, the "Credit Facility")
in June 1996 with a portion of the proceeds from the IPO.  The Company also had
other non-operating income of $278,000 for the three month period ended
September 30, 1996.

   Net loss increased from $2.4 million for the three months ended September
30, 1995 to $4.5 million for the three months ended September 30, 1996, an
increase of $2.1 million.  This increase resulted primarily from the expansion
of the local and long distance businesses and amortization expense related to
stock options granted to certain officers, other employees and directors.  The
development of the Company's business and the construction and expansion of its
network require significant expenditures, a substantial portion of which is
incurred before the realization of revenues.

NINE MONTHS ENDED SEPTEMBER 30, 1996, COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 1995

   Revenue increased from $19.4 million for the nine-month period ended
September 30, 1995 to $45.5 million for the nine months ended September 30,
1996, representing an increase of $26.1 million or 134%.  Revenue from the sale
of local and long distance telecommunications services accounted for $14.3
million of this increase.  Total local and long-distance customers increased
72% from 7,870 at September 30, 1995 to 13,552 at September 30, 1996.  Local
lines under the Company's management increased 76% from 31,763 at September 30,
1995 to 55,993 at September 30, 1996.  Average lines per customer increased
from 4.03 at September 30, 1995 to 4.33 at September 30, 1996.  Average monthly
revenue per line decreased from $66.71 for the month ended September 30, 1995
to $65.77 for the month ended September 30, 1996, due to the inclusion of
residential lines at September 30, 1996.

   Revenue from telecommunications network maintenance services increased from
$3.6 million for the nine-month period ended September 30, 1995 to $4.4 million
for the nine months ended September 30, 1996.  This increase was primarily
attributable to increased revenues from the Company's Iowa Communication
Network Maintenance Contract.  Revenue from special access and private line
services accounted for $6.9 million of the total increase in telecommunications
revenue, of which $2.9 million was from the non-recurring construction and sale
of fiber-optic networks.  The Company acquired MWR, a competitive access
provider that offers most of the Company's special access and private line
services, in April 1995 in an acquisition accounted for as a purchase.  MWR
represented $1 million and $2.6 million, respectively, of the Company's special
access and private line services revenue for the nine-month periods ended
September 30, 1995 and 1996.  Revenue of $4 million from ancillary services was
due wholly to Ruffalo, Cody direct marketing and telemarketing sales since its
acquisition in July, 1996.





                                       11
<PAGE>   13



   Cost of service increased from $12.7 million for the nine-month period ended
September 30, 1995, to $31.7 million for the nine-month period ended September
30, 1996, an increase of $19 million or 150%.  This increase in cost of service
resulted primarily from increased costs of providing local and long distance
services.  Cost of service as a percentage of telecommunications revenue
increased from 65% for the nine-month period ended September 30, 1995 to 70%
for the nine-month period ended September 30, 1996.  The cost of providing
local and long-distance services increased as a percentage of the local and
long-distance telecommunications revenue by 2.7% primarily as a result of an
increased number of higher volume, price-sensitive customers and increased
local line costs associated with expansion into new markets.  The additional
increase in cost of service as a percentage of telecommunication revenue was
due primarily to the low margin realized on the construction of sale of fiber
optic networks.

   SG&A increased from $13.1 million for the nine-month period ended September
30, 1995 to $25.6 million for the nine-month period ended September 30, 1996,
an increase of $12.5 million or 96%.  This increase was due to increased
compensation expense resulting from selling and customer support activities of
$4.3 million, additional administrative personnel expense of $2.3 million,
additional expenses of $1.6 million related to Ruffalo, Cody and Telecom and
associated costs of 4.3 million related to the growth experienced primarily in
local and long distance revenues.

   Depreciation and amortization expenses increased from $1.2 million for the
nine-month period ended September 30, 1995 to $4.7 million for the nine-month
period ended September 30, 1996, an increase of $3.5 million or 285%.  This
increase consisted of $1.5 million of amortization expense related to the
excess of estimated aggregate fair market value of certain options over the
aggregate exercise price of such options granted to certain officers, other
employees, and directors; depreciation of $634,000 related to the additional
fiber optic network purchased and built during 1995 and the first nine months
of 1996; $764,000 of depreciation related to capital costs associated with the
growth of the Company; $144,000 resulting from the amortization of one-time
installation costs primarily associated with transferring customers' local line
service from the Regional Bell Operating Companies to the Company's
telemanagement service; and amortization of goodwill and other intangible
assets of $514,000 related to the Company's acquisition of MWR in April 1995,
Ruffalo, Cody in July 1996 and Telecom in September 1996.

   Interest income increased from $79,000 for the nine-month period ended
September 30, 1995 to $3.4 million for the same period in 1996.  This increase
resulted from earnings on investments made with a portion of the proceeds from
the IPO.

   Interest expense decreased from $693,000 for the nine months ended September
30, 1995 to $543,000 for the nine months ended September 30, 1996.  This
decrease was primarily a result of lower interest expense on reduced borrowings
as a result of the Company's payment of all amounts outstanding under the
Credit Facility in June 1996 with a portion of the net proceeds from the IPO.
The Company also had other non-operating income of $278,000 for the nine month
period ended September 30, 1996.

   Net loss increased from $8.2 million for the nine-month period ended
September 30, 1995 to $13.4 million for the nine-month period ended September
30, 1996, an increase of $5.2 million.  This increase resulted primarily from
the expansion of the local and long distance businesses and amortization
expense related to stock options granted to certain officers, other employees
and directors.  The development of the Company's business and the construction
and expansion of its network require significant expenditures, a substantial
portion of which is incurred before the realization of revenues.

LIQUIDITY AND CAPITAL RESOURCES

   Since the inception of the Company in June 1991, the Company's total assets
have grown to $324.1 million at September 30, 1996.  At September 30, 1996,
$61.4 million of the total assets consisted of property and equipment, net of
depreciation.  The growth of the Company has been funded through private sales
of equity securities yielding proceeds of $41 million, drawings under the
Credit Facility, and net proceeds of approximately $258.1 million from the IPO.
At September 30, 1996, the Company's current assets of $146.6 million exceeded
its current liabilities of $39.9 million, providing working capital of $106.7
million, which represents an improvement of $106.7 million compared to December
31, 1995 primarily attributable to the Company's completion of the IPO.  At
December 31, 1995, the Company's current liabilities of $9.7 million  exceeded
current assets of $9.6 million, resulting in a working capital deficit of
$92,000.  This working capital deficit resulted from the growth experienced by
the Company, the increase in working capital components and the substantial
investment in property and equipment.

   The net cash used in operating activities totaled $10.5 million for the nine
months ended September 30, 1996 and $8.1 million for the nine months ended
September 30, 1995.  During the nine months ended September 30, 1996, cash for





                                       12
<PAGE>   14


operating activities was used primarily to fund the Company's net loss of $13.4
million for such period.  The Company also required cash to fund the growth in
trade receivables of $6.6 million and other assets of $4.3 million as a result
of the growth in local and long distance telecommunications services and
special access and private line services.  These uses of cash were partially
offset by an increase in accounts payable and accrued expenses of $4.1 million
due to the costs associated with the increase in telecommunications revenue, an
increase in deferred revenue of $6.4 million resulting primarily from amounts
received in advance in connection with the completion of construction of
network segments under long-term leases of fiber optic telecommunication
networks and an increase in depreciation and amortization expense.  During the
nine months ended September 30, 1995, cash for operating activities was used
primarily to fund the Company's net loss of $8.2 million for such period.  The
Company also required cash to fund the growth in trade receivables of $2.5
million and deferred line installation costs of $661,000 as a result of the
growth in local and long distance telecommunications services and entry into
special access and private line services.  The use of cash during the nine
months ended September 30, 1995 was partially offset by an increase in accounts
payable and accrued expenses of $1.9 million due to the costs associated with
the increase in telecommunications revenue and an increase in depreciation and
amortization expense.

   The Company's investing activities used cash of $208.4 million during the
nine months ended September 30, 1996 and $2.8 million during the nine months
ended September 30, 1995.  The significant use of cash for investing activities
for the nine months ended September 30, 1996 consisted of the purchase of
available-for-sale securities with certain of the net proceeds from the IPO,
the purchase of Ruffalo, Cody and Telecom, and the Company's continued
development and expansion of its fiber optic telecommunications network.

   During 1994, the Company started building its telemanagement business by
offering local and long distance services to business customers through the
purchase of Centrex services from two Regional Bell Operating Companies and
interexchange carrier services for termination of long distance calls.  The
equipment required for the growth of the telemanagement business and the
Company's development and construction of its fiber optic telecommunications
network resulted in purchases of equipment and fiber optic cable totaling $39.7
million and $2.4 million during the nine months ended September 30, 1996 and
1995, respectively.

   Cash received from net financing activities was $257.6 million during the
nine months ended September 30, 1996, primarily as a result of the IPO.  The
Company paid off and canceled the Credit Facility with a portion of the net
proceeds from the IPO during the same period.  Cash received from financing
activities for the nine months ended September 30, 1995 was $10.8 million and
was primarily obtained through the issuance of Common Stock for an aggregate
purchase price of $14 million in a private placement transaction.  In addition,
in April 1995 the Company issued Class B Common Stock valued at $8.3 million to
acquire MWR.

   On July 15, 1996, the Company acquired Ruffalo, Cody in a cash and stock
transaction valued at up to a maximum of approximately $19.9 million, based on
the average closing sales price of the Class A Common Stock on the Nasdaq
National Market at the time of the transaction.  On July 15, 1996, the Company
paid approximately $4.8 million in cash and issued 361,420 shares of Class A
Common Stock to the shareholders of Ruffalo, Cody, and granted options to
purchase 158,009 shares of Class A Common Stock to the holders of options to
purchase shares of Ruffalo, Cody common stock.  An additional $50,782 in cash
and 113,387 shares of Class A Common Stock were placed into escrow and will be
delivered to certain of the shareholders of Ruffalo, Cody over a period of 18
months, contingent upon the fulfillment of certain conditions relating to
Ruffalo, Cody's ongoing revenues from an agreement with a major long distance
carrier to provide telemarketing services.  The Company recorded the Ruffalo,
Cody acquisition as a purchase for accounting purposes.

   On September 20, 1996, the Company acquired Telecom for approximately $74.1
million in cash and an additional amount currently estimated to be
approximately $1.6 million to be paid to certain employees of Telecom as part
of an incentive plan.  At the time of the acquisition, Telecom had outstanding
debt of approximately $6.6 million.  The Company recorded the Telecom
acquisition as a purchase for accounting purposes.

   The Company used a portion of the net proceeds from the IPO to fund the
Telecom acquisition and for the cash portion of the Ruffalo, Cody acquisition.

   Telecom has a revolving line of credit and term loan (the "Telecom Credit
Facility") with Norwest Bank Iowa, National Association (the "Telecom Credit
Facility Bank"), with an aggregate credit limit of approximately $9.8 million.
As of September 30, 1996, Telecom had borrowings of approximately $3.7 million
outstanding under the Telecom Credit Facility.  Borrowings of less than $6
million under the Telecom Credit Facility bear interest at the Telecom Credit
Facility Bank prime rate as in effect from time to time.  Borrowings in excess
of $6 million under the Telecom Credit Facility bear interest at the





                                       13
<PAGE>   15

Telecom Credit Facility Bank prime rate as in effect from time to time plus
 .75%. Borrowings under the Telecom Credit facility are secured by substantially
all of  Telecom's assets.  The Company currently intends to retain the Telecom
Credit Facility.

   At September 30, 1996, the Company had actual contractual capital
commitments of approximately $1.8 million for costs associated with the
construction of fiber optic networks.

   The Company is currently bidding for certain personal communication services
("PCS") licenses being auctioned by the Federal Communications Commission (the
"FCC") and expects to explore alternatives to permit it to provide other
wireless services which may require substantial additional capital.  As of
October 22, 1996, the Company had submitted bids totaling approximately $32.3
million for "D" and "E" block frequency licenses covering areas of Iowa,
Illinois, Nebraska and Minnesota in the FCC's auctions of PCS licenses.  If the
Company is successful in obtaining PCS licenses, it will be required to make
significant expenditures to develop, construct and operate a PCS system.

   As of September 30, 1996, the Company estimates that its aggregate capital
requirements for the remainder of 1996, 1997 and 1998 will be approximately
$310 million.  The Company's estimated capital requirements include the
estimated cost of (i) developing and constructing its fiber optic network, (ii)
market expansion activities, (iii) constructing its network operations center
and corporate headquarters, and (iv) obtaining PCS licenses and related capital
expenditures, including those licenses described above for which the Company
currently has bids outstanding.  These capital requirements are expected to be
funded, in large part, out of the net proceeds to the Company from the Current
Offering, the net proceeds remaining from the IPO (approximately $123 million
as of September 30, 1996), and lease payments to the Company for portions of
the Company's networks.  A Registration Statement on Form S-1 (File No.
333-13885) has been filed by the Company with the Securities and Exchange
Commission in connection with the Current Offering.

   The Company may require additional capital in the future for business
activities related to those specified above and also for acquisitions, joint
ventures and strategic alliances, as well as to fund operating deficits and net
losses.  These activities could require significant additional capital not
included in the foregoing estimated aggregate capital requirements of $310
million.

   The Company's estimate of its future capital requirements contained in this
report is a "forward looking statement" within the meaning of the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995.  The
Company's actual capital requirements may differ materially as a result of
regulatory, technological and competitive developments (including new
opportunities) in the Company's industry.

   The Company expects to meet its additional capital needs with the proceeds
from credit facilities and other borrowings, and additional debt and equity
issuances.  The Company currently plans to obtain one or more additional bank
lines of credit, although no such lines of credit have yet been negotiated.
There can be no assurance that the Company will be successful in producing
sufficient cash flows or raising sufficient debt or equity capital to enable it
to meet its strategic objectives or that such funds, if available at all, will
be available on a timely basis or on terms that are acceptable to the Company.

EFFECTS OF NEW ACCOUNTING STANDARDS

   In March 1995, the Financial Accounting Standards Board (FASB) issued SFAS
No. 121, Accounting for the Impairment of Long-lived Assets and for Long-lived
Assets to Be Disposed Of, which will require the Company to account for the
impairment of long-lived assets and certain identifiable intangibles to be held
and used by the Company whenever events or changes in circumstances indicate
that the carrying amount of any asset may not be recoverable.  Adoption of SFAS
No. 121 is required in fiscal 1996.

   In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-Based
Compensation, which establishes a fair value based method for financial
accounting and reporting stock-based employee compensation plans.  However, the
new standard allows compensation to continue to be measured by using the
intrinsic value based method of accounting prescribed by Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees, but requires
expanded disclosures.  SFAS No. 123 is effective in fiscal year 1996.  The
Company has elected to continue to apply the intrinsic value-based method of
accounting for stock options.





                                       14
<PAGE>   16


   While the Company does not know precisely the impact of adopting SFAS 
No. 121 and SFAS No. 123, the Company does not expect that the adoption of SFAS 
No. 121 or SFAS No. 123 will have a material effect on the Company's
consolidated financial statements.

INFLATION

   The Company does not believe that inflation has had a significant impact on
the Company's consolidated operations.





                                       15
<PAGE>   17



                                  P A R T  II

                               OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

   The Company is dependent on the Regional Bell Operating Companies for
provision of its local and certain of its long distance services.  U S WEST
Communications, Inc. ("U S WEST") and Ameritech Corporation ("Ameritech") are
currently the Company's sole suppliers of access to local central office
switches.  The Company uses such access to partition the local switch and
provide local service to its customers.

   The Company purchases access in the form of a product generally known as
"Centrex."  Without such access, the Company could not currently provide
bundled local and long distance services, although it could provide stand-alone
long distance service.  Since the Company believes its ability to offer bundled
local and long distance services is critical to its current sales efforts, any
successful effort by U S WEST or Ameritech to deny or substantially limit the
Company's access to partitioned switches would have a material adverse effect
on the Company.

   On February 5, 1996, U S WEST filed tariffs and other notices announcing its
intention to limit future Centrex access to its switches by Centrex customers
(including the Company) throughout U S WEST's fourteen-state service region,
effective February 5, 1996 (the "U S WEST Centrex Action").  Although U S WEST
stated that it would "grandfather" existing Centrex agreements with the Company
and permit the Company to continue to use U S WEST's central office switches
through April 29, 2005, it also indicated that it would not permit the Company
to expand to new cities and would severely limit the number of new lines it
would permit the Company to partition onto U S WEST's portion of the switches
in cities currently served by the Company.  Because of U S WEST's commitment to
"grandfather" service to the Company, the Company does not believe its current
customers are at risk that service will be interrupted.  The Company has
challenged, or is challenging, the U S WEST Centrex Action before the public
utilities commissions in each of the states served by U S WEST where the
Company is doing business or currently plans to do business.  The Company based
such challenges on various state and federal laws, regulations and regulatory
policies, including Sections 251 (b)(1) and 251 (c)(4)(B) of the
Telecommunications Act, which the Company believes impose upon the Regional
Bell Operating Companies the duty not to prohibit, and not to impose
unreasonable or discriminatory conditions or limitations on, the resale of
their telecommunications services, and Section 251 (c)(4)(A) of the
Telecommunications Act, which the Company believes obligates the Regional Bell
Operating Companies to offer for resale at wholesale rates any telephone
communications services that are provided at retail to subscribers who are not
telecommunications carriers.  Additional statutes cited in the Company's
challenges include provisions of the laws of Iowa, Minnesota, Nebraska, South
Dakota, North Dakota and Colorado, which the Company believes prohibit
restrictions on the resale of local exchange services, functions or
capabilities; prohibit local exchange carriers from refusing access by other
carriers to essential facilities on the same terms and conditions as the local
exchange carrier provides to itself; and prohibit the provision of carrier
services pursuant to rates, terms and conditions that are unreasonably
discriminatory.

   In Iowa, the Company filed a complaint with the Iowa Utilities Board against
U S WEST's actions and was granted interim relief on an ex parte basis that
allowed the Company to continue to expand to new cities and expand the number
of new lines partitioned onto U S WEST's switches.  Subsequent to the grant of
interim relief, the Company on March 18, 1996 agreed to a settlement agreement
with U S WEST that permits the Company to continue to expand, without
restrictions, the number of new lines it serves in Iowa through March 18, 2001.
In addition, the settlement agreement provides that the Company may expand to
seven new markets (central offices) in Iowa per year through March 18, 2001.
As a result of the settlement agreement, the Company withdrew its complaint
before the Iowa Utilities Board.  Because MCI, AT&T and others also challenged
U S WEST's action, the Iowa Utilities Board continued to review the U S West
Centrex Action and on June 14, 1996 issued an order rejecting U S WEST's
filing. The order of the Iowa Utilities Board was appealed by U S WEST to the
Iowa District Court for Polk County on July 12, 1996.  The appeal remains
pending.

   In Nebraska, a complaint filed by the Company with respect to the U S WEST
Centrex Action is awaiting decision by the Nebraska Public Utilities
Commission.  In North Dakota, the Public Service Commission, at an October 15,
1996 "working session," directed its staff to draft an order rejecting the U S
WEST Centrex Action.  The Public Service Commission staff has informed the
Company that this order will be issued in November 1996.  In Minnesota, U S
WEST's initial filing was rejected on procedural grounds by the Public
Utilities Commission.  Nevertheless, on April 30, 1996, U S WEST refiled its
proposed limitations on Centrex service in Minnesota, proposing to
"grandfather" the service to existing customers as of July 9, 1996.  The
Company opposed this filing in a letter to the Minnesota Public Utilities
Commission on





                                       16
<PAGE>   18


May 20, 1996.  On May 31, 1996, the Minnesota Public Utilities Commission
issued an order suspending the new U S WEST filing and scheduling a
contested-case proceeding to consider it.  The Minnesota Public Utilities
Commission is expected to render a ruling in the proceedings by December 20,
1996.  In South Dakota, U S WEST has appealed the unfavorable decision of the
Public Utilities Commission in state court and has been granted a stay that
prevents the Company from marketing and selling Centrex service in South Dakota
pending appeal.  The Company anticipates that U S WEST will appeal other
unfavorable decisions by public utilities commissions in other states with
respect to the U S WEST Centrex Action.

   Other telecommunication firms also have challenged the U S WEST Centrex
Action in each of the other states where U S WEST engages in local telephone
service and public utilities commissions in several of those states have also
rejected the U S WEST Centrex action.  In Oregon, U S WEST's filing was
rejected by the Public Utilities Commission on March 7, 1996.  In South Dakota,
the Public Utilities Commission rejected the U S WEST Centrex Action on August
22, 1996.  In Colorado, on September 3, 1996, an Administrative Law Judge
issued a recommendation that the U S WEST Centrex Action be rejected.  In
Wyoming, U S WEST's filing was rejected by the Public Service Commission on
September 6, 1996.  On its own motion, the Arizona Corporation Commission
ordered U S WEST to continue the availability of Centrex services until a
comparable replacement system becomes available.  In New Mexico, the Public
Service Commission has not allowed the U S WEST's filing to become effective.
In Utah, on September 25, 1996, the Public Service Commission rejected the U S
WEST Centrex Action and ordered U S WEST to continue the availability of
Centrex service for resale.  In Montana, the Public Service Commission is
expected to render a decision with respect to the U S WEST Centrex Action in
November 1996.

   There can be no assurance that the Company will succeed in its legal
challenges to the U S WEST Centrex Action, or that this action by U S WEST, or
similar actions by other Regional Bell Operating Companies, will not have a
material adverse effect on the Company.

   As a result of its use of the Centrex product, the Company depends upon U S
WEST to process service orders placed by the Company to transfer new customers
to the Company's local service.  U S WEST has imposed a limit of processing one
new local service order of the Company per hour for each U S WEST central
office.  Furthermore, according to the Company's records, U S WEST commits an
error on one of every three lines ordered by the Company, thereby further
delaying the transition of new customers to the Company's local service.  The
Company has repeatedly requested that U S WEST increase its local service order
processing rate and improve the accuracy of such processing.  U S WEST has
refused to change its service order processing practices.

   On July 12, 1996, the Company filed a complaint with the Iowa Utilities
Board against U S WEST in connection with such actions.  At a hearing held to
consider the complaint, U S WEST acknowledged that it had not dedicated
resources to improve its processing of the Company's service orders to switch
new customers to the Company's local service because of its desire to limit
Centrex service.  In an order issued on October 10, 1996, the Iowa Utilities
Board determined that U S WEST's limitation on the processing of the Company's
service orders constituted an unlawful discriminatory practice under Iowa law.
The Iowa Utilities Board ordered the Company and U S WEST jointly to file
supplemental evidence regarding U S WEST's rate of processing orders.  There
can be no assurance, however, that the decision of the Iowa Utilities Board
will adequately resolve the service order problems or that such problems will
not impair the Company's ability to expand or to attract new customers, which
could have a material adverse effect on the Company.  U S WEST has, however,
recently begun to increase its local service order processing rate.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

   (a)   Exhibits

         11.  Statement Re:  Computation of loss per common share

         27.  Financial Data Schedule

   (b)   Report on Form 8-K

   On July 29, 1996, the Company filed a Current Report on Form 8-K which
reported that the Company had consummated the acquisition of Ruffalo, Cody for
a maximum aggregate purchase price of approximately $19.9 million.  Since it
was not practicable at the time of filing this report to provide financial
statements of Ruffalo, Cody or pro forma financial information relating to this
transaction, no financial statements were filed with this report.





                                       17
<PAGE>   19



   On August 26, 1996, the Company filed a Current Report on Form 8-K which
reported that the Company had entered into an Agreement and Plan of
Reorganization, dated August 15, 1996, with Telecom pursuant to which a newly
formed subsidiary of the Company would be merged with and into Telecom, and
Telecom would become a wholly owned subsidiary of the Company.

   On September 27, 1996, the Company filed a Current Report on Form 8-K/A,
amending its Current Report on Form 8-K dated July 29, 1996, to file
consolidated statements of income, cash flows, and redeemable common stock and
warrants and common stockholders' equity of Ruffalo, Cody for the year ended
December 31, 1993 and consolidated financial statements of Ruffalo, Cody for
the years ended December 31, 1994 and 1995 and the six months ended June 30,
1995 and 1996.  A pro forma condensed balance sheet as of June 30, 1996 and pro
forma condensed statements of income for the year ended December 31, 1995 and
the six months ended June 30, 1996 reflecting the acquisition of Ruffalo, Cody
were also filed with this report.

   On October 7, 1996, the Company filed a Current Report on Form 8-K which
reported that the Company had consummated the acquisition of Telecom on
September 20, 1996.  Since it was not practicable at the time of filing this
report to provide financial statements of Telecom or pro forma financial
information relating to this transaction, no financial statements were filed
with this report.

   On October 11, 1996, the Company filed a Current Report on Form 8-K/A,
amending its Current Report on Form 8-K dated October 7, 1996, to file
consolidated statements of income, stockholders' equity and cash flow of
Telecom for the year ended August 31, 1994 and the consolidated financial
statements of Telecom for the years ended August 31, 1995 and 1996.  A pro
forma condensed consolidated balance sheet as of June 30, 1996 and pro forma
condensed consolidated statements of income for the year ended December 31,
1995 and the six months ended June 30, 1996 reflecting the acquisition of
Telecom were also filed with this report.





                                       18
<PAGE>   20





                                   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.


                                      McLEOD, INC.
                                      (registrant)


Date: November 8, 1996                        /s/ CLARK E. MCLEOD
                                              -------------------
                                                  CLARK E. MCLEOD
                                      CHAIRMAN AND CHIEF EXECUTIVE OFFICER



Date: November 8, 1996                     /s/  STEPHEN C. GRAY
                                           ------------------------
                                                STEPHEN C. GRAY
                                      PRESIDENT & CHIEF OPERATING OFFICER





                                       19
<PAGE>   21




                               INDEX TO EXHIBITS




<TABLE>
<CAPTION>
                                                                                                    SEQUENTIALLY
   EXHIBIT                                                                                            NUMBERED
    NUMBER                                    EXHIBIT DESCRIPTION                                       PAGE
    ------                                    -------------------                                 ----------------
      <S>     <C>
      11      Statement Regarding Computation of Per Share Earnings   . . . . . . . . . . . .
      27      Financial Data Schedule . . . . . . . . . . . . . . . . . . . . . . . . . . . .
</TABLE>





                                       20