<PAGE>   1
 
   
     AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 30, 1998
    
                                                      REGISTRATION NO. 333-53475
================================================================================
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                             ---------------------
   
                                AMENDMENT NO. 2
    
                                       TO
                                    FORM S-1
            REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
                             ---------------------
                            ALLEGIANCE TELECOM, INC.
             (Exact name of registrant as specified in its charter)
 
<TABLE>
<S>                                <C>                                <C>
             DELAWARE                             4832                            75-2721491
   (State or other jurisdiction       (Primary Standard Industrial              (IRS Employer
of incorporation or organization)     Classification Code Number)           Identification Number)
</TABLE>
 
                             ---------------------
                             1950 STEMMONS FREEWAY
                                   SUITE 3026
                              DALLAS, TEXAS 75207
                           TELEPHONE: (214) 853-7100
         (Address, including zip code, and telephone number, including
            area code, of registrant's principal executive offices)
                             ---------------------
             ROYCE J. HOLLAND, CHAIRMAN AND CHIEF EXECUTIVE OFFICER
                            Allegiance Telecom, Inc.
                             1950 Stemmons Freeway
                                   Suite 3026
                              Dallas, Texas 75207
                           Telephone: (214) 853-7100
           (Name, address, including zip code, and telephone number,
                   including area code, of agent for service)
                                   Copies to:
 
<TABLE>
<S>                                                 <C>
                MARK B. TRESNOWSKI                                  ANDREW R. SCHLEIDER
                 Kirkland & Ellis                                   Shearman & Sterling
              200 East Randolph Drive                              599 Lexington Avenue
              Chicago, Illinois 60601                            New York, New York 10022
                  (312) 861-2000                                      (212) 848-4000
</TABLE>
 
                             ---------------------
 
     APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
 
     If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box:  [ ]
 
     If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering.  [ ]
 
     If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering.  [ ]
 
     If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering.  [ ]
 
     If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box:  [ ]
                             ---------------------
 
   
     THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT THAT SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
    
================================================================================
<PAGE>   2
 
                                EXPLANATORY NOTE
 
     This registration statement contains two forms of prospectus: one to be
used in connection with an offering of the registrant's Common Stock in the
United States and Canada (the "U.S. Prospectus"), and one to be used in a
concurrent offering of the registrant's Common Stock outside the United States
and Canada (the "International Prospectus" and together with the U.S.
Prospectus, the "Prospectuses"). The Prospectuses are identical except for the
front cover page. The U.S. Prospectus is included herein and is followed by the
alternative front cover page to be used in the International Prospectus. The
alternate page for the International Prospectus included herein is labeled
"Alternate Page for International Prospectus." Final forms of each Prospectus
will be filed with the Securities and Exchange Commission under Rule 424(b) of
the General Rules and Regulations under the Securities Act of 1933.
<PAGE>   3
 
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO THE REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH
STATE.
 
PROSPECTUS (Subject to Completion)
 
   
Issued June 30, 1998
    
                               12,000,000 Shares
 
                        (ALLEGIANCE TELECOM, INC. LOGO)
                                  COMMON STOCK
                            ------------------------
 
 All of the 12,000,000 shares of Common Stock offered hereby are being sold by
  the Company. Of the 12,000,000 shares of Common Stock being offered hereby,
9,600,0000 shares are being offered initially in the United States and Canada by
   the U.S. Underwriters (the "U.S. Offering") and 2,400,000 shares are being
  offered initially outside the United States and Canada by the International
Underwriters (the "International Offering," and together with the U.S. Offering,
                  the "Equity Offering"). See "Underwriters."
  Prior to the Equity Offering, there has been no public market for the Common
   Stock of the Company. It is currently anticipated that the initial public
 offering price per share of Common Stock will be between $16.00 and $18.00 per
 share. See "Underwriters" for a discussion of the factors to be considered in
                 determining the initial public offering price.
   
Concurrent with the Equity Offering, the Company will make a public offering of
 $200.0 million principal amount of its     % Senior Notes due 2008 (the "Debt
Offering"). The closing of the Debt Offering is conditioned upon the closing of
 the Equity Offering, but the closing of the Equity Offering is not conditioned
                     upon the closing of the Debt Offering.
    
                            ------------------------
 
 The Common Stock has been approved for listing, subject to official notice of
                            issuance, on the Nasdaq
                    National Market under the symbol "ALGX."
                            ------------------------
 
      SEE "RISK FACTORS" BEGINNING ON PAGE 10 FOR INFORMATION THAT SHOULD
                     BE CONSIDERED BY PROSPECTIVE INVESTORS
                            ------------------------
  THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
 EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
   AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
                               CRIMINAL OFFENSE.
                            ------------------------
 
                              PRICE $     A SHARE
                            ------------------------
 
   
<TABLE>
<CAPTION>
                                                                       UNDERWRITING
                                        PRICE TO                       DISCOUNTS AND                     PROCEEDS TO
                                         PUBLIC                       COMMISSIONS(1)                     COMPANY(2)
                                        --------                      --------------                     -----------
<S>                          <C>                              <C>                              <C>
Per Share..................                 $                                $                                $
Total(3)(4)................                 $                                $                                $
</TABLE>
    
 
------------
    (1) The Company has agreed to indemnify the Underwriters against certain
        liabilities, including liabilities under the Securities Act of 1933, as
        amended. See "Underwriters."
    (2) Before deducting expenses payable by the Company estimated at $750,000.
    (3) The Company has granted to the U.S. Underwriters an option, exercisable
        within 30 days of the date hereof, to purchase up to an aggregate of
        1,800,000 additional shares of Common Stock at the price to public less
        underwriting discounts and commissions, for the purpose of covering
        over-allotments, if any. If the U.S. Underwriters exercise such option
        in full, the total price to public, underwriting discounts and
        commissions and proceeds to Company will be $        , $        and
        $        , respectively. See "Underwriters."
   
    (4) Up to 1,200,000 shares of Common Stock have been reserved for sale, at
        the initial public offering price, to directors, officers, employees and
        business associates and other persons having relationships with the
        Company. See "Underwriters."
    
                            ------------------------
 
    The shares of Common Stock are offered, subject to prior sale, when, as and
if accepted by the Underwriters and subject to approval of certain legal matters
by Shearman & Sterling, counsel for the Underwriters. It is expected that
delivery of the shares will be made on or about            , 1998 in New York,
N.Y., against payment therefor in immediately available funds.
                            ------------------------
 
                           Joint Bookrunning Managers
 
MORGAN STANLEY DEAN WITTER                                  SALOMON SMITH BARNEY
                            ------------------------
 
DONALDSON, LUFKIN & JENRETTE
         Securities Corporation
                       GOLDMAN, SACHS & CO.
 
   
                               WARBURG DILLON READ LLC
    
 
               , 1998
<PAGE>   4
 
     NO PERSON IS AUTHORIZED IN CONNECTION WITH ANY OFFERING MADE HEREBY TO GIVE
ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS,
AND IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON
AS HAVING BEEN AUTHORIZED BY THE COMPANY OR BY ANY UNDERWRITER. THIS PROSPECTUS
DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY
SECURITY OTHER THAN THE COMMON STOCK OFFERED HEREBY, NOR DOES IT CONSTITUTE AN
OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE COMMON STOCK
OFFERED HEREBY TO ANY PERSON IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE
SUCH AN OFFER OR SOLICITATION TO SUCH PERSON. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREBY SHALL UNDER ANY CIRCUMSTANCE IMPLY THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE
HEREOF.
                            ------------------------
 
     FOR INVESTORS OUTSIDE THE UNITED STATES: NO ACTION HAS BEEN OR WILL BE
TAKEN IN ANY JURISDICTION BY THE COMPANY OR BY ANY UNDERWRITER THAT WOULD PERMIT
A PUBLIC OFFERING OF THE COMMON STOCK OR POSSESSION OR DISTRIBUTION OF THIS
PROSPECTUS IN ANY JURISDICTION WHERE ACTION FOR THAT PURPOSE IS REQUIRED, OTHER
THAN IN THE UNITED STATES. PERSONS INTO WHOSE POSSESSION THIS PROSPECTUS COMES
ARE REQUIRED BY THE COMPANY AND THE UNDERWRITERS TO INFORM THEMSELVES ABOUT AND
TO OBSERVE ANY RESTRICTIONS AS TO THE OFFERING OF THE COMMON STOCK AND THE
DISTRIBUTION OF THIS PROSPECTUS.
                            ------------------------
 
                               TABLE OF CONTENTS
 
   
<TABLE>
<CAPTION>
                                         PAGE
                                         ----
<S>                                      <C>
Prospectus Summary.....................    4
Risk Factors...........................   10
Use of Proceeds........................   25
Dividend Policy........................   25
Dilution...............................   26
Capitalization.........................   27
Selected Financial Data................   28
Management's Discussion and Analysis of
  Financial Condition and Results of
  Operations...........................   31
Business...............................   37
Management.............................   56
Certain Relationships and Related
  Transactions.........................   66
</TABLE>
    
 
   
<TABLE>
<CAPTION>
                                         PAGE
                                         ----
<S>                                      <C>
Security Ownership of Certain
  Beneficial Owners and Management.....   67
Description of Certain Indebtedness....   68
Description of Capital Stock...........   70
Shares Eligible for Future Sale........   73
Certain United States Federal Income
  Tax Consequences to Non-United States
  Holders..............................   75
Underwriters...........................   78
Legal Matters..........................   81
Experts................................   81
Additional Information.................   82
Index to Consolidated Financial
  Statements...........................  F-1
</TABLE>
    
 
                            ------------------------
 
     THIS PROSPECTUS INCLUDES "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF
THE FEDERAL SECURITIES LAWS. ALL STATEMENTS REGARDING THE COMPANY'S AND ITS
SUBSIDIARIES' EXPECTED FINANCIAL POSITION, BUSINESS AND FINANCING PLANS ARE
FORWARD-LOOKING STATEMENTS. ALTHOUGH THE COMPANY AND ITS SUBSIDIARIES BELIEVE
THAT THE EXPECTATIONS REFLECTED IN SUCH FORWARD-LOOKING STATEMENTS ARE
REASONABLE, THEY CAN GIVE NO ASSURANCE THAT SUCH EXPECTATIONS WILL PROVE TO HAVE
BEEN CORRECT. IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM SUCH EXPECTATIONS ("CAUTIONARY STATEMENTS") ARE DISCLOSED IN
THIS PROSPECTUS, INCLUDING, WITHOUT LIMITATION, IN CONJUNCTION WITH THE
FORWARD-LOOKING STATEMENTS INCLUDED IN THIS PROSPECTUS AND UNDER "RISK FACTORS"
HEREIN. ALL SUBSEQUENT WRITTEN AND ORAL FORWARD-LOOKING STATEMENTS ATTRIBUTABLE
TO THE COMPANY, ITS SUBSIDIARIES OR PERSONS ACTING ON THEIR BEHALF ARE EXPRESSLY
QUALIFIED BY THE CAUTIONARY STATEMENTS.
                            ------------------------
 
     CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING STABILIZING BIDS, SYNDICATE COVERING TRANSACTIONS AND THE IMPOSITION
OF PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITERS."
 
                                        3
<PAGE>   5
 
                               PROSPECTUS SUMMARY
 
     The following summary is qualified in its entirety by, and should be read
in conjunction with, the more detailed information and financial statements,
including the notes thereto, appearing elsewhere in this Prospectus. Unless the
context otherwise requires, references herein to "Allegiance" and the "Company"
refer to Allegiance Telecom, Inc., a Delaware corporation, and its subsidiaries.
Unless otherwise indicated, the information contained in this Prospectus: (i)
assumes a public offering price of $17.00 per share and no exercise of the U.S.
Underwriters' over-allotment option and (ii) gives effect to a
426.2953905-for-one stock split of the Company's Common Stock. Certain
information contained in this summary and elsewhere in this Prospectus,
including information under "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and information with respect to the
Company's plans and strategy for its business and related financing, includes
forward-looking statements that involve risk and uncertainties. Prospective
investors should carefully consider the factors set forth under "Risk Factors"
and are urged to read this Prospectus in its entirety.
 
                                  THE COMPANY
 
     Allegiance Telecom, Inc. seeks to be a premier provider of
telecommunications services to business, government and other institutional
users in major metropolitan areas across the United States. As a competitive
local exchange carrier ("CLEC"), Allegiance anticipates offering an integrated
set of telecommunications products and services including local exchange, local
access, domestic and international long distance, enhanced voice, data and a
full suite of Internet services. The Company was founded in April 1997 by a
management team led by Royce J. Holland, the former president, chief operating
officer and co-founder of MFS Communications Company, Inc. ("MFS"), and Thomas
M. Lord, former managing director of Bear, Stearns & Co. Inc., where he
specialized in the telecommunications, information services and technology
industries. The Company's initial equity financing of approximately $50.1
million has been provided by this management team and Madison Dearborn Capital
Partners, Morgan Stanley Capital Partners, Frontenac Company and Battery
Ventures.
 
     The Company believes that the Telecommunications Act of 1996 (the
"Telecommunications Act"), by opening the local exchange market to competition,
has created an attractive opportunity for new facilities-based CLECs like the
Company. Most importantly, the Telecommunications Act stated that CLECs should
be able to acquire the unbundled network elements ("UNEs") from the incumbent
local exchange carriers ("ILECs"), which are necessary for the cost-effective
provision of service. As such, the Telecommunications Act will enable the
Company to deploy digital switching platforms with local and long distance
capability and initially lease fiber trunking capacity from the ILECs and other
CLECs to connect the Company's switch with its transmission equipment collocated
in ILEC central offices. Thereafter, the Company plans to lease capacity or
overbuild specific network segments as economically justified by traffic volume
growth. Management believes that pursuing this "smart build" approach should:
(i) accelerate market entry by 9 to 18 months by deferring the need for city
franchises, rights-of-way and building access; (ii) reduce initial capital
requirements for individual market entry prior to revenue generation, allowing
the Company to focus its capital resources on the critical areas of sales,
marketing, and operations support systems ("OSS"); (iii) provide for ongoing
capital expenditures on a "success basis" as demand dictates; and (iv) allow the
Company to address attractive service areas selectively throughout its targeted
markets.
 
     Allegiance is currently developing tailored systems and procedures for OSS
and other back office systems that it believes will provide the Company with a
significant competitive advantage in terms of cost, processing large order
volumes and customer service. These systems are required to enter, schedule,
provision and track a customer's order from the point of sale to the
installation and testing of service and also include or interface with trouble
management, inventory, billing, collection and customer service systems. The
legacy systems currently employed by many ILECs, CLECs and long distance
carriers, which systems were developed prior to the passage of the
Telecommunications Act, generally require multiple entries of customer
information to accomplish order management, provisioning, switch administration
and billing. This process is not only labor intensive, but it also creates
numerous opportunities for errors in provisioning service and billing, delays in
 
                                        4
<PAGE>   6
 
installing orders, service interruptions, poor customer service, increased
customer churn and significant added expenses due to duplicated efforts and the
need to correct service and billing problems. The Company believes that the
practical problems and costs of upgrading legacy systems are often prohibitive
for companies whose existing systems support a large number of customers with
ongoing service.
 
   
     Allegiance plans to deploy networks in 24 Tier I markets. The Company
estimates that these 24 markets will include 18 basic trading areas ("BTAs")
with more than 20 million non-residential access lines, representing
approximately 44.7% of the total non-residential access lines in the U.S. With a
network deployment and end user, direct sales marketing strategy focusing on the
central business districts and suburban commercial districts in these areas,
Allegiance plans to address a majority of the non-residential access lines in
most of its targeted markets. The Company plans to deploy its networks
principally in two phases of development. The first, or Phase I, is to offer
services in 12 of the largest metropolitan areas in the U.S., which the Company
believes include approximately 26.0% of the nation's total non-residential
access lines. Allegiance is currently operational in three Phase I markets: New
York City, Dallas and Atlanta; and is in the process of deploying networks in
six additional Phase I markets: Chicago, Los Angeles, San Francisco, Boston,
Fort Worth and Washington, D.C. In each of these markets, the Company will use a
Lucent Technologies, Inc. ("Lucent") Series 5ESS(R)-2000 digital switch, which
provides local and long distance functionality. With the proceeds from the
Offerings (as defined herein) and the funds expected to be available under the
Vendor Financing (as defined herein), the Company intends to begin network
development in its Phase II markets. These additional 12 markets are estimated
to encompass approximately 18.7% of the total non-residential access lines in
the U.S. Management expects to commence network deployment in these cities in
1999, with service anticipated to begin during 1999 and 2000.
    
 
   
     As of June 25, 1998, the Company has sold 18,858 lines to 1,120 customers,
of which 10,993 lines for 688 customers were in service as of such date.
    
 
BUSINESS STRATEGY
 
     To accomplish its goal of becoming a premier provider of telecommunications
services to business, government, and other institutional users in U.S.
metropolitan areas, the Company has developed an end-user-focused business
strategy designed to achieve significant market penetration and deliver superior
customer care while maximizing operating margins. The key components of this
strategy include the following:
 
     Leverage Proven Management Team. The Company's veteran management team has
extensive experience and past successes in the CLEC industry, and the Company
believes that its ability to combine and draw upon the collective talent and
expertise of its senior management gives it a competitive advantage in the
effective and efficient execution of network deployment, sales, provisioning,
service installation, billing and collection, and customer service functions.
Allegiance's Chairman and Chief Executive Officer, Royce J. Holland, has more
than 25 years of experience in the telecommunications and energy industries,
including as president, chief operating officer, and co-founder of MFS. Under
his leadership, MFS grew from a start-up operation to become the largest CLEC
with approximately $1.1 billion in revenues before its acquisition by WorldCom,
Inc. ("WorldCom") in 1996. Other key Allegiance executives have significant
experience in the critical functions of network operations, sales and marketing,
back office and OSS, finance and regulatory affairs.
 
     Target End Users with Integrated Service Offerings. Allegiance plans to
focus principally on end user customers in the business, government and other
institutional market segments. The majority of these customers are expected to
be small and medium-sized businesses, to which the Company will offer "one-stop
shopping" consisting of a comprehensive package of communications services with
convenient integrated billing and a single point of contact for sales and
service. For large businesses and government and other institutional users,
which typically obtain telecommunications services from a variety of suppliers,
the Company will focus primarily on capturing a significant portion of these
customers' local exchange, intraLATA toll and data traffic. Although the Company
will principally target end-users in markets where it believes it can achieve
significant market penetration by providing superior customer care at
competitive prices, the Company may augment its core business strategy by
selectively supplying wholesale services including equipment collocation and
facilities management services to Internet service providers ("ISPs").
 
                                        5
<PAGE>   7
 
     Offer Data, Internet, and Enhanced Services to Enhance Market Penetration
and Reduce Churn. The Company believes it can accelerate new account penetration
and reduce customer churn by offering Local Area Network ("LAN")
interconnection, frame relay, Internet services, Integrated Services Digital
Network ("ISDN"), Digital Subscriber Line ("DSL"), Web page design, Web server
hosting, and other enhanced services not generally available from the ILECs (or
available only at high prices) in conjunction with traditional local and long
distance services. This strategy has been successfully employed by certain
CLECs, and Allegiance's management team has extensive experience in providing
these types of enhanced services.
 
     Utilize "Smart Build" Strategy to Maximize Speed to Market and Minimize
Investment Risk. Allegiance plans to deploy digital switching platforms with
local and long distance capability and initially lease fiber trunking capacity
from the ILECs and other CLECs to connect the Company's switch with its
transmission equipment collocated in ILEC central offices. Thereafter,
Allegiance may evolve its networks to the next stage of the "smart build"
strategy where Allegiance plans to lease dark fiber or overbuild specific
network segments as economically justified by traffic volume growth. Allegiance
expects that this "smart build" strategy will allow entry into a new market in a
six- to nine-month time frame as compared to the 18 to 24 months required to
construct a metropolitan area fiber network under the "build first, sell later"
approach required before the Telecommunications Act established a framework for
CLECs to acquire unbundled network elements. The Company believes that this
"smart build" approach has the additional advantage of reducing up-front capital
requirements. This "smart build" strategy is currently being implemented by the
Company in all its networks where it is leasing high capacity circuits to
connect the ILEC central offices with the Company's switches. In New York City,
the Company is moving to the next stage of its "smart-build" strategy, where the
Company will lease from Metromedia Fiber Network, Inc. ("MFN"), a thirty-mile
dark fiber ring in Manhattan that extends into Brooklyn.
 
     Achieve Broad Coverage of Attractive Areas within Each Targeted Market. As
a result of the substantial up-front capital requirements necessary to construct
metropolitan area fiber networks, CLECs have traditionally limited their initial
network buildout to highly concentrated downtown areas, thereby limiting their
ability to provide service to customers in other attractive, but geographically
dispersed, portions of their targeted markets. The Company intends to leverage
the benefits of using a "smart build" strategy by selectively deploying its
facilities to address attractive service areas throughout each target market in
order to optimize the Company's penetration. Prior to entering a market,
Allegiance prepares a detailed, "bottoms-up" analysis of that market's local
exchange areas using Federal Communications Commission ("FCC") and demographic
data. The Company uses this analysis, together with estimates of the costs and
potential benefits of addressing particular service areas, to identify
attractive areas, determine the optimal concentration of areas to be served and
develop its schedule for network deployment and expansion.
 
     Maximize Operating Margins by Emphasizing Facilities-Based
Services. Allegiance believes that facilities-based solutions where the Company
provides local exchange, local access, and long distance using its own
facilities should generate significantly higher gross network margins than could
be obtained by reselling such services. As a result, Allegiance plans to deploy
its marketing activities in areas where it can serve customers through a direct
connection using unbundled loops or high capacity circuits connected to
Allegiance's facilities collocated in ILEC central offices. The Company plans to
resell ILEC services only in order to provide comprehensive geographical service
coverage to customers with multiple on-net sites (which can be addressed by the
Company's facilities-based services) and a few off-net sites (which can be
addressed only by the Company's reselling ILEC services).
 
     Build Market Share by Focusing on Direct Sales. The Company believes that
the key to achieving its goals is the capturing and retaining of customers
through direct sales, a full suite of turn-key product offerings and
personalized customer care. Management believes that its targeted small and
medium-sized business customers have been neglected by the ILECs with respect to
these functions. The Company's sales management team is composed of executives
with experience in managing a large number of direct sales specialists in the
telecommunications and data networking industries. Additionally, the Company
believes it will be able to attract and retain highly qualified sales and
support personnel by offering them the opportunity to: (i) work with an
experienced and success-proven management team in building a developing,
entrepreneurial company; (ii) market a comprehensive set of products and
services and customer care options;
 
                                        6
<PAGE>   8
 
and (iii) participate in the potential economic returns made available through a
results-oriented compensation package emphasizing sales commissions and stock
options.
 
     Develop Efficient Automated Back Office Systems. Unburdened by existing
legacy OSS, Allegiance is focusing on developing, acquiring and integrating back
office systems to facilitate a smooth, efficient order management, provisioning,
trouble management, billing and collection, and customer service process. To
address this critical issue, the Company has hired a team of engineering and
information technology professionals experienced in the CLEC industry. This team
will work to develop, with the assistance of key third party vendors, OSS that
will synchronize multiple tasks such as provisioning, customer service and
billing and provide management with timely operating and financial data to most
efficiently direct network, sales and customer service resources. The Company
intends to work actively toward "electronic bonding" between the Allegiance OSS
and those of the ILEC, which would permit creation of service requests on-line.
Allegiance believes that these back office systems, once developed, will provide
it with a significant competitive advantage in terms of cost, processing large
order volumes and customer service as compared to companies using legacy
systems.
 
     Expand Customer Base Through Potential Acquisitions. The Company believes
that strategic acquisitions may produce a number of benefits, including
acceleration of market penetration, providing a customer base for cross-selling
additional services, acquiring experienced management and improving margins by
migrating resold services to the Company's network facilities.
 
                                 FINANCING PLAN
 
     Allegiance's financing plan is predicated on the pre-funding of each
market's expansion to the point at which such market's operating cash flow is
sufficient to fund its operating costs and capital expenditures ("Positive Free
Cash Flow"). This approach is designed to allow the Company to be opportunistic
and raise capital on favorable terms and conditions.
 
     To pre-fund each Phase I market's expansion to Positive Free Cash Flow, the
Company consummated the following transactions:
 
          (i) the Company received equity contributions (the "Equity
     Contributions") aggregating approximately $50.1 million, of which
     approximately $47.6 million was from affiliates of four private equity
     investment funds with extensive experience in financing telecommunications
     companies (Morgan Stanley Capital Partners, Madison Dearborn Capital
     Partners, Frontenac Company, and Battery Ventures (such affiliates
     collectively, the "Fund Investors")) and approximately $2.5 million was
     from certain members of the Allegiance management team (the "Management
     Investors"); and
 
          (ii) the Company received approximately $240.7 million of net
     proceeds, after deducting estimated underwriting discounts and commissions
     and other expenses payable by the Company, from the sale of 445,000 units
     (the "Units"), consisting in the aggregate of $445.0 million principal
     amount at maturity of the Company's 11 3/4% Senior Discount Notes due 2008
     (the "11 3/4% Notes") and 445,000 warrants (the "Warrants") to purchase an
     aggregate of 649,248 shares of Common Stock (the "Unit Offering").
 
     Since completion of the Unit Offering, the Company has increased the scope
of its business plan to accommodate (i) an expansion of the Company's network
buildout in certain Phase I markets to include additional central offices,
thereby giving the Company access to a larger number of potential customers in
those markets, (ii) an accelerated and expanded deployment of data, Internet and
enhanced services in the Company's markets and (iii) the acceleration of network
deployment in Phase II markets.
 
     The Company estimates that its cumulative cash requirements to fund its
modified business plan, including pre-funding each Phase I and Phase II market's
expansion to Positive Free Cash Flow, will be between $650 million and $700
million. To finance this modified business plan, the Company intends to
consummate the following transactions:
 
          (i) the Company is offering 12,000,000 shares of its Common Stock
     hereby; and
 
                                        7
<PAGE>   9
 
   
          (ii) the Company is offering $200.0 million aggregate principal amount
     of   % Senior Notes due 2008 (the "Notes"), of which approximately $67.4
     million will be used to purchase a portfolio of pledged securities,
     consisting of U.S. government securities, that will be pledged as security
     for the first six scheduled interest payments on the Notes (the "Debt
     Offering" and together with the Equity Offering, the "Offerings"). Interest
     on the Notes will be payable semiannually in cash on November 15 and May 15
     of each year, commencing November 15, 1998. See "Description of Certain
     Indebtedness -- Debt Offering."
    
 
     The closing of the Debt Offering is conditioned upon the closing of the
Equity Offering, but the closing of the Equity Offering is not conditioned upon
the closing of the Debt Offering. There can be no assurance that the Debt
Offering will be consummated.
 
   
     The Company is seeking to obtain approximately $100.0 million of equipment
lease or vendor financing (the "Vendor Financing") for the acquisition of
digital switches, software, electronics and associated transmission equipment.
The amount of Vendor Financing the Company will ultimately seek to obtain will
depend on a number of factors including the terms and conditions thereof, the
availability and terms of other financing and the Company's ability to acquire
digital switches, software, electronics and associated transmission equipment in
connection with the acquisition of other companies for Common Stock. There can
be no assurance that the Vendor Financing will be available on terms acceptable
to the Company or at all.
    
 
   
     The Company believes, based on its modified business plan, that the net
proceeds from the Offerings, together with cash on hand (including proceeds from
the Equity Contributions and the Unit Offering) and funding expected to be
available under the Vendor Financing will be sufficient to pre-fund its Phase I
and Phase II market deployment to Positive Free Cash Flow. If the Company
consummates the Equity Offering but not the Debt Offering or the Vendor
Financing, the Company intends to modify its deployment schedule by developing
only five to seven Phase II markets. If the Company consummates both the Equity
and Debt Offerings, but the Vendor Financing is not obtained, the Company
intends to modify its deployment schedule by developing only eight to ten Phase
II markets. In each such case, the Company would delay deployment of networks in
the remaining Phase II markets until it obtains additional financing on
acceptable terms and conditions.
    
 
   
     The actual amount and timing of the Company's future capital requirements
may differ materially from the Company's estimates as a result of, among other
things, the demand for the Company's services and regulatory, technological and
competitive developments (including additional market developments and new
opportunities) in the Company's industry. The Company also expects that it will
require additional financing (or require financing sooner than anticipated) if:
(i) the Company's development plans or projections change or prove to be
inaccurate; (ii) the Company engages in any acquisitions; (iii) the Vendor
Financing is not obtained on a timely basis or at all; or (iv) the Company
alters the schedule or targets of its roll-out plan, or in the event the Debt
Offering is not consummated, the Company accelerates the implementation of its
network deployment in the remaining Phase II markets. Sources of additional
financing may include commercial bank borrowings, vendor financing, or the
private or public sale of equity or debt securities. There can be no assurance
that such financing will be available on terms acceptable to the Company or at
all. See "Risk Factors -- Significant Capital Requirements; Uncertainty of
Additional Financing" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
    
 
                              RECENT DEVELOPMENTS
 
     In February 1998, the Company hired C. Daniel Yost to serve as its
President and Chief Operating Officer. Mr. Yost brings to the Company over 26
years of experience in the telecommunications industry, most recently as
President and Chief Operating Officer for U.S. Operations of NETCOM On-Line
Communications Services, Inc., a leading Internet service provider. Mr. Yost
also serves as a member of the Company's Board of Directors.
 
     In March 1998, Reed E. Hundt was elected to the Company's Board of
Directors. Mr. Hundt served as the chairman of the Federal Communications
Commission from 1993 to 1997. See "Management."
 
                                        8
<PAGE>   10
 
                              THE EQUITY OFFERING
 
<TABLE>
<S>                                                  <C>         <C>
Common Stock offered by the Company:
  U.S. Offering....................................   9,600,000  shares
  International Offering...........................   2,400,000  shares
                                                     ----------
          Total....................................  12,000,000  shares
                                                     ==========
Common Stock to be outstanding after the Equity
  Offering.........................................  52,341,554  shares(1)
</TABLE>
 
   
Debt Offering......................    Concurrently with the Equity Offering,
                                       the Company will make a public offering
                                       of $200.0 million principal amount of
                                       Notes. The closing of the Debt Offering
                                       is conditioned upon the closing of the
                                       Equity Offering, but the closing of the
                                       Equity Offering is not conditioned upon
                                       the closing of the Debt Offering and
                                       there can be no assurance that the Debt
                                       Offering will be consummated. See
                                       "Description of Certain Indebtedness."
    
 
   
Use of Proceeds....................    The Company intends to use the net
                                       proceeds from the Offerings, together
                                       with the remaining proceeds from the
                                       Equity Contributions and the Unit
                                       Offering and the funding expected to be
                                       available under the Vendor Financing, to
                                       fund the cost of deploying networks in
                                       its remaining Phase I and Phase II
                                       markets and the operation of those
                                       networks to Positive Free Cash Flow,
                                       including the costs to develop, acquire,
                                       and integrate the necessary OSS and other
                                       back office systems. If the Company
                                       consummates the Equity Offering but not
                                       the Debt Offering or the Vendor
                                       Financing, the Company intends to modify
                                       its deployment schedule by developing
                                       only five to seven Phase II markets. If
                                       the Company consummates both the Equity
                                       and Debt Offerings, but the Vendor
                                       Financing is not obtained, the Company
                                       intends to modify its deployment schedule
                                       by developing only eight to ten Phase II
                                       markets. In each such case, the Company
                                       would delay deployment of networks in the
                                       remaining Phase II markets until it
                                       obtains additional financing on
                                       acceptable terms and conditions. In
                                       addition, a portion of such proceeds may
                                       be used to fund acquisitions or the
                                       deployment of networks and operating
                                       costs in other markets. See "Use of
                                       Proceeds."
    
 
   
Nasdaq National Market Symbol......    "ALGX"
    
---------------
 
   
(1) Based upon 40,341,554 shares of Common Stock outstanding immediately prior
    to the Equity Offering (giving effect to the conversion of the Company's
    outstanding 12% Cumulative Convertible Preferred Stock (the "Redeemable
    Convertible Preferred Stock") into Common Stock in connection with the
    Equity Offering) and assumes the U.S. Underwriters' over-allotment option is
    not exercised. Excludes 886,594 shares reserved for issuance upon the
    exercise of options granted and 649,248 shares reserved for issuance upon
    the exercise of outstanding warrants. Also excludes 3,806,658 shares and
    2,305,718 shares which, prior to the consummation of the Equity Offering,
    will be reserved under the Company's 1998 Stock Plan and Stock Purchase Plan
    (each as defined herein), respectively. See "Management -- Stock Plans" and
    "Description of Capital Stock."
    
 
                                  RISK FACTORS
 
     See "Risk Factors" for a discussion of certain factors relating to the
Company, its business, and an investment in the Common Stock. Prior to
purchasing any of the Common Stock offered hereby, prospective purchasers should
carefully consider such risk factors in addition to the other information
contained in this Prospectus.
 
                                        9
<PAGE>   11
 
                                  RISK FACTORS
 
     Prior to purchasing any of the Common Stock offered hereby, prospective
purchasers should carefully consider the following risk factors in addition to
the other information contained in this Prospectus.
 
LIMITED HISTORY OF OPERATIONS; HISTORICAL AND ANTICIPATED FUTURE NEGATIVE EBITDA
AND OPERATING LOSSES
 
   
     The Company was formed in April 1997 and has generated operating losses and
negative cash flow from its limited operating activities to date. The Company's
primary activities have consisted of the procurement of governmental
authorizations, the acquisition of equipment and facilities, the hiring of
management and other key personnel, the raising of capital, the development,
acquisition and integration of OSS and other back office systems and the
negotiation of interconnection agreements. As of June 25, 1998, the Company has
sold 18,858 lines to 1,120 customers, of which 10,993 lines for 688 customers
were in service as of such date. As a result of the Company's limited operating
history, prospective investors have limited operating and financial data about
the Company upon which to base an evaluation of the Company's performance and an
investment in the Common Stock. The Company's ability to provide "one-stop
shopping" bundled telecommunications services on a widespread basis and to
generate operating profits and positive operating cash flow will depend on its
ability, among other things, to: (i) develop its operational support and other
back office systems; (ii) obtain state authorizations to operate as a CLEC and
any other required governmental authorizations; (iii) attract and retain an
adequate customer base; (iv) raise additional capital; (v) attract and retain
qualified personnel; and (vi) enter into and implement interconnection
agreements with ILECs. See "Business -- Business Strategy." There can be no
assurance that it will be able to achieve any of these objectives, generate
sufficient revenues to make principal and interest payments on its indebtedness
or compete successfully in the telecommunications industry.
    
 
     The development of the Company's business and the deployment of its
services and systems will require significant capital expenditures, a
substantial portion of which will need to be incurred before the realization of
significant revenues. The Company expects to continue to generate negative
earnings before interest, income taxes, depreciation and amortization ("EBITDA")
while it emphasizes development, construction, and expansion of its
telecommunications services business and until the Company establishes a
sufficient revenue-generating customer base. For the three months ended March
31, 1998 and from inception (April 22, 1997) through December 31, 1997, the
Company had operating losses of $5.9 million and $3.8 million, net losses (after
accreting redeemable preferred stock and warrant values) of $13.7 million and
$7.5 million and negative EBITDA of $5.7 million and $3.8 million, respectively.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations." The Company expects that each targeted market will generally
produce negative EBITDA for at least two to three years after operations
commence in such market, and the Company expects to experience increasing
operating losses and negative EBITDA as it expands its operations. There can be
no assurance that the Company will achieve or sustain profitability or generate
sufficient EBITDA to meet its working capital and debt service requirements,
which could have a material adverse effect on the Company. See "-- Substantial
Leverage; Possible Inability to Service Indebtedness."
 
SIGNIFICANT CAPITAL REQUIREMENTS; UNCERTAINTY OF ADDITIONAL FINANCING
 
     The expansion and development of the Company's business and deployment of
its networks, services and systems will require significant capital to fund
capital expenditures, working capital, debt service and cash flow deficits. The
Company's principal capital expenditure requirements involve the purchase and
installation of collocation equipment, network switches and switch electronics
and network operations center expenditures. The Company estimates, based on its
current business plan, that its aggregate capital requirements (including
requirements to fund capital expenditures, working capital, debt service and
cash flow deficits) to fund the deployment and operation of its networks in all
Phase I and Phase II markets to Positive Free Cash Flow will total between $650
million and $700 million. Actual capital requirements may vary based upon the
timing and success of the Company's implementation of its business plan.
 
     Since the completion of the Unit Offering, the Company has increased the
scope of its business plan to accommodate (i) an expansion of the Company's
network buildout in certain Phase I markets to include
 
                                       10
<PAGE>   12
 
   
additional central offices, thereby giving the Company access to a larger number
of potential customers in those markets, (ii) an accelerated and expanded
deployment of data, Internet and enhanced services in the Company's markets, and
(iii) the acceleration of network deployment in Phase II markets. The Company
believes, based on its modified business plan, that the net proceeds from the
Offerings, together with cash on hand (including proceeds from the Equity
Contributions and the Unit Offering), and funding expected to be available under
the Vendor Financing will be sufficient to pre-fund its Phase I and Phase II
market deployment to Positive Free Cash Flow. If the Company consummates the
Equity Offering but not the Debt Offering or the Vendor Financing, the Company
intends to modify its deployment schedule by developing only five to seven Phase
II markets. If the Company consummates both the Equity and Debt Offerings, but
the Vendor Financing is not obtained, the Company intends to modify its
deployment schedule by developing only eight to ten Phase II markets. In each
such case, the Company would delay deployment of networks in the remaining Phase
II markets until it obtains additional financing on acceptable terms and
conditions. There can be no assurance that the Vendor Financing will be
available on terms acceptable to the Company or at all.
    
 
   
     The actual amount and timing of the Company's future capital requirements
may differ materially from the Company's estimates as a result of, among other
things, the demand for the Company's services and regulatory, technological and
competitive developments (including additional market developments and new
opportunities) in the Company's industry. The Company's revenues and costs are
dependent upon factors that are not within the Company's control, such as
regulatory changes, changes in technology, and increased competition. Due to the
uncertainty of these factors, actual revenues and costs may vary from expected
amounts, possibly to a material degree, and such variations are likely to affect
the Company's future capital requirements. The Company also expects that it will
require additional financing (or require financing sooner than anticipated) if:
(i) the Company's development plans or projections change or prove to be
inaccurate; (ii) the Company engages in any acquisitions; (iii) the Vendor
Financing is not obtained on a timely basis or at all; or (iv) the Company
alters the schedule or targets of its roll-out plan or, in the event the Debt
Offering is not consummated, the Company accelerates the implementation of its
network deployment in the remaining Phase II markets. Sources of additional
financing may include commercial bank borrowings, vendor financing, or the
private or public sale of equity or debt securities.
    
 
     There can be no assurance that the Company will be successful in raising
sufficient additional capital at all or on terms that it will consider
acceptable, that the terms of additional indebtedness are within the limitations
contained in the Company's financing agreements, including the indenture
relating to the 11 3/4% Notes (the "11 3/4% Notes Indenture") and the indenture
relating to the Notes offered in the Debt Offering (the "Indenture," and,
together with the 11 3/4% Notes Indenture, the "Indentures"), or that the terms
of such indebtedness will not impair the Company's ability to develop its
business. See "-- Restrictive Covenants." Failure to raise sufficient funds may
require the Company to modify, delay or abandon some of its planned future
expansion or expenditures, which could have a material adverse effect on the
Company. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."
 
BUSINESS DEVELOPMENT AND EXPANSION RISKS; POSSIBLE INABILITY TO MANAGE GROWTH
 
     The Company is in the early stages of its operations and has only recently
begun to deploy networks in its first eight target markets. The success of the
Company will depend, among other things, upon the Company's ability to assess
potential markets, obtain required governmental authorizations, franchises and
permits, secure financing, market to, sell and provision new customers,
implement interconnection and collocation with ILEC facilities, lease adequate
trunking capacity from ILECs or other CLECs, purchase and install switches in
additional markets, implement efficient OSS and other back office systems, and
develop a sufficient customer base. The successful implementation of the
Company's business plan will result in rapid expansion of its operations and the
\provision of bundled telecommunications services on a widespread basis. Rapid
expansion of the Company's operations may place a significant strain on the
Company's management, financial and other resources.
 
     The Company's ability to manage future growth, should it occur, will depend
upon its ability to develop efficient OSS and other back office systems, monitor
operations, control costs, maintain regulatory compliance, maintain effective
quality controls and significantly expand the Company's internal management,
 
                                       11
<PAGE>   13
 
technical, information and accounting systems and to attract, assimilate and
retain additional qualified personnel. See "-- Dependence on Key Personnel."
Failure of the Company to manage its future growth effectively could adversely
affect the expansion of the Company's customer base and service offerings. There
can be no assurance that the Company will successfully implement and maintain
such operational and financial systems or successfully obtain, integrate and
utilize the employees and management, operational and financial resources
necessary to manage a developing and expanding business in an evolving, highly
regulated and increasingly competitive industry. Any failure to expand these
areas and to implement and improve such systems, procedures and controls in an
efficient manner at a pace consistent with the growth of the Company's business
could have a material adverse effect on the Company.
 
     If the Company were unable to hire sufficient qualified personnel or
develop, acquire and integrate successfully its operational and information
systems, customers could experience delays in connection of service and/or lower
levels of customer service. Failure by the Company to meet the demands of
customers and to manage the expansion of its business and operations could have
a material adverse effect on the Company.
 
DEPENDENCE ON KEY PERSONNEL
 
     The Company is managed by a small number of key executive officers, most
notably Royce J. Holland, the Company's Chairman and Chief Executive Officer.
The loss of services of one or more of these key individuals, particularly Mr.
Holland, could materially and adversely affect the business of the Company and
its prospects. The Company believes that its success will depend in large part
on its ability to develop a large and effective sales force and its ability to
attract and retain highly skilled and qualified personnel. Most of the executive
officers of the Company, including the regional vice presidents of its operating
subsidiaries, do not have employment agreements, and the Company does not
maintain key person life insurance for any of its executive officers. Although
the Company has been successful in attracting and retaining qualified personnel,
the competition for qualified managers in the telecommunications industry is
intense and, accordingly, there can be no assurance that the Company will be
able to hire or retain necessary personnel in the future. The Company and two of
its executives have been named as defendants in a lawsuit by WorldCom relating
to the Company's hiring of certain former WorldCom employees. See
"Business -- Legal Proceedings."
 
DEPENDENCE ON BILLING, CUSTOMER SERVICE AND INFORMATION SYSTEMS
 
     Sophisticated back office information and processing systems are vital to
the Company's growth and its ability to monitor costs, bill customers, provision
customer orders and achieve operating efficiencies. The Company's plans for the
development and implementation of these OSS rely, for the most part, on choosing
products and services offered by third party vendors and integrating such
products and services in-house to produce efficient operational solutions. There
can be no assurance that these systems will be successfully implemented on a
timely basis or at all or will perform as expected. Failure of these vendors to
deliver proposed products and services in a timely and effective manner and at
acceptable costs, failure of the Company to adequately identify all of its
information and processing needs, failure of the Company's related processing or
information systems, failure of the Company to effectively integrate such
products or services, or the failure of the Company to upgrade systems as
necessary could have a material adverse effect on the Company. In addition, the
Company's right to use these systems is dependent upon license agreements with
third party vendors. Certain of such agreements may be cancellable by the vendor
and the cancellation or nonrenewal of these agreements may have an adverse
effect on the Company.
 
   
     While the Company believes that its systems will be year 2000 compliant,
there can be no assurance until the year 2000 occurs that all systems will then
function adequately. Further, if the systems of the ILECs, long distance
carriers and others on whose services the Company depends or with whom the
Company's systems interface are not year 2000 compliant, it would have a
material adverse effect on the Company.
    
 
                                       12
<PAGE>   14
 
SUBSTANTIAL LEVERAGE; POSSIBLE INABILITY TO SERVICE INDEBTEDNESS
 
   
     The Company is highly leveraged. The Company's earnings for the three
months ended March 31, 1998 and the period from inception (April 22, 1997)
through December 31, 1997 were insufficient to cover fixed charges by $8.9
million and $3.7 million, respectively. On a pro forma basis, giving effect to
the Unit Offering and the Debt Offering (assuming a 12 7/8% per annum effective
interest rate on the Notes) and giving effect to $179.7 million and $205.1
million of management ownership allocation charge to be recorded in connection
with the Equity Offering, as if such transactions had occurred on January 1,
1998 and April 22, 1997, the Company's earnings before fixed charges would have
been insufficient to cover its fixed charges by $198.2 million for the three
months ended March 31, 1998 and $249.6 million for the period from inception
(April 22, 1997) through December 31, 1997, respectively.
    
 
   
     After giving pro forma effect to the Offerings, as of March 31, 1998, the
Company's aggregate outstanding indebtedness would have been $447.3 million, and
the Company's stockholders' equity would have been $228.4 million. In addition,
the accretion of original issue discount on the 11 3/4% Notes will cause an
increase in indebtedness of $197.7 million by February 15, 2008. The Company
also plans to obtain approximately $100.0 million of Vendor Financing. See
"Selected Financial Data," "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources," and
"Description of Certain Indebtedness." The Company's leverage will increase if
the Debt Offering is consummated. The Indentures limit, but do not prohibit, the
incurrence of additional indebtedness by the Company. In particular, the
Indentures permit the Company and its subsidiaries to incur an unlimited amount
of indebtedness to finance the cost of equipment, inventory and network assets.
See "-- Restrictive Covenants."
    
 
     The Company's high degree of leverage could have important consequences to
its future prospects, including but not limited to: (i) impairing the Company's
ability to obtain additional financing for working capital, capital
expenditures, acquisitions or general corporate purposes; (ii) requiring the
Company to dedicate a substantial portion of its cash flow from operations to
the payment of principal and interest on its indebtedness, thereby reducing the
funds available to the Company for its operations and other purposes, including
acquisitions and investments in product development and capital spending; (iii)
placing the Company at a competitive disadvantage with those of its competitors
which are not as highly leveraged as the Company; (iv) impairing the Company's
ability to adjust rapidly to changing market conditions; and (v) making the
Company more vulnerable in the event of a downturn in general economic
conditions or in its business or of changing market conditions and regulations.
 
     There can be no assurance that the Company will be able to meet its debt
service obligations. If the Company is unable to generate sufficient cash flow
or otherwise obtain funds necessary to make required payments, or if the Company
otherwise fails to comply with the various covenants in its debt obligations, it
would be in default under the terms thereof, which would permit the holders of
such indebtedness to accelerate the maturity of such indebtedness and could
cause defaults under other indebtedness of the Company. The Company's ability to
repay or to refinance its obligations with respect to its indebtedness will
depend on its future financial and operating performance, which, in turn, will
be subject to prevailing economic and competitive conditions and to certain
financial, business and other factors, many of which are beyond the Company's
control. These factors could include operating difficulties, increased operating
costs, pricing pressures, the response of competitors, regulatory developments,
and delays in implementing strategic projects.
 
     The successful implementation of the Company's business strategy, including
deployment of its networks and obtaining and retaining a significant number of
customers, and significant and sustained growth in the Company's cash flow are
necessary for the Company to be able to meet its debt service and working
capital requirements. There can be no assurance that the Company will
successfully implement its business strategy, that the anticipated results of
its strategy will be realized, or that the Company will be able to generate
sufficient cash flow from operating activities to meet its debt service
obligations and working capital requirements. See "Business -- Business
Strategy." If the Company's cash flow and capital resources are insufficient to
fund its debt service and working capital obligations, the Company may be forced
to reduce or delay capital expenditures (including switch and network
expenditures), sell assets, or seek to obtain
 
                                       13
<PAGE>   15
 
   
additional equity capital, or to refinance or restructure its debt. A
disposition of assets in order to make up for any shortfall in the payments due
on the Company's indebtedness could take place under circumstances that might
not be favorable to realizing the highest price for such assets. There can be no
assurance that the Company's cash flow and capital resources will be sufficient
for payment of principal of, and premium, if any, and interest on, its
indebtedness in the future, or that any such alternative measures would be
successful or would permit the Company to meet its debt service and working
capital obligations. In addition, because the Company's obligations under the
Vendor Financing, if obtained, are expected to bear interest at floating rates,
an increase in interest rates could adversely affect, among other things, the
Company's ability to meet its debt service obligations.
    
 
CONTROL BY FUND INVESTORS; POTENTIAL CONFLICTS OF INTEREST
 
     The Fund Investors, through their significant equity ownership, have the
ability to control the direction and future operations of the Company. See
"Management -- Election of Directors; Voting Agreement," "Security Ownership of
Certain Beneficial Owners and Management" and "Certain Relationships and Related
Transactions." Certain decisions concerning the operations or financial
structure of the Company may present conflicts of interest between the Fund
Investors and Management Investors and other holders of the Common Stock. In
addition to their investments in the Company, the Fund Investors or their
affiliates currently have significant investments in other telecommunications
companies and may in the future invest in other entities engaged in the
telecommunications business or in related businesses (including entities engaged
in business in areas in which the Company operates). As a result, these
investors have, and may develop, relationships with businesses that are or may
be competitive with the Company. Conflicts may also arise in the negotiation or
enforcement of arrangements entered into by the Company and entities in which
these investors have an interest. In addition, the Company and these investors
have agreed that such investors are under no obligation to bring to the Company
any investment or business opportunities of which they become aware, even if
such opportunities are within the scope and objectives of the Company. Royce J.
Holland, the Company's Chairman and Chief Executive Officer also has an
investment in, and serves on the board of directors of WNP Communications, Inc.,
which will operate in certain of the Company's target markets.
 
RESTRICTIVE COVENANTS
 
   
     The Indentures and the agreements entered into in connection with the
Equity Contributions contain a number of covenants that will limit the
discretion of the Company's management with respect to certain business matters.
These covenants, among other things, restrict the ability of the Company to
incur additional indebtedness, pay dividends and make other distributions,
prepay subordinated indebtedness, make investments and other restricted
payments, enter into sale and leaseback transactions, create liens, sell assets,
and engage in certain transactions with affiliates. In addition, the Vendor
Financing, if obtained, is expected to contain covenants, including financial
covenants, customary for such agreements. See "Certain Relationships and Related
Transactions," and "Description of Certain Indebtedness."
    
 
   
     A failure to comply with the covenants and restrictions contained in the
Indentures, the Vendor Financing or agreements relating to any subsequent
financing could result in an event of default under such agreements which could
permit acceleration of the related debt and acceleration of debt under other
debt agreements that may contain cross-acceleration or cross-default provisions,
and the commitments of the lenders to make further extensions under such other
agreements could be terminated.
    
 
DIFFICULTIES IN IMPLEMENTING LOCAL AND ENHANCED SERVICES
 
     The Company has begun, and plans to continue, to deploy high capacity
digital switches in the cities in which it will operate networks and plans
initially to rely on ILEC or CLEC facilities for certain aspects of
transmission. Subject to obtaining interconnection, this will enable the Company
to offer a variety of switched access services, enhanced services and local dial
tone. Although under the Telecommunications Act the ILECs will be required to
unbundle network elements and permit the Company to purchase only the
origination and termination services it needs, thereby decreasing operating
expenses, there can be no assurance that such unbundling will be effected in a
timely manner and result in prices favorable to the Company. In
 
                                       14
<PAGE>   16
 
addition, the Company's ability to implement successfully its switched and
enhanced services will require the negotiation of resale agreements with ILECs
and other CLECs and the negotiation of interconnection and collocation
agreements with ILECs, which can take considerable time, effort and expense and
are subject to federal, state and local regulation.
 
     In August 1996, the FCC released a decision implementing the
interconnection portions of the Telecommunications Act (the "Interconnection
Decision"). The Interconnection Decision establishes rules for negotiating
interconnection agreements and guidelines for review of such agreements by state
public utilities commissions. On July 18, 1997, the United States Court of
Appeals for the Eighth Circuit (the "Eighth Circuit") vacated certain portions
of the Interconnection Decision, including provisions establishing a pricing
methodology for unbundled network elements and a procedure permitting new
entrants to "pick and choose" among various provisions of existing
interconnection agreements between ILECs and their competitors. On October 14,
1997, the Eighth Circuit issued a decision vacating additional FCC rules that
will likely have the effect of increasing the cost of obtaining the use of
combinations of an ILEC's unbundled network elements. The Eighth Circuit
decisions create uncertainty about the rules governing pricing, terms and
conditions of interconnection agreements, and could make negotiating and
enforcing such agreements more difficult and protracted and may require
renegotiation of existing agreements. See "-- Competition." The Supreme Court
has granted a writ of certiorari to review the Eighth Circuit decisions.
 
     Many new carriers have experienced difficulties in working with the ILECs
with respect to provisioning, interconnection, collocation and implementing the
systems used by these new carriers to order and receive unbundled network
elements and wholesale services from the ILECs. Coordination with ILECs is
necessary for new carriers such as the Company to provide local service to
customers on a timely and competitive basis. The Telecommunications Act created
incentives for regional Bell operating companies ("RBOCs") to cooperate with new
carriers and permit access to their facilities by denying the RBOCs the ability
to provide in-region long distance services until they have satisfied statutory
conditions designed to open their local markets to competition. A federal
District Court has recently held these provisions of the Telecommunications Act
unconstitutional, which decision is subject to appeal. See "-- Government
Regulation." The RBOCs in the Company's markets are not yet permitted by the FCC
to offer long distance services and there can be no assurance that these RBOCs
will be accommodating to the Company once they are permitted to offer long
distance service. If the Company is unable to obtain the cooperation of a RBOC
in a region, whether or not such RBOC has been authorized to offer long distance
service, the Company's ability to offer local services in such region on a
timely and cost-effective basis would be adversely affected.
 
   
     A number of ILECs around the country have been contesting whether the
obligation to pay reciprocal compensation to CLECs should apply to local
telephone calls terminating to ISPs. The ILECs claim that this traffic is
interstate in nature and therefore should be exempt from compensation
arrangements applicable to local, intrastate calls. The FCC, however, has
determined on a number of occasions, including in its May 16, 1997 access charge
reform order, that calls to ISPs should be exempt from interstate access charges
and should be governed by local exchange tariffs. Under the Eighth Circuit
decisions, however, the states have primary jurisdiction over the determination
of reciprocal compensation arrangements and as a result, the treatment of this
issue can vary from state to state. Currently, 20 state commissions, two federal
courts and one state court have ruled that reciprocal compensation arrangements
do apply to ISP traffic. However, certain of these rulings are subject to
appeal. Disputes over the appropriate treatment of ISP traffic are pending in
eight states. The National Association of Regulatory Commissioners ("NARUC")
adopted a resolution in favor of reciprocal compensation for ISP traffic. The
Company anticipates that ISPs will be among its target customers, and adverse
decisions in these proceedings could limit the Company's ability to service this
group of customers profitably.
    
 
     The profitability of the Company's Internet access services, and related
services such as Web site hosting, may be affected by its ability to obtain
"peering" arrangements with ISPs. In recent years, major ISPs routinely
exchanged traffic with other ISPs that met certain technical criteria on a
"peering" basis, meaning that each ISP accepted traffic routed to Internet
addresses on its system from its "peers" on a reciprocal basis, without payment
of compensation. In 1997, however, UUNET Technologies, Inc. ("UUNET"), the
largest ISP, announced that it intends to greatly restrict its use of peering
arrangements with other providers, and
 
                                       15
<PAGE>   17
 
would impose charges for accepting traffic from providers other than its
"peers." Other major ISPs have reportedly adopted similar policies. There can be
no assurance that the Company will be able to negotiate "peer" status with any
of the major nationwide ISPs, or that it will be able to terminate traffic on
ISPs' networks at favorable prices. In addition, the pending merger between
WorldCom (UUNET's parent) and MCI (another major ISP) is expected to increase
the concentration of market power for ISP backbone services, and may adversely
affect the Company's ability to obtain favorable peering terms.
 
     The Company is a recent entrant into the newly created competitive local
telecommunications services industry. The local dial tone services market in
most states was only recently opened to competition due to the passage of the
Telecommunications Act and related regulatory rulings. There are numerous
operating complexities associated with providing these services. The Company
will be required to develop new products, services and systems and will need to
develop new marketing initiatives to sell these services.
 
     The Company's switched services may not be profitable due to, among other
factors, lack of customer demand, inability to secure access to ILEC facilities
on acceptable terms, and competition and pricing pressure from the ILECs and
other CLECs. There can be no assurance that the Company will be able to
successfully implement its switched and enhanced services strategy.
 
     Implementation of the Company's switched and enhanced services is also
dependent upon equipment manufacturers' ability to meet the Company's switch
deployment schedule. There can be no assurance that switches will be deployed on
the schedule contemplated by the Company or that, if deployed, such switches
will be utilized to the degree contemplated by the Company.
 
DEPENDENCE ON LEASED TRUNKING CAPACITY; FUTURE NEED TO OBTAIN PERMITS,
RIGHTS-OF-WAY, AND OTHER THIRD-PARTY AGREEMENTS
 
     Under the Company's "smart build" strategy, the Company will initially seek
to lease from ILECs and other CLECs local fiber trunking capacity connecting the
Allegiance switch to particular ILEC central offices and then replace this
leased trunk capacity in the future with its own fiber on a "success basis" as
warranted by traffic volume growth. There can be no assurance that all such
required trunking capacity will be available to the Company on a timely basis or
on terms acceptable to the Company. The failure to obtain such leased fiber
could delay the Company's ability to penetrate certain market areas or require
it to make additional unexpected up-front capital expenditures to install its
own fiber and could have a material adverse effect on the Company. If and when
the Company seeks to install its own fiber, the Company must obtain local
franchises and other permits, as well as rights-of-way to utilize underground
conduit and aerial pole space and other rights-of-way from entities such as
ILECs and other utilities, railroads, long distance companies, state highway
authorities, local governments and transit authorities. There can be no
assurance that the Company will be able to obtain and maintain the franchises,
permits and rights needed to implement its network buildout on acceptable terms.
The failure to enter into and maintain any such required arrangements for a
particular network may affect the Company's ability to develop that network and
may have a material adverse effect on the Company. See "Business -- Network
Architecture."
 
RISKS RELATING TO LONG DISTANCE BUSINESS
 
     As part of its "one-stop shopping" offering of bundled telecommunications
services to its customers, the Company plans to offer long distance services to
its customers. The long distance business is extremely competitive and prices
have declined substantially in recent years and are expected to continue to
decline. In addition, the long distance industry has historically had a high
average churn rate, as customers frequently change long distance providers in
response to the offering of lower rates or promotional incentives by
competitors. The Company will initially rely on other carriers to provide
transmission and termination services for all of its long distance traffic. The
Company will need resale agreements with long distance carriers to provide it
with transmission services. Such agreements typically provide for the resale of
long distance services on a per-minute basis and may contain minimum volume
commitments. Negotiation of these agreements involves estimates of future supply
and demand for transmission capacity as well as estimates of the calling pattern
and traffic levels of the Company's future customers. In the event the Company
fails to meet its
 
                                       16
<PAGE>   18
 
minimum volume commitments, it may be obligated to pay underutilization charges
and in the event it underestimates its need for transmission capacity, the
Company may be required to obtain capacity through more expensive means.
 
COMPETITION
 
     The telecommunications industry is highly competitive. In each of the
markets targeted by the Company, the Company will compete principally with the
ILEC serving that area. ILECs are established providers of local telephone
services to all or virtually all telephone subscribers within their respective
service areas. ILECs also have long-standing relationships with regulatory
authorities at the federal and state levels. While some FCC and state
administrative decisions and initiatives provide increased business
opportunities to telecommunications providers such as the Company, they also
provide the ILECs with pricing flexibility for their private line and special
access and switched access services. In addition, with respect to competitive
access services (as opposed to switched local exchange services), the FCC
recently proposed a rule that would provide for increased ILEC pricing
flexibility and deregulation for such access services either automatically or
after certain competitive levels are reached. If the ILECs are allowed by
regulators to offer discounts to large customers through contract tariffs,
engage in aggressive volume and term discount pricing practices for their
customers, and/or seek to charge competitors excessive fees for interconnection
to their networks, ILEC competitors such as the Company could be materially
adversely affected. If future regulatory decisions afford the ILECs increased
access services pricing flexibility or other regulatory relief, such decisions
could also have a material adverse effect on ILEC competitors such as the
Company.
 
     The Company also faces, and expects to continue to face, competition from
other current and potential market entrants, including long distance carriers
seeking to enter, reenter or expand entry into the local exchange marketplace
such as AT&T Corp. ("AT&T"), MCI Communications Corporation ("MCI"), Sprint
Corporation ("Sprint"), and WorldCom, and from other CLECs, resellers,
competitive access providers ("CAPs"), cable television companies, electric
utilities, microwave carriers, wireless telephone system operators and private
networks built by large end users. In addition, the development of new
technologies could give rise to significant new competitors to the Company. The
Company also competes with equipment vendors and installers, and
telecommunications management companies with respect to certain portions of its
business. Many of the Company's current and potential competitors have
financial, technical, marketing, personnel and other resources, including brand
name recognition, substantially greater than those of the Company, as well as
other competitive advantages over the Company.
 
     The Telecommunications Act includes provisions which impose certain
regulatory requirements on all local exchange carriers, including ILEC
competitors such as the Company, while granting the FCC expanded authority to
reduce the level of regulation applicable to any or all telecommunications
carriers, including ILECs. The manner in which these provisions of the
Telecommunications Act are implemented and enforced could have a material
adverse effect on the Company's ability to successfully compete against ILECs
and other telecommunications service providers.
 
     As a recent entrant in the integrated telecommunications services industry,
the Company has not achieved and does not expect to achieve a significant market
share for any of its services. In particular, the ILECs have long-standing
relationships with their customers, have financial, technical, marketing,
personnel and other resources substantially greater than those of the Company,
have the potential to subsidize competitive services with revenues from a
variety of businesses and currently benefit from existing regulations that favor
the ILECs over the Company in certain respects. Certain federal and state laws
and regulations that allow CLECs such as the Company to interconnect with ILEC
facilities, provide increased business opportunities for the Company. However,
such interconnection opportunities have been accompanied by increased pricing
flexibility for and relaxation of regulatory oversight of the ILECs.
 
     To the extent the Company interconnects with and uses ILEC networks to
service its customers, the Company will be dependent upon the technology and
capabilities of the ILECs to meet certain telecommunications needs of the
Company's customers and to maintain its service standards, and the Company must
interface with the ILECs' legacy OSS in order to properly provision new
customers. The
 
                                       17
<PAGE>   19
 
Telecommunications Act imposes interconnection obligations on ILECs, but there
can be no assurance that the Company will be able to obtain the interconnection
it requires at rates, and on terms and conditions, that permit the Company to
offer switched services that are both competitive and profitable. See
"-- Difficulties in Implementing Local and Enhanced Services." In the event that
the Company experiences difficulties in obtaining high quality, reliable and
reasonably priced services from the ILECs, the attractiveness of the Company's
services to its customers could be impaired.
 
   
     The long distance telecommunications market has numerous entities competing
for the same customers and a high average churn rate, as customers frequently
change long distance providers in response to the offering of lower rates or
promotional incentives. Prices in the long distance market have declined
significantly in recent years and are expected to continue to decline. The
Company will face competition from large carriers such as AT&T, MCI, Sprint, and
WorldCom. Other competitors are likely to include RBOCs providing out-of-region
(and, with the removal of regulatory barriers, in-region) long distance
services, other CLECs, microwave and satellite carriers and private networks
owned by large end users. See "-- Government Regulation." The Company may also
increasingly face competition from companies offering long distance data and
voice services over the Internet. Such companies could enjoy a significant cost
advantage because they do not currently pay carrier access charges or universal
service fees. In addition, in June 1998, Sprint announced its intention to offer
voice, data and video services over its nationwide asynchronous transfer mode
network, which Sprint anticipates will significantly reduce its cost to provide
such services. Sprint plans to bill its customers based upon the amount of
traffic carried, irrespective of the time required to send the traffic or the
traffic's destination.
    
 
     The Internet services market is highly competitive and the Company expects
that competition will continue to intensify. The Company's competitors in this
market include ISPs, other telecommunications companies, online services
providers and Internet software providers. Many of these competitors have
greater financial, technological, marketing, personnel and other resources than
those available to the Company.
 
     The Company believes that the principal competitive factors affecting its
business operations are pricing levels and clear pricing policies, reliable
customer service, accurate billing and, to a lesser extent, variety of services.
The ability of the Company to compete effectively will depend upon its continued
ability to maintain high quality, market-driven services at prices generally
equal to or below those charged by its competitors. To maintain its competitive
posture, the Company believes that it must be in a position to reduce its prices
in order to meet reductions in rates, if any, offered by others. Any such
reductions could adversely affect the Company.
 
     The recent World Trade Organization ("WTO") agreement on basic
telecommunications services could increase the level of competition faced by the
Company. Under this agreement, the United States and 72 other members of the WTO
committed themselves to opening their respective telecommunications markets
and/or foreign ownership and/or to adopting regulatory measures to protect
competitors against anticompetitive behavior by dominant telecommunications
companies, effective in some cases as early as January 1998. There can be no
assurance that the pro-competitive effects of the WTO agreement will not have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Business -- Competition."
 
   
     A continuing trend toward consolidation, mergers, acquisitions and
strategic alliances in the telecommunications industry could also increase the
level of competition faced by the Company. For example, WorldCom acquired MFS in
December 1996, has recently acquired another CLEC, Brooks Fiber Properties,
Inc., and has a pending agreement to merge with MCI. In January 1998, AT&T
announced its intention to acquire Teleport Communications Group Inc. In May
1998, SBC Communications Inc. and Ameritech Corporation agreed to merge. On June
24, 1998, AT&T announced that it has entered into a merger agreement with
Tele-Communications, Inc., a cable, telecommunications, and high speed Internet
services provider. These types of consolidations and alliances could put the
Company at a competitive disadvantage.
    
 
                                       18
<PAGE>   20
 
GOVERNMENT REGULATION
 
     The Company's networks and the provision of telecommunications services are
subject to significant regulation at the federal, state and local levels. Delays
in receiving required regulatory approvals or the enactment of new adverse
regulation or regulatory requirements may have a material adverse effect upon
the Company.
 
     The FCC exercises jurisdiction over the Company with respect to interstate
and international services. Additionally, the Company files tariffs with the
FCC. On October 29, 1996, the FCC approved an order that eliminates the tariff
filing requirements for interstate domestic long distance service provided by
non-dominant carriers such as the Company. On February 13, 1997, the United
States Court of Appeals for the District of Columbia Circuit stayed the FCC
order, and the Company is required to continue filing tariffs while this stay
remains in effect. If the stay is lifted and the FCC order becomes effective,
telecommunications carriers such as the Company will no longer be able to rely
on the filing of tariffs with the FCC as a means of providing notice to
customers of prices, terms, and conditions on which they offer interstate
services. While tariffs offered a means of providing notice of prices, terms,
and conditions, the Company intends to rely primarily on its sales force and
direct marketing to provide such information to its customers. In addition, the
Company must obtain (and has obtained through its subsidiary, Allegiance Telecom
International, Inc.) prior FCC authorization for installation and operation of
international facilities and the provision (including resale) of international
long distance services.
 
     State regulatory commissions exercise jurisdiction over the Company to the
extent it provides intrastate services. As such a provider, the Company is
required to obtain regulatory authorization and/or file tariffs at state
agencies in most of the states in which it operates. If and when the Company
seeks to overbuild certain network segments, local authorities regulate the
Company's access to municipal rights-of-way. Network buildouts are also subject
to numerous local regulations such as building codes and licensing. Such
regulations vary on a city by city and county by county basis. See
"Business -- Regulation."
 
     There can be no assurance that the FCC or state commissions will grant
required authority or refrain from taking action against the Company if it is
found to have provided services without obtaining the necessary authorizations.
If authority is not obtained or if tariffs are not filed, or are not updated, or
otherwise do not fully comply with the tariff filing rules of the FCC or state
regulatory agencies, third parties or regulators could challenge these actions.
Such challenges could cause the Company to incur substantial legal and
administrative expenses.
 
     The Telecommunications Act provides for a significant deregulation of the
domestic telecommunications industry, including the local exchange, long
distance and cable television industries. The Telecommunications Act remains
subject to judicial review and additional FCC rulemaking, and thus it is
difficult to predict what effect the legislation will have on the Company and
its operations. There are currently many regulatory actions underway and being
contemplated by federal and state authorities regarding interconnection pricing
and other issues that could result in significant changes to the business
conditions in the telecommunications industry. There can be no assurance that
these changes will not have a material adverse effect upon the Company.
 
     On December 31, 1997, the U.S. District Court for the Northern District of
Texas issued a decision (the "SBC Decision") finding that Sections 271 to 275 of
the Telecommunications Act are unconstitutional. These sections of the
Telecommunications Act impose restrictions on the lines of business in which the
RBOCs may engage, including establishing the conditions they must satisfy before
they may provide in-region interLATA telecommunications services. The SBC
Decision has been stayed while an appeal is pending before the United States
Court of Appeals for the Fifth Circuit. The Company cannot predict the likely
outcome of that appeal, although on May 15, 1998, the Court of Appeals for the
District of Columbia Circuit rejected a very similar challenge to the
constitutionality of Section 274 of the Telecommunications Act. If the SBC
Decision is upheld on appeal, however, the RBOCs would be able to provide such
in-region services immediately without satisfying the statutory conditions. This
would likely have an unfavorable effect on the Company's business for at least
two reasons. First, the SBC Decision removes the incentive RBOCs have to
cooperate with companies like Allegiance to foster competition within their
service areas so that they can qualify to offer in-region interLATA services
because the decision allows RBOCs to offer such services immediately. However,
the
 
                                       19
<PAGE>   21
 
SBC Decision does not affect other provisions of the Telecommunications Act
which create legal obligations for all ILECs to offer interconnection and
network access. Second, the Company is legally able to offer its customers both
long distance and local exchange services, which the RBOCs currently may not do.
This ability to offer "one-stop shopping" gives the Company a marketing
advantage that it would no longer enjoy if the SBC Decision were upheld on
appeal.
 
     In addition to requirements placed on ILECs, the Telecommunications Act
subjects the Company to certain federal regulatory requirements relating to the
provision of local exchange service in a market. All ILECs and CLECs must
interconnect with other carriers, provide nondiscriminatory access to
rights-of-way, offer reciprocal compensation for termination of traffic, and
provide dialing parity and telephone number portability. The Telecommunications
Act also requires all telecommunications carriers to ensure that their services
are accessible to and usable by persons with disabilities.
 
     On May 8, 1997, the FCC released an order establishing a significantly
expanded federal universal service subsidy regime. For example, the FCC
established new subsidies for telecommunications and information services
provided to qualifying schools and libraries with an annual cap of $2.3 billion
and for services provided to rural health care providers with an annual cap of
$400.0 million. The FCC also expanded the federal subsidies for local exchange
telephone service provided to low-income consumers. Providers of interstate
telecommunications service, such as the Company, as well as certain other
entities, must pay for these programs. The Company's share of these federal
subsidy funds will be based on its share of certain defined telecommunications
end-user revenues. Currently, the FCC is assessing such payments on the basis of
a provider's revenue for the previous year; since the Company had no significant
revenues in 1997, it will not be liable for subsidy payments in any material
amount during 1998. With respect to subsequent years, however, the Company is
currently unable to quantify the amount of subsidy payments that it will be
required to make and the effect that these required payments will have on its
financial condition. In the May 8th order, the FCC also announced that it will
soon revise its rules for subsidizing service provided to consumers in high cost
areas, which may result in further substantial increases in the overall cost of
the subsidy program. Several parties have appealed the May 8th order. Such
appeals have been consolidated and transferred to the United States Court of
Appeals for the Fifth Circuit where they are currently pending. In addition, on
July 3, 1997, several ILECs filed a petition for stay of the May 8th order with
the FCC. That petition is pending, as well as several petitions for
administrative reconsideration of the order.
 
     To the extent the Company provides interexchange telecommunications
service, it is required to pay access charges to ILECs when it uses the
facilities of those companies to originate or terminate interexchange calls.
Also, as a CLEC, the Company provides access services to other interexchange
service providers. The interstate access charges of ILECs are subject to
extensive regulation by the FCC, while those of CLECs are subject to a lesser
degree of FCC regulation but remain subject to the requirement that all charges
be just, reasonable, and not unreasonably discriminatory. In two orders released
on December 24, 1996, and May 16, 1997, the FCC made major changes in the
interstate access charge structure. In the December 24th order, the FCC removed
restrictions on ILECs' ability to lower access prices and relaxed the regulation
of new switched access services in those markets where there are other providers
of access services. If this increased pricing flexibility is not effectively
monitored by federal regulators, it could have a material adverse effect on the
Company's ability to compete in providing interstate access services. The May
16th order substantially increased the costs that ILECs subject to the FCC's
price cap rules ("price cap LECs") recover through monthly,
non-traffic-sensitive access charges and substantially decreased the costs that
price cap LECs recover through traffic-sensitive access charges. In the May 16th
order, the FCC also announced its plan to bring interstate access rate levels
more in line with cost. The plan will include rules that are expected to be
established sometime in 1998 that may grant price cap LECs increased pricing
flexibility upon demonstrations of increased competition (or potential
competition) in relevant markets. The manner in which the FCC implements this
approach to lowering access charge levels could have a material effect on the
Company's ability to compete in providing interstate access services. Several
parties have appealed the May 16th order. Those appeals have been consolidated
and transferred to the United States Court of Appeals for the Eighth Circuit
where they are currently pending.
 
                                       20
<PAGE>   22
 
   
     The FCC released a report to Congress on April 10, 1998 concerning its
implementation of the telecommunications subsidy provisions of the
Telecommunications Act. In that report, the FCC clarified that entities that
provide transmission capacity to ISPs are providing telecommunications services
subject to contribution requirements. The FCC indicated that it would address
the issues of whether ISPs would contribute to the universal service fund based
on the utilization of their own transmission facilities and whether certain ISP
services such as phone-to-phone IP telephony are telecommunications services
subject to universal service fund contributions and access charges at a later
date.
    
 
NEED TO ADAPT TO TECHNOLOGICAL CHANGE
 
     The telecommunications industry is subject to rapid and significant changes
in technology, with the Company relying on third parties for the development of
and access to new technology. The effect of technological changes on the
business of the Company cannot be predicted. The Company believes its future
success will depend, in part, on its ability to anticipate or adapt to such
changes and to offer, on a timely basis, services that meet customer demands.
There can be no assurance that the Company will obtain access to new technology
on a timely basis or on satisfactory terms. Any failure by the Company to obtain
new technology could have a material adverse effect on the Company.
 
ACQUISITION RELATED RISKS
 
     The Company may, as part of its business strategy, acquire other businesses
that will complement its existing business. Management is unable to predict
whether or when any prospective acquisitions will occur or the likelihood of a
material transaction being completed on favorable terms and conditions. The
Company's ability to finance acquisitions may be constrained by, among other
things, its high degree of leverage. The Indentures may significantly limit the
Company's ability to make acquisitions and to incur indebtedness in connection
with acquisitions. Such transactions commonly involve certain risks, including,
among others: the difficulty of assimilating the acquired operations and
personnel; the potential disruption of the Company's ongoing business and
diversion of resources and management time; the possible inability of management
to maintain uniform standards, controls, procedures and policies; the risks of
entering markets in which the Company has little or no direct prior experience;
and the potential impairment of relationships with employees or customers as a
result of changes in management. There can be no assurance that any acquisition
will be made, that the Company will be able to obtain additional financing
needed to finance such acquisitions and, if any acquisitions are so made, that
the acquired business will be successfully integrated into the Company's
operations or that the acquired business will perform as expected. The Company
has no definitive agreement with respect to any acquisition, although from time
to time it has discussions with other companies and assesses opportunities on an
ongoing basis.
 
     The Company may also enter into joint venture transactions. These
transactions present many of the same risks involved in acquisitions and may
also involve the risk that other joint venture partners may have economic,
business or legal interests or objectives that are inconsistent with those of
the Company. Joint venture partners may also be unable to meet their economic or
other obligations, thereby forcing the Company to fulfill these obligations.
 
INVESTMENT COMPANY ACT CONSIDERATIONS
 
     After giving effect to the Unit Offering and the Offerings, the Company
will have substantial short-term investments. See "Capitalization" and "Use of
Proceeds." This may result in the Company being treated as an "investment
company" under the Investment Company Act of 1940 (the "1940 Act"). The 1940 Act
requires the registration of, and imposes various substantive restrictions on,
certain companies ("investment companies") that are, or hold themselves out as
being, engaged primarily, or propose to engage primarily in, the business of
investing, reinvesting or trading in securities, or that fail certain
statistical tests regarding composition of assets and sources of income and are
not primarily engaged in businesses other than investing, reinvesting, owning,
holding or trading securities.
 
                                       21
<PAGE>   23
 
     The Company believes that it is primarily engaged in a business other than
investing, reinvesting, owning, holding or trading securities and, therefore, is
not an investment company within the meaning of the 1940 Act. If the Company is
found to be an investment company, the Company currently intends to rely upon a
safeharbor from the 1940 Act for certain "transient" or temporary investment
companies. However, such exemption is only available to the Company for one year
and this one-year period may terminate as soon as January 1999.
 
     If the Company were required to register as an investment company under the
1940 Act, it would become subject to substantial regulation with respect to its
capital structure, management, operations, transactions with affiliated persons
(as defined in the 1940 Act) and other matters. To avoid having to register as
an investment company, beginning in as early as January 1999, the Company may
have to invest a portion of its liquid assets in cash and demand deposits
instead of securities. The extent to which the Company will have to do so will
depend on the composition and value of the Company's total assets at that time.
Having to register as an investment company under the 1940 Act or having to
invest a material portion of the Company's liquid assets in cash and demand
deposits to avoid such registration, would have a material adverse effect on the
Company's business, financial condition and results of operations.
 
ABSENCE OF PRIOR PUBLIC MARKET; MARKET PRICE FLUCTUATIONS
 
     Prior to the Equity Offering, there has been no public market for the
Common Stock. Although the Company has applied to list the Common Stock on the
Nasdaq National Market, there can be no assurance that an active trading market
for the Common Stock will develop or be sustained. While the Underwriters (other
than Morgan Stanley & Co. Incorporated) have informed the Company that they
intend to make a market in the Common Stock, the Underwriters are not obligated
to do so and any such market making may be discontinued at any time without
notice at the sole discretion of the Underwriters. The initial public offering
price of the Common Stock offered hereby will be determined by negotiations
among the Company and the Underwriters and should not be considered an
indication of the market price of the Common Stock after the Equity Offering.
See "Underwriters." Purchasers of the Common Stock in the Equity Offering will
be subject to immediate and substantial dilution. See "Dilution." The market
price of the Common Stock may fluctuate significantly and may be affected by
various factors, including differences between the Company's actual financial or
operating results and those expected by investors and analysts, pricing and
competition in the telecommunications industry, regulatory changes, news
announcements or changes in general market conditions. In addition, broad market
fluctuation and general economic and political conditions may adversely affect
the market price of the Common Stock, regardless of the Company's actual
performance.
 
SHARES ELIGIBLE FOR FUTURE SALES
 
     Upon consummation of the Equity Offering, the Company will have 52,341,554
shares of Common Stock outstanding (assuming no exercise of the U.S.
Underwriters' over-allotment option), excluding 6,998,970 shares reserved for
issuance under the Company's stock plans and 649,248 shares reserved for
issuance upon the exercise of outstanding warrants. See "Management -- Stock
Plans" and "Description of Capital Stock." All of the shares of Common Stock
sold in the Equity Offering will be freely tradeable under the Securities Act of
1933, as amended (the "Securities Act"), unless held by an "affiliate" of the
Company, as that term is defined in the Securities Act. The Management Investors
have agreed with the Underwriters and certain other stockholders have agreed
with the Company that until one year after the date of this Prospectus (the date
of such Prospectus, the "Effective Date"), and the Fund Investors have agreed
with the Underwriters that until 180 days after the Effective Date, they will
not directly or indirectly, offer, pledge, sell, contract to sell, sell any
option or contract to purchase or otherwise dispose of any Common Stock or any
securities convertible into or exercisable or exchangeable for Common Stock, or
in any manner transfer all or a portion of the economic consequences associated
with the ownership of the Common Stock, or cause a registration statement
covering any shares of Common Stock to be filed, without the prior written
consent of Morgan Stanley & Co. Incorporated and Smith Barney Inc. or the
Company, as applicable, subject to certain limited exceptions. The Company has
also agreed not to directly or indirectly, offer, pledge, sell, contract to
sell, sell any option or contract to purchase or otherwise dispose of any Common
Stock or any securities
 
                                       22
<PAGE>   24
 
   
convertible into or exercisable or exchangeable for Common Stock or, in any
manner, transfer all or a portion of the economic consequences associated with
the ownership of the Common Stock or cause a registration statement covering any
shares of Common Stock to be filed, for a period of 180 days after the Effective
Date, without the prior written consent of Morgan Stanley & Co. Incorporated and
Smith Barney Inc., subject to certain limited exceptions including the issuance
of shares of Common Stock under the Stock Purchase Plan and 1998 Stock Plan and
grants of options pursuant to, and issuance of shares of Common Stock upon
exercise of options under, the 1997 Nonqualified Stock Option Plan and the 1998
Stock Plan. See "Management -- Stock Plans." Upon the expiration of the 180 day
and one year lock-ups described above, 26,998,992 shares of Common Stock and
13,342,562 shares of Common Stock, respectively, will become eligible for sale,
subject to compliance with Rule 144 of the Securities Act. In addition, pursuant
to the Company's Registration Agreement and the Company's Warrant Registration
Agreement (each as defined herein), holders of 26,998,992 shares of Common Stock
and warrants to purchase 649,248 shares of Common Stock, respectively, will have
the right to require the Company to register their shares under the Securities
Act. See "Description of Capital Stock -- Registration Rights." The Company also
intends to file a registration statement on Form S-8 covering the sale of
6,998,970 shares of Common Stock reserved for issuance under the Company's stock
plans. See "Management -- Stock Plans." No prediction can be made as to the
effect, if any, that sales of shares of Common Stock or the availability of
shares of Common Stock for sale will have on the market price of the Common
Stock from time to time. The sale of a substantial number of shares held by
existing stockholders, whether pursuant to subsequent public offerings or
otherwise, or the perception that such sales could occur, could adversely affect
the market price of the Common Stock and could materially impair the Company's
future ability to raise capital through an offering of equity securities. See
"Shares Eligible For Future Sale" and "Underwriters."
    
 
CERTAIN ANTI-TAKEOVER EFFECTS
 
     Certain provisions of the Company's Restated Certificate of Incorporation
(the "Restated Certificate") and Amended and Restated By-laws (the "By-laws")
may inhibit changes in control of the Company not approved by the Company's
Board of Directors. These provisions include: (i) a classified Board of
Directors; (ii) a prohibition on stockholder action through written consents;
(iii) a requirement that special meetings of stockholders be called only by the
Board of Directors; (iv) advance notice requirements for stockholder proposals
and nominations; (v) limitations on the ability of stockholders to amend, alter
or repeal the By-laws; and (vi) the authority of the Board to issue without
stockholder approval preferred stock with such terms as the Board may determine.
The Company will also be afforded the protections of Section 203 of the Delaware
General Corporation Law, which could have similar effects. See "Description of
Capital Stock."
 
     In addition, the Indentures provide that upon a "change of control," each
note holder will have the right to require the Company to purchase all or a
portion of such holder's notes at a purchase price of 101% of the accreted value
thereof (in the case of the 11 3/4% Notes) and 101% of the principal amount
thereof (in the case of the Notes), together with accrued and unpaid interest,
if any, to the date of such redemption. Such obligation, if it arises, could
have a material adverse effect on the Company. Such provision could also delay,
deter or prevent a takeover attempt.
 
RISKS REGARDING FORWARD-LOOKING STATEMENTS
 
     This Prospectus contains "forward-looking statements", which generally can
be identified by the use of forward-looking terminology such as "believes",
"expects", "may", "will", "should", or "anticipates" or the negative thereof or
other variations thereon or comparable terminology, or by discussion of strategy
that involve risks and uncertainties. Management wishes to caution the reader
that these forward-looking statements, such as the Company's plans and
strategies, its anticipation of revenues from designated markets, and statements
regarding the development of the Company's businesses, the markets for the
Company's services and products, the Company's anticipated capital expenditures,
possible changes in regulatory requirements and other statements contained
herein regarding matters that are not historical facts, are only predictions and
estimates regarding future events and circumstances. Cautionary statements are
disclosed in this Prospectus, including, without limitation, in connection with
the forward-looking statements included
 
                                       23
<PAGE>   25
 
herein and under "Risk Factors." No assurance can be given that the future
results will be achieved; actual events or results may differ materially as a
result of risks facing the Company. Such risks include, but are not limited to,
the Company's ability to successfully market its services to current and new
customers, interconnect with ILECs, develop efficient OSS and other back office
systems, provision new customers, access markets, identify, finance and complete
suitable acquisitions, install facilities, including switching electronics, and
obtain leased trunking capacity, rights-of-way, building access rights and any
required governmental authorizations, franchises and permits, all in a timely
manner, at reasonable costs and on satisfactory terms and conditions, as well as
regulatory, legislative and judicial developments that could cause actual
results to differ materially from the future results indicated, expressed or
implied, in such forward-looking statements. All subsequent written and oral
forward-looking statements attributable to the Company or persons acting on its
behalf are expressly qualified in their entirety by such cautionary statements.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of their dates. The Company undertakes no
obligations to publicly update or revise any forward-looking statements, whether
as a result of new information, future events or otherwise.
 
                                       24
<PAGE>   26
 
                                USE OF PROCEEDS
 
   
     The net proceeds to the Company from the Equity Offering are estimated to
be approximately $189.5 million (approximately $218.0 million if the U.S.
Underwriters' over-allotment option is exercised in full), after deducting
estimated underwriting discounts and commissions and other expenses payable by
the Company (assuming an initial public offering price of $17.00 per share,
representing the midpoint of the initial public offering price range). The net
proceeds to the Company from the Debt Offering are estimated to be approximately
$192.8 million, after deducting estimated underwriting discounts and commissions
and other expenses payable by the Company. The closing of the Debt Offering is
conditioned upon the closing of the Equity Offering, but the closing of the
Equity Offering is not conditioned upon the closing of the Debt Offering. There
can be no assurance that the Debt Offering will be consummated.
    
 
   
     The Company intends to use the net proceeds from the Offerings, together
with the remaining proceeds from the Equity Contributions and the Unit Offering
and funding expected to be available under the Vendor Financing, to fund the
costs of deploying networks in all 24 Phase I and Phase II markets and the
operation of those networks to Positive Free Cash Flow, including the costs to
develop, acquire and integrate the necessary OSS and other back office systems.
In addition, at the closing of the Debt Offering, the Company will use
approximately $67.4 million of the net proceeds from the Debt Offering to
purchase the pledged securities, consisting of U.S. government securities (the
"Pledged Securities"), pursuant to a collateral pledge and security agreement
(the "Pledge Agreement") made by the Company in favor of The Bank of New York
(the "Trustee"). The Pledged Securities will be pledged to the Trustee as
security for the benefit of the holders of the Notes and will be used to fund
the first six scheduled payments of interest on the Notes. See "Description of
Certain Indebtedness." The precise amount of proceeds to be used to purchase
Pledged Securities will depend on the interest rates on U.S. government
securities prevailing on the closing date of the Debt Offering. The Trustee will
hold the Pledged Securities pursuant to the Pledge Agreement pending
disbursement. If the Company consummates the Equity Offering but not the Debt
Offering or the Vendor Financing, the Company intends to modify its deployment
schedule by developing only five to seven Phase II markets. If the Company
consummates both the Equity and Debt Offerings, but the Vendor Financing is not
obtained, the Company intends to modify its deployment schedule by developing
only eight to ten Phase II markets. In each such case, the Company would delay
deployment of networks in the remaining Phase II markets until it obtains
additional financing on acceptable terms and conditions. The Company's principal
capital expenditure requirements include the purchase and installation of
digital switches, transmission equipment collocated in ILEC central offices,
customer premise equipment, and the overbuilding of leased transmission
facilities as traffic volume growth makes it economically attractive.
    
 
   
     As part of its strategy, the Company may make acquisitions and enter into
joint ventures, and a portion of the net proceeds from the Offerings may be used
for such purposes. The Company has no definitive agreement with respect to any
acquisition or joint venture, although from time to time it has discussions with
other companies and assesses opportunities on an ongoing basis. The Company may
require additional financing to complete its Phase I and Phase II market
buildout (or require financing sooner than anticipated) if: (i) the Company's
development plans or projections change or prove to be inaccurate; (ii) the
Company engages in any acquisitions; (iii) the Vendor Financing is not obtained
on a timely basis or at all; or (iv) the Company alters the schedule or targets
of its roll-out plan or, in the event the Debt Offering is not consummated, the
Company accelerates the implementation of its network deployment in the
remaining Phase II markets. There can be no assurance that such additional
financing will be available on terms acceptable to the Company or at all. See
"Prospectus Summary -- Financing Plan," "Risk Factors -- Significant Capital
Requirements; Uncertainty of Additional Financing" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
    
 
                                DIVIDEND POLICY
 
     The Company has not paid any dividends since its inception and does not
anticipate declaring or paying cash dividends in the foreseeable future, as it
intends to retain future earnings, if any, for reinvestment in its business and
repayment of indebtedness. Any determination to declare or pay cash dividends
will be at the discretion of the Company's Board of Directors, will be subject
to compliance with the Company's debt financing arrangements and will depend on
the Company's financial condition, results of operations, capital requirements
and such other factors as the Company's Board of Directors considers relevant.
Certain covenants in the Indentures prohibit or limit the ability of the Company
and its subsidiaries to declare or pay cash dividends. See "Description of
Certain Indebtedness."
 
                                       25
<PAGE>   27
 
                                    DILUTION
 
     The pro forma net tangible book value (deficit) of the Company as of March
31, 1998, after giving effect to the Equity Allocation (as defined herein) and
the conversion of the Company's Redeemable Convertible Preferred Stock to Common
Stock, was approximately $39.0 million, or $.97 per share of Common Stock. Net
tangible book value (deficit) per share represents the amount of the Company's
total tangible assets less its total liabilities, divided by the number of
shares of Common Stock outstanding. After giving effect to the receipt of $189.5
million of estimated net proceeds from the sale of Common Stock in the Equity
Offering (assuming an initial public offering price of $17.00 per share), the
pro forma net tangible book value of the Company as of March 31, 1998 would have
been approximately $228.4 million, or $4.36 per share of Common Stock. This
represents an immediate dilution in net tangible book value of $12.15 per share
to new investors purchasing shares in the Equity Offering. The following table
illustrates this dilution:
 
<TABLE>
<S>                                                           <C>      <C>
Assumed initial public offering price per share.............           $17.00
  Pro forma net tangible book value (deficit) per share as
     of March 31, 1998......................................  $ .97
  Increase in net tangible book value per share attributable
     to the Equity Offering.................................  $3.39
                                                              -----
Pro forma net tangible book value per share after the
  Equity Offering...........................................           $ 4.36
                                                                       ------
Dilution in net tangible book value per share to new
  investors purchasing shares in the Equity Offering........           $12.64
                                                                       ======
</TABLE>
 
     If the U.S. Underwriters' over-allotment option is exercised in full, the
pro forma net tangible book value per share after giving effect to the Equity
Offering would have been $4.75, representing an immediate dilution in net
tangible book value of $12.25 per share to new investors purchasing shares in
the Equity Offering and an immediate increase in net tangible book value of
$3.78 per share to existing stockholders.
 
     The foregoing computations assume no exercise of any stock options or
warrants. As of June 4, 1998, there were outstanding 886,594 options and 649,248
warrants to purchase an aggregate of 1,535,842 shares of Common Stock at
exercise prices from $2.47 to $3.46 per share for the options and $.01 per share
for the warrants. If all of the foregoing options and warrants had been
exercised as of March 31, 1998, the net tangible book value per share of Common
Stock at such date would have been $1.00 and the pro forma net tangible book
value per share after giving effect to the Equity Offering would have been
$4.29, representing an immediate dilution in net tangible book value of $12.71
per share to new investors purchasing shares in the Equity Offering and an
immediate increase in net tangible book value of $3.29 per share to existing
stockholders.
 
     The following table summarizes, on a pro forma basis as of March 31, 1998,
the number of shares of Common Stock purchased from the Company, the total
consideration paid and the average price per share paid by the existing
stockholders and new investors purchasing shares in the Equity Offering,
adjusted to give effect to the sale of the shares of Common Stock offered hereby
at an assumed initial public offering price of $17.00 per share and before
deducting the underwriting discount and the estimated expenses of the Equity
Offering payable by the Company:
 
<TABLE>
<CAPTION>
                               SHARES PURCHASED         TOTAL CONSIDERATION
                             ---------------------    -----------------------    AVERAGE PRICE
                               NUMBER      PERCENT       AMOUNT       PERCENT      PER SHARE
                             ----------    -------    ------------    -------    -------------
<S>                          <C>           <C>        <C>             <C>        <C>
Existing stockholders......  40,341,554       77%     $ 50,468,842     19.8%        $ 1.25
Investors purchasing shares
  in the Equity Offering...  12,000,000       23       204,000,000     80.2          17.00
                             ----------      ---      ------------     ----         ------
          Total............  52,341,554      100%     $254,468,842      100%        $ 4.86
                             ==========      ===      ============     ====         ======
</TABLE>
 
     The foregoing data has been computed based upon the estimated number of
shares of Common Stock to be outstanding after the Equity Offering, excluding
6,998,970 shares of Common Stock reserved for issuance under the Company's stock
plans and 649,248 shares reserved for issuance upon the exercise of outstanding
warrants. See "Management -- Stock Plans" and "Description of Capital Stock."
 
                                       26
<PAGE>   28
 
                                 CAPITALIZATION
 
     The following table sets forth the cash and capitalization of the Company
as of March 31, 1998, and as adjusted to give effect to the sale of Common Stock
in the Equity Offering (based on an assumed public offering price of $17.00 per
share) and the sale of Notes in the Debt Offering. The closing of the Debt
Offering is conditioned upon the closing of the Equity Offering, but the closing
of the Equity Offering is not conditioned upon the closing of the Debt Offering.
There can be no assurance that the Debt Offering will be consummated. This table
should be read in conjunction with "Selected Financial Data," "Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
the consolidated financial statements, including the notes thereto, and other
financial data contained elsewhere in this Prospectus.
 
   
<TABLE>
<CAPTION>
                                                                            AS OF MARCH 31, 1998
                                                              -------------------------------------------------
                                                                               AS ADJUSTED      AS ADJUSTED FOR
                                                                              FOR THE EQUITY    THE EQUITY AND
                                                                 ACTUAL          OFFERING       DEBT OFFERINGS
                                                              ------------    --------------    ---------------
                                                               (AUDITED)       (UNAUDITED)        (UNAUDITED)
<S>                                                           <C>             <C>               <C>
Cash, cash equivalents, and short-term investments..........  $257,594,702    $ 447,074,702      $ 572,424,702
Restricted cash.............................................            --               --         67,400,000
                                                              ------------    -------------      -------------
        Total cash, cash equivalents, short-term investments
        and restricted cash.................................  $257,594,702    $ 447,074,702      $ 639,824,702
                                                              ============    =============      =============
Long-term debt(1):
  11 3/4% Notes, at accreted value(2).......................  $247,329,420    $ 247,329,420      $ 247,329,420
  Notes offered in Debt Offering............................            --               --        200,000,000
                                                              ------------    -------------      -------------
      Total long-term debt..................................   247,329,420      247,329,420        447,329,420
                                                              ------------    -------------      -------------
Redeemable convertible preferred stock(3)(4):
  Redeemable convertible preferred stock, $.01 par value,
    96,000 and 0 shares authorized, 95,641.25 and 0 shares
    issued and outstanding at March 31, 1998 and as
    adjusted, respectively..................................    59,206,139               --                 --
  Preferred stock subscriptions receivable..................      (275,000)              --                 --
                                                              ------------    -------------      -------------
        Total redeemable convertible preferred stock........    58,931,139               --                 --
Redeemable warrants(2)......................................     8,257,542        8,257,542          8,257,542
Stockholders' (deficit) equity:
  Preferred stock, $.01 par value, 0 and 1,000,000 shares
    authorized, 0 and 0 shares issued and outstanding at
    March 31, 1998 and as adjusted, respectively(5).........            --               --                 --
  Common stock, $.01 par value, 102,524 and 150,000,000
    shares authorized, 1 share and 52,341,554 shares issued
    and outstanding at March 31, 1998 and as adjusted,
    respectively(4).........................................            --          523,416            523,416
  Additional paid-in capital(3)(4)(6).......................    14,405,519      495,312,187        495,312,187
  Stock subscriptions receivable............................            --         (275,000)          (275,000)
  Deferred compensation.....................................   (13,216,518)     (13,216,518)       (13,216,518)
  Deferred management ownership allocation charge(6)........            --      (98,199,717)       (98,199,717)
  Accumulated (deficit) equity(6)...........................   (21,162,048)    (155,706,276)      (155,706,276)
                                                              ------------    -------------      -------------
      Total stockholders' (deficit) equity(4)(6)............   (19,973,047)     228,438,092        228,438,092
                                                              ------------    -------------      -------------
        Total capitalization................................  $294,545,054    $ 484,025,054      $ 684,025,054
                                                              ============    =============      =============
</TABLE>
    
 
---------------
 
   
(1) Does not reflect any of the financing expected to be available under the
    Vendor Financing.
    
   
(2) Of the $250,477,150 gross proceeds from the Unit Offering, $242,293,600 was
    allocated to the initial accreted value of the 11 3/4% Notes, and $8,183,550
    was allocated to the Warrants. The Warrants may be required to be redeemed
    by the Company for cash upon the occurrence of a Repurchase Event, as
    defined in the provisions of the Warrant Agreement.
    
   
(3) In connection with the consummation of the Equity Offering, the outstanding
    shares of Redeemable Convertible Preferred Stock will be converted into
    Common Stock. At such time, the obligations of the Company to redeem the
    Redeemable Convertible Preferred Stock terminates and, therefore the value
    of the Redeemable Convertible Preferred Stock accreted to the date of the
    Equity Offering will be reclassified as an increase in the amount of Common
    Stock and additional paid-in capital in the stockholders' equity section of
    the balance sheet.
    
   
(4) As adjusted reflects the net proceeds from the issuance of Common Stock in
    the Equity Offering and the conversion of the outstanding Redeemable
    Convertible Preferred Stock into Common Stock.
    
   
(5) In connection with the consummation of the Equity Offering, the Company will
    authorize 1,000,000 shares of Preferred Stock with a $.01 par value.
    
   
(6) Upon the consummation of the Equity Offering, Allegiance LLC, the holder of
    substantially all of the Company's outstanding capital stock, will dissolve
    and its assets (which consist almost entirely of such capital stock) will be
    distributed to the Fund Investors and the Management Investors in accordance
    with a final allocation calculated immediately prior to such dissolution
    (the "Equity Allocation"). The LLC Agreement (as defined herein) provides
    that the Equity Allocation between the Fund Investors and the Management
    Investors will range between 95.0%/5.0% and 66.7%/33.3% based upon the
    valuation of the Company's Common Stock implied by the Equity Offering.
    Based upon the valuation of the Company's Common Stock, the Equity
    Allocation will be 66.7% to the Fund Investors and 33.3% to the Management
    Investors. Under generally accepted accounting principles, upon consummation
    of the Equity Offering, the Company will be required to record the $232.7
    million increase in the assets of Allegiance LLC allocated to the Management
    Investors as an increase in additional paid-in capital, of which the Company
    will be required to record $134.5 million as a non-cash, non-recurring
    charge to operating expense and $98.2 million will be recorded as deferred
    management ownership allocation charge. The deferred charge will be
    amortized at $64.6 million, $24.7 million, $8.8 million, and $.1 million
    during 1998, 1999, 2000, and 2001, respectively, which is the period over
    which the Company has the right to repurchase the securities (at the lower
    of fair market value or the price paid by the employee) in the event the
    management employee's employment with the Company is terminated. See
    "Certain Relationships and Related Transactions."
    
 
                                       27
<PAGE>   29
 
                            SELECTED FINANCIAL DATA
 
     The selected consolidated financial data presented below as of and for the
three months ended March 31, 1998 and as of and for the period from inception
(April 22, 1997) to December 31, 1997 were derived from the audited consolidated
financial statements of the Company and the notes thereto contained elsewhere in
this Prospectus, which statements have been audited by Arthur Andersen LLP,
independent public accountants. The selected pro forma statement of operations
data set forth below is unaudited and gives effect to the Debt Offering, the
Equity Offering (including the conversion of the Redeemable Convertible
Preferred Stock and the Equity Allocation), and the sale of the 11 3/4% Notes in
the Unit Offering as if such transactions had occurred on April 22, 1997, for
the period from inception through December 31, 1997 and on January 1, 1998 for
the three months ended March 31, 1998, and the selected pro forma balance sheet
data set forth below is unaudited and gives effect to such transactions as if
they had occurred on March 31, 1998. Operating results for the three months
ended March 31, 1998 are not necessarily indicative of the results that may be
expected for the entire year.
 
     From the Company's formation in April 1997 until December 16, 1997, the
Company was in the development stage. The Company has generated operating losses
and negative cash flow from its limited operating activities to date. As a
result of the Company's limited operating history, prospective investors have
limited operating and financial data about the Company upon which to base an
evaluation of the Company's performance and an investment in the Common Stock.
The selected financial data set forth below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the consolidated financial statements, including the notes
thereto, contained elsewhere in this Prospectus.
   
<TABLE>
<CAPTION>
 
                                     THREE MONTHS ENDED MARCH 31, 1998
                             --------------------------------------------------
                                                         PRO FORMA
                                            -----------------------------------
                                                               AS ADJUSTED FOR
                                                               THE EQUITY AND
                                ACTUAL       ADJUSTMENT       DEBT OFFERINGS(1)
                             ------------   -------------     -----------------
                              (AUDITED)      (UNAUDITED)         (UNAUDITED)
<S>                          <C>            <C>               <C>
STATEMENT OF OPERATIONS
  DATA:
Revenues...................  $    202,925   $          --       $     202,925
Operating expenses:
  Technical................       234,831              --             234,831
  Selling, general and
    administrative.........     5,680,031              --           5,680,031
  Management ownership
    allocation charge......            --     179,670,386(2)      179,670,386
  Depreciation and
    amortization...........       208,424              --             208,424
                             ------------   -------------       -------------
    Total operating
      expenses.............     6,123,286     179,670,386         185,793,672
                             ------------   -------------       -------------
Loss from operations.......    (5,920,361)   (179,670,386)       (185,590,747)
Interest income............     2,194,226              --(3)        2,194,226
Interest expense...........    (4,669,079)     (9,639,452)(4)     (14,308,531)
                             ------------   -------------       -------------
Net loss...................  $ (8,395,214)  $(189,309,838)      $(197,705,052)
Accretion of redeemable
  convertible preferred
  stock and warrant
  values...................    (5,264,684)         (7,435)(5)      (5,272,119)
                             ------------   -------------       -------------
Net loss applicable to
  common stock.............  $(13,659,898)  $(189,317,273)      $(202,977,171)
                             ============   =============       =============
Net loss per share,
  basic....................  $(13,659,898)                      $       (3.88)
                             ============                       =============
Net loss per share,
  diluted..................  $(13,659,898)                      $       (3.81)
                             ============                       =============
Weighted average number of
  shares outstanding,
  basic....................             1      52,341,553(6)       52,341,554
                             ============   =============       =============
 
<CAPTION>
                                     PERIOD FROM INCEPTION (APRIL 22, 1997)
                                            THROUGH DECEMBER 31, 1997
                             -------------------------------------------------------
                                                              PRO FORMA
                                                 -----------------------------------
                                                                    AS ADJUSTED FOR
                                                                    THE EQUITY AND
                                  ACTUAL          ADJUSTMENT       DEBT OFFERINGS(1)
                             -----------------   -------------     -----------------
                                 (AUDITED)        (UNAUDITED)         (UNAUDITED)
<S>                          <C>                 <C>               <C>
STATEMENT OF OPERATIONS
  DATA:
Revenues...................     $       403      $          --       $         403
Operating expenses:
  Technical................         151,269                 --             151,269
  Selling, general and
    administrative.........       3,635,872                 --           3,635,872
  Management ownership
    allocation charge......              --        205,092,580(2)      205,092,580
  Depreciation and
    amortization...........          12,639                 --              12,639
                                -----------      -------------       -------------
    Total operating
      expenses.............       3,799,780        205,092,580         208,892,360
                                -----------      -------------       -------------
Loss from operations.......      (3,799,377)      (205,092,580)       (208,891,957)
Interest income............         111,417                 --(3)          111,417
Interest expense...........              --        (40,856,994)(4)     (40,856,994)
                                -----------      -------------       -------------
Net loss...................     $(3,687,960)     $(245,949,574)      $(249,637,534)
Accretion of redeemable
  convertible preferred
  stock and warrant
  values...................      (3,814,190)          (288,568)(5)      (4,102,758)
                                -----------      -------------       -------------
Net loss applicable to
  common stock.............     $(7,502,150)     $(246,238,142)      $(253,740,292)
                                ===========      =============       =============
Net loss per share,
  basic....................     $(7,502,150)                         $       (4.87)
                                ===========                          =============
Net loss per share,
  diluted..................     $(7,502,150)                         $       (4.80)
                                ===========                          =============
Weighted average number of
  shares outstanding,
  basic....................               1         52,068,191(6)       52,068,192
                                ===========      =============       =============
</TABLE>
    
 
                                       28
<PAGE>   30
   
<TABLE>
<CAPTION>
 
                                     THREE MONTHS ENDED MARCH 31, 1998
                             --------------------------------------------------
                                                         PRO FORMA
                                            -----------------------------------
                                                               AS ADJUSTED FOR
                                                               THE EQUITY AND
                                ACTUAL       ADJUSTMENT       DEBT OFFERINGS(1)
                             ------------   -------------     -----------------
                              (AUDITED)      (UNAUDITED)         (UNAUDITED)
<S>                          <C>            <C>               <C>
OTHER FINANCIAL DATA:
EBITDA(7)..................  $ (5,711,937)  $(179,670,386)(2)   $(185,382,323)
Net cash used in operating
  activities...............    (2,195,564)             --          (2,195,564)
Net cash used in investing
  activities...............   (43,525,476)    (67,400,000)(8)    (110,925,476)
Net cash provided by
  financing activities.....   261,672,797     381,598,696(9)      643,271,493
Capital expenditures.......     8,510,255              --           8,510,255
Ratio of earnings to fixed
  charges(10)..............            --              --                  --
 
<CAPTION>
                                     PERIOD FROM INCEPTION (APRIL 22, 1997)
                                            THROUGH DECEMBER 31, 1997
                             -------------------------------------------------------
                                                              PRO FORMA
                                                 -----------------------------------
                                                                    AS ADJUSTED FOR
                                                                    THE EQUITY AND
                                  ACTUAL          ADJUSTMENT       DEBT OFFERINGS(1)
                             -----------------   -------------     -----------------
                                 (AUDITED)        (UNAUDITED)         (UNAUDITED)
<S>                          <C>                 <C>               <C>
OTHER FINANCIAL DATA:
EBITDA(7)..................     $(3,786,738)     $(205,092,580)(2)   $(208,879,318)
Net cash used in operating
  activities...............      (1,942,897)       (15,950,000)(8)     (17,892,897)
Net cash used in investing
  activities...............     (21,926,058)       (54,525,000)(8)     (76,451,058)
Net cash provided by
  financing activities.....      29,595,314        622,940,450(9)      652,535,764
Capital expenditures.......      23,912,659                 --          23,912,659
Ratio of earnings to fixed
  charges(10)..............              --                 --                  --
</TABLE>
    
 
   
<TABLE>
<CAPTION>
                                                MARCH 31, 1998
                             -----------------------------------------------------
                                                          PRO FORMA
                                            --------------------------------------
                                                                  AS ADJUSTED FOR    DECEMBER 31,
                                                                  THE EQUITY AND         1997
                                ACTUAL       ADJUSTMENT          DEBT OFFERINGS(1)      ACTUAL
                             ------------   -------------        -----------------   ------------
                              (AUDITED)      (UNAUDITED)            (UNAUDITED)       (AUDITED)
<S>                          <C>            <C>                  <C>                 <C>            <C>             <C>
BALANCE SHEET DATA (AT END
  OF PERIOD):
Cash, cash equivalents and
  short-term investments...  $257,594,702   $ 314,830,000(9)       $ 572,424,702     $ 5,726,359
Restricted cash............            --      67,400,000(8)          67,400,000              --
Property and equipment,
  net......................    32,669,385              --             32,669,385      23,900,020
Total assets...............   300,227,692     389,480,000(4)(9)      689,707,692      30,047,014
Long-term debt.............   247,329,420     200,000,000(11)        447,329,420(12)          --
Redeemable convertible
  preferred stock, net.....    58,931,139     (58,931,139)(13)                --      33,409,404
Redeemable warrants........     8,257,542              --              8,257,542              --
Stockholders' (deficit)
  equity...................   (19,973,047)    248,411,139(14)        228,438,092      (7,292,090)
</TABLE>
    
 
---------------
 
 (1) The closing of the Debt Offering is conditioned upon the closing of the
     Equity Offering, but the closing of the Equity Offering is not conditioned
     upon the closing of the Debt Offering. There can be no assurance that the
     Debt Offering will be consummated.
 
   
     The table below sets forth certain pro forma statement of operations data
     assuming the Debt Offering and the Vendor Financing are not consummated.
    
 
<TABLE>
<CAPTION>
                                                                         AS ADJUSTED FOR
                                                                       THE EQUITY OFFERING
                                                           --------------------------------------------
                                                                                  PERIOD FROM INCEPTION
                                                              THREE MONTHS          (APRIL 22, 1997)
                                                             ENDED MARCH 31,             THROUGH
                                                                  1998              DECEMBER 31, 1997
                                                           -------------------    ---------------------
                                                               (UNAUDITED)             (UNAUDITED)
<S>                                                        <C>                    <C>
Interest expense.........................................     $  (7,689,781)          $ (22,545,119)
Net loss.................................................     $(191,086,302)          $(231,325,659)
Net loss applicable to common stock......................     $(196,358,421)          $(235,428,417)
Net loss per share, basic................................     $       (3.75)          $       (4.52)
Net loss per share, diluted..............................     $       (3.69)          $       (4.45)
</TABLE>
 
     In addition, assuming the Debt Offering is not consummated on a pro forma
     basis as of March 31, 1998, the Company's cash, cash equivalents and
     short-term investments would have been $447,074,702, its total assets would
     have been $489,707,692 and its long-term debt would have been $247,329,420.
 
 (2) Upon the consummation of the Equity Offering, Allegiance LLC, the holder of
     substantially all of the Company's outstanding capital stock, will dissolve
     and its assets (which consist almost entirely of such capital stock) will
     be distributed to the Fund Investors and the Management Investors in
     accordance with a final allocation calculated immediately prior to such
     dissolution (the "Equity Allocation"). The LLC Agreement (as defined
     herein) provides that the Equity Allocation between the Fund Investors and
     the Management Investors will range between 95.0%/5.0% and 66.7%/33.3%
     based upon the valuation of the Company's Common Stock. Based upon the
     valuation of the Company's Common Stock implied by the Equity Offering, the
     Equity Allocation will be 66.7% to the Fund Investors and 33.3% to the
     Management Investors. Under generally accepted accounting principles, upon
     consummation of the Equity Offering, the Company will be required to record
     the $232.7 million
 
                                       29
<PAGE>   31
 
     increase in the assets of Allegiance LLC allocated to the Management
     Investors as an increase in additional paid-in capital, of which the
     Company will be required to record $134.5 million as a non-cash,
     non-recurring charge to operating expense and $98.2 million will be
     recorded as deferred management ownership allocation charge. The deferred
     charge will be amortized at $64.6 million, $24.7 million, $8.8 million and
     $.1 million during 1998, 1999, 2000 and 2001, respectively, which is the
     period over which the Company has the right to repurchase the securities
     (at the lower of fair market value or the price paid by the employee) in
     the event the management employee's employment with the Company is
     terminated. See "Certain Relationships and Related Transactions." The pro
     forma gives effect to the initial $134.5 million non-cash, non-recurring
     charge to operating expense and the related amortization of the deferred
     management ownership allocation charge for each period.
 
   
 (3) Pro forma interest income excludes interest income that would have been
     earned on the estimated $67.4 million of the proceeds from the Debt
     Offering required to be placed in a pledged account to secure and fund the
     first six scheduled interest payments on the Notes.
    
 
   
 (4) Reflects $6.4 million and $17.8 million of interest expense related to the
     Notes offered in the Debt Offering (assuming an effective interest rate of
     12 7/8%), $.2 million and $.5 million of amortization of the $7.2 million
     of deferred debt issuance cost related thereto, $3.0 million and $22.1
     million of interest expense related to the accretion of the 11 3/4% Notes
     and $67,350 and $.5 million of amortization of deferred debt issuance cost
     related to the 11 3/4% Notes for the three months ended March 31, 1998 and
     for the period from inception (April 22, 1997) through December 31, 1997,
     respectively.
    
 
 (5) Reflects the increase of $7,435 and $.3 million of accretion for the
     warrants for the three months ended March 31, 1998 and for the period from
     inception (April 22, 1997) through December 31, 1997, respectively.
 
 (6) The pro forma weighted average number of shares outstanding gives effect to
     (i) the 426.2953905 per share stock split to be effective in connection
     with the Equity Offering, (ii) 12,000,000 shares of the Company's Common
     Stock issued as a result of the Equity Offering and (iii) the conversion of
     95,641.25 and 95,000 shares of Redeemable Convertible Preferred Stock to
     Common Stock for the three months ended March 31, 1998 and for the period
     from inception (April 22, 1997) through December 31, 1997, respectively.
 
 (7) EBITDA represents earnings before interest, income taxes, depreciation and
     amortization. EBITDA is not a measurement of financial performance under
     generally accepted accounting principles, is not intended to represent cash
     flow from operations, and should not be considered as an alternative to net
     loss as an indicator of the Company's operating performance or to cash
     flows as a measure of liquidity. The Company believes that EBITDA is widely
     used by analysts, investors and other interested parties in the
     telecommunications industry. EBITDA is not necessarily comparable with
     similarly titled measures for other companies.
 
   
 (8) Reflects the purchase of $67.4 million of U.S. government securities, which
     securities will be placed in a pledged account, to fund the first six
     scheduled interest payments on the Notes. The period from inception (April
     22, 1997) through December 31, 1997 also reflects the $12.9 million cash
     interest payment on the Notes, which is funded through a reduction of the
     pledged account.
    
 
   
 (9) Reflects $192.8 million of net proceeds to be received from the Debt
     Offering of which $67.4 million will be required to be placed in a pledged
     account to secure and fund the first six scheduled interest payments on the
     Notes and $189.5 million of net proceeds to be received from the Equity
     Offering. In addition, net cash provided by financing activities for
     activities for the three months ended March 31, 1998 on a pro forma basis
     also reflects $.7 million of deferred debt issuance cost related to the
     Unit Offering and for the period from inception (April 22, 1997) through
     December 31, 1997 on a pro forma basis also reflects the $240.7 million of
     net proceeds from the Unit Offering.
    
 
   
(10) For purposes of calculating the ratio of earnings to fixed charges,
     earnings is defined as net loss plus fixed charges (other than capitalized
     interest). Fixed charges consist of interest and amortization of debt
     discount and debt issuance costs, whether expensed or capitalized, and that
     portion of rental expense deemed to represent interest (estimated to be
     1/3 of such expense). The Company's earnings for the three months ended
     March 31, 1998 and for the period from inception (April 22, 1997) through
     December 31, 1997 were insufficient to cover fixed charges by approximately
     $8.9 million and $3.7 million, respectively. After giving pro forma effect
     to the increase in interest expense resulting from the issuance of the
     Notes in the Debt Offering (assuming a 12 7/8% per annum effective interest
     rate on the Notes) and the 11 3/4% Notes in the Unit Offering and giving
     effect to $179.7 million and $205.1 million of management ownership
     allocation charge to be recorded in connection with the Equity Offering,
     the Company's earnings would have been insufficient to cover fixed charges
     by approximately $198.2 million and $249.6 million, for the three months
     ended March 31, 1998 and for the period from inception (April 22, 1997)
     through December 31, 1997, respectively. In the event the Debt Offering is
     not consummated, on a pro forma basis, the Company's earnings would have
     been insufficient to cover fixed charges by approximately $191.5 million
     and $231.3 million, for the three months ended March 31, 1998 and for the
     period from inception (April 22, 1997) through December 31, 1997,
     respectively.
    
 
(11) Reflects the issuance of the Notes in the Debt Offering.
 
   
(12) Does not reflect any of the financing expected to be available under the
     Vendor Financing.
    
 
   
(13) In connection with the consummation of the Equity Offering, all outstanding
     shares of Redeemable Convertible Preferred Stock will be converted to
     Common Stock. At such time, the obligation of the Company to redeem the
     Redeemable Convertible Preferred Stock terminates and, therefore, the value
     of the Redeemable Convertible Preferred Stock accreted to the date of the
     Equity Offering will be reclassified as an increase in the amount of Common
     Stock and additional paid-in capital in the stockholders' equity section of
     the balance sheet.
    
 
   
(14) Reflects the $189.5 million of net proceeds received from the sale of
     Common Stock in the Equity Offering, the conversion of the $58.9 million
     Redeemable Convertible Preferred Stock into Common Stock and the management
     ownership allocation described in footnote(2) above.
    
 
                                       30
<PAGE>   32
 
                    MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                 FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
     The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with the consolidated
financial statements and the notes thereto contained elsewhere in this
Prospectus. Certain information contained in the discussion and analysis set
forth below and elsewhere in this Prospectus, including information with respect
to the Company's plans and strategy for its business and related financing,
includes forward-looking statements that involve risk and uncertainties. See
"Risk Factors" for a discussion of important factors that could cause actual
results to differ materially from the results described in or implied by the
forward-looking statements contained herein.
 
OVERVIEW
 
     Allegiance seeks to be a premier provider of telecommunications services to
business, government and other institutional users in major metropolitan areas
across the United States. As a CLEC, Allegiance anticipates offering an
integrated set of telecommunications products and services including local
exchange, local access, domestic and international long distance, enhanced
voice, data and a full suite of Internet services. The Company was founded in
April 1997 by a management team led by Royce J. Holland, the former president,
chief operating officer and co-founder of MFS, and Thomas M. Lord, former
managing director of Bear, Stearns & Co. Inc., where he specialized in the
telecommunications, information services and technology industries. The
Company's initial equity financing of approximately $50.1 million has been
provided by the Management Investors and the Fund Investors.
 
   
     The Company has generated only nominal revenues to date. Since its
inception on April 22, 1997, the Company's principal activities have included
developing its business plans, procuring governmental authorizations, raising
capital, hiring management and other key personnel, working on the design and
development of its local exchange telephone networks and OSS, acquiring
equipment and facilities and negotiating interconnection agreements. The Company
does not expect to achieve positive EBITDA in any market until at least two to
three years after it commences initial service in such market. As a result of
its development activities, the Company has experienced significant operating
losses and negative EBITDA to date. Allegiance is currently operational in three
Phase I markets: New York City, Dallas and Atlanta; and is in the process of
deploying networks in six additional Phase I markets: Chicago, Los Angeles, San
Francisco, Boston, Fort Worth and Washington D.C. The Company expects to
continue to experience increasing operating losses and negative EBITDA as it
expands its operations. See "Risk Factors -- Limited History of Operations;
Historical and Anticipated Future Negative EBITDA and Operating Losses."
    
 
     The Fund Investors and the Management Investors currently own 95.0% and
5.0%, respectively, of the ownership interests of Allegiance LLC, an entity that
owns substantially all of the Company's outstanding capital stock. Upon
consummation of the Equity Offering, Allegiance LLC will dissolve and its assets
(which consist almost entirely of such capital stock) will be distributed to the
Fund Investors and the Management Investors in accordance with the LLC
Agreement. The LLC Agreement provides that the Equity Allocation between the
Fund Investors and the Management Investors will range between 95.0%/5.0% and
66.7%/33.3% based upon the valuation of the Company's Common Stock implied by
the Equity Offering. Based upon the current valuation of the Company's Common
Stock implied by the Equity Offering, the Equity Allocation will be 66.7% to the
Fund Investors and 33.3% to the Management Investors. Under generally accepted
accounting principles, upon consummation of the Equity Offering, the Company
will be required to record the $232.7 million increase in the assets of
Allegiance LLC allocated to the Management Investors as an increase in
additional paid-in capital, of which the Company will be required to record
$134.5 million as a non-cash, non-recurring charge to operating expense and
$98.2 million will be recorded as a deferred management ownership allocation
charge. The deferred charge will be amortized at $64.6 million, $24.7 million,
$8.8 million, and $.1 million during 1998, 1999, 2000, and 2001, respectively,
which is the period over which the Company has the right to repurchase the
securities (at the lower of fair market value or the price paid by the employee)
in the event the management employee's employment with the Company is
terminated. See "Certain Relationships and Related Transactions."
 
                                       31
<PAGE>   33
 
     As a result of the Company's limited operating history, prospective
investors have limited operating and financial data about the Company upon which
to base an evaluation of the Company's performance and an investment in the
Common Stock.
 
FACTORS AFFECTING FUTURE OPERATIONS
 
  Revenues
 
     Allegiance expects to generate most of its revenues from sales to end user
customers in the business, government, and other institution market segments,
but may augment this core revenue source by selectively supplying wholesale
services including equipment collocation and facilities management services to
ISPs. Allegiance plans to deploy its sales teams in areas where the Company can
serve customers through a direct connection using unbundled loops or high
capacity circuits connected to Allegiance's facilities collocated in ILEC
central offices. The Company currently plans to resell ILEC services only in
order to provide comprehensive geographical service coverage to customers with
multiple on-net sites (which can be addressed by the Company's facilities-based
services) and a few off-net sites (which can be addressed only by the Company's
reselling ILEC services). Allegiance believes that it will be able to generate
significantly higher gross margins by providing local exchange, local access and
long distance services using its own facilities than could be obtained by
reselling such services.
 
     Allegiance will seek to price its services competitively in relation to
that of the ILECs and may offer combined service discounts designed to give
customers incentives to buy a portfolio of services through the Company.
Although pricing will be an important part of the Company's strategy, management
believes that, especially for small to medium-sized business customers, customer
relationships, customer care, "one stop shopping" and consistent quality will be
the key to generating customer loyalty. During the past several years, market
prices for many telecommunications services have been declining, which is a
trend that the Company believes will likely continue. This decline will have a
negative effect on the Company's gross margin that may not be offset completely
by savings from decreases in the Company's cost of services.
 
     Current industry statistics demonstrate that there is significant churn of
customers within the industry, and the Company believes that the churn is
especially high when customers are only buying long distance services from a
carrier or when customers are buying resold services. Allegiance believes that
by offering LAN interconnection, frame relay, Internet services, ISDN, DSL and
other enhanced services not generally available from the ILECs (or available
only at high prices) in conjunction with traditional local and long distance
services and providing superior customer care, it will be in a position to
minimize customer churn.
 
  Operating Expenses
 
     The Company expects that its primary operating expenses will consist of
cost of services and selling, general and administrative expenses.
 
     Cost of Services. Under its "smart build" strategy, Allegiance plans to
deploy digital switching platforms with local and long distance capability and
initially lease fiber trunking capacity from the ILECs and other CLECs to
connect the Company's switch with its transmission equipment collocated in ILEC
central offices. Allegiance will lease unbundled copper loop lines and high
capacity digital lines from the ILECs to connect the Company's customers and
other carriers' networks to the Company's network. Allegiance plans to lease
capacity or overbuild specific network segments as economically justified by
traffic volume growth. In addition, Allegiance expects to increase the capacity
of its switches, and may add additional switches, in a market as demand
warrants.
 
     In October 1997, the Company entered into a five-year general agreement
with Lucent establishing terms and conditions for the purchase of Lucent
products, services and licensed materials. The agreement includes a three-year
exclusivity commitment for the purchase of products and services related to new
switches. The agreement contains no minimum purchase requirements.
 
     The Company expects switch site lease costs will be a significant part of
the Company's ongoing cost of services. The costs to lease unbundled copper loop
lines and high capacity digital lines from the ILECs will vary by ILEC and are
regulated by state authorities pursuant to the Telecommunications Act. The
Company believes that in most of the markets it plans to enter there are
multiple carriers in addition to the ILEC from
 
                                       32
<PAGE>   34
 
which it could lease trunking capacity. The Company expects that the costs
associated with these leases will increase with customer volume and will be a
significant part of the Company's ongoing cost of services.
 
     Collocation costs are also expected to be a significant part of the
Company's network development and ongoing cost of services. Under the
Telecommunications Act, carriers like the Company must be allowed to place their
equipment within the central offices of the ILEC for the purposes of
interconnecting its network with that of the ILEC ("collocation"). For example,
Allegiance will use collocation to access the ILECs unbundled networks elements.
This collocation can be a physical space or cage within the ILEC central office
where the Company would place its equipment. In some cases, virtual collocation
would be used where the ILEC places equipment within the central office and
would maintain the equipment on behalf of the Company. In this virtual
collocation scenario, the Company would not have physical access to the ILEC's
central office. For use of their central offices for collocation, ILECs
typically charge both a start-up fee as well as a monthly recurring fee. The
Company will be required to invest a significant amount of funds to develop the
central office collocation sites and to deploy the transmission and distribution
electronics.
 
     In order to enter a market, Allegiance must enter into an interconnection
agreement with the ILEC to make ubiquitous calling available to its customers.
Typically these agreements set the cost per minute to be charged by each party
for the calls which have traversed between each carrier's network. These costs
will grow in proportion to the Company's customers outbound call volume and are
expected to be a major portion of the Company's cost of services. However, the
Company does expect to generate increased revenue from the ILECs as the
Company's customers inbound calling volume increases. To the extent the
Company's customers' outbound call volume is equivalent to their inbound call
volume, the Company expects that its interconnection costs paid to the ILECs
will be substantially offset by the interconnection revenues received from the
ILECs.
 
     The Company has entered into one resale agreement with a long distance
carrier to provide the Company with transmission services and expects to enter
into resale agreements with other carriers in the future. Such agreements
typically provide for the resale of long distance services on a per-minute basis
and may contain minimum volume commitments; however, the existing resale
agreement does not contain any minimum volume commitments. In the event the
Company fails to meet its minimum volume commitments, it may be obligated to pay
underutilization charges and in the event it underestimates its need for
transmission capacity, the Company may be required to obtain capacity through
more expensive means. These costs will increase as the Company's customers' long
distance calling volume increases, and the Company expects that these costs will
be a significant portion of its cost of long distance services. As traffic on
specific routes increases, the Company may lease long distance trunk capacity.
 
     Selling, General and Administrative Expenses. The Company's selling,
general and administrative expenses will include its infrastructure costs,
including selling and marketing costs, customer care, billing, corporate
administration, personnel and network maintenance.
 
     The Company plans to employ a large direct sales force in each market and
to build a national sales force as the Company grows. To attract and retain a
highly qualified sales force, the Company plans to offer its sales and customer
care personnel a compensation package emphasizing commissions and stock options.
The Company expects to incur significant selling and marketing costs as it
continues to expand its operations. In addition, Allegiance plans to offer sales
promotions to win customers, especially in the first few years as its
establishes its market presence.
 
     Allegiance is currently developing tailored systems and procedures for OSS
and other back office systems that are required to enter, schedule, provision,
track a customer order from point of sale to the installation and testing of
service and that will include or interface with trouble management, inventory,
billing, collection and customer care service systems. Along with the
development cost of the systems, the Company will also incur ongoing expenses
for customer care and billing. As the Company's strategy stresses the importance
of personalized customer care, the Company expects that its customer care
department will become a larger part of the Company's ongoing administrative
expenses. The Company also expects billing costs to increase as its number of
customers, and the call volume, increases. Billing is expected to be a
significant part of the Company's ongoing administrative expenses.
 
                                       33
<PAGE>   35
 
     Allegiance will incur other costs and expenses, including the costs
associated with the maintenance of its network, administrative overhead, office
leases and bad debt. The Company expects that these costs will grow
significantly as its expands its operations and that administrative overhead
will be a large portion of these expenses during the start-up phase of the
Company's business. However, the Company expects these expenses to become
smaller as a percentage of the Company's revenue as the Company builds its
customer base.
 
RESULTS OF OPERATIONS
 
     From its inception on April 22, 1997 through December 16, 1997, the Company
was in the development stage of operations. Its principal activities during that
period included developing its business plans, raising capital, hiring
management and other key personnel, working on the design and development of its
local exchange telephone networks and OSS and negotiating interconnection
agreements. From inception (April 22, 1997) through December 31, 1997, the
Company's operations resulted in a $7.5 million net loss (after accreting
redeemable preferred stock and warrant values). As of December 31, 1997, the
Company generated only nominal revenues.
 
     For the three months ended March 31, 1998, the Company generated revenues
of $.2 million from local and long distance services provided to customers in
the Dallas market. The net loss for the first quarter was $13.7 million (after
accreting redeemable preferred stock and warrant values). The Company incurred
approximately $.5 million in delivering service and preparing its local exchange
facilities in Dallas, New York City and Atlanta to become operational. For the
three months ended March 31, 1998, the Company also incurred $5.7 million for
selling and general and administrative expenses, primarily resulting from $3.6
million of payroll, employee benefits, travel, legal and consulting fees
relating to the commencement of business in several Phase I markets and $1.0
million in amortization of deferred stock compensation expense. The Company also
incurred $.5 million for office space and related operating costs. Interest
expense during the three months ended March 31, 1998 was $4.7 million,
reflecting the issuance of the 11 3/4% Notes during February 1998. Interest
income during such period was $2.2 million resulting from the investment of the
net proceeds from the Equity Contributions and the Unit Offering.
 
     As required by accounting principles promulgated by the Securities Exchange
Commission, the Company is recording the potential redemption values of the
Redeemable Convertible Preferred Stock and the redeemable warrants in the
potential event that they are redeemed at fair market value in August 2004 and
February 2008, respectively. Amounts are accreted using the effective interest
method and managements' estimates of the future fair market value of these
securities when redemption is first permitted. Amounts accreted increase the
recorded value of the Redeemable Convertible Preferred Stock and redeemable
warrants on the balance sheet and result in a non-cash charge to increase the
net loss applicable to Common Stock. Upon consummation of the Equity Offering,
the redemption provisions of the Redeemable Convertible Preferred Stock
terminate and such preferred stock will be converted into Common Stock.
Accordingly, the amounts accreted for the Redeemable Convertible Preferred Stock
will be reclassified as an increase in the amount of the Common Stock and
additional paid-in capital in the stockholders' equity section of the balance
sheet.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     Allegiance plans to establish networks in 24 Tier I U.S. markets. The
Company plans to deploy its networks principally in two phases of development,
each to contain 12 major U.S. metropolitan markets.
 
     The development of the Company's business and deployment and start-up of
its networks in these markets and the establishment of reliable OSS will require
significant capital to fund capital expenditures, working capital, debt service
and cash flow deficits. The Company's principal capital expenditure requirements
include the purchase and installation of digital switches, transmission
equipment collocated in ILEC central offices, and customer premise equipment,
the development of efficient OSS and other automated back office systems, and
the overbuilding of leased transmission facilities as traffic volume growth
makes it economically attractive. Additional capital will be required for office
space, switch site, and collocation space buildout at ILEC central offices,
corporate overhead and personnel and the development, acquisition and
integration of the Company's back office systems. Future overbuilds of leased
transmissions facilities and potential strategic acquisitions may increase
capital requirements, although cash requirements may be reduced if network
expansions are accomplished over a longer time frame or market penetration rates
are less than expected.
 
                                       34
<PAGE>   36
 
     Allegiance's financing plan is predicated on the pre-funding of each
market's expansion to Positive Free Cash Flow (operating cash flow from a market
sufficient to fund such market's operating costs and capital expenditures). This
approach is designed to allow the Company to be opportunistic and raise capital
on more favorable terms and conditions.
 
   
     To pre-fund each Phase I market's expansion, the Company raised
approximately $50.1 million from the Equity Contributions and received
approximately $240.7 million of net proceeds, after deducting estimated
underwriting discounts and commissions and other expenses payable by the
Company, from the Unit Offering. Allegiance is currently operational in three
Phase I markets: New York City, Dallas and Atlanta; and is in the process of
deploying networks in six additional Phase I markets: Chicago, Los Angeles, San
Francisco, Boston, Fort Worth and Washington, D.C. As part of this effort, in
October 1997, the Company acquired two Lucent Series 5ESS(R)-2000 digital
switches in New York City and Atlanta and certain furniture and fixtures in
Dallas from US ONE Communications, Inc. for an aggregate purchase price of $19.3
million. The Company has also purchased from Lucent, switches for the Dallas,
Chicago, Los Angeles, San Francisco, Boston and Washington, D.C. markets. The
cost of these switches and related equipment and installation will be
approximately $41.6 million.
    
 
     Since completion of the Unit Offering, the Company has increased the scope
of its business plan to accommodate (i) an expansion of the Company's network
buildout in certain Phase I markets to include additional central offices,
thereby giving the Company access to a larger number of potential customers in
those markets, (ii) an accelerated and expanded deployment of data, Internet and
enhanced services in the Company's markets and (iii) the acceleration of network
deployment in Phase II markets.
 
     The Company estimates that its cumulative cash requirements to fund its
modified business plan, including pre-funding each Phase I and Phase II market's
expansion to Positive Free Cash Flow, will be between $650 million and $700
million.
 
   
     In addition to the Offerings, the Company is seeking to obtain
approximately $100.0 million of Vendor Financing for the acquisition of digital
switches, software, electronics and associated transmission equipment. The
amount of Vendor Financing the Company will ultimately seek to obtain will
depend on a number of factors including the terms and conditions thereof, the
availability and terms of other financing and the Company's ability to acquire
digital switches, software, electronics and associated transmission equipment in
connection with the acquisition of other companies for Common Stock. There can
be no assurance that the Vendor Financing will be available on terms acceptable
to the Company or at all.
    
 
   
     The Company believes, based on its modified business plan, that the net
proceeds from the Offerings, together with cash on hand (including proceeds from
the Equity Contributions and the Unit Offering) and funding expected to be
available under the Vendor Financing will be sufficient to pre-fund its Phase I
and Phase II market deployment to Positive Free Cash Flow. If the Company
consummates the Equity Offering but not the Debt Offering or the Vendor
Financing, the Company intends to modify its deployment schedule by developing
only five to seven Phase II markets. If the Company consummates both the Equity
and Debt Offerings, but the Vendor Financing is not obtained, the Company
intends to modify its deployment schedule by developing only eight to ten Phase
II markets. In each such case, the Company would delay deployment of networks in
the remaining Phase II markets until it obtains additional financing on
acceptable terms and conditions. There can be no assurance that such financing
will be available on terms acceptable to the Company or at all.
    
 
   
     The actual amount and timing of the Company's future capital requirements
may differ materially from the Company's estimates as a result of, among other
things, the demand for the Company's services and regulatory, technological and
competitive developments (including additional market developments and new
opportunities) in the Company's industry. The Company also expects that it will
require additional financing (or require financing sooner than anticipated) if:
(i) the Company's development plans or projections change or prove to be
inaccurate; (ii) the Company engages in any acquisitions; (iii) the Vendor
Financing is not obtained on a timely basis or at all; or (iv) the Company
alters the schedule or targets of its roll-out plan, or in the event the Debt
Offering is not consummated, the Company accelerates the implementation of its
network deployment in the remaining Phase II markets. Sources of additional
financing may include commercial bank borrowings, vendor financing, or the
private or public sale of equity or debt securities. There can be no
    
                                       35
<PAGE>   37
 
assurance that such financing will be available on terms acceptable to the
Company or at all. See "Risk Factors -- Significant Capital Requirements;
Uncertainty of Additional Financing."
 
     Because the Company's cost of rolling out its networks and operating its
business, as well as the Company's revenues, will depend on a variety of factors
(including the ability of the Company to meet its roll-out schedules, negotiate
favorable prices for purchases of equipment, and develop, acquire and integrate
the necessary OSS and other back office systems, as well as the number of
customers and the services for which they subscribe, the nature and penetration
of new services that may be offered by the Company, regulatory changes and
changes in technology), actual costs and revenues will vary from expected
amounts, possibly to a material degree, and such variations are likely to affect
the Company's future capital requirements. Accordingly, there can be no
assurance that the Company's actual capital requirements will not exceed the
anticipated amounts described above. Further, the exact amount of the Company's
future capital requirements will depend upon many factors, including the cost of
the development of its networks in each of its markets, the extent of
competition and pricing of telecommunications services in its markets, and the
acceptance of the Company's services. Also, the Company expects that the
expansion into additional markets will require additional financing, which may
include commercial bank borrowing, vendor financing, or the public or private
sale of equity or debt securities. There can be no assurance that the Company
will be successful in raising sufficient additional capital at all or on terms
acceptable to the Company. See "Risk Factors -- Significant Capital
Requirements; Uncertainty of Additional Financing."
 
YEAR 2000
 
     The Company has reviewed its computer systems to identify those areas that
could be affected by the "Year 2000" issue. The Company believes that its
systems are Year 2000 compliant. In addition, the Company believes that many of
its customers and suppliers, particularly the ILECs and long distance carriers,
are also impacted by the Year 2000 issue, which in turn could affect the
Company. The Company is assessing the compliance efforts of its major customers
and suppliers. If the systems of certain of the Company's customers and
suppliers, particularly the ILECs, long distance carriers and others on whose
services the Company depends or with whom the Company's systems interface, are
not Year 2000 compliant, it would have a material adverse effect on the Company.
 
                                       36
<PAGE>   38
 
                                    BUSINESS
 
THE COMPANY
 
     Allegiance seeks to be a premier provider of telecommunications services to
business, government and other institutional users in major metropolitan areas
across the United States. As a CLEC, Allegiance anticipates offering an
integrated set of telecommunications products and services including local
exchange, local access, domestic and international long distance, enhanced
voice, data and a full suite of Internet services. The Company was founded in
April 1997 by a management team led by Royce J. Holland, the former president,
chief operating officer and co-founder of MFS, and Thomas M. Lord, former
managing director of Bear, Stearns & Co. Inc., where he specialized in the
telecommunications, information services and technology industries. The
Company's initial equity financing of approximately $50.1 million has been
provided by the Management Investors and the Fund Investors.
 
     The Company believes that the Telecommunications Act, by opening the local
exchange market to competition, has created an attractive opportunity for new
facilities-based CLECs like the Company. Most importantly, the
Telecommunications Act stated that CLECs should be able to acquire the UNEs from
the ILECs, which are necessary for the cost-effective provision of service. As
such, the Telecommunications Act will enable the Company to deploy digital
switching platforms with local and long distance capability and initially lease
fiber trunking capacity from the ILECs and other CLECs to connect the Company's
switch with its transmission equipment collocated in ILEC central offices.
Thereafter, the Company plans to lease capacity or overbuild specific network
segments as economically justified by traffic volume growth. Management believes
that pursuing this "smart build" approach should: (i) accelerate market entry by
9 to 18 months by deferring the need for city franchises, rights-of-way and
building access; (ii) reduce initial capital requirements for individual market
entry prior to revenue generation, allowing the Company to focus its capital
resources on the critical areas of sales, marketing, and OSS; (iii) provide for
ongoing capital expenditures on a "success basis" as demand dictates; and (iv)
allow the Company to address attractive service areas selectively throughout its
targeted markets.
 
     Allegiance is currently developing tailored systems and procedures for OSS
and other back office systems that it believes will provide the Company with a
significant competitive advantage in terms of cost, processing large order
volumes and customer service. These systems are required to enter, schedule,
provision and track a customer's order from the point of sale to the
installation and testing of service and also include or interface with trouble
management, inventory, billing, collection and customer service systems. The
legacy systems currently employed by many ILECs, CLECs and long distance
carriers, which systems were developed prior to the passage of the
Telecommunications Act, generally require multiple entries of customer
information to accomplish order management, provisioning, switch administration
and billing. This process is not only labor intensive, but it also creates
numerous opportunities for errors in provisioning service and billing, delays in
installing orders, service interruptions, poor customer service, increased
customer churn and significant added expenses due to duplicated efforts and the
need to correct service and billing problems. The Company believes that the
practical problems and costs of upgrading legacy systems are often prohibitive
for companies whose existing systems support a large number of customers with
ongoing service.
 
   
     Allegiance plans to deploy networks in 24 Tier I markets. The Company
estimates that these 24 markets will include 18 BTAs with more than 20 million
non-residential access lines, representing approximately 44.7% of the total
non-residential access lines in the U.S. With a network deployment and end user,
direct sales marketing strategy focusing on the central business districts and
suburban commercial districts in these areas, Allegiance plans to address a
majority of the non-residential access lines in most of its targeted markets.
The Company plans to deploy its networks principally in two phases of
development. Phase I is to offer services in 12 of the largest metropolitan
areas in the U.S., which the Company believes include approximately 26.0% of the
nation's total non-residential access lines. Allegiance is currently operational
in three Phase I markets: New York City, Dallas and Atlanta; and is in the
process of deploying networks in six additional Phase I markets: Chicago, Los
Angeles, San Francisco, Boston, Fort Worth and Washington, D.C. In each of these
markets, the Company will use a Lucent Series 5ESS(R)-2000 digital switch, which
provides local and long distance functionality. With the proceeds from the
Offerings and funds expected to be available under the
    
 
                                       37
<PAGE>   39
 
   
Vendor Financing, the Company intends to begin network development in its Phase
II markets. These additional 12 markets are estimated to encompass approximately
18.7% of the total non-residential access lines in the U.S. Management expects
to commence network deployment in these cities in 1999, with service anticipated
to begin during 1999 and 2000.
    
 
   
     As of June 25, 1998, the Company has sold 18,858 lines to 1,120 customers,
of which 10,993 lines for 688 customers were in service as of such date.
    
 
     The Company is a Delaware corporation with its principal executive offices
located at 1950 Stemmons Freeway, Suite 3026, Dallas, Texas 75207, and its
telephone number is (214) 853-7100.
 
BUSINESS STRATEGY
 
     To accomplish its goal of becoming a premier provider of telecommunications
services to business, government, and other institutional users in U.S.
metropolitan areas, the Company has developed an end-user-focused business
strategy designed to achieve significant market penetration and deliver superior
customer care while maximizing operating margins. The key components of this
strategy include the following:
 
     Leverage Proven Management Team. The Company's veteran management team has
extensive experience and past successes in the CLEC industry, and the Company
believes that its ability to combine and draw upon the collective talent and
expertise of its senior management gives it a competitive advantage in the
effective and efficient execution of network deployment, sales, provisioning,
service installation, billing and collection, and customer service functions.
Allegiance's Chairman and Chief Executive Officer, Royce J. Holland, has more
than 25 years of experience in the telecommunications and energy industries,
including as president, chief operating officer, and co-founder of MFS. Under
his leadership, MFS grew from a start-up operation to become the largest CLEC
with approximately $1.1 billion in revenues before its acquisition by WorldCom
in 1996. Other key Allegiance executives have significant experience in the
critical functions of network operations, sales and marketing, back office and
OSS, finance and regulatory affairs.
 
     Target End Users with Integrated Service Offerings. Allegiance plans to
focus principally on end user customers in the business, government and other
institutional market segments. The majority of these customers are expected to
be small and medium-sized businesses, to which the Company will offer "one-stop
shopping" consisting of a comprehensive package of communications services with
convenient integrated billing and a single point of contact for sales and
service. For large businesses and government and other institutional users,
which typically obtain telecommunications services from a variety of suppliers,
the Company will focus primarily on capturing a significant portion of these
customers' local exchange, intraLATA toll and data traffic. Although the Company
will principally target end-users in markets where it believes it can achieve
significant market penetration by providing superior customer care at
competitive prices, the Company may augment its core business strategy by
selectively supplying wholesale services including equipment collocation and
facilities management services to ISPs.
 
     Offer Data, Internet, and Enhanced Services to Enhance Market Penetration
and Reduce Churn. The Company believes it can accelerate new account penetration
and reduce customer churn by offering LAN interconnection, frame relay, Internet
services, ISDN, DSL, Web page design, Web server hosting, and other enhanced
services not generally available from the ILECs (or available only at high
prices) in conjunction with traditional local and long distance services. This
strategy has been successfully employed by certain CLECs, and Allegiance's
management team has extensive experience in providing these types of enhanced
services.
 
     Utilize "Smart Build" Strategy to Maximize Speed to Market and Minimize
Investment Risk. Allegiance plans to deploy digital switching platforms with
local and long distance capability and initially lease fiber trunking capacity
from the ILECs and other CLECs to connect the Company's switch with its
transmission equipment collocated in ILEC central offices. Thereafter,
Allegiance may evolve its networks to the next stage of the "smart build"
strategy where Allegiance plans to lease dark fiber or overbuild specific
network segments as economically justified by traffic volume growth. Allegiance
expects that this "smart build" strategy will allow entry into a new market in a
six- to nine-month time frame as compared to the 18 to 24 months required to
construct a metropolitan area fiber network under the "build first, sell later"
approach required before the Telecommunications Act established a framework for
CLECs to acquire unbundled
 
                                       38
<PAGE>   40
 
network elements. The Company believes that this "smart build" approach has the
additional advantage of reducing up-front capital requirements. This "smart
build" strategy is currently being implemented by the Company in all its
networks where it is leasing high capacity circuits to connect the ILEC central
offices with the Company's switches. In New York City, the Company is moving to
the next stage of its "smart-build" strategy, where the Company will lease from
MFN, a thirty-mile dark fiber ring in Manhattan that extends into Brooklyn.
 
     Achieve Broad Coverage of Attractive Areas within Each Targeted Market. As
a result of the substantial up-front capital requirements necessary to construct
metropolitan area fiber networks, CLECs have traditionally limited their initial
network buildout to highly concentrated downtown areas, thereby limiting their
ability to provide service to customers in other attractive, but geographically
dispersed, portions of their targeted markets. The Company intends to leverage
the benefits of using a "smart build" strategy by selectively deploying its
facilities to address attractive service areas throughout each target market in
order to optimize the Company's penetration. Prior to entering a market,
Allegiance prepares a detailed, "bottoms-up" analysis of that market's local
exchange areas using FCC and demographic data. The Company uses this analysis,
together with estimates of the costs and potential benefits of addressing
particular service areas, to identify attractive areas, determine the optimal
concentration of areas to be served and develop its schedule for network
deployment and expansion.
 
     Maximize Operating Margins by Emphasizing Facilities-Based
Services. Allegiance believes that facilities-based solutions where the Company
provides local exchange, local access, and long distance using its own
facilities should generate significantly higher gross network margins than could
be obtained by reselling such services. As a result, Allegiance plans to deploy
its marketing activities in areas where it can serve customers through a direct
connection using unbundled loops or high capacity circuits connected to
Allegiance's facilities collocated in ILEC central offices. The Company plans to
resell ILEC services only in order to provide comprehensive geographical service
coverage to customers with multiple on-net sites (which can be addressed by the
Company's facilities-based services) and a few off-net sites (which can be
addressed only by the Company's reselling ILEC services).
 
     Build Market Share by Focusing on Direct Sales. The Company believes that
the key to achieving its goals is the capturing and retaining of customers
through direct sales, a full suite of turn-key product offerings and
personalized customer care. Management believes that its targeted small and
medium-sized business customers have been neglected by the ILECs with respect to
these functions. The Company's sales management team is composed of executives
with experience in managing a large number of direct sales specialists in the
telecommunications and data networking industries. Additionally, the Company
believes it will be able to attract and retain highly qualified sales and
support personnel by offering them the opportunity to: (i) work with an
experienced and success-proven management team in building a developing,
entrepreneurial company; (ii) market a comprehensive set of products and
services and customer care options; and (iii) participate in the potential
economic returns made available through a results-oriented compensation package
emphasizing sales commissions and stock options.
 
     Develop Efficient Automated Back Office Systems. Unburdened by existing
legacy OSS, Allegiance is focusing on developing, acquiring and integrating back
office systems to facilitate a smooth, efficient order management, provisioning,
trouble management, billing and collection, and customer service process. To
address this critical issue, the Company has hired a team of engineering and
information technology professionals experienced in the CLEC industry. This team
will work to develop, with the assistance of key third party vendors, OSS that
will synchronize multiple tasks such as provisioning, customer service and
billing and provide management with timely operating and financial data to most
efficiently direct network, sales and customer service resources. The Company
intends to work actively toward "electronic bonding" between the Allegiance OSS
and those of the ILEC, which would permit creation of service requests on-line.
Allegiance believes that these back office systems, once developed, will provide
it with a significant competitive advantage in terms of cost, processing large
order volumes and customer service as compared to companies using legacy
systems.
 
                                       39
<PAGE>   41
 
     Expand Customer Base Through Potential Acquisitions. The Company believes
that strategic acquisitions may produce a number of benefits, including
acceleration of market penetration, providing a customer base for cross-selling
additional services, acquiring experienced management and improving margins by
migrating resold services to the Company's network facilities.
 
MARKET OPPORTUNITY
 
     U.S. Census Bureau data indicates that the United States communications
services market (including cable television, but excluding Internet access and
content) in 1995 totaled approximately $221 billion in annual revenue. As
depicted on the chart below, wireline telecommunications services (other than
Internet access and content) purchased by non-residential users accounted for
about 43%, or approximately $96 billion, of the total U.S. market in 1995:
 
                        [US COMMUNICATIONS MARKET GRAPH]
 
     The major segments of the non-residential wireline telecommunications
services market, based on U.S. Census Bureau data, are as follows:
 
                  [NON-RESIDENTIAL WIRELESS TELECOMMUNICATIONS GRAPH]
 
Traditional voice traffic accounted for the vast majority of non-residential
communications revenue in 1995, with local exchange and exchange access
accounting for over half of the total non-residential wireline
telecommunications market (excluding Internet access and content). Due to its
rapid growth, estimates of data and Internet services revenue are not as well
established as those relating to traditional voice traffic communications.
However, the Company believes that a significant market opportunity exists for
providers of non-residential Internet services.
 
                                       40
<PAGE>   42
 
     The Company believes that the rapid opening of the local market to
competition, accelerated growth rates in local traffic related to increases in
Internet access, the desire for multiple suppliers by large businesses, and the
desire for "one-stop shopping" by small and medium-sized businesses and
consumers, presents an opportunity for new entrants to achieve product
differentiation and significant penetration into this very large, established
market. Success in this environment will, in the opinion of management, depend
primarily on speed-to-market, marketing creativity and a CLEC's ability to
provide competitively priced services rapidly and accurately, and to issue
concise, accurate integrated billing statements.
 
     Allegiance plans to deploy networks in 24 Tier I markets. The Company
estimates that these 24 markets will include 18 BTAs with more than 20 million
non-residential access lines, representing approximately 44.7% of the total
non-residential access lines in the U.S. With a network deployment and end user,
direct sales marketing strategy focusing on the most significant areas of
business concentration in these areas, Allegiance plans to address a majority of
the non-residential access lines in most of its targeted markets.
 
THE COMPANY'S TELECOMMUNICATIONS SERVICES
 
     The Company intends to tailor its service offerings to meet the specific
needs of the business, government, and other institutional end users in its
target markets. Management believes that the Company's close contact with
customers from its direct sales force and customer care personnel will enable it
to tailor its service offerings to meet customers' needs and to creatively
package its services to provide "one-stop shopping" solutions for those
customers. The Company plans to offer the following services:
 
     Local Exchange Services. The Company plans to offer local exchange
services, including local dial tone as well as enhanced features such as call
forwarding, call waiting, dial back, caller ID, and voice mail, in all of its
target markets. By offering dial tone service, the Company will also receive
originating and terminating access charges for interexchange calls placed or
received by its subscribers.
 
     PBX/Shared Tenant Services. In areas where telephone density is high and
most telephone customers desire similar services (such as office buildings,
apartments, condominiums or campus-type environments), PBX or shared tenant
services such as Centrex are among the most efficient means of providing
telephone services. The Company will offer these services in areas where market
potential warrants.
 
     ISDN and High Speed Data Services. The Company will offer high speed data
transmission services, such as wide area network ("WAN") interconnection and
broadband Internet access, via frame relay and dedicated point-to-point
connections. In order to provide these services, the Company intends to utilize
leased T1 and higher speed (multiple T1 or T3) fiber connections to medium- and
large-sized business, government, and other institutional customers, while
employing DSL and/or ISDN connections over unbundled copper loops to smaller
business users whose bandwidth requirements may not justify fiber connections or
which are located in areas where T1 connections are not available.
 
     Interexchange/Long Distance Services. The Company will offer a full range
of domestic (interLATA and intraLATA) and international long distance services,
including "1+" outbound calling, inbound toll free service, and such
complementary services as calling cards, operator assistance, and conference
calling.
 
     Enhanced Internet Services. The Company will offer dedicated and dial-up
high speed Internet access services via conventional modem connections, ISDN,
DSL, and T1 and higher speed dedicated connections.
 
     Web Site Design and Hosting Services. The Company intends to offer Web site
design services and will offer Web site hosting on its own computer servers to
provide customers with a turn-key solution that gives them a presence on the
World Wide Web.
 
     Facilities and Systems Integration Services. The Company plans to assist
individual customers with the design and implementation of turn-key solutions in
order to meet their specific needs, including the selection of the customer's
premises equipment, interconnection of LANs and WANs, provision of Advanced
Intelligent Network applications and implementation of virtual private networks.
 
     Wholesale Services to ISPs. The Company believes that with the recent
growth in demand for Internet services, numerous ISPs are unable to obtain
network capacity rapidly enough to meet customer demand and
 
                                       41
<PAGE>   43
 
eliminate network congestion problems. Allegiance plans to supplement its core
end user product offerings by providing a full array of local services to ISPs,
including telephone numbers and switched and dedicated access to the Internet.
 
SALES AND CUSTOMER SUPPORT
 
     The Company will offer an integrated package of local exchange, local
access, domestic and international long distance, enhanced voice, data
transmission, and a full suite of Internet services to small and medium-sized
businesses, with "medium-sized" describing a user having approximately 200-300
phone lines and 250 employees. Unlike large corporate, government, or other
institutional users, small and medium-sized businesses often have no in-house
telecommunications manager. Based on management's previous experience,
Allegiance believes that a direct sales and customer care program focusing on
turn-key, "one-stop shopping" solutions will have a competitive advantage in
capturing this type of customers' total telecommunications traffic.
 
     Although the vast majority of the Company's sales force will focus
primarily on the small and medium-sized business segment, the Company also
intends to provide services to large business, government, and other
institutional users, as well as to ISPs, and expects that a significant portion
of its initial revenue will come from these segments. Therefore, Allegiance will
organize its sales and customer care organizations to serve each of these three
market segments. Sales and marketing approaches in the telecommunications market
are market-segment specific, and the Company believes the following are the most
effective approaches with respect to its three targeted market segments:
 
     - Small/medium business -- The Company will use direct sales, print
       advertising, and agency programs.
 
     - Large business, government, and other institutional users -- The Company
       will use account teams, established business relationships, applications
       sales, trade show advertising, and technical journal articles.
 
     - Wholesale (ISPs) -- The Company will use direct sales, established
       business relationships, and competitive pricing.
 
     The principal portion of Allegiance's sales and customer care resources
will be dedicated to the small and medium-sized business segment. The Company
will organize account executives into teams with a team manager and a sales
support specialist. These teams will utilize telemarketing to "qualify" leads
and set up initial appointments. The Company will closely manage account
executives with regard to activity (i.e. number of sales calls per week) with
the goal of eventually calling on every prospective business customer in an
account executive's sales territory. The Company intends to use commission plans
and incentive programs to reward and retain the top performers and encourage
strong customer relationships. The sales team managers in a market will report
to a city sales director who will in turn report to a regional vice president.
In addition, each team's sales support specialist will act as a "customer
advocate" for the customers served by that team, so that the customer needs to
contact only one person for sales information and personalized customer service.
 
     The Company's wholesale sales to local and regional ISPs will be performed
by account executives reporting to the city sales director. Account executives
reporting to the senior vice president of national accounts will handle large
national ISPs. The senior vice president of national accounts will also have
responsibility for large corporate, government, and other institutional
accounts, with designated national account managers and sales support personnel
assigned to the major accounts. Unlike the small and medium-sized business
segment, the national account program will be built by recruiting national
account managers with established business relationships with large corporate
accounts, supported by technical applications personnel and customer care
specialists.
 
                                       42
<PAGE>   44
 
INFORMATION SYSTEMS
 
     Allegiance is currently developing tailored information systems and
procedures for OSS and other back-office systems that it believes will provide a
significant competitive advantage in terms of cost, processing large order
volumes, and customer service. These systems are required to enter, schedule,
provision, and track a customer's order from the point of sale to the
installation and testing of service and also include or interface with trouble
management, inventory, billing, collection and customer service systems. The
required high-level information requirements to support facilities-based service
are depicted in the following figure:
 
                       [INFORMATION REQUIREMENTS DIAGRAM]
 
     The legacy systems currently employed by most ILECs, CLECs and long
distance carriers, which were developed prior to the passage of the
Telecommunications Act, generally require multiple entries of customer
information to accomplish order management, provisioning, switch administration
and billing. This process is not only labor intensive, but it creates numerous
opportunities for errors in provisioning service and billing, delays in
installing orders, service interruptions, poor customer service, increased
customer churn, and significant added expenses due to duplicated efforts and the
need to correct service and billing problems. The Company believes that the
practical problems and costs of upgrading legacy systems are often prohibitive
for companies whose existing systems support a large number of customers with
ongoing service. Unburdened by legacy systems, the Company's team of engineering
and information technology professionals experienced in the CLEC industry is
working to develop, with the assistance of key third party vendors, OSS and
other back office systems designed to facilitate a smooth, efficient order
management, provisioning, trouble management, billing and collection, and
customer care process. See "Risk Factors -- Dependence on Billing, Customer
Service, and Information Systems."
 
                                       43
<PAGE>   45
 
     Order Management. Allegiance has signed a contract with a third-party
vendor to license their order management software. This product allows the sales
team not only to enter customer orders, but also to monitor the status of the
order as it progresses through the service initiation process.
 
     Provisioning Management. The licensed order management software also
supports the design and management of the provisioning process, including
circuit design and work flow management. The system has been designed to permit
programming into the system of a standard schedule of tasks which must be
accomplished in order to initiate service to a customer, as well as the standard
time intervals during which each such task must be completed. This way, when a
standard order is selected in the system, each required task in the service
initiation process can be efficiently managed to its assigned time interval.
 
     External Interfaces. Several external interfaces are required to initiate
service for a customer. While some of these will be automated initially via
gateways from the order management software, the most important interfaces
(those to the ILEC) will be accomplished initially via fax or e-mail. Certain
ILECs are just beginning to develop automated interfaces on a limited basis.
Allegiance intends to take a lead role with selected ILECs to create standards
for automation of these interfaces.
 
     Network Element Administration. The Company has signed a contract with a
third-party vendor to license their network element administration software. The
Company is currently developing an interface between its order management system
and the network element manager to integrate data integrity and eliminate
redundant data entry.
 
     Customer Billing. Allegiance has selected a billing services provider, and
a contract for this service is currently being negotiated. Customer information
will be electronically interfaced with this provider from the Company's order
management system via a gateway being developed, thereby integrating all
repositories of information.
 
     Billing Records. Billing records will be generated by the Lucent Series
5ESS(R)-2000 switches to record customer calling activity. These records will be
automatically processed by the billing services provider in order to calculate
and produce bills in a customer-specified billing format.
 
     Allegiance believes this integrated OSS approach will provide for faster
customer service initiation, improved billing accuracy and customization, and a
superior level of customer service. See "Risk Factors -- Dependence on Billing,
Customer Service, and Information Systems." The Company will actively work
toward "electronic bonding" between the Allegiance OSS and those of the ILECs,
which would permit creation of service requests on-line.
 
NETWORK DEPLOYMENT
 
   
     Allegiance plans to deploy networks in 24 Tier I markets. The Company
estimates that these 24 markets will include 18 BTAs with over 20 million
non-residential access lines, representing approximately 44.7% of the total
non-residential access lines in the U.S. The Company plans to deploy its
networks principally in two phases of development, with Phase I to offer service
in 12 of the largest U.S. metropolitan markets, which the Company believes
include approximately 26.0% of the nation's non-residential access lines. Phase
II will offer service in an additional 12 major U.S. metropolitan markets, which
the Company believes include approximately an additional 18.7% of total U.S.
non-residential access lines. Allegiance is currently operational in three Phase
I markets: New York City, Dallas and Atlanta; and is in the process of deploying
networks in six additional Phase I markets: Chicago, Los Angeles, San Francisco,
Boston, Fort Worth and Washington, D.C. The following table sets forth the
markets targeted by the Company in Phase I and the Company's current buildout
schedule, although the order and timing of network deployment may vary and will
depend on a number of factors, including recruiting city management, the
regulatory environment, the
    
 
                                       44
<PAGE>   46
 
Company's results of operations and the existence of specific market
opportunities, such as acquisitions, and no assurance can be given that the
Company will deploy networks in each such market:
 
                   PHASE I MARKET SIZE AND BUILDOUT SCHEDULE
 
<TABLE>
<CAPTION>
                                    ESTIMATED TOTAL NON-          % OF TOTAL U.S. NON-        INITIAL FACILITIES-
            MARKET               RESIDENTIAL ACCESS LINES(1)   RESIDENTIAL ACCESS LINES(2)   BASED SERVICE DATE(3)
            ------               ---------------------------   ---------------------------   ---------------------
                                         (THOUSANDS)
<S>                              <C>                           <C>                           <C>
New York City..................             3,298(4)                       6.7%(4)             March 1998
Dallas, TX.....................               867(5)                       1.8%(5)             April 1998
Atlanta, GA....................               612                          1.2%                April 1998
Fort Worth, TX.................                --(5)                         --(5)              3Q, 1998
Chicago, IL....................             1,951                          4.0%                 3Q, 1998
Los Angeles, CA................             3,430(6)                       7.0%(6)              3Q, 1998
Northern New Jersey............                --(4)                         --(4)              4Q, 1998
San Francisco, CA..............             2,148(7)                       4.4%(7)              4Q, 1998
Boston, MA.....................               649                          1.3%                 4Q, 1998
Long Island, NY................                --(4)                         --(4)                1999
Washington, D.C................               871                          1.8%                   1999
Orange County, CA..............                --(6)                         --(6)                1999
                                           ------                         -----
          Total................            13,826(7)                      28.2%(7)
</TABLE>
 
---------------
 
(1) Data as of December 31, 1996.
(2) Based on an estimated 49.0 million U.S. non-residential access lines as of
    December 31, 1996.
(3) Refers to the first month during which the Company could offer
    facilities-based service or the quarter or year during which the Company
    expects to be able to offer facilities-based service based on its current
    business plan.
(4) Data for New York City also includes Northern New Jersey and Long Island,
    NY.
(5) Data for Dallas, TX also includes Fort Worth, TX.
(6) Data for Los Angeles, CA also includes Orange County, CA.
(7) Data for San Francisco, CA also includes San Jose, CA and Oakland, CA, both
    of which are Phase II markets.
 
   
     The following table sets forth the markets targeted by the Company in Phase
II, although the order and timing of network deployment may vary and will depend
on a number of factors, including recruiting city management, the regulatory
environment, the Company's results of operations and the existence of specific
market opportunities, such as acquisitions, and no assurance can be given that
the Company will deploy networks in each such market. Assuming the Debt Offering
is consummated and the Vendor Financing is available to the Company, management
currently expects to commence network deployment in the following Phase II
markets in 1999, with service anticipated to begin during 1999 and 2000.
    
 
                              PHASE II MARKET SIZE
 
<TABLE>
<CAPTION>
                                                    ESTIMATED TOTAL NON-           % OF TOTAL U.S. NON-
                    MARKET                       RESIDENTIAL ACCESS LINES(1)    RESIDENTIAL ACCESS LINES(2)
                    ------                       ---------------------------    ---------------------------
                                                         (THOUSANDS)
<S>                                              <C>                            <C>
San Jose, CA...................................                --(3)                         --(3)
Oakland, CA....................................                --(3)                         --(3)
San Diego, CA..................................               790                           1.6%
Houston, TX....................................               765                           1.6%
Philadelphia, PA...............................             1,754                           3.6%
Detroit, MI....................................               821                           1.7%
Denver, CO.....................................               632                           1.3%
Baltimore, MD..................................               639                           1.3%
Seattle, WA....................................               779                           1.6%
Miami, FL......................................               769                           1.6%
St. Louis, MO..................................               449                           0.9%
Cleveland, OH..................................               654                           1.3%
                                                            -----                          ----
          Total................................             8,052(3)                       16.5%(3)
</TABLE>
 
---------------
 
(1) Data as of December 31, 1996.
(2) Based on an estimated 49.0 million U.S. non-residential access lines as of
    December 31, 1996.
(3) Data for San Jose, CA and Oakland, CA is included in data for San Francisco,
    CA in Phase I above.
 
                                       45
<PAGE>   47
 
     In the majority of its targeted markets, Allegiance will initially deploy
switches and collocate transmission equipment in ILEC central offices with heavy
concentrations of non-residential access lines. Over time, the Company plans to
expand its networks throughout the metropolitan areas to address the majority of
the business market in each area. In some markets, such as Northern New Jersey,
Allegiance will not initially deploy its own switch, but will deploy
transmission equipment in major central offices and route traffic to an existing
Allegiance switch until traffic growth warrants the addition of a switch to
service that market.
 
NETWORK ARCHITECTURE
 
   
     Allegiance is deploying Lucent Series 5ESS(R)-2000 digital switches in New
York City, Dallas, Atlanta, Chicago, Los Angeles, San Francisco, Washington,
D.C. and Boston. The Company currently plans to deploy similar switches in its
other markets. As a result of the network unbundling provisions of the
Telecommunications Act, the Company believes it can accelerate its market entry,
reduce its initial capital requirements and mitigate risks in estimating market
share growth by employing a "smart build" strategy. The Company plans to install
the Lucent switch and related equipment at a central location in each market and
deploy transmission equipment in ILEC central offices. Allegiance intends
initially to lease local network trunking facilities from the ILEC and/or one or
more CLECs in order to connect Allegiance's switch to major ILEC central offices
serving the central business district and outlying areas of business
concentrations in each market. The switch will also be connected to ILEC tandem
switches and certain interexchange carrier ("IXC") points-of-presence ("POPs").
Allegiance will deploy integrated digital loop carriers ("IDLCs") and related
equipment in each of the ILEC central offices in which it is connected. As each
customer is obtained, service will be provisioned by leasing unbundled loops
from the ILEC to connect the Company's IDLC (located in the serving central
office) to the customer premise equipment. For large business, government, or
other institutional customers or for numerous customers located in large
buildings, it may be more cost-effective for Allegiance to use leased ILEC or
CLEC capacity in the 1.5 to 150 megabit range (or perhaps a wireless local loop
leased from one of the emerging wireless CLECs) to connect the customer(s) to
the Allegiance network. In this case, Allegiance will locate its IDLC or other
equipment in the customer's building. A diagram of the Company's typical network
layout is presented in the following figure:
    
 
                          [ALLEGIANCE NETWORK DIAGRAM]
 
                                       46
<PAGE>   48
 
     Although Allegiance will initially lease its local network transmission
facilities, the Company plans to replace leased trunk capacity with its own
fiber optic facilities as and when it experiences sufficient traffic volume
growth between its switch and specific ILEC central offices.
 
     Allegiance will employ a similar "success-based" strategy to manage its
long distance network expenses. Initially, the Company will resell long distance
transmission services by buying minutes on a wholesale basis. As traffic on a
specific route increases (for example, on the New York City-Chicago route),
Allegiance will subsequently lease long distance trunk capacity connecting its
switches between the two markets. Allegiance would thus transport its calls from
New York City to Chicago (or vice versa) over its own network and terminate the
calls at the ILEC tandem switch in Chicago. For international calls, the Company
plans to negotiate agreements with various international carriers for
termination of its international calls throughout the world. As Allegiance's
international traffic volumes increase to major destinations (e.g. Canada,
Mexico, the United Kingdom, France, Germany and Japan), the Company expects to
be able to improve its resale margins.
 
IMPLEMENTATION OF SERVICES
 
   
     In order to offer services in a market, Allegiance generally must secure
certification from the state regulator and typically must file tariffs or price
lists for the services that it will offer. The certification process varies from
state to state; however, the fundamental requirements are largely the same.
State regulators require new entrants to demonstrate that they have secured
adequate financial resources to establish and maintain good customer service.
New entrants are also required to show that they have a staff that possesses the
knowledge and ability required to establish and operate a telecommunications
network. Allegiance has made such demonstrations in Texas, Georgia, California,
Illinois, Maryland and New York, where the Company has obtained certificates to
provide local exchange and intrastate toll service. Applications for such
authority are pending in the District of Columbia and Massachusetts. The Company
intends to file similar applications in the near future for New Jersey and
Virginia.
    
 
   
     Before providing local service, a new entrant must negotiate and execute an
interconnection agreement with the ILEC. While such agreements can be voluminous
and may take months to negotiate, most of the key interconnection issues have
now been thoroughly addressed and commissions in most states have ruled on
arbitrations between the ILECs and new entrants. New entrants may adopt an
interconnection agreement already entered into by the ILEC and another carrier.
Such an approach will be selectively adopted by Allegiance to enable it to enter
markets quickly while at the same time preserving its right to replace the
adopted agreement with a customized interconnection agreement that can be
negotiated once service has already been established. For example, Allegiance
has adopted the interconnection agreement entered into between Southwestern Bell
and WinStar Wireless of Texas, Inc. in Texas and has begun to negotiate
enhancements to that agreement for ultimate inclusion in Allegiance's customized
agreement with Southwestern Bell.
    
 
   
     While such interconnection agreements include key terms and prices for
interconnection circuits, a significant joint implementation effort must be made
with the ILEC in order to establish operationally efficient and reliable traffic
interchange arrangements. Such interchange arrangements must include those
between the new entrant's network and the facilities of other service providers
as well as public service agencies. For example, Allegiance worked closely with
Southwestern Bell in order to devise and implement an efficient 911 call routing
plan that will meet the requirements of each individual 911 service bureau in
Southwestern Bell areas that Allegiance will serve using its own switches.
Allegiance meets with key personnel from 911 service bureaus to obtain their
acceptance and to establish dates for circuit establishment and joint testing.
Other examples of traffic interchange and interconnection arrangements utilizing
the ILEC's network include connectivity to its out-of-band signaling facilities,
interconnectivity to the ILEC's operator services and directory assistance
personnel, and access through the ILEC to the networks of wireless companies and
interexchange carriers.
    
 
     After the initial implementation activities are completed in a market, an
on-going trunking capacity management plan must be followed to ensure that
adequate quantities of network facilities
 
                                       47
<PAGE>   49
 
(e.g., interconnection trunks) are in place, and a contingency plan must be
devised to address spikes in demand caused by events such as a
larger-than-expected customer sale in a relatively small geographic area.
 
REGULATION
 
     The Company's telecommunications services business is subject to varying
degrees of federal, state and local regulation.
 
  Federal Regulation
 
     The FCC regulates interstate and international telecommunications services.
The Company provides service on a common carrier basis. The FCC imposes certain
regulations on common carriers such as the RBOCs that have some degree of market
power. The FCC imposes less regulation on common carriers without market power
including, to date, CLECs. The FCC requires common carriers to receive an
authorization to construct and operate telecommunications facilities, and to
provide or resell telecommunications services, between the United States and
international points.
 
     In August 1996, the FCC released a decision (the "Interconnection
Decision") establishing rules implementing the Telecommunications Act
requirements that ILECs negotiate interconnection agreements and providing
guidelines for review of such agreements by state public utilities commissions.
On July 18, 1997, the Eighth Circuit vacated certain portions of the
Interconnection Decision, including provisions establishing a pricing
methodology and a procedure permitting new entrants to "pick and choose" among
various provisions of existing interconnection agreements between ILECs and
their competitors. On October 14, 1997, the Eighth Circuit issued a decision
vacating additional FCC rules that will likely have the effect of increasing the
cost of obtaining the use of combinations of an ILEC's unbundled network
elements. The Eighth Circuit decisions create uncertainty about the rules
governing pricing and the terms and conditions of interconnection agreements,
and could make negotiating and enforcing such agreements more difficult and
protracted and may require renegotiation of existing agreements. There can be no
assurance that the Company will be able to obtain or enforce interconnection
agreements on terms acceptable to the Company. The Supreme Court has granted a
writ of certiorari to review the Eighth Circuit decisions.
 
     In October 1996, the FCC adopted an order in which it eliminated the
requirement that non-dominant interstate carriers such as the Company maintain
tariffs on file with the FCC for domestic interstate services. This order
applies to all non-dominant interstate carriers, including AT&T. The order does
not apply to the switched and special access services of the RBOCs or other
local exchange providers. The FCC order was issued pursuant to authority granted
to the FCC in the Telecommunications Act to "forbear" from regulating any
telecommunications services provider if the FCC determines that the public
interest will be served. After a nine-month transition period, relationships
between interstate carriers and their customers will be set by contract. At that
point long distance companies may no longer file with the FCC tariffs for
interstate, domestic, interexchange services. Carriers have the option to
immediately cease filing tariffs. Several parties have filed notices for
reconsideration of the FCC order and other parties appealed the decision. On
February 13, 1997, the United States Court of Appeals for the District of
Columbia Circuit stayed the implementation of the FCC order pending its review
of the order on the merits. Currently, that temporary stay remains in effect.
 
     If the stay is lifted and the FCC order becomes effective,
telecommunications carriers such as the Company will no longer be able to rely
on the filing of tariffs with the FCC as a means of providing notice to
customers of prices, terms and conditions on which they offer their interstate
services. The obligation to provide non-discriminatory, just and reasonable
prices remains unchanged under the Communications Act of 1934, as amended (the
"Communications Act"). While tariffs provided a means of providing notice of
prices, terms and conditions, the Company intends to rely primarily on its sales
force and direct marketing to provide such information to its customers.
 
                                       48
<PAGE>   50
 
     The Telecommunications Act is intended to increase competition. The act
opens the local services market by requiring ILECs to permit interconnection to
their networks and establishing ILEC obligations with respect to:
 
     Reciprocal Compensation. Requires all ILECs and CLECs to complete calls
originated by competing carriers under reciprocal arrangements at prices based
on a reasonable approximation of incremental cost or through mutual exchange of
traffic without explicit payment.
 
     Resale. Requires all ILECs and CLECs to permit resale of their
telecommunications services without unreasonable restrictions or conditions. In
addition, ILECs are required to offer wholesale versions of all retail services
to other telecommunications carriers for resale at discounted rates, based on
the costs avoided by the ILEC in the wholesale offering.
 
     Interconnection. Requires all ILECs and CLECs to permit their competitors
to interconnect with their facilities. Requires all ILECs to permit
interconnection at any technically feasible point within their networks, on
nondiscriminatory terms, at prices based on cost (which may include a reasonable
profit). At the option of the carrier seeking interconnection, collocation of
the requesting carrier's equipment in the ILECs' premises must be offered,
except where an ILEC can demonstrate space limitations or other technical
impediments to collocation.
 
     Unbundled Access. Requires all ILECs to provide nondiscriminatory access to
unbundled network elements (including, network facilities, equipment, features,
functions, and capabilities) at any technically feasible point within their
networks, on nondiscriminatory terms, at prices based on cost (which may include
a reasonable profit).
 
     Number Portability. Requires all ILECs and CLECs to permit users of
telecommunications services to retain existing telephone numbers without
impairment of quality, reliability or convenience when switching from one
telecommunications carrier to another.
 
     Dialing Parity. Requires all ILECs and CLECs to provide "1+" equal access
to competing providers of telephone exchange service and toll service, and to
provide nondiscriminatory access to telephone numbers, operator services,
directory assistance, and directory listing, with no unreasonable dialing
delays.
 
     Access to Rights-of-Way. Requires all ILECs and CLECs to permit competing
carriers access to poles, ducts, conduits and rights-of-way at regulated prices.
 
     ILECs are required to negotiate in good faith with carriers requesting any
or all of the above arrangements. If the negotiating carriers cannot reach
agreement within a prescribed time, either carrier may request binding
arbitration of the disputed issues by the state regulatory commission. Where an
agreement has not been reached, ILECs remain subject to interconnection
obligations established by the FCC and state telecommunication regulatory
commissions.
 
     On May 8, 1997, the FCC released an order establishing a significantly
expanded federal universal service subsidy regime. For example, the FCC
established new subsidies for telecommunications and information services
provided to qualifying schools and libraries with an annual cap of $2.3 billion
and for services provided to rural health care providers with an annual cap of
$400.0 million. The FCC also expanded the federal subsidies for local exchange
telephone services provided to low-income consumers. Providers of interstate
telecommunications service, such as the Company, as well as certain other
entities, must pay for these programs. The Company's share of these federal
subsidy funds will be based on its share of certain defined telecommunications
end user revenues. Currently, the FCC is assessing such payments on the basis of
a provider's revenue for the previous year; since the Company had no significant
revenues in 1997, it will not be liable for subsidy payments in any material
amount during 1998. With respect to subsequent years, however, the Company is
currently unable to quantify the amount of subsidy payments that it will be
required to make or the effect that these required payments will have on its
financial condition. In the May 8th order, the FCC also announced that it will
soon revise its rules for subsidizing service provided to consumers in high cost
areas, which may result in further substantial increases in the overall cost of
the subsidy program. Several parties have appealed the May 8th order. Such
appeals have been consolidated and transferred to the United States
 
                                       49
<PAGE>   51
 
   
Court of Appeals for the Fifth Circuit where they are currently pending. In
addition, on July 3, 1997, several ILECs filed a petition for stay of the May
8th order with the FCC. That petition is pending, as well as several petitions
for administrative reconsideration of the order.
    
 
     The Telecommunications Act codifies the ILECs' equal access and
nondiscrimination obligations and preempts inconsistent state regulation. The
Telecommunications Act also contains special provisions that eliminate the AT&T
Antitrust Consent Decree (and similar antitrust restrictions on the GTOCs)
restricting the RBOCs from providing long distance services and engaging in
telecommunications equipment manufacturing. The Telecommunications Act permitted
the RBOCs to enter the out-of-region long distance market immediately upon its
enactment. Further, provisions of the Telecommunications Act permit a RBOC to
enter the long distance market in its traditional service area if it satisfies
several procedural and substantive requirements, including obtaining FCC
approval upon a showing that the RBOC has entered into interconnection
agreements (or, under some circumstances, has offered to enter into such
agreements) in those states in which it seeks long distance relief, the
interconnection agreements satisfy a 14-point "checklist" of competitive
requirements, and the FCC is satisfied that the RBOC's entry into long distance
markets is in the public interest. To date, several petitions by RBOCs for such
entry have been denied by the FCC, and none have been granted.
 
   
     On December 31, 1997, the U.S. District Court for the Northern District of
Texas issued the SBC Decision finding that Sections 271 to 275 of the
Telecommunications Act are unconstitutional. These sections of the
Telecommunications Act impose restrictions on the lines of business in which the
RBOCs may engage, including establishing the conditions they must satisfy before
they may provide in-region interLATA telecommunications services. The SBC
Decision has been stayed pending appeal. The Company cannot predict the likely
outcome of that appeal, although on May 15, 1998, the Court of Appeals for the
District of Columbia Circuit rejected a very similar challenge to the
constitutionality of Section 274 of the Telecommunications Act. If the SBC
Decision is upheld on appeal, however, the RBOCs would be able to provide such
in-region services immediately without satisfying the statutory conditions. This
would likely have an unfavorable effect on the Company's business for at least
two reasons. First, the SBC Decision removes the incentive RBOCs have to
cooperate with companies like Allegiance to foster competition within their
service areas so that they can qualify to offer in-region interLATA services
because the decision allows RBOCs to offer such services immediately. However,
the SBC Decision does not affect other provisions of the Act which create legal
obligations for all ILECs to offer interconnection and network access. Second,
the Company is legally able to offer its customers both long distance and local
exchange services, which the RBOCs currently may not do. This ability to offer
"one-stop shopping" gives the Company a marketing advantage that it would no
longer enjoy if the SBC Decision were upheld on appeal. See "-- Competition."
    
 
     Under the Telecommunications Act, any entity, including cable television
companies and electric and gas utilities, may enter any telecommunications
market, subject to reasonable state regulation of safety, quality and consumer
protection. Because implementation of the Telecommunications Act is subject to
numerous federal and state policy rulemaking proceedings and judicial review
there is still uncertainty as to what impact such legislation will have on the
Company.
 
     Pursuant to authority granted by the FCC, the Company will resell the
international telecommunications services of other common carriers between the
United States and international points. In connection with such authority, the
Company's subsidiary, Allegiance Telecom International, Inc., has filed tariffs
with the FCC stating the rates, terms and conditions for its international
services.
 
     With respect to its domestic service offerings, various subsidiaries of the
Company have filed tariffs with the FCC stating the rates, terms and conditions
for their interstate services. The Company's tariffs are generally not subject
to pre-effective review by the FCC, and can be amended on one day's notice. The
Company's interstate services are provided in competition with interexchange
carriers and, with respect to access services, the ILECs. With limited
exceptions, the current policy of the FCC for most interstate access services
dictates that ILECs charge all customers the same price for the same service.
Thus, the ILECs generally cannot lower prices to those customers likely to
contract for their services without also lowering charges for the same service
to all customers in the same geographic area, including those whose
 
                                       50
<PAGE>   52
 
telecommunications requirements would not justify the use of such lower prices.
The FCC may, however, alleviate this constraint on the ILECs and permit them to
offer special rate packages to very large customers, as it has done in a few
cases, or permit other forms of rate flexibility. The FCC has adopted some
proposals that significantly lessen the regulation of ILECs that are subject to
competition in their service areas and provide such ILECs with additional
flexibility in pricing their interstate switched and special access on a central
office specific basis; and, as discussed in the following paragraph, is
considering expanding such flexibility.
 
     In two orders released on December 24, 1996, and May 16, 1997, the FCC made
major changes in the interstate access charge structure. In the December 24th
order, the FCC removed restrictions on ILECs' ability to lower access prices and
relaxed the regulation of new switched access services in those markets where
there are other providers of access services. If this increased pricing
flexibility is not effectively monitored by federal regulators, it could have a
material adverse effect on the Company's ability to compete in providing
interstate access services. The May 16th order substantially increased the costs
that ILECs subject to the FCC's price cap rules ("price cap LECs") recover
through monthly, non-traffic sensitive access charges and substantially decrease
the costs that price cap LECs recover through traffic sensitive access charges.
In the May 16th order, the FCC also announced its plan to bring interstate
access rate levels more in line with cost. The plan will include rules that are
expected to be established sometime in 1998 that may grant price cap LECs
increased pricing flexibility upon demonstrations of increased competition (or
potential competition) in relevant markets. The manner in which the FCC
implements this approach to lowering access charge levels could have a material
effect on the Company's ability to compete in providing interstate access
services. Several parties have appealed the May 16th order. Those appeals have
been consolidated and transferred to the United States Court of Appeals for the
Eighth Circuit where they are currently pending.
 
   
     A number of ILECs around the country have been contesting whether the
obligation to pay reciprocal compensation to CLECs should apply to local
telephone calls terminating to ISPs. The ILECs claim that this traffic is
interstate in nature and therefore should be exempt from compensation
arrangements applicable to local, intrastate calls. The FCC, however, has
determined on a number of occasions, including in its May 16, 1997, access
charge reform order, that calls to ISPs should be exempt from interstate access
charges and should be governed by local exchange tariffs. Under the Eighth
Circuit decisions, however, the states have primary jurisdiction over the
determination of reciprocal compensation arrangements and as a result, the
treatment of this issue can vary from state to state. Currently, 20 state
commissions, two federal courts and one state court have ruled that reciprocal
compensation arrangements do apply to ISP traffic. However, certain of these
rulings are subject to appeal. Disputes over the appropriate treatment of ISP
traffic are pending in eight states. The NARUC adopted a resolution in favor of
reciprocal compensation for ISP traffic. The Company anticipates that ISPs will
be among its target customers, and adverse decisions in these proceedings could
limit the Company's ability to service this group of customers profitably.
    
 
  State Regulation
 
     The Telecommunications Act is intended to increase competition in the
telecommunications industry, especially in the local exchange market. With
respect to local services, ILECs are required to allow interconnection to their
networks and to provide unbundled access to network facilities, as well as a
number of other procompetitive measures. Because the implementation of the
Telecommunications Act is subject to numerous state rulemaking proceedings on
these issues, it is currently difficult to predict how quickly full competition
for local services, including local dial tone, will be introduced.
 
   
     State regulatory agencies have regulatory jurisdiction when Company
facilities and services are used to provide intrastate services. A portion of
the Company's current traffic may be classified as intrastate and therefore
subject to state regulation. The Company expects that it will offer more
intrastate services (including intrastate switched services) as its business and
product lines expand and state regulations are modified to allow increased local
services competition. To provide intrastate services, the Company generally must
obtain a certificate of public convenience and necessity from the state
regulatory agency and comply with state requirements for telecommunications
utilities, including state tariffing requirements. The Company has obtained such
certificates to provide local exchange and intrastate toll service in Texas,
Georgia, California,
    
 
                                       51
<PAGE>   53
 
   
Illinois, Maryland and New York. Applications for authority to provide local
exchange and intrastate toll services are currently pending in the District of
Columbia and Massachusetts. In Georgia, the Company has also received
certificate authority to provide intrastate interexchange alternate operator
services. In New Jersey, the Company is authorized to resell services, and
intends to file an application for facilities-based authority in the near
future. The Company also intends to file similar applications in the near future
in Virginia, Michigan, Pennsylvania, Florida and Washington. There can be no
assurance that such state authorizations will be granted.
    
 
  Local Regulation
 
     The Company's networks are subject to numerous local regulations such as
building codes and licensing. Such regulations vary on a city by city and county
by county basis. To the extent the Company decides in the future to install its
own fiber optic transmission facilities, it will need to obtain rights-of-way
over private and publicly owned land. There can be no assurance that such
rights-of-way will be available to the Company on economically reasonable or
advantageous terms.
 
COMPETITION
 
     The telecommunications industry is highly competitive. The Company believes
that the principal competitive factors affecting its business will be pricing
levels and clear pricing policies, customer service, accurate billing and, to a
lesser extent, variety of services. The ability of the Company to compete
effectively will depend upon its continued ability to maintain high quality,
market-driven services at prices generally equal to or below those charged by
its competitors. To maintain its competitive posture, the Company believes that
it must be in a position to reduce its prices in order to meet reductions in
rates, if any, by others. Any such reductions could adversely affect the
Company. Many of the Company's current and potential competitors have financial,
personnel and other resources, including brand name recognition, substantially
greater than those of the Company, as well as other competitive advantages over
the Company.
 
     Local Exchange Carriers ("LECs"). In each of the markets targeted by the
Company, the Company will compete principally with the ILEC serving that area,
such as BellSouth, Southwestern Bell, or Bell Atlantic Corporation. The Company
believes the RBOCs' primary agenda is to be able to offer long distance service
in their service territories. The independent telcos have already achieved this
goal with good early returns. Many experts expect the RBOCs to be successful in
entering the long distance market in a few states by early 1998 and in all
states by mid-1999. The Company believes the RBOCs expect to offset share losses
in their local markets by capturing a significant percentage of the in-region
long distance market, especially in the residential segment where the RBOCs'
strong regional brand names and extensive advertising campaigns may be very
successful. In the event that the SBC Decision, which held that the
Telecommunications Act's restrictions on the lines of business in which RBOCs
may engage (including the conditions to the RBOCs provision of in-region
interLATA telecommunications services) are unconstitutional, is upheld, the
RBOCs would immediately thereafter be able to enter the long distance market in
their service territories. See "-- Regulation."
 
     As a recent entrant in the integrated telecommunications services industry,
the Company has not achieved and does not expect to achieve a significant market
share for any of its services. In particular, the ILECs have long-standing
relationships with their customers, have financial, technical and marketing
resources substantially greater than those of the Company, have the potential to
subsidize competitive services with revenues from a variety of businesses and
currently benefit from certain existing regulations that favor the ILECs over
the Company in certain respects. While recent regulatory initiatives, which
allow CLECs such as the Company to interconnect with ILEC facilities, provide
increased business opportunities for the Company, such interconnection
opportunities have been (and likely will continue to be) accompanied by
increased pricing flexibility for and relaxation of regulatory oversight of the
ILECs.
 
     ILECs have long-standing relationships with regulatory authorities at the
federal and state levels. While recent FCC administrative decisions and
initiatives provide increased business opportunities to telecommunications
providers such as the Company, they also provide the ILECs with increased
pricing
 
                                       52
<PAGE>   54
 
flexibility for their private line and special access and switched access
services. In addition, with respect to competitive access services (as opposed
to switched local exchange services), the FCC recently proposed a rule that
would provide for increased ILEC pricing flexibility and deregulation for such
access services either automatically or after certain competitive levels are
reached. If the ILECs are allowed by regulators to offer discounts to large
customers through contract tariffs, engage in aggressive volume and term
discount pricing practices for their customers, and/or seek to charge
competitors excessive fees for interconnection to their networks, the income of
competitors to the ILECs, including the Company, could be materially adversely
affected. If future regulatory decisions afford the ILECs increased access
services pricing flexibility or other regulatory relief, such decisions could
also have a material adverse effect on competitors to the ILEC, including the
Company.
 
   
     Competitive Access Carriers/Competitive Local Exchange Carriers/IXCs/Other
Market Entrants. The Company also faces, and expects to continue to face,
competition from other current and potential market entrants, including long
distance carriers seeking to enter, reenter or expand entry into the local
exchange market such as AT&T, MCI, and Sprint, and from other CLECs, resellers
of local exchange services, CAPs, cable television companies, electric
utilities, microwave carriers, wireless telephone system operators and private
networks built by large end users. In addition, a continuing trend toward
consolidation of telecommunications companies and the formation of strategic
alliances within the telecommunications industry, as well as the development of
new technologies, could give rise to significant new competitors to the Company.
For example, WorldCom acquired MFS in December 1996, has recently acquired
another CLEC, Brooks Fiber Properties, Inc., and has a pending agreement to
merge with MCI. In January 1998 AT&T announced its intention to acquire Teleport
Communications Group Inc. In May 1998, SBC Communications Inc. and Ameritech
Corporation agreed to merge. On June 24, 1998, AT&T announced that it has
entered into a merger agreement with Tele-Communications, Inc., a cable,
telecommunications, and high-speed Internet services provider. These types of
consolidations and strategic alliances could put the Company at a competitive
disadvantage. The Telecommunications Act includes provisions which impose
certain regulatory requirements on all local exchange carriers, including
competitors such as the Company, while granting the FCC expanded authority to
reduce the level of regulation applicable to any or all telecommunications
carriers, including ILECs. The manner in which these provisions of the
Telecommunications Act are implemented and enforced could have a material
adverse effect on the Company's ability to successfully compete against ILECs
and other telecommunications service providers. The Company also competes with
equipment vendors and installers, and telecommunications management companies
with respect to certain portions of its business.
    
 
     The changes in the Telecommunications Act radically altered the market
opportunity for traditional CAPs and CLECs. Due to the fact that most existing
CAP/CLECs initially entered the market providing dedicated access in the
pre-1996 era, these companies had to build a fiber infrastructure before
offering services. Switches were added by most CAP/CLECs in the last year to
take advantage of the opening of the local market. With the Telecommunications
Act requiring unbundling of the LEC networks, CAP/CLECs will now be able to more
rapidly enter the market by installing switches and leasing trunk and loop
capacity until traffic volume justifies building facilities. New CLECs will not
have to replicate existing facilities and can be more opportunistic in designing
and implementing networks.
 
     The Company believes the major IXCs (AT&T, MCI, Sprint) have a two pronged
strategy: (1) keep the RBOCs out of in-region long distance as long as possible
and (2) develop facilities-based and unbundled local service, an approach
already being pursued by WorldCom with the acquisition of MFS, and more recently
by AT&T with its proposed acquisition of Teleport Communications.
 
     Competition for Provision of Long Distance Services. The long distance
telecommunications industry has numerous entities competing for the same
customers and a high average churn rate, as customers frequently change long
distance providers in response to the offering of lower rates or promotional
incentives by competitors. Prices in the long distance market have declined
significantly in recent years and are expected to continue to decline. The
Company expects to increasingly face competition from companies offering long
distance data and voice services over the Internet. Such companies could enjoy a
significant cost advantage because they do not currently pay carrier access
charges or universal service fees.
 
                                       53
<PAGE>   55
 
     Data/Internet Services Providers. The Internet services market is highly
competitive, and the Company expects that competition will continue to
intensify. The Company's competitors in this market will include ISPs, other
telecommunications companies, online services providers and Internet software
providers. Many of these competitors have greater financial, technological and
marketing resources than those available to the Company.
 
     Competition from International Telecommunications Providers. Under the
recent WTO agreement on basic telecommunications services, the United States and
72 other members of the WTO committed themselves to opening their respective
telecommunications markets and/or foreign ownership and/or to adopting
regulatory measures to protect competitors against anticompetitive behavior by
dominant telecommunications companies, effective in some cases as early as
January 1998. Although the Company believes that the WTO agreement could provide
the Company with significant opportunities to compete in markets that were not
previously accessible and to provide more reliable services at lower costs than
the Company could have provided prior to implementation of the WTO agreement, it
could also provide similar opportunities to the Company's competitors. There can
be no assurance that the pro-competitive effects of the WTO agreement will not
have a material adverse effect on the Company's business, financial condition
and results of operations or that members of the WTO will implement the terms of
the WTO agreement. See "Risk Factors -- Competition."
 
EMPLOYEES
 
   
     As of June 25, 1998, the Company had approximately 250 employees. The
Company believes that its future success will depend on its continued ability to
attract and retain highly skilled and qualified employees. None of the Company's
employees are currently represented by a collective bargaining agreement. The
Company believes that it enjoys good relationships with its employees.
    
 
LEGAL PROCEEDINGS
 
     On August 29, 1997, WorldCom sued the Company and two of its Senior Vice
Presidents. In its complaint, WorldCom alleges that these employees violated
certain noncompete and nonsolicitation agreements by accepting employment with
the Company and by soliciting then-current WorldCom employees to leave
WorldCom's employment and join the Company. In addition, WorldCom claims that
the Company tortiously interfered with WorldCom's relationships with its
employees, and that the Company's behavior constituted unfair competition.
WorldCom seeks injunctive relief, including barring two of the Company's
executives from continued employment with the Company, and monetary damages,
although it has filed no motion for a temporary restraining order or preliminary
injunction. The Company denies all claims and will vigorously defend itself. The
Company does not expect the ultimate outcome of this matter to have a material
adverse effect on the results of operations or financial condition of the
Company.
 
     On October 7, 1997, the Company filed a counterclaim against WorldCom for,
among other things, attempted monopolization of the "one-stop shopping"
telecommunications market, abuse of process, and unfair competition. WorldCom
did not move to dismiss the attempted monopolization claim, but moved to dismiss
the abuse of process and unfair competition claims. On March 4, 1998, the court
dismissed the claim for unfair competition.
 
     The Company is not party to any other pending legal proceedings that the
Company believes would, individually or in the aggregate, have a material
adverse effect on the Company's financial condition or results of operations.
 
                                       54
<PAGE>   56
 
FACILITIES
 
     The Company is headquartered in Dallas, Texas and leases offices and space
in a number of locations, primarily for sales offices and network equipment
installations. The table below lists the Company's current leased facilities:
 
<TABLE>
<CAPTION>
                                                                                   APPROXIMATE
                          LOCATION                            LEASE EXPIRATION    SQUARE FOOTAGE
                          --------                            ----------------    --------------
<S>                                                           <C>                 <C>
Dallas, TX..................................................  January 2008            40,000
Atlanta, GA.................................................  February 2003            7,400
Atlanta, GA.................................................  August 1998              1,000
Atlanta, GA.................................................  November 2001            7,900
Chicago, IL.................................................  February 2009            9,200
Chicago, IL.................................................  July 2008               14,000
Los Angeles, CA.............................................  June 2008               11,000
Los Angeles, CA.............................................  June 2008               10,000
New York, NY................................................  August 2006              8,700
New York, NY................................................  April 2008              19,500
Westchester, IL.............................................  January 2001            10,600
</TABLE>
 
     The Company believes that its leased facilities are adequate to meet its
current needs in the eight markets in which it has begun to deploy networks, and
that additional facilities are available to meet its development and expansion
needs in existing and projected target markets for the foreseeable future.
 
                                       55
<PAGE>   57
 
                                   MANAGEMENT
 
DIRECTORS, EXECUTIVE OFFICERS AND OTHER KEY EMPLOYEES
 
     The following table sets forth certain information concerning the
directors, executive officers and other key personnel of the Company, including
their ages as of May 1, 1998:
 
<TABLE>
<CAPTION>
            NAME               AGE                          POSITION(S)
            ----               ---                          -----------
<S>                            <C>   <C>
Royce J. Holland(1)..........  49    Chairman of the Board and Chief Executive Officer
C. Daniel Yost...............  49    President and Chief Operating Officer, and Director
Thomas M. Lord...............  41    Executive Vice President of Corporate Development, Chief
                                     Financial Officer, and Director
John J. Callahan.............  48    Senior Vice President of Sales and Marketing, and
                                     Director
Dana A. Crowne...............  37    Senior Vice President and Chief Engineer
Stephen N. Holland...........  46    Senior Vice President and Chief Information Officer
Patricia E. Koide............  49    Senior Vice President of Human Resources, Real Estate,
                                     Facilities and Administration
Gregg A. Long................  44    Senior Vice President of Development and Regulatory
L.C. Baird...................  54    Regional Vice President -- Southeast Division
Anthony J. Parella...........  38    Regional Vice President -- Central Division
Lawrence A. Price............  35    Regional Vice President -- Northeast Division
Paul D. Carbery..............  37    Director
James E. Crawford, III(1)....  52    Director
John B. Ehrenkranz...........  33    Director
Paul J. Finnegan.............  45    Director
Richard D. Frisbie...........  48    Director
Reed E. Hundt................  49    Director
Robert H. Niehaus (1)........  42    Director
James N. Perry, Jr. (1)......  37    Director
</TABLE>
 
---------------
 
(1) Member of the Board's Executive Committee.
 
     Royce J. Holland, the Company's Chairman of the Board and Chief Executive
Officer, has more than 25 years of experience in the telecommunications,
independent power and engineering/construction industries. Prior to founding
Allegiance in April 1997, Mr. Holland was one of several co-founders of MFS,
where he served as President and Chief Operating Officer from April 1990 until
September 1996 and as Vice Chairman from September 1996 to February 1997. In
January 1993, Mr. Holland was appointed by President George Bush to the National
Security Telecommunications Advisory Committee. Mr. Holland also presently
serves on the Board of Directors of CSG Systems, a publicly held billing
services company. Mr. Holland's brother, Stephen N. Holland, is employed as the
Company's Senior Vice President and Chief Information Officer.
 
     C. Daniel Yost, who joined the Company as President and Chief Operating
Officer in February 1998, was elected to the Company's Board of Directors in
March 1998. Mr. Yost has more than 26 years of experience in the
telecommunications industry. From July 1997 until he joined the Company, Mr.
Yost was the President and Chief Operating Officer for U.S. Operations of Netcom
On-Line Communications Services, Inc., a leading Internet service provider. Mr.
Yost served as the President, Southwest Region of AT&T Wireless Services, Inc.
from June 1994 to July 1997. Prior to that, from July 1991 to June 1994, Mr.
Yost was the President, Southwest Region of McCaw Cellular Communications/LIN
Broadcasting.
 
     Thomas M. Lord, a co-founder and Director of the Company and its Executive
Vice President of Corporate Development and Chief Financial Officer, is
responsible for overseeing the Company's mergers and acquisitions, corporate
finance and investor relations functions. Mr. Lord is an 18-year veteran in
investment banking, securities research and portfolio management, including
serving as a managing director of Bear, Stearns & Co. Inc. from January 1986 to
December 1996. In the five-year period ending December 1996,
 
                                       56
<PAGE>   58
 
Mr. Lord oversaw 43 different transactions valued in excess of $6.2 billion for
the telecommunications, information services and technology industries.
 
     John J. Callahan, who joined the Company as Senior Vice President of Sales
and Marketing in December 1997, has more than 18 years of experience in the
telecommunications industry. Most recently, Mr. Callahan was President of the
Western Division for MFS from December 1991 to November 1997, where he was
responsible for the company's sales and operations in Arizona, California,
Georgia, Florida, Illinois, Michigan, Missouri, Ohio, Oregon, Texas and
Washington. Prior to joining MFS, Mr. Callahan was Vice President and General
Manager, Southwest Division for Sprint. Mr. Callahan also held sales positions
with Data Switch and North American Telecom. Mr. Callahan was elected to the
Company's Board of Directors in March 1998.
 
     Dana A. Crowne became the Company's Senior Vice President and Chief
Engineer in August 1997. Prior to joining Allegiance, Mr. Crowne held various
management positions at MFS from the time of its founding in 1988, where his
responsibilities included providing engineering support and overseeing budgets
for the construction of MFS' networks. Mr. Crowne ultimately became Vice
President, Network Optimization for MFS from January 1996 to May 1997 and
managed the company's network expenses and planning and its domestic engineering
functions. Prior to joining MFS, Mr. Crowne designed and installed fiber optic
transmission systems for Morrison-Knudsen and served as a consultant on the
construction of private telecommunications networks with JW Reed and Associates.
 
     Stephen N. Holland joined the Company as its Senior Vice President and
Chief Information Officer in September 1997. Prior to that time, Mr. Holland
held several senior level positions involving management of or consulting on
information systems, accounting, taxation and finance. Mr. Holland's experience
includes serving as Practice Manager and Information Technology Consultant for
Oracle Corporation from June 1995 to September 1997, as Chief Financial Officer
of Petrosurance Casualty Co. from September 1992 to June 1995, as Manager of
Business Development for Electronic Data Systems, and as a partner of Price
Waterhouse. Mr. Holland's brother, Royce J. Holland, presently serves as the
Company's Chairman of the Board and Chief Executive Officer.
 
     Patricia E. Koide has been the Company's Senior Vice President of Human
Resources, Real Estate, Facilities and Administration since August 1997. Before
then, Ms. Koide was Vice President of Corporate Services, Facilities and
Administration for WorldCom from March 1997 to August 1997. Ms. Koide also held
various management positions within MFS and its subsidiaries since 1989,
including Senior Vice President of Facilities, Administration and Purchasing for
MFS North America from 1996 to 1997, Senior Vice President of Human Resources,
Facilities and Administration for MFS Telecom from 1994 to 1996, and Vice
President of Human Resources and Administration for MFS North America from 1989
to 1993. Prior to MFS, Ms. Koide was with Sprint for eight years where she
managed the company's human resources, real estate and facilities for the
Midwest.
 
   
     Gregg A. Long, who became the Company's Senior Vice President of Regulatory
and Development in September 1997, spent 11 years at Destec Energy, Inc. as
Project Development Manager -- Partnership Vice President and Director. In that
position, he was responsible for the development of gas-fired power plants from
conceptual stages through project financing. Prior to joining Destec, Mr. Long
was Manager of Project Finance at Morrison-Knudsen, where he was responsible for
analyzing and arranging finance packages for various industrial, mining and
civil projects and also served as financial consultant and analyst.
    
 
     L.C. Baird, who became the Company's Regional Vice President -- Southeast
Division in September 1997, has more than 25 years of experience in the
telecommunications industry. Prior to joining Allegiance, Mr. Baird held several
senior level positions in operating units of MFS, including serving as President
of MFS Intelenet's Southern Division from January 1993 to April 1997 and as vice
president of sales and marketing for MFS Network Technologies from August 1987
to January 1993. Mr. Baird also served as area manager for Motorola's Latin
American Communications where he was responsible for sales in Central America,
Mexico, South America and the Caribbean.
 
                                       57
<PAGE>   59
 
     Anthony J. Parella, who joined the Company as its Regional Vice
President -- Central Division in August 1997, has more than 10 years of
experience in the telecommunications industry. Prior to joining Allegiance, Mr.
Parella was Vice President and General Manager for MFS Intelenet, Inc., an
operating unit of MFS, from February 1994 to January 1997, where he was
responsible for the company's sales and operations in Texas. Mr. Parella also
served as Director of Commercial Sales for Sprint from 1991 to January 1994.
 
     Lawrence A. Price joined the Company as its Regional Vice
President -- Northeast Division in February, 1998. From February 1997 until he
joined the Company, Mr. Price was a Vice President/General Manager of WinStar
Telecommunications, Inc. From June 1995 to February 1997, Mr. Price held
management positions with ADC Telecommunications, Inc. From July 1994 to June
1995, he was the Director of U.S. Sales and Operations of ATX Telecom Systems,
Inc, and from July 1993 to July 1994 he was a sales manager with Teleport
Communications Group, Inc.
 
     Paul D. Carbery, who was elected to the Company's Board of Directors in
August 1997, is a general partner of Frontenac Company, a Chicago-based private
equity investing firm, where he specializes in investing in companies in the
telecommunications and technology industries. Mr. Carbery also presently serves
on the boards of directors of Whittman Hart, Inc., a publicly traded information
services company, and Mastering Computers Inc., a publicly traded information
technology training company.
 
     James E. Crawford, III, who was elected to the Company's Board of Directors
in August 1997, is a general partner of Frontenac Company, a Chicago-based
private equity investing firm, where he specializes in investing in companies in
the telecommunications and technology industries. Mr. Crawford also presently
serves on the boards of directors of Focal Communications Corporation ("Focal"),
a privately held CLEC that will compete with the Company, as well as of Optika
Imaging Systems, Inc., a publicly held document imaging software company, and
Cornerstone Imaging, Inc., a publicly held document imaging displays company.
 
     John B. Ehrenkranz, who was elected to the Company's Board of Directors in
March 1998, is a Principal of Morgan Stanley & Co. Incorporated where he has
been employed since 1987. Mr. Ehrenkranz is also a Principal of Morgan Stanley
Capital Partners III, Inc.
 
     Paul J. Finnegan, who was elected to the Company's Board of Directors in
August 1997, is a vice president of Madison Dearborn Partners, Inc., a
Chicago-based private equity investing firm, where he specializes in investing
in companies in the telecommunications industry. Mr. Finnegan also presently
serves on the boards of directors of Focal, a privately held CLEC that will
compete with the Company, and Omnipoint Corporation, a publicly traded PCS
provider.
 
     Richard D. Frisbie, who was elected to the Company's Board of Directors in
August 1997, is a Managing Partner of Battery Ventures, a Boston-based private
equity investing firm, where he specializes in investing in companies in the
telecommunications industry. Mr. Frisbie also presently serves on the board of
directors of Focal, a privately held CLEC that will compete with the Company.
 
     Reed E. Hundt was elected to the Company's Board of Directors in March
1998. Mr. Hundt served as chairman of the Federal Communications Commission from
1993 to 1997. He currently serves as chairman of The Forum on Communications and
Society (FOCAS) at The Aspen Institute and is a principal of Charles Ross
Partners, LLC, a consulting firm. Prior to joining the FCC, Mr. Hundt was a
partner at Latham & Watkins, an international law firm.
 
     Robert H. Niehaus, who was elected to the Company's Board of Directors in
August 1997, is a Managing Director of Morgan Stanley & Co. Incorporated where
he has been employed since 1982. Mr. Niehaus also presently serves on the boards
of directors of numerous companies including American Italian Pasta Company,
PageMart Wireless, Inc., Silgan Holdings Inc., and Waterford Wedgewood, plc. Mr.
Niehaus is also a Managing Director and a Director of Morgan Stanley Capital
Partners III, Inc.
 
     James N. Perry, Jr., who was elected to the Company's Board of Directors in
August 1997, is a vice president of Madison Dearborn Partners, Inc., a
Chicago-based private equity investing firm, where he specializes in investing
in companies in the telecommunications industry. Mr. Perry also presently serves
on the boards of directors of Focal, a privately held CLEC that will compete
with the Company, as well as
 
                                       58
<PAGE>   60
 
Omnipoint Corporation, a publicly traded PCS provider, and Clearnet
Communications, a Canadian publicly traded PCS and enhanced specialized mobile
radio company.
 
ELECTION OF DIRECTORS; VOTING AGREEMENT
 
     The Company's bylaws establish the size of the Company's Board of Directors
at 13 Directors; there is presently one vacancy. The Company anticipates that
one additional director not otherwise affiliated with the Company or any of its
stockholders will be elected by the Board of Directors following the completion
of the Equity Offering. The Company's certificate of incorporation and by-laws
provide that its Directors will be appointed and may be removed by majority vote
of the Company's stockholders (without cumulative voting).
 
     At present all directors are elected annually and serve until the next
annual meeting of stockholders, or until the election and qualification of their
successors. Effective upon the consummation of the Equity Offering, the Board of
Directors will be divided into three classes, as nearly equal in number as
possible, with each Director serving a three year term and one class being
elected at each year's annual meeting of stockholders. Messrs. Callahan,
Finnegan, Carbery, and Ehrenkranz will be in the class of directors whose term
expires at the 1999 annual meeting of the Company's stockholders. Messrs. Lord,
Yost, Crawford, Frisbie and the additional director anticipated to be appointed
by the Board of Directors will be in the class of directors whose term expire at
the 2000 annual meeting of the Company's stockholders. Messrs. Holland, Hundt,
Perry and Niehaus will be in the class of directors whose term expires at the
2001 annual meeting of the Company's stockholders. At each annual meeting of the
Company's stockholders, successors to the class of directors whose term expires
at such meeting will be elected to serve for three-year terms and until their
successors are elected and qualified.
 
     The current direct and indirect stockholders of the Company are parties to
a voting agreement, pursuant to which they have each agreed to vote all of their
shares in such a manner as to elect the following persons to serve as Directors:
Madison Dearborn Capital Partners, Morgan Stanley Capital Partners, and
Frontenac Company (and their respective successors, assigns, transferees, and
affiliates) each have the right to designate two Directors; Battery Ventures
(and its successors, assigns, transferees, and affiliates) has the right to
designate one Director; the Company's Chief Executive Officer has the right to
serve as a Director; the Management Investors (and their successors and assigns)
have the right to designate three Directors; and the final two directorships may
be filled by representatives designated by the Fund Investors and acceptable to
the Management Investors.
 
COMMITTEES OF THE BOARD OF DIRECTORS
 
     The Board of Directors currently has three committees: (i) an Executive
Committee, (ii) an Audit Committee and (iii) a Compensation Committee.
 
     The current direct and indirect stockholders of the Company are parties to
a voting agreement, pursuant to which they have agreed to vote all of their
shares in such a manner that the Executive Committee will comprise the Company's
Chief Executive Officer and three other representatives, one designated by each
of Morgan Stanley Capital Partners, Madison Dearborn Capital Partners, and
Frontenac Company (and their respective successors, assigns, transferees and
affiliates). The Executive Committee will be authorized, subject to certain
limitations, to exercise all of the powers of the Board of Directors during
periods between Board meetings.
 
     The Audit Committee is currently comprised of Messrs. Yost, Hundt, Carbery,
Ehrenkranz and Finnegan. The Audit Committee is responsible for making
recommendations to the Board of Directors regarding the selection of independent
auditors, reviewing the results and scope of the audit and other services
provided by the Company's independent accountants and reviewing and evaluating
the Company's audit and control functions.
 
     The Compensation Committee is currently comprised of Messrs. Holland,
Frisbie, Crawford, Niehaus and Perry. The Compensation Committee is responsible
for reviewing, and as it deems appropriate, recommending to the Board of
Directors, policies, practices and procedures relating to the compensation of
 
                                       59
<PAGE>   61
 
the officers and other managerial employees of the Company and the establishment
and administration of employee benefit plans. The Compensation Committee
exercises all authority under any stock option or stock purchase plans of the
Company (unless the Board appoints any other committee to exercise such
authority), and advises and consults with the officers of the Company as may be
requested regarding managerial personnel policies.
 
COMPENSATION OF DIRECTORS
 
     The Company will reimburse the members of its Board of Directors for their
reasonable out-of-pocket expenses incurred in connection with attending Company
Board or committee meetings. Additionally, the Company is obligated to maintain
its present level of directors' and officers' insurance. Members of the
Company's Board of Directors receive no other compensation for services provided
as a Director or as a member of any Board committee.
 
EXECUTIVE COMPENSATION
 
     The following table sets forth compensation paid during the period from
April 22, 1997 to December 31, 1997 to the Chief Executive Officer of the
Company (the "Named Executive Officer"). There were no other executive officers
of the Company whose annual salary and bonus exceeded $100,000 for all services
rendered to the Company during such period.
 
                           SUMMARY COMPENSATION TABLE
 
<TABLE>
<CAPTION>
                                                ANNUAL COMPENSATION
                                     ------------------------------------------
                                                                   OTHER ANNUAL
                                                                   COMPENSATION      ALL OTHER
    NAME AND PRINCIPAL POSITION      YEAR   SALARY($)   BONUS($)      ($)(A)      COMPENSATION($)
    ---------------------------      ----   ---------   --------   ------------   ---------------
<S>                                  <C>    <C>         <C>        <C>            <C>
Royce J. Holland...................  1997    $72,308      $ --          --             $ --
  Chairman of the Board and Chief
  Executive Officer
</TABLE>
 
---------------
 
(a)  Includes perquisites and other benefits paid to the Named Executive Officer
     in excess of 10% of the total annual salary and bonus received by the Named
     Executive Officer during the last fiscal year.
 
     Prior to April 1998, the Board did not have a Compensation Committee and
decisions concerning the compensation of executive officers and other key
employees of the Company were determined by the Company's Board of Directors.
During the Company's fiscal year ending December 31, 1998, Royce J. Holland, C.
Daniel Yost, Thomas M. Lord, and John J. Callahan expect to earn salaries at an
annual rate of $200,000, $200,000, $175,000, and $175,000, respectively.
 
STOCK PLANS
 
  1997 NONQUALIFIED STOCK OPTION PLAN
 
   
     On November 13, 1997, the Company's Board of Directors adopted the 1997
Nonqualified Stock Option Plan (the "Option Plan"), under which the Company may
issue to Directors, consultants, and executive and other key employees of the
Company, stock options (the "Options") exercisable for shares of the Company's
Common Stock. As of May 31, 1998, Options to acquire an aggregate of 886,594
shares of Common Stock have been granted under such Option Plan and the Company
will not grant Options for any additional shares under the Option Plan. The
Option Plan is administered by the Compensation Committee. The Option Plan
authorizes the Compensation Committee to issue Options in such forms and amounts
and on such terms as determined by the Compensation Committee. The per-share
exercise price for Options will be set by the Compensation Committee, but may
not be less than the fair market value of a share of the Company's Common Stock
on the date of grant (as determined in good faith by the Compensation
Committee). The Compensation Committee currently intends to issue Options under
the Option Plan to all Company
    
 
                                       60
<PAGE>   62
 
employees other than the Management Investors, and to set the number of Options
issued as an annual component of an employee's compensation package. The terms
of the Options issued under the Option Plan to date are, and the Compensation
Committee presently anticipates that the terms of all Options issued under the
Option Plan in the future will be, as summarized below.
 
     The Company will establish an annual amount of Options to be granted to an
employee each year. Three years' amount of Options will be issued on the first
business day of the quarter succeeding the date which a participant joins the
Company. Such Options will vest over a three-year period, with 1/3 "cliff"
vesting on the first anniversary of the date of grant and 1/12 vesting on each
of the first eight quarter-ends thereafter. Subject to available Options under
the Option Plan, one year's amount of Options will be issued on each anniversary
of the initial grant, and such Options will vest in the third year after grant,
with 1/4 vesting on each of the 27-, 30-, 33-, and 36-month anniversaries of the
date of grant. Through this mechanism, a participant will at any given time have
three years' amount of Options unvested. Vesting is accelerated 100% upon an
employee's death or permanent physical disability. If there is a sale of the
Company and the participant is terminated (or constructively terminated) within
the two-year period following the sale, vesting is accelerated 100% upon such
termination. Options expire if not exercised within six years after the date of
grant. If a participant is terminated for any reason, all unvested Options
immediately expire and all vested Options must be exercised within 90 days after
termination. Options are nontransferable during the life of the participant.
Shares of Common Stock issued upon exercise of Options are subject to various
restrictions on transferability, holdback periods in the event of a public
offering of the Company's securities and provisions requiring the holder of such
shares to approve and, if requested by the Company, sell its shares in any sale
of the Company that is approved by the Board.
 
  1998 STOCK INCENTIVE PLAN
 
   
     Prior to the consummation of the Equity Offering, the Board and
stockholders of the Company will approve the Company's 1998 Stock Incentive Plan
(the "1998 Stock Plan"). The 1998 Stock Plan will be administered by the
Compensation Committee. Certain employees, directors, advisors and consultants
of the Company will be eligible to participate in the 1998 Stock Plan (a
"Participant"). The Compensation Committee will be authorized under the 1998
Stock Plan to select the Participants and determine the terms and conditions of
the awards under the 1998 Stock Plan. The 1998 Stock Plan provides for the
issuance of the following types of incentive awards: stock options, stock
appreciation rights, restricted stock, performance grants and other types of
awards that the Compensation Committee deems consistent with the purposes of the
1998 Stock Plan. An aggregate of 3,806,658 shares of Common Stock of the Company
will be reserved for issuance under the 1998 Stock Plan, subject to certain
adjustments reflecting changes in the Company's capitalization.
    
 
     Options granted under the 1998 Stock Plan may be either incentive stock
options ("ISOs") or such other forms of non-qualified stock options ("NQOs") as
the Compensation Committee may determine. ISOs are intended to qualify as
"incentive stock options" within the meaning of Section 422 of the Internal
Revenue Code of 1986, as amended (the "Code"). The exercise price of (i) an ISO
granted to an individual who owns shares possessing more than 10% of the total
combined voting power of all classes of stock of the Company (a "10% Owner")
will be at least 110% of the fair market value of a share of Common Stock on the
date of grant and (ii) an ISO granted to an individual other than a 10% Owner
and an NQO will be at least 100% of the fair market value of a share of Common
Stock on the date of grant.
 
     Options granted under the 1998 Stock Plan may be subject to time vesting
and certain other restrictions at the sole discretion of the Compensation
Committee. Subject to certain exceptions, the right to exercise an option
generally will terminate at the earlier of (i) the first date on which the
initial grantee of such option is not employed by the Company for any reason
other than termination without cause, death or permanent disability or (ii) the
expiration date of the option. If the holder of an option dies or suffers a
permanent disability while still employed by the Company, the right to exercise
all unexpired installments of such option shall be accelerated and shall vest as
of the latest of the date of such death, the date of such permanent disability
and the date of the discovery of such permanent disability, and such option
shall be exercisable,
 
                                       61
<PAGE>   63
 
subject to certain exceptions, for 180 days after such date. If the holder of an
option is terminated without cause, to the extent the option has vested, such
option will be exercisable for 30 days after such date.
 
     All outstanding awards under the 1998 Stock Plan will terminate immediately
prior to consummation of a liquidation or dissolution of the Company, unless
otherwise provided by the Board. In the event of the sale of all or
substantially all of the assets of the Company or the merger of the Company with
another corporation, all restrictions on any outstanding awards will terminate
and Participants will be entitled to the full benefit of their awards
immediately prior to the closing date of such sale or merger, unless otherwise
provided by the Board.
 
     The Board generally will have the power and authority to amend the 1998
Stock Plan at any time without approval of the Company's stockholders, subject
to applicable federal securities and tax laws limitations (including regulations
of the Nasdaq National Market).
 
  STOCK PURCHASE PLAN
 
     The Company's Employee Stock Discount Purchase Plan (the "Stock Purchase
Plan") will be approved by the Board and stockholders prior to the consummation
of the Equity Offering. The Stock Purchase Plan is intended to give employees
desiring to do so a convenient means of purchasing shares of Common Stock
through payroll deductions. The Stock Purchase Plan is intended to provide an
incentive to participate by permitting purchases at a discounted price. The
Company believes that ownership of stock by employees will foster greater
employee interest in the success, growth and development of the Company.
 
   
     Subject to certain restrictions, each employee of the Company who is a U.S.
resident or a U.S. citizen temporarily on location at a facility outside of the
United States will be eligible to participate in the Stock Purchase Plan if he
or she has been employed by the Company for more than three months.
Participation will be discretionary with each eligible employee. The Company
will reserve 2,305,718 shares of Common Stock for issuance in connection with
the Stock Purchase Plan. Elections to participate and purchases of stock will be
made on a quarterly basis. Each participating employee contributes to the Stock
Purchase Plan by choosing a payroll deduction in any specified amount, with a
specified minimum deduction per payroll period. A participating employee may
increase or decrease the amount of such employee's payroll deduction, including
a change to a zero deduction as of the beginning of any calendar quarter.
Elected contributions will be credited to participants' accounts at the end of
each calendar quarter.
    
 
   
     Each participating employee's contributions will be used to purchase shares
for the employee's share account as promptly as practicable after each calendar
quarter. The cost per share will be 85% of the lower of the closing price of the
Company's Common Stock on the Nasdaq National Market on the first or the last
day of the calendar quarter. The number of shares purchased on each employee's
behalf and deposited in his/her share account will be based on the amount
accumulated in such participant's cash account and the purchase price for shares
with respect to any calendar quarter. Shares purchased under the Stock Purchase
Plan carry full rights to receive dividends declared from time to time. Under
the Stock Purchase Plan, any dividends attributable to shares in the employee's
share account will be automatically used to purchase additional shares for such
employee's share account. Share distributions and share splits will be credited
to the participating employee's share account as of the record date and
effective date, respectively. A participating employee will have full ownership
of all shares in such employee's share account and may withdraw them for sale or
otherwise by written request to the Compensation Committee following the close
of each calendar quarter. Subject to applicable federal securities and tax laws,
the Board will have the right to amend or to terminate the Stock Purchase Plan.
Amendments to the Stock Purchase Plan will not affect a participating employee's
right to the benefit of the contributions made by such employee prior to the
date of any such amendment. In the event the Stock Purchase Plan is terminated,
the Compensation Committee will be required to distribute all shares held in
each participating employee's share account plus an amount of cash equal to the
balance in each participating employee's cash account.
    
 
                                       62
<PAGE>   64
 
401(K) PLAN
 
     The Company is in the process of adopting a tax-qualified employee savings
and retirement plan (the "401(k) Plan") covering all of the Company's full-time
employees. Pursuant to the 401(k) Plan, employees may elect to reduce their
current compensation up to the statutorily prescribed annual limit and have the
amount of such reduction contributed to the 401(k) Plan. The 401(k) Plan is
intended to qualify under Section 401 of the Code so that contributions by
employees to the 401(k) Plan, and income earned on plan contributions, are not
taxable to employees until withdrawn from the 401(k) Plan. The trustees under
the 401(k) Plan, at the direction of each participant, invest such participant's
assets in the 401(k) Plan in selected investment options.
 
EXECUTIVE AGREEMENTS
 
  Royce J. Holland Executive Agreement
 
     In August 1997, in connection with Royce J. Holland's purchase of an
ownership interest in Allegiance LLC, the Company's sole shareholder (see
"Certain Relationships and Related Transactions" and "Security Ownership of
Certain Beneficial Owners and Management"), the Company, Allegiance LLC, and Mr.
Holland entered into an Executive Purchase Agreement (the "Holland Executive
Agreement"), including, among others, the following terms:
 
     Vesting. The Allegiance LLC securities purchased by Mr. Holland, as well as
any Company securities distributed with respect to such Allegiance LLC
securities (collectively, the "Holland Executive Securities") are subject to
vesting over a four-year period, with 20.0% vesting on the date of grant and
20.0% vesting on each of the first four anniversaries thereof. Vesting will be
accelerated by one year upon the consummation of the Equity Offering, 100.0% in
the event of Mr. Holland's death or disability, and 100.0% upon a sale of the
Company where at least 50.0% of the consideration for such sale is cash or
marketable securities.
 
     Repurchase of Securities. If Mr. Holland's employment is terminated for any
reason other than a termination by the Company without cause, Allegiance LLC and
the Company (or their assignees) will have the right to repurchase all vested
Holland Executive Securities at fair market value, and all unvested Holland
Executive Securities at the lesser of fair market value and original cost.
 
     Restrictions on Transfer; Holdback and "Drag Along" Agreements. The Holland
Executive Securities are subject to various restrictions on transferability,
holdback periods in the event of a public offering of the Company's securities
and provisions requiring the holder of such shares to approve and, if requested
by the Company, sell its shares in any sale of the Company that is approved by
the Board.
 
     Terms of Employment. Mr. Holland is an "at will" employee of the Company
and, thus, may be terminated by the Company at any time and for any reason. Mr.
Holland is not entitled to receive any severance payments upon any such
termination, other than payments in consideration of the noncompetition and
nonsolicitation agreements discussed below.
 
     Noncompetition and Nonsolicitation Agreements. During the Noncompete Period
(as defined below), Mr. Holland may not hire or attempt to induce any employee
of the Company to leave the Company's employ, nor attempt to induce any customer
or other business relation of the Company to cease doing business with the
Company, nor in any other way interfere with the Company's relationships with
its employees, customers, and other business relations. Also, during the
Noncompete Period, Mr. Holland may not participate in any business engaged in
the provision of telecommunications services in any Covered Market. As used in
the Holland Executive Agreement, the "Noncompete Period" means the period of
employment and the following additional period: (i) if Mr. Holland is terminated
prior to August 13, 2000, the period ending on the later of August 13, 2001 and
the second anniversary of termination; (ii) if Mr. Holland is terminated at any
time on or after August 13, 2000 but prior to August 13, 2001, the period ending
on August 13, 2002; and (iii) if Mr. Holland is terminated at any time on or
after August 13, 2001, the one-year period following termination; provided that
the "Noncompete Period" shall end if at any time the Company ceases to pay Mr.
Holland his base salary and benefits in existence at the time of termination
(reduced by any salary or benefits Mr. Holland receives as a result of other
employment). As used in the Holland Executive Agreement, "Covered Market"
 
                                       63
<PAGE>   65
 
means: (i) any market in which the Company is conducting business or preparing,
pursuant to a business plan approved by the Board of Directors and the Fund
Investors, to conduct business; (ii) Dallas, New York City, Atlanta, Chicago,
Los Angeles and 15 additional Phase I and Phase II markets; and (iii) any market
for which the Company has prepared a business plan unless such business plan has
been rejected by the Board of Directors or the Fund Investors.
 
  C. Daniel Yost Executive Agreement
 
     In February 1998, in connection with C. Daniel Yost's purchase of an
ownership interest in Allegiance LLC, the Company's sole shareholder (see
"Certain Relationships and Related Transactions" and "Security Ownership of
Certain Beneficial Owners and Management"), the Company, Allegiance LLC, and Mr.
Yost entered into an Executive Purchase Agreement, containing the same terms as
the Holland Executive Agreement described above.
 
  Thomas M. Lord Executive Agreement
 
     In August 1997, in connection with Thomas M. Lord's purchase of an
ownership interest in Allegiance LLC, the Company's sole shareholder (see
"Certain Relationships and Related Transactions" and "Security Ownership of
Certain Beneficial Owners and Management"), the Company, Allegiance LLC, and Mr.
Lord entered into an Executive Purchase Agreement, containing the same terms as
the Holland Executive Agreement described above.
 
  Executive Agreements Entered into by Other Management Investors
 
     Each of the Management Investors has entered into an Executive Purchase
Agreement (the "Other Executive Agreements"), including, among others, the
following terms:
 
     Vesting. The Allegiance LLC securities purchased by a Management Investor,
as well as any Company securities distributed with respect to such Allegiance
LLC securities (collectively, the "Executive Securities") are subject to vesting
over a four-year period, with 25.0% vesting on each of the first four
anniversaries of the grant date. Vesting will be accelerated by one year upon
consummation of the Equity Offering, 100.0% in the event of such Management
Investor's death or disability, and 100.0% upon a sale of the Company where at
least 50.0% of the consideration for such sale is cash or marketable securities.
 
     Repurchase of Securities. If a Management Investor's employment is
terminated for any reason, Allegiance LLC and the Company (or their assignees)
will have the right to repurchase all such Management Investor's vested
Executive Securities at fair market value, and all unvested Executive Securities
at the lesser of fair market value and original cost.
 
     Restrictions on Transfer; Holdback and "Drag Along" Agreements. The
Executive Securities are subject to various restrictions on transferability,
holdback periods in the event of a public offering of the Company's securities
and provisions requiring the holder of such shares to approve and, if requested
by the Company, sell its shares in any sale of the Company that is approved by
the Board.
 
     Terms of Employment. Each Management Investor is an "at will" employee of
the Company and, thus, may be terminated by the Company at any time and for any
reason. No Management Investor is entitled to receive any severance payments
upon any such termination.
 
                                       64
<PAGE>   66
 
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
 
     Prior to April 1998, the Company did not have a Compensation Committee and
the compensation of executive officers and other key employees of the Company
was determined by the Company's Board of Directors. Royce J. Holland, the
Company's Chairman and Chief Executive Officer, Thomas M. Lord, the Company's
Executive Vice President of Corporate Development and Chief Financial Officer,
C. Daniel Yost, the Company's President and Chief Operating Officer, and John J.
Callahan, the Company's Senior Vice President of Sales and Marketing, are all
currently members of the Company's Board of Directors. The Board of Directors
established the Compensation Committee, which is responsible for decisions
regarding salaries, incentive compensation, stock option grants and other
matters regarding executive officers and key employees of the Company. See
"-- Committees of the Board of Directors."
 
                                       65
<PAGE>   67
 
                 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
LIMITED LIABILITY COMPANY AGREEMENT
 
     On August 13, 1997, the Fund Investors and the Management Investors entered
into a limited liability company agreement (the "LLC Agreement") in order to
govern the affairs of Allegiance LLC, which presently holds the one outstanding
share of the Company's Common Stock and substantially all of the outstanding
shares of the Company's Redeemable Convertible Preferred Stock.
 
     Upon consummation of the Equity Offering, Allegiance LLC will dissolve and
its assets (which consist almost entirely of Company stock) will be distributed
to the Fund Investors and the Management Investors in accordance with the LLC
Agreement. The LLC Agreement provides that the Equity Allocation between the
Fund Investors and the Management Investors will range between 95.0%/5.0% and
66.7%/33.3% based upon the valuation of the Company's Common Stock implied by
the Equity Offering. Based upon the current valuation of the Company's Common
Stock implied by the Equity Offering, the Equity Allocation will be 66.7% to the
Fund Investors and 33.3% to the Management Investors. See "Management's
Discussion and Analysis of Financial Conditions and Results of
Operations -- Overview."
 
SECURITYHOLDERS AGREEMENT
 
     The Fund Investors, the Management Investors, the Company, and Allegiance
LLC are parties to a securityholders agreement dated as of August 13, 1997 (the
"Securityholders Agreement"). Pursuant to the terms of the Securityholders
Agreement, in the event of an approved sale of the Company, each of the Fund
Investors (and their transferees) agrees to approve and, if requested, to sell
its shares in such sale of the Company. The Securityholders Agreement, apart
from certain provisions thereof, will be automatically terminated upon the
consummation of the Equity Offering.
 
REGISTRATION AGREEMENT
 
     The Fund Investors, the Management Investors, and the Company are parties
to the Registration Agreement dated as of August 13, 1997. See "Description of
Capital Stock -- Registration Rights."
 
VOTING AGREEMENT
 
     The current direct and indirect stockholders of the Company are parties to
a voting agreement, pursuant to which they have each agreed to vote all of their
shares in such a manner as to elect the following persons to serve as Directors:
Madison Dearborn Capital Partners, Morgan Stanley Capital Partners, and
Frontenac Company (and their respective successors, assigns, transferees, and
affiliates) each have the right to designate two Directors; Battery Ventures
(and its successors, assigns, transferees, and affiliates) has the right to
designate one Director; the Company's Chief Executive Officer has the right to
serve as a Director; the Management Investors (and their successors and assigns)
have the right to designate three Directors; and the final two directorships may
be filled by representatives designated by the Fund Investors and acceptable to
the Management Investors.
 
OTHER
 
     Morgan Stanley & Co. Incorporated ("Morgan Stanley"), an affiliate of
Morgan Stanley Capital Partners, one of the Fund Investors, acted as a placement
agent in connection with the Unit Offering and received fees of approximately
$4.4 million. In addition, Morgan Stanley is one of the Underwriters and will
receive fees in connection with each of the Offerings. See "Underwriters."
 
                                       66
<PAGE>   68
 
         SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
     Prior to the Equity Offering, substantially all of the Company's
outstanding equity securities were held by Allegiance LLC. The following table
sets forth certain information regarding the beneficial ownership of the
outstanding Common Stock of the Company after giving effect to the LLC
Dissolution and the Equity Allocation and as adjusted for the Equity Offering
by: (i) each of the directors and the executive officers of the Company; (ii)
all directors and executive officers as a group and (iii) each owner of more
than 5% of the equity securities of the Company ("5% Owners"). Unless otherwise
noted, the address for each director and executive officer of the Company is c/o
the Company, 1950 Stemmons Freeway, Suite 3026, Dallas, Texas 75207.
 
<TABLE>
<CAPTION>
                                                        SHARES OWNED             SHARES OWNED
                                                          PRIOR TO             AFTER THE EQUITY
                                                     THE EQUITY OFFERING          OFFERING(1)
                                                    ---------------------    ---------------------
       NAME AND ADDRESS OF BENEFICIAL OWNER           NUMBER      PERCENT      NUMBER      PERCENT
       ------------------------------------         ----------    -------    ----------    -------
<S>                                                 <C>           <C>        <C>           <C>
DIRECTORS AND EXECUTIVE OFFICERS:
Royce J. Holland(2)...............................   3,881,105      9.6%      3,881,105      7.4%
C. Daniel Yost....................................   1,619,940      4.0       1,619,940      3.1
Thomas M. Lord(3).................................   1,822,432      4.5       1,822,432      3.5
John J. Callahan..................................     607,477      1.5         607,477      1.2
Paul D. Carbery(4)................................   4,262,999     10.6       4,262,999      8.1
James E. Crawford, III(4).........................   4,262,999     10.6       4,262,999      8.1
John B. Ehrenkranz................................          --       --              --       --
Paul J. Finnegan(5)...............................          --       --              --       --
Richard D. Frisbie(6).............................   2,131,499      5.3       2,131,499      4.1
Reed E. Hundt(7)..................................     101,246        *         101,246        *
Robert H. Niehaus(8)..............................          --       --              --       --
James N. Perry, Jr.(5)............................          --       --              --       --
All directors and executive officers as a group
  (12 persons)....................................  14,426,698     35.8      14,426,698     27.6
5% OWNERS:
Madison Dearborn Capital Partners(9)..............  10,302,247     25.5      10,302,247     19.7
Morgan Stanley Capital Partners(10)...............  10,302,247     25.5      10,302,247     19.7
Frontenac Company(11).............................   4,262,999     10.6       4,262,999      8.1
Battery Ventures(12)..............................   2,131,499      5.3       2,131,499      4.1
</TABLE>
 
---------------
 
  *  Denotes less than one percent.
 (1) Assumes no exercise of the U.S. Underwriters' over-allotment option and
     does not give effect to any purchases, if any, by such persons named in the
     table in the Equity Offering.
 (2) Includes 1,940,552 shares of Common Stock owned by the Royce J. Holland
     Family Limited Partnership, of which Royce J. Holland is the sole general
     partner. All of the shares of Common Stock owned by Mr. Holland and the
     Royce J. Holland Family Limited Partnership are subject to vesting, with
     20% of such shares of Common Stock vested on August 13, 1997, 20% vesting
     upon the consummation of the Equity Offering and an additional 20% vesting
     on each of August 13, 1998, 1999 and 2000. See "Management -- Executive
     Agreements."
 (3) Includes 911,216 shares of Common Stock owned by Mr. Lord's wife and
     children, as to which Mr. Lord disclaims beneficial ownership. All of the
     shares of Common Stock owned by Mr. Lord and his family are subject to
     vesting with 20% of such shares of Common Stock vested on August 13, 1997,
     20% vesting upon the consummation of the Equity Offering and an additional
     20% vesting on each of August 13, 1998, 1999 and 2000. See
     "Management -- Executive Agreements."
   
 (4) All shares of Common Stock shown are owned by Frontenac VII Limited
     Partnership and Frontenac Masters VII Limited Partnership. Messrs. Carbery
     and Crawford are members of Frontenac Company VII, L.L.C., the general
     partner of Frontenac VII Limited Partnership and Frontenac Masters VII
     Limited Partnership and their address is c/o Frontenac Company, 135 S.
     LaSalle Street, Suite 3800, Chicago, IL 60603. They disclaim beneficial
     ownership of these shares of Common Stock.
    
 (5) Messrs. Finnegan and Perry are vice presidents of Madison Dearborn
     Partners, Inc., the general partner of the general partner of Madison
     Dearborn Capital Partners II, L.P. and their address is c/o Madison
     Dearborn Partners, Inc., Three First National Plaza, Suite 3800, Chicago,
     IL 60602.
   
 (6) All shares of Common Stock shown are owned by Battery Ventures IV, L.P. and
     Battery Investment Partners IV, LLC. Mr. Frisbie is a managing partner of
     Battery Ventures, the general partner of these funds and his address is c/o
     Battery Ventures, 20 William Street, Wellesley, MA 02181. He disclaims
     beneficial ownership of these shares of Common Stock.
    
 (7) Mr. Hundt owns options to acquire 50,623 shares of Common Stock and Charles
     Ross Partners, LLC, a Delaware limited liability company, of which Mr.
     Hundt is a member, owns 50,623 shares of Common Stock.
 (8) Mr. Niehaus is a managing director and director of Morgan Stanley Capital
     Partners III, Inc., the general partner of the general partner of these
     funds and their address is c/o Morgan Stanley Capital Partners, 1221 Avenue
     of the Americas, New York, NY 10020.
 (9) These shares of Common Stock are owned by Madison Dearborn Capital Partners
     II, L.P.
(10) These shares of Common Stock are owned by Morgan Stanley Capital Partners
     III, L.P., MSCP III 892 Investors, L.P. and Morgan Stanley Capital
     Investors, L.P.
(11) These shares of Common Stock are owned by Frontenac VII Limited Partnership
     and Frontenac Masters VII Limited Partnership.
(12) These shares of Common Stock are owned by Battery Ventures IV, L.P. and
     Battery Investment Partners IV, LLC.
 
                                       67
<PAGE>   69
 
                      DESCRIPTION OF CERTAIN INDEBTEDNESS
 
11 3/4% NOTES
 
     The Company issued $445,000,000 aggregate principal amount at maturity of
11 3/4% Senior Discount Notes due February 15, 2008 pursuant to the 11 3/4%
Notes Indenture between the Company and The Bank of New York. The 11 3/4% Notes
were issued in units, with each unit consisting of one 11 3/4% Note and one
Warrant.
 
     No interest will be payable on the 11 3/4% Notes prior to August 15, 2003.
From and after February 15, 2003, interest on the 11 3/4% Notes will accrue at
the rate of 11 3/4% per annum from February 15, 2003 or from the most recent
interest payment date to which interest has been paid or provided for, payable
semiannually (to holders of record at the close of business on the February 1 or
August 1 immediately preceding the interest payment date) on February 15 and
August 15 of each year, commencing August 15, 2003.
 
     The 11 3/4% Notes are unsubordinated, unsecured obligations of the Company,
ranking pari passu in right of payment with all unsubordinated, unsecured
indebtedness of the Company, including the Notes offered in the Debt Offering,
and will rank senior in right of payment to all future subordinated indebtedness
of the Company.
 
     The 11 3/4% Notes may be redeemed at any time on or after February 15,
2003, in whole or in part, at 105.8750% of their principal amount at maturity,
plus accrued interest, declining to 100% of their principal amount at maturity,
plus accrued interest, on and after February 15, 2006. In addition, at any time
on or before February 15, 2001, the Company may redeem up to 35% of the
aggregate principal amount at maturity of the 11 3/4% Notes with the net
proceeds of one or more public equity offerings at a redemption price equal to
111.75% (expressed as a percentage of the accreted value of the 11 3/4% Notes on
the redemption date), provided that at least $289,250,000 aggregate principal
amount at maturity of the 11 3/4% Notes remains outstanding immediately after
such redemption.
 
     The 11 3/4% Notes Indenture contains certain restrictive covenants
including among others, limitations on the ability of the Company and its
restricted subsidiaries to incur indebtedness, pay dividends, prepay
subordinated indebtedness, repurchase capital stock, make investments, engage in
transactions with affiliates, create liens, sell assets and engage in mergers
and consolidations and certain other events which could cause an event of
default.
 
DEBT OFFERING
 
   
     Concurrent with the Equity Offering, the Company will make a public
offering of $200.0 million principal amount of its Senior Notes due 2008. See
"Prospectus Summary -- Financing Plan." The Notes will be issued pursuant to the
Indenture between the Company and The Bank of New York. Interest on the Notes
will be payable semiannually in cash on November 15 and May 15 of each year,
commencing November 15, 1998.
    
 
   
     The Indenture will provide that on the closing date of the Debt Offering,
the Company must purchase and pledge to the Trustee as security for the benefit
of the holders of the Notes, the Pledged Securities in such amount as will be
sufficient upon receipt of scheduled interest and principal payments of such
securities to provide for payment in full of the first six scheduled interest
payments due on the Notes. The Company expects to use approximately $67.4
million of the net proceeds from the Debt Offering to acquire the Pledged
Securities; however, the precise amount of the Pledged Securities to be acquired
will depend upon interest rates prevailing on the closing date of the Debt
Offering. A failure to pay interest on the Notes in a timely manner through the
first six scheduled interest payment dates will constitute an immediate Event of
Default under the Indenture, with no grace or cure period. The Pledged
Securities and pledge account established pursuant to the Pledge Agreement (the
"Pledge Account") will also secure the repayment of the principal amount and
premium on the Notes. Under the Pledge Agreement, once the Company makes the
first six scheduled interest payments on the Notes, all of the remaining Pledged
Securities, if any, will be released from the Pledge Account and thereafter the
Notes will be unsecured.
    
 
                                       68
<PAGE>   70
 
     The Notes are unsubordinated, unsecured (except as described above)
indebtedness of the Company, ranking pari passu in right of payment with all
unsubordinated, unsecured indebtedness of the Company, including the 11 3/4%
Notes, and will rank senior in right of payment to all subordinated indebtedness
of the Company.
 
     The Notes may be redeemed at the option of the Company, in whole or in
part, at any time on or after May 15, 2003, at      % of their principal amount,
plus accrued interest, declining to 100% of their principal amount, plus accrued
interest, on or after May 15, 2006. In addition, prior to May 15, 2001, the
Company may redeem up to 35% of the aggregate principal amount of the Notes with
the proceeds of one or more public equity offerings at a redemption price equal
to      % (expressed as a percentage of the principal amount of the Notes),
provided that at least 65% of the aggregate principal amount of Notes originally
issued remains outstanding after each such redemption.
 
     The Indenture will contain certain restrictive covenants, including among
others, limitations on the ability of the Company and its restricted
subsidiaries to incur indebtedness, pay dividends, prepay subordinated
indebtedness, repurchase capital stock, make investments, engage in transactions
with affiliates, create liens, sell assets and engage in mergers and
consolidations and certain other events which could cause an event of default.
 
     The closing of the Debt Offering is conditioned upon the closing of the
Equity Offering, but the closing of the Equity Offering is not conditioned upon
the closing of the Debt Offering and there can be no assurance that the Debt
Offering will be consummated.
 
   
VENDOR FINANCING
    
 
   
     In addition to the Offerings, the Company is seeking to obtain
approximately $100.0 million of Vendor Financing for the acquisition of digital
switches, software, electronics and associated transmission equipment. The
Company anticipates that if the Vendor Financing is obtained, it will most
likely be obtained by some or all of the Company's subsidiaries and may be
secured by a security interest in the capital stock or assets of such
subsidiaries. In addition, if the Vendor Financing is obtained, it is expected
to bear interest at floating rates and contain covenants, including financial
covenants, customary for such agreements. The amount of Vendor Financing the
Company will ultimately seek to obtain will depend on a number of factors
including the terms and conditions thereof, the availability and terms of other
financing and the Company's ability to acquire digital switches, software,
electronics and associated transmission equipment in connection with the
acquisition of other companies for Common Stock. There can be no assurance that
the Vendor Financing will be available on terms acceptable to the Company or at
all.
    
 
                                       69
<PAGE>   71
 
                          DESCRIPTION OF CAPITAL STOCK
 
GENERAL MATTERS
 
     At the time of the Equity Offering, the total amount of authorized capital
stock of the Company will consist of 150,000,000 shares of Common Stock, par
value $.01 per share, and 1,000,000 shares of preferred stock, par value $.01
per share (the "Preferred Stock"). Upon completion of the Equity Offering,
52,341,554 shares of Common Stock will be issued and outstanding and no shares
of Preferred Stock will be issued and outstanding. The discussion herein
describes the Company's capital stock, the Restated Certificate and By-laws to
be in effect upon consummation of the Equity Offering. The following summary of
certain provisions of the Company's capital stock describes all material
provisions of, but does not purport to be complete and is subject to, and
qualified in its entirety by, the Restated Certificate and the By-laws of the
Company that are included as exhibits to the Registration Statement of which
this Prospectus forms a part and by the provisions of applicable law.
 
     The Restated Certificate and By-laws will contain certain provisions that
are intended to enhance the likelihood of continuity and stability in the
composition of the Board of Directors and which may have the effect of delaying,
deferring or preventing a future takeover or change in control of the Company
unless such takeover or change in control is approved by the Board of Directors.
 
COMMON STOCK
 
     The issued and outstanding shares of Common Stock are, and the shares of
Common Stock being offered by the Company will be upon payment therefor, validly
issued, fully paid and nonassessable. Subject to the prior rights of the holders
of any Preferred Stock, the holders of outstanding shares of Common Stock are
entitled to receive dividends out of assets legally available therefor at such
time and in such amounts as the Board of Directors may from time to time
determine. The shares of Common Stock are not convertible and the holders
thereof have no preemptive or subscription rights to purchase any securities of
the Company. Upon liquidation, dissolution or winding up of the Company, the
holders of Common Stock are entitled to receive pro rata the assets of the
Company which are legally available for distribution, after payment of all debts
and other liabilities and subject to the prior rights of any holders of
Preferred Stock then outstanding. Each outstanding share of Common Stock is
entitled to one vote on all matters submitted to a vote of stockholders. There
is no cumulative voting.
 
     The Common Stock has been approved for listing, subject to official notice
of issuance, on the Nasdaq National Market under the symbol "ALGX."
 
PREFERRED STOCK
 
     The Company's Board of Directors may, without further action by the
Company's stockholders, from time to time, direct the issuance of shares of
Preferred Stock in series and may, at the time of issuance, determine the
rights, preferences and limitations of each series. Satisfaction of any dividend
preferences of outstanding shares of Preferred Stock would reduce the amount of
funds available for the payment of dividends on shares of Common Stock. Holders
of shares of Preferred Stock may be entitled to receive a preference payment in
the event of any liquidation, dissolution or winding-up of the Company before
any payment is made to the holders of shares of Common Stock. Under certain
circumstances, the issuance of shares of Preferred Stock may render more
difficult or tend to discourage a merger, tender offer or proxy contest, the
assumption of control by a holder of a large block of the Company's securities
or the removal of incumbent management. Upon the affirmative vote of a majority
of the total number of directors then in office, the Board of Directors of the
Company, without stockholder approval, may issue shares of Preferred Stock with
voting and conversion rights which could adversely affect the holders of shares
of Common Stock. Upon consummation of the Equity Offering, there will be no
shares of Preferred Stock outstanding, and the Company has no present intention
to issue any shares of Preferred Stock.
 
                                       70
<PAGE>   72
 
CERTAIN PROVISIONS OF THE RESTATED CERTIFICATE OF INCORPORATION AND BY-LAWS
 
     The Restated Certificate provides for the Board of Directors to be divided
into three classes, as nearly equal in number as possible, serving staggered
terms. Approximately one-third of the Board of Directors will be elected each
year. See "Management." Under the Delaware General Corporation Law, directors
serving on a classified board can only be removed for cause. The provision for a
classified board could prevent a party who acquires control of a majority of the
outstanding voting stock from obtaining control of the Board of Directors until
the second annual stockholders meeting following the date the acquiror obtains
the controlling stock interest. The classified board provision could have the
effect of discouraging a potential acquiror from making a tender offer or
otherwise attempting to obtain control of the Company and could increase the
likelihood that incumbent directors will retain their positions.
 
     The Restated Certificate provides that stockholder action can be taken only
at an annual or special meeting of stockholders and cannot be taken by written
consent in lieu of a meeting. The Restated Certificate and the By-laws provides
that, except as otherwise required by law, special meetings of the stockholders
can only be called pursuant to a resolution adopted by a majority of the Board
of Directors or by the Chief Executive Officer of the Company. Stockholders will
not be permitted to call a special meeting or to require the Board of Directors
to call a special meeting.
 
     The By-laws establish an advance notice procedure for stockholder proposals
to be brought before an annual meeting of stockholders of the Company, including
proposed nominations of persons for election to the Board of Directors.
 
     Stockholders at an annual meeting may only consider proposals or
nominations specified in the notice of meeting or brought before the meeting by
or at the direction of the Board of Directors or by a stockholder who was a
stockholder of record on the record date for the meeting, who is entitled to
vote at the meeting and who has given to the Company's Secretary timely written
notice, in proper form, of the stockholder's intention to bring that business
before the meeting. Although the By-laws do not give the Board of Directors the
power to approve or disapprove stockholder nominations of candidates or
proposals regarding other business to be conducted at a special or annual
meeting, the By-laws may have the effect of precluding the conduct of certain
business at a meeting if the proper procedures are not followed or may
discourage or defer a potential acquiror from conducting a solicitation of
proxies to elect its own slate of directors or otherwise attempting to obtain
control of the Company.
 
     The Restated Certificate and By-laws provide that the affirmative vote of
holders of at least 66 2/3% of the total votes eligible to be cast in the
election of directors is required to amend, alter, change or repeal certain of
their provisions. This requirement of a super-majority vote to approve
amendments to the Restated Certification of Incorporation and By-laws could
enable a minority of the Company's stockholders to exercise veto power over any
such amendments.
 
CERTAIN PROVISIONS OF DELAWARE LAW
 
     Following the consummation of the Equity Offering, the Company will be
subject to the "Business Combination" provisions of the Delaware General
Corporation Law. In general, such provisions prohibit a publicly held Delaware
corporation from engaging in various "business combination" transactions with
any "interested stockholder" for a period of three years after the date of the
transaction which the person became an "interested stockholder," unless (i) the
transaction is approved by the Board of Directors prior to the date the
"interested stockholder" obtained such status; (ii) upon consummation of the
transaction which resulted in the stockholder becoming an "interested
stockholder," the "interested stockholder," owned at least 85% of the voting
stock of the corporation outstanding at the time the transaction commenced,
excluding for purposes of determining the number of shares outstanding those
shares owned by (a) persons who are directors and also officers and (b) employee
stock plans in which employee participants do not have the right to determine
confidentially whether shares held subject to the plan will be tendered in a
tender or exchange offer; or (iii) on or subsequent to such date the "business
combination" is approved by the Board of Directors and authorized at an annual
or special meeting of stockholders by the affirmative vote of at least 66 2/3%
of the outstanding voting stock which is not owned by the "interested
stockholder." A "business combination" is defined to
 
                                       71
<PAGE>   73
 
include mergers, asset sales and other transactions resulting in financial
benefit to a stockholder. In general, an "interested stockholder" is a Person
who, together with affiliates and associates, owns (or within three years, did
own) 15% or more of a corporation's voting stock. The statute could prohibit or
delay mergers or other takeover or change in control attempts with respect to
the Company and, accordingly, may discourage attempts to acquire the Company.
 
LIMITATIONS ON LIABILITY AND INDEMNIFICATION OF OFFICERS AND DIRECTORS
 
     The Restated Certificate limits the liability of Directors to the fullest
extent permitted by the Delaware General Corporation Law. In addition, the
Restated Certificate of Incorporation will provide that the Company shall
indemnify Directors and officers of the Company to the fullest extent permitted
by such law. The Company anticipates entering into indemnification agreements
with its current Directors and executive officers prior to the completion of the
Offerings and any new Directors or executive officers following such time.
 
TRANSFER AGENT AND REGISTRAR
 
     The Transfer Agent and Registrar for the Common Stock is First Chicago
Trust Company of New York.
 
WARRANTS
 
     In connection with the Unit Offering, the Company issued 445,000 Warrants
pursuant to the Warrant Agreement between the Company and The Bank of New York.
Wherever particular terms of the Warrant Agreement, not otherwise defined
herein, are referred to, such defined terms are incorporated herein by
reference. A copy of the Warrant Agreement is filed as an exhibit to the
Registration Statement of which this Prospectus forms a part.
 
     Each Warrant is exercisable to purchase 1.458983995 shares of Common Stock
at an exercise price of $.01 per share, subject to adjustment. The Warrants may
be exercised at any time on or after February 3, 1999 and prior to February 3,
2008. Upon the occurrence of a merger with a person that does not have a class
of equity securities registered under the Securities Exchange Act of 1934, as
amended (the "Exchange Act") in connection with which the consideration to
stockholders of the Company is not all cash, the Company or its successor by
merger or consolidation will be required to offer to repurchase the Warrants.
All such repurchases will be at the market price of the Common Stock or other
securities issuable upon exercise of the Warrants (or, if the Common Stock (or
such other securities) are not registered under the Exchange Act, the value of
the Common Stock or other securities as determined by an independent financial
expert), less the exercise price thereof.
 
REGISTRATION RIGHTS
 
     The Fund Investors, the Management Investors, and the Company are parties
to a Registration Agreement dated as of August 13, 1997 (the "Registration
Agreement"). Each of Morgan Stanley Capital Partners, Madison Dearborn Capital
Partners, and Frontenac Company are entitled to demand two long-form
registrations and unlimited short-form registrations, and Battery Ventures is
entitled to demand one long-form registration and unlimited short-form
registrations. In addition, the Fund Investors and the Management Investors may
"piggyback" on primary or secondary registered public offerings of the Company's
securities. Each Fund Investor and Management Investor is subject to holdback
restrictions in the event of a public offering of Company securities. The
parties to the Registration Agreement have agreed to permit the holders of
Warrants to "piggyback" on any registrations under the Registration Agreement.
 
     The Company and The Bank of New York are parties to a Warrant Registration
Rights Agreement dated as of February 3, 1998 (the "Warrant Registration
Agreement"). The holders of the Warrants are entitled to "piggyback"
registration rights in connection with certain public offerings of the Common
Stock. In addition, the Company is required to use its best efforts to cause to
become effective under the Securities Act, within 180 days after the closing of
the Equity Offering, a shelf registration statement with respect to the issuance
of the Common Stock issuable upon exercise of the Warrants; provided, however,
that such shelf registration statement may not be declared effective prior to
the first anniversary of the issuance of the Warrants. Once the shelf
registration statement is declared effective the Company is required to maintain
the effectiveness of such registration statement until all Warrants have expired
or been exercised.
 
                                       72
<PAGE>   74
 
                        SHARES ELIGIBLE FOR FUTURE SALE
 
     Upon the consummation of the Equity Offering, the Company will have
52,341,554 shares of Common Stock outstanding (assuming no exercise of the U.S.
Underwriters' over-allotment option) and excluding 6,998,970 shares reserved for
issuance under the Company's stock plans and 649,248 shares reserved for
issuance upon the exercise of outstanding warrants. All of the shares of Common
Stock sold in the Equity Offering will be freely tradeable under the Securities
Act, unless held by "affiliates" of the Company as that term is defined under
the Securities Act. Upon the expiration of the lock-up agreements between the
Company, the Fund Investors, the Management Investors, certain other
stockholders and the Underwriters described below, 40,341,554 shares of Common
Stock (the "Restricted Shares") will become eligible for sale, subject to
compliance with Rule 144 of the Securities Act as described below.
 
     In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated) who has beneficially owned Restricted Shares for at
least one year, will be entitled to sell in any three-month period a number of
shares that does not exceed the greater of: (i) 1% of the number of shares of
Common Stock then outstanding (approximately 523,415 shares immediately after
the Equity Offering) or (ii) the average weekly trading volume of the Common
Stock on the Nasdaq National Market during the four calendar weeks immediately
preceding the date on which the notice of sale is filed with the Securities and
Exchange Commission. Sales pursuant to Rule 144 are subject to certain
requirements relating to manner of sale, notice and availability of current
public information about the Company. A person (or persons whose shares are
aggregated) who is not deemed to have been an affiliate of the Company at any
time during the 90 days immediately preceding the sale and who has beneficially
owned Restricted Shares for at least two years is entitled to sell such shares
pursuant to Rule 144(k) without regard to the limitations and requirements
described above.
 
   
     The Management Investors have agreed with the Underwriters and certain
other stockholders have agreed with the Company that until one year after the
date of this Prospectus (the date of such Prospectus, the "Effective Date"), and
the Fund Investors have agreed with the Underwriters that until 180 days after
the Effective Date, they will not directly or indirectly, offer, pledge, sell,
contract to sell, sell any option or contract to purchase or otherwise dispose
of any Common Stock or any securities convertible into or exercisable or
exchangeable for Common Stock, or in any manner transfer all or a portion of the
economic consequences associated with the ownership of the Common Stock, or
cause a registration statement covering any shares of Common Stock to be filed,
without the prior written consent of Morgan Stanley & Co. Incorporated and Smith
Barney Inc., or the Company, as applicable, subject to certain limited
exceptions. The Company has also agreed not to directly or indirectly, offer,
pledge, sell, contract to sell, sell any option or contract to purchase or
otherwise dispose of any Common Stock or any securities convertible into or
exercisable or exchangeable for Common Stock or, in any manner, transfer all or
a portion of the economic consequences associated with the ownership of the
Common Stock or cause a registration statement covering any shares of Common
Stock to be filed, for a period of 180 days after the Effective Date, without
the prior written consent of Morgan Stanley & Co. Incorporated and Smith Barney
Inc., subject to certain limited exceptions including the issuance of shares of
Common Stock under the Stock Purchase Plan and 1998 Stock Plan and grants of
options pursuant to, and issuance of shares of Common Stock upon exercise of
options under, the 1997 Nonqualified Stock Option Plan and the 1998 Stock Plan.
See "Management -- Stock Plans". The lock-up agreements described above may be
released at any time as to all or any portion of the shares subject to such
agreements at the sole discretion of Morgan Stanley & Co. Incorporated and Smith
Barney Inc. See "Risk Factors -- Shares Eligible for Future Sale."
    
 
     The Company intends to file a registration statement on Form S-8 covering
the sale of 6,998,970 shares of Common Stock reserved for issuance under the
1997 Nonqualified Stock Option Plan, the 1998 Stock Plan and the Stock Purchase
Plan. See "Management -- Stock Plans." Such registration statement is expected
to be filed as soon as practicable after the Effective Date and will
automatically become effective upon filing. Accordingly, shares registered under
such registration statement will be available for sale in the public market upon
issuance of such shares pursuant to the respective stock plan, unless such
shares are subject to vesting restrictions and subject to limitations on resale
by "affiliates" pursuant to Rule 144. It is anticipated that approximately
886,594 shares of Common Stock issuable upon exercise of currently outstanding
options will
 
                                       73
<PAGE>   75
 
become eligible for sale in the public market without restrictions 180 days
after the Effective Date upon expiration of the lock-up agreements, pursuant to
registration under such registration statement and subject to vesting
restrictions and volume limitations and other restrictions under Rule 144, as
applicable.
 
     The holders of the Warrants are entitled to "piggyback" registration rights
in connection with any public offering of the Common Stock. In addition, the
Company is required to use its best efforts to cause to become effective under
the Securities Act, within 180 days after the closing of the Equity Offering, a
shelf registration statement with respect to the issuance of the Common Stock
issuable upon exercise of the Warrants; provided, however, that such shelf
registration statement may not be declared effective prior to the first
anniversary of the issuance of the Warrants. Once the shelf registration
statement is declared effective, the Company is required to maintain the
effectiveness of such registration statement until all Warrants have expired or
been exercised.
 
                                       74
<PAGE>   76
 
             CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
                          TO NON-UNITED STATES HOLDERS
 
GENERAL
 
     The following is a general discussion of the principal United States
federal income and estate tax consequences of the ownership and disposition of
Common Stock by a Non-U.S. Holder. For this purpose, the term "Non-U.S. Holder"
is defined as any person or entity that is, for United States federal income tax
purposes, a foreign corporation, a non-resident alien individual, a foreign
partnership or a non-resident fiduciary of a foreign estate or trust. This
discussion is based on currently existing provisions of the Code, existing,
temporary and proposed Treasury regulations promulgated thereunder, and
administrative and judicial interpretations thereof, all as in effect or
proposed on the date hereof and all of which are subject to change, possibly
with retroactive effect, or different interpretations. This discussion is
limited to Non-U.S. Holders who hold shares of Common Stock as capital assets
within the meaning of section 1221 of the Code. Moreover, this discussion is for
general information only and does not address all of the tax consequences that
may be relevant to particular Non-U.S. Holders in light of their personal
circumstances, nor does it discuss certain tax provisions which may apply to
individuals who relinquish their U.S. citizenship or residence.
 
     An individual may, subject to certain exceptions, be deemed to be a
resident alien (as opposed to a nonresident alien) by virtue of being present in
the United States for at least 31 days in the calendar year and for an aggregate
of at least 183 days during a three-year period ending in the current calendar
year (counting for such purposes all of the days present in the current year,
one-third of the days present in the immediately preceding year, and one-sixth
of the days present in the second preceding year). Resident aliens are subject
to U.S. federal income tax as if they were U.S. citizens.
 
     EACH PROSPECTIVE PURCHASER OF COMMON STOCK IS ADVISED TO CONSULT A TAX
ADVISOR WITH RESPECT TO CURRENT AND POSSIBLE FUTURE TAX CONSEQUENCES OF
ACQUIRING, HOLDING AND DISPOSING OF COMMON STOCK AS WELL AS ANY TAX CONSEQUENCES
THAT MAY ARISE UNDER THE LAWS OF ANY U.S. STATE, MUNICIPALITY OR OTHER TAXING
JURISDICTION.
 
DIVIDENDS
 
     In the event that dividends are paid on shares of Common Stock, dividends
paid to a Non-U.S. Holder of Common Stock will be subject to withholding of
United States federal income tax at a 30% rate or such lower rate as may be
specified by an applicable income tax treaty. However, if (i) dividends are
effectively connected with the conduct of a trade or business by the Non-U.S.
Holder within the United States and, where a tax treaty applies, are
attributable to a United States permanent establishment of the Non-U.S. Holder
and (ii) an Internal Revenue Service Form 4224 or successor form is filed with
the payer, the dividends are not subject to withholding tax, but instead are
subject to United States federal income tax on a net basis at applicable
graduated individual or corporate rates. Any such effectively connected
dividends received by a foreign corporation may, under certain circumstances, be
subject to an additional "branch profits tax" at a rate of 30% or such lower
rate as may be specified by an applicable income tax treaty.
 
     Dividends paid to an address outside the United States are presumed to be
paid to a resident of such country (unless the payer has knowledge to the
contrary) for purposes of the withholding discussed above and for purposes of
determining the applicability of a tax treaty rate. However, recently finalized
Treasury Regulations pertaining to United States federal withholding tax,
generally effective for payments made after December 31, 1999 (the "Final
Withholding Tax Regulations"), provide that a Non-U.S. Holder must comply with
certification procedures (or, in the case of payments made outside the United
States with respect to an offshore account, certain documentary evidence
procedures), directly or through an intermediary to obtain the benefits of a
reduced rate under an income tax treaty. In addition, the Final Withholding Tax
Regulations will require a Non-U.S. Holder who provides an IRS Form 4224 or
successor form (as discussed above) also to provide its U.S. taxpayer
identification number.
 
                                       75
<PAGE>   77
 
     A Non-U.S. Holder of Common Stock eligible for a reduced rate of United
States withholding tax pursuant to an income tax treaty may obtain a refund of
any excess amounts withheld by filing an appropriate claim for refund with the
IRS.
 
GAIN ON DISPOSITION OF COMMON STOCK
 
     A Non-U.S. Holder generally will not be subject to United States federal
income tax with respect to gain recognized on a sale or other disposition of
Common Stock unless: (i) the gain is effectively connected with a trade or
business of the Non-U.S. Holder in the United States and, where a tax treaty
applies, is attributable to a United States permanent establishment of the
Non-U.S. Holder; (ii) in the case of a Non-U.S. Holder who is an individual and
holds the Common Stock as a capital asset, such holder is present in United
States for 183 or more days in the taxable year of the sale or other disposition
and certain other conditions are met; or (iii) the Company is or has been a
"U.S. real property holding corporation" (a "USRPHC") for United States federal
income tax purposes, as discussed below.
 
     An individual Non-U.S. Holder who falls under clause (i) above will, unless
an applicable treaty provides otherwise, be taxed on his or her net gain derived
from the sale under regular graduated United States federal income tax rates. An
individual Non-U.S. Holder who falls under clause (ii) above will be subject to
a flat 30% tax on the gain derived from the sale, which may be offset by certain
United States capital losses.
 
     A Non-U.S. Holder that is a foreign corporation falling under clause (i)
above will be taxed on its gain under regular graduated United States federal
income tax rates and may be subject to an additional branch profits tax equal to
30% of its effectively connected earnings and profits within the meaning of the
Code for the taxable year, as adjusted for certain items, unless it qualifies
for a lower rate under an applicable income tax treaty.
 
     A corporation is a USRPHC if the fair market value of the U.S. real
property interests held by the corporation is 50% or more of the aggregate fair
market value of its U.S. and foreign real property interests and any other
assets used or held for use by the corporation in a trade or business. Based on
its current and anticipated assets, the Company believes that it is not
currently, and is likely not to become, a USRPHC. However, since the
determination of USRPHC status is based upon the composition of the assets of
the Company from time to time, and because there are uncertainties in the
application of certain relevant rules, there can be no assurance that the
Company will not become a USRPHC. If the Company were to become a USRPHC, then
gain on the sale or other disposition of Common Stock by a Non-U.S. Holder
generally would be subject to U.S. federal income tax unless both (i) the Common
Stock was "regularly traded" on an established securities market within the
meaning of applicable Treasury regulations and (ii) the Non-U.S. Holder actually
or constructively owned 5% or less of the Common Stock. Non-U.S. Holders should
consult their tax advisors concerning any U.S. tax consequences that may arise
if the Company were to become a USRPHC.
 
FEDERAL ESTATE TAX
 
     Common Stock held by an individual Non-U.S. Holder at the time of death
will be included in such holder's gross estate for United States federal estate
tax purposes, unless an applicable estate tax treaty provides otherwise.
 
INFORMATION REPORTING AND BACKUP WITHHOLDING TAX
 
     Under Treasury regulations, the Company must report annually to the IRS and
to each Non-U.S. Holder the amount of dividends paid to such holder and the tax
withheld with respect to such dividends, regardless of whether withholding was
required. Copies of the information returns reporting such dividends and
withholding may also be made available to the tax authorities in the country in
which the Non-U.S. Holder resides under the provisions of an applicable income
tax treaty.
 
     A backup withholding tax is imposed at the rate of 31% on certain payments
to persons that fail to furnish certain identifying information to the payer.
Backup withholding generally will not apply to dividends paid to a
 
                                       76
<PAGE>   78
 
Non-U.S. Holder at an address outside the United States (unless the payer has
knowledge that the payee is a U.S. person). However, in the case of dividends
paid after December 31, 1999, the Final Withholding Tax Regulations provide that
a Non-U.S. Holder generally will be subject to withholding tax at a 31% rate
unless certain certification procedures (or, in the case of payments made
outside the United States with respect to an offshore account, certain
documentary evidence procedures) are complied with, directly or through an
intermediary. Backup withholding and information reporting generally will also
apply to dividends paid on Common Stock at addresses inside the United States to
Non-U.S. Holders that fail to provide certain identifying information in the
manner required. The Final Withholding Tax Regulations provide certain
presumptions under which a Non-U.S. Holder would be subject to backup
withholding and information reporting unless the Company receives certification
from the holder of the Non-U.S. Holder's Non-U.S. status.
 
     Payment of the proceeds of a sale of Common Stock by or through a United
States office of a broker is subject to both backup withholding and information
reporting unless the beneficial owner provides the payer with its name and
address and certifies under penalties of perjury that it is a Non-U.S. Holder,
or otherwise establishes an exemption. In general, backup withholding and
information reporting will not apply to a payment of the proceeds of a sale of
Common Stock by or through a foreign office of a broker. If, however, such
broker is, for United States federal income tax purposes, a U.S. person, a
controlled foreign corporation, or a foreign person that derives 50% or more if
its gross income for certain periods from the conduct of a trade or business in
the United States (or, in addition, for periods after December 31, 1999, a
foreign partnership that at any time during its fiscal year either (i) is
engaged in the conduct of a trade or business in the United States or (ii) has
as partners one or more U.S. persons that, in the aggregate, hold more than 50%
of the income or capital interest in the partnership), such payments will be
subject to information reporting, but not backup withholding, unless (i) such
broker has documentary evidence in its records that the beneficial owner is a
Non-U.S. Holder and certain other conditions are met or (ii) the beneficial
owner otherwise establishes an exemption.
 
     Any amounts withheld under the backup withholding rules generally will be
allowed as a refund or a credit against such holder's U.S federal income tax
liability provided the required information is furnished in a timely manner to
the IRS.
 
                                       77
<PAGE>   79
 
                                  UNDERWRITERS
 
   
     Under the terms and subject to the conditions contained in the Underwriting
Agreement dated as of the date hereof (the "Underwriting Agreement"), the form
of which is filed as an exhibit to the Registration Statement of which this
Prospectus forms a part, the U.S. Underwriters named below for whom Morgan
Stanley & Co. Incorporated, Smith Barney Inc., Donaldson, Lufkin & Jenrette
Securities Corporation, Goldman, Sachs & Co. and UBS Securities LLC are acting
as U.S. Representatives, and the International Underwriters named below for whom
Morgan Stanley & Co. International Limited, Smith Barney Inc., Donaldson, Lufkin
& Jenrette International, Goldman Sachs International and UBS Limited are acting
as International Representatives, have severally agreed to purchase, and the
Company has agreed to sell to them, severally, the respective number of shares
of Common Stock, set forth opposite the names of such Underwriters below:
    
 
   
<TABLE>
<CAPTION>
                                                               NUMBER OF
                            NAME                                SHARES
                            ----                              -----------
<S>                                                           <C>
U.S. Underwriters:
  Morgan Stanley & Co. Incorporated.........................
  Smith Barney Inc. ........................................
  Donaldson, Lufkin & Jenrette Securities Corporation.......
  Goldman, Sachs & Co. .....................................
  Warburg Dillon Read LLC, a subsidiary of UBS AG...........
 
                                                              -----------
     Subtotal...............................................    9,600,000
                                                              -----------
International Underwriters:
  Morgan Stanley & Co. International Limited................
  Smith Barney Inc. ........................................
  Donaldson, Lufkin & Jenrette International................
  Goldman Sachs International ..............................
  Warburg Dillon Read, a division of UBS AG.................
 
                                                              -----------
     Subtotal...............................................    2,400,000
                                                              -----------
          Total.............................................   12,000,000
                                                              ===========
</TABLE>
    
 
     The U.S. Underwriters and the International Underwriters, and the U.S.
Representatives and the International Representatives, are collectively referred
to as the "Underwriters" and the "Representatives," respectively. The
Underwriting Agreement provides that the obligations of the several Underwriters
to pay for
 
                                       78
<PAGE>   80
 
and accept delivery of the shares of Common Stock offered hereby are subject to
the approval of certain legal matters by their counsel and to certain other
conditions. The Underwriters are obligated to take and pay for all of the shares
of Common Stock offered hereby (other than those covered by the underwriters'
over-allotment option described below) if any such shares are taken.
 
     Pursuant to the Agreement between U.S. and International Underwriters, each
U.S. Underwriter has represented and agreed that, with certain exceptions: (i)
it is not purchasing any Shares (as defined herein) for the account of anyone
other than a United States or Canadian Person (as defined herein) and (ii) it
has not offered or sold, and will not offer or sell, directly or indirectly, any
Shares or distribute any prospectus relating to the Shares outside the United
States or Canada or to anyone other than a United States or Canadian Person.
Pursuant to the Agreement between U.S. and International Underwriters, each
International Underwriter has represented and agreed that, with certain
exceptions: (i) it is not purchasing any Shares for the account of any United
States or Canadian Person and (ii) it has not offered or sold, and will not
offer or sell, directly or indirectly, any Shares or distribute any prospectus
relating to the Shares in the United States or Canada or to any United States or
Canadian Person. With respect to any Underwriter that is a U.S. Underwriter and
an International Underwriter, the foregoing representations and agreements (i)
made by it in its capacity as a U.S. Underwriter apply only to it in its
capacity as a U.S. Underwriter and (ii) made by it in its capacity as an
International Underwriter apply only to it in its capacity as an International
Underwriter. The foregoing limitations do not apply to stabilization
transactions or to certain other transactions specified in the Agreement between
U.S. and International Underwriters. As used herein, "United States or Canadian
Person" means any national or resident of the United States or Canada, or any
corporation, pension, profit-sharing or other trust or other entity organized
under the laws of the United States or Canada or of any political subdivision
thereof (other than a branch located outside the United States and Canada of any
United States or Canadian Person), and includes any United States or Canadian
branch of a person who is otherwise not a United States or Canadian Person. All
shares of Common Stock to be purchased by the Underwriters under the
Underwriting Agreement are referred to herein as the "Shares."
 
     Pursuant to the Agreement between U.S. and International Underwriters,
sales may be made between the U.S. Underwriters and International Underwriters
of any number of Shares as may be mutually agreed. The per share price of any
Shares so sold shall be the public offering price set forth on the cover page
hereof, in United States dollars, less an amount not greater than the per share
amount of the concession to dealers set forth below.
 
     Pursuant to the Agreement between U.S. and International Underwriters, each
U.S. Underwriter has represented that it has not offered or sold, and has agreed
not to offer or sell, any Shares, directly or indirectly, in any province or
territory of Canada or to, or for the benefit of, any resident of any province
or territory of Canada in contravention of the securities laws thereof and has
represented that any offer or sale of Shares in Canada will be made only
pursuant to an exemption from the requirement to file a prospectus in the
province or territory of Canada in which such offer or sale is made. Each U.S.
Underwriter has further agreed to send to any dealer who purchases from it any
of the Shares a notice stating in substance that, by purchasing such Shares,
such dealer represents and agrees that it has not offered or sold, and will not
offer or sell, directly or indirectly, any of such Shares in any province or
territory of Canada or to, or for the benefit of, any resident of any province
or territory of Canada in contravention of the securities laws thereof and that
any offer or sale of Shares in Canada will be made only pursuant to an exemption
from the requirement to file a prospectus in the province or territory of Canada
in which such offer or sale is made, and that such dealer will deliver to any
other dealer to whom it sells any of such Shares a notice containing
substantially the same statement as is contained in this sentence.
 
     Pursuant to the Agreement between U.S. and International Underwriters, each
International Underwriter has represented and agreed that (i) it has not offered
or sold and, prior to the date six months after the closing date for the sale of
the Shares to the International Underwriters, will not offer or sell, any Shares
to persons in the United Kingdom except to persons whose ordinary activities
involve them in acquiring, holding, managing or disposing of investments (as
principal or agent) for the purposes of their businesses or otherwise in
circumstances which have not resulted and will not result in an offer to the
public in the United Kingdom within the meaning of the Public Offers of
Securities Regulations 1995; (ii) it has complied and will comply
 
                                       79
<PAGE>   81
 
with all applicable provisions of the Financial Services Act 1986 with respect
to anything done by it in relation to the Shares in, from or otherwise involving
the United Kingdom; and (iii) it has only issued or passed on and will only
issue or pass on in the United Kingdom any document received by it in connection
with the offering of the Shares to a person who is of a kind described in
Article 11(3) of the Financial Services Act 1986 (Investment Advertisements)
(Exemptions) Order 1996 or is a person to whom such document may otherwise
lawfully be issued or passed on.
 
     Pursuant to the Agreement between U.S. and International Underwriters, each
International Underwriter has further represented that it has not offered or
sold, and has agreed not to offer or sell, directly or indirectly, in Japan or
to or for the account of any resident thereof, any of the Shares acquired in
connection with the distribution contemplated hereby, except for offers or sales
to Japanese International Underwriters or dealers and except pursuant to any
exemption from the registration requirement of the Securities and Exchange Law
and otherwise in compliance with applicable provisions of Japanese law. Each
International Underwriter has further agreed to send to any dealer who purchases
from it any of the Shares a notice stating in substance that, by purchasing such
Shares, such dealer represents and agrees that it has not offered or sold, and
will not offer or sell, any of such Shares, directly or indirectly, in Japan or
to or for the account of any resident thereof except for offers or sales to
Japanese International Underwriters or dealers and except pursuant to any
exemption from the registration requirements of the Securities and Exchange Law
and otherwise in compliance with applicable provisions of Japanese law, and that
such dealer will send to any other dealer to whom it sells any of such Shares a
notice substantially the same statement as is contained in this sentence.
 
     The Underwriters initially propose to offer part of the Shares directly to
the public at the public offering price set forth on the cover page hereof and
part to certain dealers at a price that represents a concession not in excess of
$  a share under the public offering price. Any Underwriter may allow, and such
dealers may reallow, a concession not in excess of $  a share to other
Underwriters or to certain dealers. After the initial offering of the shares of
Common Stock, the offering price and other selling terms may from time to time
be varied by the Representatives.
 
     The Company has granted to the U.S. Underwriters an option, exercisable for
30 days from the date of this Prospectus, to purchase up to an aggregate of
1,800,000 additional shares of Common Stock at the public offering price set
forth on the cover page hereof, less underwriting discounts and commissions. The
U.S. Underwriters may exercise such option solely for the purpose of covering
over-allotments, if any, made in connection with the offering of the shares of
Common Stock offered hereby. To the extent such option is exercised, each U.S.
Underwriter will become obligated, subject to certain conditions, to purchase
approximately the same percentage of such additional shares of Common Stock as
the number set forth next to such U.S. Underwriter's name in the preceding table
bears to the total number of shares of Common Stock set forth next to the names
of all U.S. Underwriters in the preceding table.
 
     The Underwriters have informed the Company that they do not intend sales to
discretionary accounts to exceed five percent of the total number of Shares
offered by them.
 
     The Common Stock has been approved for listing, subject to official notice
of issuance, on the Nasdaq National Market under the symbol "ALGX".
 
     Each of the Company and the Fund Investors for a period of 180 days from
the date of this Prospectus, and the Management Investors and certain other
stockholders, for a period of one year from the date of this Prospectus, have
agreed that, without the prior written consent of Morgan, Stanley & Co.
Incorporated and Smith Barney Inc. on behalf of the Underwriters, it will not
(i) offer, pledge, sell, contract to sell, sell any option or contract to
purchase, purchase any option or contract to sell, grant any option, right or
warrant to purchase or otherwise transfer or dispose of, directly or indirectly,
any shares of Common Stock or any securities convertible into or exercisable or
exchangeable for shares of Common Stock or (ii) enter into any swap or other
arrangement that transfers to another, in whole or in part, any of the economic
consequences of ownership of the shares of Common Stock, whether any such
transaction described in clause (i) or (ii) above is to be settled by delivery
of shares of Common Stock or such other securities, in cash or otherwise, of
this Prospectus, other than (v) the Shares (w) the issuance by the Company of
shares of Common Stock upon the exercise of an option or a warrant or the
conversion of a security outstanding on the date of this Prospectus,
 
                                       80
<PAGE>   82
 
(x) the issuance by the Company of additional options to purchase shares of
Common Stock pursuant to the Company's existing stock option plans, (y)
transactions relating to shares of Common Stock or other securities acquired in
open market transactions after completion of the Equity Offering and (z) certain
other limited transactions.
 
   
     At the request of the Company, the Underwriters have reserved up to
1,200,000 shares of Common Stock for sale, at the initial public offering price,
to directors, officers, employees and business associates and other persons
having relationships with the Company. The number of shares of Common Stock
available for sale to the general public will be reduced to the extent such
persons purchase such reserved shares. Any reserved shares which are not so
purchased will be offered by the Underwriters to the general public on the same
basis as the other shares offered hereby.
    
 
     In order to facilitate the Equity Offering, the Underwriters may engage in
transactions that stabilize, maintain or otherwise affect the price of the
shares of Common Stock. Specifically, the Underwriters may over-allot in
connection with the Equity Offering, creating a short position in the shares of
Common Stock for their own account. In addition, to cover over-allotments or to
stabilize the price of the shares of Common Stock, the Underwriters may bid for,
and purchase, shares of Common Stock in the open market. Finally, the
underwriting syndicate may reclaim selling concessions allowed to an Underwriter
or a dealer for distributing the shares of Common Stock in the Equity Offering,
if the syndicate repurchases previously distributed shares of Common Stock in
transactions to cover syndicate short positions, in stabilization transactions
or otherwise. Any of these activities may stabilize or maintain the market price
of the shares of Common Stock above independent market levels. The Underwriters
are not required to engage in these activities, and may end any of these
activities at any time.
 
     Prior to the Equity Offering, there has been no public market for the
Common Stock. The initial public offering price will be determined by
negotiations between the Company and the U.S. Representatives. Among the factors
to be considered in determining the initial public offering price will be the
future prospects of the Company and its industry in general, sales, earnings and
certain other financial operating information of the Company in recent periods,
and the price-earnings ratios, price-sales ratios, market prices of securities
and certain financial and operating information of companies engaged in
activities similar to those of the Company. The estimated initial public
offering price range set forth on the cover page of this Prospectus is subject
to change as a result of market conditions and other factors.
 
     The Company and the Underwriters have agreed to indemnify each other
against certain liabilities, including liabilities under the Securities Act.
 
                                 LEGAL MATTERS
 
     The validity of the issuance of the Common Stock offered hereby will be
passed upon for the Company by Kirkland & Ellis (a partnership including
professional corporations), Chicago, Illinois. Certain legal matters will be
passed upon for the Underwriters by Shearman & Sterling, New York, New York.
 
                                    EXPERTS
 
     The consolidated balance sheets of the Company as of March 31, 1998 and
December 31, 1997, and the related consolidated statements of operations,
stockholders' deficit, and cash flows for the three months ended March 31, 1998
and for the period from inception (April 22, 1997) to December 31, 1997, have
been audited by Arthur Andersen LLP, independent public accountants, as
indicated in their report with respect thereto and are included herein in
reliance upon the authority of said firm as experts in giving said report.
 
                                       81
<PAGE>   83
 
                             ADDITIONAL INFORMATION
 
     The Company has filed with the Commission a Registration Statement on Form
S-1 (the "Registration Statement," which term shall encompass all amendments,
exhibits, annexes and schedules thereto) pursuant to the Securities Act, and the
rules and regulations promulgated thereunder, with respect to the Common Stock
offered hereby. This Prospectus does not contain all of the information set
forth in the Registration Statement. For further information with respect to the
Company and the Common Stock, reference is made to the Registration Statement.
Statements made in this Prospectus as to the contents of any contract, agreement
or any other document referred to are not necessarily complete. With respect to
each such contract, agreement or other document filed as an exhibit to the
Registration Statement, reference is made to the exhibit for a more complete
description of the document or matter involved, and each such statement shall be
deemed qualified in its entirety by such reference.
 
     As a result of the effectiveness of its Registration Statement on Form S-4
(Registration No. 333-49013) relating to the 11 3/4% Notes, the Company is
subject to the informational requirements of the Exchange Act and in accordance
therewith is required to file periodic reports and other information with the
Commission. Copies of the Registration Statement, periodic reports and other
information filed by the Company with the Commission can be obtained at
prescribed rates at the public reference facilities maintained by the Commission
at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, or at its regional
offices located at Citicorp Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661 and Seven World Trade Center, Suite 1300, New York, New
York 10048. In addition, the Commission maintains a website that contains
periodic reports and other information filed by the Company via the Commission's
Electronic Data Gathering and Retrieval System (EDGAR). This website can be
accessed at www.sec.gov.
 
                                       82
<PAGE>   84
 
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                              PAGE
<S>                                                           <C>
Report of Independent Public Accountants....................  F-2
Consolidated Balance Sheets as of March 31, 1998 and
  December 31, 1997.........................................  F-3
Consolidated Statements of Operations for the three months
  ended March 31, 1998 and the period from Inception (April
  22, 1997) through December 31, 1997.......................  F-4
Consolidated Statements of Stockholders' Deficit for the
  three months ended March 31, 1998 and the period from
  Inception (April 22, 1997) through December 31, 1997......  F-5
Consolidated Statements of Cash Flows for the three months
  ended March 31, 1998 and the period from Inception (April
  22, 1997) through December 31, 1997.......................  F-6
Notes to Consolidated Financial Statements..................  F-7
</TABLE>
 
                                       F-1
<PAGE>   85
 
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To the Board of Directors and Stockholders of
Allegiance Telecom, Inc.:
 
     We have audited the accompanying consolidated balance sheets of Allegiance
Telecom, Inc. (a Delaware corporation) and subsidiaries (the "Company") as of
March 31, 1998 and December 31, 1997, and the related consolidated statements of
operations, stockholders' deficit and cash flows for the three months ended
March 31, 1998, and for the period from inception (April 22, 1997) to December
31, 1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Allegiance Telecom, Inc. and
subsidiaries as of March 31, 1998 and December 31, 1997, and the results of
their operations and their cash flows for the three months ended March 31, 1998,
and for the period from inception to December 31, 1997, in conformity with
generally accepted accounting principles.
 
                                            ARTHUR ANDERSEN LLP
 
Dallas, Texas,
April 24, 1998 (except for
Note 10 which
date is June 5, 1998)
 
                                       F-2
<PAGE>   86
 
                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
 
                          CONSOLIDATED BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                          ASSETS
                                                               MARCH 31,      DECEMBER 31,
                                                                  1998            1997
                                                              ------------    ------------
<S>                                                           <C>             <C>
CURRENT ASSETS:
  Cash and cash equivalents.................................  $221,678,116    $  5,726,359
  Short-term investments....................................    35,916,586              --
  Accounts receivable.......................................       307,430           4,310
  Prepaid expenses and other current assets.................       396,460         245,152
                                                              ------------    ------------
          Total current assets..............................   258,298,592       5,975,821
PROPERTY AND EQUIPMENT:
  Property and equipment....................................    32,890,448      23,912,659
  Accumulated depreciation and amortization.................      (221,063)        (12,639)
                                                              ------------    ------------
          Property and equipment, net.......................    32,669,385      23,900,020
OTHER NON-CURRENT ASSETS:
  Deferred debt issuance costs (net of accumulated
     amortization of $100,793)..............................     9,034,603              --
  Other assets..............................................       225,112         171,173
                                                              ------------    ------------
          Total other non-current assets....................     9,259,715         171,173
                                                              ------------    ------------
          Total assets......................................  $300,227,692    $ 30,047,014
                                                              ============    ============
                          LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
  Accounts payable..........................................  $  1,962,575    $  2,261,690
  Accrued liabilities and other.............................     3,651,842       1,668,010
  Deferred revenue..........................................        68,221              --
                                                              ------------    ------------
          Total current liabilities.........................     5,682,638       3,929,700
LONG-TERM DEBT..............................................   247,329,420              --
REDEEMABLE CUMULATIVE CONVERTIBLE PREFERRED STOCK:
  Redeemable cumulative convertible preferred stock -- $.01
     par value, 96,000 and 95,000 shares authorized,
     95,641.25 and 95,000 shares issued and outstanding at
     March 31, 1998, and December 31, 1997, respectively....    59,206,139      33,409,404
  Preferred stock subscriptions receivable..................      (275,000)             --
                                                              ------------    ------------
          Total redeemable cumulative convertible preferred
            stock...........................................    58,931,139      33,409,404
REDEEMABLE WARRANTS.........................................     8,257,542              --
COMMITMENTS AND CONTINGENCIES (see Notes 5 and 7)
STOCKHOLDERS' DEFICIT:
  Common stock -- $.01 par value, 102,524 and 100,001 shares
     authorized, 1 share issued and outstanding at March 31,
     1998, and December 31, 1997............................            --              --
  Additional paid-in capital................................    14,405,519       3,008,437
  Deferred compensation.....................................   (13,216,518)     (2,798,377)
  Accumulated deficit.......................................   (21,162,048)     (7,502,150)
                                                              ------------    ------------
          Total stockholders' deficit.......................   (19,973,047)     (7,292,090)
                                                              ------------    ------------
          Total liabilities and stockholders' deficit.......  $300,227,692    $ 30,047,014
                                                              ============    ============
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       F-3
<PAGE>   87
 
                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
<TABLE>
<CAPTION>
                                                                                 PERIOD FROM
                                                                                  INCEPTION
                                                              THREE MONTHS    (APRIL 22, 1997),
                                                                 ENDED             THROUGH
                                                               MARCH 31,        DECEMBER 31,
                                                                  1998              1997
                                                              ------------    -----------------
<S>                                                           <C>             <C>
REVENUES....................................................  $    202,925      $        403
OPERATING EXPENSES:
  Technical.................................................       234,831           151,269
  Selling...................................................       689,778            22,844
  General and administrative................................     4,990,253         3,613,028
  Depreciation and amortization.............................       208,424            12,639
                                                              ------------      ------------
          Total operating expenses..........................     6,123,286         3,799,780
                                                              ------------      ------------
          Loss from operations..............................    (5,920,361)       (3,799,377)
OTHER (EXPENSE) INCOME:
  Interest income...........................................     2,194,226           111,417
  Interest expense..........................................    (4,669,079)               --
                                                              ------------      ------------
          Total other (expense) income......................    (2,474,853)          111,417
                                                              ------------      ------------
NET LOSS....................................................    (8,395,214)       (3,687,960)
ACCRETION OF REDEEMABLE PREFERRED STOCK AND WARRANT
  VALUES....................................................    (5,264,684)       (3,814,190)
                                                              ------------      ------------
NET LOSS APPLICABLE TO COMMON STOCK.........................  $(13,659,898)     $ (7,502,150)
                                                              ============      ============
NET LOSS PER SHARE, basic and diluted.......................  $(13,659,898)     $ (7,502,150)
                                                              ============      ============
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       F-4
<PAGE>   88
 
                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
 
<TABLE>
<CAPTION>
                                       COMMON STOCK
                                    ------------------   ADDITIONAL
                                    NUMBER OF              PAID-IN       DEFERRED     ACCUMULATED
                                     SHARES     AMOUNT     CAPITAL     COMPENSATION     DEFICIT         TOTAL
                                    ---------   ------   -----------   ------------   ------------   ------------
<S>                                 <C>         <C>      <C>           <C>            <C>            <C>
BALANCE, April 22, 1997 (date of
  inception)......................     --        $ --    $        --   $         --   $         --   $         --
  Issuance of common stock at $100
     per share....................      1          --            100             --             --            100
  Accretion of redeemable
     preferred stock and warrant
     values.......................     --          --             --             --     (3,814,190)    (3,814,190)
  Deferred compensation...........     --          --      3,008,337     (3,008,337)            --             --
  Amortization of deferred
     compensation.................     --          --             --        209,960             --        209,960
  Net loss........................     --          --             --             --     (3,687,960)    (3,687,960)
                                       --        ----    -----------   ------------   ------------   ------------
BALANCE, December 31, 1997........      1          --      3,008,437     (2,798,377)    (7,502,150)    (7,292,090)
  Accretion of redeemable
     preferred stock and warrant
     values.......................     --          --             --             --     (5,264,684)    (5,264,684)
  Deferred compensation...........     --          --     11,397,082    (11,397,082)            --             --
  Amortization of deferred
     compensation.................     --          --             --        978,941             --        978,941
  Net loss........................     --          --             --             --     (8,395,214)    (8,395,214)
                                       --        ----    -----------   ------------   ------------   ------------
BALANCE, March 31, 1998...........      1        $ --    $14,405,519   $(13,216,518)  $(21,162,048)  $(19,973,047)
                                       ==        ====    ===========   ============   ============   ============
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       F-5
<PAGE>   89
 
                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                                                PERIOD FROM
                                                                                 INCEPTION
                                                                                 (APRIL 22,
                                                              THREE MONTHS         1997),
                                                                 ENDED            THROUGH
                                                               MARCH 31,        DECEMBER 31,
                                                                  1998              1997
                                                              ------------    ----------------
<S>                                                           <C>             <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net loss..................................................  $ (8,395,214)     $ (3,687,960)
  Adjustments to reconcile net loss to net cash used in
     operating activities --
     Depreciation and amortization..........................       208,424            12,639
     Accretion of senior discount notes.....................     4,568,286                --
     Amortization of deferred debt issuance costs...........       100,793                --
     Deferred compensation..................................       978,941           209,960
     Changes in assets and liabilities --
       Accounts receivable..................................      (303,120)           (4,310)
       Prepaid expenses and other current assets............      (151,308)         (245,152)
       Other assets.........................................       (53,939)         (171,173)
       Accounts payable.....................................        45,951           275,089
       Accrued liabilities and other........................       737,401         1,668,010
       Deferred revenue.....................................        68,221                --
                                                              ------------      ------------
          Net cash used in operating activities.............    (2,195,564)       (1,942,897)
                                                              ------------      ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchases of property and equipment.......................    (7,608,890)      (21,926,058)
  Short-term investments....................................   (35,916,586)               --
                                                              ------------      ------------
          Net cash used in investing activities.............   (43,525,476)      (21,926,058)
                                                              ------------      ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from senior discount notes.......................   242,293,600                --
  Proceeds from issuance of warrants........................     8,183,550                --
  Debt issuance costs.......................................    (9,135,396)               --
  Proceeds from issuance of redeemable preferred stock......        62,500         5,000,000
  Proceeds from redeemable capital contributions............    20,268,543        24,595,214
  Proceeds from issuance of common stock....................            --               100
                                                              ------------      ------------
          Net cash provided by financing activities.........   261,672,797        29,595,314
                                                              ------------      ------------
INCREASE IN CASH AND CASH EQUIVALENTS.......................   215,951,757         5,726,359
CASH AND CASH EQUIVALENTS, beginning of period..............     5,726,359                --
                                                              ------------      ------------
CASH AND CASH EQUIVALENTS, end of period....................  $221,678,116      $  5,726,359
                                                              ============      ============
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       F-6
<PAGE>   90
 
                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                      MARCH 31, 1998 AND DECEMBER 31, 1997
 
1. GENERAL:
 
     Allegiance Telecom, Inc., a competitive local exchange carrier ("CLEC"),
was incorporated on April 22, 1997, as a Delaware corporation for the purpose of
providing voice, data, and Internet services to business, government, and other
institutional users in major metropolitan areas across the United States.
Allegiance Telecom, Inc. and its subsidiaries are referred to herein as the
"Company." The consolidated financial statements of the Company include the
accounts of Allegiance Telecom, Inc., Allegiance Telecom Service Corporation,
Allegiance Telecom of California, Inc., Allegiance Telecom of Georgia, Inc.,
Allegiance Telecom of Illinois, Inc., Allegiance Telecom of New Jersey, Inc.,
Allegiance Telecom of New York, Inc., Allegiance Telecom of Texas, Inc., and
Allegiance Telecom International, Inc. Each of these companies is a wholly owned
subsidiary of Allegiance Telecom, Inc.
 
     The Company plans two phases of development, the first to offer services in
12 of the largest U.S. metropolitan areas and the second to offer services in 12
additional large metropolitan areas in the U.S. The Company is currently
developing its networks in six markets: New York City, Dallas, Atlanta, Chicago,
Los Angeles, and San Francisco. During December 1997, the Company began
providing service in Dallas. Initial facilities-based service for the New York
City market began in the first quarter of 1998. Initial facilities-based
services for the Dallas and Atlanta markets are scheduled to begin in the second
quarter of 1998, for the Chicago and Los Angeles markets in the third quarter of
1998, and for the San Francisco and Boston markets in the fourth quarter of
1998. The Company is planning to begin services in an additional six markets in
the second half of 1998 and early 1999. The build-out of the second phase will
be dependent upon the Company obtaining additional financing.
 
     Until December 16, 1997, the Company was in the development stage. Since
its inception on April 22, 1997, the Company's principal activities have
included developing its business plans, procuring governmental authorizations,
raising capital, hiring management and other key personnel, working on the
design and development of its local exchange telephone networks and operations
support systems ("OSS"), acquiring equipment and facilities and negotiating
interconnection agreements. Accordingly, the Company has incurred operating
losses and operating cash flow deficits.
 
     The Company's success will be affected by the problems, expenses, and
delays encountered in connection with the formation of any new business, and the
competitive environment in which the Company intends to operate. The Company's
performance will further be affected by its ability to assess potential markets,
secure financing or raise additional capital, implement expanded interconnection
and collocation with incumbent local exchange carrier ("ILEC") facilities, lease
adequate trunking capacity from ILECs or other CLECs, purchase and install
switches in additional markets, implement efficient OSS and other back office
systems, develop a sufficient customer base, and attract, retain, and motivate
qualified personnel. The Company's networks and the provisions of
telecommunications services are subject to significant regulation at the
federal, state, and local levels. Delays in receiving required regulatory
approvals or the enactment of new adverse regulation or regulatory requirements
may have a material adverse effect upon the Company. Although management
believes that the Company will be able to successfully mitigate these risks,
there is no assurance that the Company will be able to do so or that the Company
will ever operate profitably.
 
     Expenses are expected to exceed revenues in each location in which the
Company offers service until a sufficient customer base is established. It is
anticipated that obtaining a sufficient customer base will take a number of
years, and positive cash flows from operations are not expected in the near
future.
 
                                       F-7
<PAGE>   91
                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
 
CONSOLIDATION
 
     The accompanying financial statements include the accounts of Allegiance
Telecom, Inc. and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated.
 
CASH AND CASH EQUIVALENTS
 
     For purposes of reporting cash flows, the Company includes as cash and cash
equivalents, cash, marketable securities and commercial paper with original
maturities of three months or less.
 
SHORT-TERM INVESTMENTS
 
     Short-term investments consist primarily of commercial paper with original
maturities at date of purchase beyond three months and less than 12 months. Such
short-term investments are carried at their accreted value, which approximates
fair value, due to the short period of time to maturity.
 
ACCOUNTS RECEIVABLE
 
     Accounts receivable consists of end user receivables, interest receivable,
and at December 31, 1997, a receivable from an employee.
 
PREPAID EXPENSES AND OTHER CURRENT ASSETS
 
     Prepaid expenses and other current assets consist of prepaid rent, prepaid
insurance, and refundable deposits. Prepayments are expensed on a straight-line
basis over the life of the underlying agreements.
 
PROPERTY AND EQUIPMENT
 
     Property and equipment includes switches, office equipment, furniture and
fixtures, and construction-in-progress of switches and leasehold improvements.
These assets are stated at cost, which includes direct costs and interest
expense capitalized and are depreciated once placed in service using the
straight-line method. Interest expense for the three months ended March 31, 1998
was $5,136,613 before the capitalization of $467,534 of interest expense related
to construction-in-progress. The estimated useful lives of office equipment,
furniture and fixtures, leasehold improvements and switches are two, five, and
seven years, respectively. Repair and maintenance costs are expensed as
incurred. Property and equipment at March 31, 1998, and December 31, 1997,
consisted of the following:
 
<TABLE>
<CAPTION>
                                                             MARCH 31,     DECEMBER 31,
                                                               1998            1997
                                                            -----------    ------------
<S>                                                         <C>            <C>
Construction-in-progress switches.........................  $10,774,433    $19,989,924
Construction-in-progress leasehold improvements...........      521,546      2,458,728
Construction-in-progress office equipment.................    3,272,779      1,186,457
Switches..................................................   13,835,717             --
Leasehold improvements....................................    3,696,150         37,466
Office equipment..........................................      583,560         89,855
Furniture and fixtures....................................      206,263        150,229
Less: Accumulated depreciation............................     (221,063)       (12,639)
                                                            -----------    -----------
Property and equipment, net...............................  $32,669,385    $23,900,020
                                                            ===========    ===========
</TABLE>
 
     In October 1997, the Company acquired digital switches in New York City and
Atlanta and certain furniture and fixtures from US ONE Communications for an
aggregate purchase price of approximately
                                       F-8
<PAGE>   92
                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
$19.3 million. Operating and application software costs for both network and
administration systems are capitalized and amortized over the estimated life of
the system, which approximates five years.
 
REVENUE RECOGNITION
 
     Revenue is recognized in the month in which the service is provided. All
expenses related to services provided are recognized as incurred. Deferred
revenue represents advance billings for services not yet performed. Such revenue
is deferred and recognized in the month in which the service is provided.
 
USE OF ESTIMATES IN FINANCIAL STATEMENTS
 
     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of expenses during the reporting period.
Actual results could differ from those estimates.
 
EARNINGS PER SHARE
 
     The net loss per share amount reflected on the statement of operations is
based upon the weighted average number of common shares outstanding of one
share. The preferred shares, warrants and options were not included in the net
loss per share calculation as the effect from the conversion would be
antidilutive (see Note 3). The net loss applicable to common stock at March 31,
1998, and December 31, 1997, includes the accretion of redeemable preferred
stock and warrant values of $5,264,684 and $3,814,190, respectively.
 
COMPREHENSIVE INCOME
 
     In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
130"). SFAS 130 establishes reporting and disclosure requirements for
comprehensive income and its components within the Financial Statements. The
Company's comprehensive income components were immaterial as of March 31, 1998
and the Company had no comprehensive income components as of December 31, 1997;
therefore, comprehensive income is the same as net income for both periods.
 
RECLASSIFICATIONS
 
     Certain amounts in the prior period's consolidated financial statements
have been reclassified to conform with the current period presentation.
 
3. CAPITALIZATION:
 
STOCK PURCHASE AGREEMENT AND SECURITY HOLDERS AGREEMENT
 
     On August 13, 1997, the Company entered into a stock purchase agreement
with Allegiance Telecom, L.L.C. ("Allegiance LLC") (see Note 6). Allegiance LLC
purchased 95,000 shares of 12% redeemable cumulative convertible Preferred Stock
par value $.01 per share ("Initial Closing") and agreed to make additional
contributions as necessary to fund expansion into new markets ("Subsequent
Closings"). In order to obtain funds through Subsequent Closings, the Company
must submit a proposal to Allegiance LLC detailing the funds necessary to build
out the Company's business in a new market. Allegiance LLC is not required to
make any contributions until the proposal has been approved by Allegiance LLC.
The maximum commitment of Allegiance LLC is $100 million and no capital
contributions are required to be made after the Company consummates an initial
public offering of its stock (see Note 10). As of March 31, 1998, and December
31, 1997, Allegiance LLC has contributed a total of $49.9 million and $29.6
million, respectively. At any time and from time to time after August 13, 2004,
but not after the consummation of a public offering
                                       F-9
<PAGE>   93
                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(see Note 10) or sale of the Company, each security holder in Allegiance LLC
shall have the right to require Allegiance LLC to repurchase all of the
outstanding securities held by such security holder at the greater of the
original cost for such security and the fair market value as defined in the
security holders agreement. The original cost shall be equal to the
contributions made to Allegiance LLC together with interest thereon at 12% per
annum. Twenty-three days after the issuance of a Repurchase Notice (as defined
in the Securityholders Agreement), the security holders may have the fair value
of their securities determined. Fair market value is defined as the amount
agreed to be the fair market value by Allegiance LLC, the majority of the Fund
Investors, and the majority of the Management Investors. If mutual agreement
cannot be reached, fair market value for (a) publicly traded securities
generally means the average of the closing prices of such securities for the 21
day period after the filing of the Repurchase Notice and (b) non-publicly traded
securities, a valuation determined by an appraisal mechanism. In the event the
repurchase provisions are exercised, the Company has agreed, at the request and
direction of Allegiance LLC, to take any and all actions necessary, including
declaring and paying dividends and repurchasing preferred or common stock to
enable Allegiance LLC to satisfy its repurchase obligations. Accordingly, as
required by SEC accounting standards the Company is recognizing the accretion of
the value of the Preferred Stock (as defined below) to reflect management's
estimate of the potential future fair market value of the Preferred Stock
payable in the event the repurchase provisions are exercised. Amounts are
accreted using the effective interest method assuming the Preferred Stock is
redeemed at a redemption price based on the estimated potential future fair
market value of the equity of the Company in August 2004. The accretion is
recorded each period as an increase in the balance of Preferred Stock
outstanding and a non-cash increase in the net loss applicable to common stock.
In the event of an initial public offering of the common stock of the Company
before August 2004, the redemption provision terminates. At such time, the
Preferred Stock would convert to common stock and the amounts accreted would be
reclassified as a component of additional paid-in capital in the stockholders'
equity section of the balance sheet.
 
REDEEMABLE CUMULATIVE CONVERTIBLE PREFERRED STOCK
 
     As of March 31, 1998, and December 31, 1997, the Company had authorized
96,000 and 95,000 shares, respectively of 12% redeemable cumulative convertible
Preferred Stock ("Preferred Stock"), par value $.01 per share. Each share is
convertible into shares of the Company's common stock with a par value of $.01
per share (the "Common Stock"). Each share of Preferred Stock is currently
convertible into Common Stock on a 1:1 basis, subject to certain antidilution
provisions. No dividends were declared in 1998 or in 1997. As of March 31, 1998,
and December 31, 1997, the Company had recorded accretion in the value of the
Preferred Stock using the effective interest method of $5,190,692 and
$3,814,190, to reflect the potential future repurchase value of the Preferred
Stock in August 2004 based upon management's estimate of the fair market value
of the Preferred Stock at that date.
 
     On August 13, 1997, as a result of the Initial Closing, 95,000 shares of
Preferred Stock were issued at a per share price of $52.63, for an aggregate
price of $5 million.
 
     Capital contributed in the Subsequent Closings occurring in October 1997
and January 1998, and other capital contributions totaled approximately $45.2
million.
 
     On February 25, 1998, the Company issued 522.50 shares of Preferred Stock.
The Preferred Stock was issued at a per share price of $526.32, for an aggregate
price of $275,000 which is recorded as a subscription receivable on the balance
sheet.
 
     On March 13, 1998, the Company issued 118.75 shares of Preferred Stock. The
Preferred Stock was issued at a per share price of $526.32, for an aggregate
price of $62,500.
 
                                      F-10
<PAGE>   94
                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
COMMON STOCK
 
     As of December 31, 1997, the Company had authorized 100,001 shares of $.01
par value Common Stock. One share was issued and outstanding at March 31, 1998,
and December 31, 1997. In February 1998, the Company increased the number of
authorized shares of Common Stock to 102,524 shares. Of the authorized but
unissued Common Stock, 96,000 shares are reserved for issuance upon conversion
of Preferred Stock, 5,000 shares are reserved for issuance upon exercise of
stock options issued under the Stock Option Plan (see Note 9) and 1,523 shares
are reserved for issuance, sale, and delivery upon the exercise of warrants (see
Note 4).
 
4. LONG-TERM DEBT:
 
     On February 3, 1998, the Company raised gross proceeds of approximately
$250.5 million in an offering of 445,000 Units (the "Unit Offering"), each of
which consists of one 11 3/4% Senior Discount Note due 2008 of the Company (the
"11 3/4% Notes") and one warrant to purchase .0034224719 shares of Common Stock
(the "Redeemable Warrants") at an exercise price of $.01 per share, subject to
certain antidilution provisions. Of the gross proceeds, $242.3 million was
allocated to the initial accreted value of the 11 3/4% Notes and $8.2 million
was allocated to the Redeemable Warrants. The Redeemable Warrants are separately
transferable and are exercisable at any time beginning February 3, 1999, through
their expiration on February 3, 2008. The Redeemable Warrants will also become
exercisable in connection with a public equity offering. The 11 3/4% Notes have
a principal amount at maturity of $445.0 million and an effective interest rate
of 12.45%. The 11 3/4% Notes mature on February 15, 2008. From and after
February 15, 2003, interest on the 11 3/4% Notes will be payable semi-annually
in cash at the rate of 11 3/4% per annum.
 
     The fair market value of the Redeemable Warrants was determined based upon
estimates of the fair value of the Common Stock the Redeemable Warrants could be
used to acquire and the achievement of an effective interest rate on the 11 3/4%
Notes of 12.45% required to sell the Units. The fair market value of the
Redeemable Warrants was also corroborated using the Black-Scholes valuation
model.
 
     The Company must make an offer to purchase the Redeemable Warrants for cash
at the Relevant Value upon the occurrence of a Repurchase Event. A Repurchase
Event is defined to occur when (i) the Company consolidates with or merges into
another person if the Common Stock thereafter issuable upon exercise of the
Redeemable Warrants is not registered under the Securities Exchange Act of 1934,
as amended (the "Exchange Act") or (ii) the Company sells all or substantially
all of its assets to another person, if the Common Stock thereafter issuable
upon the exercise of the Redeemable Warrants is not registered under the
Exchange Act, unless the consideration for such a transaction is cash. The
Relevant Value is defined to be the fair market value of the Common Stock as
determined by the trading value of the securities if publicly traded or at an
estimated fair market value without giving effect to any discount for lack of
liquidity, lack of registered securities, or the fact that the securities
represent a minority of the total shares outstanding. As required by SEC
accounting standards the Company is recognizing the potential future redemption
value of the Redeemable Warrants by recording accretion of the Redeemable
Warrant to its estimated fair market value at February 3, 2008 using the
effective interest method. In the event the Redeemable Warrant is exercised and
used to purchase the common stock of the Company or expires, the redemption
provisions terminate and amounts accreted would be reversed as a reduction of
the losses applicable to common stock in measuring results of operations of the
Company. Accretion recorded in the first quarter of 1998 was $73,992.
 
     The 11 3/4% Notes are redeemable by the Company, in whole or in part,
anytime on or after February 15, 2003, at 105.875% of their principal amount at
maturity, plus accrued and unpaid interest, declining to 100% of their principal
amount at maturity, plus accrued and unpaid interest on and after February 15,
2006. In addition, at any time prior to February 15, 2001, the Company may, at
its option, redeem up to 35% of the principal amount at maturity of the 11 3/4%
Notes in connection with a public equity offering at 111.750% of the
 
                                      F-11
<PAGE>   95
                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
accreted value on the redemption date; provided that at least $289.3 million
aggregate principal amount at maturity of the 11 3/4% Notes remains outstanding
after such redemption.
 
     The 11 3/4% Notes carry certain restrictive covenants that, among other
things, limit the ability of the Company to incur indebtedness, pay dividends,
issue or sell capital stock, create liens, sell assets, and enter into
transactions with any holder of 5% or more of any class of capital stock of the
Company or any of its affiliates. The Company was in compliance with all such
restrictive covenants at March 31, 1998.
 
5. LEGAL MATTERS:
 
     On August 29, 1997, WorldCom, Inc. ("WorldCom") sued the Company and two
individual employees. In its complaint, WorldCom alleges that these employees
violated certain noncompete and nonsolicitation agreements by accepting
employment with the Company and by soliciting then current WorldCom employees to
leave WorldCom's employment and join the Company. In addition, WorldCom claims
that the Company tortiously interfered with WorldCom's relationships with its
employees, and that the Company's behavior constituted unfair competition.
WorldCom seeks injunctive relief and damages, although it has filed no motion
for a temporary restraining order or preliminary injunction. The Company denies
all claims and will vigorously defend itself. The Company does not expect the
ultimate outcome to have a material adverse effect on the results of operations
or financial condition of the Company and an estimate of possible loss cannot be
made at this time.
 
     On October 7, 1997, the Company filed a counterclaim against WorldCom for,
among other things, attempted monopolization of the "one stop shopping"
telecommunications market, abuse of process, and unfair competition. WorldCom
did not move to dismiss the attempted monopolization claim, but has moved to
dismiss the abuse of process and unfair competition claims. On March 4, 1998,
the court dismissed the claim for unfair competition.
 
6. RELATED PARTIES:
 
     The Company is a majority owned subsidiary of Allegiance LLC. As of March
31, 1998, and December 31, 1997, Allegiance LLC has made aggregate capital
contributions to the Company of approximately $49.9 million and $29.6 million,
respectively. Allegiance LLC may continue to make additional capital
contributions to the Company as discussed in Note 3 to these financial
statements, but no such contributions will be required after the Company
consummates an initial public offering of its stock. Certain investors in
Allegiance LLC are also employees of the Company. Upon an initial public
offering by the Company, a sale of the Company or liquidation or dissolution of
the Company, Allegiance LLC will dissolve and its assets (which are expected to
consist almost entirely of capital stock of the Company) will be distributed to
the institutional investors and employee investors of Allegiance LLC in
accordance with an allocation formula calculated immediately prior to such
dissolution. The Company will account for any increase in the allocation of
assets to the employee investors in Allegiance LLC in accordance with generally
accepted accounting principles and SEC regulations in effect at the time of such
increase, and this will result in a charge to the Company's earnings (see Note
10).
 
     As the estimated fair market value of the Company has exceeded the price at
which units of Allegiance LLC have been sold to management employees since the
foundation of the Company, the Company has recognized deferred compensation of
$9,436,950 and $977,632 at March 31, 1998 and December 31, 1997, respectively,
of which $650,911 and $40,735 has been amortized to expense at March 31, 1998
and December 31, 1997, respectively. The deferred compensation charge is
amortized based upon the period over which the Company has the right to
repurchase the securities (at the lower of fair market value or the price paid
by the employee) in the event the management employee's employment with the
Company is terminated which expires over a four year period from the date of
issuance. During 1998 and 1997, the Company paid all
 
                                      F-12
<PAGE>   96
                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
organizational and legal fees of Allegiance LLC, the amount of which was not
material. No amounts are due from Allegiance LLC at March 31, 1998, or December
31, 1997.
 
     In connection with the Unit Offering (see Note 4), the Company incurred
approximately $4.4 million in fees to an affiliate of an investor in Allegiance
LLC.
 
7. COMMITMENTS AND CONTINGENCIES:
 
     The Company has entered into various operating lease agreements, with
expirations through 2007, for office space and equipment. Future minimum lease
obligations related to the Company's operating leases as of March 31, 1998 are
as follows:
 
<TABLE>
<S>                                                <C>
1998.............................................  $1,199,679
1999.............................................   1,588,907
2000.............................................   1,597,751
2001.............................................   1,160,961
2002.............................................   1,119,128
Thereafter.......................................   4,743,351
</TABLE>
 
     Total rent expense for the three months ended March 31, 1998, was $331,862
and for the period from inception (April 22, 1997), to December 31, 1997, was
$212,053.
 
     In October 1997, the Company entered into a five-year general agreement
with Lucent Technologies, Inc. ("Lucent") establishing terms and conditions for
the purchase of Lucent products, services, and licensed materials. This
agreement includes a three-year exclusivity commitment for the purchase of
products and services related to new switches. The agreement contains no minimum
purchase requirements.
 
8. FEDERAL INCOME TAXES:
 
     The Company accounts for income tax under the provisions of Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS
109"). SFAS 109 requires an asset and liability approach which requires the
recognition of deferred tax assets and liabilities for the expected future tax
consequences of events which have been recognized in the Company's financial
statements. The Company had approximately $2,916,156 and $460,475 of net
operating loss carryforwards for federal income tax purposes at March 31, 1998
and December 31, 1997, respectively. The net operating loss carryforwards will
expire in the years 2012 and 2013 if not previously utilized. The Company has
recorded a valuation allowance equal to the net deferred tax assets at March 31,
1998, and December 31, 1997, due to the uncertainty of future operating results.
The valuation allowance will be reduced at such time as management believes it
is more likely than not that the net deferred tax assets will be realized. Any
reductions in the valuation allowance will reduce future provisions for income
tax expense.
 
     The Company's deferred tax assets and the changes in those assets are:
 
<TABLE>
<CAPTION>
                                               DECEMBER 31,                  MARCH 31,
                                                   1997         CHANGE         1998
                                               ------------    ---------    -----------
<S>                                            <C>             <C>          <C>
Start-up costs capitalized for tax
  purposes...................................  $ 1,025,959     $ (59,848)   $   966,111
Net operating loss carryforwards.............      156,562       834,932        991,494
Valuation allowance..........................   (1,182,521)     (775,084)    (1,957,605)
                                               -----------     ---------    -----------
                                               $        --     $      --    $        --
                                               ===========     =========    ===========
</TABLE>
 
     Amortization of the original issue discount on the Notes as interest
expense is not deductible in the income tax return until paid.
                                      F-13
<PAGE>   97
                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Under existing income tax law, all operating expenses incurred prior to a
company commencing its principal operations are capitalized and amortized over a
five-year period for tax purposes.
 
9. STOCK OPTION PLAN:
 
     The Company has a stock option plan (the "Plan") under which it grants
options to purchase Common Stock. The options granted have a term of six years
and vest over a three-year period. As of March 31, 1998, and December 31, 1997,
5,000 shares of Common Stock are reserved for issuance under the Plan.
 
     The Company applies the provisions of Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" and the related
interpretations in accounting for the Plan. Had compensation cost for the Plan
been determined based on the fair value of the options as of the grant dates for
awards under the Plan consistent with the method prescribed in Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS No. 123), the Company's net loss would have increased to the
pro forma amount indicated below. The Company estimated the fair value of each
option grant using the minimum value method permitted by SFAS No. 123 for
entities not publicly traded. The Company utilized the following assumptions in
the calculations for March 31, 1998, and December 31, 1997: weighted average
risk-free interest rates of 5.88% and 6.06%, respectively, expected life of six
years, and no dividends being paid over the life of the options.
 
<TABLE>
<CAPTION>
                                                             MARCH 31,     DECEMBER 31,
                                                                1998           1997
                                                             ----------    ------------
<S>                                                          <C>           <C>
Net loss -- As reported....................................  $8,395,214     $3,687,960
Net loss -- Pro forma......................................  $8,409,836     $3,698,012
</TABLE>
 
     A summary of the status of the Plan as of March 31, 1998, and December 31,
1997, is presented in the table below:
 
<TABLE>
<CAPTION>
                                              MARCH 31, 1998             DECEMBER 31, 1997
                                        --------------------------   --------------------------
                                                  WEIGHTED AVERAGE             WEIGHTED AVERAGE
                                        SHARES     EXERCISE PRICE    SHARES     EXERCISE PRICE
                                        -------   ----------------   -------   ----------------
<S>                                     <C>       <C>                <C>       <C>
Outstanding, beginning of period......      444      $1,052.63            --      $      --
Granted...............................      314       1,052.63           444       1,052.63
Exercised.............................       --             --            --             --
Forfeited.............................     (131)      1,052.63            --             --
                                        -------                      -------
Outstanding, end of period............      627      $1,052.63           444      $1,052.63
                                        =======                      =======
Options exercisable at period-end.....       --                           --
                                        =======                      =======
Weighted average fair value of options
  granted.............................  $314.25                      $320.85
                                        =======                      =======
</TABLE>
 
     As of March 31, 1998, the 627 options outstanding under the Plan have an
exercise price of $1,052.63 and a weighted average remaining contractual life of
5.6 years. As of December 31, 1997, the 444 options outstanding have an exercise
price of $1,052.63 and a weighted average remaining contractual life of 5.8
years.
 
     As the estimated fair market value of the Company stock exceeded the
exercise price of the options granted, the Company has recognized deferred
compensation expense of $2,559,281 and $2,030,705 at March 31, 1998 and December
31, 1997, of which $328,030 and $169,225 has been amortized to expense at March
31, 1998 and December 31, 1997, respectively over the vesting period of the
options. As of March 31, 1998, the Company has reversed $599,149 of deferred
compensation related to options forfeited.
 
                                      F-14
<PAGE>   98
                   ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
10. SUBSEQUENT EVENTS:
 
CAPITAL LEASE
 
     On May 29, 1998, the Company signed a capital lease agreement for three,
four-fiber rings at an expected total cost of $3,485,000 for a term of ten years
with a renewal term of ten years.
 
PUBLIC STOCK AND NOTE OFFERINGS
 
     The Company will seek to raise approximately $200.0 million of gross
proceeds in an initial public offering of Common Stock (the "Equity Offering")
and an additional $290.0 million of gross proceeds in an offering of Senior
Notes due 2008 (the "Debt Offering") of which approximately $88.0 million will
be required to be placed in a pledged account to secure and fund the first six
scheduled payments of interest on the notes.
 
     The Fund Investors and Management Investors currently own 95.0% and 5.0%,
respectively, of the ownership interests of Allegiance LLC, an entity that owns
substantially all of the Company's outstanding capital stock. If the Equity
Offering is consummated, Allegiance LLC will dissolve and its assets (which
consist almost entirely of such capital stock) will be distributed to the Fund
Investors and the Management Investors in accordance with the LLC Agreement. The
LLC Agreement provides that the Equity Allocation between the Fund Investors and
the Management Investors will range between 95.0%/5.0% and 66.7%/33.3% based
upon the valuation of the Company's Common Stock implied by the Equity Offering.
Based upon the current valuation of the Company's Common Stock implied by the
Equity Offering, the Equity Allocation will be 66.7% to the Fund Investors and
33.3% to the Management Investors. Under generally accepted accounting
principles, upon the consummation of the Equity Offering, the Company will be
required to record the increase (based upon the valuation of the Common Stock
implied by the Equity Offering) in the assets of Allegiance LLC allocated to the
Management Investors as an increase in additional paid-in capital, a portion of
which will be recorded as a non-cash, non-recurring charge to operating expense
and a portion of which will be recorded as a deferred management ownership
allocation charge. The deferred charge will be amortized over 1998, 1999, 2000
and 2001, which is the period over which the Company has the right to repurchase
the securities (at the lower of fair market value or the price paid by the
employee) in the event the management employee's employment with the Company is
terminated. Based upon the Common Stock valuation estimated in the Equity
Offering, the total management ownership allocation charge is estimated to be
$232.7 million.
 
     In connection with the consummation of the Equity Offering, the outstanding
shares of Preferred Stock will be converted to Common Stock and the obligation
of Allegiance LLC to make additional capital contributions to the Company (and
the obligation of the members of Allegiance LLC to make capital contributions to
it) will terminate. Upon such conversion of the Preferred Stock, the obligation
of the Company to redeem the Preferred Stock also terminates and, therefore, the
Preferred Stock dividends accrued to the date of the Equity Offering will be
reclassified to additional paid-in capital in the stockholders' equity section
of the balance sheet.
 
                                      F-15
<PAGE>   99
 
                        (ALLEGIANCE TELECOM, INC. LOGO)
<PAGE>   100
 
                  ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS
 
PROSPECTUS (Subject to Completion)
 
   
Issued June 30, 1998
    
                               12,000,000 Shares
 
                        (ALLEGIANCE TELECOM, INC. LOGO)
                                  COMMON STOCK
                            ------------------------
 All of the 12,000,000 shares of Common Stock offered hereby are being sold by
  the Company. Of the 12,000,000 shares of Common Stock being offered hereby,
   2,400,000 shares are being offered initially outside the United States and
  Canada by the International Underwriters (the "International Offering") and
9,600,000 shares are being offered initially in the United States and Canada by
the U.S. Underwriters (the "U.S. Offering," and together with the International
             Offering, the "Equity Offering"). See "Underwriters."
  Prior to the Equity Offering, there has been no public market for the Common
   Stock of the Company. It is currently anticipated that the initial public
 offering price per share of Common Stock will be between $16.00 and $18.00 per
 share. See "Underwriters" for a discussion of the factors to be considered in
                 determining the initial public offering price.
   
Concurrent with the Equity Offering, the Company will make a public offering of
 $200.0 million principal amount of its     % Senior Notes due 2008 (the "Debt
Offering"). The closing of the Debt Offering is conditioned upon the closing of
 the Equity Offering, but the closing of the Equity Offering is not conditioned
                     upon the closing of the Debt Offering.
    
                            ------------------------
 
 The Common Stock has been approved for listing, subject to official notice of
                            issuance, on the Nasdaq
                    National Market under the symbol "ALGX."
                            ------------------------
 
      SEE "RISK FACTORS" BEGINNING ON PAGE 10 FOR INFORMATION THAT SHOULD
                     BE CONSIDERED BY PROSPECTIVE INVESTORS
                            ------------------------
  THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
 EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
   AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
                               CRIMINAL OFFENSE.
                            ------------------------
 
                              PRICE $     A SHARE
                            ------------------------
 
   
<TABLE>
<CAPTION>
                                                                       UNDERWRITING
                                        PRICE TO                       DISCOUNTS AND                     PROCEEDS TO
                                         PUBLIC                       COMMISSIONS(1)                     COMPANY(2)
                                        --------                      --------------                     -----------
<S>                          <C>                              <C>                              <C>
Per Share..................                 $                                $                                $
Total(3)(4)................                 $                                $                                $
</TABLE>
    
 
------------
    (1) The Company has agreed to indemnify the Underwriters against certain
        liabilities, including liabilities under the Securities Act of 1933, as
        amended. See "Underwriters."
    (2) Before deducting expenses payable by the Company estimated at $750,000.
    (3) The Company has granted to the U.S. Underwriters an option, exercisable
        within 30 days of the date hereof, to purchase up to an aggregate of
        1,800,000 additional shares of Common Stock at the price to public less
        underwriting discounts and commissions, for the purpose of covering
        over-allotments, if any. If the U.S. Underwriters exercise such option
        in full, the total price to public, underwriting discounts and
        commissions and proceeds to Company will be $      , $      and $      ,
        respectively. See "Underwriters."
   
    (4) Up to 1,200,000 shares of Common Stock have been reserved for sale, at
        the initial public offering price, to directors, officers, employees and
        business associates and other persons having relationships with the
        Company. See "Underwriters."
    
                            ------------------------
 
    The shares of Common Stock are offered, subject to prior sale, when, as and
if accepted by the Underwriters and subject to approval of certain legal matters
by Shearman & Sterling, counsel for the Underwriters. It is expected that
delivery of the shares will be made on or about            , 1998 in New York,
N.Y., against payment therefor in immediately available funds.
                            ------------------------
 
                           Joint Bookrunning Managers
 
MORGAN STANLEY DEAN WITTER  SALOMON SMITH BARNEY
                                                          INTERNATIONAL
                            ------------------------
 
DONALDSON, LUFKIN & JENRETTE
            International
   
                                GOLDMAN SACHS INTERNATIONAL
    
   
                                  WARBURG DILLON READ
    
 
               , 1998
 
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO THE REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH
STATE.
<PAGE>   101
 
                                    PART II
 
                     INFORMATION NOT REQUIRED IN PROSPECTUS
 
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
 
     The following is a statement of estimated expenses, to be paid solely by
the Company, of the issuance and distribution of the securities being
registered:
 
<TABLE>
<S>                                                           <C>
Securities and Exchange Commission registration fee.........  $ 73,278
NASD filing fee.............................................  $ 25,350
Nasdaq National Market fees.................................  $ 95,000
Blue Sky fees and expenses (including attorneys' fees and
  expenses).................................................  $ 15,000
Printing expenses...........................................  $250,000
Transfer agent's fees and expenses..........................  $  6,000
Accounting fees and expenses................................  $ 30,000
Legal fees and expenses.....................................  $200,000
Miscellaneous expenses......................................  $ 55,372
                                                              --------
          Total.............................................  $750,000
                                                              ========
</TABLE>
 
---------------
 
All amounts are estimated except for the SEC registration fee and the NASD
filing fee.
 
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
 
  General Corporation Law
 
     The Company is incorporated under the laws of the State of Delaware.
Section 145 ("Section 145") of the General Corporation Law of the State of
Delaware, as the same exists or may hereafter be amended (the "General
Corporation Law"), inter alia, provides that a Delaware corporation may
indemnify any persons who were, are or are threatened to be made, parties to any
threatened, pending or completed action, suit or proceeding, whether civil,
criminal, administrative or investigative (other than an action by or in the
right of such corporation), by reason of the fact that such person is or was an
officer, director, employee or agent of such corporation, or is or was serving
at the request of such corporation as a director, officer employee or agent of
another corporation or enterprise. The indemnity may include expenses (including
attorneys' fees), judgments, fines and amounts paid in settlement actually and
reasonably incurred by such person in connection with such action, suit or
proceeding, provided such person acted in good faith and in a manner he
reasonably believed to be in or not opposed to the corporation's best interests
and, with respect to any criminal action or proceeding, had no reasonable cause
to believe that his conduct was illegal. A Delaware corporation may indemnify
any persons who are, were or are threatened to be made, a party to any
threatened, pending or completed action or suit by or in the right of the
corporation by reasons of the fact that such person was a director, officer,
employee or agent of such corporation, or is or was serving at the request of
such corporation as a director, officer, employee or agent of another
corporation or enterprise. The indemnity may include expenses (including
attorneys' fees) actually and reasonably incurred by such person in connection
with the defense or settlement of such action or suit, provided such person
acted in good faith and in a manner he reasonably believed to be in or not
opposed to the corporation's best interests, provided that no indemnification is
permitted without judicial approval if the officer, director, employee or agent
is adjudged to be liable to the corporation. Where an officer, director,
employee or agent is successful on the merits or otherwise in the defense of any
action referred to above, the corporation must indemnify him against the
expenses which such officer or director has actually and reasonably incurred.
 
     Section 145 further authorizes a corporation to purchase and maintain
insurance on behalf of any person who is or was a director, officer, employee or
agent of the corporation, or is or was serving at the request of the corporation
as a director, officer, employee or agent of another corporation or enterprise,
against any liability asserted against him and incurred by him in any such
capacity, arising out of his status as such, whether or not the corporation
would otherwise have the power to indemnify him under Section 145.
 
                                      II-1
<PAGE>   102
 
  Certificate of Incorporation
 
     The Company's Certificate of Incorporation and By-laws provides for the
indemnification of officers and directors to the fullest extent permitted by the
General Corporation Law.
 
     All of the Company's directors and officers are covered by insurance
policies maintained by it against certain liabilities for actions taken in their
capacities as such, including liabilities under the Securities Act.
 
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
 
     Since its inception, the Company has issued the following securities
without registration under the Securities Act (the number of shares set forth
below does not give effect to the proposed stock split of the Company's Common
Stock referred to in the Prospectus).
 
     On August 13, 1997, in connection with the Company's formation, the Company
issued one share of Common Stock to Allegiance LLC for consideration of $1,000.
 
     On August 13, 1997, the Company issued 95,000 shares of Redeemable
Convertible Preferred Stock to Allegiance LLC for an aggregate initial purchase
price of approximately $5 million.
 
     On February 25, 1998, the Company issued: (i) 71.25 shares of Redeemable
Convertible Preferred Stock to Richard Fields for an aggregate initial purchase
price of $37,500; (ii) 95 shares of Redeemable Convertible Preferred Stock to
Roger Curry for an aggregate initial purchase price of $50,000; (iii) 23.75
shares of Redeemable Convertible Preferred Stock to Northwestern University for
an aggregate initial purchase price of $12,500; (iv) 237.5 shares of Redeemable
Convertible Preferred Stock to MKW Partners, L.P. for an aggregate initial
purchase price of $125,001; (v) 47.5 shares of Redeemable Convertible Preferred
Stock to Tom Shattan for an aggregate initial purchase price of $25,000; (vi)
28.5 shares of Redeemable Convertible Preferred Stock to Greg Mendel for an
aggregate initial purchase price of $15,000; and (vii) 19 shares of Redeemable
Convertible Preferred Stock to Kevin Fechtmeyer for an aggregate initial
purchase price of $10,000.
 
     On March 13, 1998, the Company issued 118.75 shares of Redeemable
Convertible Preferred Stock to Charles Ross Partners, LLC for an aggregate
initial purchase price of $62,500.
 
     The above-described transactions were exempt from registration under the
Securities Act pursuant to Section 4(2) of the Securities Act, as transactions
not involving any public offering.
 
     On February 3, 1998, the Company issued 445,000 units (the "Units"), with
each Unit consisting of one 11 3/4% Senior Discount Note due 2008 and one
warrant to purchase .0034224719 shares of the Company's Common Stock. The
Company received approximately $240.7 million of net proceeds, after deducting
underwriting discounts and commissions of approximately $8.75 million and other
expenses payable by the Company of approximately $1.0 million, from the issuance
of the Units. Such Units were issued to (i) "qualified institutional buyers" (as
defined in Rule 144A of the Securities Act), (ii) other institutional
"accredited investors" (as defined in Rule 501(a) of the Securities Act), and
(iii) outside the United States in compliance with Regulation S under the
Securities Act, and therefore, the issuance of such Units was exempt from
registration under the Securities Act. Morgan Stanley & Co. Incorporated,
Salomon Brothers Inc, Bear, Stearns & Co. Inc. and Donaldson, Lufkin & Jenrette
Securities Corporation were the initial purchasers of the Units.
 
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
 
     (a) EXHIBITS.
 
   
<TABLE>
<CAPTION>
        EXHIBIT
          NO.                                    DESCRIPTION
        -------                                  -----------
<C>                      <S>
          1.1            Form of Underwriting Agreement.
          3.1            Form of Amended and Restated Certificate of Incorporation of
                         Allegiance Telecom, Inc.
</TABLE>
    
 
                                      II-2
<PAGE>   103
 
   
<TABLE>
<CAPTION>
        EXHIBIT
          NO.                                    DESCRIPTION
        -------                                  -----------
<C>                      <S>
          3.2            Form of Amended and Restated By-Laws of Allegiance Telecom,
                         Inc.
          4.1            Form of Indenture by and between the Company and The Bank of
                         New York, as trustee (including the Form of Notes).
          4.2            Indenture, dated as of February 3, 1998, by and between the
                         Company and The Bank of New York, as trustee (incorporated
                         by reference to Exhibit 4.2 to Allegiance Telecom, Inc.'s
                         Registration Statement on Form S-4 (Registration No.
                         333-49013), filed on March 31, 1998 and amended on May 6,
                         1998, May 15, 1998 and May 22, 1998 (the "Form S-4
                         Registration Statement")).
          4.3            Form of 11 3/4% Senior Discount Notes (incorporated by
                         reference to Exhibit 4.3 to the Form S-4 Registration
                         Statement).
          4.4            Form of Collateral Pledge and Security Agreement by and
                         between the Company and The Bank of New York, as trustee.
          4.5            Form of certificate representing Common Stock.
          5.1            Opinion of Kirkland & Ellis.
         10.1            Stock Purchase Agreement, dated August 13, 1997, between
                         Allegiance LLC and the Company (incorporated by reference to
                         Exhibit 10.1 to the Form S-4 Registration Statement).
         10.2            Securityholders Agreement, dated August 13, 1997, among
                         Allegiance LLC, the Fund Investors, the Management Investors
                         and the Company (incorporated by reference to Exhibit 10.2
                         to the Form S-4 Registration Statement).
         10.3            Registration Agreement, dated August 13, 1997, among the
                         Fund Investors, the Management Investors and the Company
                         (incorporated by reference to Exhibit 10.3 to the Form S-4
                         Registration Statement).
         10.4            Warrant Registration Rights Agreement, dated as of January
                         29, 1998, by and among the Company and Morgan Stanley & Co.
                         Incorporated, Salomon Brothers Inc, Bear, Stearns & Co. Inc.
                         and Donaldson, Lufkin & Jenrette Securities Corporation, as
                         initial purchasers of the 11 3/4% Senior Discount Notes
                         (incorporated by reference to Exhibit 10.11 to the Form S-4
                         Registration Statement).
         10.5            Allegiance Telecom, Inc. 1997 Nonqualified Stock Option Plan
                         (incorporated by reference to Exhibit 10.4 to the Form S-4
                         Registration Statement).
         10.6            Allegiance Telecom, Inc. 1998 Stock Incentive Plan.
         10.7            Executive Purchase Agreement, dated August 13, 1997, among
                         Allegiance LLC, the Company and Royce J. Holland
                         (incorporated by reference to Exhibit 10.5 to the Form S-4
                         Registration Statement).
         10.8            Executive Purchase Agreement, dated August 13, 1997, among
                         Allegiance LLC, the Company and Thomas M. Lord (incorporated
                         by reference to Exhibit 10.6 to the Form S-4 Registration
                         Statement).
         10.9            Executive Purchase Agreement, dated January 28, 1998, among
                         Allegiance LLC, the Company and C. Daniel Yost (incorporated
                         by reference to Exhibit 10.7 to the Form S-4 Registration
                         Statement).
         10.10           Form of Executive Purchase Agreement among Allegiance LLC,
                         the Company and each of the other Management Investors
                         (incorporated by reference to Exhibit 10.8 to the Form S-4
                         Registration Statement).
         10.11           Warrant Agreement, dated February 3, 1998, by and between
                         the Company and The Bank of New York, as Warrant Agent
                         (including the form of the Warrant Certificate)
                         (incorporated by reference to Exhibit 10.9 to the Form S-4
                         Registration Statement).
</TABLE>
    
 
                                      II-3
<PAGE>   104
 
   
<TABLE>
<CAPTION>
        EXHIBIT
          NO.                                    DESCRIPTION
        -------                                  -----------
<C>                      <S>
         10.12           General Agreement, dated October 16, 1997, as amended,
                         between the Company and Lucent Technologies Inc.
                         (incorporated by reference to Exhibit 10.10 to the Form S-4
                         Registration Statement).
         10.13           Form of Indemnification Agreement by and between the Company
                         and its directors and officers.
         11.1            Statement Regarding Computation of Pro Forma Per Share
                         Earnings for the three months ended March 31, 1998.
         11.2            Statement Regarding Computation of Pro Forma Per Share
                         Earnings for the period from inception (April 22, 1997)
                         through December 31, 1997.
         12.1            Statement Regarding Computation of Ratios of Earnings (Loss)
                         to Fixed Charges for the three months ended March 31, 1998.
         12.2            Statement Regarding Computation of Ratios of Earnings (Loss)
                         to Fixed Charges for the period from inception (April 22,
                         1997) through December 31, 1997.
         21.1            Subsidiaries of the Company.
         23.1            Consent of Arthur Andersen, LLP.
         23.2            Consent of Kirkland & Ellis (included in Exhibit 5.1).
         24.1            Powers of Attorney (included in Part II to the Registration
                         Statement).**
         27.1            Financial Data Schedule for the three months ended March 31,
                         1998 (incorporated by reference to Exhibit 27.1 to the Form
                         S-4 Registration Statement).
         27.2            Financial Data Schedule for the period from inception (April
                         22, 1997) through December 31, 1997 (incorporated by
                         reference to Exhibit 27.2 to the Form S-4 Registration
                         Statement).
</TABLE>
    
 
---------------
 
   
** Previously filed.
    
 
     (b) FINANCIAL STATEMENT SCHEDULES.
 
          All schedules for which provision is made in the applicable accounting
     regulations of the Securities and Exchange Commission are not required
     under the related instructions, are inapplicable or not material, or the
     information called for thereby is otherwise included in the financial
     statements and therefore has been omitted.
 
ITEM 17. UNDERTAKINGS.
 
     The undersigned registrant hereby undertakes to provide to the underwriter
at closing specified in the underwriting agreement certificates in such
denominations and registered in such names as requested by the underwriter to
permit prompt delivery to each purchaser.
 
     The undersigned registrant hereby undertakes:
 
     (1) For purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act shall be deemed to be part of this registration
statement as of the time it was declared effective.
 
     (2) For purposes of determining any liability under the Securities Act of
1933, each post-effective amendment that contains a form of prospectus shall be
deemed to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.
 
                                      II-4
<PAGE>   105
 
     Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
 
                                      II-5
<PAGE>   106
 
                                   SIGNATURES
 
   
     Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Amendment No. 2 to Registration Statement to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of Dallas,
State of Texas, on June 29, 1998.
    
 
                                            ALLEGIANCE TELECOM, INC.
 
                                            By:    /s/ ROYCE J. HOLLAND
                                              ----------------------------------
                                                       Royce J. Holland
                                                   Chief Executive Officer
 
                                      ****
 
   
     Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 2 to Registration Statement has been signed on June 29, 1998 by the
following persons in the capacities indicated:
    
 
<TABLE>
<CAPTION>
                      SIGNATURE                                   CAPACITY
                      ---------                                   --------
<C>                                                    <S>                              <C>
                /s/ ROYCE J. HOLLAND                   Chairman of the Board and Chief
-----------------------------------------------------    Executive Officer (Principal
                  Royce J. Holland                       Executive Officer)
 
                          *                            President, Chief Operating
-----------------------------------------------------    Officer and Director
                   C. Daniel Yost
 
                          *                            Executive Vice President, Chief
-----------------------------------------------------    Financial Officer, and
                   Thomas M. Lord                        Director (Principal Financial
                                                         Officer)
 
                /s/ DENNIS M. MAUNDER                  Vice President and Controller
-----------------------------------------------------    (Principal Accounting
                  Dennis M. Maunder                      Officer)
 
                          *                            Senior Vice President of Sales
-----------------------------------------------------    and Marketing and Director
                  John J. Callahan
 
                          *                            Director
-----------------------------------------------------
                   Paul D. Carbery
 
                          *                            Director
-----------------------------------------------------
               James E. Crawford, III
 
                          *                            Director
-----------------------------------------------------
                 John B. Ehrenkranz
 
                          *                            Director
-----------------------------------------------------
                  Paul J. Finnegan
 
                          *                            Director
-----------------------------------------------------
                 Richard D. Frisbie
</TABLE>
 
                                      II-6
<PAGE>   107
 
<TABLE>
<CAPTION>
                      SIGNATURE                                   CAPACITY
                      ---------                                   --------
<C>                                                    <S>                              <C>
                          *                            Director
-----------------------------------------------------
                    Reed E. Hundt
 
                          *                            Director
-----------------------------------------------------
                  Robert H. Niehaus
 
                          *                            Director
-----------------------------------------------------
                 James N. Perry, Jr.
</TABLE>
 
   
     * The undersigned, by signing his name hereto, does sign and execute this
Amendment No. 2 to Registration Statement on behalf of the above named officers
and directors of Allegiance Telecom, Inc. pursuant to the Power of Attorney
executed by such officers and directors and filed with the Securities and
Exchange Commission.
    
 
      /s/ DENNIS M. MAUNDER
------------------------------------
         Dennis M. Maunder
          Attorney-in-Fact
 
                                      II-7
<PAGE>   108
 
                               INDEX TO EXHIBITS
 
   
<TABLE>
<CAPTION>
        EXHIBIT
          NO.                                    DESCRIPTION
        -------                                  -----------
<C>                      <S>
          1.1            Form of Underwriting Agreement.
          3.1            Form of Amended and Restated Certificate of Incorporation of
                         Allegiance Telecom, Inc.
          3.2            Form of Amended and Restated By-Laws of Allegiance Telecom,
                         Inc.
          4.1            Form of Indenture by and between the Company and The Bank of
                         New York, as trustee (including the Form of Notes).
          4.2            Indenture, dated as of February 3, 1998, by and between the
                         Company and The Bank of New York, as trustee (incorporated
                         by reference to Exhibit 4.2 to Allegiance Telecom, Inc.'s
                         Registration Statement on Form S-4 (Registration No.
                         333-49013), filed on March 31, 1998 and amended on May 6,
                         1998, May 15, 1998 and May 22, 1998 (the "Form S-4
                         Registration Statement")).
          4.3            Form of 11 3/4% Senior Discount Notes (incorporated by
                         reference to Exhibit 4.3 to the Form S-4 Registration
                         Statement).
          4.4            Form of Collateral Pledge and Security Agreement by and
                         between the Company and The Bank of New York, as trustee.
          4.5            Form of certificate representing Common Stock.
          5.1            Opinion of Kirkland & Ellis.
         10.1            Stock Purchase Agreement, dated August 13, 1997, between
                         Allegiance LLC and the Company (incorporated by reference to
                         Exhibit 10.1 to the Form S-4 Registration Statement).
         10.2            Securityholders Agreement, dated August 13, 1997, among
                         Allegiance LLC, the Fund Investors, the Management Investors
                         and the Company (incorporated by reference to Exhibit 10.2
                         to the Form S-4 Registration Statement).
         10.3            Registration Agreement, dated August 13, 1997, among the
                         Fund Investors, the Management Investors and the Company
                         (incorporated by reference to Exhibit 10.3 to the Form S-4
                         Registration Statement).
         10.4            Warrant Registration Rights Agreement, dated as of January
                         29, 1998, by and among the Company and Morgan Stanley & Co.
                         Incorporated, Salomon Brothers Inc, Bear, Stearns & Co. Inc.
                         and Donaldson, Lufkin & Jenrette Securities Corporation, as
                         initial purchasers of the 11 3/4% Senior Discount Notes
                         (incorporated by reference to Exhibit 10.11 to the Form S-4
                         Registration Statement).
         10.5            Allegiance Telecom, Inc. 1997 Nonqualified Stock Option Plan
                         (incorporated by reference to Exhibit 10.4 to the Form S-4
                         Registration Statement).
         10.6            Allegiance Telecom, Inc. 1998 Stock Incentive Plan.
         10.7            Executive Purchase Agreement, dated August 13, 1997, among
                         Allegiance LLC, the Company and Royce J. Holland
                         (incorporated by reference to Exhibit 10.5 to the Form S-4
                         Registration Statement).
         10.8            Executive Purchase Agreement, dated August 13, 1997, among
                         Allegiance LLC, the Company and Thomas M. Lord (incorporated
                         by reference to Exhibit 10.6 to the Form S-4 Registration
                         Statement).
         10.9            Executive Purchase Agreement, dated January 28, 1998, among
                         Allegiance LLC, the Company and C. Daniel Yost (incorporated
                         by reference to Exhibit 10.7 to the Form S-4 Registration
                         Statement).
</TABLE>
    
<PAGE>   109
 
   
<TABLE>
<CAPTION>
        EXHIBIT
          NO.                                    DESCRIPTION
        -------                                  -----------
<C>                      <S>
         10.10           Form of Executive Purchase Agreement among Allegiance LLC,
                         the Company and each of the other Management Investors
                         (incorporated by reference to Exhibit 10.8 to the Form S-4
                         Registration Statement).
         10.11           Warrant Agreement, dated February 3, 1998, by and between
                         the Company and The Bank of New York, as Warrant Agent
                         (including the form of the Warrant Certificate)
                         (incorporated by reference to Exhibit 10.9 to the Form S-4
                         Registration Statement).
         10.12           General Agreement, dated October 16, 1997, as amended,
                         between the Company and Lucent Technologies Inc.
                         (incorporated by reference to Exhibit 10.10 to the Form S-4
                         Registration Statement).
         10.13           Form of Indemnification Agreement by and between the Company
                         and its directors and officers.
         11.1            Statement Regarding Computation of Pro Forma Per Share
                         Earnings for the three months ended March 31, 1998.
         11.2            Statement Regarding Computation of Pro Forma Per Share
                         Earnings for the period from inception (April 22, 1997)
                         through December 31, 1997.
         12.1            Statement Regarding Computation of Ratios of Earnings (Loss)
                         to Fixed Charges for the three months ended March 31, 1998.
         12.2            Statement Regarding Computation of Ratios of Earnings (Loss)
                         to Fixed Charges for the period from inception (April 22,
                         1997) through December 31, 1997.
         21.1            Subsidiaries of the Company.
         23.1            Consent of Arthur Andersen, LLP.
         23.2            Consent of Kirkland & Ellis (included in Exhibit 5.1).
         24.1            Powers of Attorney (included in Part II to the Registration
                         Statement).**
         27.1            Financial Data Schedule for the three months ended March 31,
                         1998 (incorporated by reference to Exhibit 27.1 to the Form
                         S-4 Registration Statement).
         27.2            Financial Data Schedule for the period from inception (April
                         22, 1997) through December 31, 1997 (incorporated by
                         reference to Exhibit 27.2 to the Form S-4 Registration
                         Statement).
</TABLE>
    
 
---------------
 
   
** Previously filed.