UNITED STATES SECURITIES AND EXCHANGE COMMISSION ~~Washington, D.C. 20549~~

Washington, D.C. 20549

FORM 10-Q

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934	~~QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934~~
For the Quarterly Period Ended June 30, 2003.
For the Quarterly Period Ended September 30, 2003.
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934	~~TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934~~
For the transition period from to
Commission file number 0-24509

Allegiance Telecom, Inc. ~~(Exact name of registrant as specified in its charter)~~

~~Delaware~~ (~~State~~Exact orname ~~other jurisdiction~~ of registrant ~~incorporation~~as orspecified ~~organization)~~in ~~75-2721491~~its ~~(IRS Employer Identification No.~~charter)

9201 North Central Expressway Dallas, Texas 75231 (Address of principal executive offices) (Zip Code)

Delaware		75-2721491
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

~~(214) 261-7100 (Registrant's~~9201 ~~telephone~~North ~~number,~~Central ~~including area code)~~ Expressway

Dallas, Texas 75231

(Address of principal executive offices) (Zip Code)

(214) 261-7100

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý

As of ~~August 11~~November 19, 2003, the registrant has 124,742,246 shares of common stock, par value $0.01 per share outstanding.

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

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements	3
	Condensed Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002	3
	Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2003 and 2002	4
	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2003 and 2002	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	46
Item 4.	Controls and Procedures	47
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	48
Item 2.	Changes in Securities and Use of Proceeds	48
Item 3.	Defaults Upon Senior Securities	48
Item 4.	Submission of Matters to a Vote of Security Holders	48
Item 5.	Other Information	48
Item 6.	Exhibits and Reports on Form 8-K	49
	Signatures	50
	Index to Exhibits

FORM 10-Q INDEX

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets as of September 30, 2003 and December 31, 2002
	Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2003 and 2002
	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2003 and 2002
	Notes to Condensed Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures about Market Risk
Item 4.	Controls and Procedures
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings
Item 2.	Changes in Securities and Use of Proceeds
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits and Reports on Form 8-K
	Signatures
	Index to Exhibits

PART I. FINANCIAL INFORMATION ~~ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES (Debtors and Debtors-in-Possession) CONDENSED CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except share and per share data)~~

			June 30, 2003			December 31, 2002
			(Unaudited)
ASSETS
Current assets:
	Cash and cash equivalents		$	268,711		$	253,311
	Short-term investments			500			30,955
	Restricted short-term investments			1,821			—
	Accounts receivable, net			131,076			153,196
	Prepaid expenses and other current assets			22,930			18,916
		Total current assets		425,038			456,378
Property and equipment, net				810,439			924,106
Deferred debt issuance costs, net				14,541			15,879
Long-term investments, restricted				6,881			881
Other assets, net				35,225			43,974
		Total assets	$	1,292,124		$	1,441,218
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities not subject to compromise:
	Accounts payable		$	29,102		$	59,282
	Accrued liabilities and other current liabilities			74,593			124,444
	Current portion of long-term debt			—			561,532
		Total current liabilities not subject to compromise		103,695			745,258
Liabilities subject to compromise (see Note 2)				1,355,538			—
Long-term liabilities not subject to compromise:
	Long-term debt			—			639,691
	Other long-term liabilities			7			12,545
		Total long-term liabilities not subject to compromise		7			652,236
Commitments and contingencies (see Note 11)
Stockholders' equity (deficit):
	Preferred stock, $.01 par value, 1,000,000 shares authorized, no shares issued or outstanding at June 30, 2003 and December 31, 2002			—			—
	Common stock, $.01 par value, 750,000,000 shares authorized, 125,264,444 and 125,157,605 shares issued and 124,742,246 and 124,830,110 shares outstanding at June 30, 2003 and December 31, 2002, respectively			1,252			1,251
	Additional paid-in capital			1,808,569			1,808,690
	Common stock in treasury, at cost, 522,198 and 327,495 shares at June 30, 2003 and December 31, 2002, respectively			(45	)		(45	)
	Common stock warrants			1,857			1,857
	Deferred compensation			(3,387	)		(5,149	)
	Accumulated deficit			(1,975,362	)		(1,762,880	)
		Total stockholders' equity (deficit)		(167,116	)		43,724
		Total liabilities and stockholders' equity (deficit)	$	1,292,124		$	1,441,218

ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

(Debtors and Debtors-in-Possession)

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share and per share data)

	September 30, 2003			December 31, 2002
	(Unaudited)

ASSETS
Current assets:
Cash and cash equivalents	$	284,062		$	253,311
Short-term investments	501			30,955
Restricted short-term investments	1,822			—
Accounts receivable, net	117,730			153,196
Prepaid expenses and other current assets	25,139			18,916
Total current assets	429,254			456,378
Property and equipment, net	745,822			924,106
Deferred debt issuance costs, net	14,194			15,879
Long-term investments, restricted	6,905			881
Other assets, net	29,608			43,974
Total assets	$	1,225,783		$	1,441,218

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities not subject to compromise:
Accounts payable	$	37,895		$	59,282
Accrued liabilities and other current liabilities	81,324			124,444
Current portion of long-term debt	—			561,532
Total current liabilities not subject to compromise	119,219			745,258
Liabilities subject to compromise (see Note 2)	1,336,142			—
Long-term liabilities not subject to compromise:
Long-term debt	—			639,691
Other long-term liabilities	6			12,545
Total long-term liabilities not subject to compromise	6			652,236
Commitments and contingencies (see Note 11)
Stockholders’ equity (deficit):
Preferred stock, $.01 par value, 1,000,000 shares authorized, no shares issued or outstanding at September 30, 2003 and December 31, 2002	—			—
Common stock, $.01 par value, 750,000,000 shares authorized, 125,264,444 and 125,157,605 shares issued and 124,742,246 and 124,830,110 shares outstanding at September 30, 2003 and December 31, 2002, respectively	1,252			1,251
Additional paid-in capital	1,808,382			1,808,690
Common stock in treasury, at cost, 522,198 and 327,495 shares at September 30, 2003 and December 31, 2002, respectively	(45		)	(45		)
Common stock warrants	1,857			1,857
Deferred compensation	(2,569		)	(5,149		)
Accumulated deficit	(2,038,461		)	(1,762,880		)
Total stockholders’ equity (deficit)	(229,584		)	43,724
Total liabilities and stockholders’ equity (deficit)	$	1,225,783		$	1,441,218

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

ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES ~~(Debtors and Debtors-in-Possession) CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except share and per share data) (Unaudited)~~

			Three Months Ended June 30,						Six Months Ended June 30,
			2003			2002			2003			2002
Revenues			$	196,652		$	184,437		$	401,228		$	346,532
Operating expenses:
	Network			104,989			95,323			216,442			177,401
	Selling, general and administrative			98,563			110,249			215,137			212,033
	Depreciation and amortization			65,292			71,503			131,925			139,519
	Non-cash deferred compensation			656			78			1,609			532
	Goodwill impairment charge			2,105			110,823			2,105			110,823
		Total operating expenses		271,605			387,976			567,218			640,308
	Loss from operations			(74,953	)		(203,539	)		(165,990	)		(293,776	)
Other income (expense):
	Interest income			827			2,066			1,832			3,811
	Interest expense			(18,961	)		(25,342	)		(48,477	)		(49,440	)
	Gain on sale of investment (see Note 12)			3,277			—			3,277			—
		Total other income (expense)		(14,857	)		(23,276	)		(43,368	)		(45,629	)
	Loss from operations before reorganization items			(89,810	)		(226,815	)		(209,358	)		(339,405	)
Reorganization items (see Note 13)				(2,587	)		—			(3,124	)		—
Net loss			$	(92,397	)	$	(226,815	)	$	(212,482	)	$	(339,405	)
Net loss per share, basic and diluted			$	(0.76	)	$	(1.95	)	$	(1.76	)	$	(2.92	)
Weighted average number of shares outstanding, basic and diluted				120,802,701			116,170,173			120,624,040			116,049,262

(Debtors and Debtors-in-Possession)

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except share and per share data)

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2003			2002			2003			2002

Revenues	$	188,186		$	219,539		$	589,414		$	566,071
Operating expenses:
Network	96,753			118,297			313,195			295,698
Selling, general and administrative	86,047			114,247			301,184			326,280
Depreciation and amortization	65,504			72,139			197,429			211,658
Non-cash deferred compensation	631			1,510			2,240			2,042
Goodwill impairment charge	—			—			2,105			110,823
Total operating expenses	248,935			306,193			816,153			946,501
Loss from operations	(60,749		)	(86,654		)	(226,739		)	(380,430		)
Other income (expense):
Interest income	834			1,564			2,666			5,375
Interest expense	(8,988		)	(28,020		)	(58,642		)	(77,460		)
Other income (expense) (see Note 12)	2,610			—			5,887			—
Total other income (expense)	(5,544		)	(26,456		)	(50,089		)	(72,085		)
Loss from operations before reorganization items	(66,293		)	(113,110		)	(276,828		)	(452,515		)
Reorganization items (see Note 13)	3,193			—			1,247			—
Net loss	$	(63,100	)	$	(113,110	)	$	(275,581	)	$	(452,515	)
Net loss per share, basic and diluted	$	(0.52	)	$	(0.97	)	$	(2.28	)	$	(3.89	)
Weighted average number of shares outstanding, basic and diluted	120,802,701			117,197,411			120,684,247			116,436,186

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

ALLEGIANCE TELECOM, INC. AND ~~SUBSIDIARIES (Debtors and Debtors-in-Possession) CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands, except share and per share data) (Unaudited)~~ SUBSIDIARIES

				Six Months Ended June 30,
				2003			2002
Cash flows from operating activities:
	Net loss			$	(212,482	)	$	(339,405	)
		Adjustments to reconcile net loss to cash (used in) provided by operating activities—
			Depreciation and amortization		131,925			139,519
			Provision for uncollectible accounts receivable		22,565			32,387
			Gain on sale of investment		(3,277	)		—
			Accretion of investments		(1	)		(221	)
			Accretion of Series B and 127/8% notes		6,659			23,589
			Amortization of deferred debt issuance costs		1,338			1,641
			Amortization of deferred compensation		1,609			532
			Goodwill impairment charge		2,105			110,823
		Changes in assets and liabilities, net of effects of acquisitions —
			Increase in accounts receivable		(78	)		(35,237	)
			Decrease (increase) in prepaid expenses and other current assets		(6,627	)		8,097
			Decrease (increase) in other assets		2,636			(8,282	)
			Increase (decrease) in accounts payable		(30,180	)		7,823
			Increase (decrease) in accrued liabilities and other current liabilities		(65,259	)		515
	Net cash used in operating activities before reorganizations items				(149,067	)		(58,219	)
		Reorganization items:
			Increase in liabilities subject to compromise		1,355,538			—
	Net cash (used in) provided by operating activities				1,206,471			(58,219	)
Cash flows from investing activities:
	Purchases of property and equipment				(14,022	)		(82,251	)
	Capitalized interest				(275	)		(4,552	)
	Purchases of subsidiaries, net of cash acquired				—			(28,479	)
	Purchases of investments				(8,321	)		(57,634	)
	Proceeds from sale of investments				34,233			44,267
			Net cash (used in) provided by investing activities		11,615			(128,649	)
Cash flows from financing activities:
	Proceeds from issuance of common stock, net				32			2,285
	Proceeds from borrowings under senior secured credit facilities				—			129,300
	Payments on senior secured credit facilities				(5,000	)		—
	Payments on capital lease obligations				(2,825	)		(3,598	)
	Reclassification of debt subject to compromise				(1,194,891	)		—
	Other				—			(1	)
			Net cash (used in) provided by financing activities		(7,793	)		127,986
Increase (decrease) in cash and cash equivalents					15,400			(58,882	)
Cash and cash equivalents, beginning of period					253,311			374,084
Cash and cash equivalents, end of period				$	268,711		$	315,202
Supplemental disclosure of cash flow information:
	Cash paid for interest			$	18,280		$	28,412
Supplemental disclosure of non-cash investing and financing activities:
	Assets acquired under capital lease obligations				1,059			28,262
Fair value of assets acquired in business acquisitions					—			58,825
Liabilities assumed in business acquisitions					—			28,825
Common stock issued for business acquisitions (242,968 shares at June 30, 2002)					—			1,303

(Debtors and Debtors-in-Possession)

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands, except share and per share data)

(Unaudited)

	Nine Months Ended September 30,
	2003			2002
Cash flows from operating activities:
Net loss	$	(275,581	)	$	(452,515	)
Adjustments to reconcile net loss to cash provided by (used in) operating activities—
Reorganization expense, net	(1,247		)	—
Depreciation and amortization	197,429			211,658
Provision for uncollectible accounts receivable	27,731			48,535
Gain on sale of investment	(3,277		)	—
Accretion of investments	(1		)	(219		)
Accretion of Series B and 12 ⁷¤₈% notes	6,659			35,902
Amortization of deferred debt issuance costs	1,685			2,395
Amortization of deferred compensation	2,240			2,042
Goodwill impairment charge	2,105			110,823
Changes in assets and liabilities —
Decrease (increase) in accounts receivable	8,261			(64,725		)
Decrease (increase) in prepaid expenses and other current assets	(8,836		)	10,863
Decrease (increase) in other assets	5,804			(4,940		)
Decrease in accounts payable	(25,654		)	(17,177		)
Increase (decrease) in accrued liabilities and other current liabilities	(60,573		)	40,079
Net cash used in operating activities before reorganizations items	(123,255		)	(77,279		)
Reorganization items:
Reorganization expense, net	1,247			—
Net restructuring gain	(10,795		)	—
Reclassification of debt subject to compromise	(1,199,261		)
Increase in post-petition restructuring accruals	4,930			—
Increase in liabilities subject to compromise	1,349,750			—
Net cash provided by (used in) operating activities	22,616			(77,279		)
Cash flows from investing activities:
Purchases of property and equipment	(15,880		)	(110,427		)
Capitalized interest	(275		)	(5,810		)
Purchases of subsidiaries, net of cash acquired	—			(28,479		)
Purchases of investments	(8,321		)	(57,634		)
Proceeds from sale of investments	34,233			77,148
Net cash provided by (used in) investing activities	9,757			(125,202		)
Cash flows from financing activities:
Proceeds from issuance of common stock, net	32			3,147
Proceeds from borrowings under senior secured credit facilities	7,414			135,300
Payments on senior secured credit facilities	(5,000		)	—
Payments on capital lease obligations	(4,068		)	(5,037		)
Other	—			(1		)
Net cash provided by (used in) financing activities	(1,622		)	133,409
Increase (decrease) in cash and cash equivalents	30,751			(69,072		)
Cash and cash equivalents, beginning of period	253,311			374,084
Cash and cash equivalents, end of period	$	284,062		$	305,012
Supplemental disclosure of cash flow information:
Cash paid for interest	$	26,895		$	37,801
Supplemental disclosure of non-cash investing and financing activities:
Assets acquired under capital lease obligations	1,488			31,907
Fair value of assets acquired in business acquisitions	—			58,825
Liabilities assumed in business acquisitions	—			28,825
Common stock issued for business acquisitions (242,968 shares at September 30, 2002)	—			1,303

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

ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES (Debtors and Debtors-in-Possession) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Three and Six Months Ended June 30, 2003 and 2002 (Dollars in thousands, except share and per share data) (Unaudited)

~~1. General:~~ (Debtors and Debtors-in-Possession)

~~Allegiance~~NOTES ~~Telecom, Inc.~~TO isCONDENSED aCONSOLIDATED ~~facilities-based national local exchange carrier that provides integrated telecommunications services to business, government~~FINANCIAL and other institutional users in major metropolitan areas across the United States of America and it is focused primarily on small to medium-sized businesses. Allegiance Telecom, Inc. was incorporated on April 22, 1997, as a Delaware corporation, and it and its subsidiaries are generally referred to herein as the "Company." STATEMENTS

~~The Company~~Three ~~provides~~and ~~service~~Nine inMonths ~~36 of the largest metropolitan areas in the United States of America as follows: Atlanta, Austin, Baltimore, Boston, Chicago, Cleveland, Dallas, Denver,~~Ended ~~Detroit~~September 30, ~~Fort~~2003 Lauderdale, Fort Worth, Houston, Long Island, Los Angeles, Miami, Minneapolis/St. Paul, New York City, Northern New Jersey, Oakland, Ontario/Riverside, Orange County, Philadelphia, Phoenix, Pittsburgh, Portland, Sacramento, St. Louis, San Antonio, San Diego, San Francisco, San Jose, Seattle, Tampa, Washington, D.C., West Palm Beach/Boca Raton and ~~White Plains.~~ 2002

~~The Company~~(Dollars ~~has prepared the accompanying unaudited condensed consolidated financial statements~~ in accordance with accounting principles generally accepted in the United States of America for interim financial information and are in the form prescribed by the Securities and Exchange Commission in instructions to Form 10-Q and Article 10 of Regulation S-X. Accordinglythousands, ~~they~~except ~~do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for~~share ~~complete financial statements. The interim unaudited condensed consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements as of~~ and ~~for~~ ~~the~~per ~~year~~share ~~ended December 31, 2002. In the opinion of management, all adjustments (consisting only of normal recurring adjustments~~data) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003.

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

21. ~~Reorganization and Going Concern~~ General:

~~Voluntary Bankruptcy Filing. On May 14, 2003,~~ Allegiance Telecom, Inc. ~~and~~is ~~all~~a offacilities-based ~~its direct~~national ~~and~~local ~~indirect~~exchange ~~wholly~~carrier ~~owned subsidiaries filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District~~that ofprovides ~~New~~integrated ~~York~~telecommunications ~~(the~~services ~~"Bankruptcy Court") in order~~ to ~~facilitate the restructuring of the Company's debt~~business, ~~trade~~government ~~liabilities~~ and other ~~obligations.~~institutional ~~The~~users ~~Company~~in ismajor ~~currently~~metropolitan ~~operating~~areas asacross ~~a "debtor-in-possession" under~~ the ~~jurisdiction~~United States of ~~the~~America ~~Bankruptcy Court~~ and init ~~accordance~~is ~~with~~focused ~~the~~primarily ~~applicable~~on ~~provisions~~small ofto ~~the~~medium-sized ~~Bankruptcy~~businesses. Allegiance ~~Code~~Telecom, Inc. ~~the~~was ~~Federal~~incorporated ~~Rules~~on ofApril 22, ~~Bankruptcy Procedure and applicable court orders. In general~~1997, as a Delaware ~~debtor-in-possession~~corporation, ~~the~~and ~~Company~~it isand ~~authorized~~its ~~under~~subsidiaries ~~Chapter~~are 11generally toreferred ~~continue~~ to herein ~~operate~~ as ~~an ongoing business, but may not engage in transactions outside~~ the ~~ordinary course of business without the prior approval of the Bankruptcy Court~~“Company. ”

~~Under~~The Company provides ~~Section 362~~service ofin ~~the~~major ~~Bankruptcy~~metropolitan ~~Code,~~areas in the ~~filing~~United States of aAmerica ~~bankruptcy~~as ~~petition~~follows: Atlanta, ~~automatically~~Austin, ~~stays~~Baltimore, ~~most~~Boston, ~~actions~~Chicago, ~~against~~Cleveland, ~~the~~Dallas, ~~Company~~Denver, Detroit, ~~including~~Fort ~~most~~Lauderdale, ~~actions~~Fort toWorth, ~~collect~~Houston, Long Island, Los Angeles, Miami, ~~pre-petition~~Minneapolis/St. ~~indebtedness~~Paul, orNew toYork City, Northern New Jersey, Oakland, Ontario/Riverside, Orange County, Philadelphia, Phoenix, Pittsburgh, Portland, Sacramento, St. Louis, San Antonio, San Diego, San Francisco, San Jose, Seattle, Tampa, Washington, D.C., West Palm Beach/Boca Raton and White Plains.

6The Company has prepared the accompanying unaudited condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America for interim financial information and are in the form prescribed by the Securities and Exchange Commission in instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The interim unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements as of and for the year ended December 31, 2002. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003.

~~exercise control~~Certain ofamounts ~~the~~in ~~property of~~ the prior ~~Company'~~period’s ~~estate.~~condensed ~~Absent~~consolidated anfinancial ~~order~~statements ofhave ~~the~~been reclassified ~~Bankruptcy~~to ~~Court,~~conform ~~substantially~~to ~~all~~current ~~pre-petition~~period ~~liabilities will be addressed under a plan of reorganization~~presentation.

~~Under Section 365~~2. Reorganization ~~of the Bankruptcy Code, the Company may assume or reject certain pre-petition executory contracts~~ and ~~unexpired~~Going leases, including leases of real property, subject to the approval of the Bankruptcy Court and certain other conditions. In general, rejection of an unexpired lease or executory contract is treated as a pre-petition breach of the lease or contract. Counterparties to these rejected contracts or leases may file proofs of claim against the Company's estate for damages relating to such breaches. The Company cannot presently determine with certainty the ultimate aggregate liability which will result from the filing of claims relating to such contracts that have been or may be rejected. Concern:

~~The United~~Voluntary ~~States~~Bankruptcy ~~Trustee~~Filing. On ~~for~~May 14, ~~the~~2003 ~~Southern District of New York has appointed an official committee of unsecured creditors~~ (the ~~"Creditors' Committee"~~“Commencement Date”)., ~~The~~Allegiance ~~Creditors'~~Telecom, Inc. ~~Committee~~ and ~~its legal~~all ~~representatives~~of ~~have~~its adirect ~~right~~and toindirect bewholly owned ~~heard~~subsidiaries onfiled ~~all~~voluntary ~~matters~~petitions ~~that~~for ~~come~~relief ~~before~~under ~~the~~Chapter ~~Bankruptcy~~11 ~~Court. The rights and claims~~ of ~~various~~the United ~~creditors~~States ~~and~~Bankruptcy ~~security~~Code ~~holders~~in ~~will~~the beUnited ~~determined~~States byBankruptcy aCourt ~~plan~~for ofthe ~~reorganization~~Southern ~~that~~District isof ~~confirmed~~New byYork (the “Bankruptcy Court.”) ~~Under~~in ~~the~~order ~~priority~~to ~~rules~~facilitate the ~~established~~restructuring byof the ~~Bankruptcy~~Company’s ~~Code~~debt, ~~certain~~trade ~~post-petition~~ liabilities and ~~certain~~other ~~pre-petition liabilities (e~~obligations.~~g.,~~ ~~senior~~The ~~secured~~Company ~~debt)~~is ~~are~~currently ~~given~~operating ~~priority~~as ~~over unsecured pre~~“debtors-~~petition indebtedness and need to be satisfied before unsecured creditors or~~in-possession” ~~stockholders~~under ~~are~~the ~~entitled~~jurisdiction toof ~~any~~the ~~distribution.~~Bankruptcy ~~Any~~Court ~~Chapter~~and 11in ~~plan~~accordance ~~filed~~with by the ~~Company~~applicable provisions ~~may provide that unsecured creditors~~ of ~~subsidiaries~~the ofBankruptcy ~~Allegiance Telecom~~Code, ~~Inc.~~ ~~will need to be satisfied before any distribution to~~ the ~~unsecured~~Federal ~~creditors~~Rules orof ~~stockholders~~Bankruptcy ofProcedure and ~~Allegiance~~applicable ~~Telecom, Inc~~court orders. AsIn ~~a result~~general, aas ~~plan of reorganization could result~~ debtors-in-possession, ~~holders of~~ the Company~~'s common~~ ~~stock~~is ~~and~~authorized ~~Series B~~under Chapter 11 ~~3/4%~~ ~~notes~~to ~~due~~continue ~~2008~~to ~~and~~operate ~~12 7/8%~~as ~~senior~~an ~~notes~~ongoing ~~due~~business, but ~~2008~~may ~~receiving~~not ~~little~~engage orin notransactions ~~value~~outside asthe ~~part~~ordinary course of business without the ~~plan~~prior approval of ~~reorganization.~~the Bankruptcy Court.

~~In order~~Under toSection 362 ~~exit~~of the ~~Chapter~~Bankruptcy ~~11 successfully~~Code, the ~~Company~~filing ~~will~~of ~~need~~a tobankruptcy ~~propose~~petition ~~and~~automatically ~~obtain~~stays most ~~confirmation~~actions byagainst the ~~Bankruptcy~~Company, ~~Court~~including ofmost aactions ~~plan~~to ofcollect pre-petition ~~reorganization~~indebtedness ~~that~~or ~~satisfies~~to ~~the~~exercise ~~requirements~~control of the ~~Bankruptcy~~property ~~Code~~of the Company’s estate. AsAbsent ~~provided~~an byorder of the Bankruptcy ~~Code~~Court, ~~the~~substantially ~~Company~~all pre-petition ~~initially~~liabilities ~~has~~will ~~the~~be ~~exclusive~~addressed ~~right~~under ~~to solicit~~ a plan of reorganization ~~for 120 days from the date of filing its petition for relief, which expires September 11, 2003~~. ~~There can be no assurance that the~~ The Bankruptcy Court ~~will~~has ~~extend~~established ~~the~~November ~~exclusivity~~26, ~~period~~2003 ~~beyond~~as ~~that date. In addition,~~ the bar date for ~~claims has not~~filing ~~yet~~proofs ~~been~~of ~~set~~claims. AtThe ~~this~~aggregate ~~time,~~amount itof pre-petition claims is not ~~possible~~known toat this ~~predict~~time ~~accurately~~since the ~~effect~~bar ofdate ~~the~~for ~~Chapter~~claims 11has ~~reorganization~~not ~~process~~yet onpassed ~~the~~nor ~~Company's~~have ~~business, creditors or stockholders or when the Company may~~all ~~emerge~~contract ~~from~~rejection ~~Chapter~~claims ~~11.~~been ~~The Company's future results depend on the timely and successful confirmation and implementation of a plan of reorganization~~filed.

~~Accounting~~Under ~~Impact. These~~Section 365 ~~condensed~~of the ~~consolidated~~Bankruptcy ~~financial~~Code, ~~statements~~the ~~have~~Company ~~been~~may ~~prepared~~assume inor ~~accordance~~reject certain pre-petition ~~with~~executory ~~the~~contracts ~~provisions~~and ofunexpired ~~the~~leases, ~~American~~including ~~Institute~~leases of ~~Certified~~real ~~Public~~property, subject ~~Accountants~~to ~~Statement~~the approval of ~~Position~~the ~~90-7~~Bankruptcy ~~"Financial~~Court ~~Reporting~~and bycertain ~~Entities~~other inconditions. ~~Reorganization~~In general, ~~Under~~rejection ~~the~~of ~~Bankruptcy~~an ~~Code"~~unexpired ~~("SOP 90-7").~~lease ~~Pursuant~~or toexecutory ~~SOP~~contract ~~90-7,~~is ~~the~~treated ~~Company's~~as a pre-petition ~~liabilities~~breach ~~that~~of ~~are~~the ~~subject~~lease toor ~~compromise~~contract ~~are~~generally ~~reported~~resulting ~~separately~~in onany ~~the~~breach damages ~~balance~~being ~~sheet~~treated as anpre-petition ~~estimate~~liabilities. ofCounterparties to these ~~the~~rejected ~~amount~~contracts ~~that~~or ~~will~~unexpired ~~ultimately~~leases bemay ~~allowed~~file byproofs of claim against the Company’s ~~Bankruptcy~~estate ~~Court.~~for damages, if any, relating to

~~The~~such rejections. ~~following~~The ~~table~~Company ~~sets~~cannot ~~forth~~presently determine with certainty the ~~liabilities~~ultimate ofaggregate liability which will result from the ~~Company~~filing ~~subject~~of claims relating to ~~compromise~~such contracts asand ofunexpired ~~June 30,~~leases ~~2003:~~that have been or may be rejected.

	June 30, 2003
Accounts payable and other claims	$	161,673
Senior secured credit facilities, variable interest rate		465,300
Series B 113/4% notes, face amount $445,000 due February 15, 2008; effective interest rate of 12.21%; at accreted value		440,489
127/8% senior notes, face amount $205,000 due May 15, 2008; effective interest rate of 13.24%; at accreted value		202,354
Capital lease obligations		85,722
Total liabilities subject to compromise	$	1,355,538

The United States Trustee for the Southern District of New York has appointed an official committee of unsecured creditors (the “Creditors’ Committee”). The Creditors’ Committee and its legal representatives have a right to be heard on all matters that come before the Bankruptcy Court. The rights and claims of various creditors and security holders will be determined by a plan of reorganization that is confirmed by the Bankruptcy Court. Under the priority rules established by the Bankruptcy Code, certain post-petition liabilities and certain pre-petition liabilities (e.g., senior secured debt) are given priority over unsecured pre-petition indebtedness and need to be satisfied before unsecured creditors or stockholders are entitled to any distribution. Any Chapter 11 plan filed by the Company may provide that unsecured creditors of subsidiaries of Allegiance Telecom, Inc. will need to be satisfied before any distribution to the unsecured creditors or stockholders of Allegiance Telecom, Inc. As a result, a plan of reorganization could result in holders of the Company’s Series B 11 ³/₄% notes due 2008 and 12 ⁷/₈% senior notes due 2008 receiving little or no value as part of the plan of reorganization. Based on the Company’s current discussions with certain creditors regarding a plan of reorganization, the common stock of Allegiance Telecom, Inc. will probably receive no value as part of the reorganization.

~~Pursuant~~ In order to ~~SOP~~exit ~~90-7~~Chapter 11 successfully, anthe ~~objective~~Company ofwill ~~financial~~need ~~statements~~to ~~issued~~propose byand anobtain ~~entity~~confirmation inby the ~~Chapter~~Bankruptcy 11Court isof toa ~~reflect~~plan ~~its~~of ~~financial~~reorganization ~~evolution~~that ~~during~~satisfies the requirements ~~proceeding~~of the Bankruptcy Code. ~~For~~As ~~that~~provided ~~purpose~~by the Bankruptcy Code, the Company initially had the ~~financial~~exclusive ~~statements~~right to file a plan of reorganization for 120 days ~~periods~~from ~~including~~the Commencement Date, which expired September 11, 2003. Under a Bridge Order and ~~subsequent~~various Stipulation and Orders, the initial exclusivity period has been extended to ~~filing~~December 16, 2003. There can be no assurance that the Bankruptcy ~~Chapter~~Court 11will ~~petition~~extend ~~should~~the ~~distinguish~~exclusivity ~~transactions~~period ~~and~~beyond ~~events~~that date or that the ~~are~~Company ~~directly~~will ~~associated~~file ~~with~~a plan of reorganization by that date. If the Company fails to file a plan of reorganization ~~from~~during this period (or any extended period approved by the Bankruptcy Court) or if such plan is not accepted by the ~~ongoing~~required ~~operations~~number of creditors within the ~~business.~~applicable ~~Certain~~time ~~expenses~~period, ~~realized~~any ~~gains~~party ~~and~~in interest ~~losses~~may ~~and~~subsequently ~~provisions~~file ~~for~~its ~~losses~~own ~~not~~plan ~~directly~~of ~~related~~reorganization. toThe ~~ongoing~~Company ~~operations~~has been ~~are~~in ~~reflected~~discussions ~~separately~~with various third parties who may be interested in purchasing some or all of the ~~consolidated~~Company through the bankruptcy process, either ~~statement~~through a 363 sale (a sale pursuant to Section 363 of ~~operations~~Chapter as11 of the Bankruptcy Code) or in connection with a plan of reorganization. ~~items~~At ~~(see~~this ~~Note 13)~~time, it is not possible to predict accurately the effect of the Chapter 11 reorganization process on the Company’s business, creditors or stockholders, when the Company may emerge from Chapter 11 or what the disposition will be of any claims against the Company. The Company’s future results depend on the timely and successful confirmation and implementation of a plan of reorganization.

~~Additionally, pre-petition~~Accounting ~~debt~~Impact. These ~~that~~condensed isconsolidated ~~subject~~financial statements tohave ~~compromise~~been ~~must~~prepared bein ~~recorded~~accordance atwith the ~~allowed~~provisions ~~claim~~of ~~amount,~~the ~~which~~American Institute ~~generally~~of ~~results~~Certified inPublic ~~the~~Accountants ~~write-off~~Statement of ~~any~~Position 90-7 “Financial ~~deferred~~Reporting ~~financing~~by ~~amounts~~Entities ~~associated~~in ~~with~~Reorganization Under the ~~debt.~~Bankruptcy NoCode” ~~claims~~(“SOP 90-7”). ~~relating~~Pursuant to SOP 90-7, the Company’s pre-petition ~~debt~~liabilities ~~have~~that ~~been~~are subject ~~allowed~~to bycompromise ~~the~~are ~~Bankruptcy~~reported ~~Court~~separately ason ofthe ~~June 30,~~balance ~~2003.~~sheet Asas ~~a result,~~an ~~pre-petition~~estimate ~~debt~~of ~~subject~~the toamount ~~compromise~~that iswill ~~recorded~~ultimately atbe ~~its~~allowed ~~pre-petition~~by ~~value.~~the Bankruptcy Court.

~~Deferred debt~~The ~~issuance~~following ~~costs~~table ~~include~~sets forth ~~costs incurred by~~ the ~~Company~~liabilities ~~in raising debt proceeds. These costs were being amortized to interest expense over the life~~ of the ~~related debt pre-petition. In accordance with SOP 90-7, the~~ Company ~~stopped~~subject ~~recording~~to ~~interest~~compromise ~~expense on the Company's Series B 11 3/4% notes due 2008 and 12 7/8% senior notes due 2008~~ as of ~~the Commencement Date. Accordingly, the deferred debt issuance costs related to this debt is no longer being amortized. Under the Final Cash~~ ~~Collateral Order~~September 30, discussed below, the Company is required to continue incurring and paying interest under its senior secured credit facilities. Accordingly, the deferred debt issuance costs related to the senior secured credit facilities continue to be amortized to interest expense over the life of the debt. 2003:

Certain pre-petition debt that is classified as subject to compromise, specifically the senior secured credit facilities, continues to accrue interest. Interest on the remaining pre-petition debt that is subject to compromise ceased to accrue when the bankruptcy was filed. On June 23, 2003, the Company received final Bankruptcy Court approval for the use of its cash collateral under a Final Order Authorizing Use of Cash Collateral by Consent (the "Final Cash Collateral Order"). The Final Cash Collateral Order among other things: (1) restricts the Company's use of cash, (2) requires the Company to prepare and follow a budget and maintain a minimum weekly cash balance, and (3) requires the Company to provide certain financial, operational and other information to its senior lenders and the Creditors' Committee. Under this Final Cash Collateral Order, the Company is required to continue incurring and paying interest under its senior secured credit agreement.

	September 30, 2003

Accounts payable and other claims	$	135,593
Senior secured credit facilities, variable interest rate	472,714
Series B 11 ³¤₄% notes, face amount $445,000 due February 15, 2008; effective interest rate of 12.21%; at accreted value	440,489
12 ⁷¤₈% senior notes, face amount $205,000 due May 15, 2008; effective interest rate of 13.24%; at accreted value	202,354
Capital lease obligations	84,992
Total liabilities subject to compromise	$	1,336,142

~~The~~Pursuant to SOP 90-7, an ~~consolidated~~objective of financial statements ~~contained~~issued ~~herein~~by ~~have~~an ~~been~~entity ~~prepared~~ in ~~accordance~~Chapter ~~with~~11 ~~generally~~is ~~accepted~~to reflect ~~accounting~~its ~~principles~~financial ~~applicable~~evolution toduring athe ~~going~~proceeding. ~~concern,~~For ~~and~~that dopurpose, ~~not~~the financial ~~purport~~statements ~~to reflect~~for orperiods toincluding ~~provide~~and ~~all~~subsequent ofto filing the ~~possible~~Chapter 11 ~~consequences~~petition ofshould ~~the~~distinguish ~~ongoing~~transactions ~~Chapter~~and 11events ~~reorganization~~that ~~cases.~~are ~~Specifically,~~directly associated with the ~~consolidated~~reorganization ~~financial~~from ~~statements~~the doongoing ~~not~~operations ~~present~~of the ~~amount which will~~business. ~~ultimately~~Certain beexpenses, ~~paid~~realized togains ~~settle~~and ~~liabilities~~losses and ~~contingencies~~provisions ~~which~~for ~~may~~losses benot directly ~~required~~related to ongoing operations are reflected separately in the consolidated ~~Chapter~~statement 11of ~~reorganization.~~operations ~~The~~as ~~Debtors~~reorganization ~~have~~items (see Note 13).

8Additionally, pre-petition debt that is subject to compromise must be recorded at the allowed claim amount, which

not filed a plan of reorganization as of this date, but currently expect to file one in the near term. The plan, when filed is subject to the acceptance by the required creditors and approval by the Bankruptcy Court. 7

Ingenerally results ~~accordance~~in ~~with~~ the ~~guidance~~write-off ~~provided~~of byany ~~the~~deferred ~~Financial~~financing ~~Accounting~~amounts ~~Standards~~associated ~~Board~~with inthe ~~Statement of Financial Accounting Standards No~~debt. ~~144,~~ Only ~~"Accounting~~certain ~~for~~claims ~~the~~relating ~~Impairment~~to ~~or Disposal of Long~~pre-~~Lived~~petition ~~Assets",~~debt ~~the~~have ~~Company~~been ~~considered~~allowed by the ~~bankruptcy~~Bankruptcy Court ~~filing~~as onof ~~May~~September 1430, 2003 ~~a triggering event which required that the Company's long-lived assets to be evaluated for impairment~~. ~~Based~~As ona ~~management's~~result, ~~best~~a ~~estimate~~ majority of ~~the~~pre-petition ~~future~~debt ~~cash~~subject ~~flows~~to ~~of the Company, it has been determined that the undiscounted cash flows generated from the Company's assets are~~compromise ~~sufficient~~is torecorded ~~recover~~at ~~their~~its ~~current~~pre-petition ~~carrying~~ value. ~~These cash flows are based on numerous assumptions, including, among other things, the achievement of certain operating results and cost reductions.~~

~~Under accounting~~Deferred ~~guidelines~~debt ~~commonly~~issuance costs ~~referred~~include tocosts asincurred ~~"fresh~~by ~~start",~~ the ~~fair~~Company ~~value~~in ofraising ~~all~~debt ~~assets~~proceeds. ofThese costs ~~the~~were ~~Company~~being ~~will~~amortized beto ~~estimated~~interest asexpense itover ~~emerges~~the ~~from~~life ~~bankruptcy~~of inthe ~~conformity with~~related ~~accounting~~debt ~~principles~~pre-petition. ~~generally~~In ~~accepted~~accordance inwith ~~the~~SOP ~~United States of America~~90-7, ~~specifically~~the byCompany ~~Financial~~stopped ~~Accounting~~recording interest ~~Standards~~expense ~~Board~~on inthe ~~Statement~~Company’s ~~of Financial Accounting Standards No.~~Series ~~141~~B ~~"Business~~11 3/4% ~~Combinations".~~notes ~~Under~~due ~~fresh~~2008 ~~start~~and ~~accounting,~~12 7/8% ansenior ~~enterprise~~notes ~~value~~due 2008 ~~will~~as beof ~~determined~~the ~~based~~Commencement onDate. aAccordingly, ~~plan of reorganization for~~ the ~~Company~~deferred ~~and~~debt ~~will~~issuance becosts related ~~used~~ to ~~determine~~this ~~the~~debt ~~fair~~is ~~value~~no oflonger ~~all~~being ~~the Company's assets and liabilities~~amortized. ~~The~~Under ~~assumptions in~~ the ~~plan~~Final ofCash Collateral ~~reorganization~~Order, ~~may~~discussed ~~vary~~below, ~~from~~ the ~~assumptions~~Company ~~used~~is byrequired ~~the~~to ~~Company~~continue incurring asand ofpaying ~~June 30,~~interest ~~2003~~under toits ~~evaluate~~senior ~~impairment~~secured ofcredit ~~long-lived~~agreement. ~~assets~~Accordingly, ~~therefore~~ the ~~fair~~deferred ~~values~~debt ~~assigned~~issuance tocosts ~~the~~related ~~assets~~to ~~upon emergence may be different than~~ the ~~carrying~~senior ~~values~~secured credit ~~recorded~~facilities ascontinue ofto ~~June 30,~~be ~~2003.~~amortized Asto ainterest ~~result,~~expense anover ~~adjustment to~~ the ~~fair~~life ~~value~~ of ~~long-lived~~the ~~assets may be required~~debt.

~~Because~~Certain pre-petition debt ofthat ~~the~~is ~~ongoing~~classified ~~nature~~as ofsubject to compromise, specifically the ~~reorganization~~senior ~~cases~~secured credit facilities, continues to accrue interest. Interest on the ~~outcome~~remaining pre-petition ofdebt ~~which~~that is ~~not~~subject ~~presently~~to ~~determinable,~~compromise ceased to accrue when the bankruptcy ~~consolidated~~was ~~financial~~filed. ~~statements~~On ~~contained~~June 26, ~~herein~~2003, ~~are~~the ~~subject~~Company toreceived final ~~material~~Bankruptcy ~~uncertainties~~Court ~~and~~approval ~~may~~for ~~not~~the beuse ~~indicative~~of its cash collateral under an Amended Final Order Authorizing Use of Cash Collateral by Consent (the ~~results~~“Final ofCash Collateral Order”). The Final Cash Collateral Order among other things: (1) restricts the Company'’s ~~future~~use ~~operations~~of orcash, ~~financial~~(2) requires ~~position.~~the NoCompany ~~assurance~~to prepare ~~can~~and befollow ~~given~~a ~~that~~budget and maintain a minimum weekly cash balance, and (3) requires the Company ~~will~~to beprovide ~~successful~~certain infinancial, ~~reorganizing~~operational and other information to its ~~affairs~~senior ~~within~~lenders and the ~~Chapter~~Creditors’ 11Committee. ~~bankruptcy~~Under this ~~proceedings.~~Final Cash Collateral Order, the Company is required to continue incurring and paying interest under its senior secured credit agreement.

~~As a~~The ~~result~~unaudited ofcondensed consolidated ~~the~~financial ~~items~~statements ~~discussed~~contained ~~above,~~herein ~~there~~have isbeen ~~substantial~~prepared ~~doubt~~in accordance ~~about~~with ~~the~~accounting ~~Company's~~principles ~~ability~~generally toaccepted ~~continue~~in asthe aUnited ~~going concern. The ability~~ States of ~~the~~America ~~Company~~applicable to ~~continue as~~ a going concern ~~is dependent upon~~, ~~but~~and do not ~~limited~~purport to, ~~formulation,~~reflect ~~approval,~~or ~~and~~to provide ~~confirmation~~all of athe ~~plan~~possible consequences of ~~reorganization and~~ the ~~ability~~ongoing toChapter ~~obtain~~11 reorganization ~~positive~~cases. ~~results~~Specifically, ofthe ~~operations.~~unaudited ~~The~~condensed consolidated ~~financial~~ financial statements do not ~~include~~present ~~any adjustments to~~ the ~~recorded~~amount ~~amounts~~which orwill ~~reflect~~ultimately ~~any amounts that may~~ be ~~ultimately~~ paid to settle liabilities and contingencies which may be required in the Chapter 11 reorganization. orThe ~~the~~Company ~~effect~~has not filed a plan of ~~any~~reorganization ~~changes~~as of this date, ~~which~~but ~~may~~currently beintends ~~made~~to file one in ~~connection~~the ~~with~~near term. The plan, when filed will be subject to the ~~Company's~~acceptance ~~operations~~by ~~resulting~~the ~~from~~required acreditors ~~plan~~and ofapproval ~~reorganization.~~by the Bankruptcy Court.

3In accordance with the guidance provided by the Financial Accounting Standards Board in Statement of Financial Accounting Standards No. ~~Stock~~ 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company considered the bankruptcy filing on May 14, 2003 a triggering event which required that the Company’s long-lived assets be evaluated for impairment. Based ~~Compensation:~~ on management’s best estimate of the future cash flows of the Company, it has been determined that the undiscounted cash flows generated from the Company’s assets are sufficient to recover their current carrying value. These cash flows are based on numerous assumptions, including, among other things, the Company continuing to operate as a going concern and the achievement of certain operating results and cost reductions. Management does not believe there have been any triggering events requiring an evaluation of the Company’s long-lived assets for impairment during the three months ended September 30, 2003.

AtUnder ~~June 30,~~accounting guidelines ~~2003,~~commonly ~~the~~referred ~~Company~~to ~~had~~as ~~three~~“fresh ~~stock-based compensation plans~~start,” the ~~1997~~fair ~~Nonqualified~~value ~~Stock~~of ~~Option~~all ~~Plan,~~assets of the ~~1998~~Company ~~Stock~~will ~~Incentive~~be ~~Plan~~estimated ~~and~~as ~~the Employee~~it ~~Stock~~emerges ~~Discount~~from ~~Purchase~~bankruptcy ~~Plan.~~in ~~The~~conformity with ~~Company~~accounting ~~applies~~principles generally accepted in the ~~provisions~~United States of America, specifically by Financial Accounting ~~Principles~~Standards Board ~~Opinion~~in Statement of Financial Accounting Standards No. ~~25,~~141 ~~"Accounting~~“Business ~~for~~Combinations.” ~~Stock~~Under ~~Issued~~fresh tostart accounting, ~~Employees"~~an ~~("APB~~enterprise ~~No. 25")~~value ~~and~~will ~~the related~~be ~~interpretations~~determined inbased ~~accounting~~on a plan of reorganization for the Company's ~~plans.~~and ~~Fixed~~will ~~stock~~be ~~option~~used ~~and~~to ~~restricted~~determine ~~stock~~the ~~awards~~fair ~~with~~value ~~pro-rata~~of all ~~vesting~~the ~~are~~Company’s ~~recognized~~assets asand ~~expense~~liabilities ~~using~~at that time. The assumptions in the ~~straight-line~~plan ~~method~~of ~~over~~reorganization may vary from the ~~vesting~~assumptions ~~period.~~used ~~Effective~~by ~~May~~the Company as of June 1430, 2003, ~~vesting~~to ~~for~~evaluate ~~the~~impairment ~~Company's~~of ~~restricted~~long-lived ~~stock~~assets; ~~ceased~~therefore, asthe fair avalues ~~result~~assigned ofto the ~~Company's~~assets ~~bankruptcy~~upon ~~proceedings,~~emergence ~~although amortization~~may ofbe ~~deferred~~different ~~compensation~~than ~~related~~the tocarrying values ~~restricted~~recorded ~~stock~~as ~~continued~~of ~~and~~September 30, is2003. ~~included~~As ina result, an adjustment to the ~~reported~~fair ~~expense~~value ~~below~~of ~~(see~~long-lived ~~Note 2).~~assets may be required.

~~Had~~Because of the ongoing ~~compensation~~nature ~~cost~~of ~~for~~the reorganization cases, the ~~Company's~~outcome ~~plans~~of ~~been~~which ~~determined~~is ~~based~~not onpresently determinable, the ~~fair~~unaudited ~~value~~condensed ofconsolidated ~~the~~financial ~~stock~~statements contained ~~options~~herein asare ofsubject ~~the~~to ~~grant~~material ~~dates~~uncertainties ~~for~~and ~~awards~~may ~~under~~not ~~the~~be indicative ~~plans~~of ~~consistent~~the ~~with~~results of the ~~method~~Company’s future operations or financial ~~prescribed~~position. byNo assurance can be given that the ~~Financial~~Company ~~Accounting~~will ~~Standards~~be ~~Board~~successful in reorganizing ~~Statement~~its ofaffairs ~~Financial~~within ~~Accounting~~the ~~Standards~~Chapter ~~No. 123,~~11 bankruptcy proceedings.

9As a result of the items discussed above, there is substantial doubt about the Company’s ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent upon, but not limited to, formulation, approval, and confirmation of a plan of reorganization and the ability to obtain positive results of operations. The unaudited condensed consolidated financial statements do not include any adjustments to the recorded amounts or reflect any amounts that may be ultimately paid to settle liabilities and contingencies which may be required in the Chapter 11 reorganization or the

"Accounting for Stock-Based Compensation," the Company's net loss applicable to common stock and net loss per share would have increased to the pro forma amounts indicated below. The Company utilized the following assumptions in calculating the estimated fair value of each stock option on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for grants: 8

	June 30, 2003		June 30, 2002
Dividend yield	—	%	—	%
Expected volatility	123.0	%	123.0	%
Expected life	3.0		3.0
Risk-free interest rate	2.05	%	3.32	%

effect of any changes, which may be made in connection with the Company’s operations resulting from a plan of reorganization.

	Three Months Ended June 30,						Six Months Ended June 30,
	2003			2002			2003			2002
Reported net loss	$	(92,397	)	$	(226,815	)	$	(212,482	)	$	(339,405	)
Add: stock-based employee compensation expense included in reported net income		656			78			1,609			532
Deduct: stock-based employee compensation expense determined under fair value method for all awards		(10,989	)		(15,750	)		(26,355	)		(56,136	)
Pro forma net loss	$	(102,730	)	$	(242,487	)	$	(237,228	)	$	(395,009	)
Net loss per share, basic and diluted — as reported	$	(0.76	)	$	(1.95	)	$	(1.76	)	$	(2.92	)
Net loss per share, basic and diluted — pro forma	$	(0.85	)	$	(2.09	)	$	(1.97	)	$	(3.40	)

43. ~~Business~~ Stock-Based ~~Acquisitions~~Compensation:

OnAt ~~June~~September 1730, ~~2002~~ 2003, the Company ~~purchased~~had ~~substantially~~three ~~all~~stock-based ofcompensation plans, the ~~assets~~1997 Nonqualified Stock Option Plan, the 1998 Stock Incentive Plan and ~~assumed~~the ~~substantially~~Employee Stock ~~all~~Discount ofPurchase Plan. The Company applies the ~~liabilities~~provisions of ~~WorldCom's~~Accounting Principles ~~customer~~Board ~~premise~~Opinion No. 25, “Accounting for Stock Issued to ~~equipment~~Employees” ~~sales~~(“APB No. 25”) and ~~equipment~~the ~~maintenance~~related ~~businesses,~~interpretations ~~known~~ in accounting for the ~~industry~~Company’s asplans. ~~"Shared~~Fixed ~~Technologies~~stock ~~Fairchild"~~option orand ~~"Shared~~restricted ~~Technologies."~~stock ~~The~~awards ~~acquisition~~with pro-rata ~~was~~vesting ~~accounted~~are ~~for~~recognized as expense using the ~~purchase~~straight-line method, over ~~and~~the ~~accordingly,~~vesting ~~the~~period. ~~net~~Effective ~~assets~~on ~~and~~the ~~results~~Commencement ofDate, ~~operations~~vesting offor ~~Shared~~the Company’s ~~Technologies~~restricted ~~have~~stock ~~been~~ceased ~~included~~as ina result of the Company'’s ~~consolidated~~bankruptcy proceedings, ~~financial~~although ~~statements~~amortization ~~since~~of deferred compensation related to restricted stock continued and is included in the ~~date~~reported ofexpense ~~acquisition.~~below (see Note 2).

~~Revenues of~~Had ~~Shared~~compensation ~~Technologies~~cost ~~included in~~ for the Company'’s ~~condensed~~plans ~~consolidated~~been ~~financial~~determined ~~statements~~based ~~for~~on the ~~three~~fair ~~months~~value ~~ended~~of ~~June 30,~~the ~~2003~~stock options ~~and~~as ~~2002~~of ~~were~~the ~~$28,220~~grant ~~and~~dates ~~$5,472, respectively.~~for ~~Total~~awards ~~revenues~~under ~~included~~the ~~for~~plans consistent with the method ~~six~~prescribed ~~months~~by ~~ended~~the ~~June~~Financial Accounting Standards Board in Statement of Financial Accounting Standards No. 30123, ~~2003~~“Accounting ~~and~~for ~~2002~~Stock-Based Compensation,” ~~were~~the ~~$63,359~~Company’s net loss applicable to common stock and ~~$5,472,~~net ~~respectively.~~loss per ~~Total~~share ~~network~~would ~~expenses~~have ~~related~~increased to the ~~Shared~~pro ~~Technologies~~forma ~~businesses~~amounts indicated below. The ~~for~~Company utilized the ~~three~~following ~~months~~assumptions ~~ended~~in ~~June 30,~~calculating ~~2003~~the ~~and~~estimated ~~2002~~fair value ~~were~~of ~~$16,945~~each ~~and~~stock ~~$4,253,~~option ~~and~~on ~~for~~ the ~~six~~date ~~months~~of ~~ended~~grant ~~June 30,~~using ~~2003~~the ~~and~~Black-Scholes option-pricing ~~2002~~model ~~were~~with ~~$37,146~~the ~~and~~following ~~$4,253,~~weighted-average ~~respectively.~~assumptions for grants:

The following presents the unaudited pro forma results of the Company for the three and six months ended June 30, 2002, as if the acquisition of the Shared Technologies businesses had been consummated at the beginning of the period presented. The pro forma results are prepared for comparative purposes only and do not necessarily reflect the results that would have occurred had the

	September 30, 2003		September 30, 2002

Dividend yield	—	%	—	%
Expected volatility	123.0	%	123.0	%
Expected life	3.0		3.0
Risk-free interest rate	2.05	%	2.32	%

	Three Months Ended September 30,						Nine Months Ended September 30,
	2003			2002			2003			2002

Reported net loss	$	(63,100	)	$	(113,110	)	$	(275,581	)	$	(452,515	)
Add: stock-based employee compensation expense included in reported net income	631			1,510			2,240			2,042
Deduct: stock-based employee compensation expense determined under fair value method for all awards	(4,571		)	(15,878		)	(30,927		)	(72,014		)
Pro forma net loss	$	(67,040	)	$	(127,478	)	$	(304,268	)	$	(522,487	)

Net loss per share, basic and diluted — as reported	$	(0.52	)	$	(0.97	)	$	(2.28	)	$	(3.89	)
Net loss per share, basic and diluted — pro forma	$	(0.55	)	$	(1.09	)	$	(2.52	)	$	(4.49	)

~~acquisitions occurred at the beginning of the periods presented or the results which may occur in the future~~4. Business Acquisitions:

	Three Months Ended June 30, 2002			Six Months Ended June 30, 2002
	(Unaudited)			(Unaudited)
Revenue	$	215,940		$	424,631
Net loss		(223,354	)		(338,009	)
Net loss per share, basic and diluted		(1.92	)		(2.91	)

On June 17, 2002, the Company purchased substantially all of the assets and assumed substantially all of the liabilities of WorldCom’s customer premise equipment sales and equipment maintenance businesses, known in the industry as “Shared Technologies Fairchild” or “Shared Technologies.” The acquisition was accounted for using the purchase method, and accordingly, the net assets and results of operations of Shared Technologies have been included in the Company’s consolidated financial statements since the date of acquisition.

~~The purchase~~Revenues ~~price~~ of ~~the~~ Shared Technologies ~~businesses~~included ~~was~~in ~~allocated to~~ the ~~assets~~Company’s ~~acquired~~condensed ~~and~~consolidated ~~liabilities~~financial statements ~~assumed,~~for ~~based~~the onthree ~~their~~months ~~respective~~ended ~~estimated~~September 30, ~~fair~~2003 ~~values~~and at2002 ~~acquisition. The~~were ~~Company's~~$27,770 ~~purchase~~and ~~price~~$40,269, ~~allocation~~respectively. ~~was~~Total ~~finalized~~revenues ~~during~~included for the ~~quarter~~nine months ended ~~June~~September 30, 2003. ~~In connection with these final adjustments related to pre-acquisition assets~~ and ~~liabilities,~~ ~~the~~2002 ~~Company~~were ~~recorded additional goodwill of~~ $291,~~105.~~130 Atand ~~June 30~~$45, ~~2003~~741, ~~the~~respectively. Total ~~Company's~~network ~~market~~expenses ~~capitalization~~related ~~continued~~ to ~~remain~~the atShared aTechnologies ~~level~~businesses ~~below~~for ~~its book value, indicating that an~~the ~~impairment~~three ofmonths ~~enterprise~~ended ~~goodwill existed as of June~~September 30, 2003. ~~Accordingly,~~and ~~the~~2002 ~~Company~~were ~~recorded~~$16,763 aand ~~charge of~~ $223,~~105~~655, and ~~reflecting~~for the ~~amount~~nine ofmonths ~~the~~ended ~~impairment as of June~~September 30, 2003 ~~to eliminate~~and ~~the~~2002 ~~enterprise~~were ~~goodwill~~$53,909 ~~intangible.~~and $27,908, respectively.

~~5. Property~~The following presents the unaudited pro forma results of the Company for the three and ~~Equipment:~~ nine months ended September 30, 2002, as if the acquisition of the Shared Technologies businesses had been consummated at the beginning of

Property and equipment includes network equipment, land, leasehold improvements, software, office equipment, furniture and fixtures and construction-in-progress. These assets are stated at cost, which includes direct costs and capitalized interest and are depreciated over their respective useful lives using the straight-line method. During the three months ended June 30, 2003 and 2002, $50 and $1,741, respectively, of interest expense was capitalized related to network construction-in-progress. During the six months ended June 30, 2003 and 2002, $275 and $4,552, respectively, of interest expense was capitalized. Repair and maintenance costs are expensed as incurred. 10

~~Property~~the period ~~and~~presented. ~~equipment~~The atpro ~~June 30,~~forma ~~2003~~results are prepared for comparative purposes only and do ~~December 31,~~not ~~2002,~~necessarily ~~consisted~~reflect the results that would have occurred had the acquisitions occurred at the beginning of the ~~following:~~periods presented or the results which may occur in the future.

			June 30, 2003			December 31, 2002			Useful Lives (in years)
		Three Months Ended September 30, 2002			Nine Months Ended September 30, 2002
Network equipment			$	1,157,354		$	1,148,583		2-20
		(Unaudited)			(Unaudited)
Land				9,365			9,365		—
Revenue		$	219,539		$	644,170
Leasehold improvements				145,826			145,713		7-10
Net loss		(113,110		)	(451,119		)
Software				128,195			125,229		3
Net loss per share, basic and diluted		(0.97		)	(3.87		)
Office equipment and other				47,168			46,991		2-5
Furniture and fixtures				21,007			21,334		7
Property and equipment, in service				1,508,915			1,497,215
Less: Accumulated depreciation				(716,310	)		(592,069	)
	Property and equipment, in service, net			792,605			905,146
Construction-in-progress				17,834			18,960
	Property and equipment, net		$	810,439		$	924,106

11The purchase price of the Shared Technologies businesses was allocated to the assets acquired and liabilities assumed, based on their respective estimated fair values at acquisition. The Company’s purchase price allocation was finalized during the quarter ended June 30, 2003. In connection with these final adjustments related to pre-acquisition assets and liabilities, the Company recorded additional goodwill of $2,105. At June 30, 2003, the Company’s market capitalization continued to remain at a level below its book value, indicating that an impairment of enterprise goodwill existed as of June 30, 2003. Accordingly, the Company recorded a charge of $2,105, reflecting the amount of the impairment as of June 30, 2003 to eliminate the enterprise goodwill intangible.

65. ~~Other~~ Property ~~Assets~~and Equipment:

~~Other~~Property and equipment includes network equipment, land, leasehold improvements, software, office equipment, furniture and fixtures and construction-in-progress. These assets are stated at ~~June~~cost, which includes direct costs and capitalized interest and are depreciated over their respective useful lives using the straight-line method. During the three months ended September 30, 2003 and ~~December~~2002, $0 and $1,258, respectively, of interest expense was capitalized related to network construction-in-progress. During the nine months ended September 3130, 2003 and 2002, ~~consisted~~$275 and $5,810, respectively, of ~~the~~interest ~~following:~~expense was capitalized. Repair and maintenance costs are expensed as incurred.

		June 30, 2003			December 31, 2002
Acquired customer lists		$	62,800		$	62,800
Long-term deposits			16,259			17,030
Equipment pending deployment			6,565			8,688
Other			5,857			5,645
Total other assets			91,481			94,163
Less: Accumulated amortization			(56,256	)		(50,189	)
	Other assets, net	$	35,225		$	43,974

Property and equipment at September 30, 2003 and December 31, 2002, consisted of the following:

The acquired intangibles are being amortized over their estimated useful life of three years using the straight-line method. Amortization expense related to intangible assets totaled $6,067 and $18,785 during the six months ended June 30, 2003 and 2002, respectively. The estimated aggregate future amortization expense for intangible assets remaining as of June 30, 2003 is as follows:

	September 30, 2003			December 31, 2002			Useful Lives (in years)

Network equipment	$	1,168,598		$	1,148,583		2-20
Land	9,365			9,365			—
Leasehold improvements	141,889			145,713			7-10
Software	127,527			125,229			3
Office equipment and other	49,193			46,991			2-5
Furniture and fixtures	18,941			21,334			7
Property and equipment, in service	1,515,513			1,497,215
Less: Accumulated depreciation	(777,143		)	(592,069		)
Property and equipment, in service, net	738,370			905,146
Construction-in-progress	7,452			18,960
Property and equipment, net	$	745,822		$	924,106

Remainder of 2003	$	4,233
2004		2,311
Total	$	6,544

~~Long-term deposits include a $9,804 prepayment to AT&T for long-distance services~~6. Other The Company has filed a motion to reject its Master Carrier Agreement with AT&T under which this deposit was made. If approved, AT&T may have a rejection damage claim that may be equal to some or all of this prepayment and the Bankruptcy Court may allow AT&T to offset some or all of its rejection damages against this prepayment. Assets:

~~Equipment pending~~Other ~~deployment~~assets ~~consists~~at September 30, of2003 ~~equipment purchased~~ and ~~being~~December 31, ~~staged~~2002, ~~for~~consisted ~~deployment~~of in the ~~Company's network. This equipment will be classified as property and equipment when it is deployed.~~ following:

7. Accrued Liabilities and Other Current Liabilities:

	September 30, 2003			December 31, 2002

Acquired customer lists	$	62,800		$	62,800
Long-term deposits	17,262			17,030
Equipment pending deployment	6,724			8,688
Other	1,503			5,645
Total other assets	88,289			94,163
Less: Accumulated amortization	(58,681		)	(50,189		)
Other assets, net	$	29,608		$	43,974

~~Accrued~~The ~~liabilities~~acquired intangibles are being amortized over their estimated useful life of three years using the straight-line method. Amortization expense related to intangible assets totaled $8,492 and ~~other~~$26,844 ~~current~~during ~~liabilities~~the atnine ~~June~~months ended September 30, 2003 and ~~December 31,~~ 2002, ~~consisted~~respectively. The estimated aggregate future amortization expense for intangible assets remaining as of September 30, ~~the~~2003 ~~following:~~is as follows:

			June 30, 2003		December 31, 2002
Remainder of 2003		$	1,808
Accrued employee compensation and benefits			$	14,410	$	11,824
2004		2,311
Accrued network expenses				12,849		52,643
Total		$	4,119
Business acquisition costs				—		10,502
Accrued taxes				9,821		10,051
Accrued interest expense				753		4,154
Deferred revenue				34,103		29,009
Other				2,657		6,261
	Accrued liabilities and other current liabilities		$	74,593	$	124,444

~~Included~~Long-term deposits include a $8,707 prepayment to inAT&T ~~business~~for ~~acquisition~~long-distance ~~costs~~services. atThe ~~December 31,~~Company ~~2002~~has ~~are~~filed $6a motion to reject its Master Carrier Agreement with AT&T under which this deposit was made. If approved,~~684~~ ofAT&T ~~reserves~~may ~~primarily~~have ~~for~~a ~~termination~~rejection ofdamage ~~acquired~~claim ~~redundant~~that ~~network~~may ~~elements~~be ~~and~~equal ~~closure~~to some or all of ~~acquired~~this prepayment and the Bankruptcy Court may allow AT&T to ~~duplicate~~offset ~~facilities~~some or all of its rejection damages against this prepayment. The Atparties are currently engaged in negotiations.

12Equipment pending deployment consists of equipment purchased and being staged for deployment in the Company’s network. This equipment will be classified as property and equipment when it is deployed.

~~June 30, 2003,~~7. Accrued ~~all~~Liabilities ~~business acquisitions costs~~ and ~~the~~Other ~~current portion of capital lease obligation are included in liabilities subject to compromise in accordance with SOP 90-7 (see~~Current ~~Note 2).~~ Liabilities:

~~8. Long-Term~~Accrued ~~Debt~~liabilities and other current liabilities at September 30, 2003 and December 31, 2002, consisted of the following:

As a result of the Company's bankruptcy proceedings, all contractual debt payments are suspended and subject to revised payment terms during the bankruptcy process on a specific case basis. As discussed in Note 2, the only debt payments being made as of June 30, 2003 relate to interest on the senior secured credit facilities and monthly payments under capital leases. Additionally, as a result of the bankruptcy filing, there is an event of default under the senior secured credit facilities and both series of notes, which, by their terms, would ordinarily accelerate all amounts due upon the event of default.

	September 30, 2003		December 31, 2002

Accrued employee compensation and benefits	$	20,115	$	11,824
Accrued network expenses	11,571		52,643
Business acquisition costs	—		10,502
Accrued taxes	14,247		10,051
Accrued interest expense	754		4,154
Deferred revenue	29,287		29,009
Other	5,350		6,261
Accrued liabilities and other current liabilities	$	81,324	$	124,444

The senior secured credit facilities, notes and capital lease obligations are now classified as liabilities subject to compromise (see Note 2) and are not reflected in the table below. No changes to the carrying amount of these debts have been made in the accompanying condensed consolidated balance sheet as a result of the filing. 12

~~Long-term~~Included in business ~~debt~~acquisition costs at ~~June~~December 3031, ~~2003~~2002 is $6,684 of reserves primarily for termination of acquired redundant network elements and ~~December~~closure of acquired duplicate facilities. At September 3130, ~~2002~~2003, ~~consisted~~all ofbusiness ~~the~~acquisitions costs ~~following:~~are included in liabilities subject to compromise in accordance with SOP 90-7 (see Note 2).

		June 30, 2003		December 31, 2002
Series B 113/4% notes, face amount $445,000 due February 15, 2008; effective interest rate of 12.21%; at accreted value		$	—	$	433,974
127/8% senior notes, face amount $205,000 due May 15, 2008; effective interest rate of 13.24%; at accreted value			—		202,210
Senior secured credit facilities, variable interest rate			—		470,300
Capital lease obligations (see Note 9)			—		94,739
Total debt			—		1,201,223
Less: current portion of long-term debt			—		561,532
	Long-term debt	$	—	$	639,691

8. Long-Term Debt:

~~Senior~~As ~~Secured~~a ~~Credit~~result ~~Facilities. In~~of ~~February 2000,~~ the Company’s ~~closed~~bankruptcy ~~on $500~~proceedings,~~000~~ ofall ~~senior secured~~contractual ~~credit~~debt ~~facilities~~payments ~~(the~~are ~~"Credit~~suspended and ~~Facilities").~~subject ~~The~~to ~~Credit~~revised ~~Facilities~~payment ~~consist~~terms ofduring athe ~~$350,000~~bankruptcy ~~seven-year~~process ~~revolving~~on ~~credit~~a specific ~~facility~~case ~~and~~basis. aAs ~~$150~~discussed in Note 2,~~000~~ ~~two-year~~the ~~delayed~~only ~~draw~~debt ~~term~~payments being ~~loan~~made ~~facility.~~as ~~Interest~~of isSeptember 30, ~~generally~~2003 ~~the~~relate ~~London~~to ~~Interbank~~interest ~~Offered~~on ~~Rate~~the ~~("LIBOR")~~senior ~~plus~~secured credit ~~4.50%.~~facilities Asand ofmonthly ~~June 30,~~payments ~~2003,~~under ~~there~~capital ~~were~~leases. ~~$319~~Additionally,~~800~~ ~~and~~as ~~$145,500~~a result of ~~borrowings outstanding under~~ the ~~seven-year~~ ~~revolving~~bankruptcy ~~credit~~filing, ~~facility~~there ~~and~~is ~~the~~an ~~two-year~~event ~~delayed~~of ~~draw~~default ~~term~~under ~~loan~~the ~~facility,~~senior secured ~~respectively.~~credit ~~The~~facilities ~~blended~~and ~~borrowing~~both ~~rate~~series onof ~~outstanding~~notes, ~~borrowings~~which, atby ~~June 30~~their terms, ~~2003,~~would isordinarily ~~5.66%~~accelerate ~~and~~all ~~will~~amounts ~~remain~~due ~~fixed~~upon ~~until~~the ~~September 18,~~event ~~2003.~~of default.

The ~~Credit~~ ~~Facilities~~senior ~~are~~ secured bycredit facilities, ~~(1) the~~notes and capital ~~stock~~lease ofobligations ~~Allegiance~~are ~~Telecom~~now ~~Company~~classified ~~Worldwide~~as liabilities ~~(which~~subject ~~stock~~to iscompromise ~~owned~~(see ~~by its parent holding company, Allegiance Telecom,~~Note ~~Inc.) and (~~2) ~~substantially~~ ~~all of the assets of Allegiance Telecom Company Worldwide~~ and ~~its~~are ~~subsidiaries,~~not ~~including~~reflected ~~the capital stock owned by that entity~~ in ~~each of its~~ ~~subsidiaries. The Final Cash Collateral Order also provides~~ the ~~senior~~table ~~lenders with certain replacement liens as described in such Order~~below. ~~Under~~No ~~this~~changes ~~order,~~to the ~~Creditors'~~carrying ~~Committee~~amount ~~has~~of ~~until August 29,~~these ~~2003~~debts tohave ~~among~~been made ~~other~~in ~~things, challenge~~ the ~~senior~~accompanying ~~lenders'~~condensed ~~prepetition~~consolidated ~~liens,~~balance ~~claims~~sheet oras ~~security~~a ~~interests~~result or of the ~~lenders' pre-petition obligations~~filing.

~~On November 27,~~Long-term ~~2002,~~debt ~~the Company reached an agreement with its senior bank creditors regarding modifications to the Credit Facilities. Under this agreement, the Company obtained~~at ~~a waiver of all existing financial covenants through April~~September 30, 2003 and ~~replaced~~December 31, ~~those~~2002, ~~covenants~~consisted ~~during~~of ~~this period with a free cash flow from operations covenant and a total leverage covenant. Under this interim amendment,~~ the ~~Company could not permit its consolidated total debt to exceed at any time~~ following:

	September 30, 2003		December 31, 2002

Series B 11 ³/₄% notes, face amount $445,000 due February 15, 2008; effective interest rate of 12.21%; at accreted value	$	—	$	433,974
12 ⁷/₈% senior notes, face amount $205,000 due May 15, 2008; effective interest rate of 13.24%; at accreted value	—		202,210
Senior secured credit facilities, variable interest rate	—		470,300
Capital lease obligations (see Note 9)	—		94,739
Total debt	—		1,201,223
Less: current portion of long-term debt	—		561,532
Long-term debt	$	—	$	639,691

~~(i)~~Senior Secured Credit Facilities. In February 2000, the Company closed on $1500,~~275,~~000 of senior secured credit facilities (the “Credit Facilities”). The ~~from~~Credit ~~November 27,~~Facilities ~~2002~~consist ~~through~~of ~~April 29~~a $350,000 ~~2003~~seven-year revolving credit facility and ~~(ii)~~ a $~~645~~150,000 ~~thereafter~~two-year delayed draw term loan facility. ~~Under~~Interest is generally the ~~terms~~London ofInterbank ~~the~~Offered ~~interim~~Rate ~~amendment~~(“LIBOR”) plus 4.50%. As of September 30, ~~the~~2003, ~~Company~~there ~~repaid~~were $15326,~~000~~925 and $145,789 of ~~the~~borrowings ~~Credit~~outstanding ~~Facilities,~~under ~~which~~the ~~was~~seven-year ~~applied~~revolving tocredit facility and the ~~initial~~two-year delayed ~~amortization~~draw ofterm ~~the~~loan facility, ~~scheduled~~respectively. toThe ~~begin~~blended inborrowing ~~2004~~rate on outstanding borrowings at September 30, 2003, is 5.63% and will remain fixed until December 24, 2003.

~~From November 27,~~The ~~2002~~Credit toFacilities ~~April 29,~~are secured ~~2003,~~by (1) the ~~Company~~capital ~~negotiated~~stock ~~with~~of ~~its~~Allegiance ~~senior~~Telecom ~~bank~~Company ~~creditors~~Worldwide (which tostock ~~develop~~is aowned ~~mutually~~by ~~acceptable~~its ~~plan~~parent ofholding ~~restructuring. On April 29~~company, Allegiance ~~2003~~Telecom, Inc.) inand ~~anticipation~~(2) substantially all of ~~its~~the ~~breach~~assets of ~~various~~Allegiance Telecom ~~covenants~~Company inWorldwide ~~the~~and ~~Credit~~its ~~Facilities~~subsidiaries, including the ~~Company~~capital ~~and~~stock owned ~~its~~by ~~senior~~that ~~bank~~entity ~~creditors~~in ~~entered~~each ~~into~~of aits ~~forbearance agreement~~subsidiaries. The ~~Company~~Final ~~received~~Cash ~~a forbearance~~Collateral ~~from~~Order ~~its~~also provides the senior ~~bank~~lenders ~~creditors~~with ~~until~~certain ~~May 15,~~replacement ~~2003~~liens toas described ~~allow~~in ~~the~~such ~~various~~Order. ~~parties~~Under tothis ~~continue~~Order ~~negotiations.~~and Invarious ~~exchange,~~Stipulation ~~the~~and ~~Company~~Consent Orders ~~made~~the aCreditors’ ~~$5,000~~Committee ~~principal~~has ~~payment~~until ~~and~~December ~~agreed~~1, 2003 to ~~certain~~among other ~~covenants. On May 14~~things, ~~2003,~~challenge the ~~Company~~senior ~~filed~~lenders’ ~~for~~prepetition ~~bankruptcy~~liens, ~~under~~claims ~~Chapter~~or 11security interests asor ~~discussed~~the ~~above.~~lenders’ pre-petition obligations.

~~In June~~On November 27, 2002, the Company ~~requested~~reached aan ~~draw~~agreement ofwith ~~the~~its ~~remaining~~senior ~~$150,000~~bank ~~under~~creditors regarding modifications to the Credit Facilities,. ~~however~~Under this agreement, asthe Company obtained a waiver of ~~June~~all existing financial covenants through April 30, 2003, itand ~~had~~replaced ~~received~~those ~~only~~covenants ~~$135,300~~during ofthis ~~the $150,000,~~period with 3a offree ~~the~~cash 26flow ~~banks~~from operations incovenant ~~the~~and ~~bank~~a ~~syndicate~~total ~~refusing~~leverage ~~to fund the request~~covenant. OnUnder ~~July 15,~~this ~~2003~~interim amendment, the Company ~~entered~~could ~~into~~not apermit ~~settlement~~its ~~agreement~~consolidated ~~with~~total ~~Bayerische~~debt ~~Hypo-und~~to exceed ~~Vereinsbank~~at ~~and~~any ~~Bank~~time ~~Austria~~(i) $1,275,000 ~~Creditanstalt~~from ~~Corporate Finance,~~November ~~Inc. (collectively~~27, ~~the~~2002 ~~"Banks") regarding these funding disputes. On July~~through April 29, 2003, ~~the~~and ~~Bankruptcy~~(ii) $645,000 ~~Court~~thereafter. ~~approved~~Under ~~this settlement~~the ~~agreement.~~terms Onof ~~July 31,~~the interim ~~2003~~amendment, the ~~Banks delivered~~Company ~~the~~repaid ~~Net~~$15,000 ~~Funding~~of ~~Obligation~~the toCredit usFacilities, ~~the~~which was ~~Company~~applied ~~required~~to ~~under~~the ~~this~~initial ~~settlement~~amortization ~~agreement~~of in the ~~amount~~facility ofscheduled ~~$7,414.~~to begin in 2004.

~~9. Leases:~~ 13

~~The~~From ~~Company~~November 27, 2002 ~~has~~to ~~entered~~April 29, ~~into~~2003, ~~various~~the ~~capital~~Company ~~lease~~negotiated ~~agreements,~~ with ~~expirations~~its ~~through~~senior ~~2022,~~bank creditors ~~covering~~to ~~dedicated~~develop ~~optical~~a ~~fiber~~mutually ~~capacity~~acceptable ~~and~~plan ~~certain~~of ~~equipment~~restructuring. On ~~Assets~~April 29, ~~and~~2003, ~~future~~in ~~obligations~~anticipation ~~related~~of toits ~~capital~~breach ~~leases~~of ~~are~~various ~~included~~covenants in the Credit ~~accompanying~~Facilities, ~~condensed~~the ~~consolidated~~Company ~~balance~~and ~~sheet~~its insenior ~~property~~bank ~~and~~creditors ~~equipment~~entered ~~and~~into ~~liabilities~~a forbearance ~~subject~~agreement. toThe ~~compromise~~Company received a forbearance from its senior bank creditors until May 15, 2003 to allow the various parties to continue ~~respectively~~negotiations. ~~Depreciation~~In ofexchange, ~~assets~~the ~~held~~Company ~~under~~made ~~capital~~a ~~leases~~$5,000 isprincipal ~~included~~payment inand agreed ~~depreciation~~to ~~and~~certain ~~amortization~~other ~~expense~~covenants. On May 14, 2003, the Company filed for bankruptcy under Chapter 11 as discussed above.

~~The~~In June 2002, the Company ~~has~~requested ~~entered~~a ~~into~~draw ~~various~~of ~~operating~~the ~~lease~~remaining ~~agreements~~$150,000 ~~with~~under ~~expirations~~the ~~through~~Credit ~~2015~~Facilities, however, ~~for~~the ~~network~~Company ~~facilities~~initially received only $135,300 ~~office~~of ~~space~~the ~~and~~$150,000, ~~equipment~~with 3 of the 26 banks in the bank syndicate refusing to fund the request. On ~~Total~~July 15, ~~rent~~2003, ~~expense~~the onCompany ~~operating~~entered into ~~leases~~a settlement agreement with Bayerische Hypo-und Vereinsbank and Bank ~~for~~Austria ~~the~~Creditanstalt ~~three~~Corporate ~~months~~Finance, Inc. ~~ended~~(collectively, ~~June~~the “Banks”) regarding funding disputes. On July 3029, 2003, the Bankruptcy Court approved the settlement agreement and on ~~2002~~July 31, ~~was~~2003, $8the Banks delivered the Net Funding Obligation to the Company,~~173~~ ~~and~~required under the settlement agreement in the amount of $67,~~106~~414. On October 24, ~~and~~2003, the Company entered into a settlement agreement with Dresdner Bank AG regarding these funding disputes. On October 27, 2003, the Company filed a motion with the Bankruptcy Court for approval of the ~~six~~settlement agreement. The ~~months~~motion ~~ended~~is ~~June 30~~scheduled to be heard by the Court on November 19, 2003. Per ~~and~~the ~~2002~~settlement ~~was $16~~agreement,~~519~~ ~~and~~the Net Funding Obligation of $165,~~578,~~113 ~~respectively.~~will be delivered to the Company by Dresdner Bank AG within two business days following Bankruptcy Court approval.

~~Future minimum lease obligations for all non-cancelable capital and operating lease agreements with initial or remaining terms of one year or more at June 30, 2003, are as follows~~9. Leases:

Years ending December 31,		Capital Leases			Operating Leases
2003		$	7,385		$	12,954
2004			11,509			25,436
2005			11,510			25,042
2006			11,527			22,911
2007			9,181			21,370
Thereafter			104,983			66,493
	Total minimum future lease payments	$	156,095		$	174,206
Amount representing interest			(70,373	)
Present value of minimum lease payments (included in liabilities subject to compromise)			85,722
Current portion (included in liabilities subject to compromise)			(4,602	)
Long-term capital lease obligations (included in liabilities subject to compromise)		$	81,120

The Company has entered into various capital lease agreements, with expirations through 2022, covering dedicated optical fiber capacity and certain equipment. Assets and future obligations related to capital leases are included in the accompanying condensed consolidated balance sheet in property and equipment and liabilities subject to compromise, respectively. Depreciation of assets held under capital leases is included in depreciation and amortization expense.

~~Certain operating~~The ~~and~~Company ~~capital~~has ~~lease~~entered ~~agreements~~into various ~~contain~~operating ~~renewal~~lease ~~and~~agreements, ~~purchase~~with ~~options~~expirations atthrough ~~the~~2011, ~~end~~for ofnetwork facilities, ~~the~~office ~~initial~~space ~~lease~~and ~~terms~~equipment. ~~The~~Total ~~Company~~rent isexpense ~~analyzing~~on ~~its~~operating ~~contracts and~~ leases ~~to determine~~ ~~those~~for ~~executory~~the ~~contracts~~three ~~and~~months ~~unexpired~~ended ~~leases~~September 30, ~~relating~~2003 ~~to capital~~ and ~~operating~~2002, ~~leases~~was ~~that~~$6,726 ~~may~~and $9,843, beand ~~burdensome~~for to the ~~Company~~nine ~~and~~months ~~should~~ended beSeptember 30, ~~rejected~~2003 ~~pursuant~~and to2002 ~~Section 365~~was $23,245 ofand ~~the~~$26,421, ~~Bankruptcy Code~~respectively.

14Future minimum lease obligations for all non-cancelable capital and operating lease agreements with initial or remaining terms of one year or more at September 30, 2003, are as follows:

10. Capitalization:

Years ending December 31,	Capital Leases			Operating Leases

2003	$	3,791		$	5,733
2004	11,634			22,573
2005	11,623			21,916
2006	11,641			19,981
2007	9,295			17,909
Thereafter	106,604			24,465
Total minimum future lease payments	$	154,588		$	112,577

Amount representing interest	(69,596		)
Present value of minimum lease payments (included in liabilities subject to compromise)	84,992
Current portion (included in liabilities subject to compromise)	(4,719		)
Long-term capital lease obligations (included in liabilities subject to compromise)	$	80,273

~~During~~Certain ~~the~~operating ~~six~~and capital ~~months~~lease ~~ended~~agreements ~~June 30,~~contain ~~2003,~~renewal ~~56,839~~and ~~shares~~purchase ofoptions ~~common~~at ~~stock~~the ~~were~~end ~~issued~~of ~~under~~ the initial lease terms. The Company's ~~Employee~~is ~~Stock~~analyzing ~~Discount~~its ~~Purchase~~contracts ~~Plan~~and ~~for~~leases ~~proceeds~~to ofdetermine ~~$32.~~those ~~There~~executory ~~are~~contracts noand ~~more~~unexpired ~~shares~~leases ~~available~~relating ~~for~~to ~~issuance~~capital and ~~under~~operating ~~this~~leases ~~Employee~~that ~~Stock~~may ~~Discount~~be ~~Purchase~~burdensome ~~Plan.~~to the Company and should be rejected pursuant to Section 365 of the Bankruptcy Code.

~~11. Commitments and Contingencies:~~ 14

~~In October 2002, the Company executed a Master Carrier Agreement with AT&T Corp. Under this agreement, the Company committed to purchase from AT&T Corp. a minimum of $~~10~~,000 of services per year through February 2007~~. Capitalization:

~~In March 2002,~~During the ~~Company~~nine ~~executed~~months ended aSeptember 30, ~~Communications~~2003, ~~Transport~~56,839 ~~Services~~shares ~~Agreement~~of ~~with~~common ~~Southern~~stock ~~California~~were ~~Edison~~issued under the Company.’s ~~Under~~Employee ~~this~~Stock ~~agreement,~~Discount ~~the~~Purchase ~~Company~~Plan ~~committed~~for toproceeds ~~purchase from~~of ~~Southern~~$32. ~~California~~There are ~~Edison~~no ~~Company~~more anshares ~~average~~available offor ~~$260~~issuance ofunder ~~services~~this ~~each~~Employee ~~month~~Stock ~~through~~Discount Purchase ~~March 2005~~Plan.

~~In April 2003, the Company executed an Agreement for Additional Services, Security, and Settlement of Certain Matters with WorldCom, Inc~~11. ~~(on behalf of itself and all of its affiliates and subsidiaries). Under this agreement, the Company committed to purchase from WorldCom an aggregate of $14,000 of services from February~~ ~~28, 2003 to April 30, 2004 and~~ anCommitments ~~aggregate of at least $12,000 of services from May 1, 2004~~ and April 30, 2005. Furthermore, under this agreement, the Company agreed to (a) extend the term of its Domestic and Metro Private Line Special Carrier Service Agreement ("MSA") between WorldCom and the Company dated September 29, 2000, as amended, until April 30, 2005 and (b) increase the volume commitment under the MSA from $700 per month to $900 per month through April 30, 2005. Contingencies:

12In October 2002, the Company executed a Master Carrier Agreement with AT&T Corp. ~~Gain~~ onUnder ~~Sale~~this agreement, the Company committed to purchase from AT&T Corp. a minimum of ~~Investment:~~ $10,000 of services per year through February 2007. The Company has filed a motion with the Bankruptcy Court to reject the AT&T Master Carrier Agreement. The parties are currently engaged in negotiations.

AtIn ~~December~~March ~~31,~~ 2002, the Company ~~held~~executed ana ~~investment~~Communications inTransport ~~commercial~~Services ~~paper,~~Agreement ~~which~~with ~~was~~Southern California ~~included~~Edison ~~in cash and cash equivalents~~Company. ~~The~~Under ~~original~~this ~~purchase price of the commercial paper was $9~~agreement,~~025.~~ ~~During 2001,~~ the ~~investment~~Company ~~was~~committed ~~written down~~ to ~~its market value due to a decline in its value, which was deemed to be other than temporary. An impairment of $3,069~~ ~~was~~purchase ~~recorded~~from toSouthern ~~interest~~California ~~income~~Edison ~~during 2001. During June 2003, the~~ Company ~~sold~~an ~~its~~average ~~investment in the commercial paper in the open market for proceeds~~ of $~~9,233~~260 ~~which~~of ~~resulted in the Company~~services ~~realizing~~each amonth ~~gain~~through ~~of $3,277~~March 2005. The ~~proceeds of the sale were re-invested in the~~ Company's ~~money~~has ~~market~~not ~~investment~~yet ~~accounts,~~assumed ~~which~~or ~~are~~rejected ~~classified~~this asagreement ~~cash~~pursuant ~~and~~to ~~cash~~the Bankruptcy ~~equivalents~~Code.

13In April 2003, the Company executed an Agreement for Additional Services, Security, and Settlement of Certain Matters with WorldCom, Inc. ~~Reorganization~~ ~~Items:~~ (on behalf of itself and all of its affiliates and subsidiaries). Under this agreement, the Company committed to purchase from WorldCom an aggregate of $14,000 of services from February 28, 2003 to April 30, 2004 and an aggregate of at least $12,000 of services from May 1, 2004 to April 30, 2005. Furthermore, under this agreement, the Company agreed to (a) extend the term of its Domestic and Metro Private Line Special Carrier Service Agreement (“MSA”) between WorldCom and the Company dated September 29, 2000, as amended, until April 30, 2005 and (b) increase the volume commitment under the MSA from $700 per month to $900 per month through April 30, 2005. The Company has not yet assumed or rejected this agreement pursuant to the Bankruptcy Code.

~~Pursuant~~In toOctober ~~SOP 90-7~~2002, the Company executed isan ~~required~~agreement tofor ~~segregate~~financial ~~certain~~advisory ~~expenses~~and investment banking services with Greenhill & Co., ~~realized~~LLC ~~gains~~(“Greenhill”). On ~~and~~September ~~losses~~18, ~~and~~2003, ~~provisions~~the ~~for~~Bankruptcy ~~losses~~Court ~~not~~approved ~~directly~~this ~~related~~agreement. Under the agreement, the Company has agreed to ~~ongoing~~pay ~~operations~~Greenhill asa ~~reorganization~~transaction ~~items~~fee in the ~~condensed~~amount ~~consolidated~~of ~~statements~~$6,500, ofcontingent ~~operations.~~upon ~~The~~the consummation ~~following~~of ~~reorganization~~a ~~items~~plan ~~were~~of ~~incurred~~reorganization ~~during~~or the ~~three~~sale ~~and~~of ~~six~~substantially ~~months~~all ~~ended~~of ~~June 30,~~the ~~2003:~~Company’s assets.

	Three Months Ended June 30, 2003			Six Months Ended June 30, 2003
	(Unaudited)			(Unaudited)
Professional fees	$	3,047		$	3,584
Other restructuring (gains)/losses		(460	)		(460	)
Total reorganization items	$	2,587		$	3,124

In June 2003, the Company executed an agreement for advisory services with Impala Partners, LLC (“Impala”). In August 2003, the Company executed an amendment to the original agreement. Under this amendment, the Company agreed to pay Impala a success fee in the amount of $2,500 payable upon the effective date following confirmation of a plan of reorganization or the sale of the Company.

1512. Other Income and Expense:

At December 31, 2002, the Company held an investment in commercial paper, which was included in ~~ITEM~~cash 2and cash equivalents. ~~Management's~~The ~~Discussion~~original ~~and~~purchase ~~Analysis~~price of ~~Financial~~the ~~Condition~~commercial ~~and~~paper was ~~Results~~$9,025. During 2001, the investment was written down to its market value due to a decline in its value, which was deemed to be other than temporary. An impairment of ~~Operations~~ $3,069 was recorded to interest income during 2001. During June 2003, the Company sold its investment in the commercial paper in the open market for proceeds of $9,233, which resulted in the Company realizing a gain of $3,277. The proceeds of the sale were re-invested in the Company’s money market investment accounts, which are classified as cash and cash equivalents.

~~The~~On ~~following~~April ~~discussion~~15, ~~and~~2003, ~~analysis~~the Company ~~relates~~entered tointo ~~our~~a ~~financial~~settlement ~~condition~~agreement ~~and~~with ~~results~~WorldCom ofto ~~operations~~settle ~~and~~various disputes ~~should~~that beeach ~~read~~party inhad ~~conjunction~~against ~~with~~ the ~~accompanying condensed~~other. The ~~consolidated~~settlement ~~financial~~was ~~statements~~approved ~~and~~by ~~notes~~the toBankruptcy ~~those~~Court ~~financial~~in ~~statements~~the WorldCom ~~contained~~Chapter in11 ~~this~~proceeding ~~report,~~on asMay ~~well~~28, as2003. Under the ~~section~~settlement ~~captioned~~agreement, ~~"Risk~~all ~~Factors"~~pre-acquisition ~~in this report. Additionally, the~~amounts ~~following~~payable ~~discussion~~to ~~and~~WorldCom ~~analysis~~that ~~should~~were berelated ~~read~~to inthe ~~conjunction~~acquisition ~~with~~of ~~our~~Shared ~~audited~~Technologies were ~~consolidated~~forgiven. During ~~financial~~the ~~statements~~quarter ~~and~~ended September ~~notes~~30, to2003, ~~those~~the ~~financial~~Company ~~statements~~determined ~~included~~that init ~~our~~was ~~Annual~~appropriate ~~Report~~to onrecognize ~~Form 10-K~~certain ~~for~~benefits ~~the~~related ~~year~~to ~~ended~~specific ~~December 31,~~terms ~~2002.~~of ~~Allegiance~~the ~~Telecom, Inc.~~settlement isagreement ~~generally~~and relieved ~~referred~~those topre-petition inliabilities ~~the~~covered ~~remainder~~by ofthe ~~this~~settlement, ~~report~~resulting asin a ~~"we,"~~gain ~~"our~~of ~~company" or "Allegiance"~~$2,610.

~~OVERVIEW~~ 15

We are a facilities-based national local exchange carrier that provides telecommunications services to business, government and other institutional users in major metropolitan areas across the United States and we are focused primarily on small to medium-sized businesses13. ~~We currently offer an integrated suite of telecommunications products and services~~ ~~including~~Reorganization local, long distance, Internet, data colocation, web hosting and customer premise equipment sales and maintenance services. Our principal competitors are the incumbent local exchange carriers (also known in the industry as the "ILECs"), as well as long distance carriers, customer premises sales and maintenance businesses, and other integrated communications providers. Items:

~~We began~~Pursuant ~~operations in late 1997 with an objective~~ to ~~grow~~SOP ~~rapidly~~90-7, ~~and establish our company as a national local exchange carrier covering~~ the ~~major metropolitan areas across the United~~ ~~States.~~Company Byis ~~the~~required ~~end~~to ofsegregate ~~2001,~~certain ~~we completed the network rollout in our 36 targeted markets: Atlanta~~expenses, ~~Austin,~~realized ~~Baltimore,~~gains ~~Boston,~~and ~~Chicago, Cleveland, Dallas, Denver, Detroit, Fort Lauderdale, Fort Worth,~~losses ~~Houston,~~and ~~Long~~provisions ~~Island,~~for ~~Los~~losses ~~Angeles,~~not ~~Miami,~~directly ~~Minneapolis/St.~~related ~~Paul,~~to ~~New~~ongoing ~~York,~~operations ~~Northern~~as reorganization ~~New~~items ~~Jersey,~~in ~~Oakland,~~the ~~Ontario/Riverside,~~condensed ~~CA,~~consolidated ~~Orange~~statements ~~County,~~of ~~Philadelphia, Phoenix, Pittsburgh, Portland, Sacramento, St~~operations. The ~~Louis,~~following ~~San~~reorganization ~~Antonio,~~items ~~San~~were ~~Diego,~~incurred ~~San~~during ~~Francisco,~~the ~~San~~three ~~Jose,~~and ~~Seattle,~~nine months ~~Tampa,~~ended ~~Washington~~September 30, ~~D.C., West Palm Beach/Boca Raton and White Plains, NY.~~ 2003:

We use multiple technologies in our network and a mixture of leased and owned facilities at the edge of our communications network in order to effectively and efficiently serve our customer base where it is physically located. Management's focus is on providing facilities-based services, and we generally provide services via resale on a limited basis. We utilize what is known as the unbundled network element platform ("UNE-P") to deliver services in a small number of sales where our facilities-based services would not be practicable or cost effective and as an interim measure until the resold services can be converted to facilities-based services. UNE-P is a method where a carrier can lease all elements of a service from an incumbent local carrier, including switching. As of June 30, 2003, approximately 95% of our retail lines in service were provided over our own network facilities. The services that we provide via our own network generate higher margins than services provided by other carriers that are resold by us. Consistent with our facilities-based approach, we install voice and data aggregation and switching equipment in our own premises. We also install voice and data aggregation equipment in the central offices or "hubs" of the existing local incumbent carrier's networks, also known as colocation. This voice and data aggregation equipment connects directly to customers through the "local loop," which consists of the existing copper wire and fiber running from the central offices to each customer location. The local loop is owned by the incumbent carriers but can be leased by competitive carriers under the terms of the Telecommunications Act of 1996. As of June 30, 2003, we had transmissions equipment colocated in 851 central offices. Our local presence in incumbent local exchange carrier central offices along with our leasing of the local loops provides us with a flexible platform for delivering traditional voice and data access services to end-user customers. We connect our colocations to our main switching center in each market by either leasing additional network elements from the incumbent carriers and other providers on a short-term basis or by using

	Three Months Ended September 30, 2003			Nine Months Ended September 30, 2003
	(Unaudited)			(Unaudited)

Professional fees	$	7,142		$	9,548
Other restructuring (gains)/losses	(10,335		)	(10,795		)
Total reorganization items	$	(3,193	)	$	(1,247	)

~~dedicated~~ITEM ~~fiber on a long-term basis~~2. WeManagement’s Discussion ~~have~~and ~~increasingly~~Analysis ~~focused on dedicated fiber because~~ of ~~the~~Financial ~~growth~~Condition ~~of our customer base~~ and ~~traffic~~Results ~~volume~~of ~~as well as its reliability.~~ Operations

~~As we~~The ~~have~~following ~~developed~~discussion and ~~our~~analysis ~~local~~relates ~~networks~~ to ~~service~~our ~~end-user~~financial ~~customers,~~condition weand ~~have~~results ~~also~~of ~~attempted~~operations toand should ~~capitalize~~be onread ~~our~~in ~~expertise~~conjunction ~~and~~with ~~investment at~~ the ~~edge~~accompanying ofcondensed ~~our~~consolidated financial ~~network~~statements and ~~in our~~notes ~~intercity~~to ~~Internet~~those ~~backbone.~~financial Westatements ~~have~~contained ~~leveraged~~in ~~our~~this report, ~~network~~as ~~assets~~well byas ~~providing~~the ~~network~~section ~~solutions~~captioned to“Risk ~~other~~Factors” ~~service~~in ~~providers~~this report. Additionally, ~~primarily~~ the ~~leading~~following ~~national~~discussion and ~~regional~~analysis ~~Internet~~should ~~providers.~~be ~~These~~read in ~~national~~conjunction ~~network~~with ~~providers~~our ~~have~~audited ~~end-user~~consolidated ~~customers~~financial ~~but~~statements doand ~~not~~notes ~~generally~~to ~~have~~those financial ~~the~~statements ~~facilities~~included ~~and~~in ~~expertise~~our toAnnual ~~directly~~Report ~~access~~on ~~these~~Form 10-K, ~~customers~~as amended infor ~~all~~the ~~relevant~~year ~~geographic~~ended ~~areas~~December 31, ~~through~~2002. ~~the~~Allegiance ~~local loop~~Telecom, Inc. ~~Many~~is ofgenerally ~~these~~referred ~~providers~~to ~~focus~~in on the ~~residential~~remainder ~~Internet~~of ~~access~~this ~~market.~~report as “we,” “our company” or “Allegiance.”

~~BANKRUPTCY PROCEEDINGS~~ OVERVIEW

OnWe ~~May 14,~~are ~~2003~~a ~~(the~~facilities-based national ~~"Commencement~~local ~~Date"),~~exchange ~~Allegiance~~carrier ~~Telecom, Inc.~~that ~~and~~provides ~~its~~telecommunications ~~direct~~services ~~and indirect owned subsidiaries filed voluntary petitions for~~to ~~relief~~business, ~~under~~government ~~Chapter~~and 11other ofinstitutional ~~the~~users ~~United~~in ~~States~~major ~~Bankruptcy~~metropolitan ~~Code~~areas across in the United States ~~Bankruptcy~~and ~~Court~~we ~~for~~are ~~the~~focused ~~Southern~~primarily ~~District~~on ofsmall ~~New~~to ~~York (the "Bankruptcy Court"). The reorganization is being jointly~~medium-sized ~~administered under the caption "In re Allegiance Telecom, Inc~~businesses. ~~et al. Case No. 03-13057 (RDD)" (the "Chapter 11 cases").~~ We ~~are~~ currently ~~operating~~offer ~~our~~an ~~business~~integrated ~~as "debtors-in-possession"~~suite ~~under the jurisdiction~~ of ~~the~~telecommunications products ~~Bankruptcy Court~~ and inservices ~~accordance~~including ~~with~~local, ~~the~~long ~~applicable~~distance, ~~provisions~~Internet, ~~of the~~data ~~Bankruptcy Code~~colocation, ~~the~~web ~~Federal~~hosting ~~Rules~~and ofcustomer ~~Bankruptcy~~premise ~~Procedure~~equipment sales and ~~applicable court orders~~maintenance services. InOur ~~general,~~principal ascompetitors ~~debtors-in-possession, we~~ are ~~authorized~~the toincumbent ~~continue~~local toexchange ~~operate as an~~carriers ~~ongoing~~(also ~~business,~~known ~~but may not engage~~ in ~~transactions outside~~ the ~~ordinary~~industry ~~course~~as ~~of business without~~ the ~~prior~~“ILECs”), ~~approval~~as ofwell ~~the~~as ~~Bankruptcy~~long ~~Court.~~distance ~~We plan to continue operating our business in the~~carriers, ~~ordinary~~customer ~~course.~~premises ~~Consistent~~sales ~~with~~and ~~the~~maintenance ~~provisions of the Bankruptcy Code~~businesses, ~~we plan to pay our vendors for all goods~~ and ~~services~~other ~~provided~~integrated communications ~~or delivered after the Commencement Date~~providers.

~~In order~~We tobegan ~~reorganize~~operations ~~and~~in late ~~emerge~~1997 ~~from~~with ~~Chapter~~an 11objective ~~successfully, we will need~~ to ~~propose,~~grow rapidly and ~~obtain~~establish ~~confirmation~~our bycompany ~~the~~as ~~Bankruptcy Court,~~ a ~~plan of reorganization that satisfies the~~ ~~requirements~~national oflocal ~~the~~exchange ~~Bankruptcy~~carrier ~~Code.~~covering ~~As provided by~~ the ~~Bankruptcy~~major ~~Code,~~metropolitan weareas ~~initially have~~ across the ~~exclusive~~United ~~right to file a plan of reorganization for 120 days~~States. ~~The~~By ~~initial~~the ~~period~~end of ~~exclusivity~~ ~~ends on September 11~~2001, ~~2003 and~~ we ~~intend~~completed ~~to request that~~ the ~~Bankruptcy~~network ~~Court~~rollout ~~extend~~in ~~the~~our 36 ~~exclusivity~~targeted ~~period.~~markets: ~~There~~Atlanta, ~~can~~Austin, beBaltimore, noBoston, ~~assurance~~Chicago, ~~that the Bankruptcy Court will grant such~~Cleveland, ~~extension.~~Dallas, IfDenver, weDetroit, ~~fail~~Fort toLauderdale, ~~file a~~Fort ~~plan~~Worth, ofHouston, ~~reorganization~~Long ~~during~~Island, ~~this~~Los Angeles, ~~period~~Miami, ~~(or~~Minneapolis/St. ~~any~~Paul, ~~extended~~New ~~period~~York, ~~approved~~Northern byNew ~~the~~Jersey, ~~Bankruptcy~~Oakland, Ontario/Riverside, ~~Court)~~CA, orOrange ifCounty, ~~such~~Philadelphia, ~~plan~~Phoenix, ~~is not accepted by the required number of~~Pittsburgh, ~~creditors~~Portland, ~~within 180 days after the Commencement Date~~Sacramento, ~~any party in interest may subsequently file its own plan of reorganization~~St. ALouis, ~~plan~~San ofAntonio, ~~reorganization~~San ~~would address~~Diego, ~~among~~San ~~other things~~Francisco, San ~~our~~Jose, ~~pre-petition~~Seattle, ~~obligations~~Tampa, ~~set~~Washington, ~~forth~~D.C., ~~the~~West ~~revised~~Palm ~~capital~~Beach/Boca ~~structure~~Raton ~~of the newly reorganized entity~~ and ~~provide for our corporate governance subsequent to exit from bankruptcy. There can~~White bePlains, ~~no assurance at this time that a plan of reorganization will be confirmed by the Bankruptcy Court or that any such plan will be implemented successfully~~NY.

~~Under~~We use multiple ~~Section 362~~technologies in our network and a mixture of leased and owned facilities at the edge ~~Bankruptcy~~of ~~Code~~our communications network in order to effectively and efficiently serve our customer base where it is physically located. Our focus is on providing facilities-based services, and we generally provide services via resale on a limited basis. We utilize resale and what is known as the ~~filing~~unbundled network element platform (“UNE-P”) to deliver services in a small number of sales where our facilities-based services would not be practicable or cost effective and as an interim measure until the resold services can be converted to facilities-based services. UNE-P is a ~~bankruptcy~~method ~~petition~~where ~~automatically~~a ~~stays~~carrier ~~most~~can ~~actions~~lease ~~against~~all elements of a ~~debtor~~service from an incumbent local carrier, including ~~most~~switching. ~~actions~~As of toSeptember ~~collect~~30, 2003, approximately 95% of our retail lines in service were ~~pre~~provided over our own network facilities. The services that we provide via our own network generate higher margins than services provided by other carriers that are resold by us. Consistent with our facilities-~~petition~~based ~~indebtedness~~approach, orwe install tovoice ~~exercise~~and ~~control~~data ~~over~~aggregation and switching equipment in our own premises. We also install voice and data aggregation equipment in the ~~property~~central offices or “hubs” of the ~~debtor'~~existing local incumbent carrier’s ~~estate~~networks, also known as colocation. ~~Absent~~This anvoice ~~order~~and ofdata aggregation equipment connects directly to customers through the ~~Bankruptcy~~“local ~~Court~~loop,” ~~substantially~~which ~~all~~consists ~~pre-petition~~of ~~liabilities~~the existing copper wire ~~are~~and ~~subject~~fiber running from the local incumbent carrier’s central offices to ~~payment,~~each customer iflocation. ~~any,~~The local loop is owned by the incumbent carriers but can be leased by competitive carriers under the ~~plan~~terms of ~~reorganization~~the Telecommunications Act of 1996. ~~The~~As ~~aggregate~~of ~~amount~~September 30, 2003, we had transmissions equipment colocated in 851 central offices. Our local presence in incumbent local exchange carrier central offices along with our leasing of ~~pre~~the local loops provides us with a flexible platform for delivering traditional voice and data access services to end-~~petition~~user ~~claims~~customers. isWe ~~not~~connect ~~known~~our atcolocations ~~this~~to ~~time~~our ~~since~~main switching center in each market by either leasing additional network elements from the ~~bar~~incumbent carriers ~~date~~and ~~for~~other ~~claims~~providers ~~has~~on ~~not~~a ~~yet~~short-term ~~been~~basis ~~set~~or by using dedicated fiber ~~nor~~on a long-term basis. We have ~~all~~increasingly ~~contract~~focused ~~rejection~~on ~~claims~~dedicated ~~been~~fiber ~~filed.~~because of the growth of our customer base and traffic volume as well as its reliability.

~~Under Section 365~~As ofwe ~~the~~have ~~Bankruptcy~~developed ~~Code,~~our local wenetworks ~~may~~to ~~assume~~service orend-user ~~reject~~customers, ~~certain~~we ~~executory~~have ~~contracts~~also ~~and~~attempted ~~unexpired~~to capitalize ~~leases,~~on ~~including~~our ~~leases~~expertise ofand ~~real~~investment ~~property,~~at ~~subject to~~ the ~~approval~~edge of ~~the~~ ~~Bankruptcy~~our ~~Court~~network and ~~certain~~in our ~~other~~intercity ~~conditions~~Internet backbone. InWe ~~general,~~have ~~rejection~~leveraged ofour annetwork ~~unexpired~~assets ~~lease~~by providing ornetwork ~~executory~~solutions ~~contract~~to isother ~~treated~~service asproviders, aprimarily ~~pre-petition~~the ~~breach~~leading national ofand ~~the~~regional ~~lease~~Internet ~~or contract~~providers. ~~Subject to~~These ~~certain~~national ~~exceptions,~~network ~~this~~providers ~~rejection~~have end-user ~~relieves~~customers usbut ofdo ~~performing~~not ~~our~~generally ~~future~~have ~~obligations~~the ~~under~~facilities ~~that~~and ~~lease~~expertise orto directly ~~contract~~access ~~but~~these ~~entitles~~customers ~~the~~in ~~counterparty~~all torelevant ageographic ~~pre-petition~~areas ~~general~~through ~~unsecured claim,~~the iflocal ~~any,~~loop. ~~for~~Many ~~damages~~of ~~against~~these ~~our~~providers ~~estate~~focus ~~caused~~on by the ~~deemed~~residential Internet access market.

17BANKRUPTCY PROCEEDINGS

~~breach. Counterparties~~On ~~to these rejected contracts or leases may file proofs of claim against our estate for such damages. Generally~~May 14, ~~the~~2003 ~~assumption of an executory contract or unexpired lease~~(the ~~requires~~“Commencement ~~a debtor to cure most existing defaults~~Date”), ~~including~~Allegiance ~~payment of any pre-petition amounts outstanding~~Telecom, ~~under such executory contract or unexpired lease~~ Inc. ~~Due to the uncertain nature of many of the potential rejection~~ and ~~abandonment~~its ~~related~~direct ~~claims~~ and ~~to the uncertain amount needed for cure payments, we are unable to project the magnitude of these claims and cure amounts with any~~indirect ~~degree~~subsidiaries ~~of certainty at this time.~~ filed

The United States Trustee for the Southern District of New York has appointed an official committee of unsecured creditors (the "Creditors' Committee"). The Creditors' Committee and its legal representatives have a right to be heard on all matters relating to our Chapter 11 cases that come before the Bankruptcy Court. There can be no assurance that the Creditors' Committee will support our positions or our ultimate plan of reorganization, once proposed, and disagreements between the Creditors' Committee and Allegiance could protract the Chapter 11 cases and could negatively impact Allegiance's ability to operate during the Chapter 11 cases. 17

~~The~~voluntary ~~rights~~petitions ~~and~~for ~~claims~~relief ofunder ~~various~~Chapter ~~creditors~~11 ~~and security holders will be determined by a plan~~ of ~~reorganization~~the ~~that~~United isStates ~~confirmed by the~~ Bankruptcy ~~Court;~~Code ~~under~~ in the ~~priority~~United ~~rules established~~States ~~by the~~ Bankruptcy ~~Code,~~Court ~~certain~~for ~~post-petition~~the ~~liabilities~~Southern ~~and~~District ~~certain~~of ~~pre-petition~~New ~~liabilities~~York (ethe “Bankruptcy Court”).~~g.,~~ ~~our~~The ~~senior~~reorganization ~~secured~~is ~~debt)~~being ~~need~~jointly toadministered beunder ~~satisfied before unsecured~~the ~~creditors~~caption or“In ~~stockholders~~re ~~are~~Allegiance ~~entitled~~Telecom, Inc. toet ~~any~~al. ~~distribution~~Case No. 03-13057 (RDD)” ~~Any~~(the “Chapter 11 ~~plan~~cases”). ~~filed~~We byare uscurrently ~~may~~operating ~~provide~~our ~~that~~business ~~unsecured~~as “debtors-in-possession” ~~creditors~~under ofthe ~~subsidiaries~~jurisdiction of ~~Allegiance~~the ~~Telecom, Inc.~~Bankruptcy ~~will~~Court ~~need~~and ~~to be~~in ~~satisfied~~accordance ~~before~~with ~~any~~the ~~distribution~~applicable toprovisions of the ~~unsecured~~Bankruptcy ~~creditors~~Code, orthe ~~stockholders~~Federal Rules of ~~Allegiance~~Bankruptcy ~~Telecom, Inc.~~Procedure Asand aapplicable ~~result,~~court aorders. ~~plan~~In ofgeneral, ~~reorganization~~as debtors-in-possession, ~~could~~we ~~result~~are inauthorized ~~holders~~to ofcontinue ~~our~~to ~~common~~operate ~~stock~~as ~~and~~an ongoing ~~bonds~~business, ~~receiving~~but ~~little~~may ornot noengage ~~value~~in astransactions ~~part~~outside of the ~~plan~~ordinary course of business ~~reorganization.~~without Inthe ~~light~~prior approval of the ~~foregoing,~~Bankruptcy weCourt. ~~consider~~We ~~our~~plan ~~common~~to continue ~~stock~~operating ~~and~~ our ~~bonds~~business toin bethe ~~highly~~ordinary ~~speculative~~course. ~~and~~Consistent wewith ~~caution~~ the provisions ~~holders~~ of ~~such~~ ~~securities~~the ~~that~~Bankruptcy ~~such securities may ultimately be determined to have no value. Accordingly~~Code, we ~~urge~~plan ~~that~~to ~~extreme~~pay ~~caution~~our bevendors ~~exercised~~for ~~with~~all ~~respect~~goods ~~to existing~~ and services ~~future~~provided ~~investments~~or indelivered ~~any~~after ~~of such~~the ~~securities~~Commencement ~~and claims~~Date.

AtIn order to reorganize ~~this~~and ~~time,~~emerge itfrom isChapter ~~not~~11 ~~possible~~successfully, we will need to ~~predict~~propose, ~~accurately~~and obtain confirmation by the ~~effect~~Bankruptcy Court, a plan of reorganization that satisfies the ~~Chapter~~requirements 11of the Bankruptcy Code. As provided by the Bankruptcy Code, we initially had the exclusive right to file a plan of reorganization ~~process~~for 120 days, onwhich ~~our~~expired ~~business~~September 11, ~~our~~2003. ~~creditors~~Under a Bridge Order and various Stipulation and Orders, the initial exclusivity period has been extended until December 16, 2003. There can be no assurances that the Bankruptcy Court will extend the exclusivity period beyond that date. If we fail to file a plan of reorganization during this period (or ~~our~~any ~~stockholders~~extended period approved by the Bankruptcy Court) or ~~when~~if wesuch plan is not accepted by the required number of creditors within the applicable time period, any party in interest may ~~emerge~~subsequently ~~from~~file its own plan of reorganization. We have been engaged in discussions with various third parties who may be interested in purchasing some or all of our company through the bankruptcy process, either through a 363 sale (a sale pursuant to Section 363 of Chapter 11 of the Bankruptcy Code) or in connection with a plan of reorganization. A ~~Our~~plan ~~future~~of ~~results~~reorganization ~~depend~~would onaddress, among other things, the ~~timely~~terms ~~and~~of ~~successful~~any ~~confirmation~~such ~~and~~sale, ~~implementation~~the treatment of our pre-petition obligations, the revised capital structure of the newly reorganized entity and provide for our corporate governance subsequent to exit from bankruptcy. There can be no assurance at this time that a plan of reorganization. will be confirmed by the Bankruptcy Court or that any such plan will be implemented successfully.

~~For~~Under Section 362 of ~~copies~~the Bankruptcy Code, the filing of ~~court~~a ~~filings~~bankruptcy ~~made~~petition inautomatically ~~our~~stays most ~~Chapter~~actions 11against ~~cases~~a debtor, ~~please~~including gomost actions to collect pre-petition indebtedness or to exercise control over the property of the debtor’s estate. Absent an order of the Bankruptcy Court's, ~~website~~substantially all pre-petition liabilities are subject to payment, atif ~~www~~any, under the plan of reorganization.~~nysb~~ The Bankruptcy Court has established November 26, 2003 as the bar date for filing proofs of claims.~~uscourts.gov.~~ ~~Please~~The ~~note~~aggregate ~~that~~amount aof ~~PACER~~pre-petition ~~password~~claims is ~~required~~not known toat ~~access documents~~this ontime since the ~~Bankruptcy~~bar ~~Court's~~date ~~website.~~for claims has not yet passed nor have all contract rejection claims been filed.

~~RESULTS~~Under OFSection 365 ~~OPERATIONS—Three~~of the Bankruptcy Code, we may assume or reject certain executory contracts and unexpired ~~Six~~leases, ~~Months~~including ~~Ended~~leases ~~June 30~~of real property, ~~2003~~subject ~~Compared~~to ~~With~~the ~~Three~~approval of the Bankruptcy Court and ~~Six~~certain ~~Months~~other ~~Ended~~conditions. In general, rejection of an ~~June 30~~unexpired lease or executory contract is treated as a pre-petition breach of the lease or contract, ~~2002~~ generally resulting in any breach damages being treated as pre-petition liabilities. Subject to certain exceptions, this rejection relieves us of performing our future obligations under that unexpired lease or contract but entitles the counterparty to a pre-petition general unsecured claim, if any, for damages against our estate caused by the rejection. Counterparties to these rejected contracts or unexpired leases may file proofs of claim against our estate for such damages, if any. Generally, the assumption of an executory contract or unexpired lease requires a debtor to cure most existing defaults, including payment of any pre-petition amounts outstanding under such executory contract or unexpired lease. Due to the uncertain nature of many of the potential rejection and abandonment related claims and to the uncertain amount needed for cure payments, we are unable to project the magnitude of these claims and cure amounts with any degree of certainty at this time.

~~Revenues~~ The United States Trustee for the Southern District of New York has appointed an official committee of unsecured creditors (the “Creditors’ Committee”). The Creditors’ Committee and its legal representatives have a right to be heard on all matters relating to our Chapter 11 cases that come before the Bankruptcy Court. There can be no assurance that the Creditors’ Committee will support our positions or our ultimate plan of reorganization, once proposed, and disagreements between the Creditors’ Committee and Allegiance could protract the Chapter 11 cases and could negatively impact Allegiance’s ability to operate during the Chapter 11 cases.

~~During~~The ~~the~~rights ~~second~~and ~~quarter~~claims of various ~~2003~~creditors and ~~2002,~~security weholders ~~generated~~will ~~revenues~~be determined by a plan of reorganization ~~approximately~~that ~~$196.7 million~~is ~~and~~confirmed ~~$184.4 million,~~by ~~respectively.~~the ~~For~~Bankruptcy Court; under the ~~six~~priority ~~months~~rules ~~ended~~established ~~June 30,~~by ~~2003~~the ~~and~~Bankruptcy ~~2002~~Code, wecertain ~~generated~~post-petition ~~revenues~~liabilities ofand certain ~~approximately~~pre-petition ~~$401.2 million~~liabilities ~~and $346~~(e.~~5 million~~g., ~~respectively.~~our ~~Revenues~~senior ~~have~~secured ~~increased~~debt) 7%need ~~compared~~ to ~~the three~~be ~~months~~satisfied ~~ended~~before ~~June 30,~~unsecured ~~2002~~creditors ~~and~~or ~~16%~~stockholders ~~compared~~are entitled to ~~the six months ended June 30, 2002~~any distribution. ~~This~~Any ~~increase~~Chapter in11 ~~revenues~~plan isfiled ~~attributable~~by tous anmay ~~increase~~provide inthat ~~the~~unsecured creditors ~~number~~ of ~~customers~~subsidiaries ~~and~~of ~~services~~Allegiance ~~and products sold; specifically~~Telecom, ~~our revenue growth during the three and six months ended June~~ ~~30,~~Inc. ~~2003~~will ~~was~~need ~~enhanced~~to bybe satisfied ~~our~~before ~~acquisition~~any ofdistribution to the ~~customer~~unsecured ~~premise~~creditors ~~equipment~~or ~~sales~~stockholders ~~and equipment~~of ~~maintenance~~Allegiance ~~businesses~~Telecom, Inc. As ~~also~~a ~~known as Shared Technologies Fairchild~~result, a inplan ~~June 2002,~~of ~~which~~reorganization ~~contributed~~could ~~$28.2 million~~result ~~and~~in ~~$63.4 million~~holders toof ~~2003~~our ~~revenues~~bonds ~~for the three~~ and ~~six months~~other ~~ended~~securities ~~June 30,~~receiving ~~2003,~~little ~~and~~or ~~$5.5 million~~no ~~and~~value ~~$5.5 million~~as topart ~~2002~~of ~~revenues for~~ the ~~three~~plan ~~and~~of reorganization. Based ~~six~~on ~~months~~current discussions ~~ended~~with our creditors

~~June 30,~~regarding a plan ~~2002~~of reorganization, ~~respectively~~Allegiance Telecom, Inc. ~~Our~~common ~~revenue~~stock iswill ~~lower~~probably receive ~~than~~no value as part of the reorganization. In light of the foregoing, we consider our ~~projected~~bonds ~~revenue~~and common stock to be highly speculative and ~~has~~we ~~been~~caution the ~~negatively~~holders ~~impacted~~of bysuch securities that such securities may ultimately be determined to have no value. Accordingly, ~~among~~we ~~other~~urge ~~things:~~that extreme caution be exercised with respect to existing and future investments in any of such securities and claims.

~~Our focus~~At ~~has~~this ~~shifted~~time, ~~from~~it ~~high~~is ~~revenue~~not possible ~~growth~~ to ~~profitability~~predict ~~and~~accurately ~~we do not anticipate~~ the ~~level~~effect of ~~revenue growth that we have experienced in~~ the ~~past.~~Chapter ~~Future~~11 ~~revenue growth will~~reorganization ~~depend~~process on our ~~ability to add new customers~~business, ~~retain~~our ~~existing~~creditors ~~customers~~or ~~and~~our ~~manage~~stockholders ~~churn,~~or ~~increase~~when ~~customer~~we ~~usage~~may emerge ~~and~~from ~~sell~~Chapter ~~additional~~11. ~~services~~Our tofuture ~~our~~results ~~existing~~depend ~~customers.~~on Wethe ~~believe~~timely ~~that~~and ~~managing our~~successful ~~churn~~confirmation isand ~~one~~implementation of ~~our~~a ~~biggest~~plan ~~challenges~~of reorganization. ~~The~~No ~~amount~~assurance ofcan be ~~churn~~given ~~directly~~that ~~impacts~~we ~~our~~will ~~revenues.~~be ~~See~~successful ~~the~~in ~~discussion~~reorganizing ofour ~~line~~affairs ~~churn~~within ~~under~~ the Chapter ~~caption~~11 ~~"Liquidity and Capital Resources" below~~proceedings.

~~Local voice~~For ~~service~~copies ~~revenues~~of ~~for~~court filings ~~the~~made ~~three~~in ~~months~~our ~~ended~~Chapter ~~June 30,~~11 ~~2003 and 2002 were $87.6 million and $96.9 million~~cases, ~~and~~please ~~for~~go to the ~~six~~Bankruptcy ~~months ended June 30,~~Court’s ~~2003 and 2002~~website, ~~were~~at ~~$172~~www.~~8 million and $186~~nysb.~~1 million, respectively~~uscourts. The decrease in local voice service revenues during 2003 is primarily a result of lower rates for carrier access and interconnection revenues as mandated by our negotiated agreements with carriers, the FCC and certain statesgov. ~~Local~~Please ~~voice~~note ~~service~~that ~~revenues as~~ a ~~percent~~PACER ofpassword ~~total revenues has decreased from~~is ~~approximately~~required ~~53% for the quarter ended June 30, 2002~~ to ~~approximately~~access ~~45%~~documents ~~for~~on the ~~quarter~~Bankruptcy ~~ended~~Court’s ~~June 30, 2003~~website. ~~Local voice service revenues consisted of:~~

~~We expect~~RECENT local voice service revenues to continue to decrease from period to period as a percent of total revenues, as a result of our increasing focus on integrated voice, data and customer premise equipment sales and services, the resolution of certain regulatory disputes and uncertainties and lower rates for carrier access and interconnection revenues as mandated by our negotiated agreements with carriers, the FCC and certain states. We are currently examining certain of these negotiated access agreements to determine which of those executory contracts may be burdensome to us and should be rejected pursuant to Section 365 of the Bankruptcy Code. There can be no assurance that we will be able to reject these access agreements; if we are able to reject such agreements, we believe these other DEVELOPMENTS

19On November 13, 2003, Oscar Private Equity Investments filed a class action securities lawsuit in the District Court of the Northern District of Texas entitled Oscar Private Equity Investments v. Allegiance Telecom, Inc., et al., (Index No. 2-03CV-2761H) (the “Complaint”). The action is brought against Royce J. Holland and Thomas M. Lord as officers of the Company. The Complaint specifically states that the Company is not named a defendant although it is styled as an action against the Company. The Complaint alleges that, the defendant officers breached their fiduciary duty to the plaintiff class, violated Section 10(b) of the Securities and Exchange Act of 1934, and violated Rule 10b-5 of the Securities and Exchange Commission (“SEC”) promulgated thereunder. The action seeks compensatory damages of an unspecified amount, rescission, and the award of costs and disbursements of bringing suit. The Company’s insurance carriers have been notified of the lawsuit. Although it is too early for the Company to reach a conclusion as to the ultimate outcome of this action, management believes that there are substantial defenses to the claims asserted in this action, and the defendant officers intend to defend against the action vigorously.

~~carriers would~~RESULTS ~~need~~OF toOPERATIONS—Three ~~pay~~and Nine usMonths ~~for~~Ended ~~access at our higher tariffed rates which could increase our access revenues from these carriers. See the discussion under "Risk Factors~~September 30," ~~which~~2003 ~~contains~~Compared aWith ~~detailed discussion~~Three ~~of the risks~~ and ~~uncertainties~~Nine ~~associated~~Months Ended ~~with~~September 30, ~~our local voice revenues.~~ 2002

Long distance service revenues for the three months ended June 30, 2003 and 2002 were $11.1 million and $12.0 million, and for the six months ended June 30, 2003 and 2002 were $22.6 million and $22.7 million, respectively. Long distance service revenues as a percent of total revenues has remained consistent at approximately 6% for the quarters ended June 30, 2003 and 2002. We have negotiated a new long distance agreement with another carrier that should reduce our costs to provide long distance services to our customers and allow us to be more competitive in the pricing of our long distance services. The process of moving our long distance traffic to our new carrier has begun and we expect to realize cost savings as this process is completed. Revenues

~~Data revenues,~~During ~~including~~the ~~revenues~~third ~~generated~~quarter of ~~from~~2003 ~~Internet access, web hosting~~ and ~~high-speed data services~~2002, ~~for~~we ~~the~~generated ~~three~~revenues ~~months~~of ~~ended~~approximately ~~June 30, 2003 and 2002 were~~ $69188.72 million and $70219.05 million, ~~and~~respectively. ~~for~~For the ~~six~~nine months ended ~~June~~ September 30, 2003 and 2002, ~~were~~we generated revenues of approximately $~~142~~589.54 million and $~~132~~566.21 million, respectively. ~~Data~~Revenues ~~revenues as a percent of total revenues has~~ have decreased ~~from~~$31.3 ~~approximately~~million 39or 14% ~~for~~compared to the ~~quarter~~three ~~ended~~months ~~June~~ended September 30, 2002. toMost ~~approximately~~of ~~35%~~this ~~for~~decrease ~~the quarter~~was ~~ended~~a ~~June 30,~~result ~~2003.~~of Wea ~~also~~decrease ~~believe~~of $11.9 ~~that~~million ~~the~~in ~~continuing~~intercarrier ~~evolution~~compensation ofand ~~communications~~a ~~networks~~decrease ~~will~~of ~~promote~~$12.5 ~~the~~million ~~integration~~in customer ofequipment ~~voice~~sales and ~~data~~maintenance ~~services~~revenues. ~~over~~Our ~~the~~revenue ~~same~~is ~~facilities,~~lower ~~thereby~~than ~~further~~our ~~increasing~~projected ~~the~~revenue ~~availability~~and ofhas ~~cost-effective~~been ~~data~~negatively ~~offerings.~~impacted by, among other things:

~~The rate of growth in our data revenues has been affected by negative trends. We believe that~~ • the ~~demand for high-end web hosting services has decreased in response to a~~ ~~general~~commencement ~~economic slowdown. Moreover, an over capacity~~ of ~~data center space has decreased prices for these high-end services. High-end services include dedicated hosting services where we provide the customer with a dedicated computer server in~~ our ~~data~~Chapter ~~centers~~11 and colocation services where we provide data center space and services for a customer who locates its own computer server on our premises. We believe that the general economic slowdown has caused a deterioration in our shared hosting business as well. cases

Similarly, the demand for services we offer to network service providers who provide dial-up Internet access services is also experiencing the effects of over capacity and decreased demand. The resulting financial hardship has lessened the number of these types of network service providers. During 2000, we signed a long-term contract to provide an integrated network solution and certain services to Genuity Solutions Inc., a network services provider and operator of a nationwide Internet network. Our contract was established specifically to support Genuity's customer contracts, including that with America Online, and expires on December 31, 2006. Under this contract, Genuity committed to pay us an aggregate of $563.0 million over the term of the contract, subject to our performance under and the other terms and conditions of the contract. Genuity assigned our Integrated Network Solution Purchase Agreement to a subsidiary of Level 3 Communications, Inc. on February 4, 2003. We anticipate that Level 3 will continue to be our largest customer for the foreseeable future. For the three months ended June 30, 2003 and 2002, revenues from this contract were $27.0 million and $20.0 million, and for the six months ended June 30, 2003 and 2002, revenues were $56.9 million and $34.4 million, respectively. The revenues from this contract accounted for 14% and 11% of our total revenues for the quarters ended June 30, 2003 and 2002, respectively, and 39% and 29% of our data revenues for the same periods. In addition, approximately 85% of the reciprocal compensation earned by us from other carriers is as a result of the other carriers terminating Level 3 traffic on our networks. Reciprocal compensation revenues for the three months ended June 30, 2003 and 2002, were $7.2 million and $10.0 million and for the six months ended June 30, 2003 and 2002 were $15.7 million and $17.9 million, respectively. The contract contains specific provisions that allow Level 3 to decrease its purchase commitment in certain situations, including but not limited to, if Level 3's customer, AOL, reduces its services with Level 3 under Level 3's service relationship with AOL. In such an event, Level 3 is required to use commercially reasonable efforts to move some of its existing business to • churn

20• the going concern qualification contained in our 2002 year-end independent accountant’s report

~~Allegiance to minimize~~ • the ~~effect of any downturn of business on Allegiance. In addition, Level 3 is obligated to allocate any such discontinuance of business proportionately across all of~~ ~~Level 3's~~general ~~suppliers~~malaise ~~serving~~in the ~~area~~telecommunications inindustry which ~~AOL~~has ~~requests~~adversely ~~a discontinuance of service. Level 3 is obligated when practicable to give us ninety days written notice of any discontinuance~~affected ofthe ~~service~~willingness ~~as a result~~ of apotential ~~downturn~~customers ~~in business from AOL. Finally, Level 3 may not exercise its right~~ to ~~reduce~~purchase ~~its~~their ~~service as a result of a downturn in business from AOL under the contract~~telecommunications ~~until~~services ~~after October 1, 2003. Level 3 has informally told us that it expects to suffer a downturn in business~~ from ~~AOL.~~competitive ~~Level 3 has not provided us with any specific notice of the amount of downturn we can experience~~carriers, ~~but has indicated that~~ such ~~downturn~~as ~~could be "massive".~~ us

~~The contract also provides that if we receive a going concern qualification or experience an event of default as defined under~~ • our ~~senior credit agreement, (a) Level 3 may~~ ~~exercise~~inability ~~an option~~ to ~~purchase~~receive ~~all~~bid ~~of the dedicated assets~~ and ~~infrastructure~~performance ~~used~~bonds ~~by us to provide the integrated network solution to Level 3 and (b) Level 3 would still be required to continue to purchase certain services from us~~ for ~~the~~potential ~~remainder~~customer of the term of the agreement. If Level 3 exercises its option, it would be required to pay (1) for the dedicated assets, the remaining undepreciated value of the dedicated assets (as reflected on our books at the time of exercise of the option) and (2) for the certain services, the remaining overall value of the agreement less the amounts paid to purchase the dedicated assets and infrastructure. Any such purchase transaction would require Bankruptcy Court approval. We have not received any notice from Level 3 that it intends to exercise its rights under this provision of the agreement. contracts

~~We recently received communications from Level 3 claiming, among other things, that we have failed to meet~~ • the ~~applicable performance warranties under the contract; and that~~ ~~certain~~poor ~~rights~~economy ~~that~~which ~~Level 3~~ has ~~under~~caused ~~the contract, including, but not limited to, Level 3's ability to require us to secure another subcontractor for certain services and/or Level 3 can terminate~~ our ~~ability~~customers to supply such services, may already be triggered. In addition, Level 3 has claimed that it is entitled to offsets against the August 2003 payment for Allegiance's alleged failure to deliver certain services. We do not believe that we have failed to meet the performance warranties alleged by Level 3; we do not believe that we have failed to deliver the services alleged by Level 3; nor do we believe that, even if Allegiance has not delivered the services in accordance with the contract, that the offset amounts claimed by Level 3 are calculated in accordance with the contract. If we are found to have failed to meet the performance warranties under the contract, Level 3 may offset future payments to us and, if such failure continues for an extended period of time, Level 3 could terminate the contract. If we were to lose some or all of the revenues under this contract, we do not believe we could implement sufficient cost-cutting measures to offset such decrease ~~in revenues. The resulting reduction in revenue (including reduction in reciprocal compensation revenues) and/~~or ~~loss~~delay ~~of this contract would~~their ~~have~~purchases afrom material adverse effect on our business. We are continuing our negotiations with Level 3 to modify certain service level warranties, remedies and penalties under the contract. We can provide no assurances that these negotiations will be successfully concluded. us

On• decreases ~~August 8, 2003, Level 3 paid Allegiance approximately $11.8 million of the $25 million quarterly payment due~~ in ~~August 2003.~~carrier ~~Level~~access 3and ~~offset~~interconnection ~~against~~revenues ~~the quarterly payment approximately $507 thousand for certain offsets that Level 3 claims it is~~ due ~~for Allegiance's alleged failure~~ to ~~deliver~~dispute ~~certain~~settlements ~~ports. In addition, Level 3 has withheld~~and ~~approximately~~FCC-mandated ~~$12.7 million~~regulatory ofrate the August 2003 payment until Level 3 has an order from the bankruptcy court confirming Level 3's reservation of rights with respect to Level 3's claims for offsets. Allegiance vigorously denies that Level 3 is entitled to any of the offsets claimed by Level 3. reductions

~~Notwithstanding~~• decreases ~~these~~in ~~trends~~our ~~and~~web ~~uncertainties,~~hosting werevenues ~~expect~~as we continued ~~demand by small and medium sized business customers for dedicated access~~ to ~~the~~curtail ~~Internet~~that and integrated services. Indeed, our Integrated Access Service which delivers high-speed, "always on" Internet access and allows multiple voice, data and Internet combinations over a single access loop remains our fastest growing product line

21• decreases and turnover in our sales force

~~offering. During~~On ~~the~~a ~~quarter~~year-to-date ~~ended June 30~~basis, revenues ~~2003,~~have ~~Integrated~~increased ~~Access Service including one or more voice or data services represented approximately 42~~4% ofcompared ~~our~~to ~~gross~~the ~~lines~~nine ~~sold~~months ~~for~~ended ~~the quarter.~~September 30, We2002. ~~believe~~This ~~that~~increase ~~line~~in ~~churn~~revenues ~~rates~~is ~~(the~~attributable ~~rate~~to atour ~~which~~acquisition ~~customers disconnect their lines) for this type~~ of ~~service~~the customer ~~when~~premise ~~voice~~equipment sales and ~~data~~equipment ~~are~~maintenance ~~bundled~~businesses, isalso known ~~lower~~as ~~than~~Shared ~~that~~Technologies ofFairchild, ~~our~~in ~~local~~June 2002, ~~voice~~which ~~service~~contributed $91.1 ~~One~~million ofto ~~the challenges~~2003 werevenues ~~face~~for inthe ~~this~~nine ~~area~~months isended ~~ongoing~~September 30, 2003, ~~network efficiency~~ and ~~service~~$45.7 ~~delivery~~million ~~improvements~~ to ~~retain~~2002 ~~the~~revenues ~~competitive~~for ~~advantages~~the ofnine ~~this~~months ~~service~~ended September 30, ~~offering.~~2002, respectively.

~~In June 2002,~~Our wefocus ~~acquired~~has ~~substantially~~shifted from ~~all~~high ofrevenue ~~the~~growth ~~assets~~to profitability and ~~assumed~~we ~~certain~~do ~~liabilities~~not ofanticipate the ~~customer~~level ~~premise equipment sales and customer premise equipment maintenance~~of ~~businesses,~~revenue ~~also~~growth ~~known~~that aswe ~~Shared~~have ~~Technologies~~experienced ~~Fairchild,~~in ~~from~~the ~~WorldCom~~past. WeFuture ~~believe~~revenue ~~the~~growth ~~acquisition~~will depend ofon ~~these businesses enhances~~ our ability to ~~offer~~add ~~additional~~new ~~services to our~~ customers~~. Further~~, ~~we believe~~retain ~~this~~existing ~~acquisition presents an opportunity to cross-sell our other integrated telecommunications services to the~~ customers ~~of these acquired businesses. Customer premise equipment sales~~ and ~~maintenance~~ ~~revenues~~manage ~~for the three months ended June 30~~churn, ~~2003~~increase ~~and~~customer ~~2002~~usage ~~were $28.2 million~~ and ~~$5.5 million~~sell ~~and~~additional ~~for~~services ~~the~~to ~~six~~our ~~months ended June 30, 2003 and 2002 were $63.4 million~~existing ~~and $5~~customers.~~5 million,~~ ~~respectively.~~We ~~Customer~~believe ~~premise~~that ~~equipment~~managing ~~sales~~our ~~and~~churn ~~maintenance revenues as a percent of total revenues~~ is ~~approximately~~one ~~14% and 3% for the quarters ended June 30, 2003 and 2002. As a result~~ of our ~~bankruptcy,~~biggest ~~we have had not been able to obtain bid and performance bonds or provide other types of financial security as required by many of our customers~~challenges. ~~As a result,~~ weThe ~~have~~amount ~~lost~~of ~~current~~churn ~~customers~~directly toimpacts our ~~competitors and have a reduced ability to gain new customers~~revenues. ~~Moreover,~~See ~~certain~~the ~~customers~~discussion ~~will~~of ~~not purchase services from companies in bankruptcy, so certain~~line ~~opportunities~~churn ~~are~~under ~~not~~the ~~available~~caption to“Liquidity ~~us. The loss of current~~ and ~~potential~~Capital ~~customers~~Resources” ~~has impacted our revenues and will continue to impact our revenues as long as these conditions exist~~below.

~~Network Expenses~~ 19

~~For~~Local voice service revenues for the ~~quarters~~three months ended ~~June~~September 30, 2003 and 2002, ~~network expenses~~ were $~~105~~80.09 million and $9596.36 million, and for the ~~six~~nine months ended ~~June~~September 30, 2003 and 2002, ~~network expenses~~ were $~~216~~253.47 million and $~~177~~282.47 million, respectively. ~~Network~~The ~~expenses~~decrease ~~related~~in tolocal ~~the~~voice ~~Shared~~service ~~Technologies business, acquired in~~revenues ~~June 2002,~~during ~~included~~2003 inis ~~the~~primarily ~~quarters~~a ~~ended~~result ~~June 30,~~of ~~2003~~lower ~~and~~rates ~~2002~~for ~~were~~carrier ~~$16.9 million~~access and interconnection ~~$4.3 million,~~revenues ~~and~~as ~~for~~mandated ~~the~~by ~~six~~our ~~months~~negotiated ~~ended~~agreements ~~June 30~~with carriers, ~~2003~~the FCC and ~~2002~~certain ~~were $37~~states.~~1 million~~ ~~and~~Local ~~$4.3 million,~~voice ~~respectively.~~service ~~Network~~revenues ~~expenses~~ as a ~~percentage~~ percent of total revenues ~~increased~~has decreased from 52approximately 44% for the quarter ended ~~June~~ September 30, 2002 to 53approximately 43% for the quarter ~~ended~~ ~~June~~ended September 30, 2003. ~~While~~Local ~~there~~voice ~~can~~service ~~be no assurance that we will be successful in creating operating efficiencies, we expect to control costs and that network expenses as a percentage of total~~ revenues ~~will~~consisted ~~reduce over time. We are performing an extensive review~~ of our network architecture and a rationalization of the overall profitability of our business on a colocation, market, and product basis. As such, we may decommission a colocation arrangement, rebuild or replace infrastructure facilities and reduce or sell entire markets. In addition, we may eliminate some products and services currently offered. As a result of such events, we may be able to reduce our future network costs. With respect to the implementation of this review and rationalization, we may convert a limited number of facilities-based customers to UNE-P, deploy alternate unbundled network element applications, or, in some instances, eliminate a colocation, product or service completely. In addition, we are analyzing our contracts and leases to determine those executory contracts and unexpired leases relating to our network that may be burdensome to us and should be rejected pursuant to Section 365 of the Bankruptcy Code. If we receive Bankruptcy Court approval to reject any of these executory contracts or unexpired leases, we expect our future network costs to decrease as a result. :

~~Gross~~• the ~~margin~~monthly ~~has~~recurring ~~decreased~~charge ~~from 48%~~ for ~~the~~basic ~~quarter~~local ~~ended~~voice June 30, 2002 to 47% for the quarter ended June 30, 2003. This decrease in gross margin is related, among other things, to the lower margin contributed by our customer premise equipment sales and maintenance businesses, decreased margins of certain web hosting and bundled products, and FCC-mandated decreases in carrier access and service;

22• usage-based charges to end-users for local and toll calls in certain markets;

~~interconnection~~• charges ~~revenues.~~for ~~Gross~~additional ~~margin~~services isand ~~calculated~~features assuch ~~revenues less network expenses, divided by revenues. We expect our gross margins to improve~~ as wecall ~~reject~~waiting ~~burdensome network contracts~~ and~~/or enter~~ ~~into~~call ~~amendments or new contracts with lower costs and as we realize cost efficiencies in our network expenses over time.~~ forwarding;

~~Network~~• certain ~~expenses~~non-recurring ~~include:~~charges, such as set-up and installation charges; and

~~Network~~• carrier ~~expenses~~access doand ~~not~~interconnection ~~include~~revenues anfrom ~~allocation~~switched ofaccess ~~our~~charges ~~depreciation~~to orlong distance ~~amortization~~carriers ~~expenses.~~and reciprocal compensation charges to other local carriers.

~~The costs~~We toexpect ~~lease~~ local ~~loop~~voice service ~~lines,~~revenues ~~high-capacity~~to ~~digital~~continue ~~T-1~~to ~~loop~~decrease ~~lines,~~from ~~and~~period ~~high-capacity~~to ~~digital~~period ~~interoffice~~as ~~facilities~~a ~~from~~percent ~~the incumbent local~~of ~~exchange~~total ~~carriers~~revenues, ~~vary~~as bya ~~carrier~~result ~~and~~of byour ~~state~~increasing ~~and~~focus ~~are~~on ~~regulated~~integrated ~~under~~voice, ~~the~~data and ~~Telecommunications~~customer ~~Act~~premise ofequipment ~~1996.~~sales Inand ~~virtually all areas~~services, wethe ~~lease~~resolution ~~local~~of ~~loop~~certain regulatory ~~lines~~disputes and ~~high-capacity~~uncertainties ~~digital T-1~~and ~~loop~~lower ~~lines~~rates ~~from~~for ~~the~~carrier ~~incumbent~~access ~~local~~and interconnection ~~exchange~~revenues ~~carriers~~as tomandated ~~connect~~by our ~~customers'~~negotiated ~~premises~~agreements towith carriers, ~~our transmission equipment colocated in~~ the ~~central~~FCC ~~offices~~and ofcertain ~~the incumbent carriers~~states. ~~In the~~We ~~areas~~are ofcurrently ~~low~~examining ~~density~~certain ~~and~~of these ~~traffic~~negotiated inaccess ~~the~~agreements ~~metropolitan~~to ~~areas~~determine ~~that~~which weof ~~serve,~~those weexecutory contracts ~~also~~may ~~depend~~be onburdensome ~~the incumbent local exchange carriers~~ to ~~provide~~ us ~~high-capacity~~and ~~digital~~should ~~interoffice facilities~~be torejected ~~connect~~pursuant ~~our switch~~ to Section 365 ~~our~~of ~~transmission equipment colocated in~~ the ~~incumbents'~~Bankruptcy ~~central offices~~Code. InThere ~~the~~can ~~areas~~be ofno ~~high~~assurance ~~density~~that ~~and~~we ~~traffic~~will be inable ~~our markets, in addition~~ to ~~the~~reject ~~incumbent carriers,~~these ~~there~~access ~~are~~agreements; ~~other~~if ~~carriers from whom~~ we ~~lease~~are ~~high-capacity~~able ~~digital~~to ~~interoffice~~reject ~~facilities;~~such agreements, we ~~can~~believe ~~generally~~these ~~lease~~other ~~those~~carriers ~~interoffice~~would ~~facilities~~need atto ~~lower~~pay orus ~~comparable~~for ~~prices~~access ~~and~~at ~~with~~our higher ~~network~~tariffed ~~reliability~~rates ~~than~~which ~~those~~could ~~interoffice~~increase ~~facilities~~our ~~provided~~access byrevenues ~~the~~from ~~incumbent local exchange~~ these carriers. WeSee ~~have~~the ~~increasingly~~discussion ~~focused~~under on“Risk ~~obtaining~~Factors,” ~~these~~which ~~high-capacity~~contains ~~digital~~a detailed ~~interoffice~~discussion ~~facilities on dedicated fiber. Even in areas~~ of ~~high~~the ~~density~~risks and ~~traffic~~uncertainties inassociated with our ~~markets, however, the incumbent~~ local ~~exchange carriers are sometimes the only available source of~~voice ~~high-capacity digital interoffice facilities~~revenues.

Long distance service revenues for the three months ended September 30, 2003 and 2002 were $9.8 million and $12.7 million, and for the nine months ended September 30, 2003 and 2002 were $32.4 million and $35.5 million, respectively. Long distance service revenues as a percent of total revenues has decreased from approximately 6% for the quarter ended September 30, 2002 to approximately 5% for the quarter ended September 30, 2003. We have negotiated a new long ~~expect~~distance agreement with a new long-distance provider that ~~our~~should ~~network~~reduce our costs into ~~absolute~~provide ~~dollars~~long ~~will~~distance ~~increase~~services ~~with~~to ~~customer~~our ~~volume~~customers and ~~sales~~allow us to be more competitive in the pricing of our ~~products~~long ~~and~~distance services. ~~and~~We ~~will~~have bealso filed a ~~significant~~motion ~~part~~to ofreject our ~~ongoing~~existing Master Carrier Agreement with AT&T. If approved our variable cost ofper minute for long distance services will decrease. We are currently in negotiations with AT&T. We are currently in the process of balancing our long distance traffic between our new carrier and our existing carrier, and we expect to realize cost savings as this process is completed.

23Data revenues, including revenues generated from Internet access, web hosting and high-speed data services, for the three months ended September 30, 2003 and 2002 were $69.7 million and $70.0 million, and for the nine months ended September 30, 2003 and 2002 were $212.2 million and $202.2 million, respectively. Data revenues as a percent of total revenues has increased from approximately 32% for the quarter ended September 30, 2002 to approximately 37% for the quarter ended September 30, 2003. We also believe that the continuing evolution of communications networks will promote the integration of voice and data services over the same facilities, thereby further increasing the availability of cost-effective data offerings.

InThe rate of growth in our ~~accounting~~data ~~for~~revenues ~~the~~has ~~costs~~been ofaffected ~~constructing~~by ~~switching~~negative ~~and~~trends. ~~transmission~~We ~~equipment~~believe that the demand for high-end web hosting services has decreased in response to a ~~new~~general economic ~~market~~slowdown. Moreover, an over capacity of data center space has decreased prices for these high-end services. High-end services include dedicated hosting services where we ~~capitalized~~provide asthe customer with a ~~component~~dedicated computer ofserver ~~property~~in our data centers and ~~equipment~~colocation ~~only~~services where we provide data center space and services for a customer who locates its own computer server on our premises. We believe that the ~~initial~~general economic slowdown has ~~non-recurring~~caused ~~charges~~a ~~associated~~deterioration ~~with~~in our ~~network~~shared ~~facilities~~hosting business as well. We are currently exploring the potential sale of our shared web hosting business and any sale of this business would decrease our shared web hosting data revenues.

~~We incur~~Similarly, ~~"reciprocal~~the ~~compensation"~~demand ~~costs in providing both voice and data~~ for services ~~and~~we ~~expect~~offer ~~reciprocal compensation costs~~ to benetwork aservice ~~major~~providers ~~portion~~who ofprovide ~~our~~dial-up ~~cost~~Internet access of services. Weis ~~must~~also ~~enter into~~experiencing ~~an interconnection agreement with~~ the ~~incumbent~~effects ~~local~~of ~~exchange~~over ~~carrier~~capacity ~~in each market we provide service to make widespread calling available to our customers~~ and ~~these agreements are approved by~~decreased ~~the state regulatory agency~~demand. ~~These~~The ~~agreements~~resulting ~~typically~~financial ~~set~~hardship ~~the~~has ~~cost~~lessened ~~per minute to be charged by each party for~~ the ~~calls~~number ~~that~~of ~~are~~these ~~exchanged between the two carriers' networks. Generally, a carrier~~types ~~must~~of ~~compensate another carrier when a local call by the first carrier's customer terminates on the other carrier's~~ network. ~~These~~service ~~reciprocal compensation costs are a variable cost that will grow as our customers' outbound calling volume grows~~providers. ~~Over~~During ~~time~~2000, ~~the rates for reciprocal compensation have decreased and in some of our markets,~~ we ~~exchange~~signed ~~local traffic with the incumbent local carrier on~~ a ~~bill~~long-~~and-keep~~term ~~basis~~contract ~~(which generally means that neither carrier pays for the traffic that moves across the other carrier's network). We also incur switched access charges for~~to ~~intrastate~~provide ~~toll~~an ~~traffic we exchange with other carriers. The rates for intrastate access traffic are regulated by state authorities and are usually contained in carriers' access tariffs.~~ integrated

The cost of securing long distance service capacity is a variable cost that increases in direct relationship to increases in our customer base and increases in long distance calling volumes. We have entered into a new long distance agreement and have filed a motion with the Bankruptcy Court to reject our existing long distance agreement. Although there can be no assurances that the Bankruptcy Court grants this motion, if we are successful, our variable cost per minute for long distance services will decrease. If we are unsuccessful in rejecting this contract, we are required under that contract to spend a minimum dollar amount each month. 20

Wenetwork solution ~~install~~and ~~voice~~certain ~~and~~services ~~data~~to ~~aggregation~~Genuity Solutions Inc., a network services provider and ~~switching~~operator ~~equipment~~of ina ~~space~~nationwide ~~owned~~Internet ornetwork. ~~leased~~Our bycontract ~~other~~was established ~~parties~~specifically to support Genuity’s customer contracts, including that ~~locating~~with ~~our~~America ~~equipment~~Online, inand ~~central~~expires ~~offices~~on ofDecember 31, ~~local~~2006. ~~incumbent~~Under ~~exchange~~this ~~carriers'~~contract, ~~networks~~Genuity committed to pay us an aggregate of $563.0 million Weover the ~~incur~~term ~~rent~~of the contract, subject to our performance under and ~~utility~~the ~~charges~~other interms and ~~leasing~~conditions ~~this~~of ~~space~~the contract. Genuity assigned our Integrated Network Solution Purchase Agreement to a subsidiary of Level 3 Communications, Inc. on February 4, 2003. We ~~expect~~anticipate ~~these~~that Level 3 ~~costs~~will continue to ~~generally~~be ~~remain~~our ~~constant~~largest incustomer for the ~~near~~ foreseeable future. asFor wethe dothree ~~not~~months ~~plan~~ended toSeptember 30, ~~expand~~2003 toand ~~additional~~2002, ~~colocation~~revenues ~~sites~~from this contract were $27.3 million Weand ~~are~~$26.2 million, inand for the nine ~~process~~months ofended ~~evaluating~~September 30, ~~our~~2003 ~~colocation~~and ~~space~~2002, ~~needs~~revenues asfrom ~~part~~this contract were $84.2 million and $60.5 million, respectively. The revenues from this contract accounted for 14% and 12% of our ~~bankruptcy~~total revenues for the quarters ended September 30, 2003 and we2002, ~~may~~respectively, ~~reduce~~and 39% and 37% of our data revenues for the ~~number~~same periods. In addition, approximately 85% of ~~colocations~~the reciprocal ~~that~~compensation weearned ~~are~~by ~~currently~~us ~~occupying~~from ~~which~~other ~~could~~carriers ~~reduce~~is as a result of the other carriers terminating Level 3 traffic on our networks. Reciprocal ~~colocation~~compensation ~~expenses~~revenues for the three months ended September 30, 2003 and 2002 were $4.0 million and $7.1 million and for the nine months ended September 30, 2003 and 2002 were $19.8 million and $25.0 million, respectively.

WeThe contract contains specific provisions that allow Level 3 to ~~sell~~(a) ~~and~~decrease ~~install~~its ~~telecommunications~~purchase commitment in certain situations, including but not limited to, if Level 3’s customer, ~~premise~~AOL, ~~equipment~~reduces ~~and~~its ~~provide~~services ~~maintenance~~with Level 3 under Level 3’s service relationship with AOL or (b) to decrease the purchase commitment or terminate the contract if Level 3 receives a bona fide competitive offer for a certain amount of services from a third party for services similar in type to the services provided by Company under the contract and the Company does not agree to reduce its prices to match the competitive offer. In the event, Level 3 is required to use commercially reasonable efforts to move some of its existing business to Allegiance to minimize the effect of any downturn of business on Allegiance. In addition, Level 3 is obligated to allocate any such ~~equipment~~discontinuance of business proportionately across all of Level 3’s suppliers serving the area in which AOL requests a discontinuance of service. Level 3 ~~Our~~is ~~costs~~obligated when practicable to ~~provide~~give ~~these~~us ~~products~~ninety ~~and~~days ~~services~~written notice ~~include~~of ~~both~~any ~~time and~~discontinuance ~~material~~of ~~costs~~service as a result of a downturn in business from AOL. ~~These~~Finally, ~~costs~~Level 3 ~~will~~may ~~increase~~not orexercise ~~decrease~~its right to reduce its service as a result of a downturn in ~~relation~~business from AOL under the contract until after October 1, 2003. Level 3 has informally told us that it expects to suffer a downturn in business from AOL, but Level 3 has not provided us with any formal notice under the ~~demand~~contract ~~for~~of ~~these~~the ~~products~~amount ~~and~~of ~~services.~~downturn we will experience.

WeLevel 3 has indicated to the Company that in its contract with AOL, ~~have~~Level ~~developed~~3 has agreed to a ~~national~~scheduled ~~Internet~~reduction ~~data~~in ~~network~~services bybeginning ~~connecting~~in ~~our~~the ~~markets~~third quarter ~~with~~of ~~leased~~2004 ~~high-capacity~~through ~~digital~~the ~~lines~~fourth quarter of 2004. Level ~~The~~3 ~~costs~~has also told the Company that as a result of ~~these~~such scheduled ~~lines~~downturn, ~~will~~Level ~~increase~~3 ifexpects weto ~~need~~pass through a downturn of at least 39% of the managed modem ports provided by the Company to Level 3 starting in the ~~increase~~third ~~capacity~~quarter of 2004 through the fourth quarter of 2004 in addition to ~~address~~any downturn ~~increased~~related ~~customer~~to a reduction in demand for services from AOL. The Company plans to oppose any pass through of the scheduled downturn in services from AOL. In the event that Level 3 is successful in passing through the scheduled downturn to the Company, the Company is unable at this time to determine with any certainty the revenue impact, if any, of such a pass through.

WeIn the event that ~~currently~~Level ~~have~~3 receives a ~~number~~competitive ofoffer ~~settlement-free~~from ~~peering~~a ~~arrangements~~third ~~with~~party ~~other~~under ~~Internet~~the ~~backbone~~contract ~~providers.~~and Allegiance ~~Most~~does ofnot ~~these~~match ~~arrangements~~the ~~are~~competitive offer, Level 3 may either reduce the ~~month-~~purchase commitment under the contract to~~-month~~ ~~and~~the ~~generally~~amount ~~can~~of beservices ~~terminated~~covered by ~~either~~the competitive ~~party~~offer ~~upon~~or ~~notice.~~terminate the contract in its entirety. If wethe ~~lose~~Company ~~any~~matches ofa ~~these~~qualifying ~~arrangements~~competitive offer, orAllegiance ifwill experience reduced revenues under the ~~other~~contract. Level ~~Internet~~3 ~~backbone~~has ~~provider~~indicated ~~requires~~that ~~payment~~it bybelieves that usthe prices for the ~~exchange~~services ofunder ~~traffic,~~the ~~our~~contract ~~network~~are ~~costs~~above market and that it may seek ~~materially~~competitive ~~increase~~offers from third parties in conformance with the contract. If Level 3 does receive a competitive offer that complies with the contract’s requirements, the Company could experience reduced revenues under the contract.

~~Selling~~The contract also provides that if we receive a going concern qualification or experience an event of default as defined under our senior credit agreement, ~~General~~(a) Level 3 may exercise an option to purchase all of the dedicated assets and infrastructure ~~Administrative~~used ~~Expenses~~ by us to provide the integrated network solution to Level 3 and (b) Level 3 would still be required to continue to purchase certain services from us for the remainder of the term of the agreement. If Level 3 exercises its option, it would be required to pay (1) for the dedicated assets, the remaining undepreciated value of the dedicated assets (as reflected on our books at the time of exercise of the option) and (2) for the certain services, the remaining overall value of the agreement less the amounts paid to purchase the dedicated assets and infrastructure. Any such purchase transaction would require Bankruptcy Court approval. We have not received any notice from Level 3 that it intends to exercise its rights under this provision of the agreement.

~~For~~We ~~the~~have ~~quarters~~received communications ~~ended~~from ~~June~~Level 303 claiming, ~~2003~~among ~~and~~other ~~2002~~things, ~~selling,~~that ~~general~~we ~~and~~have failed ~~administrative~~to ~~expenses~~meet ~~were~~the ~~$98.6 million~~applicable performance warranties under the contract; and that ~~$110.2~~certain rights that Level ~~million,~~3 ~~and~~has ~~for~~ under the ~~six~~contract, ~~months~~including, ~~ended~~but not ~~June 30~~limited to, ~~2003~~Level 3’s ability to require us to secure another subcontractor for certain services and/or ~~2002~~Level 3 can terminate our ability to supply such services, ~~selling~~may already be triggered. In addition, ~~general~~Level 3 ~~and~~has claimed ~~administrative~~that ~~expenses~~it ~~were~~is ~~$215.1~~entitled to offsets against the August ~~million~~2003 and November ~~$212~~2003 payments for Allegiance’s alleged failure to deliver certain services.~~0 million~~ Finally, ~~respectively~~Level 3 has alleged that the Company's failure to deliver certain services may constitute a breach of the contract. We ~~Selling,~~do ~~general~~not ~~and~~believe ~~administrative~~that ~~expenses~~we ~~related~~have failed to meet the ~~Shared~~performance ~~Technologies~~warranties ~~business~~alleged by Level 3; we do not believe that we have failed to deliver the services alleged by Level 3; we do not believe that we have breached the contract; nor do we believe that, ~~acquired~~even if Allegiance has not delivered the services in ~~June 2002~~accordance with the contract, ~~included~~that the offset amounts claimed by Level 3 are calculated in accordance with the contract. If we are found to have failed to meet the performance warranties under the contract, Level 3 may offset future payments to us and, if such failure continues for an extended period of time, Level 3 could terminate the contract.

24If the Company experiences a downturn in its services with Level 3, the Company may offer similar services to other internet service providers, except AOL among others. If Level 3 terminates the contract the Company may offer services in competition with Level 3 to AOL and all other Internet service providers. If we were to lose some or all of the revenues under this contract, we do not believe we could implement sufficient cost-cutting measures to offset such decrease in revenues. The resulting reduction in revenue (including reduction in reciprocal compensation revenues) and/or loss of this contract would have a material adverse effect on our business. We are continuing our negotiations with Level 3 to modify certain service level warranties, remedies and penalties under the contract, as well as other modifications to the contract. We can provide no assurances that these negotiations will be successfully concluded.

~~the quarters~~On ~~ended~~November ~~June 30~~3, 2003, Level ~~and~~3 ~~2002~~paid ~~were~~Allegiance approximately $1113.9 million ~~and~~of the $~~1.1~~25 million, ~~and~~quarterly ~~for~~payment due in November 2003. Level 3 offset against the ~~six~~quarterly ~~months~~payment ~~ended~~approximately ~~June~~$89 ~~30,~~thousand ~~2003~~for ~~and~~certain offsets ~~2002~~that ~~were~~Level ~~$24~~3 claims it is due for Allegiance’s alleged failure to deliver certain ports.~~7 million~~ ~~and~~In addition, Level 3 has withheld approximately $111.10 million, ~~respectively.~~of ~~Selling,~~the ~~general~~November 2003 ~~and~~payment ~~administrative~~until ~~expenses~~Level as3 ahas ~~percentage~~an order from the Bankruptcy Court confirming Level 3’s reservation of ~~total~~rights ~~revenues~~with respect ~~decreased~~to ~~from~~Level ~~60%~~3’s claims for ~~the~~offsets. ~~quarter~~Allegiance ~~ended~~vigorously ~~June 30,~~denies ~~2002~~that Level 3 is entitled to ~~50%~~any ~~for~~of the ~~quarter ended~~offsets ~~June 30,~~claimed ~~2003.~~by Level 3.

Selling, general and administrative expenses have decreased due to our cost containment efforts (including a decrease in our headcount), increased collection efforts, which have resulted in a decrease in bad debt expense, and the achievement of certain economies of scale as we have grown the business. During the six months ended June 30, 2003, these decreases were offset by the inclusion of selling, general and administrative expenses related to the Shared Technologies business and by $8.7 million of employee bonuses paid including those under a key employee retention program, causing an overall increase in selling, general and administrative expenses compared to the six months ended June 30, 2002. 21

~~Selling,~~Notwithstanding these ~~general~~trends and ~~administrative expenses include salaries~~uncertainties, ~~benefits~~we ~~and~~expect ~~related~~continued ~~personnel~~demand ~~costs,~~by ~~administration~~small and ~~facilities~~medium ~~costs, sales and marketing costs, customer care and~~sized ~~billing~~business ~~costs,~~customers ~~investor and~~for ~~media~~dedicated ~~relations,~~access ~~insurance,~~to ~~professional~~the ~~fees~~Internet and ~~bad debt expense~~integrated services. AsIndeed, ~~a result of~~ our ~~transition~~Integrated ~~from~~Access ~~rapid~~Service ~~revenue~~which ~~growth~~delivers tohigh-speed, “always aon” ~~plan~~Internet ~~geared~~access ~~towards reducing cash used in operations~~ and ~~achieving positive~~allows ~~cash~~multiple ~~flow~~voice, wedata ~~reduced headcount, including the number of sales teams during the second half of 2002~~ and ~~first~~Internet combinations ~~half~~over ofa ~~2003.~~single ~~Our~~access ~~total~~loop ~~headcount~~remains ~~decreased~~our ~~from~~fastest ~~4,628~~growing ~~at June 30, 2002 to~~product ~~3,312~~offering. atDuring ~~June 30,~~the ~~2003.~~quarter Asended ~~of June~~September 30, 2003, ~~the~~Integrated ~~sales~~Access Service ~~force,~~represented ~~including~~approximately ~~sales~~37% ~~managers~~of ~~and~~our ~~sales~~net ~~administrators,~~lines ~~had~~sold ~~decreased~~for tothe ~~961 from 1,433 as of June 30, 2002. We expect~~quarter ~~selling, general~~ (and ~~administrative~~when ~~expenses~~including toall ~~continue~~services todelivered ~~decrease~~via asT1 acircuits, ~~percentage~~54% of ~~revenues as we focus on reducing cash used, integrating~~ our ~~operations~~net lines ~~and~~sold ~~achieving~~for ~~economies~~the ~~of scale in our business~~quarter). We ~~are~~believe ~~analyzing~~that ~~our~~line ~~contracts~~churn ~~and~~rates ~~leases~~(the torate ~~determine~~at which ~~those~~customers ~~executory~~disconnect ~~contracts~~their ~~and~~lines) ~~unexpired~~for ~~leases~~Integrated ~~relating~~Access toService ~~our~~when voice ~~selling, general~~ and ~~administrative~~data ~~expenses~~are ~~that~~bundled ~~may~~is belower ~~burdensome~~than ~~to us~~that ~~and~~of ~~should~~our belocal ~~rejected~~voice ~~pursuant~~service. ~~to Section 365~~ One of the ~~Bankruptcy~~challenges ~~Code. If~~ we ~~receive~~face ~~Bankruptcy~~in ~~Court~~this ~~approval~~area tois ~~reject~~ongoing ~~any~~network ofefficiency ~~these executory contracts or unexpired leases, we expect our~~and ~~future~~service ~~selling,~~delivery ~~general~~improvements ~~and~~to ~~administrative~~retain ~~costs~~the tocompetitive ~~decrease~~advantages asof athis service ~~result~~offering.

~~Depreciation~~ In June 2002, we acquired substantially all of the assets and assumed certain liabilities of the customer premise equipment sales and customer premise equipment maintenance business, also known as Shared Technologies Fairchild, from WorldCom. Customer premise equipment sales and maintenance revenues for the three months ended September 30, 2003 and 2002 were $27.8 million and $40.3 million and for the nine months ended September 30, 2003 and 2002 were $91.1 million and $45.7 million, respectively. Customer premise equipment sales and maintenance revenues as a percent of total revenues is approximately 15% and 18% for the quarters ended September 30, 2003 and 2002. As a result of our bankruptcy, until we received Bankruptcy Court authority to procure limited bid and performance bonds on October 8, 2003, we had not been able to obtain certain bid and performance bonds or provide other types of financial security as required by many of our customers. As a result, we have lost current customers to our competitors and have a reduced ability to gain new customers. Moreover, some customers will not purchase services from companies in bankruptcy, so certain opportunities are not available to us. The loss of current and potential customers has impacted our revenues and will continue to impact our revenues as long as these conditions exist.

~~During~~Network the quarters ended June 30, 2003 and 2002, depreciation expense was $62.3 million and $63.0 million, respectively. For the six months ended June 30, 2003 and 2002, depreciation expense was $125.8 million and $120.7 million, respectively. The increase is primarily the result of capital expenditures and assets placed in service between June 30, 2002 and June 30, 2003. Expenses

~~Amortization~~For the quarters ended September 30, 2003 and 2002, network expenses were $96.8 million and $118.3 million, and for the nine months ended September 30, 2003 and 2002, network expenses were $313.2 million and $295.7 million, respectively. Network expenses related to the Shared Technologies business, acquired in June 2002, included in the quarters ended September 30, 2003 and 2002 were $16.8 million and $23.7 million, and for the nine months ended September 30, 2003 and 2002 were $53.9 million and $27.9 million, respectively. Network expenses as a percentage of ~~Purchased~~total revenues ~~Intangibles~~ decreased from 54% for the quarter ended September 30, 2002 to 51% for the quarter ended September 30, 2003. While there can be no assurance that we will be successful in creating or continuing the existing operating efficiencies, we expect to control costs and that network expenses as a percentage of total revenues will reduce over time. We are performing an extensive review of our network architecture and a rationalization of the overall profitability of our business on a colocation, market, and product basis. As such, we may decommission a colocation arrangement, rebuild or replace infrastructure facilities and reduce or sell entire markets. In addition, we may eliminate some products and services currently offered. As a result of such events, we may be able to reduce our future network costs. With respect to the implementation of this review and rationalization, we may convert a limited number of facilities-based customers to UNE-P, deploy alternate unbundled network element applications, or, in some instances, eliminate a colocation, product or service completely. In addition, we are analyzing our contracts and leases to determine those executory contracts and unexpired leases relating to our network that may be burdensome to us and should be rejected pursuant to Section 365 of the Bankruptcy Code. If we receive Bankruptcy Court approval to reject any of these executory contracts or unexpired leases, we expect our future network costs to decrease as a result.

InGross ~~connection~~margin ~~with~~has increased ~~the~~from ~~acquisitions~~46% ~~completed~~for ~~since~~the ~~inception~~quarter ended September 30, we2002 ~~assigned~~to an49% ~~aggregate~~for ofthe quarter ~~$62.8~~ended September ~~million~~30, of2003. ~~the~~The ~~purchase~~increase ~~price~~in togross ~~customer~~margin ~~lists.~~is ~~These~~related, ~~intangible~~among ~~assets~~other ~~are~~things ~~being~~to ~~amortized~~reduced ~~over~~network ~~their~~expenses ~~estimated~~related ~~useful~~to ~~lives~~network ofoptimization activities, ~~one~~as towell ~~three~~as ~~years.~~reductions ~~For~~in network expenses associated with the bankruptcy ~~quarters~~process. Gross ~~ended~~margin ~~June 30,~~is calculated ~~2003~~as ~~and~~revenues ~~2002~~less network expenses, wedivided ~~recorded~~by $3revenues.~~0 million~~ ~~and~~We expect ~~$8.5 million~~our ofgross ~~amortization~~margins ofto ~~customer~~improve ~~lists,~~as ~~and~~we ~~for~~reject ~~the~~burdensome ~~six~~network ~~months~~contracts ~~ended~~and ~~June 30,~~/or enter ~~2003~~into ~~and~~amendments ~~2002,~~or wenew ~~recorded~~contracts ~~$6.1 million~~with ~~and~~lower ~~$18.8 million~~costs ofand ~~amortization~~as ofwe ~~customer~~realize cost ~~lists,~~efficiencies ~~respectively.~~in our network over time.

~~Deferred~~Network ~~Compensation Expenses~~ expenses include:

~~For~~ • the ~~quarters ended June 30, 2003 and 2002, we recognized $0.7 million and $0.1 million, respectively, of amortization of deferred~~ ~~compensation~~cost ~~expense, and for the six months ended June 30, 2003 and 2002, we recognized $1.6 million and $0.5 million, respectively,~~ of ~~amortization~~leasing oflocal ~~deferred~~loop ~~compensation expense.~~lines ~~Such~~which ~~deferred~~connect ~~compensation~~our ~~was~~customers ~~recorded in connection with membership units of Allegiance Telecom, LLC sold~~ to ~~certain~~our ~~management employees and grants of stock options and~~ network;

25• the cost of leasing high-capacity digital lines that interconnect our network and with the networks of the incumbent local exchange carriers;

~~restricted~~• the ~~common~~cost ~~shares~~of toleasing ~~certain~~high-capacity ~~employees~~digital ~~under~~lines that connect our ~~1997~~switching equipment ~~stock~~to ~~option~~our ~~plan~~transmission ~~and~~equipment ~~1998~~located ~~stock~~in ~~incentive~~the ~~plan.~~central offices of the incumbent local exchange carrier;

~~Interest Expense and Interest Income~~ 22

~~For~~ • the ~~three months ended June 30, 2003 and 2002 and the six months ended June 30, 2003 and 2002, interest expense was $19.0 million,~~ ~~$25.3 million,~~cost ~~$48.5 million and $49.4 million, respectively. Prior to the Commencement Date~~ of ~~our~~enhancing Chapter 11 cases, interest expense included the accretion of the 113/4% notes and related amortization of the original issue discount, the amortization of the original issue discount on the 127/8% notes, and the interest charges and amortization of deferred debt issuance costs related to our $500 million senior secured credit facilities. As of the Commencement Date of our Chapter 11 cases, we stopped recording interest expense on the 113/4% notes and the 127/8% notes in accordance with Statement of Position 90-7. Additionally, the deferred debt issuance costs related to this debt are no longer being amortized to interest expense. Under a Bankruptcy Court order, we are required to continue incurring and paying interest under our senior secured credit facilities and we have continued to amortize the deferred debt issuance costs related to the senior secured credit facilities to interest expense. network;

~~Interest~~• the ~~income~~cost ~~for~~of ~~three~~completing ~~and six months ended June 30~~local, ~~2003~~toll ~~was $0.8 million~~ and ~~$1.8 million,~~long ~~respectively.~~distance ~~Interest~~calls ~~income~~originated ~~for~~by ~~three and six months ended~~our ~~June 30~~customers, ~~2002~~including ~~was~~switched ~~$2.1 million~~access and ~~$3.8 million,~~reciprocal ~~respectively.~~compensation ~~Interest~~charges ~~income results from short-term investments, cash and cash equivalents. Interest income during~~paid ~~the~~by ~~periods ended June 30, 2002 is greater than for the periods ended June 30, 2003 because we had additional cash invested in interest-bearing instruments and because of higher average interest rates.~~ us;

~~During~~ • the cost ~~three months ended June 30, 2003, at the direction~~ of ~~the~~long USdistance ~~Trustee~~services inresold ~~our~~by ~~Chapter~~us ~~11 cases, we sold an investment in commercial paper in the open market in order~~ to ~~comply~~ ~~with~~ our ~~revised investment guidelines. The sale was at market value and resulted in the realization of a gain of $3.3 million.~~ customers;

~~Operating~~• the cost ~~Losses~~ of leasing space in incumbent local exchange carrier central offices and the cost of electric power purchased from the incumbent for colocating our transmission equipment;

~~Our loss from operations for the three~~ • operating and ~~six~~maintenance ~~months~~expenses ~~ended June 30, 2003 was $75.0 million and $166.0 million, respectively. Our loss from operations~~ for ~~the~~dark ~~three and six months ended June 30, 2002 was $203.5 million and $293.8 million, respectively.~~ fiber;

~~Reorganization~~• the cost ~~Items~~ of customer premise equipment which has been sold by us and the cost of providing maintenance services on such equipment;

~~Reorganization items consist of costs associated with our bankruptcy proceedings that are not directly attributable to~~ • the cost ~~ongoing operations~~ of ~~our~~Internet ~~business. During~~transit ~~the three~~ and six months ended June 30, 2003, we incurred $3.0 million and $3.6 million, respectively, in professional fees and recognized a gain of $0.5 million and $0.5 million, respectively, related to other restructuring activities. We expect to continue to incur significant costs associated with our reorganization. transport;

26• the cost of leasing certain portions of our nationwide Internet network; and

~~LIQUIDITY~~• for Shared ~~AND~~Technologies, ~~CAPITAL~~the ~~RESOURCES~~ costs of equipment and labor for the installation and maintenance of equipment.

AsNetwork of June 30, 2003, we had approximately $269.2 million of unrestricted cash and short-term investments, compared with $284.3 million of unrestricted cash and short-term investments as of December 31, 2002. The 5% decrease during 2003 is primarily due to the funding of our operating losses, restructuring expenses, ~~interest payments on debt, capital expenditures, and working capital requirements, partially offset by cash generated from investments. We~~ do not ~~have any~~ ~~off-balance~~include ~~sheet~~an ~~financing~~allocation ~~arrangements, special purpose entities or asset securitizations. On June 23, 2003, we received final Bankruptcy Court approval for the use~~ of our ~~cash collateral~~depreciation ~~under~~or aamortization ~~Final Order Authorizing Use of Cash Collateral by Consent (the "Final Cash Collateral Order")~~expenses. The Final Cash Collateral Order among other things: (1) restricts our use of cash, (2) requires us to prepare and follow a budget and maintain a minimum weekly cash balance, and (3) requires us to provide certain financial, operational and other information to our senior lenders. Under this Final Cash Collateral Order, we are required to continue incurring and paying interest under our senior secured credit agreement (at the applicable non-default rate of interest).

AsThe costs to lease local ofloop ~~June 30~~lines, ~~2003,~~high-capacity wedigital ~~had~~T-1 ~~approximately~~loop $1lines,~~355.5 million~~ ofand ~~outstanding~~high-capacity ~~liabilities~~digital interoffice ~~subject~~facilities tofrom ~~compromise,~~the ~~including~~incumbent ~~$1,108.1 million~~local ofexchange ~~indebtedness~~carriers ~~(including~~vary by ~~debt~~carrier and by state and are regulated under ~~our~~the ~~senior~~Telecommunications ~~secured~~Act ~~credit~~of 1996. ~~agreement~~In virtually all areas, we lease local loop lines and ~~two~~high-capacity digital ~~series~~T-1 ofloop ~~bonds).~~lines Wefrom ~~are~~the ~~party~~incumbent local exchange carriers to aconnect our ~~senior~~customers’ ~~secured~~premises ~~credit~~to ~~agreement~~our ~~and~~transmission ~~two~~equipment ~~indentures~~colocated in the central offices of the incumbent carriers. AsIn the areas of ~~June 30,~~low ~~2003~~density and traffic in the metropolitan areas that we serve, ~~approximately~~we also depend on the incumbent local ~~$465.3 million~~exchange ofcarriers ~~our~~to ~~indebtedness~~provide ~~was~~us ~~borrowed~~high-capacity ~~under~~digital interoffice facilities to connect our ~~senior~~switch ~~secured~~to ~~credit~~our ~~agreement,~~transmission asequipment ~~described~~colocated in ~~more~~the ~~detail~~incumbents’ central ~~below~~offices. AsIn the areas of ~~that~~high ~~same~~density ~~date~~and traffic in our markets, ~~approximately~~in addition ~~$642~~to the incumbent carriers, there are other carriers from whom we lease high-capacity digital interoffice facilities; we can generally lease those interoffice facilities at lower or comparable prices and with higher network reliability than those interoffice facilities provided by the incumbent local exchange carriers.~~8 million~~ We have increasingly focused on obtaining these high-capacity digital interoffice facilities on dedicated fiber. Even in areas of ~~our~~high ~~indebtedness~~density ~~was~~and ~~borrowed~~traffic ~~under~~in our ~~two~~markets, ~~indentures.~~however, the incumbent local exchange carriers are sometimes the only available source of high-capacity digital interoffice facilities.

~~Our existing~~We ~~cash~~expect and short-term investment balances will decline further during fiscal 2003. Decreased demand for our services or high customer churn, as noted above, could adversely impact our liquidity. Customer demand for our services depends in part on our ability to efficiently and timely switch customers from their prior carrier to our service, respond to customer service and billing issues and provide quality service. Given our bankruptcy filing, the continued poor economic environment as well as the instability and bankruptcies of customers and others in the telecom industry and their subsequent negative impact on our performance in 2002, we do not believe that ~~we have raised the capital necessary to build and operate~~ our network ~~in each of our 36 markets to the point at which operating cash flow from the market is sufficient to fund its ongoing operating~~ costs ~~and capital expenditures. We expect to reduce our debt in the bankruptcy reorganization process; however, at this time, we cannot predict the levels of debt that we~~ will ~~maintain~~continue ~~after the reorganization process is complete. It is possible that if the debt reduction is not enough, because of operating performance or other factors, we still may not be able~~ to ~~fully fund our operations, planned capital investments and debt service. One result of our recapitalization would~~ be a ~~substantial~~ ~~reduction~~significant inpart ~~the value~~ of our ~~high~~ongoing ~~yield~~cost ~~debt securities and common stock, potentially to zero. Please see the discussion below under the caption "Senior Secured Credit Agreement" and~~of ~~above under the caption "Risk Factors~~services."

~~Our financial~~In ~~projections~~accounting ~~are~~for ~~based~~the costs ~~on forecasts~~ of, ~~among~~constructing ~~other~~switching ~~things, customer demand~~ and ~~line~~transmission ~~churn,~~equipment ~~i.e. the rate at which customers discontinue their lines. Customers leave our service~~ for a ~~variety~~new ~~of reasons, including but not limited to, the customer: (a) leaving our service area, (b) going out of business or downsizing its business, (c) being unhappy with our service, (d) general~~ market ~~conditions~~, ~~(e) leaving for better pricing, (f) needing a different telecom solution that~~ we ~~do not provide, (g) disruptions in service~~ ~~relating~~capitalized toas ~~our~~a ~~network~~component ~~optimization~~of ~~activities~~property and ~~(h) concern~~equipment ~~regarding~~only ~~our financial condition and~~ the ~~need for debt restructuring. In the quarter ended June 30, 2003, the average~~initial ~~retail~~non-recurring ~~line~~charges ~~churn~~associated ~~was~~with ~~approximately 2.7% and including wholesale,~~ our ~~average~~network ~~line churn was approximately 1~~facilities.8%. Line churn is the number of voice grade equivalent lines (for example, a fully- utilized data T-1 counts as 24 lines) that are disconnected each month divided by the total number of voice grade equivalent lines that we have in service at the beginning of that month. The line churn is difficult to forecast and remains one of the specific challenges on which we are. We expect that retail line churn as well as retail and wholesale line churn will range between 2% to 3% in 2003. We expect

27We incur “reciprocal compensation” costs in providing both voice and data services and expect reciprocal compensation costs to be a major portion of our cost of services. We must enter into an interconnection agreement with the incumbent local exchange carrier in each market we provide service to make widespread calling available to our customers and these agreements are approved by the state regulatory agency. These agreements typically set the cost per minute to be charged by each party for the calls that are exchanged between the two carriers’ networks. Generally, a carrier must compensate another carrier when a local call by the first carrier’s customer terminates on the other carrier’s network. These reciprocal compensation costs are a variable cost that will grow as our customers’ outbound calling volume grows. Over time, the rates for reciprocal compensation have decreased and in some of our markets, we exchange local traffic with the incumbent local carrier on a bill-and-keep basis (which generally means that neither carrier pays for the traffic that terminates on the other carrier’s network). We also incur switched access charges for intrastate toll traffic we exchange with other carriers. The rates for intrastate access traffic are regulated by state authorities and are usually contained in carriers’ access tariffs.

~~retail and~~The ~~wholesale~~cost ~~line~~of ~~churn~~securing tolong distance ~~improve~~service incapacity ~~2004~~is ~~and~~a ~~beyond.~~variable Wecost ~~have~~that ~~responded~~increases toin ~~high~~direct ~~line~~relationship to ~~churn~~increases ~~with~~in ~~many~~our customer ~~retention~~base ~~initiatives~~and ~~including,~~increases ~~new~~in ~~service~~long ~~offerings,~~distance ~~more attractive rate~~calling ~~plans,~~volumes. ~~back~~We ~~office~~have ~~improvements,~~entered ~~roll~~into ~~out~~a ofnew ~~Singl.eView~~long ~~billing~~distance ~~system,~~agreement ~~proactive contact with customers,~~ and ~~root~~have ~~cause~~filed ~~resolutions.~~a motion ~~The~~with ~~above~~the ~~churn~~Bankruptcy ~~metrics~~Court doto ~~not~~reject ~~include~~our ~~churn~~existing ~~related~~long todistance ~~businesses~~agreement. ~~such~~We asare ~~Shared~~currently ~~Technologies,~~engaged ~~Allegiance~~in ~~Business~~negotiations ~~Internet~~with ~~access services, or web hosting~~AT&T. Although Wethere can ~~provide~~be no assurances that wethe Bankruptcy ~~will~~Court begrants ~~able~~this tomotion, ~~effectively~~if ~~manage~~we orare ~~reduce~~successful, our ~~line~~variable ~~churn.~~cost per minute for long distance services will decrease. If we are ~~unable~~unsuccessful toin rejecting dothis socontract, ~~this~~we ~~will~~are ~~materially~~required ~~affect~~under ~~our~~that ~~business,~~contract ~~revenues~~to ~~and~~spend ~~liquidity.~~a minimum dollar amount each month.

Decreased customer demand may also stem from uncertainty of our bankruptcy filing, the industry in which we compete and the general economy. Many of our competitors have also declared bankruptcy, de-listed from the public securities markets and/or identified financing problems. Some of our potential customers as well as current customers have expressed concerns about our financial stability in light of our bankruptcy filing, the general economy and the telecommunications industry in general. We believe customer perception will continue to have an impact on our ability to attract and retain customers. Specifically, our financial condition has limited our ability to secure bid and performance bonds which are required by some customers of our customer premises equipment sales and maintenance business. Moreover, our customers may not purchase additional services and may cancel existing services as a result of our bankruptcy filing, our specific financial condition, including the independent auditors' report for 2002 that cites conditions which raise substantial doubt about our ability to continue as a going concern, and general economic conditions. We may reduce our presence in a number of colocations and this may impact customer service and increase customer churn. 23

~~For the~~We ~~quarters~~install ~~ended~~voice ~~June 30,~~and ~~2003~~data aggregation and ~~2002,~~switching weequipment ~~made~~in ~~capital~~space ~~expenditures~~owned ofor ~~$4.8 million~~leased ~~and~~by ~~$42.4 million,~~other ~~respectively. For the six months ended June 30~~parties, ~~2003~~including ~~and~~locating ~~2002,~~our weequipment ~~made~~in ~~capital~~central ~~expenditures~~offices of ~~$14.0 million~~local ~~and~~incumbent ~~$82.3 million,~~exchange carriers’ ~~respectively~~networks. AsWe ofincur ~~June 30,~~rent ~~2003,~~and weutility ~~had~~charges ~~transmission equipment colocated~~ in ~~851~~leasing ~~central~~this ~~offices~~space. We ~~Pursuant~~expect these costs to ~~our~~generally ~~current~~remain ~~business~~constant ~~plan,~~in wethe ~~expect~~near tofuture ~~spend~~as ~~approximately~~we ~~the~~do ~~same~~not plan ~~amount~~to ~~for~~expand ~~capital~~to ~~expenditures~~additional ~~for~~colocation ~~the~~sites. ~~last~~We ~~two~~are ~~quarters~~in the process of evaluating ~~2003~~our ascolocation ~~that~~space ~~spent~~needs ~~for~~as ~~the~~part ~~first~~of ~~two~~our ~~quarters~~bankruptcy ofand ~~2003.~~we Wemay ~~expect~~reduce tothe ~~fund~~number ~~our~~of ~~capital~~colocations ~~expenditures~~that ~~with~~we ~~available~~are ~~cash~~currently ~~and~~occupying ~~future~~which ~~cash~~could reduce ~~flow.~~our colocation expenses.

We ~~have~~ ~~purchased~~sell dedicated fiber rings in 24 of our markets. As of June 30, 2003, we had dedicated fiber rings in operation in 24 markets including Austin, Baltimore, Boston, Chicago, Dallas, Denver, Detroit, Ft. Worth, Houston, Long Island, Los Angeles, New York City, Northern New Jersey, Philadelphia, Phoenix, Pittsburgh, Portland, San Antonio, San Diego, San Francisco, St. Louis, Seattle, Washington, D.C., and ~~White~~install ~~Plains. We have also acquired long-haul point to point fiber connectivity between several markets in the northeast corridor. Our cost of~~telecommunications ~~fiber~~customer ~~includes~~premise ~~both the amounts we pay to the fiber provider as well as the cost of the electronic~~ equipment ~~that we purchase~~ and ~~install~~provide tomaintenance ~~make~~services ~~the~~on ~~fiber~~such ~~operational~~equipment. ~~As of June 30, 2003, our~~ ~~total~~Our costs ~~have been $191.9 million, and we are committed~~ to ~~spend~~provide ~~an additional $164.6 million for this fiber, which will be incurred over the life of~~ these ~~existing~~products ~~fiber~~and ~~supply arrangements~~services ~~ending~~include inboth ~~2023.~~time ~~We plan to fund this cost with our available cash~~ and ~~future cash flow~~material costs. WeThese ~~are~~costs ~~analyzing~~will ~~our~~increase ~~fiber~~or ~~contracts~~decrease in ~~light~~relation ~~of our bankruptcy and may need~~ to ~~reject certain of such contracts pursuant to Section 365 of~~ the ~~Bankruptcy~~demand ~~Code.~~for ~~Alternatively, we may attempt to re-negotiate~~ these ~~contracts with the vendors to obtain more reasonable terms in~~ ~~light~~products ofand ~~current market conditions~~services.

28We have developed a national Internet data network by connecting our markets with leased high-capacity digital lines. The costs of these lines will increase if we need to increase capacity to address increased customer demand.

~~Contractual~~We ~~Obligations~~ currently have a number of settlement-free peering arrangements with other Internet backbone providers. Most of these arrangements are month-to-month and generally can be terminated by either party upon notice. If we lose any of these arrangements or if the other Internet backbone provider requires payment by us for the exchange of traffic, our network costs may materially increase.

~~The following summarizes some of our future financial commitments at June 30~~Selling, ~~2003~~General and ~~the effect such obligations are expected to have on our liquidity~~Administrative ~~and cash flow in future periods:~~ Expenses

				Payments due by Period
Contractual Obligations (1)		Total		Less than 1 year		1 to 3 years		3 to 5 years		After 5 Years
		(dollars in millions)
Long-term debt(2)
Principal payments		$	1,123	$	30	$	320	$	568	$	205
	Interest payments		452		104		190		158		—
Capital lease obligations, including interest(3)			154		11		23		20		100
Operating leases			174		26		49		41		58
Other material long-term obligations(3)			65		26		33		6		—
Total contractual cash obligations		$	1,968	$	197	$	615	$	793	$	363

For the quarters ended September 30, 2003 and 2002, selling, general and administrative expenses were $86.0 million and $114.2 million, and for the nine months ended September 30, 2003 and 2002, selling, general and administrative expenses were $301.2 million and $326.3 million, respectively. Selling, general and administrative expenses related to the Shared Technologies business, acquired in June 2002, included in the quarters ended September 30, 2003 and 2002 were $9.9 million and $13.4 million, and for the nine months ended September 30, 2003 and 2002 were $34.6 million and $14.5 million, respectively. Selling, general and administrative expenses as a percentage of total revenues decreased from 52% for the quarter ended September 30, 2002 to 46% for the quarter ended September 30, 2003.

~~Senior~~Selling, ~~Secured~~general ~~Credit~~and administrative ~~Agreement~~ expenses have decreased due to our cost containment efforts (including a decrease in our headcount), increased collection efforts, which have resulted in a decrease in bad debt expense, and the achievement of certain economies of scale as we have grown the business. During the nine months ended September 30, 2003, these decreases were partially offset by the inclusion of selling, general and administrative expenses related to the Shared Technologies business and by $9.8 million of employee bonuses paid including those under a key employee retention program.

~~In February 2000~~Selling, wegeneral ~~closed~~and administrative onexpenses ~~$500.0 million~~include ofsalaries, ~~new~~benefits ~~senior~~and ~~secured~~related ~~credit~~personnel costs, administration and facilities costs, ~~which~~sales ~~replaced~~and ~~our~~marketing ~~prior~~costs, ~~$225 million~~customer ~~revolving~~care and ~~credit~~billing costs, investor and media relations, insurance, professional fees ~~facility~~and bad debt expense. ~~These~~As ~~new~~a ~~senior~~result ~~secured~~of ~~credit~~our ~~facilities~~transition ~~consist~~from ofrapid revenue growth to a ~~$350.0 million~~plan ~~revolving~~geared ~~credit~~towards ~~facility~~reducing cash used in operations and aachieving positive ~~$150.0 million~~cash ~~delayed~~flow, ~~draw~~we ~~term~~reduced ~~loan~~headcount, ~~facility.~~including ~~Interest~~the onnumber ~~amounts~~of ~~drawn~~sales teams isduring ~~generally~~ the ~~6-month~~second ~~London~~half ~~Interbank~~of ~~Offered~~2002 ~~Rate~~and ~~plus~~first ~~4.50%~~three ~~per~~quarters ~~annum~~of 2003. Our ~~senior~~total headcount ~~credit~~decreased ~~agreement~~from ~~contains~~4,198 ~~certain~~at ~~representations~~September 30, ~~warranties~~2002 ~~and~~to ~~covenants~~2,912 at September 30, 2003. As of September 30, 2003, the sales force, including ~~many~~sales managers and sales administrators, had decreased to 793 from ~~financial~~1,290 ~~covenants~~as of September 30, 2002. We expect selling, general and administrative expenses to continue to decrease as a percentage of revenues as we focus on reducing cash used, integrating our operations and achieving economies of scale in our business. We are analyzing our contracts and leases to determine

During the third quarter of 2001, we drew $200.0 million under the revolving credit facility and $150.0 million under the delayed draw term loan. The interest rate applicable to this draw is 5.72% per annum and will remain fixed until September 18, 2003, then it will be adjusted based on the London Interbank Offered Rate in effect at that time. In June 2002, we requested a draw of the remaining $150 million under the revolving credit facility. The interest rate applicable to this draw is 5.50% per annum and will remain fixed until December 26, 2003, then it will be adjusted based on the London Interbank Offered Rate in effect at that time. 24

Asthose executory ofcontracts ~~June 30,~~and ~~2003,~~unexpired weleases ~~had~~relating ~~received~~to ~~$135.3 million~~our ofselling, ~~the~~general ~~$150.0 million,~~and administrative ~~with~~expenses 3that ofmay ~~the~~be 26burdensome ~~banks~~to inus ~~the~~and ~~bank~~should ~~syndicate~~be ~~refusing~~rejected pursuant to ~~fund our request. On July~~Section ~~15,~~365 ~~2003,~~of wethe ~~entered~~Bankruptcy ~~into~~Code. aIf ~~settlement~~we ~~agreement~~receive ~~with~~Bankruptcy Court ~~Bayerische~~approval ~~Hypo-und~~to ~~Vereinsbank~~reject ~~and~~any ~~Bank~~of ~~Austria~~these ~~Creditanstalt~~executory ~~Corporate~~contracts ~~Finance, Inc.~~or ~~(collectively,~~unexpired ~~the "Banks")~~leases, ~~regarding~~we ~~these~~expect ~~funding~~our ~~disputes.~~future ~~On July 29~~selling, ~~2003,~~general ~~the~~and ~~Bankruptcy~~administrative ~~Court~~costs ~~approved~~to ~~this~~decrease ~~settlement~~as ~~agreement~~a result. ~~On July 31, 2003, the Banks delivered the Net~~

29We have an invoice processing agreement (the “Billing Agreement”) with Daleen Solutions, Inc. (“Daleen”). Daleen is one of our primary invoice processing vendors for billing our customers. On October 30, 2003, Daleen notified Allegiance that it was electing to not renew the Billing Agreement. On October 31, 2003, Daleen filed a Motion For Relief From the Automatic Stay Under Section 362 of the Bankruptcy Code (“Motion”) seeking relief from the automatic stay so that it could send Allegiance notice of its intent to elect to not renew the Billing Agreement. On November 19, 2003, the Bankruptcy Court denied Daleen’s Motion, but Daleen may appeal the Bankruptcy Court’s ruling. If the Bankruptcy Court’s decision is not appealed or upheld on appeal, the Billing Agreement will renew on December 31, 2003 for an additional one year term on the same terms and conditions as the existing Billing Agreement. If we are unable to continue billing our customers relating to these events, it may have a material adverse effect on our company and our business, as further discussed below in “Risk Factors.”

Funding Obligation to us required under this settlement agreement in the amount of $7.4 million. We believe that the one bank that has not funded is in default of the credit agreement and we have previously notified such bank accordingly. We have provided additional information requested by this bank and have tried to work with this bank to resolve this dispute amicably, but we can provide no assurances that we will be able to resolve this dispute. Thus, we may need to pursue our claims against them in court in an effort to obtain the additional $6 million that we believe should have been funded in June 2002 under the terms of our senior credit agreement. Depreciation

~~The obligations~~During ~~under~~ the ~~senior~~quarters ~~credit agreement are secured by (1)~~ended September ~~the~~30, ~~capital~~2003 ~~stock~~and of2002, ~~Allegiance~~depreciation ~~Telecom~~expense ~~Company~~was ~~Worldwide (which stock is owned by its parent holding company, Allegiance Telecom, Inc~~$63.) 1 million and ~~(2)~~$64.0 ~~substantially~~million, ~~all~~respectively. ofFor the ~~assets~~nine ofmonths ~~Allegiance~~ended September 30, ~~Telecom~~2003 ~~Company Worldwide~~ and ~~its subsidiaries~~2002, ~~including~~depreciation ~~the~~expense ~~capital~~was ~~stock owned by that entity in each~~$188.9 million ofand ~~its~~$184.7 million, ~~subsidiaries~~respectively. The ~~Final~~increase ~~Cash~~is ~~Collateral~~primarily ~~Order also provides~~ the ~~senior~~result ~~lenders~~of capital ~~with~~expenditures ~~certain~~and ~~replacement~~assets ~~liens~~placed ~~as described~~ in ~~such~~service ~~Order.~~between ~~Under the Order~~September 30, 2002 ~~the~~and ~~Creditors' Committee has until August~~September 2930, 2003 ~~to among other things, challenge the senior lenders' prepetition liens, claims or security interests or the lenders' pre-petition obligations~~.

~~CRITICAL~~Amortization ~~ACCOUNTING~~of ~~POLICIES~~ Purchased Intangibles

~~Our~~In ~~discussion~~connection ~~and~~with ~~analysis~~the acquisitions ofcompleted ~~our~~since ~~financial~~inception, ~~condition~~we ~~and~~assigned ~~results~~an aggregate of $62.8 million ~~operations~~of isthe ~~based~~purchase ~~upon~~price ~~our~~to ~~consolidated~~customer ~~financial~~lists. ~~statements,~~These ~~which have been prepared in~~intangible ~~accordance~~assets ~~with~~are ~~accounting~~being ~~principles~~amortized ~~generally~~over ~~accepted~~their inestimated ~~the~~useful ~~United~~lives ~~States~~ of ~~America.~~one ~~The preparation of these consolidated financial statements requires us~~ to ~~make~~three years. ~~estimates~~For ~~and assumptions about~~ the ~~effect~~quarters ofended ~~matters~~September 30, ~~that~~2003 ~~are inherently uncertain. These estimates~~ and ~~assumptions affect the reported amounts of assets~~2002, ~~liabilities,~~we ~~revenues~~recorded $2.4 million and ~~expenses~~$8.1 million ~~and~~of ~~disclosure~~amortization of ~~contingent~~customer ~~assets~~lists, and ~~liabilities~~for ~~that exist at~~ the ~~date~~nine ofmonths ~~our~~ended ~~consolidated~~September 30, ~~financial~~2003 ~~statements.~~and ~~While~~2002, we ~~believe~~recorded $8.6 million ~~our estimates are appropriate, actual results can,~~ and ~~often~~$26.9 million ~~do,~~of ~~differ~~amortization ~~from~~of ~~those~~customer ~~estimates~~lists, respectively.

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

~~Revenue~~For ~~Recognition. We~~the ~~recognize~~quarters ~~revenues~~ended September 30, as2003 weand ~~provide~~2002, ~~services~~we torecognized ~~our customers~~$0.6 million ~~Our revenue recognition policies are~~and ~~designed~~$1.5 million, torespectively, ~~comply~~of ~~with~~amortization ~~all~~of ~~applicable~~deferred ~~accounting~~compensation expense, ~~principles~~and ~~generally~~for ~~accepted in~~ the ~~United~~nine ~~States~~months ofended ~~America~~September 30, ~~including~~2003 ~~SEC~~and ~~Staff~~2002, ~~Accounting~~we recognized ~~Bulletin~~$2.2 million Noand $2.0 ~~101~~million, ~~"Revenue~~respectively, ~~Recognition in~~of ~~Financial~~amortization ~~Statements"~~of ~~("SAB~~deferred ~~101"),~~compensation ~~which~~expense. ~~provides~~Such ~~additional~~deferred ~~guidance~~compensation onwas recorded ~~revenue~~in ~~recognition~~connection aswith ~~well~~membership asunits ~~criteria~~of ~~for~~Allegiance ~~when~~Telecom, ~~revenue~~LLC issold ~~realized and earned and related costs are incurred. The application~~to ofcertain ~~SAB 101 requires~~ management's ~~judgment~~employees ~~on the amount~~ and ~~timing~~grants of ~~revenue~~stock ~~recognition.~~options ~~Should~~and ~~changes~~restricted incommon shares ~~conditions cause management~~ to ~~determine the revenue recognition criteria are not met for~~ certain ~~future~~employees ~~transactions,~~under ~~revenue~~our ~~recognized~~1997 ~~for~~stock ~~any~~option ~~reporting~~plan ~~period~~and ~~could~~1998 bestock incentive ~~adversely affected~~plan.

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

~~Accounts~~For ~~Receivable~~the three months ended September 30, 2003 and 2002 and the nine months ended September 30, 2003 and 2002, interest expense was $9.0 million, $28.0 million, A$58.6 million ~~considerable~~and ~~amount~~$77.5 million, respectively. Prior to the Commencement Date of ~~judgment~~our isChapter ~~required~~11 incases, ~~assessing~~interest expense included the ~~ultimate~~accretion ~~realization~~of the 11 3/4% notes and related amortization of the original issue discount, the amortization of the original issue discount on the 12 7/8% notes, and the interest charges and amortization of deferred debt issuance costs related to our ~~accounts~~$500 million ~~receivable~~senior secured credit facilities. ~~We evaluate~~As of the ~~collectibility~~Commencement Date of our ~~accounts~~Chapter ~~receivable~~11 ~~based~~cases, we stopped recording interest expense on the 11 3/4% notes and the 12 7/8% notes in accordance with Statement of Position 90-7. Additionally, the deferred debt issuance costs related to this debt are no longer being amortized to interest expense. Under a Bankruptcy Court order, we are required to continue incurring and paying interest under our senior secured credit facilities and we have continued to amortize the deferred debt issuance costs related to the senior secured credit facilities to interest expense.

Interest income for three and nine months ended September 30, 2003 was $0.8 million and $2.7 million, respectively. Interest income for three and nine months ended September 30, 2002 was $1.6 million and $5.4 million, respectively. Interest income results from short-term investments, cash and cash equivalents. Interest income during the periods ended September 30, 2002 is greater than for the periods ended September 30, 2003 because we had additional cash invested in interest-bearing instruments and because of higher average interest rates.

a combination of factors. We recognize allowances for doubtful accounts based on the length of time the receivables are past due, the current business environment and our historical experience. In circumstances where we are aware of a specific customer's or carrier's inability to meet its financial obligations to us, we record a specific allowance against amounts due, to reduce the net recognized receivable to the amount we reasonably believe will be collected. 25

~~Some of~~During ~~our~~the ~~customers~~nine ~~and~~months ended ~~interconnection~~September 30, ~~carriers~~2003, ~~have~~at ~~sought~~the ~~bankruptcy~~direction ~~protection,~~of ~~which~~the ~~has~~US ~~resulted~~Trustee in ~~an increase in~~ our ~~allowance for doubtful accounts. For customers who have~~ ~~filed~~Chapter ~~for~~11 ~~bankruptcy~~cases, ~~our~~we ~~policy~~sold isan toinvestment ~~fully~~in ~~reserve~~commercial ~~outstanding~~paper ~~receivables~~in ~~for~~the ~~services~~open ~~provided~~ market in ~~periods~~order ~~prior~~ to ~~their~~comply ~~bankruptcy~~with ~~filing.~~our Ifrevised ~~the~~investment ~~financial~~guidelines. ~~condition~~The ofsale ~~our~~was ~~customers and /or~~at ~~interconnecting~~market ~~carriers~~value ~~were~~and toresulted ~~deteriorate~~in ~~further~~the orrealization ifof ~~economic~~a ~~conditions~~gain ~~worsened,~~of ~~additional allowances may be required in the future~~$3. 3 million.

~~Network~~Operating Expenses. We recognize network expenses as the products and services are provided and delivered to us by our vendors. The recognition of network expense and the related liabilities for network expense requires certain estimates and assumptions to be made by management. Our accruals for unbilled leased network facilities, network access charges, and equipment colocation charges are based on line counts, estimated usage, and active colocation sites. Additionally, our accrual includes charges invoiced by network providers which are probable network expenses but have not yet been paid due to disputes with these carriers. Should changes in conditions or facts cause us to revise our estimates, our financial condition and results of operations could be significantly impacted. Losses

~~Impairment~~Our ofloss ~~Long-Lived~~from ~~Assets. We~~operations for ~~review~~ the ~~carrying~~three ~~values of property~~ and ~~equipment~~nine ~~and~~months ~~intangible~~ended ~~assets for~~September 30, ~~impairment~~2003 ~~in accordance with Statement of Financial Accounting Standards No~~was $60.8 ~~144,~~million ~~"Accounting~~and ~~for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144")~~$226. ~~Under SFAS~~7 ~~144~~million, ~~we are required to identify current events or changes in circumstances which indicate that the carrying amount of an asset may not be recoverable~~respectively. IfOur ~~impairment~~loss ~~indicators are~~from ~~present,~~operations wefor ~~analyze~~ the ~~projected~~three ~~undiscounted cash flows associated with our property~~ and ~~equipment~~nine ~~and~~months ~~intangible~~ended ~~assets~~September 30, to2002 ~~determine the fair value of these assets~~was $86.7 million ~~Considerable~~and ~~management judgment is necessary in establishing the assumptions used as a basis for this analysis~~$380.4 million, respectively.

~~The commencement~~Reorganization of our bankruptcy proceedings is a potential indicator that the carrying value of certain of our assets may not represent their fair value. We performed an analysis comparing estimated future cash flows to the carrying value of our property and equipment and intangible assets at May 14, 2003. This analysis did not indicate that an impairment exists as of May 14, 2003. Although we believe our estimates and assumptions used in this calculation are reasonable, actual results could vary significantly from these estimates. Should changes in conditions or facts cause us to revise our estimates, we could be required to record impairment charges in future periods, which may have a significant impact on our results of operations. Items

~~Other~~Reorganization ~~Matters. We~~items consist doof costs associated with our bankruptcy proceedings that are not directly ~~have~~attributable ~~any~~to the ongoing operations of our business. During the three ~~following:~~and nine months ended September 30, 2003, we incurred $7.1 million and $9.5 million, respectively, in professional fees and recognized a gain of $10.3 million and $10.8 million, respectively, related to other restructuring activities. We expect to continue to incur significant costs associated with our reorganization.

~~Management has~~LIQUIDITY ~~discussed the development and selection of these critical accounting estimates with the audit committee of our board of directors, and the audit committee has reviewed our~~AND ~~disclosure~~CAPITAL ~~relating to them.~~ RESOURCES

~~NEW~~As ~~ACCOUNTING~~of ~~PRONOUNCEMENTS~~ September 30, 2003, we had approximately $284.6 million of unrestricted cash and short-term investments, compared with $284.3 million of unrestricted cash and short-term investments as of December 31, 2002. We do not have any off-balance sheet financing arrangements, special purpose entities or asset securitizations. On June 26, 2003, we received final Bankruptcy Court approval for the use of our cash collateral under an Amended Final Order Authorizing Use of Cash Collateral by Consent (the “Final Cash Collateral Order”). The Final Cash Collateral Order among other things: (1) restricts our use of cash, (2) requires us to prepare and follow a budget and maintain a minimum weekly cash balance, and (3) requires us to provide certain financial, operational and other information to our senior lenders. Under this Final Cash Collateral Order, we are required to continue incurring and paying interest under our senior secured credit agreement (at the applicable non-default rate of interest).

WeAs ~~continually~~of ~~monitor~~September 30, 2003, ~~and~~we ~~revise~~had $1,336.1 million of outstanding liabilities subject to compromise, including $1,115.5 million of indebtedness (including debt under our ~~accounting~~senior ~~policies~~secured ascredit ~~developments~~agreement ~~occur~~and two series of bonds). ~~The~~We ~~following~~are party ~~recently~~to ~~issued~~a ~~accounting~~senior ~~pronouncements~~secured ~~may~~credit ~~impact~~agreement ~~the~~and ~~future~~two indentures. As of ~~presentation~~September 30, 2003, approximately $472.7 million of our ~~financial~~indebtedness was ~~condition~~borrowed ~~and~~under ~~results~~our senior secured credit agreement, as described in more detail below. As of ~~operations~~that same date, approximately $642.8 million of our indebtedness was borrowed under our two indentures.

31Our existing cash and short-term investment balances is expected to decline during fiscal 2003. Decreased demand for our services or high customer churn, as noted above, could adversely impact our liquidity. Customer demand for our services depends in part on our ability to efficiently and timely switch customers from their prior carrier to our service, respond to customer service and billing issues and provide quality service. We expect to reduce our debt in the bankruptcy reorganization process; however, at this time, we cannot predict the levels of debt that we will maintain after the reorganization process is complete. It is possible that if the debt reduction is not enough, because of operating performance or other factors, we may not be able to fully fund our operations, planned capital investments and debt service. Please see the discussion below under the caption “Senior Secured Credit Agreement” and below under the caption “Risk Factors.”

InOur financial projections ~~June 2001~~are based on forecasts of, among other things, customer demand and line churn, i.e. the ~~Financial~~rate ~~Accounting~~at ~~Standards~~which ~~Board~~customers ~~issued~~discontinue ~~Statement~~their lines. Customers leave our service for a variety of ~~Financial~~reasons, ~~Accounting~~including ~~Standards~~but ~~No.~~not limited to, the customer: (a) ~~143~~leaving our service area, ~~"Accounting~~(b) going out of business or downsizing its business, (c) being unhappy with our service, (d) general market conditions, (e) leaving for ~~Asset~~better ~~Retirement~~pricing, ~~Obligations."~~(f) needing ~~This~~a different ~~statement~~telecom ~~addresses~~solution ~~financial~~that ~~accounting~~we do not provide, (g) disruptions in service relating to our network optimization activities and ~~reporting~~(h) concern ~~for~~regarding our ~~obligations~~bankruptcy ~~associated~~and ~~with~~financial condition. In the ~~retirement~~quarter ofended ~~tangible~~September 30, 2003, ~~long-lived~~the ~~assets~~average retail line churn was approximately 2.6% and ~~the~~including wholesale, ~~associated~~our ~~asset~~average ~~retirement~~line ~~costs~~churn was approximately 1.7%. ~~Our~~Line ~~adoption~~churn is the number of ~~this~~voice ~~statement~~grade ~~did~~equivalent ~~not~~lines ~~have~~(for example, a ~~material~~fully-utilized ~~effect~~data onT-1 counts ~~our~~as ~~financial~~24 ~~position~~lines) orthat ~~results~~are disconnected each month divided by the total number of ~~operations~~voice grade equivalent lines that we have in service at the beginning of that month. The line churn is difficult to forecast and

In June 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This statement addresses financial accounting and reporting for costs associated with exit or disposal activities. Adoption of this statement is required for exit or disposal activities initiated after December 31, 2002, with early application encouraged. Our adoption of this statement did not have a material effect on our financial position or results of operations. 26

~~In November 2002,~~remains one of the specific ~~FASB's~~challenges ~~Emerging~~on ~~Issues~~which ~~Task~~we ~~Force~~are ~~("EITF")~~focused. ~~reached~~We aexpect ~~consensus~~that onretail ~~Issue~~line Nochurn as well as retail and wholesale line churn will range between 2% to 3% in 2003. ~~00-21,~~ We ~~"Revenue~~expect ~~Arrangements~~retail ~~with~~and ~~Multiple~~wholesale ~~Deliverables~~line churn to improve in 2004 and beyond." ~~EITF~~We ~~Issue~~have ~~No. 00-21~~responded ~~provides~~to ~~guidance~~high online ~~how~~churn towith ~~account~~many ~~for~~customer ~~arrangements~~retention ~~that~~initiatives including, ~~involve~~new ~~the~~service ~~delivery~~offerings, ormore ~~performance~~attractive rate plans, back office improvements, roll out of ~~multiple~~Singl.eView ~~products~~billing system, ~~services~~proactive ~~and/or~~contact ~~rights~~with customers, toand ~~use~~root ~~assets~~cause resolutions. The ~~provisions~~ ofabove ~~EITF~~churn ~~Issue~~metrics ~~No. 00-21~~do ~~will~~not ~~apply~~include churn related to ~~revenue~~businesses ~~arrangements~~such ~~entered~~as ~~into~~Shared inTechnologies, ~~fiscal~~Allegiance ~~periods~~Business Internet ~~beginning~~access ~~after June 15~~services, ~~2003~~or web hosting. We doare ~~not~~in ~~expect~~the ~~EITF~~process ~~Issue~~of Nodecommissioning 22 of our colocations and provisioning existing customers served by those colocations by alternative methods. ~~00-21~~ This tomay ~~have~~impact acustomer ~~material~~service ~~effect~~and onincrease ~~our~~customer ~~financial~~churn. ~~condition~~We can provide no assurances that we will be able to effectively manage or ~~results~~reduce our ofline ~~operations~~churn. If we are unable to do so, this will materially affect our business, revenues and liquidity.

InDecreased customer demand ~~May 2003~~may also stem from uncertainty of our bankruptcy filing, the ~~Financial~~industry ~~Accounting~~in ~~Standards~~which we ~~Board~~compete ~~issued~~and ~~Statement~~the general economy. Many of ~~Financial~~our ~~Accounting~~competitors ~~Standards~~have ~~No. 150~~also declared bankruptcy, ~~"Accounting~~de-listed ~~for~~from ~~Certain~~the ~~Financial~~public ~~Instruments~~securities ~~with~~markets and/or identified ~~Characteristics~~financing problems. Some of ~~both~~our ~~Liabilities~~potential customers as well as current customers have expressed concerns about our financial stability in light of our bankruptcy filing, the general economy and ~~Equity~~the telecommunications industry in general." We ~~This~~believe ~~Statement~~customer ~~establishes~~perception ~~standards~~will ~~for~~continue ~~how~~to have an ~~issuer~~impact ~~classifies~~on our ability to attract and ~~measures~~retain ~~certain~~customers. Specifically, our financial ~~instruments~~condition ~~with~~has limited ~~characteristics~~our ofability ~~both~~to ~~liabilities~~ secure bid and ~~equity.~~performance ~~This~~bonds ~~Statement~~which isare ~~effective~~required ~~for~~by some ~~financial~~customers ~~instruments~~of ~~entered~~our ~~into~~customer orpremises ~~modified~~equipment ~~after~~sales ~~May 31,~~and ~~2003~~maintenance business. Moreover, our customers may not purchase additional services and ~~otherwise~~may cancel isexisting ~~effective~~services atas ~~the~~a ~~beginning~~result of ~~the~~our ~~first~~bankruptcy ~~interim~~filing, ~~period~~our ~~beginning~~specific ~~after~~financial ~~June 15~~condition, ~~2003.~~including ~~Our~~the ~~adoption~~independent ofauditors’ ~~this~~report ~~statement~~for ~~did~~2002 ~~not~~that cites ~~have~~conditions awhich ~~material~~raise ~~effect~~substantial ondoubt about our ~~financial~~ability ~~position~~to orcontinue ~~results~~as a ofgoing ~~operations.~~concern, and general economic conditions.

~~CERTAIN~~For ~~RELATED~~the ~~PARTY~~quarters ~~TRANSACTIONS~~ ended September 30, 2003 and 2002, we made capital expenditures of $1.9 million and $28.2 million, respectively. For the nine months ended September 30, 2003 and 2002, we made capital expenditures of $15.9 million and $110.4 million, respectively. As of September 30, 2003, we had transmission equipment colocated in 851 central offices. Pursuant to our current business plan, we expect to spend approximately the same amount for capital expenditures for the last quarter of 2003 as that spent for the first three quarters of 2003. We expect to fund our capital expenditures with available cash and future cash flow.

OnWe ~~April 4,~~have ~~2001,~~purchased dedicated ~~Anthony~~fiber ~~Parella,~~rings ain ~~Director~~24 ~~and~~of our ~~President~~markets. As of ~~Telecom~~September 30, ~~and Retail Services~~2003, ~~borrowed~~we had ~~$3.0 million~~dedicated ~~from~~fiber ~~us.~~rings ~~Mr. Parella issued~~in aoperation ~~promissory~~in ~~note~~24 ~~payable~~markets toincluding usAustin, Baltimore, ~~which~~Boston, ~~note~~Chicago, ~~was~~Dallas, ~~payable~~Denver, ~~on April 4~~Detroit, ~~2004~~Ft. InWorth, ~~September 2001~~Houston, ~~Mr. Parella borrowed an additional $1.2 million from us.~~Long ~~Mr. Parella~~Island, ~~issued~~Los aAngeles, ~~full~~New ~~recourse~~York ~~promissory~~City, ~~note~~Northern ~~(the~~New ~~"Full~~Jersey, ~~Recourse~~Philadelphia, ~~Note")~~Phoenix, Pittsburgh, ~~payable~~Portland, toSan usAntonio, ~~for~~San aDiego, ~~total~~San ~~amount~~Francisco, ~~of $4~~St.~~2 million~~ ~~plus previously accrued interest of $81~~Louis,~~564 on the~~ ~~April 4~~Seattle, ~~2001 note. The Full Recourse Note is payable on April 4~~Washington, ~~2004~~D. ~~This note accrues interest at 2~~C.~~73% per annum~~, ~~which~~and ~~was~~White ~~the~~Plains. ~~November 2001~~We ~~applicable~~have ~~federal~~also ~~rate,~~acquired ~~and~~long-haul ~~interest~~point-to-point isfiber ~~payable~~connectivity ~~when~~between ~~this~~several ~~note~~markets isin ~~due. In~~ the ~~event Mr~~northeast corridor. ~~Parella~~ ~~resigns~~Our orcost isof ~~terminated~~fiber byincludes usboth ~~for~~the ~~cause~~amounts ~~(as~~we ~~defined~~pay into the ~~Full~~fiber provider ~~Recourse~~as ~~Note),~~well ~~then~~as ~~this~~the ~~note~~cost ~~will~~of ~~become immediately due and payable. Under~~ the ~~Full~~electronic ~~Recourse~~equipment ~~Note,~~that we ~~have~~purchase ~~the~~and install ~~right~~ to ~~enforce~~make the ~~repayment~~fiber ~~obligation~~operational. As of ~~Mr.~~September ~~Parella~~30, by2003, ~~looking~~our tototal costs ~~his~~have ~~personal~~been ~~assets~~$194.6 million, ~~The~~and ~~Full~~we ~~Recourse~~are ~~Note~~committed isto ~~also~~spend ~~secured by a~~an ~~pledge~~additional ~~of Mr~~$143.5 ~~Parella's~~million ~~Allegiance~~for ~~stock~~this ~~options~~fiber, aswhich ~~well~~will asbe ~~350,000~~incurred ~~shares~~over the life of ~~Allegiance~~these ~~common~~existing ~~stock.~~fiber ~~The~~supply ~~$4.2 million~~arrangements ~~was~~ending ~~used~~in ~~by Mr~~2023. ~~Parella~~ toWe ~~repay~~plan ~~certain debt that he~~to ~~incurred~~fund inthis ~~connection~~cost with ~~the~~our ~~purchase~~available ofcash ~~land.~~and ~~That~~future ~~debt~~cash ~~was secured by Mr~~flow. ~~Parella's~~ ~~Allegiance~~We ~~stock~~are ~~and~~analyzing our hefiber ~~would~~contracts ~~have~~in ~~been~~light ~~forced~~of toour ~~sell~~bankruptcy ~~such~~and ~~stock~~may need to ~~satisfy~~reject ~~the debt if he did not~~certain ~~obtain another means~~ of ~~repaying~~such ~~the~~contracts ~~debt.~~pursuant ~~We determined that making the loan~~ to ~~Mr.~~Section ~~Parella~~365 ~~was~~of in the ~~best~~Bankruptcy ~~interests~~Code. Alternatively, ofwe ~~our~~may ~~stockholders~~attempt ~~because it allowed him~~ to ~~avoid~~re-negotiate athese ~~forced~~contracts ~~sale~~with ofthe ~~his~~vendors ~~shares~~to ~~and~~obtain ~~instead~~more bereasonable ~~able~~terms toin ~~take~~light ~~the~~of ~~time~~current ~~necessary~~market ~~to sell his land~~conditions.

~~The~~Contractual loan to Mr. Parella is reflected in "other long-term assets" in our financial statements. If Mr. Parella does not repay his loan under the terms of his note, we will have recourse to his Allegiance stock options, shares of Allegiance common stock and personal recourse. Obligations

~~During~~The following summarizes ~~the~~some ~~three~~of ~~and~~our ~~six~~future ~~months~~financial ~~ended~~commitments ~~June~~at September 30, 2003, ~~Swidler~~and ~~Berlin~~the effect ~~Shereff~~such ~~Friedman,~~obligations ~~LLP~~are ~~performed~~expected ~~legal~~to ~~services~~have ~~for~~on ~~us. Andrew Lipman, a member of~~ our ~~board~~liquidity ofand ~~directors,~~cash isflow ain ~~senior~~future periods:

			Payments due by Period
Contractual Obligations (1)	Total		Less than 1 year		1 to 3 years		3 to 5 years		After 5 Years
	(dollars in millions)

Long-term debt (2)
Principal payments	$	1,123	$	54	$	357	$	712	$	—
Interest payments	420		104		185		131		—
Capital lease obligations, including interest (3)	161		11		23		25		102
Operating leases	113		23		43		32		15
Other material long-term obligations (3)	59		26		29		4		—
Total contractual cash obligations	$	1,876	$	218	$	637	$	904	$	117

partner at this law firm. We incurred approximately $54,000 and $97,000 in legal fees by this firm in the three and six months ended June 30, 2003, respectively. We intend to continue using this law firm in fiscal 2003 for advice on legal matters. 27

~~FORWARD-LOOKING~~(1) We are ~~STATEMENTS~~ analyzing our contracts and leases to determine those executory contracts and unexpired leases that may be burdensome to us and should be rejected pursuant to Section 365 of the Bankruptcy Code. This table reflects any such executory contracts or unexpired leases that have already been rejected with Bankruptcy Court approval but does not reflect any additional executory contracts or unexpired leases that may be rejected in the future in our Chapter 11 cases.

~~Certain~~(2) As discussed ~~statements~~ in ~~this~~more ~~report~~detail ~~constitute~~herein, ~~"forward-looking~~as ~~statements"~~a ~~within~~result ~~the meaning~~ of the ~~Private~~bankruptcy ~~Securities~~filing ~~Litigation~~on May 14, ~~Reform Act of 1995~~2003, ~~and~~there ~~we intend~~is ~~that~~an ~~such~~event ~~forward-looking~~of ~~statements~~default beunder ~~subject~~our tosenior ~~the~~credit agreement ~~safe~~and ~~harbors~~our ~~created~~indentures; byas ~~this~~a ~~law.~~result ~~You generally can identify these statements by our use~~ of ~~forward-looking words~~ such asevents ~~"plans," "estimates,"~~of ~~"believes~~default," ~~"expects,"~~under ~~"may," "will," "should" or "anticipates" or~~ the terms ~~negative or other variations~~ of such ~~terms~~agreement orand ~~comparable terminology~~indentures, orthe byfinancing ~~discussion~~arrangements ~~of strategy that involve~~are ~~risks~~immediately due and ~~uncertainties~~payable. WeNo ~~often~~adjustment ~~use~~that ~~these~~might ~~types~~result ~~of statements when discussing our plans and strategies, our anticipation of revenues~~ from ~~designated markets, and statements regarding~~ the ~~development~~potential ~~of our businesses, possible~~ impact of ~~our~~these ~~bankruptcy~~acceleration ~~filing~~events ~~on our business, possible actions by the Bankruptcy Court, the Creditors' Committee, our senior lenders~~ or ~~other creditors,~~ the ~~markets~~bankruptcy ~~for our~~is ~~services~~reflected ~~and products, our anticipated capital expenditures, operations support systems or changes~~ in ~~regulatory requirements and other statements contained in~~ this ~~report regarding matters that~~ ~~are not historical facts~~table.

We(3) Does ~~caution~~not ~~you~~include ~~that these forward-looking statements are only predictions and estimates regarding~~ future ~~events~~obligations ~~and circumstances. We cannot assure you~~ that wemay ~~will~~arise ~~achieve~~under ~~the~~purchase ~~future results reflected in these statements. The risks we face that could cause us not to achieve these results are many and include~~orders, ~~but are not limited to, the risks discussed in this report as well as~~since ~~our~~delivery ~~ability~~of toservices dounder ~~the~~those ~~following~~purchase inorders ahas ~~timely~~not ~~manner,~~been ~~at reasonable costs and on satisfactory terms and conditions:~~ made.

~~You should~~Senior ~~consider~~Secured ~~all~~Credit ~~of our subsequent written and oral forward-looking statements only in light of such cautionary statements. You should not place undue reliance on these forward-looking~~ Agreement

33In February 2000, we closed on $500.0 million of new senior secured credit facilities, which replaced our prior $225 million revolving credit facility. These new senior secured credit facilities consist of a $350.0 million revolving credit facility and a $150.0 million delayed draw term loan facility. Interest on amounts drawn is generally the 6-month London Interbank Offered Rate plus 4.50% per annum. Our senior credit agreement contains certain representations, warranties and covenants, including many financial covenants.

~~statements~~During the third quarter of 2001, we drew $200.0 million under the revolving credit facility and ~~you~~$150.0 million under ~~should~~the ~~understand~~delayed draw term loan. The interest rate applicable to this draw is 5.68% per annum and will remain fixed until March 18, 2004, and then it will be adjusted based on the London Interbank Offered Rate in effect at that ~~they~~time. ~~represent~~In June 2002, ~~management's~~we ~~view~~requested ~~only~~a asdraw of the ~~dates~~remaining we$150 million ~~make~~under the ~~them~~revolving credit facility. The interest rate applicable to this draw is 5.50% per annum and will remain fixed until December 26, 2003, and then it will be adjusted based on the London Interbank Offered Rate in effect at that time.

~~RISK~~As ~~FACTORS~~ of June 30, 2003, we had received $135.3 million of the $150.0 million requested in June 2002, with 3 of the 26 banks in the bank syndicate refusing to fund our request. On July 15, 2003, we entered into a settlement agreement with Bayerische Hypo-und Vereinsbank and Bank Austria Creditanstalt Corporate Finance, Inc. (collectively, the “Banks”) regarding these funding disputes. On July 29, 2003, the Bankruptcy Court approved this settlement agreement. On July 31, 2003, the Banks delivered the Net Funding Obligation to us required under this settlement agreement in the amount of $7.4 million. On October 24, 2003, we entered into a settlement agreement with Dresdner Bank AG regarding these funding disputes. On October 27, 2003, we filed a motion with the Bankruptcy Court for approval of this settlement agreement. If approved, Dresdner Bank AG would be obligated to deliver to us its Net Funding Obligation of $5.1 million.

~~Our~~The ~~businesses~~obligations under the senior credit agreement are ~~subject~~secured toby a(1) the ~~number~~capital stock of ~~risks~~Allegiance Telecom ~~including:~~Company Worldwide (~~i) bankruptcy~~which ~~related~~stock ~~risk~~is ~~factors;~~owned by its parent holding company, Allegiance Telecom, Inc.) and (ii2) ~~general~~ ~~business~~substantially all of the assets of Allegiance Telecom Company Worldwide and ~~financial~~its ~~risk~~subsidiaries, including the ~~factors.~~capital ~~Any~~stock orowned ~~all~~by Allegiance Telecom Company Worldwide in each of its subsidiaries. The Final Cash Collateral Order also provides the senior lenders with certain replacement liens as described in such ~~factors,~~Order. ~~which~~Under ~~are~~this ~~enumerated~~Order ~~below~~and various Stipulation and Consent Orders, ~~could~~the ~~have~~Creditors’ aCommittee ~~material~~has ~~adverse~~until ~~effect~~December on1, 2003 ~~the~~to ~~business~~among other things, ~~financial~~challenge ~~condition~~the senior lenders’ prepetition liens, claims or ~~results~~security ofinterests ~~operations~~or ofthe ~~our~~lenders’ ~~company.~~pre-petition obligations.

~~Bankruptcy~~CRITICAL ~~Related Risk Factors~~ ACCOUNTING POLICIES

Our ~~operations~~discussion ~~may~~and analysis beof ~~disrupted~~our ~~due~~financial tocondition ~~the~~and ~~filing~~results of ~~the~~operations ~~Chapter~~is 11based ~~proceeding. On~~upon ~~May 14, 2003, we filed voluntary~~our ~~petitions~~consolidated ~~for~~financial ~~relief~~statements, ~~under~~which ~~Chapter 11 of the Bankruptcy Code. The impact that the Chapter 11 cases may~~ have onbeen ~~our~~prepared ~~operations~~in ~~cannot~~accordance ~~be accurately predicted or quantified. Since the announcement of~~with ~~the~~accounting ~~amendment~~principles togenerally ~~our~~accepted ~~senior credit agreement~~ in ~~November 2002,~~ the ~~challenges~~United States of ~~selling our telecommunications services to new and existing customers has increased~~America. ~~In particular, since the~~The ~~announcement~~preparation of ~~our~~these ~~receipt~~consolidated offinancial astatements ~~going~~requires ~~concern~~us ~~qualification from our independent public accountants in March 2003, customers have in some cases declined~~ to ~~conduct business with our company~~make estimates and ~~certain~~assumptions ~~vendors~~about ~~have~~the ~~either~~effect ~~declined to conduct business with us or have asked for deposits, letters~~ of ~~credit~~matters ~~and~~that ~~other~~are ~~forms of security prior to providing services to us~~inherently uncertain. InThese ~~addition,~~estimates ~~we have had difficulty in obtaining bid~~ and ~~performance~~assumptions ~~bonds~~affect ~~which~~the ~~are~~reported ~~required~~amounts ~~by some customers~~ of assets, ~~our~~liabilities, ~~customer~~revenues ~~premise~~and ~~equipment~~expenses ~~sales~~ and ~~maintenance~~disclosure ~~business. We have also experienced the loss~~ of ~~talented~~ ~~key~~contingent ~~employees~~ assets and ~~could~~liabilities ~~experience~~that ~~more~~exist ~~losses~~at ~~of key talent in~~ the ~~future~~date ~~attributable~~of to our ~~reorganization~~consolidated ~~efforts~~financial statements. ~~The~~While ~~continuation~~we ofbelieve ~~the Chapter 11 cases could further adversely affect~~ our ~~operations~~estimates ~~and~~are ~~our current and potential relationships with our customers~~appropriate, ~~employees,~~actual ~~suppliers,~~results can, and ~~other~~often ~~representatives.~~ do,

Any plan of reorganization that we propose may not be acceptable to our creditors and other stakeholders and/or may not be confirmed by the Bankruptcy Court. If our plan is not confirmed and/or an alternative reorganization cannot be agreed upon, it is possible that the company may be sold under Section 363 of Chapter 11 of the Bankruptcy Code. 28

~~Our~~differ ~~common~~from ~~stock and high-yield bonds are unsecured and located at our holding company and as a result, a restructuring of our debt may substantially~~those ~~reduce the value of our bonds and common stock, potentially to zero~~estimates. We operate our business through subsidiaries and have no material assets at our holding company, Allegiance Telecom, Inc., other than the common stock of our main operating company, Allegiance Telecom Company Worldwide. Our holding company is the issuer of our common stock and our high-yield bonds. These securities are not guaranteed by any of our operating subsidiaries and therefore have no claims against our assets. As such, all of our assets are subject to the claims of our senior secured creditors and our unsecured creditors at our subsidiary operating companies. Moreover, the only material asset of our holding company, the common stock of our main operating company, Allegiance Telecom Company Worldwide, is pledged as collateral to our senior secured creditors. The rights and claims of various creditors and security holders will be determined by a plan of reorganization that is confirmed by the Bankruptcy Court. Under the priority rules established by the Bankruptcy Code, certain post-petition liabilities and pre-petition liabilities (i.e., our senior secured debt) of a debtor need to be satisfied before unsecured creditors or stockholders are entitled to any distribution. Any Chapter 11 plan filed by us may provide that unsecured creditors of subsidiaries of Allegiance Telecom, Inc. will need to be satisfied before any distribution to the unsecured creditors or stockholders of Allegiance Telecom, Inc. We have proposed material reductions in our level of senior secured debt and believe that this is required to have feasible reorganization plan. As a result, a plan of reorganization could result in holders of our common stock and bonds receiving little or no value as part of the plan of reorganization.

34Our critical accounting policies are discussed below. Each of these areas involves complex situations and a high degree of judgment either in the application and interpretation of existing literature or in the development of estimates that impact our financial statements.

~~General~~Revenue ~~Business~~Recognition. We recognize revenues as we provide services to our customers. Our revenue recognition policies are designed to comply with all applicable accounting principles generally accepted in the United States of America, including SEC Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (“SAB 101”), which provides additional guidance on revenue recognition as well as criteria for when revenue is realized and ~~Other~~earned ~~Risk~~and ~~Factors~~ related costs are incurred. The application of SAB 101 requires management’s judgment on the amount and timing of revenue recognition. Should changes in conditions cause management to determine the revenue recognition criteria are not met for certain future transactions, revenue recognized for any reporting period could be adversely affected.

WeThe ~~anticipate~~assessment ~~having~~of collectibility ~~future~~is ~~operating~~particularly ~~and~~critical ~~net~~in ~~losses. We~~determining ~~have~~whether ~~incurred~~or ~~operating~~not ~~and~~revenue should ~~net~~be ~~losses~~recognized. ~~every~~A ~~year~~portion ~~since~~of weour ~~began operations.~~revenues Weis ~~have~~for ~~invested~~reciprocal ~~significant~~compensation generated ~~amounts~~by ofcalls ~~capital~~placed ~~and~~to ~~other~~Internet ~~expenditures~~service inproviders ~~developing~~who ~~our~~are ~~business and deploying~~ our ~~networks~~customers. In addition, ~~systems~~a ~~and~~portion ~~services~~of ~~and~~our werevenues ~~will~~is ~~continue~~switched toaccess ~~invest~~charge ~~capital~~ revenue for connecting ~~the operation of~~ our ~~business.~~voice Wecustomers ~~will continue~~ to ~~have~~their ~~significant~~selected ~~operating~~toll ~~and~~or ~~net~~long ~~losses~~distance incarriers for ~~our~~outbound ~~business~~calls ~~until~~or wefor ~~establish~~delivering ainbound ~~sufficient~~toll ~~revenue-generating~~and ~~customer~~long ~~base~~distance totraffic ~~cover~~ to our ~~costs~~voice customers. ~~For~~ ~~the~~Our ~~quarter~~ability ~~ended~~to ~~June 30,~~earn ~~2003,~~reciprocal wecompensation ~~had~~revenues ~~net~~and switched ~~operating~~access ~~losses~~revenues ofas ~~$75.0 million~~well ~~and~~as ~~net~~the ~~losses~~rates ~~including~~is ~~reorganization~~the ~~items~~subject of ~~$92.4 million. Even if we emerge from~~numerous ~~bankruptcy,~~regulatory weand ~~can~~legal ~~make~~challenges noand ~~assurances~~various ~~that~~interconnection weagreements. ~~will~~Until these ~~achieve~~issues orare ~~sustain~~ultimately ~~profitability~~resolved, orour ~~generate~~policy ~~sufficient~~is ~~operating income~~ to ~~meet~~recognize ~~our~~these ~~working~~revenues only ~~capital,~~when ~~capital~~realization ~~expenditure~~is ~~and debt service requirements~~probable.

~~Our~~Accounts ~~customer~~Receivable. A ~~contract~~considerable ~~with~~amount ~~Level 3 Communications represented 14%~~ of ~~our~~judgment ~~total~~is required ~~revenues~~in ~~for~~assessing the ~~quarter~~ultimate ~~ended~~realization ~~June 30, 2003 and the loss~~ of ~~this customer would materially and adversely impact~~ our ~~business.~~accounts ~~Our largest customer is Level 3 Communications, Inc~~receivable., ~~who~~We evaluate is the ~~assignee~~collectibility of ~~Genuity Solutions Inc.'s~~our ~~interest~~accounts inreceivable ~~the~~based ~~Genuity/Allegiance~~on ~~Integrated~~a ~~Network Solution Purchase Agreement.~~combination ~~Revenues~~of ~~from this contract were $27~~factors.~~0 million~~ ~~and~~We ~~$20.0 million~~recognize allowances for ~~the~~doubtful ~~three~~accounts ~~months~~based ~~ended~~on ~~June 30, 2003 and 2002, and $56.9 million and $34.4 million for~~ the ~~six~~length ~~months ended June 30, 2003 and 2002, respectively. This represented 14% and 11%~~ of ~~our~~time ~~total revenues for~~ the ~~quarters~~receivables ~~ended~~are ~~June 30~~past due, ~~2003~~the ~~and~~current ~~2002,~~business ~~respectively,~~environment and ~~39% and 29% of~~ our ~~data~~historical ~~revenues for the same periods~~experience. In ~~addition,~~circumstances ~~approximately~~where ~~85%~~we ofare ~~the~~aware ~~reciprocal~~of ~~compensation earned by us from other carriers is as~~ a ~~result of the other carriers terminating the Level 3~~specific traffic on our networks. Reciprocal compensation revenues for the three months ended June 30, 2003 and 2002, were $7.2 million and $10.0 million and for the six months ended June 30, 2003 and 2002 were $15.7 million and $17.9 million, respectively. We anticipate that Level 3 will continue to be our largest customer’s ~~for~~or ~~the~~carrier’s ~~foreseeable~~inability ~~future. If we fail~~ to meet ~~the~~its ~~performance~~financial ~~warranties under this contract or fulfill certain other~~ obligations ~~under this contract, Level 3 may be allowed~~ to ~~offset future payments to~~ us ~~and~~, ~~if such~~we ~~failure~~record ~~continues~~a ~~for~~specific anallowance ~~extended~~against ~~period~~amounts ~~of time~~due, ~~Level 3 could terminate this contract. The contract contains specific provisions that allow Level 3~~ to ~~decrease~~reduce ~~its~~the ~~purchase~~net ~~commitment~~recognized inreceivable ~~certain situations, including but not limited~~ to, ~~if Level 3's customer, AOL, reduces its services with Level 3 under Level 3's contract with AOL. If we were to lose some or all of~~ the ~~revenues~~amount ~~under the contract,~~ we doreasonably ~~not~~ believe wewill ~~could~~be ~~implement sufficient cost-cutting measures to offset such decrease in revenues~~collected. The resulting reduction in revenue (including reduction in reciprocal compensation revenues) and/or loss of this contract would have a material adverse effect on us. Please see the discussion of this customer contract under "Management's Discussion and Analysis of Financial Condition and Results of Operations."

~~The~~Some ~~regulation~~ of ~~interconnection~~our ~~with~~customers ~~incumbent local carriers involves uncertainties,~~ and ~~the resolution of these uncertainties could adversely affect our~~ ~~business.~~interconnection ~~Although the incumbent local~~ carriers ~~are~~have ~~required~~sought ~~under~~bankruptcy ~~the~~protection, ~~Telecommunications~~which ~~Act~~has ofresulted in ~~1996~~an toincrease ~~unbundle~~in ~~and~~our ~~make~~allowance ~~available~~for ~~elements~~doubtful ofaccounts. ~~their~~For ~~network~~customers ~~and~~who ~~permit us to~~have ~~purchase~~filed ~~only~~for ~~the origination and termination services that we need~~bankruptcy, ~~thereby decreasing~~ our ~~capital~~policy ~~and~~is ~~operating~~to ~~expenses,~~fully ~~such~~reserve ~~unbundling~~outstanding ~~may~~receivables for ~~not~~services beprovided ~~done~~in asperiods ~~quickly~~prior asto wetheir ~~require~~bankruptcy ~~and may be priced higher than we expect~~filing. ~~This~~If ~~is important because we rely on~~ the financial ~~facilities~~condition of ~~these other carriers to provide services to~~ our customers. ~~Our~~and ~~ability~~/or tointerconnecting ~~obtain~~carriers ~~these~~were ~~interconnection agreements on~~to ~~favorable~~deteriorate ~~terms,~~further ~~and~~or ~~the~~if ~~time~~economic ~~and~~conditions ~~expense involved in negotiating them~~worsened, ~~can~~additional allowances may be ~~adversely~~required ~~affected~~in bythe ~~legal and regulatory developments~~future.

~~The United~~Network ~~States~~Expenses. We ~~Supreme~~recognize ~~Court~~network ~~vacated~~expenses aas ~~FCC~~the products ~~rule~~and ~~determining~~services ~~which~~are ~~network~~provided ~~elements~~and ~~the~~delivered ~~incumbent~~to ~~local~~us ~~carriers~~by ~~must~~our ~~provide~~vendors. toThe recognition ~~competitors~~of onnetwork anexpense ~~unbundled~~and ~~basis.~~the ~~On November 5,~~related ~~1999,~~liabilities ~~the~~for ~~FCC~~network ~~released~~expense requires ancertain ~~order~~estimates ~~revising~~and ~~its~~assumptions ~~unbundled~~to ~~network~~be ~~element~~made ~~rules~~by tomanagement. ~~conform~~Our accruals tofor ~~the~~unbilled ~~Supreme~~leased ~~Court's~~network ~~interpretation~~facilities, ofnetwork ~~the~~access ~~law~~charges, and equipment ~~reaffirmed~~colocation ~~the~~charges ~~availability~~are ofbased ~~the unbundled~~on ~~network~~line ~~elements~~counts, ~~including~~estimated ~~local~~usage, ~~loops~~ and active ~~dedicated~~colocation ~~transport~~sites. Additionally, ~~the~~our ~~principal~~accrual ~~elements~~includes ~~used~~charges invoiced by network ~~us.~~providers Wewhich ~~use~~are ~~unbundled~~probable ~~local~~network ~~loops~~expenses ~~and~~but ~~unbundled~~have ~~high~~not ~~capacity~~yet ~~digital~~been paid ~~loops~~due to ~~connect~~disputes ~~our~~with these carriers. Should changes in conditions or facts ~~customer~~cause ~~locations~~us to revise our ~~voice~~estimates, our financial condition and results of operations could be significantly impacted.

35Impairment of Long-Lived Assets. We review the carrying values of property and equipment and intangible assets for impairment in accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). Under SFAS 144, we are required to identify current events or changes in circumstances which indicate that the carrying amount of an asset may not be recoverable. If impairment indicators are present, we analyze the projected undiscounted cash flows associated with our property and equipment and intangible assets to determine the fair value of these assets. Considerable management judgment is necessary in establishing the assumptions used as a basis for this analysis.

~~and data~~The ~~transmission~~commencement ~~equipment~~of ~~colocated~~our bankruptcy inproceedings ~~the~~is ~~incumbent~~a ~~local~~potential ~~carriers'~~indicator ~~central~~that ~~offices,~~the ~~and~~carrying ~~dedicated~~value ~~transport~~of certain toof ~~connect~~ our ~~transmission~~assets ~~equipment~~may tonot ~~our~~represent ~~switches~~their ~~and~~fair ~~data~~value. ~~equipment~~We ~~which~~performed ~~are~~an ~~generally~~analysis ~~located~~comparing atestimated ~~our~~future ~~central~~cash ~~offices.~~flows ~~The FCC also stated its intention~~ to ~~review every three years~~ the ~~unbundling~~carrying ~~obligations~~value of ~~incumbent local exchange carriers. The U.S. Court of Appeals for~~our ~~the~~property ~~District~~and ofequipment ~~Columbia~~and ~~Circuit~~intangible ~~remanded,~~assets ~~but~~at ~~did not vacate, the FCC's Order on~~ May 2414, ~~2002~~2003. ~~The~~This analysis ~~FCC's~~did ~~request~~not ~~for~~indicate ~~rehearing of~~ that ~~decision~~an ~~was~~impairment ~~denied,~~exists ~~but~~as ~~the Court agreed to delay until February 20, 2003 the issuance~~ of ~~the mandate. On February~~May 2014, 2003~~, the FCC announced its decision in the triennial review as briefly discussed below~~. ~~While these court and FCC~~ ~~proceedings~~Although ~~were pending,~~ we ~~entered~~believe ~~into~~our ~~interconnection~~estimates ~~agreements~~and ~~with~~assumptions aused ~~number~~in ofthis ~~incumbent~~calculation ~~local carriers through negotiations or~~are reasonable, inactual ~~some~~results ~~cases,~~could ~~adoption~~vary ofsignificantly ~~another~~from ~~competitive~~these ~~local carrier's~~estimates. ~~approved~~Should ~~agreement.~~changes ~~These agreements remain~~ in ~~effect,~~conditions ~~although~~or infacts ~~some~~cause ~~cases~~us ~~one~~to orrevise ~~both~~our ~~parties~~estimates, ~~may~~we could be ~~entitled~~required to ~~demand~~record ~~renegotiation~~impairment ofcharges ~~particular provisions or of the entire agreement based on intervening changes~~ in ~~the~~future ~~law. However~~periods, itwhich ismay have ~~uncertain~~a ~~whether~~significant ~~any~~impact ofon ~~these~~our ~~agreements~~results ~~will be so renegotiated or whether we will be able to obtain renewal~~ of ~~these agreements on as favorable terms when they expire~~operations.

Our facilities-based strategy allows us to control much of our network but we are still dependent on certain essential network elements that we lease from incumbent carriers. On December 20, 2001, the FCC released a Notice of Proposed Rulemaking as part of its comprehensive "triennial review" of the unbundling rules it implemented on November 5, 1999. In this review, the FCC examined the circumstances under which incumbent local exchange carriers will be required to make parts of their networks available to carriers like Allegiance on an unbundled basis under Section 251 of the Telecommunications Act of 1996. In particular, the FCC reviewed whether incumbents should be required to offer on an unbundled basis, among other things, local voice grade loops, unbundled network element platforms, high capacity loops such as those we use for many of our data and integrated voice and data services, subloops, network interface devices, the high-frequency portion of the loop, switching, and interoffice transmission facilities. The FCC announced its decision on February 20, 2003 in the triennial review proceeding. Although the text of the decision has not yet been released, our understanding of the decision is as follows. 29

36Other Matters. We do not have any of the following:

~~approach is consistent with our smart~~• Off-~~build~~balance ~~strategy~~sheet ~~for local transport of using ILEC facilities only as a transition to dark fiber or the facilities of other providers.~~ financial arrangements

~~Any limitation~~• Trading onactivities ~~the~~that ~~availability of unbundled network elements, especially unbundled local loops, network interface devices or interoffice transmission facilities, could increase our~~include ~~costs~~non-exchange ~~and~~traded ~~otherwise~~contracts ~~have~~accounted afor ~~material~~at ~~adverse~~fair ~~impact on our business.~~ value

~~On February 15,~~Management ~~2002, the FCC released a Notice of Proposed Rulemaking requesting comment on the future regulatory treatment of wireline broadband Internet access services. The FCC~~ has ~~tentatively concluded that when an entity provides wireline broadband Internet access over its own transmission facilities, the service should be classified as an information service, rather~~discussed ~~than a telecommunications service. If~~ the ~~FCC~~development ~~adopts this conclusion, wireline broadband Internet access services provided by local exchange carriers would be subject to substantially less regulation,~~ and ~~this~~selection ~~could~~of ~~result~~these incritical ~~the~~accounting ~~incumbent~~estimates ~~carriers~~with ~~not having to provide unbundled loops or unbundled high capacity digital loops over~~ the ~~lines used by us to provide broadband Internet access. We~~ ~~purchase~~audit ~~unbundled~~committee ~~high~~of ~~capacity digital loops from incumbent carriers to provide~~ our ~~own~~board ~~broadband Internet access service and integrated access service. While we cannot predict the outcome~~ of ~~this proceeding~~directors, ~~any~~and ~~curtailment of~~ the ~~incumbent~~audit ~~carriers'~~committee ~~unbundling~~has ~~obligations for the loop component used by them to provide broadband Internet access services or changes in the cost basis therefore~~reviewed ~~could materially increase~~ our ~~costs~~disclosure ~~and~~relating ~~adversely affect our ability~~ to ~~compete effectively with the incumbent carriers' broadband Internet access products~~them. ~~Our current understanding is that the FCC will issue this rulemaking in the near future.~~

~~In early~~NEW ~~May 2003, the Illinois legislature passed and the governor signed legislation that could significantly increase rates for unbundled local loops that SBC charges to~~ACCOUNTING competitors including us in Illinois. We are currently evaluating the impact of the legislation on our business, but we expect that our network expenses for unbundled loops in certain local calling zones of the Chicago metropolitan area may be increased to a level that will make our products and services less competitive with SBC's retail offerings. The legislation grandfathers up to 35,000 existing lines under the old rates for two years but applies to all new installations immediately. In addition, any lines that churn off of service may not be replaced by new lines at the grandfathered rate, but rather will be at the new rates. A lawsuit was filed seeking to overturn the Illinois law in federal district court and seeking a stay of the effectiveness of the law. The district court overturned the law and stayed the effectiveness of the rate increase. SBC has appealed this ruling. If the district court's decision is not ultimately upheld, we may have to significantly reduce or abandon our efforts to add new lines or customers in certain calling areas of Illinois and evaluate the viability of continuing to operate in the Chicago market when the two year grandfathering period has expired. If the district court's decision is ultimately overturned or other states in which we operate were to enact similar legislation, it could have a material adverse impact on our business. PRONOUNCEMENTS

37We continually monitor and revise our accounting policies as developments occur. The following recently issued accounting pronouncements may impact the future presentation of our financial condition and results of operations.

~~The~~In ~~FCC~~June 2001, isthe Financial ~~also~~Accounting ~~planning~~Standards toBoard ~~issue~~issued aStatement ~~Notice~~ of ~~Proposed~~Financial ~~Rulemaking~~Accounting Standards toNo. 143, ~~examine~~“Accounting ~~and potentially revise the procedure and rules~~ for ~~calculating~~Asset ~~the~~Retirement ~~prices~~Obligations.” ~~that ILECs charge competitors for~~This ~~unbundled~~statement ~~network~~addresses ~~elements~~financial ~~(UNEs).~~accounting ~~The~~and ~~process~~reporting ~~could~~for ~~result~~obligations associated inwith anthe ~~increase~~retirement ~~(possibly~~of ~~material)~~tangible inlong-lived ~~the~~assets ~~prices~~and ~~that we pay~~ the ~~ILECs~~associated asset ~~for~~retirement ~~UNEs~~costs. AOur ~~material~~adoption ~~increase~~of inthis ~~UNE~~statement ~~prices,~~did ~~especially~~not ~~for local loops and local transport, would~~ have a material effect ~~adverse impact~~ on our ~~business.~~financial position or results of operations.

~~The~~In ~~regulation of access charges involves uncertainties~~June 2002, ~~and~~ the ~~resolution of these uncertainties could adversely affect our business. We~~ ~~earn~~Financial ~~"access~~Accounting ~~charge"~~Standards ~~revenue~~Board byissued ~~connecting~~Statement ~~our~~of ~~voice~~Financial ~~service customers to their selected toll and long distance carriers for outbound calls or by delivering inbound toll and long distance traffic to~~Accounting ~~our~~Standards ~~voice service customers~~No. ~~Our interstate access charges were filed largely mirroring those used by the National Exchange Carrier Association ("NECA")~~ 146, an“Accounting ~~association~~for ofCosts ~~independent~~Associated ~~local~~with ~~exchange carriers,~~Exit ~~and our state access charges were generally set at rates comparable to those set by state associations similar to NECA~~ or ~~of individual incumbent carriers operating in other areas within the~~Disposal ~~same state~~Activities.” ~~These~~This ~~charges~~statement ~~are~~addresses ~~generally~~financial ~~higher~~accounting ~~than those charged by the larger carriers operating in the same areas because these large carriers have many more customers~~ and ~~therefore~~reporting ~~have lower per~~for ~~unit~~ costs. ~~Access~~associated ~~charges~~with ~~are~~exit ~~intended~~or todisposal ~~compensate~~activities. ~~the~~Adoption ~~local~~of ~~exchange~~this ~~carrier for the costs incurred in originating and terminating toll and long distance calls on its network and we believe our~~statement ~~access~~is ~~charges~~required ~~are~~for ~~appropriately~~exit ~~set~~or atdisposal ~~levels~~activities ~~approximately~~initiated ~~the~~after ~~same as those of the smaller carriers~~December 31, 2002, ~~but~~with weearly ~~anticipate~~application ~~that these rates will decline over time~~encouraged. Our ~~switched~~adoption ~~access rates will have to be adjusted to comply with future decisions~~ of ~~the~~this ~~FCC~~statement ordid ~~state commissions and these adjustments could~~ not have a material ~~adverse~~ effect on ~~us.~~our Wefinancial ~~have~~position ~~entered~~or ~~into~~results ~~a limited number~~ of ~~agreements with other carriers regarding access rates which settled certain access charge disputes~~operations. We are in the process of evaluating these agreements to determine whether to reject or assume these agreements in our Chapter 11 bankruptcy cases. There can be no assurance that we will be able to reject those access agreements; if we are able to reject such agreements, we believe the other carriers would need to pay us for access at our higher tariffed rates which could increase our access revenues.

~~On April~~In November 272002, ~~2001,~~ the ~~FCC~~FASB’s ~~issued~~Emerging aIssues ~~Report~~Task ~~and~~Force ~~Order~~(“EITF”) inreached ~~the~~a ~~Access~~consensus ~~Charge~~on ~~Reform~~Issue No. 00-21, ~~docket~~“Revenue ~~addressing~~Arrangements ~~competitive~~with ~~local~~Multiple ~~exchange carrier interstate access charge rates~~Deliverables.” ~~The~~EITF ~~FCC~~Issue ~~established~~No. 00-21 ~~safe~~provides ~~harbor~~guidance ~~benchmark~~on ~~interstate~~how ~~rates that decrease over three years~~ to ~~the~~account ~~rates~~for ~~charged~~arrangements ~~by incumbent local exchange carriers. The FCC stated~~ that ~~interexchange carriers must pay the~~ ~~benchmark~~involve ~~rates for~~ the ~~interstate~~delivery ~~access services they receive~~ or ~~face~~performance ~~suit~~of inmultiple ~~federal~~products, ~~court.~~services ~~AT&T has appealed the FCC's Report~~ and/or rights ~~Order~~ to ~~the~~use Uassets.S. ~~Court~~The ofprovisions ~~Appeals for the District~~ of ~~Columbia Circuit.~~EITF OnIssue ~~April~~No. ~~27,~~00-21 ~~2001,~~will ~~the~~apply ~~FCC also released a Notice of Proposed Rulemaking pursuant~~ to revenue ~~which~~arrangements itentered isinto ~~examining~~in ~~all~~fiscal ~~forms~~periods ofbeginning ~~intercarrier compensation including access charges~~after June 15, ~~and seeks comment on the feasibility of adopting a bill-and-keep approach for all such compensation~~2003. ~~Federally-mandated~~Our ~~reductions in access charges or~~ adoption of ~~a bill-and-keep~~this ~~approach~~statement ~~could~~did not have a material ~~adverse~~ effect on usour iffinancial weposition ~~are~~or ~~unable~~results toof ~~offset them with other revenues~~operations.

On In May 312003, ~~2002,~~the ~~WorldCom~~Financial Accounting ~~Network~~Standards ~~Services, Inc.~~Board ~~filed~~issued anStatement ~~informal~~of ~~complaint~~Financial ~~against~~Accounting usStandards No. 150, at“Accounting ~~the~~for ~~FCC~~Certain ~~claiming~~Financial ~~that~~Instruments itwith Characteristics isof ~~entitled~~both toLiabilities aand ~~refund~~Equity.” ofThis aStatement ~~portion of the interstate~~establishes ~~switched~~standards ~~access~~for ~~charges~~how ~~paid~~an byissuer ~~WorldCom~~classifies toand usmeasures ~~prior~~certain tofinancial instruments ~~the~~with ~~effective~~characteristics ~~date~~ of ~~the~~both ~~safe~~liabilities ~~harbor~~and ~~benchmark~~equity. ~~rates~~This ~~that~~Statement is iteffective ~~alleges~~for ~~were~~financial ~~unjust~~instruments ~~and~~entered ~~unreasonable.~~into Weor ~~have~~modified ~~since~~after May 31, ~~settled this matter~~2003, ~~along with~~and ~~other~~otherwise ~~disputes~~is ~~that~~effective ~~each~~at ~~party~~the ~~had~~beginning ~~against~~of the ~~other.~~first interim ~~The~~period ~~settlement~~beginning ~~was~~after ~~effective April~~June 15, 2003. ~~and~~Our ~~was~~adoption ~~approved~~of bythis statement, ~~the~~certain ~~Bankruptcy~~provisions ~~Court~~of inwhich ~~the~~have ~~WorldCom~~been ~~Chapter~~delayed, 11did ~~proceeding~~not onhave a ~~May 28,~~material ~~2003.~~effect on our financial position or results of operations.

~~On May 31,~~CERTAIN ~~2000, the FCC approved a proposal made by a coalition of the largest incumbent local carriers, AT&T and Sprint, to restructure interstate access charges. Pursuant to~~RELATED ~~the~~PARTY proposal, certain incumbent carriers, designated as "price cap" incumbent local carriers, are required to reduce their interstate access rates to targeted levels approved by the FCC or submit cost studies to justify different rates. We anticipate that implementation of the FCC's decision will lead to an industry-wide reduction in interstate access rates, even by those carriers that are not bound by the decision, including smaller TRANSACTIONS

38On April 4, 2001, Anthony Parella, President of Shared Technologies, borrowed $3.0 million from us. Mr. Parella issued a promissory note payable to us, which note was payable on April 4, 2004. In September 2001, Mr. Parella borrowed an additional $1.2 million from us. Mr. Parella issued a full recourse promissory note (the “Full Recourse Note”) payable to us for a total amount of $4.2 million plus previously accrued interest of $81,564 on the April 4, 2001 note. The Full Recourse Note is payable on April 4, 2004. This note accrues interest at 2.73% per annum, which was the November 2001 applicable federal rate, and interest is payable when this note is due. In the event Mr. Parella resigns or is terminated by us for cause (as defined in the Full Recourse Note), then this note will become immediately due and payable. Under the Full Recourse Note, we have the right to enforce the repayment obligation of Mr. Parella by looking to his personal assets. The Full Recourse Note is also secured by a pledge of Mr. Parella’s Allegiance stock options, as well as 350,000 shares of Allegiance common stock. The $4.2 million was used by Mr. Parella to repay certain debt that he incurred in connection with the purchase of land. That debt was secured by Mr. Parella’s Allegiance stock and he would have been forced to sell such stock to satisfy the debt if he did not obtain another means of repaying the debt. We determined that making the loan to Mr. Parella was in the best interests of our stockholders because it allowed him to avoid a forced sale of his shares and instead be able to take the time necessary to sell his land.

~~carriers. Reduction~~The inloan ~~interstate~~to Mr. Parella ~~access~~is ~~rates~~reflected ~~will~~in ~~have~~“other acurrent ~~material~~assets” ~~adverse~~in ~~effect~~our onfinancial statements. usIf ~~unless we are able to offset the access revenues with other revenues~~Mr. Parella does not

Several states in which we offer intrastate access services, including Colorado, Maryland, Massachusetts, Missouri, New Jersey, New York, Texas, Virginia and Washington, have proposed or required that access charges of competitive local carriers be capped at the rates charged by incumbent local carriers operating in the same area as the competitive local carriers with respect to calls originating or terminating in such area, except where the competitive carrier can establish that its costs justify a higher access rate through a formal cost proceeding. We believe that it is possible that other states will enact similar requirements. We also believe, however, that it is more likely that many states will use the same approach for intrastate long distance as the FCC ultimately decides to use for interstate long distance. If these proposals are adopted, they could have a material adverse effect on our revenues. 30

Werepay ~~could~~his ~~lose revenues if calls to Internet service providers are treated as long distance interstate calls. We earn "reciprocal~~loan ~~compensation" revenue by terminating on our network, local calls that originate on another carrier's network. We believe that~~ under the ~~Telecommunications~~terms ~~Act~~ of ~~1996,~~his other local exchange carriers should have to compensate us when their customers place calls to our customers who are Internet service providers. Most incumbent local carriers disagree. A majority of our reciprocal compensation revenues are a result from calls to our customers that are Internet service providersnote, ~~such~~we aswill ~~Level 3. Regulatory decisions providing that other carriers do not~~ have torecourse ~~compensate us for these calls could limit our ability~~ to ~~service~~his ~~this~~Allegiance ~~group of customers profitably and could have a material adverse effect on us. Given the uncertainty as to whether reciprocal compensation should be payable in~~stock ~~connection with calls to Internet service providers~~options, weshares ~~recognize such revenue only when realization~~ of itAllegiance iscommon ~~probable.~~stock In addition, the per minute compensation rates the FCC established for calls to Internet service providers under new interconnection agreements are significantly lower than the reciprocal compensation rates under our previous agreements. Although no order has yet been issued, it has been reported that on August 7, 2003, the Minnesota Public Utilities Commission established a rate of zero cents for terminating local calls subject to reciprocal compensation. We believe, based on the recommendation of the Commission staff, that this reduction will not take place until we negotiate and ~~execute~~personal ~~an amendment to our interconnection agreement with Qwest in Minnesota to reflect this regulatory change~~recourse. ~~These reductions in compensation will have a material adverse effect on us if we are unable to offset them with other revenues.~~

~~The obligation~~During tothe ~~pay~~three ~~reciprocal~~and ~~compensation~~nine months ~~does~~ended ~~not extend to long distance interstate calls. The FCC in its Declaratory Ruling of February~~September 2630, ~~1999~~2003, ~~determined~~Swidler ~~that~~Berlin ~~Internet service~~Shereff ~~provider traffic is interstate for jurisdictional purposes~~Friedman, ~~but~~LLP ~~also~~performed legal ~~determined~~services ~~that its current rules neither required nor prohibited the payment of reciprocal compensation~~ for ~~such calls~~us. ~~In the~~Andrew ~~absence~~Lipman, of a ~~federal~~member ~~rule, the FCC determined that state commissions had authority to interpret and enforce the reciprocal compensation provisions~~ of ~~existing~~our ~~interconnection~~board ~~agreements and to determine the appropriate treatment~~ of ~~Internet~~directors, ~~service~~is ~~provider traffic in arbitrating new agreements. The Court of Appeals for the District of Columbia Circuit issued~~ a ~~decision on March 24,~~ ~~2000,~~senior ~~vacating~~partner ~~the~~at ~~Declaratory~~this ~~Ruling.~~law ~~The court held that the FCC had not adequately explained its conclusion that calls to Internet service providers should not be treated as "local" traffic~~firm. ~~On April 27,~~We ~~2001,~~recorded ~~the~~approximately ~~FCC~~$0 ~~issued its Order on remand from the Court of Appeals~~ and ~~concluded~~$97,000 ~~that it had erred~~ in legal ~~its~~fees ~~analysis~~by ofthis ~~Internet~~firm ~~traffic~~ in the ~~Declaratory~~three ~~Ruling. In that Order, the FCC categorized such traffic as "information access"~~ and ~~held~~nine ~~that~~months itended ~~is not subject to reciprocal compensation obligations. Nonetheless~~September 30, ~~it established an interim~~ 2003, ~~transitional~~respectively. ~~recovery~~We ~~mechanism pursuant~~intend to ~~which Internet service provider traffic will~~ continue tousing bethis ~~compensated,~~law ~~but~~firm atin ~~rates~~fiscal ~~declining over a period of three years. In a decision issued May 3, 2002, the U.S. Court of~~2003 ~~Appeals~~ for ~~the~~advice ~~District of Columbia Circuit remanded for further proceedings, but did not vacate, the FCC's Order~~ on ~~remand,~~legal ~~holding that the section of the Act on which the FCC relied did not support its conclusion that Internet service provider~~ matters.

39FORWARD-LOOKING STATEMENTS

~~traffic~~Certain statements in isthis ~~not~~report constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, and we intend that such forward-looking statements be subject to ~~reciprocal~~the ~~compensation~~safe harbors created by this law. You Ingenerally acan ~~Notice~~identify these statements by our use of ~~Proposed~~forward-looking ~~Rulemaking~~words such ~~released~~as ~~April 27~~“plans,” ~~2001~~“estimates,” ~~the~~“believes,” ~~FCC~~“expects,” ~~initiated~~“may,” a“will,” ~~rulemaking~~“should” toor “anticipates” ~~examine~~or ~~all~~the ~~forms~~negative or other variations of ~~intercarrier~~such ~~compensation, including~~terms ~~reciprocal~~or ~~compensation~~comparable terminology, or by discussion of strategy that involve risks and ~~sought~~uncertainties. We ~~comment~~often onuse ~~the~~these ~~feasibility~~types of ~~adopting~~statements awhen ~~bill-~~discussing our plans and~~-keep~~ ~~approach~~strategies, our ~~for~~anticipation ~~such~~of ~~compensation.~~revenues ~~Federally-mandated~~from ~~reductions~~designated inmarkets, ~~reciprocal~~and statements regarding ~~compensation~~the ~~will~~development ~~have~~of aour ~~material~~businesses, ~~adverse~~possible ~~effect~~impact of our bankruptcy filing on our usbusiness, ifpossible weactions ~~are~~by ~~unable~~the toBankruptcy ~~offset~~Court, ~~them~~the ~~with~~Creditors’ Committee, ~~other~~our ~~revenues.~~senior ~~Additional~~lenders ~~disputes~~or ~~over~~other creditors, the ~~appropriate~~markets ~~treatment~~for ofour ~~Internet~~services and ~~service~~products, ~~provider~~our ~~traffic~~anticipated ~~are~~capital expenditures, operations support systems ~~expected.~~or changes in regulatory requirements and other statements contained in this report regarding matters that are not historical facts.

~~Our~~We ~~success~~caution ~~depends~~you onthat ~~our key personnel and we may not be able to replace key employees who leave, especially during our reorganization under Chapter 11 of the~~these ~~Bankruptcy~~forward-looking ~~Code.~~statements We are ~~managed~~only bypredictions aand ~~number~~estimates ofregarding ~~key~~future events ~~employees,~~and ~~most notably Royce J~~circumstances. ~~Holland,~~We ~~our~~cannot ~~Chairman~~assure ~~and~~you ~~Chief~~that ~~Executive~~we ~~Officer,~~will ~~who~~achieve ~~is widely recognized as one of~~ the future ~~pioneers~~results reflected in ~~managing~~these ~~providers of competitive local exchange services~~statements. The ~~loss~~risks ofwe ~~services~~face ofthat ~~one or more of these key individuals, particularly Mr. Holland,~~ could ~~materially~~cause ~~and adversely~~us ~~affect~~not ~~our~~to ~~business~~achieve ~~and~~these ~~our~~results ~~prospects.~~are ~~Most~~many ofand ~~our~~include, ~~key~~but ~~employees~~are do not ~~have~~limited ~~employment agreements~~to, ~~and~~the risks wediscussed doin ~~not~~this ~~maintain~~report ~~key~~as ~~person~~well ~~life~~as ~~insurance for any of~~ our ~~employees.~~ability ~~We cannot assure you that we will be able~~ to ~~hire~~do orthe ~~retain~~following ~~necessary~~in ~~personnel~~a timely ~~during this process and if we are unable to do so~~manner, ~~this~~at ~~could~~reasonable ~~have~~costs aand ~~material~~on ~~effect~~satisfactory onterms ~~us.~~and conditions:

We are dependent on effective billing, customer service and information systems and we may have difficulties in developing, maintaining and enhancing these systems. Sophisticated back office information and processing systems are vital to • our ~~growth and our ability to control and monitor costs,~~ bill and service customers, initiate, implement and track customer orders and achieve operating efficiencies. We have introduced a new billing platform across our geographic markets and plan to migrate all customers to this new billing platform. Although we are taking steps to manage the implementation of the new billing system and we believe that the new billing system will enhance our ability to ~~accurately~~obtain ~~and~~court ~~efficiently~~approval ~~bill~~with ~~for~~respect ~~our services, we cannot assure you that the transition~~ to ~~the~~motions ~~new billing system will not have any adverse impact on our business. We believe this new billing system will be more effective and accurate~~ in ~~delivering the quality billing functions that we need. Since~~ our ~~inception,~~Chapter ~~we have also been engaged in developing and integrating our essential~~11 ~~information~~cases ~~systems~~prosecuted consisting of our billing system, our sales order entry system, our customer implementation system, our electronic bonding systems and our switch information systems. In addition, we continue to integrate our acquired businesses. These are challenging projects because all of these systems were developed by ~~different~~us ~~vendors~~from ~~and~~time must be coordinated through custom software and integration processes. Our sales, line count and other core operating and financial data are generated by these systems and the accuracy of this data depends on the quality and progress of the system integration project. Although we have made significant progress in our system integration efforts, we have not completed it and we may experience additional negative adjustments to our financial and operating data as we complete this effort. These adjustments have not had a material adverse effect on our financial or operating data to date but until we complete the entire project we cannot assure you that any such adjustments arising out of our systems integration efforts will not have a material adverse effect in the future. If we are unable to develop, acquire and integrate our operations and financial systems, our customers could experience delays in connection of service, billing issues and/or lower levels of client service. We also cannot assure you that any of our systems will be successfully implemented on a timely basis or at all or will perform as expected because among other things,: time;

40• our ability to develop, prosecute, confirm and consummate one or more plans of reorganization with respect to the Chapter 11 cases;

~~Our~~• risks ~~failure~~associated with third parties seeking and obtaining court approval to ~~successfully~~terminate or ~~implement~~shorten ~~these~~the ~~systems~~exclusivity ~~would~~period ~~have~~for Allegiance to propose and confirm one or more plans of reorganization, for the appointment of a ~~material~~Chapter ~~adverse~~11 ~~effect~~trustee onor ~~our~~to convert ~~business~~the ~~and~~Chapter ~~prospects.~~11 cases to Chapter 7 cases;

~~We are dependent on many vendors and suppliers and their financial difficulties may adversely affect~~ • our ~~business. We depend on many~~ ~~vendors~~ability ~~and suppliers~~ to ~~conduct~~obtain ~~our business. For example, we purchase our network assets~~ and ~~customer~~maintain ~~premise~~normal ~~equipment from equipment manufacturers~~ and ~~other~~reasonable ~~suppliers~~terms ~~and~~with wevendors ~~lease fiber~~ and ~~other~~ ~~circuits~~service ~~from~~providers ~~other~~and carriers as well as from companies who construct these network elements for resale. Many of these third parties have experienced substantial financial difficulties in recent months, in some cases leading to ~~bankruptcies~~maintain ~~and~~contracts ~~liquidations.~~that Inare ~~particular,~~critical ~~the providers of fiber for our metropolitan fiber rings as well as our long-haul fiber routes have experienced financial difficulties, including difficulty in raising the necessary capital~~ to ~~complete fiber construction projects and in some cases filing for bankruptcy. The financial difficulties of these companies could have a material adverse effect on~~ our ~~business and prospects.~~ operations;

~~On February 14, 2003, Broadwing Communications Services, Inc., a supplier of long distance services to us, alleged that we were in material default of~~ • our ~~Master Service~~ ~~Agreement~~ability ~~with Broadwing. Broadwing is demanding $6.6 million in disputed charges and is threatening~~ to ~~terminate~~perform ~~service~~under ~~to our customers. Broadwing has also demanded an additional security deposit from us. In response, we sought~~ and ~~received~~maintain ~~a temporary restraining order. An agreed preliminary injunction was signed on April 17, 2003, preventing Broadwing from terminating~~ our ~~service~~ ~~and~~Level ~~referring~~3 ~~the~~customer ~~dispute to arbitration. We have not included this dispute in network costs as of June 30, 2003, as we believe it is not probable that we will be required to pay this disputed amount.~~ contract;

~~Our financial results could be adversely affected by churn and the financial difficulties of our customers. We expect retail as well as~~• Daleen ~~retail and wholesale line churn to continue to average approximately 2% to 3% per month~~Solutions, ~~which means that approximately 2% to 3% of our total number of retail/retail and wholesale lines in service would discontinue our service each month~~Inc.'s ~~However, our~~ ability to ~~retain~~perform ~~our~~under ~~customers~~its ~~and control our churn rate (including line churn) is dependent on a number of factors, including (a) our ability to provide quality service, customer care and accurate and timely~~ billing, ~~(b) our~~services ability to offer competitive pricing and overcome so called "win-back" programs offered by our competitors, (c) our ability to timely meet the needs and demands of our customers, (d) our ability to properly incentivize our sales force to build strong customer relationships, (e) the economic viability of our customers (see the discussion in the following paragraph), (f) the strength and recovery of the United States economy, (g) our ability to limit service disruptions as we optimize our network and (h) an ability to overcome our customers' concerns regarding our bankruptcy. We can make no assurances that our churn rates (including line churn) will not increase. If our churn rates (including line churn) increase or are higher than expected, this could have a material adverse effect on our business and prospects. contract;

We• the ~~provide~~potential ~~services~~adverse todirect ~~small~~ and ~~medium-sized~~indirect ~~businesses~~impact ~~as well as network service providers. Many~~ of ~~these~~the ~~businesses~~Chapter ~~have~~11 ~~experienced substantial financial difficulties in recent months, in some~~ cases ~~leading to bankruptcies and liquidations. The financial difficulties of these companies could have a material adverse effect~~ on our ~~financial results if we are unable to collect~~ revenues from these customers or if such customers reject the customer's contract with us in its bankruptcy. In addition, among other things, we believe companies in financial difficulty are less likely to expand their operations and related demand for communications services and to migrate from dial-up Internet connections to more advanced dedicated connections such as those that we offer. business;

41• the costs and availability of financing;

~~The financial difficulties of other competitive communications providers could adversely affect~~ • our ~~business. Many competitive local~~ ~~exchange~~ability ~~carriers, long distance carriers, and other emerging communications providers have experienced substantial financial difficulties over the past year, in some cases leading~~ to ~~bankruptcies~~execute ~~and liquidations. The financial difficulties of these companies could reflect poorly on~~ our ~~own~~business ~~financial stability~~plan, ~~may~~including ~~diminish~~ our ability to ~~obtain~~provide ~~further capital, may adversely affect the~~quality ~~willingness~~customer ofservice ~~potential customers to move their communications services to an emerging carrier like Allegiance~~ and ~~may~~develop ~~result~~efficient inoperations ~~losses~~support orsystems ~~write-offs of reciprocal compensation~~ and ~~access~~other ~~revenues~~back ~~from~~office ~~these carriers. Moreover~~systems, we have experienced efforts by established carriers to promote this problem by suggesting to their customers that they should not risk placing their communications services in the hands of an emerging carrier including one that has filed for bankruptcy. Some of our competitors have emerged from bankruptcy and others currently in bankruptcy may do so as well. Many of these companies have been able to reduce their debt and otherwise recapitalize their business and as a result, may be able to gain greater market share by reducing the prices for their products and services. These companies may be able to reduce their prices to a point lower than our prices and yet still be able to make a profit because of their reduced debt. We may lose business as a result of this price competition, and such loss of business may have a material adverse effect on us.

~~If we do not interconnect with and maintain efficient working relationships with~~ • our ~~primary competitors, the incumbent local carriers, our business will be~~ adversely affected. Many new carriers, including us, have experienced difficulties in working with the incumbent local carriers with respect to initiating, interconnecting, and implementing the systems used by these new carriers to order and receive unbundled network elements and wholesale services and locating the new carriers' equipment in the offices of the incumbent local carriers. As a competitive carrier, we must coordinate with incumbent local carriers so that we can provide local service to customers on a timely and competitive basis. The Telecommunications Act of 1996 created incentives for regional Bell operating companies to cooperate with competitive carriers and permit access to their facilities by denying such companies the ability to provide in-region long distance services until they have satisfied statutory conditions designed to open their local markets to competition. The FCC has granted approval to BellSouth and Verizon to provide in-region long distance service in every state where they operate. The FCC has granted approval to SBC Communications to provide in-region long distance service in Californiaattract, ~~Texas,~~motivate ~~Oklahoma, Missouri, Arkansas, Kansas,~~ and/or ~~Nevada;~~retain ~~and~~key to Qwest to provide such service in Montana, Utah, Washington, Wyoming, Colorado, Idaho, Iowa, Nebraska. North Dakota, South Dakota, New Mexico and Oregon. Once authorized to provide long distance service, the RBOCs may have less incentive to be accommodating to us. In addition, these companies may limit the development of their systems that they were doing prior to being permitted to offer long distance services. employees;

The regional Bell operating companies have been fined numerous times by both federal and state authorities for their failure to comply with applicable telecommunications laws and regulations. We do not believe these fines have had any meaningful impact on the anticompetitive practices of many of these companies and in fact believe that these practices are increasing in most of our markets. We attempt to enforce our rights against these incumbent monopolies but often times the remedies are inadequate to change their anticompetitive practices and in any event provide us with little or no recovery of the damages we have suffered as a result of these practices. Moreover• regulatory, ~~efforts by us to enforce our rights against these companies may further diminish the level of~~ ~~cooperation~~judicial we receive from them. If we cannot obtain the cooperation of a regional Bell operating company in a region, whether or not it has been authorized to offer long distance service or a regional Bell operating company otherwise fails to meet our requirements, for example, because of (1) labor shortages, (2) work stoppages or (3) disruption caused by mergers or other organizational changes or terrorist attacks, our ability to offer local services in such region on a timely and ~~cost-effective~~legislative basis will be materially adversely affected. Specifically, Verizon and the unions, Communications Workers of America and the International Brotherhood of Electrical Workers, have been working with a Federal developments;

42• general economic conditions; and

~~mediator~~• the ~~since~~effects ~~July 29,~~of ~~2003, attempting to renegotiate~~ the ~~applicable~~war ~~union contracts. Although the union contracts expired at midnight August 2, 2003, Verizon employees~~ in 13Iraq ~~states~~ and ~~the~~any ~~District~~other ofhostilities ~~Columbia~~or ~~have~~act ~~reported~~of towar ~~work~~or ~~as normal. We purchase services from Verizon to enable us to provide services to our existing and new customers and~~ any ~~strike by these unions could~~ ~~have~~terrorist ~~a material adverse affect on our business~~attack.

~~We have~~You ~~experienced~~should ~~difficulties~~consider ~~also with receiving payment from the incumbent local exchange carriers on reciprocal compensation, access charges, and other services provided by us to~~all ~~them. These balances in some instances may be significant and material. We have generally been able to reach mutually acceptable settlements~~ of ~~these~~our ~~amounts~~subsequent inwritten the past, but there can be no assurance that we will be able to do so in the future. If we do not receive payments from the incumbent local exchange carriers with respect to these services provided by us to them and~~/or~~ iforal weforward-looking ~~are~~statements ~~unable~~only to reach settlement agreements for the incumbent local exchange companies to pay amounts owed to us, it could have a material adverse effect on us. In addition, some of our interconnection agreements allow the incumbent local exchange carriers to increase the security amount held by them. In addition, some utilities may seek additional assurances in ~~the~~light ~~form~~ of ~~deposits or other security in~~ ~~accordance~~such with our bankruptcy filings and the bankruptcy rules. If we are forced to increase any security provided to these carriers, this would reduce the amount of cash available for expenses of our business which could have a material adverse effect on our business. cautionary

Our principal competitors for local services, the incumbent local carriers, and potential additional competitors, have advantages that may materially adversely affect our ability to compete with them. The telecommunications industry is highly competitive. In each of the markets targeted by us, we will compete principally with the incumbent local carrier serving that area. Many of our current and potential competitors in the local market have financial, technical, marketing, personnel and other resources, including brand name recognition, substantially greater than ours, as well as other competitive advantages over us. Incumbent local carriers also enjoy other advantages that may adversely affect our ability to compete with them, such as our need to purchase critical elements of our network from them. Incumbent local carriers are established providers of local telephone services to all or virtually all telephone subscribers within their respective service areas. Incumbent local carriers also have long-standing relationships with federal and state regulatory authorities. FCC and state administrative decisions and initiatives provide the incumbent local carriers with pricing flexibility for their: 31

In addition, with respect to competitive access services, such as special access services as opposed to switched access services, the FCC recently granted incumbent local carriers increased pricing flexibility and deregulation for such access services after certain competitive levels are reachedstatements. ~~If the incumbent local carriers are allowed by regulators to offer discounts to~~You ~~large~~should ~~customers~~not ~~through~~place ~~contract~~undue ~~tariffs,~~reliance ~~engage~~on inthese ~~aggressive~~forward-looking ~~volume~~statements and ~~term discount pricing practices for their customers, and/or seek to charge competitors excessive fees for interconnection to~~you ~~their~~should ~~networks~~understand orthat ~~access~~they torepresent ~~unbundled~~management’s ~~network~~view ~~elements,~~only ~~competitors such~~ as usof ~~could be materially adversely affected. If future regulatory decisions afford~~ the ~~incumbent~~dates ~~local carriers increased~~we ~~pricing~~make ~~flexibility or other regulatory relief, such decisions could also have a material adverse effect on competitors such as us~~them.

~~We also~~RISK ~~face, and expect to continue to face, competition in the local market from other current and potential market entrants, including long distance carriers seeking to enter, reenter or expand entry~~ FACTORS

43Our businesses are subject to a number of risks including: (i) bankruptcy related risk factors; and (ii) general business and financial risk factors. Any or all of such factors, which are enumerated below, could have a material adverse effect on the business, financial condition or results of operations of our company.

~~into the~~Bankruptcy ~~local exchange marketplace such as AT&T, WorldCom and Sprint, and from other competitive local carriers, wireless carriers, resellers, competitive access providers, cable television~~Related ~~companies,~~Risk electric utilities, microwave carriers and private networks built by large end users. In addition, the development of new technologies could give rise to significant new competitors in the local market. Factors

~~Significant~~Our ~~competition~~operations inmay ~~providing~~be ~~long~~disrupted ~~distance~~due to ~~and~~the ~~Internet~~filing ~~services~~of ~~could~~the ~~reduce~~Chapter ~~the~~11 ~~demand~~proceeding. On May 14, 2003, we filed voluntary petitions for ~~and~~relief ~~profitability~~under Chapter 11 of ~~our~~the ~~services~~Bankruptcy Code. WeThe impact that ~~also~~the ~~face~~Chapter ~~significant~~11 ~~competition~~cases may have on our operations cannot be accurately predicted or quantified. Since the announcement of the amendment to our senior credit agreement in ~~providing~~November 2002, ~~long~~the ~~distance~~challenges ~~and~~of ~~Internet~~selling our telecommunications products and services to new and existing customers has increased. ~~Many~~In particular, since the announcement of ~~these~~our ~~competitors~~receipt ~~have~~of ~~greater~~a ~~financial,~~going concern ~~technological~~qualification from our independent public accountants in March 2003, customers ~~marketing~~have in some cases declined to conduct business with our company and certain vendors have either declined to conduct business with us or have asked for deposits, ~~personnel~~letters of credit and other ~~resources~~forms ~~than~~of ~~those~~security prior to providing ~~available~~services to us. In addition, we have had difficulty in obtaining bid and performance bonds which are required by some customers of our customer premise equipment sales and maintenance business. We have also experienced the loss of talented key employees and could experience more losses of key talent in the future attributable to our reorganization efforts. The continuation of the Chapter 11 cases could further adversely affect our operations and our current and potential relationships with our customers, employees, suppliers, and other representatives.

~~The long~~Any ~~distance~~plan ~~telecommunications~~of ~~market~~reorganization ~~has~~that ~~numerous entities competing for the same customers and a high average turnover rate, as customers frequently change long distance~~we ~~providers~~propose inmay ~~response~~not tobe ~~the~~acceptable ~~offering of lower rates or promotional incentives. Prices in the long distance market have declined significantly in recent years and are expected~~ to ~~continue~~our tocreditors ~~decline. We face competition from large carriers such as AT&T, WorldCom~~ and ~~Sprint,~~other ~~wireless~~stakeholders ~~carriers~~ and ~~many smaller long distance carriers. Other competitors include regional Bell operating companies~~/or ~~providing~~may ~~long~~not ~~distance~~be ~~services~~confirmed ~~outside~~by ~~of their local service area and, with~~ the ~~removal~~Bankruptcy ~~of regulatory barriers, long distance services within such local service areas, other competitive local carriers, microwave and satellite carriers and private networks owned by large end users~~Court. ~~The~~If ~~FCC~~our ~~has~~plan ~~granted approval to provide in-region long distance service to BellSouth and Verizon~~is innot ~~all~~confirmed ~~of their states; to SBC Communications in California, Texas, Oklahoma, Missouri, Arkansas, Kansas~~ and/or ~~Nevada;~~an ~~and~~alternative toreorganization ~~Qwest~~cannot inbe ~~Montana,~~agreed ~~Utah~~upon, ~~Washington,~~it ~~Wyoming, Colorado, Idaho, Iowa,~~is ~~Nebraska,~~possible ~~North~~that ~~Dakota,~~the ~~South~~company ~~Dakota, New Mexico and Oregon. We~~ may ~~also~~be ~~increasingly~~sold ~~face~~under ~~competition~~Section 363 ~~from~~of ~~companies~~Chapter ~~offering~~11 ~~local and long distance data and voice services over the Internet. Such companies could enjoy a significant cost advantage because they do not currently pay many~~ of the ~~charges~~Bankruptcy ~~or fees that we have to pay~~Code.

~~The~~We may lose exclusivity by failing to ~~Internet~~submit ~~services~~a ~~market~~plan isof ~~highly~~reorganization ~~competitive~~by ~~and~~the ~~there~~end ~~are~~of ~~limited~~the ~~barriers~~exclusivity period. Allegiance currently is the only party able to ~~entry.~~submit Wea ~~expect~~plan ~~that~~of ~~competition~~reorganization ~~will~~in ~~continue~~its tobankruptcy ~~intensify~~proceeding. However, ~~Our~~if ~~competitors~~we indo ~~this~~not ~~market~~submit ~~include~~a plan of ~~Internet~~reorganization ~~service~~by ~~providers~~December 16, ~~incumbent~~2003, ~~local~~or ~~carriers~~any extension, ~~other~~any ~~telecommunications~~party ~~companies,~~in ~~online~~interest may ~~service~~submit ~~providers,~~a ~~cable~~plan ~~companies,~~of ~~and~~reorganization ~~Internet~~that ~~software~~may ~~providers.~~include the sale of the company pursuant to Section 363 of Chapter 11 Bankruptcy Code.

~~Our~~Any ~~need~~sale toof ~~comply~~the ~~with~~company ~~extensive~~may ~~government~~not include ~~regulation~~all ~~can~~of ~~increase~~the ~~our~~assets ~~costs~~of ~~and~~the ~~slow~~company. There ~~our~~can ~~growth.~~be ~~Our~~no ~~networks~~assurances ~~and~~that ~~the~~if ~~provision~~we ofenter ~~telecommunications~~into ~~services~~a ~~are~~sale ~~subject~~of ~~to significant regulation at~~ the ~~federal,~~company ~~state~~under ~~and~~Section ~~local~~363 ~~levels.~~of ~~Delays~~Chapter in11 ~~receiving~~Bankruptcy ~~required~~Code ~~regulatory approvals or the enactment of new adverse regulation~~that orany ~~regulatory~~assets ~~requirements~~not ~~may~~sold ~~slow~~will ~~our~~be ~~growth~~operated ~~and~~as ~~have~~ a ~~material~~going ~~adverse effect upon us~~concern.

~~The~~Our common stock and high-yield bonds ~~FCC~~are ~~exercises~~unsecured ~~jurisdiction~~and ~~over~~located usat ~~with~~our ~~respect~~holding tocompany ~~interstate~~and as a result, a restructuring of our debt may substantially reduce the value of our bonds and common ~~international~~stock, ~~services~~potentially to zero. We ~~must~~operate ~~obtain~~our business through subsidiaries and have no material assets at our holding company, Allegiance Telecom, Inc., other than the common stock of our main operating company, Allegiance Telecom Company Worldwide. Our holding company is the issuer of our common stock and our high-yield bonds. These securities are not guaranteed by any of our operating subsidiaries and therefore have ~~obtained~~no claims ~~through~~against the assets of those operating subsidiaries. As such, all of the assets of those operating subsidiaries are subject to the claims of our senior secured creditors and our unsecured creditors at our subsidiary operating companies. Moreover, the only material asset of our holding company, the common stock of our main operating company, Allegiance Telecom Company Worldwide, is ~~International~~pledged as collateral to our senior secured creditors. The rights and claims of various creditors and security holders will be determined by a plan of reorganization that is confirmed by the Bankruptcy Court. Under the priority rules established by the Bankruptcy Code, certain post-petition liabilities and pre-petition liabilities (i.e., our senior secured debt) of a debtor need to be satisfied before unsecured creditors or stockholders are entitled to any distribution. We have proposed material reductions in our level of senior secured debt and believe that this is required to have a feasible reorganization plan. Any Chapter 11 plan filed by us may provide that unsecured creditors of subsidiaries of Allegiance Telecom, Inc. will need to be satisfied before any distribution to the unsecured creditors or stockholders of Allegiance Telecom, Inc. As ~~prior~~a result, ~~FCC~~a ~~authorization~~plan ~~for~~of ~~installation~~reorganization ~~and~~could ~~operation~~result in holders of ~~international~~our ~~facilities~~bonds ~~and~~receiving little or no value as part of the ~~provision~~plan of reorganization. Based on current discussions with our creditors regarding a plan of reorganization, ~~including~~our bycommon ~~resale~~stock will probably receive no value as part of the reorganization. In light of the foregoing, we consider our bonds and common stock to be highly speculative and we caution the holders of ~~international~~such ~~long~~securities that ~~distance~~such ~~services~~securities may ultimately be determined to have no value. Accordingly, we urge that extreme caution be exercised with respect to existing and future investments in any of such securities and claims.

State regulatory commissions exercise jurisdiction over us because we provide intrastate services. We are required to obtain regulatory authorization and/or file tariffs at state agencies in most of the states in which we operate. If and when we seek to build our own network segments, local authorities regulate our access to municipal rights-of-way. Constructing a network and selling and maintaining telephone equipment is also subject to numerous local regulations such as building codes and licensing. Such regulations vary on a city by city and county by county basis. In some states, we are required to obtain state contractor licenses. If we do not obtain such required licenses, we may be subject to fines and other penalties. 32

~~Regulators at~~General ~~both the federal and state level require us to pay various fees and assessments~~Business, ~~file periodic reports, and comply with various rules regarding the contents of our bills,~~ ~~protection~~Financial ~~of subscriber privacy, service quality~~ and ~~similar~~Other ~~matters~~Risk ~~on an ongoing basis.~~ Factors

44We anticipate having future operating and net losses. We have incurred operating and net losses every year since we began operations. We have invested significant amounts of capital and other expenditures in developing our business and deploying our networks, systems and services and we will continue to invest capital for the operation of our business. We will continue to have significant operating and net losses in our business until we establish a sufficient revenue-generating customer base to cover our costs. For the quarter ended September 30, 2003, we had net operating losses of $60.7 million and net losses including reorganization items of $63.1 million. Even if we emerge from bankruptcy, we can make no assurances that we will achieve or sustain profitability or generate sufficient operating income to meet our working capital, capital expenditure and debt service requirements.

WeOur customer contract with ~~cannot~~Level 3 ~~assure~~Communications ~~you~~represented ~~that~~14% of our total revenues for the quarter ~~FCC~~ended orSeptember 30, ~~state~~2003 ~~commissions~~and ~~will~~the ~~grant~~loss ~~required~~of ~~authority~~this orcustomer ~~refrain~~would materially and adversely impact our business. Our largest customer is Level 3 Communications, Inc., who is the assignee of Genuity Solutions Inc.’s interest in the Genuity/Allegiance Integrated Network Solution Purchase Agreement. Revenues from ~~taking~~this ~~action~~contract ~~against~~were us$27.3 million ifand we$26.2 million ~~are~~for ~~found~~the tothree months ~~have~~ended ~~provided~~September 30, ~~services~~2003 ~~without~~and ~~obtaining~~2002, and $84.2 million and $60.5 million for the ~~necessary~~nine ~~authorizations~~months ended September 30, or2003 toand ~~have~~2002, respectively. ~~violated~~This represented 14% and 12% of our total revenues for the quarters ended September 30, 2003 and 2002, respectively, and 39% and 37% of our data revenues for the same periods. In addition, approximately 85% of the reciprocal compensation earned by us from other ~~requirements~~carriers is as a result of ~~their~~the other ~~rules~~carriers terminating the Level 3 traffic on our networks. Reciprocal compensation revenues for the three months ended September 30, 2003 and 2002, ~~orders~~were $4.0 million ~~Regulators~~and $7.1 million and for the nine months ended September 30, 2003 and 2002 were $19.8 million and $25.0 million, respectively. We anticipate that Level 3 will continue to be our largest customer for the foreseeable future. If we fail to meet the performance warranties under this contract or ~~others~~fulfill certain other obligations under this contract, Level 3 may be allowed to offset future payments to us and, if such failure continues for an extended period of time, Level 3 could ~~challenge~~terminate ~~our~~this ~~compliance~~contract. The contract contains specific provisions that allow Level 3 (a) to decrease its purchase commitment in certain situations, including but not limited to, if Level 3’s customer, AOL, reduces its services with ~~applicable~~Level 3 ~~rules~~under Level 3’s contract with AOL, or (b) to decrease the purchase commitment or terminate the contract if Level 3 receives a bona fide competitive offer for a certain amount of services from a third party for services similar in type to the services provided by Company under the contract and ~~orders~~the Company does not agree to reduce its prices to match the competitive offer. ~~Such~~In ~~challenges~~addition, if the Company matches any qualifying competitive offer from a third party, the Company could ~~cause~~experience usreduced revenues. If we were to ~~incur~~lose ~~substantial~~some ~~legal~~or all ~~and~~of ~~administrative~~the ~~expenses~~revenues under the contract, we do not believe we could implement sufficient cost-cutting measures to offset such decrease in revenues or be able to replace the revenues in a short period of time. The resulting reduction in revenue (including reduction in reciprocal compensation revenues) and/or ~~cause~~loss of this contract would have a material adverse ~~effects~~effect on us. Please see the discussion of this customer contract under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

InOne ~~addition,~~of ~~federal~~our ~~and~~primary ~~state~~invoice ~~regulators~~processing ~~regulate~~vendors ~~our~~has ~~ability~~a to"going ~~discontinue~~concern" qualification ~~services~~ and~~/or~~ ~~change~~any ~~prices~~financial difficulties experienced by it could have an adverse impact to our ~~customers~~business. We ~~can~~have ~~give~~an noinvoice ~~assurance~~processing ~~that~~agreement we(the “Billing ~~will~~Agreement”) bewith ~~able~~Daleen toSolutions, ~~discontinue~~Inc. (“Daleen”). Daleen is one of our primary invoice ~~unprofitable~~processing ~~services~~vendors tofor billing our customers inand we believe that the amounts paid by us under the Billing Agreement represent a ~~timely~~substantial ~~fashion~~portion of Daleen’s revenues. The ~~Nor~~original ~~can~~term weof the ~~provide~~Billing ~~any~~Agreement ~~assurance~~expires on December 31, 2003 and automatically renews for additional one year terms, unless either party gives the other party notice of its intent to not renew this agreement at least sixty days prior to the expiration of then existing term. On October 30, 2003, Daleen notified us that weit ~~can~~was ~~raise~~electing ~~prices~~to ornot ~~change~~renew ~~our~~the Billing ~~rate~~Agreement, ~~plans~~but ~~for~~that ~~such~~it ~~unprofitable~~would ~~services~~like into discuss the terms of a ~~timely~~new contract. On ~~fashion~~October 31, 2003, Daleen filed a Motion For Relief From the Automatic Stay Under Section 362 of the Bankruptcy Code (“Motion”) seeking relief from the automatic stay so that it could send us notice of its intent to elect to not renew the Billing Agreement. On November 19, 2003, the Bankruptcy Court ~~Accordingly~~denied Daleen’s Motion, webut Daleen may beappeal ~~forced~~the toBankruptcy ~~continue~~Court’s ruling. If tothe ~~charge~~Bankruptcy ~~reduced~~Court’s decision ~~prices~~is ~~for~~not ~~unprofitable~~appealed ~~services~~or upheld on appeal, the Billing Agreement will renew on December 31, 2003 for an additional one year term on the ~~foreseeable~~same ~~future.~~terms and conditions as the existing Billing Agreement.

Deregulation of the telecommunications industry involves uncertainties, and the resolution of these uncertainties could materially adversely affect our business. The Telecommunications Act of 1996 remains subject to judicial review and additional FCC rulemaking, and thus it is difficult to predict what effect the legislation will have on us and our operations. There are currently many regulatory actions underway and being contemplated by federal and state authorities regarding interconnection pricing, access to and pricing for unbundled network elements and other issues that could result in significant changes to the business conditions in the telecommunications industry. We cannot assure you that these changes will not have a material adverse effect upon us. On February 20, 2003, the FCC announced its decision in its triennial review of the obligations of incumbent carriers to provide competitors access to unbundled network elements. A brief summary of that decision is provided under "The regulation of interconnection with incumbent local carriers involves uncertainties, and the resolution of these uncertainties could adversely affect our business." 33

WeOn ~~continue~~January to30, ~~monitor~~2003, ~~our~~Daleen ~~network~~Technologies, ~~from~~Inc.’s auditors, aKPMG ~~performance~~LLP, ~~and~~issued ~~cost~~an ~~perspective~~Independent ~~and~~Auditors’ asReport aon ~~result~~Daleen Technologies, Inc. ~~our~~that ~~network~~contained ~~optimization~~a ~~routines~~“going ~~may~~concern” ~~have~~qualification. Daleen anis ~~adverse~~a ~~effect~~wholly onowned ~~our~~subsidiary of Daleen Technologies, Inc. ~~customers~~(“Daleen Technologies”). On ~~Our~~May ~~engineering~~21, 2003, ~~and~~Daleen ~~operations~~Technologies ~~organizations~~filed ~~continually~~a ~~monitor~~Form ~~and~~8-K ~~analyze~~with the ~~utilization~~Securities ofand ~~our~~Exchange Commission ~~network.~~warning Asthat aif ~~result,~~we ~~they~~fail ~~may~~to ~~develop~~continue ~~projects~~business with Daleen Technologies and Daleen Technologies fails to ~~modify~~obtain additional financing or ~~eliminate~~fails ~~network~~to ~~circuits~~engage orin ~~colocation~~one ~~facilities~~or ~~that~~more ~~are~~strategic ~~underutilized~~alternatives, orit ~~unprofitable.~~may ~~This~~have ~~ongoing~~a ~~process~~material adverse ~~may~~effect ~~result~~on inDaleen ~~limited~~Technologies’ ~~network~~ability ~~outages~~to ~~for~~operate as a ~~subset~~going concern. In ofaddition, ~~our~~on ~~customers,~~October ~~adversely~~31, ~~affecting~~2003, ~~our~~Daleen ~~relationship~~Technologies filed a Form 8-K with ~~them~~the Securities and ~~may~~Exchange ~~increase~~Commission ~~our~~warning ~~customer~~that ~~disputes~~if we cease to do business with Daleen Technologies and/ Daleen Technologies fails to obtain additional financing or ~~customer~~fails ~~churn.~~to engage in one or more strategic alternatives, it may have a material adverse effect on Daleen Technologies’ ability to operate as a going concern.

~~Our~~There ~~common~~can ~~stock~~be isno anassurance ~~extremely~~that ~~risky~~Daleen ~~investment~~will ~~for~~remain ain business ~~variety~~through ofthe ~~reasons,~~migration ~~including~~of ~~those~~our ~~listed~~customers inoff the ~~"Bankruptcy~~Daleen ~~Related~~service ~~Risk Factors"~~or ~~above.~~provide ~~The Company's common stock is currently traded on~~ the ~~Over~~services ~~the~~required ~~Counter Bulletin Board~~ under the ~~symbol~~Billing ~~"ALGXQ~~Agreement.~~OB".~~ If ~~The~~Daleen ~~NASDAQ~~ceases ~~National~~to ~~Market~~remain ~~delisted~~in ~~the~~business ~~common stock~~or onfails ~~May 27,~~to ~~2003.~~provide Wethe ~~believe~~services ~~there~~under isthe ~~now~~Billing ~~decreased~~Agreement, ~~liquidity~~it ofmay ~~our~~have ~~common~~a material ~~stock.~~adverse ~~Extreme~~effect ~~caution~~on ~~should~~our becompany ~~exercised~~and ~~with~~our ~~respect to investments in any of such securities~~business.

~~Our~~The ~~past~~regulation ~~acquisitions~~of ~~may~~interconnection with beincumbent ~~difficult~~local tocarriers ~~integrate~~involves uncertainties, ~~disrupt~~and the resolution of these uncertainties could adversely affect our business,. Although ~~dilute~~the ~~our~~incumbent ~~stockholders~~local ~~and~~carriers ~~divert~~are ~~management~~required ~~attention.~~under Wethe Telecommunications ~~have~~Act ~~acquired~~of a1996 ~~number~~to ofunbundle ~~companies~~and asmake ~~part~~available elements of their network and permit us to purchase only the origination and termination services that we need, thereby decreasing our ~~business~~capital ~~plan~~and operating expenses, ~~especially~~such ~~companies~~unbundling ~~that~~may ~~provide~~not be ~~Internet~~done as quickly as we require, may be priced higher than we expect, and/or the ~~web~~incumbent ~~hosting~~local exchange carriers may erect barriers to use of such elements. This is important because we rely on the facilities of these other carriers to provide services to our customers. ~~Acquisitions~~Our ~~involve~~ability ~~risks~~to ~~and~~obtain ~~present~~these interconnection ~~issues,~~agreements ~~including~~on favorable terms, ~~among~~and the time and expense ~~others:~~involved in negotiating them, can be adversely affected by legal and regulatory developments.

45The United States Supreme Court vacated a FCC rule determining which network elements the incumbent local carriers must provide to competitors on an unbundled basis. On November 5, 1999, the FCC released an order revising its unbundled network element rules to conform to the Supreme Court’s interpretation of the law, and reaffirmed the availability of the unbundled network elements, including local loops and dedicated transport, the principal elements used by us. We use unbundled local loops and unbundled high capacity digital loops to connect our customer locations to our voice and data transmission equipment colocated in the incumbent local carriers’ central offices, and dedicated transport to connect our transmission equipment to our switches and data equipment which are generally located at our central offices. The FCC also stated its intention to review every three years the unbundling obligations of incumbent local exchange carriers. The U.S. Court of Appeals for the District of Columbia Circuit remanded, but did not vacate, the FCC’s Order on May 24, 2002. The FCC’s request for rehearing of that decision was denied, but the Court agreed to delay until February 20, 2003 the issuance of the mandate. On February 20, 2003, the FCC announced its decision in the triennial review as briefly discussed below. While these court and FCC proceedings were pending, we entered into interconnection agreements with a number of incumbent local carriers through negotiations or, in some cases, adoption of another competitive local carrier’s approved agreement. These agreements remain in effect, although in some cases one or both parties may be entitled to demand renegotiation of particular provisions or of the entire agreement based on intervening changes in the law. However, it is uncertain whether any of these agreements will be so renegotiated or whether we will be able to obtain renewal of these agreements on as favorable terms when they expire. The incumbent local exchange carriers have in each instance requested renegotiation of our interconnection agreements.

WeOur facilities-based ~~can~~strategy ~~make~~allows nous ~~assurances~~to ~~that~~control wemuch ~~will~~of beour ~~able~~network tobut ~~successfully~~we ~~integrate~~are ~~acquired~~still ~~businesses~~dependent oron certain ~~operations~~essential network elements that we ~~have~~lease ~~acquired~~from incumbent carriers. InOn December 20, ~~addition~~2001, wethe ~~may~~FCC ~~not~~released ~~achieve~~a Notice of Proposed Rulemaking as part of its comprehensive “triennial review” of the ~~anticipated~~unbundling ~~benefits~~rules it ~~from~~implemented ~~our~~on ~~acquisitions~~November 5, 1999. IfIn wethis ~~fail~~review, tothe ~~achieve~~FCC examined the circumstances ~~anticipated~~under ~~benefits~~which ~~from~~incumbent ~~such~~local ~~acquisitions,~~exchange wecarriers ~~may~~will ~~incur~~be ~~increased~~required ~~expenses~~to make ~~and~~parts ~~experience~~of atheir ~~shortfall~~networks inavailable ~~our~~to ~~anticipated~~carriers ~~revenues~~like ~~and~~Allegiance weon ~~may~~an unbundled ~~not~~basis under Section 251 of the Telecommunications Act of 1996. ~~obtain~~In aparticular, ~~satisfactory~~the ~~return~~FCC reviewed whether incumbents should be required to offer on ~~our~~an ~~investment.~~unbundled basis, among other things, local voice grade loops, unbundled network element platforms, high capacity loops

~~ITEM 3. Quantitative and Qualitative Disclosures About Market Risk~~ 34

~~Our~~such ~~investment~~as ~~policy~~those iswe use ~~limited~~for bymany of our ~~existing~~data ~~bond~~and ~~indentures~~integrated voice and ~~senior~~data ~~credit~~services, ~~agreement.~~subloops, network Weinterface ~~are~~devices, ~~restricted~~the tohigh-frequency ~~investing~~portion inof ~~financial~~the ~~instruments~~loop, ~~with a~~switching, ~~maturity~~and ofinteroffice ~~one~~transmission ~~year or less~~facilities. The ~~indentures~~FCC ~~require~~announced ~~investments~~its indecision ~~high quality instruments~~on February 20, ~~such~~2003 asin ~~obligations of~~ the ~~U.S.~~triennial ~~government~~review orproceeding ~~any~~and ~~agency~~released ~~thereof~~the written ~~guaranteed~~order byon ~~the~~August ~~United~~21, ~~States of~~2003. In ~~America~~addition, ~~money~~the ~~market~~FCC ~~deposits~~has ~~and~~subsequently ~~commercial~~issued ~~paper~~clarifications ~~with~~to athe ~~rating~~order through errata. General highlights of ~~A1/P1.~~the order are as follows:

We• In ~~are~~general, ~~thus~~the ~~exposed~~FCC’s totriennial ~~market~~review ~~risk~~order ~~related~~revised toits ~~changes~~standard inof ~~short-term~~review ~~U.S.~~for determining ~~interest~~when ~~rates.~~unbundled Wenetwork ~~manage~~elements ~~these~~are ~~risks~~made byavailable ~~closely~~to ~~monitoring~~competitors. Specifically, ~~market~~the ~~rates~~FCC’s ~~and~~revised standard recognized the ~~duration~~benefits of ~~our~~ ~~investments.~~facilities-based Wecompetition doand ~~not~~confirmed ~~enter~~that ~~into~~continued ~~financial~~provision orof ~~commodity~~UNEs ~~investments~~is essential ~~for~~to ~~speculation~~the orgrowth ~~trading~~of ~~purposes~~facilities-based ~~and~~networks ~~are~~such ~~not~~as athose ~~party~~operated ~~to any financial or commodity derivatives~~by us.

~~Interest~~• With ~~income~~respect ~~earned~~to onunbundled ~~our~~switching, ~~investment~~the ~~portfolio~~FCC isadopted ~~affected~~a byprocess ~~changes~~whereby inthe ~~short-term~~state public ~~interest~~utilities ~~rates.~~commission Wewill ~~believe~~consider ~~that~~whether wecompetitors are ~~not~~impaired ~~exposed~~if they todo ~~significant~~not ~~changes~~have inaccess ~~fair value~~to Bell companies’ ~~because~~switch ofservices ~~our~~on ~~conservative~~a ~~investment~~UNE basis ~~strategy.~~under ~~However,~~ the ~~estimated~~regulatory ~~interest~~construct ~~income~~known ~~for~~as ~~2003,~~unbundled ~~based~~network onelement platform ~~the~~(“UNE-P”). ~~estimated~~We ~~average~~expect ~~2002~~that ~~earned~~this ~~rate~~state onreview ~~investments,~~will isresult ~~$3.4 million.~~in ~~Assuming~~ a ~~100-basis-point~~review ~~drop in~~ of the ~~estimated~~hot ~~average~~cut ~~rate,~~process we(transferring ~~would~~a becustomer ~~exposed~~from tothe aBell’s ~~$2.4 million~~systems ~~reduction~~to inour systems) ~~interest~~and ~~income~~could ~~for~~potentially ~~the~~enhance ~~year.~~our ~~The~~ability ~~following~~to ~~table~~transition ~~illustrates~~new ~~this impact on~~customers ato ~~quarterly~~our ~~basis:~~ networks.

	Quarter Ending
	March 2003		June 2003		September 2003		December 2003		Total
	(dollars in millions)
Estimated average investments	$	274.0	$	266.4	$	227.4	$	175.4
Estimated average interest earned at the average rate of 1.44% for the year ended December 31, 2002		1.0		1.0		0.8		0.6	$	3.4
Estimated impact of interest rate drop		0.7		0.7		0.6		0.4		2.4

• The decision also confirms that facilities-based competitive carriers like us can continue to obtain access to loops in almost all markets. The FCC also clarified the conditions under which the Bell companies must make available unbundled loops for competitors. This should reduce the time it takes us to install a customer’s services, especially in certain ILEC areas.

~~Our~~• On transport ~~outstanding long-term debt consists both of long-term~~issues, ~~fixed~~the ~~rate~~FCC ~~notes,~~adopted ~~not~~a ~~subject~~standard toproposed ~~interest~~by ~~rate~~us ~~fluctuations,~~whereby ~~and our senior~~transport ~~secured~~will ~~credit~~be ~~facilities.~~taken ~~Borrowings~~off ~~under~~the ~~our~~UNE ~~senior~~list ~~secured~~on ~~credit~~a ~~facilities~~route-specific ~~incur~~basis ~~interest~~when atthere aare ~~variable~~two competitive ~~rate,~~wholesale ~~based~~providers onof ~~leverage~~transport ~~ratios,~~or ~~and~~three isself-provisioned transport ~~currently~~links ~~the~~by ~~London~~non-ILEC ~~Interbank Offered Rate plus 4~~sources.~~50%.~~ ~~Our~~This ~~blended~~approach ~~borrowing~~is ~~rate,~~consistent ~~taking~~with ~~new~~our smart-build ~~borrowings~~strategy ~~into~~for ~~account,~~local istransport ~~now~~of ~~5.66%~~using ~~per~~ILEC ~~annum~~facilities ~~and~~only ~~this~~as ~~interest~~a transition ~~rate~~to ~~will~~dark ~~remain~~fiber ~~fixed~~or ~~until~~the ~~September 18,~~facilities ~~2003.~~of ~~Therefore,~~other providers.

46• The FCC decision also makes it easier for competitive carriers like us to obtain Enhanced Extended Links (“EELs”). These are combinations of loops and transport that connect back to the competitive carrier’s switch. Although we do not currently use EELs on an extensive basis, this aspect of the triennial review gives us an opportunity to efficiently expand our facilities-based network to additional areas not directly accessed by our current colocation footprint and to potentially reduce the number of colocations we have, thereby reducing our network costs.

we• The ~~will~~FCC exempted hybrid fiber/copper loops that provide packetized data transmission from the UNE rules. The FCC preserved access to high-capacity loops, such as DS1’s, DS3’s, dark fiber and copper subloops that transmit services using existing TDM (time division multiplexing) technology. Since virtually all of our current business customers are served using unbundled copper loops or DS1’s that use TDM technology, the FCC’s exemption of hybrid fiber/copper loops that provide packet-based technology should not beimpact ~~exposed~~our current operations. In the future, as new packet-based technologies are deployed in the local loop infrastructure, this ruling by the FCC could cause an adverse impact on our ability to ~~market~~compete with ~~risk~~the ~~related~~ILECs for small to ~~rate~~medium-sized ~~fluctuations~~business ~~until~~customers. We and other competitive carriers have appealed the ~~end~~broadband sections of the ~~third~~triennial review ~~quarter~~order in the D.C. Circuit Court of ~~2003~~Appeals based on our view that the FCC’s exemption of hybrid/fiber loops is unlawful and in violation of the Telecommunications Act of 1996. We are unable to predict at this time the timing or outcome of the decision by the D.C. Circuit Court on this matter.

~~Beginning~~• The inFCC ~~September 2003,~~also weexempted ~~will~~from beunbundling ~~exposed~~any end-to-end ~~market~~fiber ~~risk~~loop ~~related~~that is defined as fiber-to-the-home ~~market~~(“FTTH”) ~~changes~~for innew greenfield developments. After the ~~London~~release ~~Interbank~~of ~~Offered~~the triennial ~~Rate~~review order, the FCC issued an errata that expanded the FTTH definition beyond residential dwellings to include end-to-end fiber loops that also extend all the way to a premise that would include small businesses that we might serve. We and other competitive ~~market~~carriers ~~indexes~~have sought a stay of this aspect of the triennial review order which is also pending before the D.C. ~~Based~~Circuit Court of Appeals. The D.C. Circuit has subsequently consolidated all stay motions and appeals of the triennial review order and has indicated its intent to consider all challenges to the triennial review order on ~~our~~an ~~current~~expedited ~~level~~basis. The Court has announced a schedule for hearing all of ~~debt~~these appeals with oral arguements scheduled for January 28, 2004. We anticipate a decision from the ~~impact~~D.C. Circuit Court could be issued as early as the second quarter of a2004. If ~~100-basis-point~~the ~~increase~~FTTH section inof ~~our~~the ~~average~~triennial ~~interest~~review ~~rate~~order is not ultimately overturned, it would prevent ~~cause~~us anfrom ~~increase~~being inable ~~interest~~to ~~expense~~provide ~~during~~services ~~2003~~to ofsmall ~~$1.0 million.~~businesses in new greenfield developments.

~~ITEM 4. Controls and Procedures~~ 35

~~Our~~In ~~principal~~addition ~~executive~~to ~~officer~~the ~~and~~potential ~~our~~impact ~~principal~~on ~~financial~~our ~~officer,~~business from ~~after~~the ~~management's~~hybrid/fiber ~~evaluation,~~loop ~~with~~and the ~~participation~~FTTH sections of ~~such~~the ~~officers~~triennial review, ~~have evaluated~~ the ~~effectiveness~~ILECs ofhave ~~our~~recently ~~disclosure~~filed ~~controls~~petitions ~~and~~for ~~procedures~~reconsideration ~~(as~~at ~~defined~~the inFCC ~~Exchange~~seeking greater ~~Act~~relief ~~Rules 13a-15(e)~~from ~~and~~certain ~~15d-15(e))~~additional asaspects of the ~~end~~FCC’s ofdecision. These petitions seek to expand the ~~period~~FTTH ~~covered~~new-build bygreenfield ~~this~~exemption ~~report,~~to ~~and~~apply ~~have~~also ~~concluded~~to ~~that,~~fiber-to-the-curb ~~based~~deployments onas ~~such~~well. We ~~evaluation,~~and ~~that~~other ~~our~~competitive ~~disclosure~~carriers ~~controls~~are ~~and~~opposing ~~procedures~~these ~~were~~petitions ~~effective.~~at the ~~There~~FCC, ~~was~~and noa ~~change~~decision c

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