21ST CENTURY TELECOM GROUP INC, 10-K, 1999-03-31

21ST CENTURY TELECOM GROUP INC
10-K, 1999-03-31
COMMUNICATIONS SERVICES, NEC

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

FORM 10-K

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

For the fiscal year ended ___________________

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

For the transition period from April 1, 1998 to December 31, 1998

Commission File Number 333-47235
[OBJECT OMITTED]
21st CENTURY TELECOM GROUP, INC.
(Exact name of registrant as specified in its charter)

ILLINOIS
(State or other jurisdiction of 36-4076758
incorporation or organization) (IRS Employer Identification No.)

350 NORTH ORLEANS
SUITE 600
CHICAGO, ILLINOIS 60654
(312) 955-2100
(Address and telephone number of principal executive office)

Securities registered pursuant to Section 12(b) of the Act: NONE

Securities registered pursuant to Section 12(g) of the Act: NONE

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No__

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K. [ ]

On March 27, 1999, 4,218,388.9 shares of the Registrant's Common Stock were
outstanding. The aggregate market value of the voting stock held by
non-affiliates is not applicable as no established public trading market exists
for the voting of the Registrant.

TABLE OF CONTENTS

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PART I
Page
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Item 1. Business 1
Item 2. Properties 10
Item 3. Legal Proceedings 11
Item 4. Submission of Matters to A Vote of Security Holders 11

PART II

Item 5. Market For Registrant's Common Equity and Related Shareholder Matters 12
Item 6. Selected Financial Data 14
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 15
Item 7a. Quantitative & Qualitative Disclosures about Market Risk 19
Item 8. Financial Statements and Supplementary Data 19
Item 9. Changes and Disagreements with Accountants On Accounting Financial Disclosure 19

PART III

Item 10. Directors and Executive Officers of the Registrant 20
Item 11. Executive Compensation 25
Item 12. Security Ownership of Certain Beneficial Owners and Management 29
Item 13. Certain Relationships 32

PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 33

</TABLE>

When used in this Report, the words "intends," expects," "plans," "estimates,"
"projects," "believes," "anticipates," and similar expressions are intended to
identify forward-looking statements. Except for historical information contained
herein, the matters discussed and the statements made herein concerning the
Company's future prospects are "forward-looking statements" within the meaning
of Section 27A of the Securities Act and Section 21E of the Securities Exchange
Act. Although the Company believes that its plans, intentions and expectations
reflected in such forward-looking statements are reasonable, it can give no
assurance that such plans, intentions or expectations will be achieved. There
can be no assurance that future results will be achieved, and actual results
could differ materially from the forecast and estimates. Important factors that
could cause actual results to differ materially include, but are not limited to,
the Company's limited operating history, including a history of losses,
significant capital requirements, high leverage, debt service requirements and
restrictive covenants related to its outstanding securities, ability to complete
DRS Network construction, its dependence on key personnel and ability to manage
growth. The Company's future results may also be impacted by other risk factors
listed in its Registration Statement filed on Form S-4 (333-47235). In addition,
such forward-looking statements are necessarily based upon assumptions and
estimates that may be incorrect or imprecise and involve known and unknown risks
and other facts. Given these uncertainties, prospective investors are cautioned
not to place undue reliance upon such forward-looking statements. The Company
undertakes no obligation to publicly release any revisions to the
forward-looking statements or reflect events or circumstances after the date of
this document.

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PART I

Item 1. Business.

21st Century Telecom Group, Inc. ("21st Century" or the "Company") is a
Chicago-based company incorporated in October, 1992.

21st Century is an integrated, facilities-based communications company,
which seeks to be the first provider of bundled voice, video and high-speed
Internet and data services in selected midwestern markets beginning with
Chicago's Area 1. The City of Chicago has awarded the Company a 15-year
renewable franchise for Area 1. Area 1 stretches more than 16 miles along
Chicago's densely populated lakefront skyline and includes the affluent
residential neighborhoods of the Gold Coast, Lincoln Park and Dearborn Park and
the nation's second largest business and financial district. The Company has
developed and has begun to install and activate an advanced fiber optic network
that employs a Distributed Ring-Star architecture characterized by
fiber-richness, two-way interactivity, SONET, as well as broadband optical
technologies based redundancy and self-healing attributes (the "DRS Network").
The DRS Network accommodates not only traditional voice and video applications,
but also the rapidly growing demand for high-speed data services. The Company
believes that its DRS Network provides the Company with significant strategic
advantages that differentiate 21st Century from its competitors, such as
improved time-to-market, multiple revenue streams, enhanced service quality and
reliability, and the provisioning of competitively-priced bundled services.

The Company has secured a 15-year renewable attachment agreement with the
Chicago Transit Authority (the "CTA"), which reduced costly and time-consuming
"make-ready" and underground construction for the backbone portion of the DRS
Network and enabled the Company to install and activate the DRS Network backbone
rapidly and efficiently by taking advantage of access to the CTA's rail systems.
The Company also has secured pole attachment agreements with Commonwealth Edison
Company ("Commonwealth Edison") and a subsidiary of Ameritech Corporation
("Ameritech") which provide 21st Century access to scarce pole space within Area
1 to further facilitate deployment of its DRS Network. The decentralized
configuration of the DRS Network, which includes distributed hubs and nodes that
act "intelligently" to route network traffic efficiently, together with the CTA
and the pole attachment agreements, enables network construction to be driven in
large part by market demand and revenue potential in contrast to the
conventional approach of building a system from the headend outward on a
block-by-block basis. To fully exploit this advantage, the Company's sales and
marketing strategy is coordinated with ongoing network construction and focused
on securing bulk contracts with multiple dwelling units ("MDUs"). The Company
believes that this strategy will help to identify the optimal sequence of node
activation on the DRS Network and tie capital expenditures directly to
revenue-producing subscribers.

21st Century's DRS Network currently provides telephone, video, audio and
data services. These services include 111 analog video channels, 59 virtual
information channels with local content (e.g., train and airline schedules,
restaurant menus, local news and sports scores, stock quotes and expressway
traffic updates) and 24 specialty audio channels (e.g., international and
foreign language programming, BBC radio broadcasts, reading services for the
blind, commercial-free music categories and select distant-market FM stations),
with significant capacity for additional broadband and narrowband products and
services. The Company's residential and home office data product is its 4 Mbps
(Megabits per second) cable modem Internet access service (high speed cable
modem), which is delivered at symmetrical speeds more than 125 times faster than
the prevalent 28.8 Kbps (Kilobits per second) telephone modem and 25 times
faster than an integrated services digital network ("ISDN") modem. The Company
is also hosting websites for commercial customers. The Company is also providing
switched, facilities-based competitive local exchange carrier ("CLEC") services
with last mile connectivity and local dial tone to both commercial accounts and
selected residential subscribers and will be expanding to more residential and
commercial accounts during the year. The Company offers a broad range of
competitive telephony services (e.g., local, long distance and enhanced
services) to both commercial accounts and selected residential subscribers, most
of whom currently have no facilities-based alternative to the service provided
over the network of the incumbent local exchange carrier ("ILEC"). The Company
will be co-locating in 10 Ameritech Central offices in the second quarter of
1999 and will have immediate access to telephone customers in Area 1. The
Company will offer high-speed, flexible bandwidth access services concurrent
with its build-out of the commercial district.

1
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21st Century has taken significant steps to implement its business plan and
service offerings in Chicago's Area 1. During this past year, the Company has
rapidly built its DRS Network, with 23% of the estimated 350,000 Homes Passed in
its service territory and 18% of the planned 350 miles of plant completed by
December 31, 1998; acquired, installed and activated its telephone switch, and
began to offer telephone services to a targeted video subscriber base;
established a state-of-the art customer service call center; initiated its
focused outdoor advertising program; acquired bulk service and right of entry
contracts to provide video services to over 400 residential multiple dwelling
unit buildings at December 31, 1998; acquired over 14,000 orders for video,
Internet and telephone services at December 31, 1998; activated almost 10,500
video, Internet and telephony connections by December 31, 1998; and, in early
1999 completed a strategic acquisition to accelerate the Company's commercial
business plan.

Business Strategy and Competitive Advantages

The Company believes that it can utilize its innovative DRS Network,
superior product offerings and other strategic assets to compete strongly in
Chicago's Area 1 and other selected markets. 21st Century's strategy and
competitive advantages include the following:

High-Capacity, Full-Service DRS Network. 21st Century's business plan
leverages upon the advantages of its innovative, internally-developed DRS
Network architecture in providing fully integrated voice, video and high-speed
data services. Key attributes of the DRS Network include (i) an advanced
integrated network design built to the rigorous Bellcore standards, (ii) the
distribution of switching and traffic routing mechanics at specific locations
out on the DRS Network (rather than being concentrated at one point as in
conventional networks), allowing the Company to efficiently and economically
route traffic regardless of penetration and usage levels, (iii) a SONET and
broadband optical technology based redundancy and self-healing architecture with
both circuit and route diversity, (iv) multiple layers of power redundancy to
ensure network reliability and (v) a large fiber capacity permitting delivery of
advanced two-way, fully-interactive broadband services, as well as significant
unutilized capacity to allow the Company to upgrade services, add applications
and develop new product offerings without service interruption or interference.

Cost-Effectiveness of the DRS Network on a Revenue-Driven Basis. The
decentralized configuration of the DRS Network, combined with the CTA and pole
attachment agreements, allows the Company to rapidly and efficiently deploy the
DRS Network to accommodate market demand on a revenue-driven basis. This
strategy contrasts sharply with the typical approach of building a conventional
hybrid fiber-coaxial cable system from the headend outward on a block-by-block
basis. This DRS Network advantage, in conjunction with the Company's recently
adopted strategy of co-locating most of its service nodes with Ameritech
switches, will also allow the Company to more efficiently utilize its capital
resources to sell bundled telephone, cable and Internet services so as to secure
larger MDU contracts. Thus, more significant revenue streams should be realized
earlier in the construction buildout plan than would be realized by a
conventional coaxial cable system buildout. For example, after a large MDU is
activated for telephone services, the Company will then market its premium cable
and pay-per-view video services, as well as its high-speed Internet services to
the telephone customers in that MDU. For commercial subscribers, the Company
will seek initially to sell its services in Chicago's dense central downtown
area to (i) small to mid-sized commercial accounts and communications-intensive
businesses that will benefit from the Company's telephone, high-speed data and
Internet services and (ii) organizations such as the Building Owners Management
Association and other facilities management companies that influence the
selection of communications facilities at multiple buildings and within industry
associations which the Company services.

2
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Superior Product Offerings on a Bundled Basis. The Company believes that
its voice, video, high-speed Internet and data offering is superior to
competitive products currently available in Area 1 in terms of (i) the breadth
and quality of the individual product offerings, (ii) the extent of the enhanced
service features offered to the customer and (iii) the ability to bundle such
product offerings into simple, convenient and attractively-priced packages. 21st
Century's fiber-rich DRS Network is designed with up to three broadband
amplifiers in cascade between its Network Operations Center ("NOC") and the
subscriber (compared to up to 40 amplifiers used by conventional networks). This
reduction in amplifiers significantly reduces signal degradation and results in
higher video quality, increased reliability, superior audio, and greater data
transmission capacity and accuracy. The Company's virtual information channels,
which provide useful local content and information, are currently not available
from any other single source in Area 1. The Company's high-speed data offering
includes cable modems that provide access to the Internet at 4 Mbps, which is
approximately 125 times faster than the prevalent 28.8 Kbps telephone modem and
25 times faster than an ISDN modem. Beginning in the second quarter of 1999, the
Company expects to begin marketing a broad range of telephony services (e.g.,
local, long distance, call waiting, call forwarding, caller ID, voicemail and
three-way calling) to more than 500,000 potential businesses and 350,000
potential residential users in and adjacent to Area 1, most of whom, to the
Company's best knowledge, currently have no facilities-based alternative to the
service provided over the ILEC's network. The Company's bundled service offering
will provide customers with convenient "one-stop shopping," attractive pricing
through package discounts, a single source for installation and service, the
option of "no waiting" customer self-installation and the ease of a single
monthly bill for all services. Bundling services allows the Company to reduce
its customer acquisition and installation costs.

Strategic Assets. The Company's core strategic assets include (i) the
15-year renewable franchise granted by the City of Chicago, which permits the
construction and installation of a network serving the entirety of Chicago's
Area 1, (ii) the attachment agreement negotiated with the CTA and the pole
attachment arrangements negotiated with Commonwealth Edison and Ameritech, which
facilitate the timely and efficient buildout of the DRS Network through the
utilization of scarce pole space and city infrastructure rights-of-way and (iii)
CLEC certification from the Illinois Commerce Commission. These assets are
extremely important due to the fact that right-of-way and utility pole
attachment space are exhausted in Area 1 of Chicago today. The Company, in many
locations, secured the last available space with its agreements. Each of these
assets is a valuable and important component of the Company's facilities-based
business strategy and together would be very difficult for another entrant to
replicate.

First-to-Market Advantages. The Company's new telephone co-location
strategy allows the Company to get to market much faster with its telephone and
Internet services, sell its telephone and Internet services to customers outside
its Area 1 cable TV franchise, and significantly improve its ability to "upsell"
its premium services behind its basic telephone services inside Area 1. The
Company believes that its co-location strategy, in conjunction with its
accelerated buildout of the DRS Network will enable it to quickly acquire a
significant customer base, and that its right-of-way and pole attachment
agreements will give it a future time-to-market and pricing advantage over other
prospective bundled and single-service providers attempting to enter the Chicago
market.

Experienced Management. The Company's management team has extensive and
diverse experience in the cable television, Internet, data and
telecommunications industries. The Company's senior management has demonstrated
its expertise by constructing and activating the NOC, completing the northern
fiber transport ring of the DRS Network, securing necessary video programming
content, initiating appropriate billing to support the Company's planned product
lines, executing its newly adopted co-location telephone strategy, and building
its own force to operate its own 24 hour Customer Service Support Center, all
which prove that the Company's management personnel understand their markets and
technologies.

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Superior Customer Care. The Company is committed to providing superior
customer care to differentiate itself from its competitors. To accomplish this,
the Company has (i) contracted with a third party to provide a single billing
statement for its residential telephone, cable TV and Internet services, (which
facilitates bundled discounting for multiple services, permits customized
billing statements and enables monthly, transactional and metered billing to
support the Company's planned product lines), (ii) established a state-of-the
art call center staffed with highly trained customer service professionals and
technical support specialists available 24 hours a day, seven days a week and
(iii) negotiated the purchase of a highly rated Internet service provider to
sell into and manage the Company's business operations. The Company has provided
a dedicated toll-free number to the call center for all subscriber needs and
continuously monitors call center performance measures. The Company believes
that the quality and reliability of its services will result in fewer in-bound
subscriber complaints, service requests and other non-revenue producing calls.
The Company has also installed sophisticated status monitoring equipment in the
NOC and throughout its DRS Network, which should allow the Company to become
aware of and remedy potential problems before they are detectable by
subscribers. In addition, the Company is building an integrated network
management center to proactively monitor and maintain its voice, video, and
Internet data services.

Market Expansion. The Company intends to expand its operations at the
appropriate time to selected midwestern markets which have the size,
demographics and geographical location suitable for its business strategy.
Although the Company may consider stand-alone systems, the Company expects to
focus on markets in which it can use its Chicago DRS Network and NOC to achieve
synergies and economies of scale. In March 1998, the Company was awarded a
franchise to provide cable service to the Village of Skokie, and in March 1999
was awarded a franchise in the Village of Northbrook, both Chicago suburban
communities northwest of the Company's existing Area 1 franchise. Skokie's and
Northbrook's homes will be served by an extension of the Company's DRS Network.

Market Overview

The city of Chicago is the third largest urban market in the United States
and Area 1 is the densest section in the city, characterized by a high
concentration of MDU's and commercial office buildings. Area 1 has several
significant and attractive attributes, including (i) a relatively high density
of 12,000 housing units per square mile (compared with a density for the entire
city of Chicago of 5,000 housing units per square mile), (ii) more than 350,000
homes (many of which are located in the upscale demographically attractive
lakefront neighborhoods), (iii) the lowest priced unbundled urban telephone
loops in the country, (iv) the nation's second largest business and financial
district, and (v) existing cable penetration (reportedly 37%) that the company
believes is significantly below the national average of urban areas. The Area
contains many ethnic enclaves, each with its own particular characteristics and,
therefore, marketing opportunities. There are approximately 51,000 companies
employing more then 500,000 people in the city's prominent business and
financial district, which includes such business and landmarks as the Chicago
Mercantile Exchange, Sears Tower, Chicago Board of Trade, Federal Reserve,
Hancock Building, Merchandise Mart, Amoco Tower, major banks and other premier
businesses.

Interactive Broadband DRS Network

DRS Network Components. The DRS Network consists of six main components:
the NOC, the Transport Ring, Transport Hubs, Campus Rings, Campus Hubs and
Service Distribution Nodes.

The NOC processes voice, video and data signals before they are transported
to the rest of the system. An ISP site and video headend are located at the NOC
together with a telephone switch. The NOC also functions as a gateway to other
networks outside the DRS Network. The NOC monitors DRS Network activity and
receives real-time information regarding DRS Network performance and network
powering system status. The NOC also monitors the activation of equipment at the
premises of the Company's telephony subscribers.

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The Transport Ring, a group of fiber-optic cables that carries voice,
video, high-speed Internet and data signals between the NOC and the Transport
Hubs. Transport Hubs connect the Transport Ring and the Campus Rings and also
provide a diagnostic function by trouble-shooting potential problems on the DRS
Network. The Campus Rings are groups of fiber-optic cables that carry voice,
video, Internet and high-speed data signals between the Transport Hubs and the
Campus Hubs. The Campus Hubs connect the Campus Rings and the lines that feed
the Service Distribution Nodes and provide a diagnostic function similar to the
Transport Hubs. The Service Distribution Nodes connect the subscribers to the
Campus Hubs via high-speed coaxial cable. The Service Distribution Nodes
represent the point in the DRS Network where light sent over the DRS Network via
fiber-optic cable is translated into radio frequencies for delivery to the
subscriber. The "star distribution" of the DRS Network refers to the star-shaped
DRS Network components branching off each Service Distribution Node to the
subscribers.

Delivery of telephony services over the DRS Network requires the
installation of switching and other ancillary equipment at the NOC and at the
building to be served, where the existing twisted-pair telephone wire will
connect to the DRS Network. The Company has executed an agreement for the
acquisition and installation of such equipment.

Design Attributes. The Company's DRS Network was conceived and designed by
the Company's engineers and incorporates SONET and broadband optics technology,
Ring and Star architectures as well as wave-division multiplexing elements, and
includes certain attributes of Hybrid Fiber Coax ("HFC") technologies. Key
attributes of the DRS Network include (i) an advanced integrated network design
built to Bellcore standards, (ii) the distribution of switching and traffic
routing mechanics at specific locations out on the DRS Network (rather than
being concentrated at one point as in conventional networks), allowing the
Company to efficiently and economically route traffic regardless of penetration
and usage levels, (iii) a SONET-based redundancy and self-healing architecture
with both circuit and route diversity, (iv) a broadband AM fiber optic
technology based redundancy and self-healing transport architecture with both
circuit and route diversity, (v) multiple layers of power redundancy to ensure
network reliability and (vi) a large fiber capacity permitting delivery of
advanced two-way, fully-interactive broadband services, as well as significant
unutilized capacity to allow the Company to upgrade services, add applications
and develop new product offerings without service interruption or interference.
In addition, the DRS Network is designed with up to three amplifiers in cascade
between its NOC and the subscriber (compared to up to 40 amplifiers used by
conventional networks). This reduction in amplifiers significantly reduces
signal degradation and results in higher video quality and reliability, a
superior audio component and greater data transmission capacity and accuracy.

The DRS Network uses signal processing techniques to deliver communication
services such as Internet access and high-speed data, Shared Tenant Services,
Small Business Services and Plain Telephone Services, which the Company intends
to provide directly or in conjunction with strategic business partners. The DRS
Network is able to separate data and voice signals from the video signals, which
will enable it to provide higher reliability and the advanced network management
necessary for residential and commercial data communications and telephony
services.

DRS Network Advantages. The DRS Network has several advantages including
(i) intelligent routing of network traffic, (ii) advanced functionality at
subscribers' premises, (iii) efficient introduction of new switched and
broadband services and (iv) dedicated two-way, high-speed data connectivity.

Intelligent Routing of Traffic. The DRS Network routes traffic
intelligently using grooming and hairpinning techniques. Grooming is a
technique by which voice, video and data signals are kept on the DRS
Network, thereby decreasing the reliance on and the costs incurred by using
other companies' communications networks. Hairpinning, a type of grooming,
is a technique that allows voice, video and data signals to be diverted
away from the Company's NOC, where network traffic is likely to be heavy,
and routed by Campus Hubs or Transport Hubs.

Advanced Functionality at Subscribers' Premises. The Company uses an
advanced analog Home Communications Terminal (set-top box) with 512K RAM
and flash memory, which will allow it to provide subscribers additional
functions and features. Among such functions and features are interactive
data channel capability, impulse pay-per-view, fully computerized
addressability, forward and return path capability, bit-mapped graphics,
downloadable software capability, fully interactive seven-day electronic
program guide, enhanced signal theft protection and dataport connectivity
to printers, faxes and personal computers.

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Efficient Introduction of New Switched and Broadband Technologies. 21st
Century should be able to introduce most new switched and broadband
technologies to its subscribers without causing service interruption or
interference. The DRS Network's architecture has reserved bandwidth from
750MHz to 810MHz. This bandwidth has been allocated for future digital
video services representing approximately 90 to 100 channels. While the
Company does not anticipate conversion to digital in the immediate future
given the DRS Network's initial 111 analog video channel offering, the DRS
Network's large fiber capacity will allow the Company to upgrade services,
add applications and develop new product offerings without service
interruption or interference. The distributed nature of the architecture
also allows containment of upgrades by hub area rather than requiring
upgrades system wide.

Dedicated, Two-Way, High-Speed Data Connectivity. The DOC allows true
two-way (duplex), high-speed interactivity. At the DOC, a redundant series
of routers, servers and switches are installed, from which typical ISP
functionalities (Domain Naming System, Mail, News, Proxy, etc.) are
administered and dual connections to national ISPs are maintained. 21st
Century will store the most popular Web pages, along with local content, in
servers located in the DOC. By storing these Web pages and local content
within the DOC and providing cable modem access to these resources,
subscribers can truly receive any of this information at up to 4 Mbps, or
approximately 125 times faster than the prevalent 28.8 Kbps telephone
modem. As a further benefit, since the cable modem is connected directly
from the subscriber's PC to the coaxial portion of the DRS Network, there
is no need for a second telephone line to access the Internet, no delay
associated with dialing into and signing onto a typical ISP's modem
service, and no surcharge for making a call into the DOC (as is typically
the case with 128 Kbps ISDN service).

As an integral part of the DRS Network design, the Company has reserved
fiber-optic capacity dedicated for providing a wide variety of high-speed data
services, including high-speed (up to OC-12) private line quality access to the
Internet. The use of multi-protocol switching platforms in both the Campus and
Transport hubs and the DRS Network's high fiber count will allow the Company to
offer private virtual networks to link offices, buildings and campuses located
in Area 1. Further, the high-speed data network will extend to both commercial
and residential areas and will support a host of other applications, including
telecommuting, distance-learning, software distribution, site mirroring, bulk
data transfer and teleconferencing.

Broadband Services

The Company's service offering includes a wide range of voice, video and
high-speed data services that the Company expects to provide on a bundled basis.
The Company's bundled service offering provides customers with convenient
"one-stop shopping," attractive pricing through bundled discounts, a single
source for installation and service, and the ease of a single monthly bill.

Video and Audio. The Company currently offers 111 analog video channels, 59
virtual information channels with local content and 24 specialty audio channels,
with significant capacity for additional broadband and narrowband products and
services. The 111 analog video channels include a basic package of 88 channels,
one of the largest basic packages in the United States, designed to appeal to
Chicago's ethnic and cultural diversity. Basic video channels for business
customers also include specialized business programming such as Bloomberg, CNN,
CNN Financial, and Knowledge TV. Programming for the Company's video offering
comes from national and local networks, including most major networks such as
ESPN, HBO, Showtime, Disney, CourtTV, and local Chicago affiliates of ABC, CBS,
NBC and Fox. The video offering includes an on-screen, interactive viewing
guide, one-button VCR recording and pay-per-view movies, with start times every
30 minutes, 24 hours per day.

Also included in the Company's basic video package are 59 interactive
information channels, which include local bus and train schedules, airline
schedules, restaurant menus, local news and sports scores, stock quotes,
personal ads, and other relevant local content. This server-delivered
information is accessed on the customer's television via a specialized universal
remote control.

<PAGE>

The Company's 24 specialty audio channels include international and foreign
language broadcasts (selected to appeal to concentrations of nationalities
residing in Chicago's Area 1), BBC radio broadcasts, Chicago Reading Information
Services which offers reading services for the blind, commercial-free music
categories, and select distant-market FM stations.

High-Speed Internet and Data Services. The Company provides high-speed
Internet access services using a high-speed cable modem in much the same way
customers currently receive Internet services over a modem linked to the local
telephone network. The cable modems presently being used with the Company's DRS
Network will operate at 4 Mbps, which is approximately 25 times faster than ISDN
modems, and more than 125 times faster than the prevalent 28.8 Kbps analog
modems. The customer's cable line (with cable modem) will be connected directly
into the Internet. Because the cable modem connects through a cable line rather
than through a telephone line, the Internet connection will always be active and
there will be no need to dial up for access to the Internet or wait to connect
through a port leased by an ISP. The Company is also hosting websites for
commercial customers and expects to offer private virtual networks to link
offices, buildings or campuses located throughout the franchise area. In
addition to supporting cable modem services for Internet access, the DRS Network
is capable of connecting computers or computer networks via a separate fiber
connection. By connecting computers or computer networks at multiple locations,
subscribers can establish virtual local area networks, over which they can
transport data. The Company expects to offer a full range of high-speed data
transport services (ISDN, DSL, T-1, OC1, 2,3, etc.) to enable customers to
conduct video conferences, provide telephony over Internet connections, conduct
E-Commerce, apply distance learning concepts, and otherwise take full advantage
of the enormous bandwidth capabilities of the DRS network.

Telephony. During the fourth quarter of 1998, the Company modified its
strategy to include use of a concept known as "co-location". Co-location is the
act of placing the Company's access nodes in certain Ameritech switching centers
so they are co-located with, and have direct access to, Ameritech's "last mile"
distribution cable pairs (unbundled loops). This allows the Company to reach
more customers faster by leasing Ameritech's "last mile" facilities and using
them to connect the Company's telephone switch to potential customers through
the Ameritech "last mile" loops. This strategy modification also allows the
Company to sell dial accessed Internet services at reasonable rates. The Company
intends to sell a full range of local and long distance telephone services and
dial accessed Internet services to many of its customers beginning in April
1999. The co-location strategy will allow sale of these services to all Area 1
customers, and to many outside Area 1, by July 1999. Co-location accelerates and
expands the Company's telephone coverage considerably. Cable modem high-speed
Internet access service will continue to be limited to Area 1.

The Company provides local, long distance, custom calling services, voice
mail, Operator services and enhanced services to customers in certain cable
franchise neighborhoods today. Enhanced services range from the basic offering,
such as call waiting, call forwarding and three way calling, to the more
advanced offering, such as caller ID and caller ID with name and automatic call
back. These customers use the Company's DRS Network exclusively, and do not use
the leased "co-location" facilities in any way. The Company's interconnection
requirements with other telephone companies have been met and the Company's
current customers enjoy complete telephone services including single source
billing. The Company plans to make available to business customers the full
range of switched and private line voice and data services. The Company
anticipates that it will provide wireless and paging services in the future on a
resale basis.
<PAGE>

The Company is fully integrated with the public switched network (PSN) via
an interconnection agreement with Ameritech. On April 20, 1998, the Company
executed an interconnection agreement with Ameritech, pursuant to the 1996
Telecommunications Act. The agreement has been fully implemented and the Company
has the same access to all local, national and international customers as
previously existing ILECs.

The DRS Network provides the backbone for connecting the Company switch to
the ILEC central offices and access to the existing twisted pair network and for
connecting directly to customer premises.

Future Broadband Services. The Company's DRS Network will enable it to
provide additional broadband services in the future, including (i) high-speed
data transmission connecting homes and offices ("extranets"), (ii) wholesale
transport and interconnection (local loop) services to connect long-distance
carriers to their customers, (iii) security services, including closed-circuit
television security monitoring and alarm systems, and (iv) interactive energy
management services, which involve active monitoring by the customer of energy
usage and cost. The Company may seek strategic partnerships and alliances to
provide a number of these services.

Sales and Marketing

21st Century plans to capitalize on its position as a new communications
company that brings competition, choice and innovative bundling of
communications products to the residential and commercial markets covered by its
DRS Network.

Residential Marketing. The Company's marketing plan for residential
customers focuses on establishing positive relationships with rental agents,
owners, and managers of MDU's and with single family homes. The Company expects
those relationships will pave the way for positive relationships with customers.
The Company expects to sell bundled services, leading with different services in
different market segments.

Business (Commercial) Marketing. In February, 1999, the Company purchased a
highly rated ISP that has established an excellent service reputation in the
Chicago area business community. The Company intends to use that ISP to sell
into and manage its Chicago business market operations. The Company intends to
market and sell all of its services to the Chicago business community, and to
establish specially priced bundled services to meet the business community
needs. The focus will be on business customers with more than five telephone
lines, and Internet and data transport services will be stressed to those
customers. The Company also intends to sell its telephone and Internet dialed
services to businesses outside Area 1, and to offer special service features to
Chicago companies with offices in other locations. The Company intends to
especially focus on large business work-at-home telecommuter needs, and on the
small office/home office market segments whose needs include all of the services
in the Company's portfolio.

Sales Plan. The Company's residential sales force is organized to address
the residential and small office market. As previously stated, the Company
recently acquired a business sales and management capability. The current
residential sales force will continue to focus on residential bulk,
right-of-entry, and single family home sales. All sales personnel will sell
individual and bundled services according to its customers' wants and needs. The
Company currently uses its own direct sales force, a contract telemarketing
group, and a contract door-to-door sales group to sell services. The Company
intends to augment these sales channels with agency agreements with building
managers, owners, and rental agents.

Customer Care

The Company believes that customer care is an essential element of its
operations and is committed to providing superior customer care to differentiate
it from its competitors. The Company believes the quality and reliability of its
services will result in fewer in-bound subscriber complaints, service requests
and other non-revenue producing calls. In addition, the Company has installed
sophisticated status-monitoring and diagnostic equipment on both the NOC and its
DRS Network, which should allow the Company to become aware of and remedy many
potential problems before they are detectable by subscribers.

Billing. The Company has contracted with a third party to provide a single
billing statement for its residential voice, video, Internet and data services.
This technology will facilitate bundled discounting for multiple services,
permit customized billing statements and permit monthly, transactional and
metered billing to support the Company's planned product lines. The third
party's billing and information management system is currently integrated for
residential voice, video, Internet and data services.
<PAGE>

Customer Service Professionals. The Company's call center is currently
staffed with 20 full-time customer service professionals ("CSPs") trained to
handle calls 24 hours a day, seven days a week. Each CSP is highly trained and
has a thorough understanding of the Company's service offerings. The Company has
provided a dedicated toll-free number to the call center for all subscriber
needs and continuously monitors call center performance measures.

Competition

All of the Company's principal business activities are highly competitive.
The Company's competitors include some of the nation's largest regional and
independent local exchange carriers, as well as cable television providers,
ISPs, satellite-based companies, and long-distance carriers. Many of these
carriers have substantially greater access to capital than 21st Century, and
significantly greater experience than the Company in providing voice, video,
Internet and data services.

Chicago Franchise

21st Century was awarded a 15-year renewable franchise effective June 1996
by the City of Chicago for the construction of a fiber cable network in
Chicago's Area 1, representing one of the first second-provider franchise awards
for a large urban area. Under this 15-year renewable franchise, the Company has
been granted unrestricted access to the public right-of-way to construct,
operate and maintain its DRS Network to all residential and commercial
subscribers in the franchise area. The franchise requires that the Company
provide ubiquitous service to all residential subscribers in the franchise area
in accordance with a specified time schedule, and allows the Company to
selectively provide service to the franchise area's business and financial
districts.

Skokie Franchise

In March of 1998, 21st Century was awarded a 15-year renewable franchise by
the Village of Skokie. The City boundaries of Skokie are contiguous with a
portion of the Chicago Area 1 franchise (at the NW corner). The Skokie franchise
area consists of 23,000 homes, 2,800 businesses, and 38,000 employees.

Northbrook Franchise

In March of 1999, 21st Century was awarded a renewable franchise expiring
December 31, 2014 by the Village of Northbrook located just northwest of Skokie.
The Northbrook franchise area consists of 11,000 homes. This franchise award is
contingent upon the Company's securing the funds necessary to build its
Northbrook network by September 10, 1999.
<PAGE>

Franchises typically contain many conditions, such as time limitations on
commencement and completion of system construction, customer service standards,
minimum number of channels and the provision of free service to schools and
certain other public institutions. The Company believes that the conditions in
its franchises in Chicago's Area 1, Skokie and Northbrook are fairly typical.
The franchises obligate the Company to meet a number of local regulatory
requirements, including (i) notices to subscribers of service and fee changes,
(ii) system design, construction, maintenance and technical criteria that, among
other things, require that the system be fully constructed within specified
times, (iii) interconnection with other cable operators serving the
municipalities for purposes of public, educational and governmental ("PEG") and
leased access, (iv) various payments to the Chicago Access Corporation ("CAC")
for PEG local access obligations, including an annual payment of one percent of
annual gross revenues for PEG/I-Net, (v) preservation of channel capacity for
PEG local access, (vi) equal employment and affirmative action requirements and
(vii) development and fulfillment of standards for customer service and consumer
complaints. The Company is required to pay a fee for both the Chicago and Skokie
franchises to the issuing authority equal to 5% of gross revenues received from
the operation of its cable television system.

Employees

At December 31, 1998, the Company had 195 full-time employees. The Company
considers its relations with its employees to be satisfactory. The Company
recruits from several major industries for employees with skills in voice,
video, Internet, and data technologies.

Item 2. Properties.

The Company entered into a 15-year lease, dated January 31, 1997 (the
"Apparel Lease") for its headquarters and NOC, located at 350 N. Orleans, Suite
600, Chicago, IL 60654. The Apparel Lease covers 40,397 square feet.

The Company entered into a lease, dated July 15, 1998 (the "1998 Lease")
for its warehouse, located at 1401 South Jefferson Street, Chicago, IL. The 1998
Lease which covers 17,265 square feet, will expire on September 15, 2003.

The Company entered into a lease, dated October 1, 1998 (the "1998
Sublease") for its warehouse, located at 2640 W. Bradley Place, Chicago, IL. The
1998 Sublease which covers 48,000 square feet, will expire on April 30, 2006.

On February 26, 1999, the Company assumed a five year lease, dated June 1,
1998 (the "Premises"), located at 407 South Dearborn Street, IL. The Premises
which covers 18,430 square feet, will expire on May 31, 2003.

On February 26, 1999, the Company assumed a two year lease, dated March 14,
1997 (the"Complex"), located at 600 South Federal, Chicago, IL. The Complex
which covers 2,308 square feet, will expire on May 13, 1999.

The Company's principal physical assets consist of fiber optic network and
equipment, located either at the equipment site or along the DRS Network. The
Company's distribution equipment along the DRS Network is generally attached to
utility poles under pole rental agreements with local public utilities, although
in some areas the distribution cable is buried in underground ducts or trenches.
The Company's franchise from the City of Chicago gives the Company rights of way
for its DRS Network. The physical components of the DRS Network require
maintenance and periodic upgrading to keep pace with technology advances. The
Company believes its properties, taken as a whole, are in good operating
condition and are suitable for the Company's business operations.

Item 3. Legal Proceedings.

The Company is not aware of any pending or threatened litigation that could
have a material adverse effect on the Company's financial condition, results of
operation, or cash flow.

Item 4. Submission of Matters to A Vote of Security Holders.
NONE.

<PAGE>

Part II

Item 5. Market For Registrant's Common Equity and Related Stockholder Matters.

Common Stock

There is no established public trading market for the Company's common
stock, and accordingly, no high and low bid information or quotations are
available with respect to the Company's common stock. At December 31, 1998,
there were 3,493,965.7 shares of common stock outstanding and held of record by
approximately 60 shareholders and 27,429.2 shares reflected as common shares to
be issued related to a separation agreement. At December 31, 1998, options and
warrants to purchase an aggregate of 3,591,827.5 shares of common stock were
outstanding. All outstanding options and warrants provide for antidilution
adjustments in the event of certain mergers, consolidations, reorganizations,
recapitalizations, stock dividends, stock splits or other changes in the
corporate structure of the Company.

The Company has filed with the Securities and Exchange Commission (the
"Commission"), a Registration Statement on Form S-4 (including all amendments
thereto the "Registration Statement") under the Securities Act of 1933, with
respect to the New Notes and the New Exchangeable Preferred Stock (as defined in
the Registration Statement) offered in connection with an exchange offer. For
further information with respect to the Company, the New Notes and New
Exchangeable Preferred Stock offered in connection with the exchange offer,
reference is made to the Registration Statement and the exhibits and schedules
filed therewith. The Registration Statement, including exhibits and schedules
thereto, may be inspected without charge at the SEC's Public Reference Room at
450 Fifth Street, N.W., Washington, D.C. 20549, or by calling the SEC at
1-800-SEC-0330, or from the SEC's Internet web site at http:\\www.sec.gov.

Rights of Class A Convertible 8% Cumulative Preferred Stock Shareholders

The Class A Convertible 8% Cumulative Preferred Stock (the "Class A
Preferred Stock") shareholders possess the right to require the sale of the
Company. This provision provides that at any time and from time to time after
the fourth anniversary of the date of issuance of the Senior Discount Notes and
Senior Cumulative Exchangeable Preferred stock and ending on the earlier of the
consummation of a qualified public offering and the seventh anniversary of the
date of issuance of the Senior Discount Notes, the Class A Preferred Stock
shareholders have the right to require the sale of the Company.

In addition, the holders of the Class A Preferred Stock are collectively in
a position to control the taking of many significant corporate actions by the
Company, including the making of any significant capital commitments, the
incurrence of any significant indebtedness, merger and the payment of dividends
on the common stock, pursuant to agreements which provide that prior to taking
such actions, the Company will need to obtain the approval of the nominees to
the Board of Directors of the holders of the Class A Preferred Stock. These
rights have been modified by the covenants related to the 12 1/4% Senior
Discount Notes.

Dividend Policy

The Company has never declared or paid any cash dividends on its capital
stock and does not anticipate paying cash dividends on its capital stock in the
foreseeable future. It is the current policy of the Company's Board of Directors
to retain earnings to finance the expansion of the Company's operations. Future
declaration and payment of dividends, if any, will be determined in light of the
then-current conditions, including the Company's earnings, operations, capital
requirements, financial condition and other factors deemed relevant by the Board
of Directors. In addition, the Company's ability to pay dividends is limited by
the terms of the Indenture governing the 12 1/4% Senior Discount Notes, the
Amended Articles and the terms of the Company's existing preferred stock.

<PAGE>

Recent Sales of Unregistered Securities

In April 1998, pursuant to a Purchase, Joinder & Waiver Agreement, the
Company issued 6.3316 shares of Class A Convertible 8% Cumulative Preferred
Stock at a price of $15,793.84 per share and warrants to purchase 5,327.1 shares
of common stock at a price of $.000001 per share to an investor. In addition,
2,248.9 shares of voting common stock and 2,248.9 shares of non-voting common
stock were issued in conjunction with this sale.

On December 31, 1998, the Company entered into an agreement with Glen
Milligan, a Director of the Company and Chairman of the Company's Board of
Directors, whereby the Company will issue 27,429.2 common shares to Mr. Milligan
over a period of three years, beginning on August 21, 1999, or such other number
of shares as is necessary to provide Mr. Milligan with .261% of the Company's
common stock outstanding at August 21 of each year for the next three years.
These shares have been reflected on the Consolidated Balance Sheet at December
31, 1998, as common stock to be issued.

Recent Developments

On February 26, 1999, the Company issued 696,994 shares of its no par value
common stock to certain officers of EnterAct Corp. EnterAct is a Chicago-based
provider of Internet access and commercial data services, which was acquired by
the Company.

12
<PAGE>

Item 6. Selected Consolidated Financial Data.

For the Nine For the Year Ended and as of March 31,
Months Ended and as of -----------------------------------------------------------------------
December 31, 1998 1998 1997 1996 1995 1994
------------------- -------------- ------------- ------------ ------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Operating revenues $ 873,898 $ 189,023 $ 27,480 $ - $ - $ -

Net loss $ (32,788,712) $(15,030,544) $ (2,817,292) $(1,026,609) $ (779,314) $(303,030)

Net loss attributable to
common shares $ (41,717,419) $(19,265,007) $ (3,296,273) $(1,026,609) $ (779,314) $(303,030)

Basic and diluted
loss per share $ (11.94) $ (7.37) $ (1.66) $ (0.64) $ (0.52) $ (0.21)

Total Assets $ 254,343,973 $262,732,604 $ 14,396,708 $ 1,664,877 $ 847,659 $ 428,914

Total redeemable preferred
stock $ 52,617,006 $ 46,492,812 $ 16,794,963 $ - $ - $ -

Total shareholders' equity $ (33,907,034) $ 3,938,630 $ (2,960,337) $(1,744,556) $(1,063,122) $(297,536)

</TABLE>

<PAGE>

Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.

The following is a discussion and analysis of the historical results of
operations and financial condition of 21st Century Telecom Group, Inc. (the
"Company") and factors affecting the Company's financial resources. The
discussion of the results of operations and financial condition for the nine
months ended December 31, 1998, includes a comparative analysis to the twelve
months ended March 31, 1998. The Company believes the analysis of the two
periods to be comparable, due to the ramp-up nature of the Company's operations
during the twelve months ended March 31, 1998. Furthermore, the Securities and
Exchange Commission considers a nine month period to be sufficiently equivalent
to a year. This discussion should be read in conjunction with the consolidated
financial statements, including the notes thereto, included elsewhere in this
Report. This discussion contains forward-looking statements which are qualified
by reference to, and should be read in conjunction with, the Company's
discussion regarding forward-looking statements as set forth in this Report.

General

21st Century was awarded a franchise in 1996 by the City of Chicago that
allows for the construction of the DRS Network in Chicago's Area 1. Under this
15-year renewable license, the Company is granted unrestricted access to the
public right-of-way to construct, operate and maintain its DRS Network to all
residential and commercial subscribers. Since inception, the Company's principal
focus has been the development of its communications business in Chicago's Area
1.

The Company has incurred net losses in each year since its inception, and
as of December 31, 1998, the Company had an accumulated deficit of $66,505,268.
As the Company anticipates that it will continue to expand its operations, it
anticipates that it will continue to incur net losses during the next several
years as a result of (i) substantially increased depreciation and amortization
from the construction of networks, (ii) significantly increased operating
expenses as it builds its subscriber base and (iii) interest charges associated
with the Senior Discount Notes. There can be no assurance that growth in the
Company's revenues or subscriber base will occur or that the Company will be
able to achieve or sustain profitability or positive cash flow.

Results of Operations

Nine Months Ended December 31, 1998 Compared to Twelve Months Ended March 31,
1998.

Revenues. The Company generated subscriber revenues of $873,898 for the
nine months ended December 31, 1998 and $189,023 for the twelve months ended
March 31, 1998. The increased subscriber revenues resulted from the installation
of service into contracted buildings on the new Distributed Ring-Star ("DRS")
network and sales efforts to increase penetration of services into these
buildings. At December 31, 1998, the Company was providing service to 10,455
connections in 40 bulk Multiple Dwelling Units ("MDUs") and 107 right of entry
("ROE") buildings. As of December 31, 1998, there were 3,690 backlogged
connection orders for bulk MDU and ROE customers.

Expenses. The Company incurred operating expenses that represent network
operating costs related to the delivery of cable, Internet and telephony
services of $2,678,047 and $2,023,310 for the nine months ended December 31,
1998 and for the twelve months ended March 31, 1998, respectively. This increase
is the result of the continued ramp-up in the design and construction of the
network, acquisition of video programming and the addition of employees. The
increase was also impacted by the start-up of the Company's telephony operations
during the nine months ended December 31, 1998. Telephony expenses included
connection and usage charges for testing the new switch and related consulting
costs. Selling, general and administrative expenses were $16,345,750 and
$10,216,919 for the nine months ended December 31, 1998 and for the twelve
months ended March 31, 1998, respectively. This increase reflects the Company's
acquisition and servicing of subscribers, promotion costs and the addition of
employees to support Information Technology functions established within the
Company, as well as certain key sales and marketing positions. Also impacting
the increase in selling expenses were production, printing and

<PAGE>

distribution costs for a new marketing image program during the quarter ended
December 31, 1998. Additionally, the Company incurred general and administrative
expenses for one-time employment related costs for the separation of certain
employees and for the recruitment of certain key new hires. Also during the nine
months ended December 31, 1998, the Company established a state-of-the art call
center staffed with customer service professionals and technical support
specialists available 24 hours a day, seven days a week which has contributed to
the increase in general and administrative expenses. Depreciation and
amortization costs were $3,876,779 and $1,411,847 for the nine months ended
December 31, 1998 and for the twelve months ended March 31, 1998, respectively.
The increase in depreciation and amortization costs is primarily attributable to
the increase in plant placed into service as the Company continues to buildout
its network. Effective July 1, 1998, the estimated service lives for hub sites
and outside plant were changed from 7 to 13 years. In addition, the estimated
service lives for certain software and furniture and fixtures were changed from
5 to 7 years. These changes were made to correspond to industry norms for these
types of assets. These changes in depreciable lives resulted in a reduction of
depreciation expense of approximately $1,200,000. Interest expense increased
from $3,722,947 to $18,232,959 due to interest associated with the Senior
Discount Notes issued in February 1998. Interest income increased from
$2,373,867 to $8,670,695 due primarily to interest earned on the increased level
of cash held by the Company, as a result of the issuance of the Senior Discount
Notes and Exchangeable Preferred Stock in February 1998. Amortization of
issuance costs on Senior Discount Notes increased from $218,411 to $1,199,770,
as a result of the timing of the issuance and its subsequent amortization.

Net Loss. For the nine months ended December 31, 1998 and for the twelve
months ended March 31, 1998, the Company incurred net losses amounting to
$32,788,712 and $15,030,544, respectively. The Company expects its net losses to
continue to increase as it introduces new services and as the Company continues
to build-out the DRS Network and seeks to expand its business.

Twelve Months Ended March 31, 1998 Compared to Twelve Months Ended March 31,
1997.

Revenues. The Company generated subscriber revenues of $189,023 for the
twelve months ended March 31, 1998. Subscriber revenues for the twelve months
ended March 31, 1997 were $27,480. The commencement and ramp-up of subscriber
revenues resulted principally from the purchase of 1,734 bulk subscribers from
an affiliated entity during January 1997. By the end of March 31, 1998, the
Company was providing service to 3,052 subscribers in 14 bulk MDUs and pursuant
to certain ROE contracts. As of March 31, 1998, there were 1,762 backlogged
connection orders for both bulk MDU and ROE customers.

Expenses. The Company incurred operating expenses of $2,023,310 and
$200,911 for the twelve months ended March 31, 1998 and 1997, respectively. The
increase in operating expenses resulted from activities required to accelerate
the network build-out, operate the franchise and deliver services. The component
of operating expenses that represents network operating costs related to the
delivery of cable and telecommunications services increased from $12,653 for the
twelve months ended March 31, 1997 to $1,345,921 for the twelve months ended
March 31, 1998. This increase is directly related to the continued ramp-up in
the design and construction of the network, as well as the addition of
employees. The component of operating expenses that represents local access,
origination programming fees and franchise fees increased from $188,258 for the
twelve months ended March 31, 1997, to $677,389 for the twelve months ended
March 31, 1998. Programming fees for the upgraded channel lineup made possible
by the fiber enriched network increased from zero dollars to more than $195,000.
Public Educational and Government access programming fees which are payable to
the Chicago Access Corporation amounted to over $250,000, as annual installment
payments of $100,000 for 1997 and 1998 were paid in fiscal 1998. Access costs
required to offer Internet services paid to both wholesale ISPs and exchange
carriers that lease transport to the wholesale ISPs added $125,000 to 1998
expenses. Depreciation and amortization costs were $1,411,847 and $170,108 for
the twelve months ended March 31, 1998 and 1997, respectively. The increase in
depreciation and amortization costs is primarily attributable to the
amortization of leasehold improvements upon the occupation of the space in the
Apparel Center and the depreciation of the network equipment as it is placed
into service. Selling, general and administrative expenses were $10,216,919 and
$2,337,534 for the twelve months ended March 31, 1998 and 1997, respectively.
The increase in selling, general and administrative expenses reflects the
Company's acquisition of subscribers, promotion costs, the addition of
employees, and compensation expense related to stock options granted to certain
officers and employees in October 1997. Interest expense increased from $437,843
to $3,722,947 due primarily to the interest associated with the Senior Discount
Notes issued in February 1998. Interest income increased from $301,624 to
$2,373,867 due primarily to interest earned on the increased level of cash held
by the Company as a result of the issuance of the Senior Discount Notes and
Exchangeable Preferred Stock in February 1998. Amortization of issuance costs on
Senior Discount Notes of $218,411 for the year ended March 31, 1998, resulted
from the issuance costs associated with the Senior Discount Notes issued in
February 1998 and their subsequent amortization.
<PAGE>

Net Loss. For the twelve months ended March 31, 1998 and 1997, the Company
incurred net losses amounting to $15,030,544 and $2,817,292, respectively.

Liquidity and Capital Resources

Net cash used in operating activities was $17,518,151, $8,080,516 and
$6,910,766 for the nine months ended December 31, 1998 and for the twelve months
ended March 31, 1998 and 1997, respectively. Net cash used in operating
activities for the nine months ended December 31, 1998, resulted principally
from the Company's net loss from operations and an increase in inventory levels
due to the planned accelerated build-out of the DRS Network. These items were
partially offset by amortization of the discount on the 12 1/4% Senior Discount
Notes, amortization of debt issuance costs, depreciation expense and stock
compensation expenses. Net cash used in operating activities for the twelve
months ended March 31, 1998, resulted principally from the Company's net loss
from operations and purchases of inventory, offset by increases in accounts
payable, amortization of the discount on the Senior Discount Notes, depreciation
expense and the compensation expense recognized related to the stock option
plan. Net cash used in operating activities for the year ended March 31, 1997,
resulted from the net loss from operations and increases in prepayments
consisting primarily of the $3,000,000 prepayment of franchise fees to the City
of Chicago and decreases in various payables made possible by the equity
infusion of approximately $20 million.

Cash flow used in investing activities totaled $126,770,357, $25,665,047
and $3,628,163 for the nine months ended December 31, 1998 and for the twelve
months ended March 31, 1998 and 1997, respectively. Cash requirements in the
nine months ended December 31, 1998, consisted of costs for the continued
deployment of the network in the Area 1 franchise and installing and
facilitating the telephone switching equipment in the Telephone Operations
Center ("TOC"), which is located at corporate headquarters. Also contributing to
the increase in cash used for investing activities was an increase in short term
investments which reflects an effort to improve returns on monies previously
classified as cash. Cash requirements in the twelve months ended March 31, 1998,
consisted of the cost of building and equipping the NOC and facilitating the
corporate headquarters and network construction. In addition, $10 million was
invested in a security which matured on December 7, 1998. Cash requirements in
the year ended March 31, 1997, consisted primarily of the purchase of 1,734 Area
1 bulk subscribers for $3,381,300.

Cash flow used in financing activities was $450,108 for the nine months
ended December 31, 1998. In the nine months ended December 31, 1998, the sale of
Class A Preferred Stock generated $100,000 which was offset by $131,040 payment
on debentures plus accrued interest and the settlement of a bank payable for
$419,068. Cash flow from financing activities was $243,154,859 and $18,768,915
for the twelve months ended March 31, 1998 and 1997, respectively. In the twelve
months ended March 31, 1998, the private sale of $200 million in Senior Discount
Notes; the sale of $50 million in Exchangeable Preferred Stock; and the sale of
Class A Preferred Stock; generated a net of $192,113,175, $48,025,236, and
$2,597,380, respectively. For the year ended March 31, 1997, approximately
$20,000,000 of cash flow was generated through the private sale of preferred
equity.

The cost of network development, construction and start-up activities of
the Company has required and will continue to require substantial capital. The
Company estimates that its aggregate capital expenditure requirements related to
DRS Network construction in Area 1 for the nine months ended December 31, 1998
and for the fiscal years 1999 and 2000, the time frame in which construction of
the DRS Network in Area 1 is expected to be completed, will total approximately
$250 million, of which approximately $54 million was spent during calendar year
1998. The Company will fund these expenditures from the net proceeds of the sale
of the 12 1/4% Senior Discount Notes and the 13 3/4% Senior Cumulative
Exchangeable Preferred Stock. In order to retain funds available to support its
operations, the Company has no expectation of paying cash interest on the Senior
Discount Notes or cash dividends on the Exchangeable Preferred Stock prior to
February 15, 2003. The Company may require additional financing in the future if
it begins to develop additional franchise areas or if the development of Area 1
in Chicago is delayed or requires costs in excess of current expectations. There
can be no assurance that the Company will be able to obtain any additional debt
or equity financing, or that the terms thereof will be favorable to the Company
or its existing creditors or investors. On August 5, 1998, the Company entered
into a $40 million bank revolving credit facility with a number of banks to
provide supplemental financing. As of December 31,1998, no borrowings have been
made under this facility. On October 30, 1998, the Company entered into
Amendment No. 1 to its bank revolving credit facility which adjusted certain
operating covenants.

<PAGE>

Impact of Year 2000

The Company has been actively and aggressively working to ensure Year 2000
compliance which included an awareness program started in the third quarter of
1998. The Company has initiated a formal program to address the Year 2000 issue
that includes a project office. The Company has substantially completed a
comprehensive inventory and assessment of Information Technology (IT) and non-IT
related systems and equipment that may be affected by Year 2000 issues. The
Company has contracted with a third party to assist with its Year 2000
assessment. Management does not anticipate any significant future expenditures,
apart from approximately $70,000 in fees charged by this third party and certain
system components not covered by service maintenance agreements, in conjunction
with the Year 2000 issue. The Company has completed the replacement of all
financial systems to meet Year 2000 compliance. Substantially all of the
remaining critical business systems have been certified by the vendors to be
Year 2000 compliant. The Company's testing plan may include unit testing as well
as regression analysis. The replacement and remediation of IT and non-IT systems
is expected to be substantially complete in the third quarter of 1999. The
Company is assessing the Year 2000 readiness of its critical vendors and
suppliers and has sent letters inquiring as to their status regarding their Year
2000 readiness. The Company will perform additional procedures as necessary to
evaluate risks associated with third parties and will consider these risks when
establishing contingency plans. The Company is developing contingency plans to
mitigate the potential disruptions that may result from Year 2000 issues. These
plans may include securing alternative sources for critical vendors and
suppliers, as well as other measures considered appropriate by management and
are anticipated to be completed in the third quarter of 1999.

While the Company believes its efforts to avoid any material adverse effect
on the Company's operations or financial condition will be successful, given the
complexity and risks, there can be no assurance these efforts will be
successful. Risks include, but are not limited to, the readiness of vendors,
suppliers, and remediation projects. However, the Company does not anticipate
any disruptions in the ability to provide our products and services subsequent
to December 31, 1999. The Company has not incurred incremental costs to date and
believes the total cost of the Year 2000 project will not have a material effect
on its results of operations.

Recent Developments

On February 26, 1999, the Company acquired EnterAct Corp. ("EnterAct"), a
Chicago-based provider of Internet access and commercial data services. EnterAct
has approximately 50 employees, and is the highest rated Chicago Area Internet
Services Provider by Mind Spring Enterprises. The majority of EnterAct's
approximately 10,000 customers are residential dial up Internet access
customers; however, a significant portion of EnterAct's 1998 calendar year
revenues were derived from Internet, data and consulting services provided to
its business customer base. In connection with this transaction, the Company
issued 696,994 shares of its no par value common stock to certain officers of
EnterAct and agreed to pay an additional $6,500,000. The Company paid $2,500,000
at the closing and issued two non-interest bearing notes totaling $4 million.
The notes are payable to executives of EnterAct over two years, one half due on
the first anniversary date and one half due on the second anniversary date. In
addition, a stock option plan was approved and options were awarded to certain
employees of EnterAct. EnterAct will become the Company's business service
division, developing, marketing and selling data and telephony services to the
business community.

In March of 1999, the Company was awarded a renewable franchise expiring
December 31, 2014 by the Village of Northbrook, located just northwest of
Skokie. This franchise award is contingent upon the Company's securing the funds
necessary to build its Northbrook network by September 10, 1999.

<PAGE>

Item 7a. Quantitative & Qualitative Disclosures about Market Risk.

Other than the Company's exposure to interest rate risk on its debt, the
Company has determined that it does not have a material exposure to market risk.
(See Note 5 to the financial statements).

Item 8. Financial Statements and Supplementary Data.

The consolidated financial statements and supplementary data required under
Item 8 of Part II are set forth in Part IV, Item 14 of this Form 10-K.

Item 9. Disagreements on Accounting and Financial Disclosure

None.
<PAGE>

PART III

Item 10. Directors and Executive Officers of the Registrant.

The current directors and executive officers of the Company are listed
below. Directors and executive officers of the Company are elected to serve
until they resign or are removed, are otherwise disqualified to serve or until
their successors are elected and qualified.

Name Age Position(s) with Company
------ ---- ------------------------
Edward T. Joyce 56 Chairman of the Board
Robert J. Currey 53 President, Chief Executive Officer and Director
Ronald D. Webster 49 Chief Financial Officer and Treasurer
John A. Brouse 50 Vice President Engineering
David Jacobs 35 Vice President of Customer Operations
Roxanne Jackson 34 Vice President of Human Resources
Eric D. Kurtz 34 Vice President of Operations and Assistant Secretary
Dennis Parker 61 Vice President of Marketing and Planning
Susan R. Quandt 44 Vice President of Sales
Christopher Young 43 Vice President and Chief Information Officer
William Farley 56 Director
Elzie Higginbottom 57 Director
Dr. Charles E. Kaegi 48 Director
David Kronfeld 51 Director
James H. Lowry 58 Director
Glenn W. Milligan 50 Director (Chairman of the Board until January 1,
1999 and Chief Executive Officer until August
13, 1998)
Thomas M. Neustaetter 47 Director

Edward T. Joyce has served as a Director of the Company since the Company's
inception in October 1992. Mr. Joyce founded his own firm in 1971, now known as
Edward T. Joyce and Associates, P.C., a law firm dealing with commercial
litigation. Mr. Joyce became Chairman of the Board of the Company as of January
1, 1999.

Robert J. Currey has served as a Director of the Company since February
1997 and was named President and Chief Operating Officer on March 1, 1998. On
August 13, 1998 Mr. Currey was named the President and Chief Executive Officer
of the company. Prior to joining the company, Mr. Currey served as Group
President of Telecommunications Services for McLeod USA, a wholly owned
subsidiary of McLeod, Inc., from September 1997 through February 1998. Mr.
Currey continues to serve on the board of directors of McLeod USA. From March
1990 until September 1997, he served as President and Chief Executive Officer of
Consolidated Communications. From 1988 to 1990, Mr. Currey served as Senior Vice
President of Operations and Engineering at Citizens Utilities Company in
Stanford, Connecticut. From 1987 to 1988, Mr. Currey served as Executive Vice
President at US Sprint in Kansas City, Missouri.

Ronald D. Webster joined the Company as Chief Financial Officer in
September 1997 and was named Treasurer of the company on October 13, 1998. He
was previously Vice President and Treasurer at Telephone Data Systems, Inc.,
where he served from July 1983 until May 1987 and from April 1988 until August
1997. Prior thereto, he held executive positions with Ideal School Supply Corp.
and Trans Union Corporation.

John A. Brouse has served as the Company's Vice President of Engineering
since August 1998. From April 1997 until August 1998, Mr. Brouse served as Vice
President of Network Operations. Prior to that time, Mr. Brouse was Operations
Engineering Director for Jones Intercable, Inc. from June 1988 to April 1997.
Mr. Brouse received the cable industry's prestigious Polaris Award in 1996.

David L. Jacobs has served as Vice President of Customer Operations since
July 1998. Prior to that time Mr. Jacobs was Senior Director of Engineering and
Technology for Ameritech New Media and was also Ameritech's New Media Director
of Technical Support and New Product Development. He held various positions with
Illinois Bell prior to his appointment at Ameritech.
<PAGE>

Roxanne Jackson has served as the Company's Vice President of Human
Resources since May 1996. From January 1994 to May 1996, Ms. Jackson was the
Human Resources Director for Metz Baking Group. From August 1992 until January
1994, Ms. Jackson served as the Director of Human Resources for Fox Television
Stations, Inc.

Eric D. Kurtz has served as the Company's Vice President of Operations
since February 1999. Previously Mr. Kurtz served as Vice President of Corporate
Development and Regulatory Affairs since March 1997. From April 1989 until July
1996, Mr. Kurtz was a General Manager with Time Warner's Milwaukee & Chicago
Divisions. During this time he also served as a board member of the Wisconsin
Cable Communications Association and as its President from September 1994 to
September 1996.

Dennis D. Parker has served as the Company's Vice President of Marketing
and Planning since November 1998. Mr. Parker served as President and CEO of
Prairie Systems from 1995 until 1998; President and CEO of ITN (Illuminet) from
1989 until 1995, and was President and Managing Director of the Princeton
Institute from 1985 until 1989. Prior to that, Mr. Parker was in planning and
operations for AT&T Information Systems Division.

Susan R. Quandt has served as the Company's Vice President of Sales since
December 1997. From December 1994 to December 1997, Ms. Quandt served as
Executive Vice President of Taylor-Winfield, an information technology market
consulting and executive recruiting firm. From January 1992 to September 1994,
Ms. Quandt served as Vice President of Marketing and Product Development of
Call-Net Enterprises Inc., a national long-distance telephone company owned by
Sprint Canada. From January 1989 to December 1991, Ms. Quandt served as Vice
President of Marketing for Schneider Communications, Inc., a regional
long-distance telephone company.

Christopher Young has served as Vice President and Chief Information
Officer for the Company since August of 1998. He previously held the position of
CIO at Mercury Marine from 1997 until 1998. He was CIO for Siemens
Electromechanical Components, Inc., from 1995 until 1997 and served as Director
of Information Technology for Consolidated Communications Directories from 1990
until 1995.

William F. Farley has served as a Director of the Company since September
1998. Mr. Farley has been Chairman and CEO of Fruit of the Loom, Inc. since he
acquired the company in 1985. Mr. Farley sits on various educational, civic and
cultural boards including, The Horatio Alger Association Board of Directors, The
Chicago Council on Foreign Relations, American Textile Manufacturers Institute,
American Apparel Manufacturers Association, and Rush Hospital Heart Institute,
among others.

Elzie L. Higgenbottom has served as a Director of the Company since
September 1998. Mr. Higgenbottom has been involved in real estate development,
management, and construction of single and multi-family and commercial real
estate for more than two decades. East Lake Management and Development
Corporation, a firm he founded, has become one of the largest minority-owned
real estate services firms in the Midwestern United States under his management.
Mr. Higgenbottom currently serves on the governing board of the Housing
Authority of Cook County, Illinois, and the Board of Directors of Cole Taylor
Bank and Mercy Hospital.

Dr. Charles E. Kaegi has served as a Director of the Company since the
Company's inception in October 1992. Dr. Kaegi has been in private practice of
medicine since July 1979. From November 1979 to present, Dr. Kaegi has held
positions at Ravenswood Hospital Medical Center as: Attending Physician
(November 1979 to present); Medical Director, Alcohol & Drug Abuse Program (July
1994 to present); Medical Director, Community Mental Health Center (November
1994 to present); Medical Education (January 1980 to present); Secretary of the
Department of Psychiatry (January 1993-present); and Consultant to Community
Mental Health Center (March 1980 to August 1985). Dr. Kaegi is the cousin of Mr.
Glenn Milligan.

<PAGE>

David Kronfeld has served as a Director of the Company since February 1997.
Mr. Kronfeld founded JK&B Capital in January 1996 and has been its Manager since
that time. Mr. Kronfeld is a General Partner at Boston Capital Ventures where he
specializes in the telecommunications and software industries. From October 1984
to August 1989, Mr. Kronfeld served as Vice President of Acquisitions and
Venture Investments at Ameritech.

James H. Lowry has served as a Director of the Company since February 1997.
Mr. Lowry serves as President and Chief Executive Officer of James H. Lowry &
Associates ("JHLA"), a consulting company established in 1975. Prior to
establishing JHLA, Mr. Lowry served as the Director of Public Service Practice
for McKinsey & Company from 1967 to 1975.

Glenn W. Milligan, the Company's founder, served as Chairman of the Board
until January 1, 1999 and until August 13, 1998 had been the Chief Executive
Officer of the Company since its inception in October 1992. Mr. Milligan was
President and Chief Executive Officer of 21st Century Technology Group, Inc.
from April 1986 to October 1992. From July 1985 until March 1986, Mr. Milligan
served as Regional Director for the Walt Disney Company. Mr. Milligan served as
Area Manager for Showtime Networks, Inc. from March 1984 to June 1985. From July
1979 to November 1983, Mr. Milligan was the Chief Executive Officer of DAEOC,
Inc., a diversified government contractor.

Thomas M. Neustaetter has served as a Director of the Company since
February 1997. Mr. Neustaetter has been an officer of the Chatterjee Management
Group, a division of Chatterjee Management Company, since January 1996. From
January 1995 to January 1996, Mr. Neustaetter was the Managing Director for
Bancroft Capital Corporation in New York City, a company he founded. From August
1986 to December 1994, Mr. Neustaetter was employed at Chemical Banking
Corporation in New York City.

Committees of the Board of Directors

The Board currently has three committees, the Executive Committee and the
Compensation Committee and the Audit Committee.

The Executive Committee makes recommendations to the Board of Directors
regarding issues such as finance, strategic planning and long-range goals for
the Company. The current members of the Executive Committee are Glenn Milligan,
Edward Joyce and David Kronfeld.

The Compensation Committee reviews and recommends the compensation and
bonus arrangements for executive level management of the Company and administers
the Company's stock option plans. The current members of the Compensation
Committee are Glenn Milligan, Edward Joyce and Thomas Neustaetter.

The Audit Committee examines and considers matters relating to the
financial affairs of the Company including reviewing the Company's annual
financial statements, the scope of the independent annual audit and the
independent auditor's letter to management concerning the effectiveness of the
Company's internal financial and accounting controls. The current members of the
Audit Committee are Edward T. Joyce and Thomas Neustaetter.

<PAGE>

Compensation Committee Interlocks and Insider Participation

As stated above, the current members of the Compensation Committee are
Messrs. Milligan, Joyce and Neustaetter. Mr. Milligan also served as the Chief
Executive Officer of the Company from April 1, 1998 until December 31, 1998.
Director Compensation

Directors of the Company receive no directors' fees. Directors are
reimbursed for their reasonable out-of-pocket travel expenditures incurred in
connection with their service as directors.

Compensation Plan

1998 Employee Stock Option Plan. The Company's 1998 Employee Stock Option
Plan (the "1998 Employee Stock Option Plan") provides for the grant of options
that are not intended to qualify as "incentive stock options" under Section 422
of the Internal Revenue Code of 1986, as amended (the "Code"), to employees of
the Company. The Compensation Committee of the Board of Directors administers
the 1998 Employee Stock Option Plan and grants options to purchase Common Stock
thereunder.

On April 14, 1998, the Company's Board of Directors approved the 1998
Employee Stock Option Plan for a total of 50,000 shares of common stock to be
awarded to employees of the Company.

The Compensation Committee has the exclusive authority to establish, amend
and rescind appropriate rules and regulations relating to the Employee Stock
Option Plan. Each participant's option will expire as of the earliest of: (i)
the date on which it is forfeited under the provisions of the Employee Stock
Option Plan; (ii) ten years from the option date; and (iii) the date on which it
expires pursuant to the relevant option agreement. The option price may be
greater than, less than or equal to the fair market value on the option date as
determined in the sole discretion of the Compensation Committee.

As of December 31, 1998, there were 27,325 options to acquire shares of
Common Stock outstanding pursuant to the 1998 Employee Stock Option Plan.

1998 Key Management Stock Option Plan. The Company's 1998 Stock Option Plan
(the "1998 Key Management Stock Option Plan") provides for the grant of options
that are not intended to qualify as "incentive stock options" under Section 422
of the Internal Revenue Code of 1986, as amended (the "Code"), to key employees.
The Compensation Committee of the Board of Directors administers the 1998 Key
Management Stock Option Plan and grants options to purchase Common Stock
thereunder.

On April 14, 1998, the Company's Board of Directors approved the 1998 Key
Management Stock Option Plan for a total of 150,000 shares of common stock to be
awarded to key management employees.

The Compensation Committee has the exclusive authority to establish, amend
and rescind appropriate rules and regulations relating to the Key Management
Stock Option Plan. Each participant's option will expire as of the earliest of:
(i) the date on which it is forfeited under the provisions of the Key Management
Stock Option Plan; (ii) ten years from the option date; and (iii) the date on
which it expires pursuant to the relevant option agreement. The option price may
be greater than, less than or equal to the fair market value on the option date
as determined in the sole discretion of the Compensation Committee.

An option participant may not exercise an option or any portion thereof
until such option or such portion thereof has become fully vested. Pursuant to
the Key Management Stock Option Plan, options generally vest 25% each year and
are fully vested after four years.

<PAGE>

As of December 31, 1998, options to acquire 139,500 shares of Common Stock
were outstanding pursuant to the 1998 Key Management Stock Option Plan.

1998 Stock Option Agreement. The Company's 1998 Stock Option Agreement
("the Agreement") provides for the grant of options that are not intended to
qualify as "incentive stock options" under Section 422 of the Internal Revenue
Code of 1986, as amended (the "Code"), to employees of the Company. The
Compensation Committee of the Board of Directors administers "the Agreement" and
grants options to purchase Common Stock thereunder.

On April 14, 1998, the Company's Board of Directors approved the 1998 Stock
Option Agreement for a total of 331,200 shares of common stock to be awarded to
two named executive officers of the Company.

The Compensation Committee has the exclusive authority to establish, amend
and rescind appropriate rules and regulations relating to the Agreement. Each
participant's option will expire as of the earliest of: (i) the date on which it
is forfeited under the provisions of the Employee Stock Option Plan; (ii) ten
years from the option date; and (iii) the date on which it expires pursuant to
the relevant option agreement. The option price may be greater than, less than
or equal to the fair market value on the option date as determined in the sole
discretion of the Compensation Committee.

An option participant may not exercise an option or any portion thereof
until such option or such portion thereof has become fully vested. Pursuant to
the Stock Option Plan, 139,100 options were vested immediately on August 28,
1998 and the remaining future vesting options generally vest 1/48th each month
retroactive to the date of hire and are fully vested after four years. All
options become 100% vested and immediately exercisable prior to a Change in
Control (as such term is defined in the Agreement).

As of December 31, 1998, options to acquire 331,200 shares of Common Stock
were outstanding pursuant to the 1998 Stock Option Agreement.

1997 Stock Option Plan. The Company's 1997 Stock Option Plan (the "1997
Stock Option Plan") provides for the grant of options that are not intended to
qualify as "incentive stock options" under Section 422 of the Internal Revenue
Code of 1986, as amended (the "Code"), to key employees. The Compensation
Committee of the Board of Directors administers the Stock Option Plan and grants
options to purchase Common Stock thereunder.

On January 30, 1997, the Company's Board of Directors approved a stock
option plan. The aggregate number of shares of Common Stock that may be issued
under options under the 1997 Stock Option Plan may not exceed 728,667.7 shares.
Reserved shares may be either authorized but unissued shares or treasury shares,
and will be distributed at the discretion of the Board of Directors.

The Compensation Committee has the exclusive authority to establish, amend
and rescind appropriate rules and regulations relating to the 1997 Stock Option
Plan. Each participant's option will expire as of the earliest of : (i) the date
on which it is forfeited under the provisions of the Stock Option Plan; (ii) ten
years from the option date; and (iii) the date on which it expires pursuant to
the relevant option agreement. The option price may be greater than, less than
or equal to the fair market value on the option date as determined in the sole
discretion of the Compensation Committee.

An option participant may not exercise an option or any portion thereof
until such option or such portion thereof has become fully vested. Pursuant to
the Stock Option Plan, options generally vest 1/48th each month and are fully
vested after four years. All options become 100% vested and immediately
exercisable prior to a Change in Control (as such term is defined in the Stock
Option Plan).

As of December 31, 1998, options to 591,324 shares of Common Stock were
outstanding pursuant to the Stock Option Plan.

<PAGE>

Item 11. Executive Compensation.

Summary Compensation Table

The following table sets forth information concerning compensation of (i)
the Company's Chief Executive Officer during the nine month transition year (TY)
ended December 31, 1998 and (ii) each executive officer of the Company whose
total annual salary and bonus equaled or exceeded $100,000 in the fiscal year
ended December 31, 1998 (collectively, the "Named Executive Officers");
Compensation information for the fiscal years (FY) ended March 31, 1998 and 1997
are also included:

Long-Term Compensation
Awards

Annual Compensation Number
Of
Securities

Underlying
Named Officers and Principal
Position Year Salary ($) Bonus ($) Other($)(1) Options
- -------- ---- ---------- --------- - ----------- -------
<S> <C> <C> <C> <C> <C>
Glenn W. Milligan, Chairman TY-1998 179,779 25,000 6,488 158,589.5 (2)
of the Board until January 1, FY-1998 188,648 48,089 29,169 131,160.3
1999 And Chief Executive Officer FY-1997 170,833 6,875 4,000
until August 31, 1998

Robert J. Currey TY-1998 65,133 441,346 84,418 278,200
President and Chief Executive FY-1998 92,780 0 0
Officer FY-1997 0 0 0

Ronald D. Webster TY-1998 113,003 50,000 3,692 162,300.2
Chief Financial Officer FY-1998 92,308 50,000 3,462 109,300.2
FY-1997 0 0 0

John A. Brouse TY-1998 98,941 6,500 16,799 36,443.4
Vice President Engineering FY-1998 92,780 3,807 41,218 36,443.4
FY-1997 0 0 0

Susan R. Quandt TY-1998 112,782 0 9,481 72,866.8
Vice President Sales FY-1998 25,823 0 3,023 72,866.8
FY-1997 0 0 0

Richard Wiegand-Moss (3) TY-1998 73,042 0 198,095 51,874.4 (4)
Former Chief Operating Officer FY-1998 150,566 6,990 36,232 72,866.8 (4)
FY-1997 117,709 5,729 13,750

Jay E. Carlson (5) TY-1998 70,330 10,000 82,040 37,000 (6)
Former Chief Technical Officer FY-1998 120,800 3,625 40,196 91,083.5
FY-1997 0 0 0

</TABLE>

(1) Includes amounts reimbursed for relocation expenses; and in the case of Mr.
Milligan, the amount includes an annual membership fee to a private club;
and in the case of Mr. Carlson and Mr. Moss, the amount includes severance
payments.
(2) On December 31, 1998, Mr. Milligan was granted 27,429.2 shares of the
Company's common stock, representing the lesser of 20,000 shares or such
other number as to provide Mr. Milligan with .261% of the Company's common
shares outstanding.
(3) Mr. Wiegand-Moss was the Company's Chief Operating Officer from August 1996
to March 1998. Effective March 4, 1998, he ceased to be the Chief Operating
Officer and became Senior Vice President of Customer Operations. Mr.
Wiegand-Moss left the Company in May 1998.
(4) In March 1998, the options granted to Mr. Wiegand-Moss were reduced from
109,300.2 shares to 72,866.8 shares when he ceased to be the Chief
Operating Officer and became Senior Vice President of Customer Operations.
Unvested shares totaling 57,425.8 were forfeited when he left the Company
in May of 1998.
(5) Mr. Carlson was the Company's Chief Technical Officer from November 3, 1997
to August 1998. Mr. Carlson left the Company in August 1998.
(6) In March 1999 in conjunction with a settlement and general release, the
options granted to Mr. Carlson were reduced from 91,083.5 shares to 37,000
shares, representing the shares fully vested when he ceased to be the Chief
Technical Officer.

<PAGE>

The following table contains certain information concerning the stock
option grants made to each of the Named Executive Officers during the transition
year ended December 31, 1998.

<TABLE>

Option Grants in Last Fiscal Year
Individual Grants
-------------- ------------- ----------------
<CAPTION>

% of Total
Number of Options
Securities granted to Potential Realizable Value
Underlying Employees in at Assumed Annual Rates of
Name Options Fiscal Year Exercise or Market Price Expiration Stock Price Appreciation for
------ Base Price at Date of ----------- Option Term (3)
Granted ($/Sh) Grant ($/Sh) Date 5% 10%
------- ------ ------ ---- -- ---
<S> <C> <C> <C> <C> <C> <C> <C>
Glenn W. Milligan 27,429.2(1) 5.3 0.00 4.50 N/A $ 201,057 $ 320,149
Robert J. Currey 278,200(2) 53.2 1.12 4.50 03/06/08 $1,727,629 $2,935,522
Ronald D. Webster 53,000(2) 10.2 4.50 4.50 04/14/08 $ 149,991 $ 380,108
John A. Brouse -- -- -- -- -- -- --
Susan R. Quandt -- -- -- -- -- -- --
Richard Wiegand-Moss -- -- -- -- -- -- --
Jay E. Carlson -- -- -- -- -- -- --

</TABLE>

(1) On December 31, 1998, Mr. Milligan was granted 27,429.2 shares of the
Company's common stock, representing the lesser of 20,000 shares or such
other number as to provide Mr. Milligan with .261% of the Company's common
shares outstanding.

(2) Stock options vest 1/48th each month and are fully vested after four years;
provided that such officer remains continuously employed by the Company.

(3) These amounts are based on compounded annual rates of stock price
appreciation of five and ten percent over the 10-year term of the options,
are mandated by rules of the Securities and Exchange Commission and are not
indicative of expected stock performance. Actual gains, if any, on stock
option exercises are dependent on future performance of the Common Stock,
overall market conditions, as well as the option holders' continued
employment throughout the vesting period. The amounts reflected in this
table may not necessarily be achieved or may be exceeded. The indicated
amounts are net of the option exercise price but before taxes that may be
payable upon exercise.

The following table sets forth certain information regarding options to
purchase Common Stock held as of December 31, 1998 by each of the Named
Executive Officers. None of such Named Executive Officers exercised any options
during the year ended December 31, 1998

<PAGE>

<TABLE>

Aggregated Fiscal Year-End Option Values
<CAPTION>

Number of Securities Underlying Value of Unexercised In-the-Money
Unexercised Options at Fiscal Options at
Year End Fiscal Year End (1)
------------------------------- --------------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
<S> <C> <C> <C> <C>
Glenn W. Milligan 131,160.3 27,429.2 $443,322 $123,431
Robert J. Currey 168,079.0 110,121.0 $568,107 $372,209
Ronald D. Webster 54,050.4 108,249.8 $122,977 $405,458
John A. Brouse 15,097.3 21,336.0 $ 51,029 $ 72,116
Susan R. Quandt 18,466.0 54,400.8 $ 62,415 $183,875
Richard Wiegand-Moss 51,847.4 -- $175,244 $175,244
Jay E. Carlson 37,000.0 -- $125,060 $125,060

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

</TABLE>

(1) There was no public trading market for the Common Stock as of December
31, 1998. Accordingly, these values have been calculated by determining
the difference between the estimated fair market value of the Company's
Common Stock underlying the option as of December 31, 1998 ($4.50 per
share) and the exercise price per share payable upon exercise of such
options. In determining the fair market value of the Company's Common
Stock, the Board of Directors considered various factors, including the
Company's financial condition and business prospects, its operating
results, and the absence of a market for its Common Stock.

Employment Agreements

Glenn W. Milligan. Mr. Milligan entered into an agreement with the Company
as of January 1, 1999 with a term that ends on August 21, 2001. As of August 31,
1998, Mr. Milligan ceased to be the Chief Executive Officer of the Company and
on January 1, 1999 ceased to be the Chairman of the Board. However, pursuant to
the agreement, Mr. Milligan continues to be entitled to an annual base salary of
$170,000 and an annual bonus of $100,000. Mr. Milligan is also entitled to
receive annually the lesser of 20,000 shares of the Company's common stock or
such other number of shares as is necessary to provide him with .261% of the
outstanding shares of common stock as of August 21 of each year until August 21,
2001. Mr. Milligan can also receive stock options covering such number of shares
pursuant to any separate agreement. Mr. Milligan is generally entitled to the
standard executive benefits provided by the Company. In the event of his death
Mr. Milligan's spouse, or his designated beneficiary, is entitled to continue to
receive the benefits to which Mr. Milligan would have been entitled to under the
agreement for the remainder of the term.

Robert J. Currey. Mr. Currey was employed by the Company as its President
and Chief Executive Officer pursuant to an employment agreement dated March 6,
1998. Pursuant to the employment agreement Mr. Currey is entitled to an annual
base salary of at least $181,000 and an annual bonus of at least $175,000. Mr.
Currey is eligible for an annual review and at the discretion of the Board of
Directors his salary can be increased but not decreased. Mr. Currey's contract
entitled him to receive stock options for 278,000 shares of the Company's common
stock, 50% of which vested immediately with the remaining "later vesting stock"
to be vested over a period ending February 2002. The Board may also award a
special bonus to Mr. Currey. Upon a termination of his employment agreement, Mr.
Currey is generally entitled to specific severance benefits, and depending on
the reason for termination, he may be entitled to an amount equal to
approximately two times the annual salary and bonus stated in the contract.

<PAGE>

Ronald D. Webster. Mr. Webster entered into an employment agreement with
the Company as of November 3, 1997. The employment agreement will expire on
January 1, 2000. Pursuant to the employment agreement, Mr. Webster is entitled
to an initial annual base salary of $160,000 and a minimum annual bonus of
$50,000 on each of December 31, 1997, 1998, and 1999. In addition, he is
entitled to receive stock options covering such number of shares pursuant to a
separate agreement. Upon a termination of his employment agreement, Mr. Webster
is generally entitled to severance benefits, and depending on the reason for
termination, he may be entitled to an amount equal to two times the annual
salary and bonus he would have received for the year during which such
termination occurs.

John A. Brouse. Mr. Brouse entered into an employment agreement with the
Company as of November 3, 1997. The employment agreement will expire on August
3, 2001. Pursuant to the employment agreement, Mr. Brouse is entitled to an
initial annual base salary of $117,200 and is entitled to participate in any
performance based bonus plan provided by the employer. In addition, he is
entitled to receive stock options covering such number of shares pursuant to a
separate agreement. Upon a termination of his employment, depending on the
reason for termination, Mr. Brouse is generally entitled to severance benefits,
and he may be entitled to an amount equal to two times the annual salary and
bonus he would have received for the year during which such termination occurs.

Susan R. Quandt. Ms. Quandt entered into an employment agreement with the
Company as of December 26, 1997. The employment agreement will expire on
December 26, 1999. Pursuant to the employment agreement, Ms. Quandt is entitled
to an initial annual base salary of $125,000 and is entitled to participate in
any performance based bonus plan provided by the employer. In addition, she is
entitled to receive stock options covering such number of shares pursuant to a
separate agreement. Upon a termination of her employment, depending on the
reason for termination, Ms. Quandt is generally entitled to severance benefits,
and she may be entitled to an amount equal to one times the annual salary and
bonus she would have received for the year during which such termination occurs.

Richard Wiegand-Moss. Mr. Wiegand-Moss was employed by the Company as its
Chief Operating Officer pursuant to an employment agreement in August 1996. In
March 1998, he entered into another employment agreement with the Company,
pursuant to which he ceased to be the Chief Operating Officer and became Senior
Vice President of Customer Operations effective March 4, 1998. Pursuant to the
employment agreement in 1998, he was entitled to an initial annual base salary
of $150,000. In May 1998, Mr. Wiegand-Moss resigned from the Company. On May 5,
1998, Mr. Wiegand entered into a Separation Agreement and General Release with
the Company.
All unvested options were forfeited.

Jay E. Carlson. Mr. Carlson entered into an employment agreement with the
Company as of November 3, 1997. Mr. Carlson resigned from the Company on August
31, 1998. Mr. Carlson entered into a Separation Agreement and General Release
with the Company on March 5, 1999, Terms of this agreement a lump sum amount of
$150,000, which is equal to his annual salary for the most recent year. Pursuant
to the agreement, Mr. Carlson retained the 37,000 shares of Company common stock
which represent the amount that had fully vested as of August 31, 1998. The
agreement included the forgiveness of a loan of $53,000 which Mr. Carlson had
received from the Company.

All employment agreements contain confidentiality provisions and
non-compete provisions.

<PAGE>

Item 12. Principal Shareholders.

The following table sets forth certain information at March 15, 1999,
regarding beneficial ownership of the capital stock of the Company by (i) each
person known by the Company to beneficially own more than 5% of the outstanding
capital stock of the Company, (ii) each director of the Company, (iii) each
Named Executive Officer of the Company and (iv) all directors and executive
officers as a group.

Number of Shares of
Number of Shares of Class A Convertible
Common Stock 8% Cumulative
Beneficially Preferred Stock Percent of Aggregate
Name of Beneficial Owner Owned (1) Beneficially Owned(2) Voting Rights(3)
------------------------ ------------ --------------------- ----------------
<S> <C> <C> <C>
Purnendu Chatterjee(4) 757,600.3 633.2 24.3%
JK&B Capital(5) 378,800.2 316.6 12.7
William Farley(6) 303,040.0 253.3 10.3
Myron M. Cherry(7) 269,625.3 12.7 5.4
Boston Capital Ventures III, L.P.(8) 151,520.1 126.6 5.2
Elske Bolitho(9) 305,000.0 -- 5.9
Thomas Neustaetter(4)(10) 757,600.3 633.2 24.3

Charles E. Kaegi, M.D.(11)(16) 932,480.0 6.3 16.8
Edward T. Joyce(12)(16) 758,496.7 50.8 14.5
David Kronfeld(13) 530,320.3 443.2 17.5
Glenn W. Milligan(14)(16) 687,684.8 4.7 12.4
James H. Lowry(16) 19,000.0 -- *
Robert Currey(16) 63,754.1 -- 1.2
Ronald Webster(15)(16) 48,557.6 9.5 1.2
All executive officers and directors as a group 3,777,300.0 1,147.7 67.4

* Less than 1%.

</TABLE>

(1) The persons named in this table have sole voting power with respect to all
shares of Common Stock shown as beneficially owned by them, subject to
community property laws where applicable and except as indicated in the
other footnotes to this table. Beneficial ownership is determined in
accordance with the rules of the SEC. In computing the number of shares
beneficially owned by a person and the percentage ownership of that person,
shares of Common Stock subject to options and warrants held by that person
that are currently exercisable or exercisable within 60 days after March
15, 1999, are deemed outstanding. Such shares, however, are not deemed
outstanding for the purpose of computing the percentage ownership of any
other person.

(2) Each share of Class A Convertible 8% Cumulative Preferred Stock converts
into one thousand shares of Common Stock at the option of the shareholder.

(3) Percent of Aggregate Voting Rights, for each beneficial owner, was
determined based upon a fraction. The numerator of such fraction is the sum
of (a) the number of outstanding shares of Common Stock beneficially owned
by such owner, plus (b) the number of shares of Common Stock into which the
number of shares of Class A Convertible 8% Cumulative Preferred Stock
beneficially owned by such owner are convertible, plus (c) the number of
shares of Common Stock issuable upon exercise of options and warrants
beneficially owned by such owner and which are exercisable within 60 days
of March 15, 1999. The denominator of such fraction is the sum of (a) the
aggregate number of shares of Common Stock outstanding on March 15, 1999,
plus (b) the number of shares of Common Stock into which the aggregate
number of shares of Class A Convertible 8% Cumulative Preferred Stock
outstanding on March 15, 1999 are convertible, plus (c) the aggregate
number of shares of Common Stock issuable upon exercise of options and
warrants beneficially owned by such owner and which are exercisable within
60 days of March 15, 1999.

<PAGE>

(4) Represents 112,445.2 shares of Common Stock, 266,354.9 shares of Common
Stock issuable upon exercise of warrants and 316.6 shares of Class A
Convertible 8% Cumulative Preferred Stock held by Quantum Industrial
Partners LDC ("QIP"). The address of QIP is c/o Curacao Corporation
Company, Kaya Flamboyan 9, Willemstad, Curacao, Netherlands Antilles.
Also includes 65,218.2 shares of Common Stock, 154,485.9 shares of Common
Stock issuable upon exercise of warrants and 183.6 shares of Class A
Convertible 8% Cumulative Preferred Stock held by S-C Phoenix Holdings,
L.L.C. ("S-C Phoenix"). The address of S-C Phoenix is c/o Chatterjee
Management Company, 888 Seventh Avenue, New York, New York 10106. This
total also includes 45.2 shares of Class A Convertible 8% Cumulative
Preferred Stock, 16,069.8 shares of Common Stock and 38,035.5 shares of
Common Stock issuable upon exercise of warrants held by Winston Partners
II, LLC and 87.8 shares of Class A Convertible 8% Cumulative Preferred
Stock, 31,157.2 shares of Common Stock and 73,833.6 shares of Common
Stock issuable upon exercise of warrants held by Winston Partners II, LDC
(Winston Partners II, LLC and Winston Partners II, LDC, collectively
"Winston Partners"). The address of Winston Partners II, LLC is c/o
Chatterjee Management Company, 888 Seventh Avenue, New York, New York
10106. The address of Winston Partners II, LDC is c/o Curacao Corporation
Company, Kaya Flamboyan 9, Willemstad, Curacao, Netherlands Antilles.
QIP, S-C Phoenix and Winston Partners are associated with Chatterjee
Management Company. Chatterjee Management Company is managed and
controlled by Purnendu Chatterjee. Dr. Chatterjee may be deemed to have
the power to direct the voting and disposition of the shares owned by
QIP, S-C Phoenix and Winston Partners. Dr. Chatterjee and Mr. George
Soros may each be deemed to have the power to direct the voting and
disposition of the shares owned by S-C Phoenix. In addition, Mr. Soros,
Mr. Stanley F. Druckenmiller and Soros Fund Management LLC may be deemed
to have the power to direct the voting and disposition of the shares
owned by QIP. The Percent of Aggregate Voting Rights excludes 224,890.4
shares of non-voting Common Stock beneficially owned by Purnendu
Chatterjee.

(5) Represents 221.6 shares of Class A Convertible 8% Cumulative Preferred
Stock, 78,711.6 shares of Common Stock and 186,448.5 shares of Common
Stock issuable upon exercise of warrants held by JK&B Capital, L.P. and
95.0 shares of Class A Convertible 8% Cumulative Preferred Stock,
33,733.6 shares of Common Stock and 79,906.5 shares of Common Stock
issuable upon exercise of warrants held by JK&B Capital II, L.P. (JK&B
Capital, L.P. and JK&B Capital II, L.P., collectively "JK&B Capital").
The address of JK&B Capital is 205 North Michigan, Suite 808, Chicago, IL
60601. The Percent of Aggregate Voting Rights excludes up to 112,445.2
shares of non-voting Common Stock beneficially owned by JK&B Capital.

(6) Represents the following securities held by the following entities:
116.1 shares of Class A Convertible 8% Cumulative Preferred Stock,
41,229.9 shares of Common Stock and 97,663.4 shares of Common Stock
issuable upon exercise of warrants held by Velocity Capital, L.L.C. of
which Mr. Farley is a member, and 105.5 shares of Class A Convertible
8% Cumulative Preferred Stock, 37,481.7 shares of Common Stock and
88,785.0 shares of Common Stock issuable upon exercise of warrants
held by The Retirement Program of Farley, Inc. of which Mr. Farley is
the sole member of the Pension Investment Committee and 31.7 shares of
Class A Convertible 8% Cumulative Preferred Stock, 11,244.5 shares of
Common Stock and 26,635.5 shares of Common Stock issuable upon
exercise of warrants held by Union Underwear Pension Plan of which Mr.
Farley is the sole member of the Pension Investment Committee. Mr.
Farley disclaims beneficial ownership of all shares except for 73.9
shares of class A Convertible 8% Cumulative Preferred Stock, 26,237.2
shares of common stock, and 62,149.4 shares of Common Stock issuable
upon exercise of warrants held by Velocity Capital, L.L.C., of which
Mr. Farley is a member. The percentage of Voting Rights excludes
89,956.1 shares of Non-voting Common Stock. Mr. Farley disclaims
beneficial ownership of all shares of Non-voting Common Stock except
for 26,237.2 shares. The address of Mr. Farley is 233 South Wacker
Drive, 5000 Sears Tower, Chicago, Illinois, 60606. The Percent of
Aggregate Voting Rights excludes 89,956.1 shares of non-voting Common
Stock beneficially owned by Mr. Farley.

(7) Includes 72,223.3 shares of Common Stock issuable upon exercise of
options. The address of Mr. Cherry is 30 North LaSalle, #2300, Chicago,
Illinois 60602. The Percent of Aggregate Voting Rights excludes 4,497.8
shares of non-voting Common Stock beneficially owned by Mr. Cherry.

(8) Includes 106,542.0 shares of Common Stock issuable upon exercise of
warrants. The address of Boston Capital Ventures III, L.P. is Old City
Hall, 45 School Street, Boston, MA 02108. The Percent of Aggregate Voting
Rights excludes 44,978.1 shares of non-voting Common Stock beneficially
owned by Boston Capital Ventures III, L.P..
<PAGE>

(9) Represents 153,000 shares of Common Stock held by Elske Bolitho, Trustee
of Robert W. Bolitho Trust, and 152,000 shares of Common Stock held by
Elske Bolitho, Trustee of Elske Bolitho Trust. The address of Ms. Bolitho
is 13376 185th Place N, Jupiter, Florida 33478.

(10) All of such shares are beneficially owned by Purnendu Chatterjee. Mr.
Neustaetter is an officer of the Chatterjee Management Group, a division
of Chatterjee Management Company. Mr. Neustaetter is an officer of
Chatterjee Management Company. Mr. Neustaetter disclaims beneficial
ownership of these shares, over which he does not have dispositive or
voting control. The business address of Mr. Neustaetter is c/o Chatterjee
Management Company, 888 Seventh Avenue, New York, NY 10106.

(11) Includes 172,202.2 shares of Common Stock and 376,721.8 shares of Common
Stock issuable upon exercise of options held by Charles E. Kaegi, M.D.,
S.C., Defined Contribution Pension Plan and Trust, 26,990.0 shares of
Common Stock held by Charles E. Kaegi, M.D., S.C., Defined Benefit
Pension Plan and Trust, 1,700.0 shares of Common Stock held by Charles E.
Kaegi, M.D., S.C. Profit Sharing Pension Plan and Trust, 321,240.0 shares
of Common Stock held jointly with Mr. Kaegi's wife, and 17,470.0 shares
of non-voting Common Stock owned by Mr. Kaegi's wife. The Percent of
Aggregate Voting Rights excludes 2,248.9 shares of non-voting Common
Stock held by Mr. Kaegi.

(12) Includes 269,516.5 shares of Common Stock issuable upon exercise of
options held by Mr. Joyce, 96,620.0 shares of Common Stock and 52,291.5
shares of Common Stock issuable upon exercise of options held by Mr.
Joyce's wife, 28,500 shares of Common Stock issuable upon exercise of
warrants held by Mr. Joyce, 12.9 shares of Class A Convertible 8%
Cumulative Preferred Stock and 10,867.3 shares of Common Stock issuable
upon exercise of warrants held by Edward T. Joyce, as Trustee of the
Edward T. Joyce Ltd. Employees' Profit Sharing Plan, and 4.1 shares of
Convertible Class A Preferred Stock and 3,409.3 shares of Common Stock
issuable upon exercise of warrants held by Edward T. Joyce, as Trustee of
the Individual Retirement Account for Edward T. Joyce. The Percent of
Aggregate Voting Rights excludes 18,058.7 shares of non-voting Common
Stock beneficially owned by Mr.
Joyce.

(13) All such shares are held of record by JK&B Capital and Boston Capital
Ventures III, L.P. Mr. Kronfeld is a Manager of JK&B Management, L.L.C. a
General Partner of JK&B Capital, L.P. and JK&B Capital II, L.P. Mr.
Kronfeld is General Partner of Boston Ventures III, LP. The business
address of Mr. Kronfeld is c/o JK&B Capital, 205 North Michigan, Suite
808, Chicago, IL 60601.

(14) Includes 316,160.3 shares of Common Stock issuable upon exercise of
options held by Mr. Milligan, and 93,750.0 shares of Common Stock and
61,225.5 shares of Common Stock issuable upon exercise of options held by
Mr. Milligan's wife. The Percent of Aggregate Voting Rights excludes
1,686.7 shares of non-voting Common Stock beneficially owned by Mr.
Milligan.

(15) Includes 44,025.04 shares of Common Stock issuable upon exercise of
options and 7990.6 shares of Common Stock issuable upon exercise of
Warrants. Also includes 3165.5 shares of Common Stock and 8.9 shares of
Class A Convertible 8% Cumulative Preferred Stock held by LaSalle
National Bank, as custodian for Ron Webster IRA Rollover. The Percent of
Aggregate Voting Rights excludes 3165.5 shares of non-voting Common
Stock.

(16) The address of each such person is c/o the Company, 350 N. Orleans
Street, Suite 600, Chicago, IL 60654.

(17) Includes the aggregate of 1,183,694.8 shares of Common Stock issuable
upon exercise of options and 965,696.5 shares of Common Stock issuable
upon exercise of warrants. See notes 10, 11, 12, 13, 14 and 15 above. The
Percent of Aggregate Voting Rights excludes 407,682.6 shares of
non-voting Common Stock.

<PAGE>

Item 13. Certain Relationships and Related Transactions.

Sale of Capital Stock

In April 1998, pursuant to a Purchase, Joinder & Waiver Agreement, the
Company issued 6.3316 shares of Class A Convertible 8% Cumulative Preferred
Stock at a price of $15,793.84 per share and warrants to purchase 5,327.1 shares
of Common Stock at a price of $.000001 per share to an investor. In addition,
2,248.9 shares of voting common stock and 2,248.9 shares of non-voting common
stock were issued in conjunction with this sale.

The Company believes that the transaction set forth above was made on terms
no less favorable to the Company than would have been obtained from unaffiliated
third parties. The Company has adopted a policy whereby all future transactions
between the Company and its officers, directors and affiliates will be on terms
no less favorable to the Company than could be obtained from unrelated third
parties and were approved by a majority of the disinterested members of the
Board of Directors.

<PAGE>

PART IV

Item 14. Exhibits, Consolidated Financial Statement Schedules and Reports on
Form 8-K.

(a) Financial Exhibits, Financial Statement Schedule and Exhibits:

1. Financial Statements

- Report of Independent Public Accountants
- Consolidated Balance Sheets as of December 31, 1998 and March 31, 1998.
- Consolidated Statements of Income for the nine months ended December
31, 1998 and for the years ended March 31, 1998 and 1997
- Consolidated Statements of Changes in Shareholders' Equity for the
nine months ended December 31, 1998 and for the years ended March
31, 1998 and 1997
- Consolidated Statements of Cash Flows for the nine months ended
December 31, 1998 and for the years ended March 31, 1998 and 1997
- Notes to Consolidated Financial Statements

2. Financial Statement Schedule

The following schedule, for which provision is made in the applicable
accounting regulations of the Securities Exchange Commission and is
thereby required is filed herewith:

Schedule II - 21st Century Telecom Group, Inc. - Consolidated Valuation
and Qualifying Accounts for the nine months ended December 31, 1998 and
for the years ended March 31, 1998 and 1997.

All other schedules are omitted because they are not applicable,
immaterial or the required information is included in the Consolidated
Financial Statements on notes thereto.

(b) Reports on Form 8-K:

On current Report Form 8-K, dated December 21, 1998, under "Item 8. Change
in Fiscal Year," the Company announced to change the fiscal year from that
used in its most recent filing with the Securities and Exchange Commission
(SEC). The Company's new fiscal year-end is December 31.

1. Exhibits

Exhibits listed in the Exhibit Index are filed with this report or
incorporated by reference therein.

<PAGE>

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors of
21st Century Telecom Group, Inc.:

We have audited the accompanying consolidated balance sheets of 21st
Century Telecom Group, Inc. (the "Company") (an Illinois corporation) and
subsidiaries as of December 31, 1998 and March 31, 1998, and the related
consolidated statements of operations, cash flows and shareholders' equity for
the nine months ended December 31, 1998 and for each of the two years in the
period ended March 31, 1998. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of 21st Century
Telecom Group, Inc. and subsidiaries as of December 31, 1998 and March 31, 1998,
and the results of their operations and their cash flows for the nine months
ended December 31, 1998 for each of the two years in the period ended March 31,
1998, in conformity with generally accepted accounting principles.

Our audits are made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The financial statement schedule included
in Item 14(a)(2) is presented for purposes of complying with the Securities and
Exchange Commission's rules and is not a required part of the basic financial
statements. This schedule has been subjected to the auditing procedures applied
in the audits of the basic financial statements and, in our opinion, fairly
states in all material respects the financial data required to be set forth
therein in relation to the basic financial statements taken as a whole.

Arthur Andersen LLP
Chicago, Illinois
February 5, 1999

<PAGE>

<TABLE>
21st CENTURY TELECOM GROUP, INC.
CONSOLIDATED BALANCE SHEETS

December 31, March 31,
ASSETS 1998 1998
------
--------------- --------------
<S> <C> <C>
Current Assets
Cash and cash equivalents $ 72,901,622 $ 217,640,238
Accounts receivable, less allowances of $1,376 and $0, respectively 157,082 10,359
Short term investments 98,464,936 10,000,000
Inventory 10,385,575 1,991,690
Prepaid expenses and other 598,878 168,152
----------------- -----------------
Total current assets 182,508,093 229,810,439

Property, Plant and Equipment
Leasehold improvements 5,647,709 4,010,868
Other property, plant and equipment 57,475,153 16,588,094
Less: accumulated depreciation (4,814,143) (1,193,236)
----------------- -----------------
Property, plant and equipment, net 58,308,719 19,405,726

Other Assets
Restricted cash collateral reserve 1,796,880 1,796,880
Prepaid franchise fees 3,685,961 3,505,706
Debt issuance costs, net of amortization of $1,386,138 and $218,411, respectively 6,601,105 7,668,414
Deferred franchise costs, net of amortization of $623,681 and $489,093, respectively 350,144 463,989
Bank commitment fee, net of amortization of $78,604 898,302 -
Deferred mapping and design, net of amortization of $93,071 and $58,501, respectively 44,880 79,450
Other deferred costs 149,889 2,000
----------------- -----------------
Total other assets 13,527,161 13,516,439
----------------- -----------------
Total assets $ 254,343,973 $ 262,732,604
================= =================

LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 10,688,242 $ 6,691,683
Accrued severance 1,230,000 200,000
Accrued expenses and other 1,261,982 1,860,410
----------------- -----------------
Total current liabilities 13,180,224 8,752,093

Noncurrent Liabilities
Debentures payable - 28,849
Interest payable - 42,203
Senior discount notes, net of discount of $140,681,223 and $159,656,983, respectively 222,453,777 203,478,017
----------------- -----------------
Total noncurrent liabilities 222,453,777 203,549,069
----------------- -----------------
Total liabilities 235,634,001 212,301,162

Redeemable Preferred Stock
13 3/4% senior cumulative exchangeable preferred stock, $.01 par value,
55,458.12 and 50,000 shares outstanding, respectively 52,617,006 46,492,812
Shareholders' Equity
Class A convertible 8% cumulative preferred stock, no par value,
1,554.8 shares outstanding 24,611,966 21,751,665
Voting and non-voting common stock (no par value; issued and outstanding shares,
3,493,965.7 at December 31, 1998 and 3,489,467.9 at March 31, 1998;
secondary common share warrants outstanding, 1,747,066 at December 31, 1998
and 1,741,738.9 at March 31, 1998) 7,862,836 6,974,836
Common shares to be issued (no par value; 27,429.2 shares) 123,432 -
Retained deficit (66,505,268) (24,787,871)
----------------- -----------------
Total shareholders' equity (33,907,034) 3,938,630
----------------- -----------------
Total liabilities and shareholders' equity $ 254,343,973 $ 262,732,604
================= =================

See accompanying Notes to the Consolidated Financial Statements.

</TABLE>
<PAGE>

<TABLE>
21st CENTURY TELECOM GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS

<CAPTION>
For the Year
For the Nine Ended March 31,
Months Ended -----------------------------------------------
December 31, 1998 1998 1997
--------------------- ---------------------- ---------------------
<S> <C> <C> <C>
Operating revenues $ 873,898 $ 189,023 $ 27,480

Operating expenses
Network operations 2,678,047 2,023,310 200,911
Sales and marketing 3,533,731 2,213,723 -
General and administrative 12,812,019 8,003,196 2,337,534
Depreciation and amortization 3,876,779 1,411,847 170,108
--------------------- ---------------------- ---------------------

Total operating expenses 22,900,576 13,652,076 2,708,553
--------------------- ---------------------- ---------------------

Operating loss (22,026,678) (13,463,053) (2,681,073)
Interest expense (18,232,959) (3,722,947) (437,843)
Interest income 8,670,695 2,373,867 301,624
Amortization of issuance costs (1,199,770) (218,411) -
--------------------- ---------------------- ---------------------

Net loss (32,788,712) (15,030,544) (2,817,292)

Preferred stock requirements (8,928,707) (4,234,463) (478,981)
--------------------- ---------------------- ---------------------

Net loss attributable to common shares $ (41,717,419) $ (19,265,007) $ (3,296,273)
===================== ====================== =====================

Weighted average common
shares outstanding 3,493,836.5 2,615,061.0 1,988,365.0

Basic and diluted loss per share $ (11.94) $ (7.37) $ (1.66)
===================== ====================== =====================

See accompanying Notes to the Consolidated Financial Statements.
</TABLE>
<PAGE>

<TABLE>
21st CENTURY TELECOM GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Year
For the Nine Ended March 31,
Months Ended -------------------------------------------
December 31, 1998 1998 1997
------------------- ------------------- --------------------
<S> <C> <C> <C>
Operating Activities
Net loss $ (32,788,712) $ (15,030,544) $ (2,817,292)
Adjustments to reconcile net loss to net
cash used for operating activities:
Depreciation and amortization 3,876,779 1,411,847 170,108
Amortization of debt discount 18,975,760 3,478,017
Amortization of debt issuance costs 1,199,770 218,411
Stock compensation 843,789 1,004,776 44,190
Common stock to be issued 123,432 - -
Changes in operating assets and liabilities:
Affiliate receivable and payable - - (372,819)
Receivables, net (146,723) 103,121 (27,480)
Other current assets (8,982,612) (2,299,723) (3,365,825)
Accounts payable (274,621) 3,154,912 (331,025)
Accrued expenses and other
current liabilities 963,330 - 147,533
Noncurrent assets and liabilities, net (1,308,343) (121,333) (358,156)
------------------- ------------------- --------------------

Net Cash Used for Operating Activities (17,518,151) (8,080,516) (6,910,766)
------------------- ------------------- --------------------

Investing Activities
Purchase of held-to-maturity securities (88,464,936) (10,000,000) -
Purchase of subscribers from affiliate - - (3,381,300)
Capital expenditures (38,305,421) (15,665,047) (246,863)
------------------- ------------------- --------------------

Net Cash Used for Investing Activities (126,770,357) (25,665,047) (3,628,163)
------------------- ------------------- --------------------

Financing Activities
Payable to bank (419,068) 419,068 -
Proceeds from senior discount notes - 200,000,000 -
Issuance costs related to senior discount notes - (7,886,825) -
Proceeds from issuance of exchangeable preferred
stock, net of issuance costs - 48,025,236 -
Cash paid for letters of credit - - (1,796,880)
Proceeds from (payments on) debentures (131,040) - 153,660
Proceeds from issuance of class A preferred stock,
net of issuance costs 100,000 2,597,380 20,267,604
Issuance of common stock - - 144,531
------------------- ------------------- --------------------

Net Cash Provided by (Used For) Financing Activities (450,108) 243,154,859 18,768,915
------------------- ------------------- --------------------

Increase (Decrease) in Cash and Cash Equivalents (144,738,616) 209,409,296 8,229,986
Cash and Cash Equivalents at Beginning of Period 217,640,238 8,230,942 956
------------------- ------------------- --------------------

Cash and Cash Equivalents at End of Period $ 72,901,622 $ 217,640,238 $ 8,230,942
=================== =================== ====================

See accompanying Notes to the Consolidated Financial Statements.

</TABLE>
<PAGE>

<TABLE>
21ST CENTURY TELECOM GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED DECEMBER 31, 1998 AND FOR THE YEARS ENDED MARCH 31, 1998 AND 1997

Common Class A
Shares to Preferred Retained Unearned
Total Common Stock be Issued Stock Deficit Compensation
------------- ------------- ----------- ------------ ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balances, March 31, 1996 $ (1,744,556) $ 488,001 $ $ $(2,226,557) $ (6,000)
Net loss (2,817,292) (2,817,292)
Stock issuances 1,421,281 1,421,281
Accrued preferred stock dividends (280,795) (280,795)
Class A preferred stock proceeds
allocated to related common share
warrants 4,324,549 4,324,549
Class A preferred stock issuance
costs allocated to related common
share warrants (286,927) (286,927)
Preferred stock accretion (198,186) (198,186)
Amortization of unearned
compensation 2,889 2,889
Related party purchase, in excess
of cost (3,381,300) (3,381,300)
------------- ------------- ----------- ------------ ------------- -------------
Balances, March 31, 1997 (2,960,337) 2,565,604 (5,522,830) (3,111)
Net loss (15,030,544) (15,030,544)
Reclassification of Class A preferred
stock to permanent equity 16,794,963 16,794,963
Stock issuances 2,597,380 2,597,380
Exchange of initial and debt warrants
for voting and non voting common
shares
Accrued preferred stock dividends (973,958) 1,872,892 (2,846,850)
Preferred stock accretion (87,014) 1,300,633 (1,387,647)
Class A preferred stock proceeds
allocated to related common share
warrants 825,037 (825,037)
Class A preferred stock issuance
costs allocated to related common
share warrants (10,834) 10,834
Exchangeable Preferred Stock
proceeds allocated to related
common shares warrants 2,700,000 2,700,000
Exchangeable Preferred stock
issuance costs allocated to related
common share warrants (106,636) (106,636)
Stock option accrual 972,865 972,865
Stock compensation 28,800 28,800
Amortization of unearned
compensation 3,111 3,111
------------- ------------- ----------- ------------ ------------- -------------
Balances, March 31, 1998 3,938,630 6,974,836 21,751,665 (24,787,871)
Net loss (32,788,712) (32,788,712)
Stock issuances 223,432 44,211 123,432 55,789
Accrued preferred stock dividends (5,437,332) 1,620,938 (7,058,270)
Preferred stock accretion (686,841) 1,183,574 (1,870,415)
Stock options 843,789 843,789
------------- ------------- ----------- ------------ ------------- -------------
Balances, December 31, 1998 $(33,907,034) $ 7,862,836 $ 123,432 $ 24,611,966 $(66,505,268) $ -
============= ============= =========== ============ ============= =============

Common Common Class A
Shares to Share Preferred
Common Shares be Issued Warrants Shares
-------------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
Balances, March 31, 1996 1,683,000.0
Net loss
Stock issuances 691,343.6
Accrued preferred stock dividends
Class A preferred stock proceeds
allocated to related common share
warrants 1,161,307.6
Class A preferred stock issuance
costs allocated to related common
share warrants
Preferred stock accretion
Amortization of unearned
compensation
Related party purchase, in excess
of cost
-------------- ------------ ----------- -----------
Balances, March 31, 1997 2,374,343.6 1,161,307.6
Net loss
Reclassification of Class A preferred
stock to permanent equity 1,380.3
Stock issuances 168.2
Exchange of initial and debt warrants
for voting and non voting common
shares 1,100,724.4
Accrued preferred stock dividends
Preferred stock accretion
Class A preferred stock proceeds
allocated to related common share
warrants 141,561.3
Class A preferred stock issuance
costs allocated to related common
share warrants
Exchangeable Preferred Stock
proceeds allocated to related
common shares warrants 438,870
Exchangeable Preferred stock
issuance costs allocated to related
common share warrants
Stock option accrual
Stock compensation 14,399.9
Amortization of unearned
compensation
-------------- ------------ ----------- -----------
Balances, March 31, 1998 3,489,467.9 1,741,738.9 1,548.5
Net loss
Stock issuances 4,497.8 27,429.2 5,327.1 6.3
Accrued preferred stock dividends
Preferred stock accretion
Stock options
-------------- ------------ ----------- -----------
Balances, December 31, 1998 3,493,965.7 27,429.2 1,747,066.0 1,554.8
============== ============ =========== ===========

</TABLE>

<PAGE>

21st CENTURY TELECOM GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Summary of Significant Accounting Policies

Basis of Consolidation and Presentation

21st Century Telecom Group, Inc. ("21st Century" or the "Company") is a
Chicago-based company incorporated in October 1992. 21st Century is an
integrated, facilities-based communications company, which seeks to be the first
provider of bundled voice, video and high-speed Internet and data services in
selected midwestern markets beginning with Chicago's Area 1. At December 31,
1998, management believes the Company operates in only one reportable segment.
The City of Chicago has awarded the Company a 15-year renewable franchise for
Area 1. Area 1 stretches more than 16 miles along Chicago's densely populated
lakefront skyline including the nation's second largest business and financial
district.

The Company's accounting and reporting principles conform to generally
accepted accounting principles. The consolidated financial statements include
two wholly-owned subsidiaries. There have been no significant intercompany
transactions or activities within or between these subsidiaries through December
31, 1998. On December 21, 1998 the Company changed its fiscal year end from
March 31 to December 31.

Cash and Cash Equivalents

Cash and cash equivalents at December 31,1998 and March 31, 1998, consist
of cash on hand at certain banks, as well as investments with maturities of 90
days or less. The investments are stated at cost, which approximates market
value. All investments were purchased in accordance with debt restrictions.

Receivables

Receivables are reflected at their net realizable value.

Short Term Investments

Short term investments are held to maturity and are stated at cost which
approximates market value. At December 31, 1998 and March 31, 1998, short term
investments consisted of time deposit accounts, certificates of deposit and
money market deposits, with fixed rates of interest all with maturities of less
than one year. These investments were purchased in accordance with debt
restrictions.

Inventories

Inventory consists primarily of converters, modems and materials that will
be requisitioned for use in constructing the Company's network and is stated at
the lower of cost (principally the first-in, first-out method) or market.

Property, Plant and Equipment

Property, plant and equipment are stated at cost including labor and
overhead expenses associated with construction. Cost includes capitalized
interest on funds borrowed to finance construction. Capitalized interest for the
nine months ended December 31, 1998 was $780,680. Depreciation on property,
plant and equipment was computed by applying the straight-line method over the
estimated service lives for depreciable plant and equipment. Repairs of all
property, plant and equipment and minor replacements and renewals are charged to
expense as incurred. Major replacements and betterments are capitalized.
Leasehold improvements were depreciated on a straight-line basis over the term
of the lease, fifteen years. The Company began to depreciate leasehold
improvements in September 1997.

The lives of depreciable property, plant and equipment range from 3 to 15
years. Effective July 1, 1998, the estimated service lives for hub sites and
outside plant were changed from 7 to 13 years. In addition, the estimated
service lives for certain software and furniture and fixtures were changed from
5 to 7 years. These changes were made to correspond to industry norms for these
types of assets. These changes in depreciable lives resulted in a reduction of
depreciation expense of approximately $1,200,000.

<PAGE>

Deferred Franchise Costs

The Company has deferred franchise costs, including legal costs, associated
with obtaining the franchises from the City of Chicago and the Village of
Skokie. Deferred franchise costs are being amortized over five years.

Deferred Mapping and Design Costs

The Company has deferred certain mapping and design costs associated with
strand mapping the Area 1 region within the City of Chicago. Deferred mapping
and design costs are being amortized over three years.

Debt Issuance Costs

Costs associated with the issuance of the Company's debt securities (see
Note 5) have been capitalized and are being amortized using the effective
interest rate method.

Advertising Costs

The Company expenses the cost of advertising as incurred. Advertising
expense for the nine months ended December 31, 1998 was $1,270,592. The Company
did not incur significant advertising costs prior to April 1, 1998.

Revenue Recognition

The Company recognizes voice, video, Internet and data revenues as services
are provided to subscribers.

Accounting for Stock-Based Compensation

The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 123, "Accounting for Stock-Based Compensation," for disclosure purposes.
However, it continues to recognize compensation cost based on Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." See
Note 9 for the disclosures required by SFAS No. 123.

Earnings Per Share

Basic per share amounts were based on weighted average common shares
outstanding, excluding common stock equivalents, of 3,493,836.5, 2,615,061.0 and
1,988,365.0 for the nine months ended December 31, 1998 and for the twelve
months ended March 31, 1998 and 1997, respectively. Given the anti-dilutive
effect of including common stock equivalents in the calculation, diluted
earnings per share amounts are not presented.

At December 31, 1998, common stock equivalents included: (1) 1,308,196
common share warrants related to the Class A Convertible 8% Cumulative Preferred
Stock, (2) 438,870 common share warrants related to 13 3/4% Senior Cumulative
Exchangeable Preferred Stock, (3) 1,250,000 options issued in connection with
certain Directors' guarantee of a loan, (4) 575,766.8 vested employee stock
options, and (5) 18,994.7 common share warrants issued to a financial advisor.
The net loss attributable to common shares on which the basic earning per share
calculation is based, reflects the net loss increased by the amount of preferred
dividends and accretion related to the Class A Convertible 8% Cumulative
Preferred Stock and 13 3/4% Senior Cumulative Exchangeable Preferred Stock.

At March 31, 1998, these common stock equivalents included the following:
(1) 1,302,868.9 common share warrants related to the Class A Convertible 8%
Cumulative Preferred Stock, (2) 438,870 common share warrants related to 13 3/4%
Senior Cumulative Exchangeable Preferred Stock, (3) 1,250,000 options issued in
connection with certain Directors' guarantee of a loan, (4) 287,829.9 employee
vested stock options, and (5) 18,994.7 common share warrants issued to a
financial advisor. The net loss attributable to common shares on which the basic
earnings per share calculation is based, reflects the net loss increased by the
amount of preferred dividends and accretion related to the Class A Convertible
8% Cumulative Preferred Stock and 13 3/4% Senior Cumulative Exchangeable
Preferred Stock.

At March 31, 1997, these common stock equivalents included the following:
(1) 1,161,307.6 common share warrants related to the Class A Convertible 8%
Cumulative Preferred Stock, (2) 1,000,966.8 shares of voting and non-voting
common stock which replaced the initial and debt warrants associated with the
Class A Convertible 8% Cumulative Preferred Stock as discussed in Note 9, (3)
1,250,000 options issued in connection with certain Directors' guarantee of a
loan, and (4) 18,994.7 stock warrants issued to a financial advisor.

<PAGE>

Cash Flow Information

For the nine months ended December 31, 1998 and for the years ended March
31, 1998 and 1997, the Company has not paid any income taxes. For the nine
months ended December 31, 1998 and for the years ended March 31, 1998 and 1997,
the Company paid $131,040, $193,922 and $274,993, respectively, in interest.

Use of Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

Long-Lived Assets

The Company periodically reviews the values assigned to long-lived assets
such as property, plant and equipment and identifiable intangibles to determine
whether any impairments are other than temporary. If the impairment is
permanent, a loss is recognized. No impairment losses have been recognized by
the Company.

Disclosure of Fair Value of Financial Instruments

The carrying amount reported in the balance sheets for cash and cash
equivalents, accounts receivable, short term investments, accounts payable and
other current liabilities approximates fair value because of the short-term
maturity of these financial instruments. The carrying amount reported in the
balance sheets for the 12 1/4% Senior Discount Notes approximates fair value.

Reclassifications

Certain prior year balances have been reclassified to conform with the
current year presentation.

2. Property, Plant and Equipment

The components of property, plant and equipment follow:
<TABLE>
<CAPTION>

December 31, March 31, Estimated life
1998 1998 (years)
------------------ ------------------ -----------------
<S> <C> <C> <C>
Transmission and distribution systems $40,831,723 $14,994,770 3 - 13
Leasehold improvements 5,647,709 4,010,868 15
Other equipment 5,272,864 641,825 3 - 7
Furniture and fixtures 727,522 403,702 3 - 7
Construction in progress 10,643,044 547,797 N/A
------------------ ------------------

Property, plant and equipment, at cost 63,122,862 20,598,962
Less: accumulated depreciation (4,814,143) (1,193,236)
------------------ ------------------

Net property, plant and equipment $58,308,719 $19,405,726
================== ==================

</TABLE>

Depreciation expense charged to operations for the nine months ended
December 31, 1998 and for the years ended March 31, 1998 and 1997 was
$3,629,017, $1,186,302 and $6,934, respectively.

3. Prepaid Franchise Fees

The Company was required to prepay $3,000,000 of franchise fees within
120 days of being awarded the franchise by the City of Chicago. In accordance
with the franchise agreement, the prepaid franchise fees earn interest for the
period outstanding at a rate equal to the Company's cost of borrowed funds. The
borrowing rate of the Company, at the time of the prepayment, was 10%. The
interest accrued on the prepaid franchise fees for the nine months ended
December 31, 1998 and for the years ended March 31, 1998 and 1997 amounted to
$226,027, $299,994, and $216,575, respectively. These prepaid franchise fees are
reduced as revenues are billed to customers.

<PAGE>

4. Related Party Transactions

The Company was related through some common ownership and common management
to 21st Century Technology Group, Inc. ("Technology").

In January 1997, the Company paid approximately $459,000 of accrued legal
fees to one of its directors, either individually or to entities controlled by
him, for legal services rendered by him to the Company in connection with the
Company's cable service offering and its obtaining the Chicago franchise.

5. Debt

A summary of debt outstanding at December 31, 1998 and March 31, 1998, is
as follows:

December 31, March 31,
1998 1998
------------------- -------------------
<S> <C> <C>
Convertible Subordinated Debentures, Series 1, 25%, due 1998 $ - $ 52,702
Convertible Subordinated Debentures, Series 2, 25%, due 1999 28,849 28,849
12 1/4% Senior Discount Notes Due 2008 222,453,777 203,478,017
------------------- -------------------

Total $ 222,482,626 $ 203,559,568
=================== ===================

</TABLE>

Convertible Subordinated Debentures

Prior to February 1, 1997, all subordinated debentures were convertible to
common stock based on a conversion ratio of $2 to 1 share of common stock.

Conversion of $147,298 of the Series 1 convertible debentures occurred on
May 17, 1996. Conversion of $111,151 of the Series 2 convertible debentures
occurred on April 28, 1996. Conversion of $150,000 of the Series 3 convertible
debentures occurred on November 14, 1996. Conversion of $200,000 of the Series 4
convertible debentures and $196,854 of the Series 5 convertible debentures
occurred on January 31, 1997.

Total debenture conversions to common stock for Series 1 through 5
convertible debentures resulted in the issuance of 616,280 additional shares of
common stock between April 1996 and January 1997. (See Note 8 for conversion
effects on common shares outstanding.) Subsequent to January 31, 1997, these
debentures were no longer convertible.

During the three months ended September 30, 1998, the convertible
subordinated debentures, Series 1, at 25% interest, due 1998 in the amount of
$52,702 plus accrued interest was paid. In addition, the convertible
subordinated debentures, Series 2, at 25% interest, due 1999 in the amount of
$28,849 was reclassed from long term debt to short term debt and is included in
accrued expenses and other in the Consolidated Balance Sheet at December 31,
1998.

12 1/4% Senior Discount Notes Due 2008

On February 9, 1998, the Company issued $363,135,000 of 12 1/4% Senior
Discount Notes due 2008 (the "Notes"). The proceeds from the issue were
$200,000,000 which represent a yield to maturity on the Notes of 12 1/4%
(computed on a semi-annual bond equivalent basis). The discount and issuance
costs are being amortized through February 15, 2003 using the effective interest
rate method. Thereafter, cash interest accrues until the notes mature in 2008.
For the nine months ended December 31, 1998 and for the year ended March 31,
1998, the amortized discount totaled $18,975,760 and $3,478,017, respectively.
Issuance costs for the transaction totaled $7,886,825. The amount of
amortization recognized for the nine months ended December 31, 1998 and the year
ended March 31, 1998 was $1,199,770 and $218,411, respectively. The notes are
unsecured obligations.

The notes are redeemable at the Company's option in whole or part, on
February 15, 2003, 2004 and 2005, at a redemption price of 106.1250, 104.0833
and 102.0417, respectively and at the principal amount thereafter. In addition,
the Company has the right to redeem up to 1/3 of the Notes with the proceeds of
an initial public offering. The redemption price would also include accrued
interest earned through the date of redemption.

<PAGE>

Upon a change of control, each holder of Notes may require the Company to
purchase all or any portion of such holder's Notes at a purchase price equal to
101% of the Accreted Value thereof plus accrued and unpaid interest, if any, to
the date of purchase. Accreted value means, as of any date, the amount for each
$1,000 principal amount at maturity of the Senior Discount Notes as specified in
the terms of the Notes.

The Notes include certain restrictive covenants relating to, among other
things, limitations on additional indebtedness, payment of dividends, investment
options, asset sales, liens on assets and mergers and consolidations. The
Company is in compliance with the covenants at December 31, 1998.

Bank Revolving Credit Facility

On August 5, 1998, the Company entered into a revolving credit facility
with a number of banks for an aggregate amount of $40,000,000. As of December
31, 1998, no borrowings have been made under this facility. In connection with
the initiation of its bank revolving credit facility, as of December 31, 1998,
the Company incurred $976,906 in bank commitment fees and other related costs
which are being amortized on a straight-line basis over its five year term.

The credit facility contains general and financial covenants that place
certain restrictions on the Company. On October 30, 1998, the Company entered
into Amendment No. 1 to its bank revolving credit facility which adjusted
certain operating covenants. The Company is limited with respect to: the
incurrence of certain liens; the sale of assets under certain circumstances;
permitting any subsidiary distribution restrictions; certain consolidations;
mergers and transfers; and the use of loan proceeds.

6. Class A Convertible 8% Cumulative Preferred Stock

Preferred
Shares Amount
------------ ----------------

March 31, 1996 -- --
January 30, 1997
Proceeds 1,380.3 $17,475,451
Issuance costs -- (1,159,469)
Accrued dividends -- 280,795
Accretion -- 198,186
------------ ----------------
March 31, 1997 1,380.3 16,794,963
September 23, 1997
Proceeds 63.3 819,439
Issuance costs -- (49,166)
November 20, 1997
Proceeds 9.5 121,842
January 20, 1998
Proceeds 95.4 891,062
Accrued dividends 1,872,892
Accretion 1,300,633
------------ ----------------
March 31, 1998 1,548.5 21,751,665
Stock issuance 6.3 55,789
Accrued dividends -- 1,620,938
Accretion -- 1,183,574
============ ================
December 31, 1998 1,554.8 $24,611,966
============ ================

On January 30, 1997 several investors contracted with the Company to
purchase 1,380.3 shares of the Company's Class A Convertible 8% Cumulative
Preferred Stock and initial, secondary and debt warrants for a purchase price of
$15,793.84 per share, totaling $21.8 million. A portion of the initial purchase
price was allocated to the common share warrants. The allocation was based on
the market value of the common stock at the date of the sale of the Class A
Convertible 8% Cumulative Preferred Stock and the number of related secondary
warrants, initial warrants and debt warrants associated with such preferred
stock. The fair market value of the common stock at the date of the sale was
estimated to be $2 per share. The number of secondary warrants associated with
the initial purchase amounted to 1,161,307.6. The number of initial and debt
warrants associated with the initial purchase was based on the number of voting
and non-voting common shares that these warrants were replaced with as a result
of a subsequent amendment to the related stock purchase agreement as discussed
below. These initial and debt warrants were replaced with 1,000,966.8 shares of
voting and non-voting common stock. This allocation resulted in $4,324,549 and
$17,475,451 being recorded as common stock and redeemable preferred stock,
respectively, at March 31, 1997. Issuance costs of $1,446,396 were incurred in
conjunction with the sale of the Class A Convertible 8% Cumulative Preferred
Stock. These issuance costs were allocated between the Class A Convertible 8%
Cumulative Preferred Stock and the related warrants based on the relative
portions of the proceeds allocated to each. The carrying value of the Class A

<PAGE>

Convertible 8% Cumulative Preferred Stock is being accreted to its redemption
value (using the effective interest method) over the four year period from the
date of the original preferred stock purchase agreement to the date the stock
becomes mandatorily redeemable under the original agreement or the date at which
the Class A preferred shareholders can compel sale of the Company under the
amended agreement, both dates being January 30, 2001. The Class A convertible 8%
Cumulative Preferred Stock is recorded on the balance sheet at the allocated
portion of the purchase price paid by investors, less the allocated portion of
the issuance costs, plus accrued and unpaid preferred stock dividends, plus
accretion. At March 31, 1997, certain of the provisions of the agreement were as
follows:

- Each preferred share is convertible into one thousand common shares.

- Dividends accrue daily on the aggregate amount paid at an annual rate
of 8%. Unpaid dividends compound on a semi-annual basis on June 30 and
December 31. At the consummation of a qualified public offering, all
accrued and unpaid dividends would be converted into common stock
without the issuance of additional shares. A qualified public offering
is one in which (1) the public purchases at least $25 million of common
stock, (2) the price per share paid is at least twice the liquidation
value per share of the Class A Convertible 8% Cumulative Preferred
Stock, (3) the common stock is traded on a national exchange or The
Nasdaq Stock Market, and (4) the shares issued and sold represent at
least 20% of the common stock outstanding after the public offering.

- Upon consummation of a qualified public offering, all preferred shares
are required to be converted into common shares.

- At any time after the fourth anniversary of the date of the purchase
and before the earlier of the date of the consummation of a qualified
public offering or the seventh anniversary of the date of the purchase,
each holder of the stock has the right from time to time to require the
Company to repurchase all, but not less than all, of their shares held
(the put arrangement). The shares would be repurchased by the Company
for the greater of: (1) the purchase price paid by the holder of the
stock, plus all accrued and unpaid dividends, or (2) the market value
of the shares.

- "Initial Warrants" were granted to the investors who may increase their
ownership percentage up to another 12%. These warrants expire on May
31, 2008. The warrants are exercisable at $.000001 per share of common
stock only if the Company does not meet certain pre-established
performance indicators. The Company had until May 31, 1998 to meet
these performance indicators.

- "Secondary Warrants" to purchase up to 1,331,774.8 shares of common
stock at $.000001 per share of common stock were also granted to the
investors. These secondary warrants expire on January 30, 2007.

- - "Debt Warrants", in addition to the initial and secondary warrants
discussed above, will vest to the new investors if the Company does
not receive Board of Director approval by July 31, 1997, for a $50
million senior debt financing arrangement. Under this provision the
Company is to issue warrants to purchase shares representing 2% of the
outstanding common stock on the first day of each month until the
definitive document with respect to such debt is in place. Any such
warrants issued would expire ten years from the date of issue. Any
debt warrants would also be exercisable at $.000001 per share of
common stock.

During December 1997, the Company and its Class A Convertible 8% Cumulative
Preferred Stock shareholders negotiated a number of changes to the original
Stock Purchase Agreement. These changes were formally ratified on January 8 and
14, 1998. The original put arrangement as discussed above was removed and was
replaced by the right of the Class A preferred shareholders to require the sale
of the Company. The new provision provides that at any time and from time to
time after the fourth anniversary of the date of issuance of the senior discount
notes and senior cumulative exchangeable preferred stock and ending on the
earlier to occur of the consummation of a qualified public offering and the
seventh anniversary of the date of issuance of the senior discount notes, the
Class A preferred shareholders have the right to require the sale of the
Company. The liquidation value of the preferred stock is the sum of the original
cost plus any accrued and unpaid dividends. The right to obtain additional
common shares under the initial warrant and debt warrant provisions as discussed
above was removed and was replaced by an agreement to increase the Class A
preferred shareholders ownership on a fully diluted basis by an additional 8% by
issuing additional common stock. One-half of this additional stock is voting and
the other half is non-voting. A portion of the proceeds and issuance costs
associated with the sale of the Class A Convertible 8% Cumulative Preferred
stock were allocated to the initial and debt warrants and reflected in common
stock at March 31, 1997.

<PAGE>

In addition, the holders of the Class A preferred stock are collectively in
a position to control the taking of many significant corporate actions by the
Company, including the making of any significant capital commitments, the
incurrence of any significant indebtedness, merger and the payment of dividends
on the common stock, pursuant to agreements which provide that prior to taking
such actions, the Company will need to obtain the approval of the nominees to
the Board of Directors of the holders of the Class A preferred stock. These
rights have been modified by the covenants related to the 12 1/4% Senior
Discount Notes (see Note 5).

Of the $21.8 million for the related January 30, 1997 sale, $21.7 million
was received by March 31, 1997, with the remainder received by April 22, 1997.
The purchase resulted in the preferred shareholders having an approximate 37%
ownership interest in the Company on a fully diluted basis excluding the
contingently issuable common shares from the exercise of the initial warrants
and the debt warrants. The proceeds from this preferred stock offering were used
to (1) repay a $5 million revolving credit note to LaSalle Northwest National
Bank, (2) purchase the subscriber base of a related party located in the Chicago
franchise area for $3,381,300, (3) retire existing Company debt and accounts
payable in the amount of $541,166, and (4) pay transaction costs of $1,446,396.
The balance of the proceeds were used for working capital and capital
expenditures to build the network, operating center and network infrastructure.

On September 23, November 20, 1997 and January 20, 1998, several investors
contracted with the Company to purchase 63.3, 9.5 and 95.4 shares, respectively,
of the Company's Class A Convertible 8% Cumulative Preferred Stock and initial,
secondary and debt warrants for a purchase price of $15,793.84 per share,
totaling approximately $2.6 million. A portion of the initial purchase price was
allocated to the common share warrants. The allocation was based on the market
value of the common stock at the date of the sale of the Class A Convertible 8%
Cumulative Preferred Stock and the number of related secondary, initial and debt
warrants associated with such preferred stock. The fair market value of the
common stock at the date of the sale was estimated to be $2 per share for the
September 23 and November 20, 1997 sales and $4.50 per share for the January 20,
1998 sale. The number of secondary warrants associated with the three purchases
amounted to 53,271, 7,990, and 80,300, respectively. The number of initial and
debt warrants associated with the three purchases was based on the number of
voting and non-voting common shares that these warrants were replaced with as a
result of the amendment to the related stock purchase agreement as discussed
above. These initial and debt warrants were replaced with 37,009, 6,089 and
56,660 shares of voting and non-voting common stock, respectively. This
allocation resulted in $180,561, $28,158 and $616,318 being recorded as common
stock on the three sales dates, respectively and $819,439, $121,842 and $891,062
being recorded as Class A preferred stock on the three sales dates,
respectively. Issuance costs of $60,000 were incurred in conjunction with the
sale of the Class A Convertible 8% Cumulative Preferred Stock on September 23,
1997. These issuance costs were allocated between the Class A Convertible 8%
Cumulative Preferred Stock and the related warrants based on the relative
portions of the proceeds allocated to each. The purchases were based on the same
terms as those previously mentioned for the $21.8 million preferred stock
issuance.

In April 1998, pursuant to a Purchase, Joinder & Waiver Agreement, the
Company agreed to issue 6.3316 shares of Class A Convertible 8% Cumulative
Preferred Stock at a price of $15,793.84 per share and warrants to purchase
5,327.1 shares of Common Stock at a price of $.000001 per share to an investor.

7. 13 3/4 % Senior Cumulative Exchangeable Preferred Stock

Preferred
Shares Amount
------------ -----------------

February 9, 1998
Proceeds 50,000 $47,300,000
Issuance costs -- (1,868,126)
Accrued dividends -- 973,924
Accretion -- 87,014
------------ -----------------

March 31, 1998 50,000 46,492,812
Accrued dividends -- 5,437,353
Accretion -- 686,841
Stock dividends 5,458.12 --
------------ -----------------

December 31, 1998 55,458.12 $52,617,006
============ =================
<PAGE>

On February 9, 1998, 50,000 shares of 13 3/4% Senior Cumulative
Exchangeable Preferred Stock Due 2010 and related common share warrants were
issued. The net proceeds received were $48,025,236. The Exchangeable Preferred
Stock will rank senior to all other classes of equity securities of the Company.

The value of the 438,870 common stock warrants issued, $2,605,000, has been
allocated to common shareholders' equity, (see Note 8).

The carrying value of the 13 3/4% Senior Cumulative Exchangeable Preferred
Stock is being accreted to its redemption value (using the effective interest
method) over the five year period from the date of issue to the date the stock
first becomes redeemable, February 15, 2003. The 13 3/4% Senior Cumulative
Exchangeable Preferred Stock is recorded on the balance sheet at the allocated
portion of the purchase price paid by investors, less the allocated portion of
the issuance costs, plus accrued and unpaid dividends, plus accretion.

On or prior to February 15, 2001, the Company may redeem in whole but not
in part, the outstanding Exchangeable Preferred Stock at a redemption price of
113 3/4% of the liquidation preference ($1,000 per share) plus accumulated
unpaid dividends to date of redemption with the net proceeds of an Equity
Offering. An equity offering means either (a) an underwritten primary public
offering of common stock of the Company pursuant to an effective registration
statement under the Securities Act or (b) a primary offering of capital stock
(other than disqualified stock) of the Company to one or more persons primarily
engaged in a related business. On February 15, 2003, 2004, 2005 and 2006 (and
thereafter), at a redemption price of 106.8750%, 104.5833%,102.2917% and 100%,
respectively, of the liquidation preference ($1,000 per share) plus accumulated
unpaid dividends, the Exchangeable Preferred Stock may be redeemed in whole, or
in part, at the Company's option. On February 15, 2010, the Exchangeable
Preferred Stock is mandatorily redeemable.

In the event of a change of control, the Company shall offer to purchase
all outstanding shares of Exchangeable Preferred Stock, in whole or in part, at
a purchase price equal to 101% of the aggregate liquidation preference ($1,000
per share) thereof, plus accumulated and unpaid dividends, if any to the date of
purchase.

Dividends are payable quarterly on February 15, May 15, August 15 and
November 15. Dividends are payable in cash except that on or prior to February
15, 2003, dividends may be paid by the issuance of additional shares of
Exchangeable Preferred Stock at the Company's option.

On May 15, August 17 and November 16, 1998, the Company issued 1,833.3,
1,781.8 and 1,843.02, respectively, of additional shares of Exchangeable
Preferred Stock as the quarterly dividends on the 13 3/4 % Senior Cumulative
Exchangeable Preferred Stock Due 2010.

The restrictive covenants related to the Exchangeable Preferred Stock are
similar to those indicated for the 12 1/4% Senior Debenture Notes as discussed
in Note 5. The Company is in compliance with these covenants at December 31,
1998.

8. Common Shares

On January 9, 1998, the common shareholders approved an amendment to the
Articles of Incorporation to increase the number of authorized common shares to
50,000,000 from 1,000,000. On the same date, the directors of the Company
declared a 1,000 for 1 share split of the Company's issued and outstanding
common shares. All common share amounts and per share amounts have been restated
to reflect this amendment and related split.

On January 9, 1998, the Company obtained the approval of the common
shareholders for an amendment to the Articles of Incorporation to authorize
1,000,000 shares of non-voting common stock.

At December 31, 1998 and March 31, 1998, the Company had 50,000,000 shares
of no par common stock authorized, of which 3,493,965.7 and 3,489,467.9 are
issued and outstanding, respectively.

<PAGE>

Changes in the Company's common shares and related amounts during the nine
months ended December 31, 1998 and the years ended March 31, 1998 and 1997, are
as follows:
Common
Shares Amount
----------------- -----------------
March 31, 1996 1,683,000.0 $ 488,001
April 28, 1996 84,490.0 168,980
May 17, 1996 146,540.0 293,080
November 14, 1996 115,410.0 230,820
January, 1997 -- (3,381,300)
January 28, 1997 75,063.6 188,721
January 30, 1997 -- 4,037,622
January 31, 1997 269,840.0 539,680
----------------- -----------------

March 31, 1997 2,374,343.6 2,565,604

September 23, 1997 -- 169,727
November 20, 1997 -- 28,158
January 20, 1998 1,100,724.4 --
January 20, 1998 -- 616,318
February 9, 1998 -- 2,593,364
February 9, 1998 14,399.9 28,800
Compensation expense
related to stock
option plan -- 972,865
----------------- -----------------
March 31, 1998 3,489,467.9 6,974,836

April 14, 1998 4,497.8 44,211
Compensation expense
related to stock
option plan -- 843,789
----------------- -----------------
December 31, 1998 3,493,965.7 $ 7,862,836
================= =================

In January 1997, the Company purchased Technology's Area 1 subscriber base
and related equipment for $3,381,300. As this is considered to be a related
party transaction, the Company could only capitalize Technology's book value of
the purchased subscribers and the related equipment. As Technology's book value
was zero at the time of purchase, the entire purchase price is shown as a
reduction to shareholders' equity and is included in voting and non-voting
common stock on the Consolidated Balance Sheets.

As discussed in Note 6, portions of the proceeds and issuance costs
associated with the September 23 and November 20, 1997 and January 20, 1998
sales of Class A Convertible 8% Cumulative Preferred Stock were allocated to the
related common share warrants. These allocations resulted in net amounts of
$169,727, $28,158 and $616,318 being recorded as common equity on September 23
and November 20, 1997 and January 20, 1998, respectively, (see Note 6 for
additional discussion related to the allocation of the proceeds and issuance
costs). Certain of the common stock warrants were replaced with voting and
non-voting common stock. These shares were reflected as outstanding on January
20, 1998.

On January 20, 1998, as a result of the amended Class A Convertible 8%
Cumulative Preferred Stock purchase agreement (formally ratified in January 1998
and discussed in Note 6) 550,362.2 voting and 550,362.2 non-voting shares were
effectively issued. These shares replaced the initial and debt warrants
associated with the Class A Preferred Stock. The value associated with these
warrants was recorded on the related purchase dates of the Preferred Stock:
January 30, September 23, and November 20, 1997, and January 20, 1998.

<PAGE>

On February 9, 1998, certain Company officers received common shares as
part of their compensation. Total shares issued were 14,399.9 at $2 per share.
Also on February 9, 1998, as discussed in Note 7, portions of the proceeds and
issuance costs from the sale of 13 3/4% Exchangeable Preferred Stock were
allocated to the related common share warrants.

In April 1998, pursuant to a Purchase, Joinder & Waiver Agreement, the
Company issued 2,248.9 shares of voting common stock and 2,248.9 shares of
non-voting common stock and warrants to purchase 5,327.1 shares of Common Stock
at a price of $.000001 per share to an investor.

On December 31, 1998, the Company entered into an agreement with Glen
Milligan, a Director of the Company and Chairman of the Company's Board of
Directors, whereby the Company will issue 27,429.2 common shares to Mr. Milligan
over a period of three years, beginning August 21, 1999, or such other number of
shares as is necessary to provide Mr. Milligan with .261% of the Company's
common stock outstanding at August 21 of each year for the next three years.
These shares have been reflected on the Consolidated Balance Sheet at December
31, 1998 as common shares to be issued.

9. Stock Based Compensation Plans

Effective January 30, 1997, the Company established a common stock option
plan. No options were granted under the plan until October 14, 1997. Options to
purchase 728,667.8 shares of the Company's stock were originally granted under
the plan of which 591,324 were outstanding as of December 31, 1998. Options vest
over 48 months from the date of employment and expire after ten years. Options
vested under this plan as of December 31, 1998 totaled 367,521.1. During the
nine months ended December 31, 1998, an executive participant in this plan
separated from the Company. This executive was originally granted 91,083.5
shares of which 54,083.5 shares were forfeited as of December 31, 1998.

Effective April 14, 1998, the Company established three new additional
stock option plans: the Executive Plan, the Key Management Plan, and the
Employee Plan.

Under the Executive Plan, 331,200 options are available for grant to two
executive officers of the Company. As of December 31, 1998, all 331,200 shares
available under the Executive Plan were awarded. Effective March 6, 1998,
278,200 options were awarded to an executive officer. The exercise price of the
278,200 shares was established at $1.12 per share which is less than the $4.50
per share fair market value determined by the Board of Directors. One half of
the 278,200 options awarded on March 6, 1998 or 139,100 shares vested
immediately and a total of $470,158 was recorded as compensation expense as a
result of the vesting of the 139,100 options. On April 14, 1998, an executive
officer was awarded 53,000 options under the Executive Plan at an exercise price
of $4.50 per share, which was determined by the Board of Directors to be the
fair market value of the underlying common stock at the time of grant. All
remaining options vest over 48 months from the date of employment and expire
after ten years. At December 31, 1998, 185,745.7 options were vested under the
Executive Plan.

<PAGE>

Under the Key Management Plan and the Employee Plan, 150,000 and 50,000
options, respectively, were available for grant. As of December 31, 1998, a
total of 137,500 options were granted under the Key Management Plan, 22,500 of
which vested immediately. A total of 25,925 options were granted under the
Employee Plan. The exercise price of options under both plans, which was
determined by the Board of Directors to be the fair market value of the
underlying common stock at the time of grant, is $4.50 per share. All remaining
options under these plans vest over four years beginning July 1, 1999 and expire
10 years from date of grant.

The Company accounts for the plans under APB Opinion No. 25, under which
$843,789 and $972,865 of compensation expense was recognized for the nine months
ended December 31, 1998 and for the year ended March 31, 1998, respectively,
relating to stock option awards to employees. Had compensation cost for such
stock option awards under the plan been determined consistent with SFAS No. 123,
the Company's net loss, net loss attributable to common shares and basic and
diluted loss per share would have been increased to the following pro forma
amounts:

Nine Months Ended Twelve Months Ended
December 31, 1998 March 31, 1998
------------------------ ---------------------------
<S> <C> <C>
Net loss As reported ($32,788,712) ($15,030,544)
Pro forma ($33,001,845) ($15,102,676)

Net loss attributable As reported ($41,717,419) ($19,265,007)
to common shares Pro forma ($42,930,552) ($19,337,139)

Basic and diluted As Reported ($11.94) ($7.37)
loss per share Pro forma ($12.00) ($7.39)

</TABLE>

<PAGE>

A summary of the status of the Company's stock option plans for the nine
months ended December 31, 1998 and the twelve months ended March 31, 1998 and
changes during the respective periods is presented in the table and narrative
below:

Nine Months Ended Twelve Months Ended
December 31, 1998 March 31, 1998
------------------------ ------------------------
Shares Wtd Avg Shares Wtd Avg
(000) Ex Price (000) Ex Price
<S> <C> <C> <C> <C>
Outstanding at beginning of year 692.3 1.12
Granted 493.8 2.60 728.7 1.12
Exercised
Forfeited 100.9 1.12 36.4 1.12
Expired
Canceled ______ ______
Outstanding at end of year 1,085.2 1.79 692.3 1.12

Exercisable end of year 575.8 287.8
Weighted average fair value of
options granted 2.99 3.91

</TABLE>

The 493,825 options granted in the nine months ended December 31, 1998 have
an exercise price between $1.12 and $4.50 with a weighted average exercise price
of $1.79 and a weighted average remaining contractual life of 8.75 years.

The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions used for the option grants in the nine months ended December 31,
1998: risk-free interest rate of 5.51 percent; expected dividend yields of 0
percent; expected life of 10 years; and expected volatility of 0 percent.

10. Income Taxes

The Company uses an asset and liability approach to account for income
taxes. Deferred income taxes (credit) reflect the impact of temporary
differences between amounts of assets and liabilities for financial reporting
purposes and such amounts as measured by tax laws. These temporary differences
are determined in accordance with Statement of Financial Accounting Standards
(FAS) No. 109, "Accounting for Income Taxes." The temporary differences and net
operating loss carryforward, which give rise to deferred tax assets at December
31, 1998 and March 31, 1998, are as follows:

December 31, 1998 March 31, 1998
Deferred Tax Deferred Tax
Asset/(Liability) Asset/(Liability)
----------------- -----------------
Employee related $ 1,235,194 $ 463,584
Property, plant and equipment
depreciation expense (2,072,079) (588,411)
Accretion of discount on senior
discount notes 8,876,819 1,374,974
Amortization of debt issuance costs
related to senior discount notes 275,091 43,297
Other 67,016 --
Net operating loss carryforward 12,330,877 6,619,846
Valuation allowance (20,712,918) (7,913,290)
--------------- -----------
$ -- $ --
=============== ============

<PAGE>

The provision (credit) for income taxes is summarized as follows:

For the nine
months ended Year Ended Year Ended
December 31, 1998 March 31, 1998 March 31, 1997
Current income tax expense
Federal $ -- $ -- $ --
State -- -- --
Deferred income tax expense
Federal (11,435,581) (4,850,473) (896,666)
State (2,345,790) (1,092,854) (202,026)
-------------- -------------- -------------
(13,781,371) (5,943,327) (1,098,692)
Valuation allowance 13,781,371 5,943,327 1,098,692
-------------- -------------- -------------

$ -- $ -- $ --
============== ============== =============

The income tax provision (credit) differs from amounts at the statutory
federal income tax rate as follows:

For the nine
months ended Year Ended Year Ended
December 31, 1998 March 31, 1998 March 31, 1997
----------------- --------------- --------------
<S> <C> <C> <C>
Income tax provision (credit) at
statutory rate $ (11,476,049) $ (5,260,690) $ (986,052)
Meals and entertainment 15,338 14,993 19,210
Disallowed portion of original
issue discount on senior 5,799 --
discount notes 33,570
State income taxes (2,354,230) (703,429) (131,850)
Valuation allowance 13,781,371 5,943,327 1,098,692
----------------- -------------- ---------------
Income tax provision (credit) as
reported $ -- $ -- $ --
================= ============== ===============

</TABLE>

At December 31, 1998, the Company had cumulative tax net operating loss
carryforwards aggregating approximately $31,060,000 expiring between 2008 and
2019. At December 31, 1998, the Company had recorded a valuation allowance
related to its net deferred tax assets aggregating approximately $20,713,000.

<PAGE>

11. Commitments And Contingencies

Litigation

The Company is not aware of any pending or threatened litigation that could
have a material adverse effect on the results of operations, financial position
or cash flow of the Company.

Operating Leases and Other

The Company obtained two letters of credit totaling $1,796,880. The first
letter, for $500,000, was obtained as part of the Chicago franchise agreement
mentioned earlier. The second letter is for the benefit of the Merchandise Mart
totaling $1,296,880 and was obtained in place of a security deposit related to
the Merchandise Mart lease. These letters of credit are fully collateralized by
cash, which is reflected as a restricted cash collateral reserve on the balance
sheet. The Company invests the cash in commercial paper which matures daily. For
the nine months ended December 31, 1998 and for the years ended March 31, 1998
and 1997, the commercial paper investments had earned $71,920, $95,505 and
$11,411, respectively, in interest income.

The Company entered into a 15-year lease, dated January 31, 1997 (the
"Apparel Lease") for its headquarters and NOC. The Apparel Lease initially
covered 32,422 square feet, and was increased on July 1, 1998 to cover 40,397
square feet.

As of December 31, 1998, the aggregate minimum rental commitments under
this and other lease agreements were as follows:

1999 $1,509,497
2000 1,569,007
2001 1,568,549
2002 1,426,606
2003 1,369,391
Thereafter 10,757,262
-----------
Total $18,200,312

Rent expense under operating leases was $1,499,097, $662,753 and $55,152
for the nine months ended December 31, 1998 and for the years ended March 31,
1998 and 1997 respectively.

In March 1998, The Company signed a purchase agreement with Nortel for
telecommunications equipment. This agreement covers three years and the purchase
of a minimum of $25,000,000 of equipment during the three year period.

12. Subsequent Events

On February 15, 1999, the Company issued 1,906.37 additional shares of
Exchangeable Preferred Stock as the quarterly dividends on the 13 3/4% Senior
Cumulative Exchangeable Preferred Stock Due 2010.

On February 26, 1999, the Company acquired EnterAct Corp. ("EnterAct"), a
Chicago-based provider of Internet access and commercial data services. EnterAct
has approximately 50 employees. The majority of EnterAct's approximately 10,000
customers are residential dial up Internet access customers; however, a
significant portion of EnterAct's 1998 calendar year revenues were derived from
Internet, data and consulting services provided to its business customer base.
In connection with this transaction, the Company issued 696,994 shares of its no
par value common stock to certain officers of EnterAct and agreed to pay an
additional $6,500,000. The Company paid $2,500,000 at the closing and issued two
non-interest bearing notes totaling $4 million. The notes are payable to
executives of EnterAct over two years, one half due on the first anniversary
date and one half due on the second anniversary date. In addition, a stock
option plan was approved and options were awarded to certain employees of
EnterAct. EnterAct will become 21st Century's commercial division, developing,
marketing and selling data and telephony services to the business community.

<PAGE>

<TABLE>

Quarterly Financial Data

(Unaudited)

For the Three Months Ended
---------------------------------------------------------------------------------
December 31, 1998 September 30, 1998 June 30, 1998 March 31, 1998
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating revenues $ 453,861 $ 280,159 $ 139,878 $ 65,491

Operating loss $ (8,847,454) $ (7,293,150) $ (5,886,074) $ (5,252,740)

Net loss attributable to common shares $(15,514,946) $ (13,978,871) $ (12,223,602) $ (9,132,218)

Basic and diluted loss per share $ (4.44) $ (4.00) $ (3.50) $ (2.74)

For the Three Months Ended
---------------------------------------------------------------------------------
December 31, 1997 September 30, 1997 June 30, 1997 March 31, 199
---------------------------------------------------------------------------------
Operating revenue $ 43,877 $ 37,158 $ 42,497 $ 27,480

Operating loss $ (4,816,430) $ (2,190,282) $ (1,203,601) $ (802,586)

Net loss attributable to common shares $ (5,573,193) $ (2,638,655) $ (1,920,941) $ (1,183,561)

Basic and diluted loss per share $ (2.34) $ (1.11) $ (0.81) $ (0.52)

</TABLE>

Quarterly loss per share amounts may not total loss per share amounts for the
year due to changes in the number of shares outstanding.

21st CENTURY TELECOM GROUP, INC.

SCHEDULE II-CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS

For the Nine Months Ended December 31, 1998

Additions
-------------------------------
Balance Charged to Balance
Beginning of Charged to Other Other End of
Period Income Accounts Deductions Period
--------------- ------------- ---------------- --------------- -------------
<S> <C> <C> <C> <C> <C>
1998
Allowance for uncollectibles $ - (1) $ 1,376 $ - $ - $ 1,376

</TABLE>

(1) An allowance for uncollectibles was not recorded in the two years ended
March 31, 1998 and 1997.

<PAGE>

Signatures

Pursuant to the requirements of the Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.

21st CENTURY TELECOM GROUP, INC.

/s/ Ronald D. Webster
---------------------------------------------
By: Ronald D. Webster, Chief Financial Officer

/s/ Byron E. Hill
---------------------------------------
By: Byron E. Hill, Corporate Controller

Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

PRINCIPAL EXECUTIVES AND ACCOUNTING OFFICERS

Signature Title Date

/s/ Edward T. Joyce Chairman of the Board of Directors March 27, 1999
- -----------------------
Edward T. Joyce

/s/ Robert J. Currey President, Chief Executive Officer March 27, 1999
- ----------------------- and Director
Robert J. Currey

/s/ Ronald D. Webster Chief Financial Officer March 27, 1999
- -----------------------
Ronald D. Webster

/s/ William Farley Director March 27, 1999
- ------------------------
William Farley

/s/ Elzie Higginbottom Director March 27, 1999
- ----------------------
Elzie Higginbottom

/s/ Dr. Charles E. Kaegi Director March 27, 1999
- -----------------------
Dr. Charles E. Kaegi

/s/ James H.Lowry Director March 27, 1999
- -----------------------
James H. Lowry

/s/ Glenn W. Milligan Director March 27, 1999
- -----------------------
Glenn W. Milligan

/s/ David Kronfeld Director March 27, 1999
- -----------------------
David Kronfeld

/s/ Thomas Neustaetter Director March 27, 1999
- -----------------------
Thomas Neustaetter

/s/ Byron E.Hill Controller March 27, 1999
- -----------------------
Byron Hill

<PAGE>

EXHIBIT INDEX

Exhibit No. Description of Exhibits

3.1* Amended Articles of Incorporation

3.2* By-laws

4.1* Indenture dated February 15, 1998 between the Company, as
Issuer, and State Street Bank and Trust, as Trustee, with
respect to the 12 1/4 Senior Discount Notes Due 2008

4.2* Form of the 12 1/4Senior Discount Notes Due 2008

4.3* Indenture dated as of February 15, 1998 between the Company and
IBJ Stirred Bank & Trust Company, as Trustee, with respect to
the Exchange Debenture

4.4* Form of the 13 3/4Senior Cumulative Exchangeable Preferred Stock Due 2010

4.5* Registration Rights Agreement dated as of February 2, 1998 by and among
the Company and Credit Suisse First Boston Corporation, BancAmerica
Robertson Stephens and BancBoston Securities, Inc., as Initial Purchasers

10.1* Franchise Agreement dated as of June 24, 1996 by and among the City of
Chicago and the Company

10.2* License Agreement dated as of October 27, 1994 by and among the Chicago
Transit Authority and the Company

10.3* CSG Master Subscriber Management System Agreement dated as of
May 28, 1997 by and among CSG Systems, Inc. and the Company

10.4* Telemarketing Consultation Agreement dated as of August 5, 1997 by and
among the Company and ITI Marketing Services, Inc.

10.5* Pole Attachment Agreement dated as of April 3, 1996 by and among the
Company and Commonwealth Edison Company

10.6* Pole Attachment Agreement dated as of November 14, 1998 by and among the
Company and Ameritech--Illinois

10.7* Office Lease dated January 31, 1997 by and among the Company and LaSalle
National Bank

10.8* Franchise Agreement dated as of March 16, 1998 by and between the Village
of Skokie, Illinois and 21st Century Cable TV of Illinois, Inc.

10.9* Interconnection Agreement dated as of May 5, 1997 by and between
Ameritech Information Industry Services and 21st Century Telecom of
Illinois, Inc.

10.10* Network Products Purchase Agreement by and between Northern Telecom Inc.
and the Company

12.1 Statement regarding Computation of Earnings Ratio to Fixed Charges

21.1* Subsidiaries of the Company

23.1 Consent of Arthur Andersen with Respect to the Company

27.1 Financial Data Schedule

* Incorporated herein by reference to the Company's S-4 Registration Statement
filed on March 3, 1998 (Commission File No. 333-47235).

<TABLE>
Exhibit 12.1

21st CENTURY TELECOM GROUP, INC.
COMPUTATION OF RATIO OF EARNINGS TO COMBINED FIXED CHARGES,
INTEREST CHARGES, AND PREFERRED STOCK REQUIREMENTS

For the Year Ended March 31,
For the Nine -------------------------------------------------------
Months Ended
December 31, 1998 1998 1997 1996 1995
------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
1. Earnings
(a) Loss before interest expense and income taxes $ (13,355,983) $(11,089,186) $ (2,379,449) $ (811,921) $ (663,886)
(b) Portion of rental expense representative of
the interest factor (1) (499,699) (220,918) (18,384) (11,422) (8,855)
------------- ------------ ------------ ------------ ------------
Total of 1(a) and 1(b) $ (12,856,284) $(10,868,268) $ (2,361,065) $ (800,499) $ (655,031)

2. Combined fixed charges
(a) Total interest expense $ 19,432,729 $ 3,941,358 $ 437,843 $ 214,688 $ 115,428
(b) Portion of rental expense representative of
the interest factor (1) 499,699 220,918 18,384 11,422 8,855
(c) Dividends and accretion on Class A Convertible
8% Cumulative preferred stock 2,804,513 3,173,525 478,981 - -
(d) Dividends and accretion on 13 3/4% senior
cumulative exchangeable preferred stock due 2010 6,124,194 1,060,938 - - -
------------- ------------ ------------ ------------ ------------
Total combined fixed charges (2(a) through 2(d)) $ 28,861,135 $ 8,396,739 $ 935,208 $ 226,110 $ 124,283

Total interest charges (2(a) through 2(b)) $ 19,932,428 $ 4,162,276 $ 456,227 $ 226,110 $ 124,283
------------- ------------ ------------ ------------ ------------

Total preferred stock requirements (2(c) through 2(d))$ 8,928,707 $ 4,234,463 $ 478,981 $ - $ -
------------- ------------ ------------ ------------ ------------

3. Ratio of earnings to charges and stock requirements
Ratio of earnings to combined fixed charges $ (0.45) $ (1.29) $ (2.52) $ (3.54) $ (5.27)
============= ============ ============ ============ ============

Ratio of earnings to interest charges $ (0.64) $ (2.61) $ (5.18) $ (3.54) $ (5.27)
============= ============ ============ ============ ============

Ratio of earnings to preferred stock requirements $ (1.44) $ (2.57) $ (4.93) $ N/A $ N/A
============= ============ ============ ============ ============

4. Deficiency related to less than one-to-one coverage
Ratio of earnings to combined fixed charges $ 41,717,419 $19,265,007 $ 3,296,273 $ 1,026,609 $ 779,314
============= ============ ============ ============ ============

Ratio of earnings to interest charges $ 32,788,712 $15,030,544 $ 2,817,292 $ 1,026,609 $ 779,314
============= ============ ============ ============ ============

Ratio of earnings to preferred stock requirements $ 21,784,991 $15,102,731 $ 2,840,046 $ N/A $ N/A
============= ============ ============ ============ ============

</TABLE>

(1) 21st Century considers one-third of total rental expense to represent return
on capital.

Exhibit 23.1

CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

As independent public accountants, we hereby consent to the incorporation by
reference of our report dated February 5, 1999 included in this Form 10-K for
nine months ended December 31, 1998, into 21st Century Telecom Group, Inc.'s
previously filed Registration Statement on Form S-4 No. 333-47235.

Chicago, Illinois Arthur Andersen LLP
March 31, 1999

<ARTICLE> 5
<LEGEND>
This schedule contains summary financial data from the consolidated
financial statements included in the Company's transition report on Form 10-K
for the nine months ended December 31, 1998.
</LEGEND>
<CIK> 0001056751
<NAME> 21st Century

<S> <C>
<PERIOD-TYPE> 9-mos
<FISCAL-YEAR-END> Dec-31-1998
<PERIOD-START> Apr-1-1998
<PERIOD-END> Dec-31-1998
<CASH> 72,901,622
<SECURITIES> 98,464,936
<RECEIVABLES> 158,458
<ALLOWANCES> 1,376
<INVENTORY> 10,385,575
<CURRENT-ASSETS> 182,508,093
<PP&E> 63,122,862
<DEPRECIATION> 4,814,143
<TOTAL-ASSETS> 254,343,973
<CURRENT-LIABILITIES> 13,180,224
<BONDS> 222,453,777
52,617,006
24,611,966
<COMMON> 7,862,836
<OTHER-SE> 66,505,268
<TOTAL-LIABILITY-AND-EQUITY> 254,343,973
<SALES> 873,898
<TOTAL-REVENUES> 873,898
<CGS> 2,678,047
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