ALLEGIANCE TELECOM INC, S-1/A, 1999-03-30

ALLEGIANCE TELECOM INC
S-1/A, 1999-03-30
TELEPHONE COMMUNICATIONS (NO RADIOTELEPHONE)

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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 30, 1999

REGISTRATION NO. 333-74765

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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Amendment No. 1 to

FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933

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

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DELAWARE 4832 75-2721491
(State or other jurisdiction of (Primary Standard Industrial (IRS Employer
incorporation or organization) Classification Code Number) Identification Number)
</TABLE>

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1950 STEMMONS FREEWAY, SUITE 3026
DALLAS, TEXAS 75207
TELEPHONE: (214) 261-7100
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)

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MARK B. TRESNOWSKI
SENIOR VICE PRESIDENT
AND
GENERAL COUNSEL
ALLEGIANCE TELECOM, INC.
4 WESTBROOK CORPORATE CENTER, SUITE 400
WESTCHESTER, ILLINOIS 60154
(708) 836-5200
(Name, address, including zip code, and telephone number, including area code,
of agent for service)

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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or interest
reinvestment plans, check the following box: [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box: [ ]

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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT THAT SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SEC, ACTING PURSUANT TO SAID SECTION 8(A), MAY
DETERMINE.

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THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND WE ARE NOT SOLICITING OFFERS TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.

SUBJECT TO COMPLETION, ISSUED MARCH 30, 1999

PROSPECTUS

[ALLEGINANCE TELECOM, INC., LOGO]

COMMON STOCK

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In connection with the offering of our Series B 11 3/4% Senior Discount
Notes in February 1998, we issued warrants to purchase shares of our common
stock. Under this prospectus, we are offering up to 649,248 shares of our common
stock that holders of warrants may purchase upon exercising the warrants. We
will pay all expenses in connection with this offering. We have not engaged an
underwriter for this offering.

Our common stock is quoted on the Nasdaq National Market under the trading
symbol "ALGX."

On March 29, 1999, the last reported sale price of our common stock was
$25.25 per share.

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INVESTING IN OUR COMMON STOCK INVOLVES RISKS.
SEE "RISK FACTORS" BEGINNING ON PAGE 6.

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The Securities and Exchange Commission and state securities regulators have
not approved or disapproved these securities or determined if this prospectus is
truthful or complete. Any representation to the contrary is a criminal offense.

March , 1999
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You should rely only on the information contained in this prospectus.
Allegiance has not authorized anyone to provide you with different information.
Allegiance is not making an offer of these securities in any state where the
offer is not permitted. You should not assume that the information provided by
this prospectus is accurate as of any date other than the date on the front of
this prospectus.

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TABLE OF CONTENTS

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PAGE
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Prospectus Summary.......................................... 1
Risk Factors................................................ 6
Use of Proceeds............................................. 15
Determination of Offering Price............................. 15
Plan of Distribution........................................ 15
Dividend Policy............................................. 15
Market Price of Common Stock................................ 16
Selected Financial Data..................................... 17
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 20
Business.................................................... 32
Management.................................................. 52
Certain Relationships and Related Transactions.............. 61
Security Ownership of Certain Beneficial Owners and
Management................................................ 63
Description of Certain Indebtedness......................... 65
Description of Capital Stock................................ 68
Description of the Warrants................................. 72
Certain U.S. Federal Income Tax Considerations.............. 76
Legal Matters............................................... 80
Experts..................................................... 80
Where You Can Find More Information......................... 80
Index to Consolidated Financial Statements.................. F-1
</TABLE>

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PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus.
This summary may not contain all of the information that you should consider
before purchasing our common stock. You should read the entire prospectus
carefully.

ALLEGIANCE

Allegiance seeks to be a premier provider of telecommunications services to
business, government and other institutional users in major metropolitan areas
across the United States. We offer an integrated set of telecommunications
products and services including local exchange, local access, domestic and
international long distance, enhanced voice, data and a full suite of Internet
services.

Our business plan covers 24 of the largest metropolitan areas in the U.S.
We estimate that these 24 markets include more than 21 million non-residential
access lines, representing about 44.7% of the total non-residential access lines
in the U.S. With a strategy focusing on the central business districts and
suburban commercial districts in these areas, we plan to address a majority of
the non-residential access lines in most of our targeted markets. As of March
15, 1999, we were operating in eleven markets: New York City, Dallas, Atlanta,
Fort Worth, Chicago, Los Angeles, San Francisco, Boston, Oakland, Philadelphia
and Washington, D.C. As of that date we were in the process of deploying our
networks in six other markets: Houston, Long Island, Northern New Jersey, Orange
County, San Diego and San Jose.

Under the Telecommunications Act of 1996, we have the status of a
competitive local exchange carrier or "CLEC" and, as such, in each of our
markets we compete primarily with the existing or incumbent local exchange
carrier or "ILEC." The ILECs, such as Bell Atlantic, BellSouth and Southwestern
Bell, have historically had a monopoly in providing local wireline phone
service.

Our principal executive offices are located at 1950 Stemmons Freeway, Suite
3026, Dallas, Texas 75207 and our telephone number is (214) 261-7100.

BUSINESS STRATEGY

Our goal is to achieve significant market penetration and deliver superior
customer care while maximizing operating margins. The key components of our
strategy include the following:

Leverage Proven Management Team. Our Chairman and Chief Executive
Officer, Royce J. Holland, has more than 25 years of experience in the
telecommunications and energy industries, including as President, Chief
Operating Officer and co-founder of MFS Communications, one of the first
companies to compete with the existing telephone companies that enjoyed a
monopoly in providing local phone service. Under his leadership, MFS
Communications grew from a start-up operation to become the largest
competitor to the incumbent local exchange carriers.

Target Customers with Integrated Service Offerings. We focus
principally on customers in the business, government and other
institutional market segments. The majority of our customers are small and
medium-sized businesses, to which we offer "one-stop shopping" by giving
them the ability to purchase a comprehensive package of communications
services from a single supplier.

Utilize "Smart Build" Strategy to Maximize Speed to Market and
Minimize Investment Risk. We will continue to pursue what we refer to as a
"smart build" strategy. Under this strategy, we purchase and install
switches, locate our equipment in the central office facilities of
incumbent local exchange carriers and lease other elements of their
networks until growth justifies our ownership of additional network assets.
By this strategy, we intend to reduce our initial capital expenditures,
reduce the time it takes to enter and expand in a geographic market and
generate higher returns on invested capital.

Maximize Operating Margins by Emphasizing Facilities-Based
Services. We believe that by using our own facilities to provide service,
we should generate significantly higher gross margins than

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we could obtain by reselling services provided entirely on another
carrier's facilities. As a result, we focus our marketing activities on
areas where we can serve customers through a direct connection to our
facilities.

Develop Efficient Automated Back Office Systems. We intend to automate
most of the processes involved in switching a customer to our networks. Our
goal is to minimize the time between customer order and service
installation. To achieve this goal, we are developing, acquiring and
integrating information technology systems to support our operations, and
we are establishing an on-line and real-time connection of our operations
support systems with those of the incumbent local exchange carriers, also
referred to as "electronic bonding."

Expand Through Potential Acquisitions. We plan to pursue strategic
acquisitions to expand our customer base and acquire additional experienced
management.

RECENT DEVELOPMENTS

On March 19, 1999, we announced that we intend to offer 10,000,000 shares
of our common stock in an underwritten primary offering. We recently retained
Goldman Sachs Credit Partners L.P., TD Securities (USA) Inc. and Morgan Stanley
Senior Funding Inc. to arrange a senior secured revolving credit facility
maturing December 31, 2005 for a subsidiary of Allegiance Telecom, Inc. These
banks have received commitments for this facility aggregating in excess of $200
million from various lenders. These commitments remain subject to various
conditions including the negotiation and execution of a definitive credit
agreement. See "Description of Certain Indebtedness -- Revolving Credit
Facility." Assuming the closing of our anticipated common stock offering and of
the credit facility, we plan to accelerate deployment of our networks in Detroit
and Baltimore into 1999.

Based on preliminary information, we estimate that for the three months
ended March 31, 1999, we will have consolidated revenues of $9.7 million and
earnings before interest, income taxes, depreciation and amortization,
management ownership allocation charge and noncash deferred compensation of
negative $25 million; and will have made capital expenditures of approximately
$60 million. We believe that for the first quarter of 1999, we will have sold
44,500 lines and that 32,000 lines will have been installed.

THE OFFERING

Allegiance has registered 649,248 shares of common stock to be issued under
the terms of the warrant agreement governing the warrants that Allegiance issued
as part of 445,000 units, each consisting of one warrant and one 11 3/4% senior
discount note due 2008. The exercise price under the warrants is $.01 for each
share of common stock. Thus, Allegiance will receive only nominal gross proceeds
from the sale of common stock upon exercise of the warrants and no net proceeds
after deducting the expenses associated with the offering. No fractional shares
of common stock will be issued upon exercise of the warrants. Instead, at the
time of exercise, Allegiance will pay to the holder of the warrant an amount in
cash equal to the current market value of any fractional share. The warrants
will expire on April 1, 2008.

RISK FACTORS

See "Risk Factors" for a discussion of certain factors relating to our
business and an investment in the common stock.

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SUMMARY FINANCIAL DATA

The summary consolidated financial data presented below as of and for the
year ended December 31, 1998 and as of and for the period from inception on
April 22, 1997 through December 31, 1997 were derived from the audited
consolidated financial statements of Allegiance and the notes thereto contained
elsewhere in this prospectus, which statements have been audited by Arthur
Andersen LLP, independent public accountants. The summary pro forma statements
of operations data set forth below is unaudited and gives effect to:

- Allegiance's initial public offering of common stock, including the
conversion of the redeemable convertible preferred stock and the
adjustments to reflect the equity allocation as described in footnote
(1), and

- the sale of our 12 7/8% notes, 11 3/4% notes and redeemable warrants,

as if such transactions had occurred on April 22, 1997 for the period from
inception through December 31, 1997 and on January 1, 1998 for the year ended
December 31, 1998. Dollar amounts are in thousands, except per share amounts.

From Allegiance's formation in April 1997 until December 16, 1997,
Allegiance was in the development stage. Allegiance has generated operating
losses and negative cash flow from its operating activities to date. The
selected financial data set forth below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the consolidated financial statements, including the notes
thereto, contained elsewhere in this prospectus.

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PERIOD FROM INCEPTION ON APRIL 22, 1997
YEAR ENDED DECEMBER 31, 1998 THROUGH DECEMBER 31, 1997
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PRO FORMA PRO FORMA
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ACTUAL ADJUSTMENTS AS ADJUSTED ACTUAL ADJUSTMENTS AS ADJUSTED
----------- ----------- ----------- ----------- ----------- -----------
(AUDITED) (UNAUDITED) (AUDITED) (UNAUDITED)
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STATEMENT OF OPERATIONS DATA:
Revenues.......................... $ 9,786.2 $ -- $ 9,786.2 $ 0.4 $ -- $ 0.4
Operating expenses:
Network......................... 9,528.8 -- 9,528.8 151.2 -- 151.2
Selling, general and
administrative................ 46,089.4 -- 46,089.4 3,425.9 -- 3,425.9
Management ownership allocation
charge........................ 167,311.9 12,557.7(1) 179,869.6 -- 171,743.4(1) 171,743.4
Non-cash deferred
compensation.................. 5,307.2 -- 5,307.2 209.9 -- 209.9
Depreciation and amortization... 9,002.8 -- 9,002.8 12.7 -- 12.7
----------- ----------- ----------- ----------- ----------- -----------
Total operating
expenses................ 237,240.1 12,557.7 249,797.8 3,799.7 171,743.4 175,543.1
Loss from operations.............. (227,453.9) (12,557.7) (240,011.6) (3,799.3) (171,743.4) (175,542.7)
Interest income................... 19,917.4 --(2) 19,917.4 111.4 --(2) 111.4
Interest expense.................. (38,951.7) (23,264.0)(3) (62,215.7) -- (41,212.5)(3) (41,212.5)
----------- ----------- ----------- ----------- ----------- -----------
Net loss.......................... (246,488.2) (35,821.7) (282,309.9) (3,687.9) (212,955.9) (216,643.8)
Accretion of redeemable
convertible preferred stock and
warrant values.................. (11,971.4) (7.4)(4) (11,978.8) (3,814.2) (288.6)(4) (4,102.8)
----------- ----------- ----------- ----------- ----------- -----------
Net loss applicable to common
stock........................... $(258,459.6) $(35,829.1) $(294,288.7) $ (7,502.1) $(213,244.5) $(220,746.6)
=========== =========== =========== =========== =========== ===========
Net loss per share, basic and
diluted......................... $ (10.53) $ (5.85) $(17,610.68) $ (4.37)
=========== =========== =========== ===========
Weighted average number of shares
outstanding, basic and
diluted......................... 24,550,346 25,791,208(5) 50,341,554 426 50,498,062(5) 50,498,488
=========== =========== =========== =========== =========== ===========
OTHER FINANCIAL DATA:
EBITDA(6)......................... $ (45,832.0) $ --(1) $(45,832.0) $ (3,576.7) $ --(1) $ (3,576.7)
Net cash used in operating
activities...................... (17,269.8) (13,196.9)(7) (30,466.7) (1,942.9) (13,196.9)(7) (15,139.8)
Net cash used in investing
activities...................... (319,170.4) 13,196.9(7) (305,973.5) (21,926.0) (55,836.5)(7) (77,762.5)
Net cash provided by financing
activities...................... 593,215.5 -- 593,215.5 29,595.3 572,340.4(8) 601,935.7
Capital expenditures(9)........... 113,538.7 -- 113,538.7 21,926.0 -- 21,926.0
</TABLE>

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AS OF DECEMBER 31,
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1998 1997
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(AUDITED)
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BALANCE SHEET DATA:
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 262,501.7 $ 5,726.4
Short-term investments.................................... 143,389.7 --
Short-term investments, restricted........................ 25,542.8 --
Accounts receivable (net of allowance for doubtful
accounts of $577.2 and $0, respectively)................ 6,186.6 4.3
Prepaid expenses and other current assets................. 1,243.2 245.2
----------- ---------
Total current assets................................ 438,864.0 5,975.9
Property and Equipment:
Property and equipment...................................... 153,875.4 23,912.6
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Accumulated depreciation and amortization................... (9,015.4) (12.7)
Property and equipment, net......................... 144,860.0 23,899.9
Other Non-Current Assets:
Deferred debt issuance costs (net of accumulated
amortization of $733.7 and $0, respectively).............. 16,078.4 --
Long-term investments, restricted........................... 36,699.2 --
Other assets................................................ 1,372.7 171.2
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Total other non-current assets...................... 54,150.3 171.2
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Total assets........................................ $ 637,874.3 $30,047.0
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LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Accounts payable............................................ $ 20,981.7 $ 2,261.7
Accrued liabilities and other............................... 26,176.8 1,668.0
----------- ---------
Total current liabilities........................... 47,158.5 3,929.7
Long-term Debt.............................................. 471,652.1 --
Redeemable Cumulative Convertible Preferred Stock -- 0 and
40,498,062 shares issued and outstanding at December 31,
1998 and December 31, 1997, respectively.................. -- 33,409.4
Redeemable Warrants......................................... 8,634.1 --
Commitments and Contingencies Stockholders' Equity
(Deficit):
Common stock-- 50,341,554 and 426 shares issued and
outstanding at December 31, 1998 and December 31, 1997,
respectively.............................................. 503.4 --
Additional paid-in capital.................................. 416,729.9 3,008.4
Deferred compensation....................................... (14,617.3) (2,798.4)
Deferred management ownership allocation charge............. (26,224.7) --
Accumulated deficit......................................... (265,961.7) (7,502.1)
----------- ---------
Total stockholders' equity (deficit)................ 110,429.6 (7,292.1)
----------- ---------
Total liabilities and stockholders' equity
(deficit)........................................... $ 637,874.3 $30,047.0
=========== =========
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(1) In connection with the initial public offering of common stock, Allegiance
Telecom, LLC, an entity that owned substantially all of Allegiance's
outstanding capital stock, was dissolved and its assets, which consisted
almost entirely of such capital stock, were distributed to the Allegiance
Telecom, LLC investors in accordance with its limited liability company
agreement. This agreement provides that the equity allocation between the
original fund investors and the management investors be 66.7% and 33.3%,
respectively, based upon the valuation implied by the initial public
offering of common stock.

Under generally accepted accounting principles, upon consummation of the
initial public offering of common stock, Allegiance recorded the increase
in the assets of Allegiance Telecom, LLC allocated to the management
investors as a $193.5 million increase in additional paid-in capital, of
which $122.5 million was recorded as a non-cash, non-recurring charge to
operating expense and $71.0 million was recorded as deferred management
ownership allocation charge. The deferred charge was amortized at $44.8
million during 1998, respectively, and will be further amortized at $18.8
million, $7.2 million and $.2 million during the years 1999, 2000 and 2001,
respectively; this is

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the period over which Allegiance has the right to repurchase the
securities, at the lower of fair market value or the price paid by the
employee, in the event the management employee's employment with Allegiance
is terminated. See "Certain Relationships and Related Transactions."

The period from inception on April 22, 1997 through December 31, 1997 pro
forma gives effect to the initial $122.5 million non-cash, non-recurring
charge to operating expense and the related amortization of the deferred
management ownership allocation charge for the period. The year ended
December 31, 1998 pro forma gives effect to the additional amortization of
the deferred management ownership allocation charge.

(2) Pro forma interest income excludes interest income that would have been
earned on the estimated $69.0 million of the proceeds from the offering of
our 12 7/8% notes required to be placed in a pledge account to secure and
fund the first six scheduled interest payments on the 12 7/8% notes.

(3) Reflects $19.8 million and $18.2 million of interest expense related to the
12 7/8% notes, $.2 million and $.1 million of amortization of the $4.1
million of original issuance discount, $.3 million and $.3 million of
amortization of the $7.0 million of deferred debt issuance cost related to
the 12 7/8% notes, $2.9 million and $22.1 million of interest expense
related to the accretion of the 11 3/4% notes and $.1 million and $.5
million of amortization of the $9.8 million of deferred debt issuance cost
related to the 11 3/4% notes for the year ended December 31, 1998 and for
the period from inception on April 22, 1997 through December 31, 1997,
respectively.

(4) Reflects the increase of $7,435 and $.3 million of accretion for the
redeemable warrants for the year ended December 31, 1998 and for the period
from inception on April 22, 1997 through December 31, 1997, respectively.

(5) The pro forma weighted average number of shares outstanding gives effect to
Allegiance's common stock issued as a result of the initial public offering
of common stock, and the conversion of redeemable convertible preferred
stock to common stock.

(6) EBITDA represents earnings before interest, income taxes, depreciation and
amortization, management ownership allocation charge and non-cash deferred
compensation. EBITDA is not a measurement of financial performance under
generally accepted accounting principles, is not intended to represent cash
flow from operations, and should not be considered as an alternative to net
loss as an indicator of Allegiance's operating performance or to cash flows
as a measure of liquidity. Allegiance believes that EBITDA is widely used
by analysts, investors and other interested parties in the
telecommunications industry. EBITDA is not necessarily comparable with
similarly titled measures for other companies.

(7) Reflects the purchase of $69.0 million of U.S. government securities, which
securities were placed in a pledge account, to fund the first six scheduled
interest payments on the 12 7/8% notes. For the year ended December 31,
1998 and for the period from inception on April 22, 1997 through December
31, 1997, also reflects the $13.2 million cash interest payment on May 15
and November 15, respectively, on the 12 7/8% notes, which is funded
through a reduction of the pledge account.

(8) Reflects $193.8 million of net proceeds received from the offering of the
12 7/8% notes of which $69.0 million was required to be placed in a pledge
account to secure and fund the first six scheduled interest payments on the
12 7/8% notes, $137.8 million of net proceeds received from the initial
public offering of common stock, and $240.7 million of net proceeds from
the offering of the 11 3/4% notes and redeemable warrants.

(9) Reflects cash paid for capital expenditures.

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RISK FACTORS

You should carefully consider the following risk factors, as well as other
information in this prospectus, before you decide whether to invest in our
common stock.

OUR LIMITED HISTORY OF OPERATIONS MAY NOT BE A RELIABLE BASIS FOR EVALUATING OUR
PROSPECTS

Because of our short operating history, you have limited operating and
financial data which you can use to evaluate our performance and determine
whether you should invest in our common stock. From our inception on April 22,
1997 through December 16, 1997, we were in the development stage of operations.

UNDER CERTAIN CIRCUMSTANCES WE MAY NEED ADDITIONAL CAPITAL TO EXPAND OUR
BUSINESS AND INCREASE REVENUE

We may need additional capital to fund capital expenditures, working
capital, debt service and cash flow deficits during the period in which we are
expanding and developing our business and deploying our networks, services and
systems. We estimate, based on our current business plan, that approximately
$750 million to $850 million of capital will be necessary to fund the deployment
and operation of our networks in all of our initial 24 markets to the point at
which operating cash flow from a market will be sufficient to fund such market's
operating and capital expenditures. This amount includes capital expenditures,
working capital and cash flow deficits, but excludes debt service. We have
raised approximately $554 million of capital to date. The actual amount and
timing of our future capital requirements may differ materially from our
estimates as a result of prevailing economic conditions and financial, business
and other factors, many of which are beyond our control. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."

We believe that the proceeds from our anticipated common stock offering and
borrowings expected to be available under a senior credit facility, together
with our cash on hand, will be sufficient to pre-fund market deployment in all
24 targeted markets. However, we have not yet entered into the credit facility
and if established, we will only be able to borrow under the credit facility if
we are in compliance with certain financial covenants. In the event we cannot
borrow under the credit facility we may need to access alternative sources of
capital. If we are unable to do so we may not be able to expand as we expect,
which may have an adverse effect on us.

IF WE DO NOT EFFECTIVELY MANAGE RAPID EXPANSION OF OUR BUSINESS, OUR FINANCIAL
CONDITION WILL SUFFER

We are in the early stages of our operations and have only recently begun
to deploy networks in our first 17 target markets. If we are successful in the
implementation of our business plan, we will be rapidly expanding our operations
and providing bundled telecommunications services on a widespread basis. This
rapid expansion may place a significant strain on our management, financial and
other resources. If we fail to manage our growth effectively, we may not be able
to expand our customer base and service offerings as we have planned.

OUR SUCCESS DEPENDS ON OUR KEY PERSONNEL AND WE MAY NOT BE ABLE TO REPLACE KEY
EXECUTIVES WHO LEAVE

We are managed by a small number of key executive officers, most notably
Royce J. Holland, our Chairman and Chief Executive Officer. The loss of services
of one or more of these key individuals, particularly Mr. Holland, could
materially and adversely affect our business and our prospects. Most of our
executive officers do not have employment agreements, and we do not maintain key
person life insurance for any of our executive officers. The competition for
qualified personnel in the telecommunications industry is intense. For this
reason, we cannot assure you that we will be able to hire or retain necessary
personnel in the future.

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WE ARE DEPENDENT ON EFFECTIVE BILLING, CUSTOMER SERVICE AND INFORMATION SYSTEMS
AND WE MAY HAVE DIFFICULTIES IN DEVELOPING THESE SYSTEMS

Sophisticated back office information and processing systems are vital to
our growth and our ability to monitor costs, bill customers, initiate, implement
and track customer orders and achieve operating efficiencies. We cannot assure
you that these systems will be successfully implemented on a timely basis or at
all or will perform as expected because:

- our vendors may fail to deliver proposed products and services in a
timely and effective manner and at acceptable costs;

- we may fail to adequately identify all of our information and processing
needs;

- our processing or information systems may fail or be inadequate;

- we may be unable to effectively integrate such products or services;

- we may fail to upgrade systems as necessary; and

- third party vendors may cancel or fail to renew license agreements that
relate to these systems.

WE MAY BE ADVERSELY IMPACTED BY YEAR 2000 ISSUES, MANY OF WHICH ARE BEYOND OUR
CONTROL

The "year 2000" issue generally describes the various problems that may
result from the improper processing of dates and date-sensitive transactions by
computers and other equipment as a result of computer hardware and software
using two digits to identify the year in a date. The failure to process dates
could result in network and system failures or miscalculations causing
disruptions in operations including, among other things, a temporary inability
to process transactions, send invoices or engage in other routine business
activities. A failure of our customers or vendors, including other
telecommunications operators, to cause their software and systems to be year
2000 compliant could have a material adverse effect on us and on our ability to
meet our obligations. Until the year 2000 occurs, we will not know for sure that
all systems will then function adequately. In addition, we are dependent upon
third-party suppliers, including other telecommunications operators, for the
delivery of interconnection and other services and on third-party customers for
the purchase of our services. In many cases, our services and operations require
electronic interfacing with the systems and networks of third-party
telecommunication operators such as the incumbent local exchange carriers. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Impact of the Year 2000."

WE FACE POTENTIAL CONFLICTS OF INTEREST CAUSED BY FUND INVESTOR CONTROL WHICH
COULD BE DETRIMENTAL TO HOLDERS OF OUR SECURITIES

You should be aware that the investment funds that provided our initial
equity hold a majority of our board seats and a significant amount of our common
stock and that as a result, our direction and future operations may be
controlled by these funds. For a discussion of the voting agreement among our
original fund and management investors regarding the election of nominees to the
board of directors, see the discussion under "Certain Relationships and Related
Transactions." In addition, decisions concerning our operations or financial
structure may present conflicts of interest between these investors and our
management and other holders of our securities, including our notes. In addition
to their investments in us, these investors or their affiliates currently have
significant investments in other telecommunications companies and may in the
future invest in other entities engaged in the telecommunications business or in
related businesses, including entities that compete with us. Conflicts may also
arise in the negotiation or enforcement of arrangements entered into by us and
entities in which these investors have an interest.

OUR SUBSTANTIAL INDEBTEDNESS COULD MAKE US UNABLE TO SERVICE INDEBTEDNESS AND
MEET OUR OTHER REQUIREMENTS AND COULD ADVERSELY AFFECT OUR FINANCIAL HEALTH

We have a significant amount of debt outstanding and plan to access
additional debt financing to fund our business plan. On December 31, 1998, we
had $471.7 million of outstanding indebtedness and $110.4 million of
stockholders' equity. We anticipate incurring additional indebtedness in the
future,

7
<PAGE> 11

including a senior secured revolving credit facility that we expect to close in
April 1999. See the discussion of this credit facility in the section titled
"Description of Certain Indebtedness -- Revolving Credit Facility."

This level of debt could:

- impair our ability to obtain additional financing for working capital,
capital expenditures, acquisitions or general corporate purposes;

- require us to dedicate a substantial portion of our cash flow from
operations to the payment of principal and interest on our indebtedness,
thereby reducing the funds available for the growth of our networks;

- place us at a competitive disadvantage with those of our competitors who
do not have as much debt as we do;

- impair our ability to adjust rapidly to changing market conditions; and

- make us more vulnerable if there is a downturn in general economic
conditions or in our business.

The successful implementation of our business plan is essential for us to
meet our working capital, capital expenditure and debt service requirements.
Allegiance's earnings for the year ended December 31, 1998 and for the period
from inception on April 22, 1997 through December 31, 1997 were insufficient to
cover fixed charges by approximately $249.3 million and $3.7 million,
respectively. After giving pro forma effect to the increase in interest expense
resulting from the issuance of the 12 7/8% notes and the 11 3/4% notes and
giving effect to $12.6 million and $171.7 million of management ownership
allocation charge to be recorded in connection with the initial public offering
of common stock, Allegiance's earnings would have been insufficient to cover
fixed charges by approximately $285.1 million and $216.6 million, for the year
ended December 31, 1998 and for the period from inception on April 22, 1997
through December 31, 1997, respectively. We cannot assure you that we will be
able to meet our working capital, capital expenditure and debt service
requirements.

LIMITATIONS IMPOSED BY RESTRICTIVE COVENANTS COULD LIMIT HOW WE CONDUCT BUSINESS
AND A DEFAULT UNDER OUR INDENTURES AND FINANCING AGREEMENTS COULD SIGNIFICANTLY
IMPACT OUR ABILITY TO REPAY OUR INDEBTEDNESS

Our indentures and the agreements entered into in connection with our
initial equity funding contain covenants that restrict our ability to:

- incur additional indebtedness;

- pay dividends and make other distributions;

- prepay subordinated indebtedness;

- make investments and other restricted payments;

- enter into sale and leaseback transactions;

- create liens;

- sell assets; and

- engage in certain transactions with affiliates.

Our future financing arrangements, including the senior secured revolving
credit facility discussed in the section titled "Description of Certain
Indebtedness -- Revolving Credit Facility," will most likely contain similar or
more restrictive covenants, as well as other covenants that will require us to
maintain specified financial ratios and satisfy financial tests. As a result of
these restrictions, we are limited in how we conduct business and we may be
unable to raise additional debt or equity financing to operate during

8
<PAGE> 12

general economic or business downturns, to compete effectively or to take
advantage of new business opportunities. This may affect our ability to generate
revenues and make profits. Without sufficient revenues and cash, we may not be
able to pay interest and principal on our indebtedness.

Our failure to comply with the covenants and restrictions contained in our
indentures and other financing agreements could lead to a default under the
terms of these agreements. If such a default occurs, the other parties to such
agreements could declare all amounts borrowed and all amounts due under other
instruments that contain provisions for cross-acceleration or cross-default due
and payable. In addition, lenders under our future financing arrangements could
terminate their commitments to lend to us. If that occurs, we cannot assure you
that we would be able to make payments on our indebtedness, meet our working
capital and capital expenditure requirements, or that we would be able to find
additional alternative financing. Even if we could obtain additional alternative
financing, we cannot assure you that it would be on terms that are favorable or
acceptable to us.

WE MAY NOT HAVE THE FUNDS NECESSARY TO FINANCE THE CHANGE OF CONTROL OFFER WHICH
MAY BE REQUIRED BY OUR INDENTURES

Our indentures provide that upon a change of control, each note holder will
have the right to require us to purchase all or a portion of such holder's
notes. We would be required to purchase the notes at a purchase price of 101% of
the accreted value of the 11 3/4% notes and 101% of the principal amount of the
12 7/8% notes, plus any accrued and unpaid interest to the date of repurchase.
It is possible that we will not have sufficient funds at that time to repurchase
our notes.

IF WE DO NOT INTERCONNECT WITH OUR PRIMARY COMPETITORS, THE INCUMBENT LOCAL
EXCHANGE CARRIERS, OUR BUSINESS WILL BE ADVERSELY AFFECTED

Many new carriers, including Allegiance, have experienced difficulties in
working with the incumbent local exchange carriers with respect to initiating,
interconnecting, and implementing the systems used by these new carriers to
order and receive unbundled network elements and wholesale services and locating
the new carriers' equipment in the offices of the incumbent local exchange
carriers. As a new carrier, we must coordinate with incumbent local exchange
carriers so that we can provide local service to customers on a timely and
competitive basis. The Telecommunications Act created incentives for regional
Bell operating companies to cooperate with new carriers and permit access to
their facilities by denying such companies the ability to provide in-region long
distance services until they have satisfied statutory conditions designed to
open their local markets to competition. The regional Bell operating companies
in our markets are not yet permitted by the FCC to offer long distance services.
These companies may not be accommodating to us once they are permitted to offer
long distance service. If we cannot obtain the cooperation of a regional Bell
operating company in a region, whether or not it has been authorized to offer
long distance service, our ability to offer local services in such region on a
timely and cost-effective basis will be adversely affected.

IF WE DO NOT OBTAIN PEERING ARRANGEMENTS WITH INTERNET SERVICE PROVIDERS, THE
PROFITABILITY OF OUR INTERNET ACCESS SERVICES WILL SUFFER

The profitability of our Internet access services, and related services
such as Web site hosting, may be adversely affected if we are unable to obtain
"peering" arrangements with Internet service providers. In the past, major
Internet service providers routinely exchanged traffic with other Internet
service providers that met technical criteria on a "peering" basis, meaning that
each Internet service provider accepted traffic routed to Internet addresses on
their system from their "peers" on a reciprocal basis, without payment of
compensation. However, since 1997, UUNET Technologies, Inc., the largest
Internet service provider, has been greatly restricting the use of peering
arrangements with other providers, and has been imposing charges for accepting
traffic from providers other than its "peers." Other major Internet service
providers have adopted similar policies. We do not currently have any peering
arrangements and cannot assure you that we will be able to negotiate "peer"
status with any of the major nationwide Internet service providers

9
<PAGE> 13

in the future, or that we will be able to terminate traffic on Internet service
providers' networks at favorable prices.

OUR OFFERING OF LONG DISTANCE SERVICES IS AFFECTED BY OUR ABILITY TO ESTABLISH
EFFECTIVE RESALE AGREEMENTS

As part of our "one-stop shopping" offering of bundled telecommunications
services to our customers, we offer long distance services. We have relied and
will continue to rely on other carriers to provide transmission and termination
services for all of our long distance traffic. We will continue to enter into
resale agreements with long distance carriers to provide us with transmission
services. Such agreements typically provide for the resale of long distance
services on a per-minute basis and may contain minimum volume commitments.
Negotiation of these agreements involves estimates of future supply and demand
for transmission capacity as well as estimates of the calling pattern and
traffic levels of our future customers. If we fail to meet our minimum volume
commitments, we may be obligated to pay underutilization charges and if we
underestimate our need for transmission capacity, we may be required to obtain
capacity through more expensive means.

OUR PRINCIPAL COMPETITORS FOR LOCAL SERVICES, THE INCUMBENT LOCAL EXCHANGE
CARRIERS, AND POTENTIAL ADDITIONAL COMPETITORS, HAVE ADVANTAGES THAT MAY
ADVERSELY AFFECT OUR ABILITY TO COMPETE WITH THEM

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

- private lines, which are private, dedicated telecommunications
connections between customers;

- special access services, which are dedicated lines from a customer to a
long distance company provided by the local phone company; and

- switched access services, which refers to the call connection provided by
the local phone company's switch between a customer's phone and the long
distance company's switch.

In addition, with respect to competitive access services, such as special
access services as opposed to switched access services, the FCC is considering
allowing incumbent local exchange carriers increased pricing flexibility and
deregulation for such access services either automatically or after certain
competitive levels are reached. If the incumbent local exchange carriers are
allowed by regulators to offer discounts to large customers through contract
tariffs, engage in aggressive volume and term discount pricing practices for
their customers, and/or seek to charge competitors excessive fees for
interconnection to their networks, competitors such as us could be materially
adversely affected. If future regulatory decisions afford the incumbent local
exchange carriers increased pricing flexibility or other regulatory relief, such
decisions could also have a material adverse effect on competitors such as us.

We also face, and expect to continue to face, competition in the local
market from other current and potential market entrants, including long distance
carriers seeking to enter, reenter or expand entry into the local exchange
marketplace such as AT&T, MCI WorldCom and Sprint, and from other competitive
local exchange carriers, resellers, competitive access providers, cable
television companies, electric utilities, microwave carriers, wireless telephone
system operators and private networks built by large end users. In addition, the
development of new technologies could give rise to significant new competitors
in the local market.

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<PAGE> 14

SIGNIFICANT COMPETITION IN PROVIDING LONG DISTANCE AND INTERNET SERVICES COULD
REDUCE THE DEMAND AND PROFITABILITY OF OUR SERVICES

We also face significant competition in providing long distance and
Internet services. Many of these competitors have greater financial,
technological, marketing, personnel and other resources than those available to
us.

The long distance telecommunications market has numerous entities competing
for the same customers and a high average turnover rate, as customers frequently
change long distance providers in response to the offering of lower rates or
promotional incentives. Prices in the long distance market have declined
significantly in recent years and are expected to continue to decline. We face
competition from large carriers such as AT&T, Sprint, and MCI WorldCom and many
smaller long distance carriers. Other competitors are likely to include regional
Bell operating companies providing long distance services outside of their local
service area and, with the removal of regulatory barriers, long distance
services within such local service areas, other competitive local exchange
carriers, microwave and satellite carriers and private networks owned by large
end users. We may also increasingly face competition from companies offering
local and long distance data and voice services over the Internet. Such
companies could enjoy a significant cost advantage because they do not currently
pay many of the charges or fees that we have to pay. In addition, in June 1998,
Sprint announced its intention to offer voice, data and video services over its
nationwide asynchronous transfer mode network, which Sprint anticipates will
significantly reduce its cost to provide such services. Sprint plans to bill its
customers based upon the amount of traffic carried, irrespective of the time
required to send the traffic or the traffic's destination.

The Internet services market is highly competitive and we expect that
competition will continue to intensify. Our competitors in this market include
Internet service providers, other telecommunications companies, online services
providers and Internet software providers.

OUR NEED TO COMPLY WITH EXTENSIVE GOVERNMENT REGULATION CAN INCREASE OUR COSTS
AND SLOW OUR GROWTH

Our networks and the provision of telecommunications services are subject
to significant regulation at the federal, state and local levels. Delays in
receiving required regulatory approvals or the enactment of new adverse
regulation or regulatory requirements may slow our growth and have a material
adverse effect upon us.

The FCC exercises jurisdiction over us with respect to interstate and
international services. We must obtain, and have obtained through our
subsidiary, Allegiance Telecom International, Inc., prior FCC authorization for
installation and operation of international facilities and the provision,
including by resale, of international long distance services. Additionally, we
file publicly available documents detailing our services, equipment and pricing,
also known as "tariffs," with the FCC for both international and domestic
long-distance services.

State regulatory commissions exercise jurisdiction over us because we
provide intrastate services. We are required to obtain regulatory authorization
and/or file tariffs at state agencies in most of the states in which we operate.
If and when we seek to build our own network segments, local authorities
regulate our access to municipal rights-of-way. Constructing a network is also
subject to numerous local regulations such as building codes and licensing. Such
regulations vary on a city by city and county by county basis.

Regulators at both the federal and state level require us to pay various
fees and assessments, file periodic reports, and comply with various rules
regarding the contents of our bills, protection of subscriber privacy, and
similar matters on an on-going basis.

We cannot assure you that the FCC or state commissions will grant required
authority or refrain from taking action against us if we are found to have
provided services without obtaining the necessary authorizations, or to have
violated other requirements of their rules and orders. Regulators or others
could challenge our compliance with applicable rules and orders. Such challenges
could cause us to incur substantial legal and administrative expenses.
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<PAGE> 15

DEREGULATION OF THE TELECOMMUNICATIONS INDUSTRY INVOLVES UNCERTAINTIES, AND THE
RESOLUTION OF THESE UNCERTAINTIES COULD ADVERSELY AFFECT OUR BUSINESS

The Telecommunications Act provides for a significant deregulation of the
domestic telecommunications industry, including the local exchange, long
distance and cable television industries. The Telecommunications Act remains
subject to judicial review and additional FCC rulemaking, and thus it is
difficult to predict what effect the legislation will have on us and our
operations. There are currently many regulatory actions underway and being
contemplated by federal and state authorities regarding interconnection pricing
and other issues that could result in significant changes to the business
conditions in the telecommunications industry. We cannot assure you that these
changes will not have a material adverse effect upon us.

THE REGULATION OF INTERCONNECTION WITH INCUMBENT LOCAL EXCHANGE CARRIERS
INVOLVES UNCERTAINTIES, AND THE RESOLUTION OF THESE UNCERTAINTIES COULD
ADVERSELY AFFECT OUR BUSINESS

Although the incumbent local exchange carriers are required under the
Telecommunications Act of 1996 to unbundle and make available elements of their
network and permit us to purchase only the origination and termination services
that we need, thereby decreasing our operating expenses, such unbundling may not
be done as quickly as we require and may be priced higher than we expect. This
is important because we rely on the facilities of these other carriers to
connect to our high capacity digital switches so that we can provide services to
our customers. Our ability to obtain these interconnection agreements on
favorable terms, and the time and expense involved in negotiating them, can be
adversely affected by legal developments.

A recent Supreme Court decision vacated a FCC rule determining which
network elements the incumbent local exchange carriers must provide to
competitors on an unbundled basis. We expect that the FCC will conduct a
rulemaking to adopt new standards for unbundling of network elements in
conformance with this decision. The implementation of these and other FCC rules
may lead to further litigation. This may complicate our interconnection
negotiations, and may adversely affect our existing agreements and operations.

WE COULD LOSE REVENUE IF CALLS TO INTERNET SERVICE PROVIDERS ARE TREATED AS LONG
DISTANCE INTERSTATE CALLS

We believe that other local exchange carriers should have to compensate us
when their customers place calls to Internet service providers who are our
customers. Most incumbent local exchange carriers disagree. Internet service
providers are among our target customers, and decisions providing that other
carriers do not have to compensate us for these calls could limit our ability to
service this group of customers profitably.

For all other local calls, it is clear that the telecommunications company
whose customer calls a customer of a second telecommunications company must
compensate the second company. This is known as reciprocal compensation. This
rule does not apply to long distance interstate calls and the FCC in its
Declaratory Ruling of February 26, 1999, determined that Internet service
provider traffic is interstate for jurisdictional purposes, but that its current
rules neither require nor prohibit the payment of reciprocal compensation for
such calls. In the absence of a federal rule, the FCC determined that state
commissions have authority to interpret and enforce the reciprocal compensation
provisions of existing interconnection agreements, and to determine the
appropriate treatment of Internet service provider traffic in arbitrating new
agreements.

THE REGULATION OF ACCESS CHARGES INVOLVES UNCERTAINTIES, AND THE RESOLUTION OF
THESE UNCERTAINTIES COULD ADVERSELY AFFECT OUR BUSINESS

To the extent we provide long-distance, often referred to as
"interexchange," telecommunications service, we are required to pay access
charges to other local exchange carriers when we use the facilities of those
companies to originate or terminate interexchange calls. As a competitive local
exchange carrier, we
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<PAGE> 16

also provide access services to other long distance service providers. The
interstate access charges of incumbent local exchange carriers are subject to
extensive regulation by the FCC, while those of competitive local exchange
carriers are subject to a lesser degree of FCC regulation, but remain subject to
the requirement that all charges be just, reasonable, and not unreasonably
discriminatory. Disputes have arisen regarding the regulation of access charges
and these may be resolved adversely to us.

The FCC has made major changes in the interstate access charge structure.
The manner in which the FCC implements and monitors these increased pricing
flexibility changes could have a material adverse effect on our ability to
compete in providing interstate access services.

Some interexchange carriers, including AT&T, have also asked the FCC to
take regulatory action to prevent competitive local exchange carriers from
charging allegedly "excessive" access charges. Although no complaints have been
filed against us, we do provide access service to interexchange carriers and we
could be subject in the future to allegations that our charges for this service
are unjust and unreasonable. In that event, we would have to provide the FCC
with an explanation of how we set our rates and justify them as reasonable. We
can give no assurance that the FCC will accept our rates as reasonable. If our
rates are reduced by regulatory order, this could have a material adverse effect
on our profitability.

IF WE DO NOT CONTINUALLY ADAPT TO TECHNOLOGICAL CHANGE, WE COULD LOSE CUSTOMERS
AND MARKET SHARE

The telecommunications industry is subject to rapid and significant changes
in technology, and we rely on outside vendors for the development of and access
to new technology. The effect of technological changes on our business cannot be
predicted. We believe our future success will depend, in part, on our ability to
anticipate or adapt to such changes and to offer, on a timely basis, services
that meet customer demands. We cannot assure you that we will obtain access to
new technology on a timely basis or on satisfactory terms. Any failure by us to
obtain new technology could cause us to lose customers and market share.

WE HAVE APPLIED FOR, BUT NOT YET RECEIVED, ASSURANCE FROM THE SEC REGARDING OUR
STATUS UNDER THE INVESTMENT COMPANY ACT AND IF WE ARE SUBJECT TO THE INVESTMENT
COMPANY ACT, IT COULD ADVERSELY AFFECT OUR FINANCING ACTIVITIES AND FINANCIAL
RESULTS

Allegiance currently has substantial short-term investments, pending the
deployment of our capital in the pursuit of building our business. See
"Capitalization" and "Use of Proceeds." This may result in Allegiance being
deemed as an "investment company" under the Investment Company Act of 1940. This
statute requires the registration of, and imposes various substantive
restrictions on, certain companies that are, or hold themselves out as being,
engaged primarily, or propose to engage primarily in, the business of investing,
reinvesting or trading in securities, or that fail certain statistical tests
regarding composition of assets and sources of income even though they do not
intend to be primarily engaged in the businesses of investing, reinvesting,
owning, holding or trading securities.

Allegiance believes that it is primarily engaged in a business other than
investing, reinvesting, owning, holding or trading securities and, therefore, is
not an investment company within the meaning of this statute. While we believe
this means we are not an investment company within the meaning of that law, we
have been able to also rely on a safe harbor in that law for certain transient
or temporary investment companies. However, this exemption is only available to
companies for a one-year period and that one-year period terminated in January
1999. We have applied to the SEC for a one-year exemptive order declaring that
Allegiance is not an investment company and not required to register under this
statute. We have not yet received such an order, and it is possible that we will
not ultimately be successful in receiving such an order. We believe that if we
are granted the exemption, under our current business plan we will have deployed
a sufficient amount of capital by the end of the one-year period such that we
would not then be deemed to be an investment company.

If we were required to register as an investment company under the
Investment Company Act, we would become subject to substantial regulation with
respect to our capital structure, management,

13
<PAGE> 17

operations, transactions with affiliated persons and other matters. To avoid
having to register as an investment company, we may have to invest a portion of
our liquid assets in cash and demand deposits instead of short-term securities.
The extent to which we will have to do so will depend on the composition and
value of our total assets at that time. Having to register as an investment
company or having to invest a material portion of our liquid assets in cash and
demand deposits to avoid such registration, could have a material adverse effect
on our business, financial condition and results of operations.

FUTURE SALES OF OUR STOCK BY EXISTING STOCKHOLDERS MAY ADVERSELY AFFECT OUR
STOCK PRICE

As of March 15, 1999, we have 50,360,866 shares of common stock
outstanding. While certain of these shares are "restricted securities" under the
federal securities laws, such shares are or will be eligible for sale subject to
restrictions as to timing, manner, volume, notice and the availability of
current public information regarding Allegiance. Sales of substantial amounts of
stock in the public market, or the perception that sales could occur, could
depress the prevailing market price for our stock. Sales may also make it more
difficult for us to sell equity securities or equity-related securities in the
future at a time and price that we deem appropriate.

ANTI-TAKEOVER PROVISIONS IN ALLEGIANCE'S CHARTER AND BYLAWS COULD LIMIT OUR
SHARE PRICE AND DELAY A CHANGE OF MANAGEMENT

Our certificate of incorporation and by-laws contain provisions that could
make it more difficult or even prevent a third party from acquiring Allegiance
without the approval of our incumbent board of directors. See "Description of
Capital Stock."

OUR FORWARD-LOOKING STATEMENTS MAY MATERIALLY DIFFER FROM ACTUAL EVENTS OR
RESULTS

This prospectus contains "forward-looking statements," which you generally
can identify by our use of forward-looking words such as "believes," "expects,"
"may," "will," "should," or "anticipates" or the negative or other variations of
such terms or comparable terminology, or by discussion of strategy that involve
risks and uncertainties. We often use these types of statements when discussing
our plans and strategies, our anticipation of revenues from designated markets,
and statements regarding the development of our businesses, the markets for our
services and products, our anticipated capital expenditures, operations support
systems, changes in regulatory requirements and other statements contained in
this prospectus regarding matters that are not historical facts.

We caution you that these forward-looking statements are only predictions
and estimates regarding future events and circumstances. We cannot assure you
that we will achieve the future results reflected in these statements. The risks
we face that could cause us not to achieve these results include, but are not
limited to our ability to do the following in a timely manner, at reasonable
costs and on satisfactory terms and conditions:

- successfully market our services to current and new customers;

- interconnect with and develop cooperative working relationships with
incumbent local exchange carriers;

- develop efficient operations support systems and other back office
systems;

- successfully and efficiently transfer new customers to our networks and
access new geographic markets;

- identify, finance and complete suitable acquisitions;

- borrow under our senior credit facility;

- install new switching facilities and other network equipment; and

- obtain leased fiber optic line capacity, rights-of-way, building access
rights and any required governmental authorizations, franchises and
permits.
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<PAGE> 18

Regulatory, legislative and judicial developments could also cause actual
results to differ materially from the future results reflected in such
forward-looking statements. You should consider all of our subsequent written
and oral forward-looking statements only in light of such cautionary statements.
You should not place undue reliance on these forward-looking statements and you
should understand that they speak only as of the dates we make them.

USE OF PROCEEDS

Allegiance would receive gross proceeds of $6,492.48 if all 649,248 shares
are sold upon exercise of the warrants at an exercise price of $.01 per share.
Allegiance would not have any proceeds after payment of expenses associated with
the offering.

DETERMINATION OF OFFERING PRICE

Under the warrant agreement dated as of February 3, 1998 between Allegiance
and The Bank of New York, the warrant agent, 445,000 warrants were issued with
each outstanding warrant originally representing the right to acquire
.0034224719 shares of Allegiance common stock for an initial exercise price of
$.01 per share. The exercise price and conversion ratio are subject to
adjustments as provided in the warrant agreement. In connection with the
Allegiance initial public offering on July 7, 1998, the common stock was split
such that each warrant became a right to acquire 1.45898399509 shares of common
stock. The exercise price remained at $.01 per share. The terms, conditions and
exercise price per share for the warrants were determined through negotiations
between Allegiance and the placement agents of the units which included the
warrants.

PLAN OF DISTRIBUTION

The shares issuable upon exercise of the warrants are offered solely by
Allegiance; no underwriters are participating in the offering. Warrants may be
exercised by giving written notice to the warrant agent, The Bank of New York,
and paying the exercise price as specified in the warrant agreement.

DIVIDEND POLICY

We do not anticipate paying any cash dividends in the foreseeable future.
Any future determination to pay dividends will be at the discretion of our board
of directors and will be dependent upon then existing conditions, including our
financial condition, results of operations, contractual restrictions, capital
requirements, business prospects, and other factors our board of directors deems
relevant. In addition, our current financing agreements effectively prohibit us
from paying cash dividends for the foreseeable future.

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<PAGE> 19

MARKET PRICE OF COMMON STOCK

Allegiance's common stock is traded on the Nasdaq National Market under the
symbol "ALGX." Allegiance completed the initial public offering of its common
stock on July 1, 1998. The following table sets forth, for the periods
indicated, the high and low sales prices for the common stock as reported by the
Nasdaq National Market.

<TABLE>
<CAPTION>
COMMON STOCK PRICE
------------------
HIGH LOW
------- -------
<S> <C> <C>
Year ended December 31, 1998:
Third quarter (from July 1, 1998)......................... 15.688 6.250
Fourth quarter............................................ 13.375 5.000
Year ended December 31, 1999:
First quarter (through March 24, 1999).................... 31.000 11.563
</TABLE>

A recent reported last sale price for Allegiance common stock, as reported
on the Nasdaq National Market, is set forth on the cover page of this
prospectus. On March 15, 1999, we had approximately 128 holders of record of
common stock.

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<PAGE> 20

SELECTED FINANCIAL DATA

The selected consolidated financial data presented below as of and for the
year ended December 31, 1998 and as of and for the period from inception on
April 22, 1997 through December 31, 1997 were derived from the audited
consolidated financial statements of Allegiance and the notes thereto contained
elsewhere in this prospectus, which statements have been audited by Arthur
Andersen LLP, independent public accountants. The selected pro forma statements
of operations data set forth below is unaudited and gives effect to:

- the sale of our 12 7/8% notes, 11 3/4% notes and redeemable warrants,

<TABLE>
<CAPTION>
PERIOD FROM INCEPTION ON APRIL 22, 1997
YEAR ENDED DECEMBER 31, 1998 THROUGH DECEMBER 31, 1997
---------------------------------------- ----------------------------------------
PRO FORMA PRO FORMA
-------------------------- --------------------------
ACTUAL ADJUSTMENTS AS ADJUSTED ACTUAL ADJUSTMENTS AS ADJUSTED
----------- ----------- ----------- ----------- ----------- -----------
(AUDITED) (UNAUDITED) (AUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues............................. $ 9,786.2 $ -- $ 9,786.2 $ 0.4 $ -- $ 0.4
Operating expenses:
Network............................ 9,528.8 -- 9,528.8 151.2 -- 151.2
Selling, general and
administrative................... 46,089.4 -- 46,089.4 3,425.9 -- 3,425.9
Management ownership allocation
charge........................... 167,311.9 12,557.7(1) 179,869.6 -- 171,743.4(1) 171,743.4
Non-cash deferred compensation..... 5,307.2 -- 5,307.2 209.9 -- 209.9
Depreciation and amortization...... 9,002.8 -- 9,002.8 12.7 -- 12.7
----------- ----------- ----------- ----------- ----------- -----------
Total operating expenses..... 237,240.1 12,557.7 249,797.8 3,799.7 171,743.4 175,543.1
Loss from operations................. (227,453.9) (12,557.7) (240,011.6) (3,799.3) (171,743.4) (175,542.7)
Interest income...................... 19,917.4 --(2) 19,917.4 111.4 --(2) 111.4
Interest expense..................... (38,951.7) (23,264.0)(3) (62,215.7) -- (41,212.5)(3) (41,212.5)
----------- ----------- ----------- ----------- ----------- -----------
Net loss............................. (246,488.2) (35,821.7) (282,309.9) (3,687.9) (212,955.9) (216,643.8)
Accretion of redeemable convertible
preferred stock and warrant
values............................. (11,971.4) (7.4)(4) (11,978.8) (3,814.2) (288.6)(4) (4,102.8)
----------- ----------- ----------- ----------- ----------- -----------
Net loss applicable to common
stock.............................. $(258,459.6) $(35,829.1) $(294,288.7) $ (7,502.1) $(213,244.5) $(220,746.6)
=========== =========== =========== =========== =========== ===========
Net loss per share, basic and
diluted............................ $ (10.53) $ (5.85) $(17,610.68) $ (4.37)
=========== =========== =========== ===========
Weighted average number of shares
outstanding, basic and diluted..... 24,550,346 25,791,208(5) 50,341,554 426 50,498,062(5) 50,498,488
=========== =========== =========== =========== =========== ===========
OTHER FINANCIAL DATA:
EBITDA(6)............................ $ (45,832.0) $ --(1) $(45,832.0) $ (3,576.7) $ --(1) $ (3,576.7)
Net cash used in operating
activities......................... (17,269.8) (13,196.9)(7) (30,466.7) (1,942.9) (13,196.9)(7) (15,139.8)
Net cash used in investing
activities......................... (319,170.4) 13,196.9(7) (305,973.5) (21,926.0) (55,836.5)(7) (77,762.5)
Net cash provided by financing
activities......................... 593,215.5 -- 593,215.5 29,595.3 572,340.4(8) 601,935.7
Capital expenditures(9).............. 113,538.7 -- 113,538.7 21,926.0 -- 21,926.0
</TABLE>

17
<PAGE> 21

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------------
1998 1997
----------- ---------
(AUDITED)
<S> <C> <C>
BALANCE SHEET DATA:
ASSETS
Cash, cash equivalents, short-term investments, and
restricted short-term investments......................... $ 431,434.2 $ 5,726.4
Accounts receivable (net of allowance for doubtful accounts
of $577.2 and $0, respectively)........................... 6,186.6 4.3
Prepaid expenses and other current assets................... 1,243.2 245.2
Property and equipment, net................................. 144,860.0 23,899.9
Total other non-current assets.............................. 54,150.3 171.2
----------- ---------
Total assets........................................ $ 637,874.3 $30,047.0
=========== =========

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities......................................... 47,158.5 3,929.7
Long-term Debt.............................................. 471,652.1 --
Redeemable Cumulative Convertible Preferred Stock -- 0 and
40,498,062 shares issued and outstanding at December 31,
1998 and December 31, 1997, respectively.................. -- 33,409.4
Redeemable Warrants......................................... 8,634.1 --
Commitments and Contingencies
Stockholders' Equity (Deficit):
Common stock -- 50,341,554 and 426 shares issued and
outstanding at December 31, 1998 and December 31, 1997,
respectively.............................................. 503.4 --
Additional paid-in capital.................................. 416,729.9 3,008.4
Deferred compensation....................................... (14,617.3) (2,798.4)
Deferred management ownership allocation charge............. (26,224.7) --
Accumulated deficit......................................... (265,961.7) (7,502.1)
----------- ---------
Total stockholders' equity (deficit)................ 110,429.6 (7,292.1)
----------- ---------
Total liabilities and stockholders' equity
(deficit)........................................... $ 637,874.3 $30,047.0
=========== =========
</TABLE>

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

Under generally accepted accounting principles, upon consummation of the
initial public offering of common stock, Allegiance recorded the increase in
the assets of Allegiance Telecom, LLC allocated to the management investors
as a $193.5 million increase in additional paid-in capital, of which $122.5
million was recorded as a non-cash, non-recurring charge to operating
expense and $71.0 million was recorded as deferred management ownership
allocation charge. The deferred charge was amortized at $44.8 million during
1998, and will be further amortized at $18.8 million, $7.2 million and $.2
million during 1999, 2000 and 2001, respectively; this is the period over
which Allegiance has the right to repurchase the securities, at the lower of
fair market value or the price paid by the employee, in the event the
management employee's employment with Allegiance is terminated. See "Certain
Relationships and Related Transactions."

(2) Pro forma interest income excludes interest income that would have been
earned on the estimated $69.0 million of the proceeds from the offering of
the 12 7/8% notes required to be placed in a pledge account to secure and
fund the first six scheduled interest payments on the 12 7/8% notes.

18
<PAGE> 22

(6) EBITDA represents earnings before interest, income taxes, depreciation and
amortization, management ownership allocation charge and non-cash deferred
compensation. EBITDA is not a measurement of financial performance under
generally accepted accounting principles, is not intended to represent cash
flow from operations, and should not be considered as an alternative to net
loss as an indicator of Allegiance's operating performance or to cash flows
as a measure of liquidity. Allegiance believes that EBITDA is widely used by
analysts, investors and other interested parties in the telecommunications
industry. EBITDA is not necessarily comparable with similarly titled
measures for other companies.

(7) Reflects the purchase of $69.0 million of U.S. government securities, which
securities were placed in a pledge account, to fund the first six scheduled
interest payments on the 12 7/8% notes. For the year ended December 31, 1998
and for the period from inception on April 22, 1997 through December 31,
1997, also reflects the $13.2 million cash interest payment on May 15 and
November 15, respectively, on the 12 7/8% notes, which is funded through a
reduction of the pledge account.

(8) Reflects $193.8 million of net proceeds received from the offering of the
12 7/8% notes of which $69.0 million was required to be placed in a pledge
account to secure and fund the first six scheduled interest payments on the
12 7/8% notes, $137.8 million of net proceeds received from the initial
public offering of common stock, and $240.7 million of net proceeds from the
offering of the 11 3/4% notes and redeemable warrants.

(9) Reflects cash paid for capital expenditures.

19
<PAGE> 23

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

Allegiance is a competitive local exchange carrier ("CLEC"), seeking to be
a premier provider of telecommunications services to business, government and
other institutional users in major metropolitan areas across the United States.
Allegiance offers an integrated set of telecommunications products and services
including local exchange, local access, domestic and international long
distance, data and a full suite of Internet services. Its principal competitors
are incumbent local exchange carriers ("ILECs"), such as the regional Bell
operating companies and GTE Corporation operating units.

Allegiance is developing its networks throughout the United States using
what it refers to as a "smart build" approach. In contrast to the traditional
network build-out strategy under which carriers install their own
telecommunications switch in each market and then construct their own fiber
optic networks to reach customers, Allegiance installs its own switch in each
market but then leases other elements of the network from the ILECs. The
smart-build strategy specifically involves:

- leasing existing ILEC copper wire connections throughout a local market
area, also called the "local loop," which connect customers to the
central offices or "hubs" of an ILEC network, and

- installing, or physically locating, transmission equipment in these
central offices to route customer traffic through them to Allegiance's
own switch.

Locating equipment at ILEC facilities, also known as "collocation," is
central to the success of the smart build strategy. By collocating, Allegiance
has the ability to lease, on a monthly or long-term basis, local loop and other
network elements owned by the ILEC. This enables Allegiance to reach a wide
range of customers without having to build network connections to each one of
them.

Management believes that the smart build approach offers a number of
competitive advantages over the traditional build-out strategy by allowing
Allegiance to:

- accelerate market entry by nine to eighteen months through eliminating or
at least deferring the need for city franchises, rights-of-way and
building access;

- reduce initial capital expenditures in each market, allowing Allegiance
to focus its initial capital resources on the critical areas of sales,
marketing, and operations support systems, instead of on constructing
extensive fiber optic networks to each customer;

- improve return on capital by generating revenue with a smaller capital
investment;

- defer capital expenditures for network assets to the time when revenue
generated by customer demand is available to finance such expenditures;
and

- address attractive service areas selectively throughout target markets
and not just in those areas where Allegiance owns network transmission
facilities.

Once traffic volume justifies further investment, we may lease unused fiber
to which Allegiance adds its own electronic transmission equipment or construct
our own fiber network. This unused fiber is known as "dark fiber" because no
light is transmitted through it while it is unused. Allegiance believes that
dark fiber is readily available in most major markets. See "-- Results of
Operations" for a discussion of our leasing of dark fiber.

Allegiance has rapidly deployed its networks since commencing service in
December 1997 and was operating in nine markets across the United States as of
the end of 1998, and eleven as of March 15,

20
<PAGE> 24

1999. Allegiance has had significant success in selling its services to
customers, with approximately 86,500 lines sold during 1998. The table below
provides selected key operational data:

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------
1998 1997
----------- ----
<S> <C> <C>
Markets Served.............................................. 9 0
Number Of Switches Deployed................................. 7 0
Central Office Collocations................................. 101 0
Addressable Market (Business Lines)......................... 3.6 million 0
Lines Sold.................................................. 86,500 20
Lines Installed............................................. 47,700 9
Sales Force Employees....................................... 295 0
Total Employees............................................. 649 40
</TABLE>

Allegiance does not begin to develop a new market until it has raised the
capital that it projects to be necessary to build its network and operate that
market to the point at which operating cash flow from the market is sufficient
to fund such market's operating costs and capital expenditures.

RESULTS OF OPERATIONS

Allegiance commenced operations in August 1997. During the period from
August to December 1997, Allegiance did not sell any services or open any
markets. Instead, substantial effort was devoted to developing business plans,
initiating applications for governmental authorizations, hiring management and
other key personnel, working on the design and development of local exchange
telephone networks and operations support systems, acquiring equipment and
facilities, and negotiating interconnection agreements. Allegiance initiated
service by buying phone lines at wholesale prices and then reselling them to
nine "beta" customers in Dallas during December 1997, generating only $400 of
revenue for that period. Given that Allegiance has significantly increased its
customer base and geographic markets from the commencement of operations in
Dallas during 1997, comparisons of 1998 results with those of 1997 are not
meaningful.

Allegiance first provided service using its own switch and transmission
equipment in April 1998 to customers in New York City. Throughout the remainder
of 1998, it initiated facilities based services in Atlanta, Boston, Chicago,
Dallas, Fort Worth, Los Angeles, Oakland and San Francisco. In January 1999,
Allegiance announced that it was operational in Philadelphia. In March 1999,
Allegiance announced that it was operational in Washington, D.C., including
suburban Maryland and Virginia. Allegiance expects to become operational in San
Jose during the first quarter of 1999. Allegiance plans to open five additional
markets during 1999 for which it has already raised the necessary capital. In
addition, assuming the closing of our anticipated common stock offering and of
the credit facility, we plan to accelerate deployment of our networks in Detroit
and Baltimore into 1999.

Although Allegiance initiated resale services in Dallas in 1997, Allegiance
sales teams have focused their efforts almost exclusively on selling services
that require the use of Allegiance facilities. Allegiance earns significantly
higher margins by providing facilities based services instead of resale
services. During the fourth quarter of 1998, facilities based lines represented
91% of all lines sold and 83% of all lines installed, as compared to 86% of
lines sold and 73% of lines installed for the third quarter of 1998 and 51% of
lines sold and 17% of lines installed for the second quarter of 1998. For the
full year, 67,100 facilities based lines were sold, and 30,500 of those were
installed. Resale lines sold during 1998 totaled 19,400, of which 17,200 were
installed. Allegiance continues to emphasize the sale of facilities based
services and lines. We estimate that the proportion of customer lines for which
we simply resell service provided by other carriers will continue to decline to
the point that, eventually, no more than 5% of all lines Allegiance sells will
be resale lines.

21
<PAGE> 25

During 1998, Allegiance generated $9.8 million of revenue. The majority,
$6.9 million, was local service revenue consisting of:

- the monthly recurring charge for basic service;

- usage based charges for local calls in certain markets;

- charges for services, such as call waiting and call forwarding; and

- to a lesser extent, non-recurring charges, such as charges for additional
lines for an existing customer.

Access charges, which we earn by connecting Allegiance local service
customers to their selected long distance carriers for outbound calls or by
delivering inbound long distance traffic to Allegiance local service customers,
accounted for $2.2 million of Allegiance's 1998 revenues. Some interexchange
carriers, including AT&T, have also asked the FCC to take regulatory action to
prevent competitive local exchange carriers from charging allegedly "excessive"
access charges. Although no complaints have been filed against us, we do provide
access service to interexchange carriers and we could be subject in the future
to allegations that our charges for this service are unjust and unreasonable.
See "Business -- Federal Regulation." As of December 31, 1998, approximately 20%
of Allegiance's local service customers had chosen Allegiance as their long
distance carrier. Long distance revenues during 1998 amounted to $.7 million.
All other sources of revenue accounted for approximately $10,000 during 1998.

During 1998, Allegiance recognized an insignificant amount of revenue from
"reciprocal compensation" generated by having customers of other local exchange
carriers calling Internet service providers which are Allegiance customers.
Allegiance had no revenue from reciprocal compensation during 1997. Given the
uncertainty as to whether reciprocal compensation should be payable in
connection with calls to Internet service providers, Allegiance recognizes such
revenue only when realization of it is certain, which in most cases will be upon
receipt of cash. See "Business -- Federal Regulation" for a discussion of
reciprocal compensation.

The revenue yield, or revenue generated per line per month, was
approximately $56.00 for all of 1998. Allegiance received significant orders for
lines from certain Internet service providers during the fourth quarter of 1998.
As these lines are installed, the current mix between end-user retail lines and
Internet service provider wholesale lines will change. However, the switch
capacity used for the Internet service provider lines will be well below
Allegiance's policy limit of 20%. Internet service provider wholesale lines
typically generate approximately half the revenue yield, excluding the
reciprocal compensation component of revenue, of that provided by an end-user
retail line. The revenue yield may decline during the first half of 1999 as a
result of the change in the mix. However, data and Internet services such as
frame relay, which is a high speed data service used to transmit data between
computers, dedicated and dial-up access to the Internet, web page design, e-mail
and domain name service, which we introduced in December 1998, may partially, or
perhaps completely, offset the reduction anticipated from the receipt of those
orders.

Although our primary focus is on serving higher margin, higher revenue
generating end-user lines, significant Internet wholesale line orders, such as
those received during the fourth quarter of 1998, contribute positively to gross
margin even excluding the reciprocal compensation component of revenue. For this
reason, we will accept such orders in the future but do not plan to allow the
installation of such lines to constitute more than 20% of our switch capacity.

During 1998, Allegiance did not have sales of or revenue from installation
of customer premise equipment. Allegiance did not have revenue from system
integration activities, wireless, data or Internet services. Allegiance does not
plan to sell customer premise equipment or wireless services in the foreseeable
future.

22
<PAGE> 26

Acquisitions during 1999 may increase revenues and revenue yield.
Allegiance has had discussions, and will continue to have discussions in the
foreseeable future, concerning potential acquisitions of Internet service
providers and other providers of telecommunications services.

The systems that have historically been used to switch customers from their
existing carrier to Allegiance and to begin providing them service generally
require multiple entries of customer information by hand and exchanged by fax
with the ILEC. In January 1999, Allegiance announced that it had successfully
achieved "electronic bonding" between its operations support systems and those
of Bell Atlantic in the New York City market with respect to processing local
service orders. Electronic bonding is a method in which manual processing and
faxing of information is replaced with electronic processing where our computer
systems and those of other carriers communicate directly. The manual approach
which we must use in the absence of electronic bonding is not only labor
intensive, but also creates numerous opportunities for:

- errors in providing new service and billing;

- service interruptions;

- poor customer service; and

- increased customer turnover.

These problems create added expenses and decrease customer satisfaction.

Without electronic bonding, confirmation of receipt and installation of
orders has taken from two business days to one month. Electronic bonding is
expected to improve productivity by decreasing the period between the time of
sale and the time a customer's line is installed. During 1999, Allegiance
expects to electronically bond with Bell Atlantic in other markets and with
other ILECs. Currently, Allegiance and Bell Atlantic are testing electronic
bonding in Boston and Allegiance and Southwestern Bell are testing electronic
bonding in Dallas. The early results of these efforts have been encouraging.
Allegiance and Pacific Bell are discussing the possibility of using this same
template to pass service requests between these parties. Ameritech has also
contacted us regarding the initiation of a project to electronically bond.

Allegiance is also working towards the electronic bonding of its billing
process, the process of gathering customer specific information about their
current service options and the process of identifying and resolving customer
service problems. These additional "electronic bonding" initiatives will require
additional capital expenditures and should result in additional efficiencies.

Network expenses increased from $.2 million in 1997 to $9.5 million in
1998. This sharp increase is consistent with the deployment of our networks and
initiation and growth of our services during 1998. Network expenses represent:

- the cost of leasing high capacity digital lines that interconnect
Allegiance's network with ILEC networks;

- the cost of leasing high capacity digital lines that connect Allegiance's
switching equipment to Allegiance transmission equipment located in ILEC
central offices;

- the cost of leasing local loop lines which connect Allegiance's customers
to Allegiance's network;

- the cost of leasing space in ILEC central offices for collocating
Allegiance transmission equipment; and

- the cost of leasing Allegiance's nationwide Internet network.

The costs to lease local loop lines and high capacity digital lines from
the ILECs vary by ILEC and are regulated by state authorities under the
Telecommunications Act of 1996. Allegiance believes that in many instances there
are multiple carriers in addition to the ILEC from which it can lease high
capacity

23
<PAGE> 27

lines, and that Allegiance can generally lease those lines at lower prices than
are charged by the ILEC. Allegiance expects that the costs associated with these
leases will increase with customer volume and will be a significant part of its
ongoing cost of services. The cost of leasing switch sites is also a significant
part of Allegiance's ongoing cost of services.

In constructing its initial switching and transmission equipment for a new
market, Allegiance capitalizes only the non-recurring charges associated with
its initial network facilities and the monthly recurring costs of those network
facilities until the switching equipment begins to carry revenue producing
traffic. Typically, the charges for just one to two months are capitalized. We
expense the monthly recurring and non-recurring costs resulting from the growth
of existing collocation sites, and the costs related to expansion of the network
to additional collocation sites in operational markets as we incur these
charges.

In an effort to reduce network expenses, Allegiance is moving to the next
stage of its smart build strategy in New York City and Dallas by entering into
leases for dark fiber to which Allegiance is installing its own electronic
equipment. These leases are accounted for as capital leases. In New York City,
Allegiance has entered into an agreement to lease three rings of dark fiber in
Manhattan with an extension into Brooklyn. In the Dallas market, Allegiance has
reached an agreement to lease one ring of dark fiber in Dallas County.
Allegiance anticipates that any future dark fiber leases will have roughly
similar terms and conditions and therefore it is likely that such additional
dark fiber leases, if any, will also be accounted for as capital leases.

We expect "reciprocal compensation" costs to be a major portion of our cost
of services. Allegiance must enter into an interconnection agreement with the
ILEC in each market to make widespread calling available to Allegiance's
customers. These agreements typically set the cost per minute to be charged by
each party for the calls that are exchanged between the two carriers' networks.
Generally, a carrier must compensate another carrier when a local call by the
first carrier's customer terminates on the second carrier's network. These
reciprocal compensation costs will grow for Allegiance as its customers'
outbound call volume grows. We expect, however, to generate increased revenue
from the ILECs as inbound calling volume to our customers increases. If our
customers' outbound call volume is equivalent to their inbound call volume, our
interconnection costs paid to the ILECs will be substantially offset by the
interconnection revenues we receive from them.

The cost of securing long distance service capacity will increase as
Allegiance's customers long distance calling volume increases. Allegiance
expects that these costs will be a significant portion of its cost of long
distance services. Allegiance has entered into one resale agreement with a long
distance carrier to provide Allegiance with the ability to provide our customers
with long distance service. Allegiance expects to enter into resale agreements
for long distance service with other carriers in the future. Such agreements
typically provide for the resale of long distance services on a per-minute basis
and may contain minimum volume commitments. Allegiance's existing resale
agreement, however, does not contain a minimum volume commitment. If Allegiance
agrees to minimum volume commitments and fails to meet them, it may be obligated
to pay underutilization charges. Under most of these agreements, if a company
underestimates its need for transmission capacity and exceeds the maximum amount
agreed to under such agreements, it may be required to obtain capacity through
more expensive means.

Allegiance leases high capacity digital lines which comprise its Internet
network, and currently has servers in New York, Dallas and San Francisco. The
costs of these lines will increase as Allegiance opens new markets and connects
the additional markets to its Internet network.

Selling, general and administrative expenses increased to $46.1 million in
1998 from just $3.4 million in 1997, primarily due to the growth of our
business. Selling, general and administrative expenses include salaries and
related personnel costs, facilities costs, legal and consulting fees. The number
of employees increased to 649 as of December 31, 1998, from 40 as of December
31, 1997. As of December 31, 1998, the sales force, including sales manager and
sales administrators, had grown to 295. Allegiance did not employ any account
executives, major account managers or sales engineers prior to January 1998.
During

24
<PAGE> 28

1999, Allegiance expects the number of its sales personnel to grow
significantly. Allegiance currently does not use agents to sell its services nor
does it currently use any print or other media advertising campaigns.

As Allegiance continues to grow in terms of number of customers and call
volume, we expect that ongoing expenses for customer care and billing will
increase.

The magnitude of our net loss for 1998 is principally due to the management
ownership allocation charge, a non-cash charge to income. Allegiance's original
private equity fund investors and its original management team investors owned
95.0% and 5.0%, respectively, of the ownership interests of Allegiance Telecom,
LLC, an entity that owned substantially all of Allegiance's outstanding capital
stock prior to Allegiance's initial public offering of its common stock. As a
result of that offering, the assets of Allegiance Telecom, LLC, which consisted
almost entirely of such capital stock, were distributed to the original fund
investors and management investors in accordance with the Allegiance Telecom,
LLC limited liability company agreement. This agreement provided that the equity
allocation between the fund investors and management investors would be 66.7%
and 33.3%, respectively, based upon the valuation implied by the initial public
offering. Under generally accepted accounting principles, Allegiance recorded
the increase in the assets of Allegiance Telecom, LLC allocated to the
management investors as a $193.5 million increase in additional paid-in capital.
Of this charge, we recorded $122.5 million as a non-cash, non-recurring charge
to operating expense and $71.0 million as a deferred management ownership
allocation charge. We amortized $44.8 million of the deferred charge in 1998. We
will further amortize this deferred charge at $18.8 million, $7.2 million and
$.2 million during 1999, 2000 and 2001, respectively. This period is the
time-frame over which Allegiance has the right to repurchase the securities, at
the lower of fair market value or the price paid by the employee, in the event
the management employee's employment with Allegiance is terminated.

In addition to the above expenses, Allegiance recognized $5.3 million and
$.2 million amortization of deferred stock compensation expense for the years
ended December 31, 1998 and 1997, respectively, also non-cash charges. Such
deferred compensation was recorded in connection with membership units of
Allegiance Telecom, LLC sold to certain management employees and grants to
employees under Allegiance's 1997 Stock Option Plan made prior to Allegiance's
initial public offering of common stock.

Depreciation expense increased from approximately $13,000 in 1997 to $9.0
million in 1998, consistent with the completion of Allegiance's networks and
initiation of services in nine markets by December 31, 1998.

Interest expense for the year ended December 31, 1998 was $39.0 million.
There was no interest expense incurred during 1997. Interest expense recorded
during 1998 reflects the issuance on February 3, 1998 of 11 3/4% Senior Discount
Notes due 2008, and the issuance on July 7, 1998 of 12 7/8% Senior Notes due
2008. See "-- Liquidity and Capital Resources" below for a discussion of these
note offerings. Allegiance capitalizes a portion of its interest costs as part
of the construction cost of its networks, in accordance with Statement of
Financial Accounting Standards No. 34. The amount of interest capitalized during
1998 was $2.8 million. No interest was capitalized during 1997. Interest income
during 1998 and 1997 was $19.9 million and $.1 million, respectively, resulting
from the investment of excess cash and from U.S. Government securities which we
purchased and placed in a pledge account to secure the semi-annual payments of
interest through May 2001 on the 12 7/8% Senior Notes due 2008.

Allegiance has recorded the potential redemption value of its redeemable
warrants in the event that they are redeemed at fair market value in February
2008. Amounts are accreted using the effective interest method and management's
estimates of the future fair market value of such warrants when redemption is
first permitted. Amounts accreted increase the recorded value of such warrants
on the balance sheet and result in a non-cash charge to increase the net loss
applicable to Allegiance's common stock. Accretion of $.5 million related to the
redeemable warrants has been recorded for the year ending December 31, 1998.

Until the consummation of Allegiance's initial public offering of common
stock, Allegiance also recorded the potential redemption values of its
redeemable convertible preferred stock, in the event that they would be redeemed
at fair market value in August 2004. At the time of the initial public offering,

25
<PAGE> 29

such preferred stock was converted into common stock. Accordingly, the amounts
accreted for the redeemable convertible preferred stock were reclassified as an
increase to additional paid-in capital in the stockholders' equity section of
the balance sheet, and there has been, and will be, no additional accretion of
redeemable convertible preferred stock values beyond that point in time.
Accretion related to the redeemable convertible preferred stock of $11.5 million
was recorded for the year ending December 31, 1998 and $3.8 million was recorded
for the year ending December 31, 1997.

Our net loss for 1998, after the non-cash, one-time management allocation
charge and amortization of deferred compensation and a portion of the deferred
management allocation charge, but before the accretion of the redeemable
convertible preferred stock and redeemable warrants, was $246.5 million and was
$3.7 million for the period from inception to December 31, 1997. After deducting
accretion of preferred stock and warrant values, the net loss applicable to
common stock was $258.5 million and $7.5 million for the year ended December 31,
1998 and for the period from inception to December 31, 1997, respectively.

Many securities analysts use the measure of earnings before deducting
interest, taxes, depreciation and amortization, also commonly referred to as
"EBITDA," as a way of evaluating a company. Allegiance had EBITDA loss of $45.8
million and $3.6 million for the year ended December 31, 1998 and for the period
from inception to December 31, 1997, respectively. In calculating EBITDA,
Allegiance also excludes the non-cash charges to operations for management
ownership allocation charge and deferred stock compensation expense totaling
$172.6 million and $.2 million for the year ended December 31, 1998 and for the
period from inception to December 31, 1997, respectively.

Allegiance expects to continue to experience increasing operating losses
and negative EBITDA as a result of its development activities and as it expands
its operations. Allegiance does not expect to achieve positive EBITDA in any
market until at least its second year of operation in such market.

LIQUIDITY AND CAPITAL RESOURCES

Allegiance's financing plan is predicated on the pre-funding of each
market's expansion to positive free cash flow. By using this approach,
Allegiance avoids being in the position of seeking additional capital to fund a
market after Allegiance has already made significant capital investment in that
market. We believe that by raising all required capital prior to making any
commitments in a market, we can raise capital on more favorable terms and
conditions.

Allegiance plans to establish networks in the 24 largest U.S. metropolitan
markets. We estimate that we will need approximately $750 million to $850
million to construct these networks and fund our operating losses in these
markets to the point of positive free cash flow. We have raised approximately
$554 million in total capital since our inception. We believe that the proceeds
from the anticipated offering of our common stock and the anticipated senior
credit facility, together with existing capital resources, will be sufficient to
pre-fund market deployment in all of our 24 targeted markets.

We may decide to seek additional capital in the future to expand our
business and sources of additional financing may include vendor financing and/or
the private or public sale of Allegiance's equity or debt securities. We cannot
assure you, however, that such financing will be available at all or on terms
acceptable to Allegiance, or that Allegiance's estimate of additional funds
required is accurate.

The actual amount and timing of Allegiance's future capital requirements
may differ materially from its estimates as a result of, among other things:

- the cost of the development of its networks in each of its markets;

- a change in or inaccuracy of its development plans or projections that
leads to an alteration in the schedule or targets of its roll-out plan;

- the extent of price and service competition for telecommunications
services in its markets;

- the demand for its services;

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<PAGE> 30

- regulatory and technological developments, including additional market
developments and new opportunities, in Allegiance's industry;

- an inability to borrow under its senior credit facility; and

- the consummation of acquisitions.

Allegiance's cost of rolling out its networks and operating its business,
as well as its revenues, will depend on a variety of factors, including:

- its ability to meet its roll-out schedules;

- its ability to negotiate favorable prices for purchases of equipment;

- its ability to develop, acquire and integrate the necessary operations
support systems and other back office systems;

- the number of customers and the services for which they subscribe;

- the nature and penetration of new services that Allegiance may offer; and

- the impact of changes in technology and telecommunication regulations.

As such, actual costs and revenues may vary from expected amounts, possibly
to a material degree, and such variations are likely to affect Allegiance's
future capital requirements.

Allegiance initially raised approximately $50.1 million from certain
members of the Allegiance management team and from affiliates of four private
equity investment funds with extensive experience in financing
telecommunications companies: Madison Dearborn Capital Partners, Morgan Stanley
Capital Partners, Frontenac Company and Battery Ventures.

On February 3, 1998, Allegiance raised gross proceeds of approximately
$250.5 million in an offering of 445,000 units, each unit consisting of one
11 3/4% note and one redeemable warrant to purchase .0034224719 shares of common
stock at an exercise price of $.01 per share, subject to certain antidilution
provisions. Net proceeds of approximately $240.7 million were received from this
offering.

The 11 3/4% notes have a principal amount at maturity of $445.0 million and
an effective interest rate of 12.45%. The 11 3/4% notes mature on February 15,
2008. From and after February 15, 2003, interest on such notes will be payable
semi-annually in cash at the rate of 11 3/4% per annum. The accretion of
original issue discount will cause an increase in indebtedness from December 31,
1998 to February 15, 2008 of $174.5 million.

Allegiance completed the initial public offering of its common stock and
the offering of the 12 7/8% notes early in the third quarter of 1998. Allegiance
raised net proceeds of approximately $124.8 million from the offering of these
notes and approximately $137.8 million from its initial public offering of
common stock.

The 12 7/8% notes mature on May 15, 2008. Interest on these notes is
payable in cash semi-annually, commencing November 15, 1998. The 12 7/8% notes
were sold at less than par, resulting in an effective rate of 13.24%, and the
value of the 12 7/8% notes is being accreted, using the effective interest
method, from the $200.9 million gross proceeds realized at the time of the sale
to the aggregate value at maturity, $205.0 million, over the period ending May
15, 2008. In connection with the sale of the 12 7/8% notes, Allegiance purchased
U.S. Government securities for approximately $69.0 million and placed them in a
pledge account to fund interest payments for the first three years the 12 7/8%
notes are outstanding. Such securities are reflected in the balance sheet as of
December 31, 1998, at accreted value of approximately $62.2 million, $25.5
million of which we classified as current assets and $36.7 million of which we
classified in other non-current assets.

Allegiance made capital expenditures of $21.9 million and $113.5 million
during 1997 and 1998, respectively, for property, plant, equipment, software and
hardware necessary in deploying its networks in

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<PAGE> 31

nine markets and providing operations and other support systems necessary in
conducting its business. Allegiance also used capital during 1998 to fund its
operations; excess cash was used to purchase short-term investments and money
market investments.

On December 31, 1998, Allegiance had transmission equipment collocated in
101 ILEC central offices. Allegiance anticipates that it will more than double
its number of collocations during 1999. As of December 31, 1998, Allegiance had
committed $17.1 million of its capital for switching equipment and switch
facilities and $3.2 million for dark fiber leases. Under Allegiance's current
business plans, it plans to make approximately $250 million in capital
expenditures in 1999, including purchases of switching equipment, switch and
sales facilities, transmission equipment and collocation facilities.

As of December 31, 1998, Allegiance had approximately $405.9 million of
cash and short-term investments. This amount excludes the $62.2 million of
restricted U.S. Government securities that have been placed in a pledge account.

On March 19, 1999, Allegiance announced that it intends to offer 10,000,000
shares of its common stock in an underwritten primary offering. On that date,
Allegiance also announced that it had retained Goldman Sachs Credit Partners
L.P., TD Securities (USA) Inc. and Morgan Stanley Senior Funding, Inc. to
arrange a senior secured revolving credit facility maturing December 31, 2005
for a subsidiary of Allegiance Telecom, Inc. These banks have received
commitments for this facility aggregating in excess of $200.0 million from
various lenders. These commitments remain subject to various conditions
including the negotiation and execution of a definitive credit agreement. This
revolving facility will be available, subject to satisfaction of certain terms
and conditions, to provide purchase money financing for the acquisition,
construction and improvement of telecommunications assets by Allegiance's
operating subsidiaries. Borrowings under the facility will not be available
until we reach certain financial and operating objectives, and then will only be
available to the extent we have achieved certain further objectives and have
maintained certain financial ratios and covenants. See the discussion under
"Description of Certain Indebtedness -- Revolving Credit Facility." Based on
Allegiance's current business plan, we do not expect to draw on this facility
until 2000.

The facility will be structurally senior to Allegiance's 12 7/8% notes and
11 3/4% notes issued in 1998. The facility will be secured by substantially all
of the assets of Allegiance's subsidiaries and the stock of the Allegiance
borrowing subsidiary and will be guaranteed by Allegiance Telecom, Inc. Interest
rates under the facility will be tied to the level of debt compared to
consolidated EBITDA and is initially expected to be the London Interbank
Offering Rate + 3.75%. The commitment fee on the undrawn portion of the facility
is initially expected to be 1.50% of the total amount of the facility, with
step-downs based on utilization. The facility will also contain certain
representations, warranties, covenants and events of default customary for
credits of this nature and otherwise agreed upon by the parties. We expect that
this facility will close in April 1999. See the section titled "Description of
Certain Indebtedness -- Revolving Credit Facility" for a further discussion of
this credit facility.

Allegiance's earnings for the year ended December 31, 1998 and for the
period from inception on April 22, 1997 through December 31, 1997 were
insufficient to cover fixed charges by approximately $249.3 million and $3.7
million, respectively. After giving pro forma effect to the increase in interest
expense resulting from the issuance of the 12 7/8% notes and the 11 3/4% notes
and giving effect to $12.6 million and $171.7 million of management ownership
allocation charge to be recorded in connection with the initial public offering
of common stock, Allegiance's earnings would have been insufficient to cover
fixed charges by approximately $285.1 million and $216.6 million, for the year
ended December 31, 1998 and for the period from inception on April 22, 1997
through December 31, 1997, respectively.

IMPACT OF THE YEAR 2000

calculations may be inaccurate. The failure to process dates could result in
network and system failures or miscalculations causing disruptions in operations
including, among other things, a temporary inability to process transactions,
send invoices or engage in other routine business activities.

State of Readiness. Generally, Allegiance has identified two areas for year
2000 review: internal systems and operations, and external systems and services.
As a new enterprise, Allegiance does not have older systems that are not year
2000 ready. As it develops its network and support systems, Allegiance intends
to ensure that all systems will be year 2000 ready. Allegiance is purchasing its
operations support systems with express specifications, warranties and remedies
that all systems be year 2000 ready. In addition, Allegiance requires all
vendors supplying third party software and hardware to warrant year 2000
readiness. However, there can be no assurance until the year 2000 that all
systems will then function adequately. Also, Allegiance intends to sell its
telecommunications services to companies that may rely upon computerized systems
to make payments for such services, and to interconnect certain portions of its
network and systems with other companies' networks and systems. These
transactions and interactions could expose Allegiance to year 2000 problems.

Allegiance is in the process of conducting a company-wide inventory of all
computer systems on which the company relies, both within and outside of
Allegiance. This inventory is scheduled to be completed by the end of May 1999.
Allegiance will use this inventory to contact its external suppliers, vendors
and providers to obtain information about their year 2000 readiness and, based
on that information, will assess the extent to which these external information
technology and non-information technology systems, including embedded
technology, could cause a material adverse effect on Allegiance's operations in
the event that the systems fail to properly process date-sensitive transactions
after December 31, 1999.

Allegiance's assessment of its year 2000 readiness will be ongoing as it
continues to develop its own operations support systems and becomes reliant on
the systems of additional third parties as a result of the geographic expansion
of its business into additional markets. As a result, Allegiance may in the
future identify a significant internal or external year 2000 issue which, if not
remedied in a timely manner, could have a material adverse effect on
Allegiance's business, financial condition and results of operations.

Costs to Address Year 2000 Issues. Allegiance has used its internal
information technology and other personnel in identifying year 2000 issues.
Allegiance does not anticipate any significant costs to make its internal
systems year 2000 compliant because it does not expect any remediation to be
required and does not expect to make material expenditures for outside
consultants to assist Allegiance in its effort to address year 2000 issues.
Because no material year 2000 issues have yet been identified in connection with
external sources, Allegiance cannot reasonably estimate costs that may be
required for remediation or for implementation of contingency plans. As
Allegiance gathers information relating to external sources of year 2000 issues,
Allegiance will reevaluate its ability to estimate costs associated with year
2000 issues. There can be no assurance that as additional year 2000 issues are
addressed, Allegiance's costs to remediate such issues will be consistent with
its historical costs.

Risks of Year 2000 Issues. Allegiance cannot reasonably ascertain the
extent of the risks involved in the event that any one system fails to process
date-sensitive calculations accurately because it has not identified any
material year 2000 issues. Potential risks include:

- the inability to process customer billing accurately or in a timely
manner;

- the inability to provide accurate financial reporting to management,
auditors, investors and others;

- litigation costs associated with potential suits from customers and
investors;

- delays in implementing other information technology projects as a result
of work by internal personnel on year 2000 issues;

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<PAGE> 33

- delays in receiving payment or equipment from customers or suppliers as a
result of their systems' failure; and

- the inability to occupy and operate in a facility.

Any one of these risks, if they materialize, could individually have a
material adverse effect on Allegiance's business, financial condition or results
of operations.

All of Allegiance's information technology and non-information technology
systems and products relating to Allegiance's external issues are manufactured
or supplied by other companies outside of Allegiance's control. As a result, we
cannot assure you that the systems of any of those companies will be year 2000
ready. In particular, Allegiance will be dependent upon other ILECs, long
distance carriers and other companies for interconnection and completion of
off-network calls. These interconnection arrangements are material to
Allegiance's ability to conduct its business and failure by any of these
providers to be year 2000 ready may have a material adverse effect on
Allegiance's business in the affected market. Moreover, although Allegiance has
taken every precaution to purchase its internal systems to be fully year 2000
ready, there can be no assurance that every vendor will fully comply with the
contract requirements. If some or all of Allegiance's internal and external
systems fail or are not year 2000 ready in a timely manner, there could be a
material adverse effect on Allegiance's business, financial condition or results
of operations.

Contingency Plans. Even though Allegiance has not identified any specific
year 2000 issues, Allegiance believes that the design of its networks and
support systems could provide Allegiance with certain operating contingencies in
the event material external systems fail. In all of its markets, however,
Allegiance has or intends to establish interconnection agreements with the ILECs
and other regional and international carriers. If one of these carriers fails
for any reason, including year 2000 problems, there may be little Allegiance can
do to mitigate the impact of such a failure on Allegiance's operations.
Allegiance has attempted to ensure that its own operating facilities and systems
are fully backed up with auxiliary power generators capable of operating all
equipment and systems for indeterminate periods should power supplies fail,
subject to the availability of fuel to run these generators. Allegiance also has
the ability to relocate headquarters and administrative personnel to other
Allegiance facilities should power and other services at its Dallas headquarters
fail. Because of the inability of Allegiance's contingency plans to eliminate
the negative impact that disruptions in ILEC service or the service of other
carriers would create, there can be no assurance that Allegiance will not
experience numerous disruptions that could have a material effect on
Allegiance's operations.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Allegiance's investment policy is limited by its existing bond indentures.
Allegiance is restricted to investing in financial instruments with a maturity
of one year or less. The indentures require investments in high quality
instruments, such as obligations of the U.S. Government or any agency thereof
guaranteed by the United States of America, money market deposits, and
commercial paper with a rating of A1/P1.

Allegiance is thus exposed to market risk related to changes in short-term
U.S. interest rates. Allegiance manages these risks by closely monitoring market
rates and the duration of its investments. Allegiance does not enter into
financial or commodity investments for speculation or trading purposes and is
not a party to any financial or commodity derivatives.

Interest income earned on Allegiance's investment portfolio is affected by
changes in short-term U.S. interest rates. Allegiance believes that it is not
exposed to significant changes in fair value because of its conservative
investment strategy. However, the estimated interest income for the calendar
year 1999, based on the average 1998 earned rate on investments, is $13.6
million and assuming a 100 basis point

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<PAGE> 34

drop in the average rate, Allegiance would be exposed to a $2.5 million
reduction in interest income for the year. The following table illustrates this
impact on a quarterly basis:

<TABLE>
<CAPTION>
QUARTER ENDING
--------------------------------------
MARCH JUNE SEPTEMBER DECEMBER
1999 1999 1999 1999 TOTAL
------ ------ --------- -------- -----
($S IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Estimated Average Outstanding Balance....................... $367.4 $290.7 $213.9 $131.8
Estimated Interest Earned at Estimated Rate of 5.4% at
December 31, 1998......................................... $ 5.0 $ 3.9 $ 2.9 $ 1.8 $13.6
Estimated Impact of Interest Rate drop...................... $ 0.9 $ 0.7 $ 0.5 $ 0.3 $ 2.5
</TABLE>

Allegiance has outstanding long term, fixed rate notes, not subject to
interest rate fluctuations.

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<PAGE> 35

BUSINESS

OVERVIEW

Allegiance seeks to be a premier provider of telecommunications services to
business, government and other institutional users in 24 of the largest major
metropolitan areas across the United States. Allegiance offers an integrated set
of telecommunications products and services including local exchange, local
access, domestic and international long distance, enhanced voice, data and a
full suite of Internet services. Allegiance generally prices these services at a
discount of 5% to 15% below the prices charged by the incumbent local exchange
carriers. Allegiance was founded in April 1997 by a management team led by Royce
J. Holland, the former President, Chief Operating Officer and co-founder of MFS
Communications, and Thomas M. Lord, former Managing Director of Bear, Stearns &
Co. Inc., where he specialized in the telecommunications, information services
and technology industries.

Allegiance believes that the Telecommunications Act, by opening the local
exchange market to competition, has created an attractive opportunity for new
facilities-based competitive local exchange carriers like Allegiance. Most
importantly, the Telecommunications Act stated that these carriers, known as
CLECs, should be able to lease the various elements of the ILECs' networks,
which are necessary for the cost-effective provision of service. This aspect of
the Telecommunications Act, which is referred to as "unbundling" the ILEC
networks, has enabled Allegiance to deploy digital switches with local and long
distance capability and lease fiber optic lines from the ILECs, other CLECs, and
other telecommunications companies to connect Allegiance's switch with its
transmission equipment located in ILEC central offices. Once traffic volume
growth justifies further capital investment, Allegiance may lease dark fiber or
construct its own fiber network.

Allegiance has developed procedures, together with its back office systems
vendors, MetaSolv, DSET, Lucent and Intertech, that it believes will provide it
with a significant competitive advantage in terms of reducing costs, processing
large order volumes and providing customer service. Back office systems enable a
phone company to enter, schedule and track a customer's order from the point of
sale to the installation and testing of service. These systems also include or
interface with trouble management, inventory, billing, collection and customer
service systems.

Allegiance is determined to achieve electronic bonding, the on-line and
real-time connection of Allegiance's operations support systems with those of
the ILECs, with each of the incumbent telecommunications companies in most of
its markets by the end of 1999. On January 8, 1999, Allegiance and Bell Atlantic
became the first major facilities-based CLEC and ILEC to formally engage in
electronic bonding after working since April 1998 to develop the necessary
software and processes. This will allow Allegiance to create service requests
on-line, leading to faster installations of customer orders through a reduction
in errors associated with multiple manual inputs. Allegiance expects electronic
bonding to improve productivity by decreasing the period between the time of
sale and the time a customer's line is installed in the Allegiance network. In
addition, Allegiance expects that the simplified process will reduce selling,
general and administrative costs.

Allegiance believes that it will be some time before many other CLECs and
telecommunications service companies will be able to implement similar
electronic bonding systems. Unlike Allegiance, which is a new company designing
its systems specifically for electronic bonding, most of these other carriers
have systems that have been in place for years and already support a large
number of customers with ongoing service. Updating these systems can therefore
disrupt service and be much more costly and time consuming.

Allegiance intends to continue network deployment of its initial 24
markets. Allegiance estimates that these 24 markets will include more than 21
million non-residential access lines. According to Allegiance estimates, this
represents approximately 44.7% of the total non-residential access lines in the
U.S. With a strategy focusing on the central business districts and suburban
commercial districts in these areas, Allegiance plans to address a majority of
the non-residential access lines in most of its targeted markets.

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<PAGE> 36

As of March 15, 1999, Allegiance was operational in eleven markets: New
York City, Dallas, Atlanta, Fort Worth, Chicago, Los Angeles, San Francisco,
Boston, Oakland, Philadelphia and Washington, D.C. As of such date, Allegiance
was in the process of deploying networks in six other markets: Houston, Long
Island, Northern New Jersey, Orange County, San Diego and San Jose.

BUSINESS STRATEGY

To accomplish its goal of becoming a premier provider of telecommunications
services to business, government, and other institutional users in major U.S.
metropolitan areas, Allegiance has developed a customer-focused business
strategy designed to achieve significant market penetration and deliver superior
customer care while maximizing operating margins. The key components of this
strategy include the following:

Leverage Proven Management Team. Allegiance's veteran management team has
extensive experience and past successes in the CLEC industry. Allegiance
believes that its ability to combine and draw upon the collective talent and
expertise of its senior management gives it a competitive advantage in the
effective and efficient execution of network deployment, sales, provisioning,
service installation, billing and collection, and customer service functions.
Allegiance's Chairman and Chief Executive Officer, Royce J. Holland, has more
than 25 years of experience in the telecommunications and energy industries,
including as President, Chief Operating Officer and co-founder of MFS
Communications, one of the first companies to compete with the ILECs. Under his
leadership, MFS Communications grew from a start-up operation to become the
largest competitor to the incumbent local exchange carriers. It grew to $1.1
billion in revenues before its acquisition by WorldCom, Inc. in 1996. Dan Yost,
the President and Chief Operating Officer of Allegiance, has more than 26 years
of telecommunications industry experience, including experience as President and
Chief Operating Officer of Netcom On-Line Communications Services, Inc. from
July 1997 to February 1998, and as President, Southwest Region of AT&T Wireless
Services, Inc. from June 1994 to July 1997. Other key Allegiance executives have
significant experience in the critical functions of network operations, sales
and marketing, back office and operations support systems, finance and
regulatory affairs.

Target Customers with Integrated Service Offerings. Allegiance focuses
principally on customers in the business, government and other institutional
market segments. The majority of our customers are small and medium-sized
businesses, to which we offer "one-stop shopping" by giving them the ability to
purchase a comprehensive package of communications services from a single
supplier. We also offer convenient integrated billing and a single point of
contact for sales and service. We offer the following services in most of our
markets:

- local and long distance services,

- local area network interconnection,

- frame relay, a high speed data service used to transmit data between
computers and designed to operate at higher speeds,

- Internet services, and

- Integrated Services Digital Network ("ISDN"), an internationally agreed
upon standard which, through special equipment, allows two-way,
simultaneous voice and data transmission in digital formats over the same
transmission line.

In addition, we expect to offer the following services beginning in 1999:

- Digital Subscriber Lines ("DSL"), which allow high speed digital
connection for carrying voice and data traffic over copper lines,

- Web page design, and

- Web server hosting.

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These comprehensive services are generally not available from the ILECs, or
available only at high prices. By offering a comprehensive package of
communications services together with traditional local and long distance
services, we believe that we can accelerate our ability to establish new
customer accounts and reduce the number of customers who discontinue our
services and switch to other telecommunications providers.

For large businesses and government and other institutional users, which
typically obtain telecommunications services from a variety of suppliers, we
focus primarily on capturing a significant portion of these customers' local
exchange, intraLATA toll, which are the calls that fall within a local service
area, and data traffic. Although we will principally target end-users in markets
where we believe we can achieve significant market penetration by providing
superior customer care at competitive prices, we may augment our core business
strategy by selectively supplying wholesale services including equipment
collocation and facilities management services to Internet service providers.

Utilize "Smart Build" Strategy to Maximize Speed to Market and Minimize
Investment Risk. We will continue to pursue what we refer to as a "smart build"
strategy. Under this strategy, we

- purchase and install switches;

- locate our equipment in the central office facilities of incumbent local
exchange carriers; and

- lease unbundled network elements from the incumbent local exchange
carriers until growth justifies our ownership of additional network
assets.

Once traffic volume justifies further investment, we may then lease dark
fiber or construct our own fiber network.

We believe that this smart build strategy offers a number of economic
benefits. First, the strategy allows us to enter into a new market in a six- to
nine-month time frame, less than half the 18-24 months generally required under
the traditional "build first, sell later" approach required before the
Telecommunications Act established a framework for CLECs to acquire unbundled
network elements. We believe that this smart build strategy has the additional
advantage of reducing initial capital requirements in each market, allowing us
to focus our initial capital resources on the critical areas of sales, marketing
and operations support systems, instead of on constructing extensive fiber optic
networks to each customer.

We are currently implementing this smart build strategy in all of our
networks where we lease high capacity circuits to connect the central office
facilities of incumbent local exchange carriers with our switches. In New York
City, we are moving to the next stage of our smart build strategy, by leasing a
thirty-mile dark fiber ring in Manhattan which extends into Brooklyn. We are in
the process of leasing a dark fiber ring in the Dallas market.

Achieve Broad Coverage of Attractive Areas within Each Targeted Market. As
a result of the substantial up-front capital requirements necessary to construct
metropolitan area fiber networks, CLECs have traditionally limited their initial
networks to highly concentrated downtown areas, which limits their ability to
provide service to customers in other attractive, but geographically dispersed,
markets. We prepare a detailed, "bottoms-up" analysis of a market's local
exchange areas using FCC and demographic data. We use this analysis, together
with estimates of the costs and potential benefits of addressing particular
service areas to:

- identify attractive markets;

- determine the optimal concentration of areas to be served; and

- develop our schedule for deploying and expanding our network.

This will enable us to address the most attractive service areas throughout
each of our target markets, such as suburban business parks and concentrated
downtown areas, without having to construct our own fiber network to the
customer premises in each of these areas.

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<PAGE> 38

Maximize Operating Margins by Emphasizing Facilities-Based Services. We
believe that by using our own facilities to provide local exchange, local
access, and long distance service, we should generate significantly higher gross
margins than we could obtain by reselling services provided entirely on another
carrier's facilities. As a result, we focus our marketing activities on areas
where we can serve customers through a direct connection using unbundled loops
or high capacity circuits connected to our facilities. We generally resell ILEC
services only to provide comprehensive geographical service coverage to
customers with multiple sites where the customer is physically connected to our
switches and which can be addressed by our facilities-based services, and a few
off-switch sites, which can be addressed only by reselling ILEC services.

Build Market Share by Focusing on Direct Sales. We use a direct sales force
to sell directly to customers and provide them personalized customer care
through a single point of contact. By using this approach, we hope to maximize
our market share, particularly among small and medium-sized businesses. We
believe that ILECs have generally neglected to target small and medium-sized
business customers with direct sales efforts. Our sales management team is
composed of executives with experience in managing a large number of direct
sales specialists in the telecommunications and data networking industries.
Additionally, we believe that we can attract and retain highly qualified sales
and support personnel by offering them the opportunity to:

- work with an experienced and success-proven management team in building a
developing, entrepreneurial company;

- market a comprehensive set of products and services and customer care
options; and

- participate in the potential economic returns made available through a
results-oriented compensation package emphasizing sales commissions and
stock options.

Develop Efficient Automated Back Office Systems. We intend to automate most
of the processes involved in switching a customer to our networks. Our goal is
to accelerate the time between customer order and service installation, reduce
overhead costs and improve customer service. To achieve this goal, we are
developing, acquiring and integrating information technology systems to support
our operations, and we are establishing an electronic bonding arrangement with
the incumbent local exchange carriers. To address these critical issues, we have
hired an experienced team of engineering and information technology
professionals. This team is working to develop, with the assistance of key third
party vendors, operations support systems that synchronize multiple tasks such
as provisioning, customer service and billing and provide management with timely
operating and financial data to most efficiently direct network, sales and
customer service resources. In addition, with electronic bonding, we should be
able to provide better customer care since we will be able to more readily
pinpoint any problems with a customer's order. See "-- Information Systems" for
a discussion of electronic bonding.

Expand Through Potential Acquisitions. We plan to pursue strategic
acquisitions to accelerate our market penetration, expand our customer base, and
acquire additional experienced management.

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MARKET OPPORTUNITY

U.S. Census Bureau data indicates that the United States communications
services market, including cable television, but excluding Internet access and
content, in 1997 totaled approximately $256 billion in annual revenue. As
depicted on the chart below, wireline telecommunications services, other than
Internet access and content, purchased by non-residential users accounted for
about 44%, or approximately $113 billion, of the total U.S. market in 1997:
[US COMMUNICATIONS MARKET GRAPH]

The major segments of the non-residential wireline telecommunications
services market, based on U.S. Census Bureau data, are as follows:
[NON-RESIDENTIAL WIRELINE TELECOMMUNICATIONS MARKET GRAPH]

Traditional voice traffic accounted for the vast majority of
non-residential communications revenue in 1997, with local exchange and exchange
access accounting for over half of the total non-residential wireline
telecommunications market, excluding Internet access and content. Due to its
rapid growth, estimates of data and Internet services revenue are not as well
established as those relating to traditional voice traffic communications.
However, Allegiance believes that a significant market opportunity exists for
providers of non-residential Internet services.

Allegiance believes that the rapid opening of the local market to
competition, accelerated growth rates in local traffic related to increases in
Internet access, the desire for multiple suppliers by large businesses, and the
desire for "one-stop shopping" by small and medium-sized businesses and
consumers, presents an opportunity for new entrants to achieve product
differentiation and significant penetration into this very large, established
market. Success in this environment will, in the opinion of management, depend

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primarily on speed-to-market, marketing creativity, superior customer service,
and a CLEC's ability to provide competitively priced services rapidly and
accurately and to issue concise, accurate integrated billing statements.

ALLEGIANCE'S TELECOMMUNICATIONS SERVICES

Allegiance tailors its service offerings to meet the specific needs of the
business, government, and other institutional customers in its target markets.
Management believes that Allegiance's close contact with customers from its
direct sales force and customer care personnel will enable it to tailor its
service offerings to meet customers' needs and to creatively package its
services to provide "one-stop shopping" solutions for those customers.

Local Exchange Services. Allegiance offers local telephone services,
including local dial tone as well as other features such as:

- call forwarding;

- call waiting;

- dial back;

- caller ID; and

- voice mail.

By offering dial tone service, Allegiance also receives originating and
terminating access charges for interexchange calls placed or received by its
subscribers.

Private Branch Exchange/Shared Tenant Services. In areas where telephone
density is high and most telephone customers desire similar services, such as
office buildings, apartments, condominiums or campus-type environments, a
private branch exchange or services such as Centrex are among the most efficient
means of providing telephone services. A private branch exchange, also known as
"PBX," is a switching system located within an office building and owned by a
customer which allows calls from the outside to be routed directly to the
individual instead of through a central number. PBX also allows for calling
within an office by way of four digit extensions. Centrex is a service that
offers features similar to those of a PBX, except that the switching equipment
is located at the telephone carrier's premises and not at the customer's
premises. The use of the Centrex service eliminates the need for large capital
expenditures on a PBX. Allegiance intends to offer these services in areas where
market potential warrants.

Integrated Services Digital Network and High Speed Data
Services. Allegiance offers high speed data transmission services, such as:

- wide area network interconnection, which are remote computer
communications systems that allow file sharing among geographically
distributed workgroups; wide area networks typically use links provided
by local telephone companies; and

- broadband Internet access, also known as "wideband," which allows large
quantities of data to be transmitted simultaneously.

These services may be provided via frame relay and dedicated point-to-point
connections. In order to provide these services, Allegiance intends to utilize
leased high capacity connections, such as multiple DS-1, DS-3, T1 or T3
connections, to medium- and large-sized business, government, and other
institutional customers. Allegiance may also employ DSL and/or ISDN connections
over unbundled copper wire connections to smaller business users whose
telecommunications requirements may not justify such high capacity connections
or which are located in areas where T1 connections are not available.

Interexchange/Long Distance Services. Allegiance offers a full range of:

- domestic long distance services, such as:

-- interLATA, which are calls that pass one "Local Access and Transport
Area" or "LATA" to another, and such calls must be carried across the
LATA boundary by a long-distance carrier,

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<PAGE> 41

-- intraLATA, which is a call that falls within the local service area of
a single local telephone company, and

- international long distance services.

These services include "1+" outbound calling, inbound toll free service,
and such complementary services as calling cards, operator assistance, and
conference calling.

Enhanced Internet Services. Allegiance offers dedicated and dial-up high
speed Internet access services via conventional modem connections, ISDN, and T1
and higher speed dedicated connections. In addition, Allegiance expects to offer
DSL services beginning in 1999. Dedicated access services are telecommunications
lines dedicated or reserved for use by particular customers.

Web Site Design and Hosting Services. Allegiance plans to offer Web site
design services and Web site hosting on its own computer servers to provide
customers with a complete, easy to use key solution that gives them a presence
on the World Wide Web.

Facilities and Systems Integration Services. Allegiance offers individual
customers assistance with the:

- design and implementation of complete, easy to use solutions in order to
meet their specific needs, including the selection of the customer's
premises equipment, interconnection of local area networks and wide area
networks, and

- implementation of virtual private networks. Virtual private networks
simulate private line networks without actually building a private
network and offer special services such as abbreviated dialing, where a
customer can call between offices in different area codes without having
to dial all eleven digits.

Wholesale Services to Internet Service Providers. Allegiance believes that
with the recent growth in demand for Internet services, numerous Internet
service providers are unable to obtain network capacity rapidly enough to meet
customer demand and eliminate network congestion problems. Allegiance plans to
supplement its core customer product offerings by providing a full array of
local services to Internet service providers, including telephone numbers and
switched and dedicated access to the Internet.

SALES AND CUSTOMER SUPPORT

Allegiance offers an integrated package of local exchange, local access,
domestic and international long distance, enhanced voice, data, and a full suite
of Internet services to small and medium-sized businesses. Unlike large
corporate, government, or other institutional users, small and medium-sized
businesses often have no in-house telecommunications manager. Based on
management's previous experience, Allegiance believes that a direct sales and
customer care program focusing on complete, "one-stop shopping" solutions will
have a competitive advantage in capturing this type of customer's total
telecommunications traffic.

Although the vast majority of Allegiance's sales force is focused primarily
on the small and medium-sized business segment, Allegiance also provides
services to large business, government, and other institutional users, as well
as to Internet service providers, and expects that a significant portion of its
initial revenue will come from these segments. Therefore, Allegiance has
organized its sales and customer care organizations to serve each of these three
market segments. Sales and marketing approaches in the telecommunications market
are market-segment specific, and Allegiance believes the following are the most
effective approaches with respect to its three targeted market segments:

- Small/medium businesses -- Allegiance uses direct sales.

- Large business, government, and other institutional users -- Allegiance
uses account teams, established business relationships, applications
sales and technical journal articles, and is an exhibitor at trade shows.

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<PAGE> 42

- Wholesale carriers, primarily Internet service providers -- Allegiance
uses direct sales, established business relationships, and competitive
pricing.

Allegiance organizes account executives into teams of six to eight persons
with a team manager and a sales support specialist. These teams utilize
telemarketing to "qualify" leads and set up initial appointments. Allegiance
closely manages account executives with regard to the number of sales calls per
week, with the goal of eventually calling on every prospective business customer
in an account executive's sales territory. Allegiance uses commission plans and
incentive programs to reward and retain the top performers and encourage strong
customer relationships. The sales team managers for each market report to a city
sales vice president who in turn reports to a regional vice president.

Allegiance's wholesale sales to Internet service providers are performed by
account executives reporting to the vice president of national accounts. The
vice president of national accounts also has responsibility for large corporate,
government, and other institutional accounts, with designated national account
managers and sales support personnel assigned to the major accounts. Unlike the
small and medium-sized business segment, the national account program is being
built by recruiting national account managers with established business
relationships with large corporate accounts, supported by technical applications
personnel and customer care specialists.

Allegiance has focused its efforts on developing a personalized customer
care program. Allegiance's customer service representatives are available seven
days a week, 24 hours a day. In addition, Allegiance uses customer care
specialists to support its national accounts.

INFORMATION SYSTEMS

Allegiance is continuing to develop its tailored information systems and
procedures for operations support and other back office systems that it believes
will provide a significant competitive advantage in terms of cost, processing
large order volumes, and customer service. These systems are required to enter,
schedule, provision, and track a customer's order from the point of sale to the
installation and testing of service and also include or interface with trouble
management, inventory, billing, collection and customer service systems. The
existing systems currently employed by most ILECs, CLECs and long distance
carriers, which were developed prior to the passage of the Telecommunications
Act, generally require multiple entries of customer information to accomplish
order management, provisioning, switch administration and billing. This process
is not only labor intensive, but it creates numerous opportunities for errors in
provisioning service and billing, delays in installing orders, service
interruptions, poor customer service, increased customer turnover, and
significant added expenses due to duplicated efforts and decreased customer
satisfaction.

Allegiance believes that the practical problems and costs of upgrading
existing systems are often prohibitive for companies whose existing systems
support a large number of customers with ongoing service. Because Allegiance
does not have systems designed prior to the expanded interaction between CLECs
and ILECs introduced by the Telecommunications Act, Allegiance's team of
engineering and information technology professionals experienced in the CLEC
industry is free to develop operations support and other back office systems
designed to facilitate a smooth, efficient order management, provisioning,
trouble management, billing and collection, and customer care process. See "Risk
Factors -- We Are Dependent on Effective Billing, Customer Service and
Information Systems and We May Have Difficulties in Developing These Systems."

Order Management. Allegiance is licensing MetaSolv's order management
software. This product allows the sales team not only to enter customer orders
onsite, via computer and/or over the Internet, but also to monitor the status of
the order as it progresses through the service initiation process.

Provisioning Management. The licensed order management software also
supports the design and management of the provisioning process, including
circuit design and work flow management. The system has been designed to permit
programming into the system of a standard schedule of tasks which must be
accomplished in order to initiate service to a customer, as well as the standard
time intervals during which
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<PAGE> 43

each such task must be completed. This way, when a standard order is selected in
the system, each required task in the service initiation process can be
efficiently managed to its assigned time interval.

External Interfaces. Several external interfaces are required to initiate
service for a customer. While some of these are automated via gateways from the
order management software, the most important interfaces, those to the ILEC,
have generally been accomplished via fax or e-mail. In an effort to make this
process more efficient, Allegiance and Bell Atlantic announced on January 8,
1999, the first implementation of electronic bonding between the operations
support system of a facilities-based CLEC and an ILEC.

Electronic bonding will allow Allegiance to access data from the ILEC,
submit service requests electronically, and more quickly attend to errors in the
local service request form because an order is bounced back immediately if the
ILEC determines that there is a mistake. As a result, Allegiance expects to be
able to eventually reduce the time frame required to switch service to
Allegiance from approximately 25 business days to as low as five business days,
as compared to three days currently required to switch to a new long distance
carrier. Electronic bonding should also enable Allegiance to improve its ability
to provide better customer care since Allegiance will more readily be able to
pinpoint where any problems may have occurred with a customer's order.

Network Element Administration. Allegiance licenses software for
administrating each element of the Allegiance network. Allegiance is currently
developing an interface between its order management system and the network
element manager to integrate data integrity and eliminate redundant data entry.

Customer Billing. Allegiance has selected a billing services provider which
credits the collections made to Allegiance's lock-box. Customer information is
electronically interfaced with this provider from Allegiance's order management
system via a gateway, thereby integrating all repositories of information. We
are continuing to develop other enhancements to the gateway.

Billing Records. Local and intraLATA billing records are generated by the
Lucent Series 5ESS(R)-2000 switches to record customer calling activity.
InterLATA billing records are generated by the long distance carrier with whom
Allegiance has a resale agreement, to record customer calling activity. These
records will be automatically processed by the billing services provider in
order to calculate and produce bills in a customer-specified billing format.

NETWORK DEPLOYMENT

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The following table sets forth the initial markets targeted by Allegiance
and the current buildout schedule. The order and timing of network deployment
may vary and will depend on a number of factors, including recruiting city
management, the regulatory environment, Allegiance's results of operations and
the existence of specific market opportunities, such as acquisitions. Allegiance
may also elect not to deploy networks in each such market.

MARKET SIZE AND BUILDOUT SCHEDULE

<TABLE>
<CAPTION>
ESTIMATED TOTAL % OF TOTAL INITIAL
NON-RESIDENTIAL U.S. NON-RESIDENTIAL FACILITIES-BASED
MARKET ACCESS LINES(1) SERVICE DATE(3) ACCESS LINES(2)
- ------ --------------- -------------------- ----------------
(THOUSANDS)
<S> <C> <C> <C>
New York City............................... 3,298(4) 6.7%(4) March 1998
Dallas, TX.................................. 867(5) 1.8%(5) April 1998
Atlanta, GA................................. 612 1.2% April 1998
Fort Worth, TX.............................. --(5) --(5) July 1998
Chicago, IL................................. 1,951 4.0% September 1998
Los Angeles, CA............................. 3,430(6) 7.0%(6) October 1998
San Francisco, CA........................... 2,148(7) 4.4%(7) November 1998
Boston, MA.................................. 649 1.3% December 1998
Oakland, CA................................. --(7) --(7) December 1998
Philadelphia, PA............................ 1,754 3.6% February 1999
Washington, D.C. ........................... 871 1.8% March 1999
San Jose, CA................................ --(7) --(7) 1999
Northern New Jersey......................... --(4) --(4) 1999
Houston, TX................................. 765 1.6% 1999
Orange County, CA........................... --(6) --(6) 1999
San Diego, CA............................... 790 1.6% 1999
Long Island, NY............................. --(4) --(4) 1999
Baltimore, MD............................... 639 1.3% 1999
Detroit, MI................................. 821 1.7% 1999
Denver, CO.................................. 632 1.3% 2000
Seattle, WA................................. 779 1.6% 2000
Cleveland, OH............................... 654 1.3% 2000
Miami, FL................................... 769 1.6% 2000
St. Louis, MO............................... 449 0.9% 2000
------ ----
Total............................. 21,878 44.7%
====== ====
</TABLE>

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

(1) Data as of December 31, 1996.

(2) Based on an estimated 49.0 million U.S. non-residential access lines as of
December 31, 1996.

(3) Refers to the first month during which Allegiance could offer
facilities-based service or the year during which Allegiance expects to be
able to offer facilities-based service based on its current business plan.

(4) Data for New York City also includes Northern New Jersey and Long Island,
NY.

(5) Data for Dallas, TX also includes Fort Worth, TX.

(6) Data for Los Angeles, CA also includes Orange County, CA.

(7) Data for San Francisco, CA also includes San Jose, CA and Oakland, CA.

In the majority of its targeted markets, Allegiance will initially deploy
switches and collocate transmission equipment in ILEC central offices with heavy
concentrations of non-residential access lines. Over time, Allegiance plans to
expand its networks throughout the metropolitan areas to address the majority of
the business market in each area. In some markets, such as Northern New Jersey,
Allegiance

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will not initially deploy its own switch, but will deploy transmission equipment
in major central offices and route traffic to an existing Allegiance switch
until traffic growth warrants the addition of a switch to service that market.

NETWORK ARCHITECTURE

An important element of Allegiance's smart build strategy is the
installation of Lucent Series 5ESS(R)-2000 digital switches and related
equipment at a central location in each market. As of March 15, 1999, Allegiance
had deployed 9 switches to serve 11 markets: New York City, Dallas, Atlanta,
Chicago, Los Angeles, San Francisco, Fort Worth, Oakland, Boston, Philadelphia
and Washington, D.C. As of such date, Allegiance was installing additional
switches in each of Houston and San Diego.

Initially, Allegiance intends to lease local network trunking facilities
from the ILEC and/or one or more CLECs in order to connect Allegiance's switch
to major ILEC central offices serving the central business district and outlying
areas of business concentrations in each market. The switch will also be
connected to ILEC tandem switches and certain interexchange carrier
points-of-presence, the equivalent of a local phone company's central office. To
access the largest number of customers possible without having to lay fiber to
each of their premises, Allegiance will also locate access equipment such as
integrated digital loop carriers and related equipment in each of the ILEC
central offices in which it is connected.

As each customer is signed up, service will be provided by leasing
unbundled loops from the ILEC to connect Allegiance's integrated digital loop
carriers located in the serving central office to the customer premise
equipment. For large business, government, or other institutional customers or
for numerous customers located in large buildings, it may be more cost-effective
for Allegiance to use leased ILEC or CLEC capacity in the 1.5 to 150 megabit
range, or perhaps a wireless local loop leased from one of the emerging wireless
CLECs, to connect the customer(s) to the Allegiance network. In this case,
Allegiance will locate its integrated digital loop carriers or other equipment
in the customer's building.

Although Allegiance will initially lease its local network transmission
facilities, Allegiance plans to replace leased capacity with its own fiber optic
facilities as and when it experiences sufficient traffic volume growth between
its switch and specific ILEC central offices or as other factors make these
arrangements more attractive.

IMPLEMENTATION OF SERVICES

To offer services in a market, Allegiance generally must secure
certification from the state regulator and typically must file tariffs or price
lists for the services that it will offer. The certification process varies from
state to state; however, the fundamental requirements are largely the same.
State regulators require new entrants to demonstrate that they have secured
adequate financial resources to establish and maintain good customer service.
New entrants must also show that they possess the knowledge and ability required
to establish and operate a telecommunications network. Allegiance has made such
demonstrations in Texas, Georgia, California, Illinois, Maryland, New York, New
Jersey, Virginia, Massachusetts and Washington, D.C., where Allegiance has
obtained certificates to provide local exchange and intrastate toll services.
Applications for such authority are pending in Colorado, Michigan, Washington
and Pennsylvania, where Allegiance has obtained interim operating authority.
Allegiance intends to file similar applications in the near future in Ohio,
Missouri and Florida.

Before providing local service, a new entrant must negotiate and execute an
interconnection agreement with the ILEC. While such agreements can be voluminous
and may take months to negotiate, most of the key interconnection issues have
now been thoroughly addressed and commissions in most states have ruled on
arbitrations between the ILECs and new entrants. However, interconnection rates
and conditions may be subject to change as the result of future commission
actions or other changes in the regulatory environment. Under a recent United
States Supreme Court ruling, new entrants may adopt either all or portions of an
interconnection agreement already entered into by the ILEC and another carrier.
Such an approach will be selectively adopted by Allegiance to enable it to enter
markets quickly while at the same time preserving its right to replace the
adopted agreement with a customized interconnection agreement
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<PAGE> 46

that can be negotiated once service has already been established. For example,
Allegiance has adopted the interconnection agreement entered into between
Southwestern Bell and WinStar Wireless of Texas, Inc. in Texas and has begun to
negotiate enhancements to that agreement for ultimate inclusion in Allegiance's
customized agreement with Southwestern Bell.

While such interconnection agreements include key terms and prices for
interconnection, a significant joint implementation effort must be made with the
ILEC in order to establish operationally efficient and reliable traffic
interchange arrangements. Such interchange arrangements must include those
between the new entrant's network and the facilities of other service providers
as well as public service agencies. For example, Allegiance worked closely with
Southwestern Bell in order to devise and implement an efficient 911 call routing
plan that will meet the requirements of each individual 911 service bureau in
Southwestern Bell areas that Allegiance will serve using its own switches.
Allegiance meets with key personnel from 911 service bureaus to obtain their
acceptance and to establish dates for circuit establishment and joint testing.
Other examples of traffic interchange and interconnection arrangements utilizing
the ILEC's network include connectivity to its out-of-band signaling facilities,
interconnectivity to the ILEC's operator services and directory assistance
personnel, and access through the ILEC to the networks of wireless companies and
interexchange carriers.

Allegiance has entered into interconnection agreements with the ILECs in
each of the states in which its current eleven geographic markets are located.
In Georgia, New York and Texas, however, the original interconnection agreements
have expired. Allegiance is operating under the terms of these agreements while
negotiating new interconnection agreements. The new agreements will likely have
retroactive effective dates.

After the initial implementation activities are completed in a market,
Allegiance follows an on-going capacity management plan to ensure that adequate
quantities of network facilities, such as interconnection trunks are in place,
and a contingency plan must be devised to address spikes in demand caused by
events such as a larger-than-expected customer sale in a relatively small
geographic area.

REGULATION

Allegiance's telecommunications services business is subject to federal,
state and local regulation.

Federal Regulation

The FCC regulates interstate and international telecommunications services,
including the use of local telephone facilities to originate and terminate
interstate and international calls. Allegiance provides such services on a
common carrier basis. The FCC imposes certain regulations on common carriers
such as the ILECs that have some degree of market power. The FCC imposes less
regulation on common carriers without market power including, to date, CLECs
like Allegiance. The FCC requires common carriers to receive an authorization to
construct and operate telecommunications facilities, and to provide or resell
telecommunications services, between the United States and international points.

Under the Telecommunications Act, any entity, including cable television
companies and electric and gas utilities, may enter any telecommunications
market, subject to reasonable state regulation of safety, quality and consumer
protection. Because implementation of the Telecommunications Act is subject to
numerous federal and state policy rulemaking proceedings and judicial review
there is still uncertainty as to what impact such legislation will have on
Allegiance.

The Telecommunications Act is intended to increase competition. The act
opens the local services market by requiring ILECs to permit interconnection to
their networks and establishing ILEC obligations with respect to:

Reciprocal Compensation. Requires all local exchange carriers to
complete calls originated by competing local exchange carriers under
reciprocal arrangements at prices based on tariffs or negotiated prices.

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<PAGE> 47

Resale. Requires all ILECs and CLECs to permit resale of their
telecommunications services without unreasonable restrictions or
conditions. In addition, ILECs are required to offer wholesale versions of
all retail services to other telecommunications carriers for resale at
discounted rates, based on the costs avoided by the ILEC in the wholesale
offering.

Interconnection. Requires all ILECs and CLECs to permit their
competitors to interconnect with their facilities. Requires all ILECs to
permit interconnection at any technically feasible point within their
networks, on nondiscriminatory terms, at prices based on cost, which may
include a reasonable profit. At the option of the carrier seeking
interconnection, collocation of the requesting carrier's equipment in the
ILECs' premises must be offered, except where an ILEC can demonstrate space
limitations or other technical impediments to collocation.

Unbundled Access. Requires all ILECs to provide nondiscriminatory
access to unbundled network elements including, network facilities,
equipment, features, functions, and capabilities, at any technically
feasible point within their networks, on nondiscriminatory terms, at prices
based on cost, which may include a reasonable profit.

Number Portability. Requires all ILECs and CLECs to permit users of
telecommunications services to retain existing telephone numbers without
impairment of quality, reliability or convenience when switching from one
telecommunications carrier to another.

Dialing Parity. Requires all ILECs and CLECs to provide "1+" equal
access to competing providers of telephone exchange service and toll
service, and to provide nondiscriminatory access to telephone numbers,
operator services, directory assistance, and directory listing, with no
unreasonable dialing delays.

Access to Rights-of-Way. Requires all ILECs and CLECs to permit
competing carriers access to poles, ducts, conduits and rights-of-way at
regulated prices.

ILECs are required to negotiate in good faith with carriers requesting any
or all of the above arrangements. If the negotiating carriers cannot reach
agreement within a prescribed time, either carrier may request binding
arbitration of the disputed issues by the state regulatory commission. Where an
agreement has not been reached, ILECs remain subject to interconnection
obligations established by the FCC and state telecommunication regulatory
commissions.

In August 1996, the FCC released a decision establishing rules implementing
the ILEC interconnection obligations described above. On July 18, 1997, the
Eighth Circuit vacated certain portions of this decision and narrowly
interpreted the FCC's power to prescribe and enforce rules implementing the
Telecommunications Act. On January 25, 1999, the United States Supreme Court
reversed the Eighth Circuit decision and reaffirmed the FCC's broad authority to
issue rules implementing the Telecommunications Act, although it did vacate a
rule determining which network elements the incumbent local exchange carriers
must provide to competitors on an unbundled basis. Allegiance, however, leases
only the basic unbundled network elements from the ILEC and therefore does not
expect reconsideration of the unbundling rules to have an adverse effect on its
smart build strategy.

Nevertheless, the FCC likely will conduct additional rulemaking proceedings
to conform to the Supreme Court's interpretation of the law, and these
proceedings may result in further judicial review. While these court proceedings
were pending, Allegiance entered into interconnection agreements with a number
of ILECs through negotiations or, in some cases, adoption of another CLEC's
approved agreement. These agreements remain in effect, although in some cases
one or both parties may be entitled to demand renegotiation of particular
provisions based on intervening changes in the law. However, it is uncertain
whether Allegiance will be able to obtain renewal of these agreements on
favorable terms when they expire.

The Telecommunications Act codifies the ILECs' equal access and
nondiscrimination obligations and preempts inconsistent state regulation. The
Telecommunications Act also contains special provisions that replace prior
antitrust restrictions that prohibited the regional Bell operating companies
from providing
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<PAGE> 48

long distance services and engaging in telecommunications equipment
manufacturing. The Telecommunications Act permitted the regional Bell operating
companies to enter the out-of-region long distance market immediately upon its
enactment. Further, provisions of the Telecommunications Act permit a regional
Bell operating company to enter the long distance market in its in-region states
if it satisfies several procedural and substantive requirements, including:

- obtaining FCC approval upon a showing that the regional Bell operating
company has entered into interconnection agreements or, under some
circumstances, has offered to enter into such agreements in those states
in which it seeks long distance relief;

- the interconnection agreements satisfy a 14-point "checklist" of
competitive requirements; and

- the FCC is satisfied that the regional Bell operating company's entry
into long distance markets is in the public interest.

To date, several petitions by regional Bell operating companies for such
entry have been denied by the FCC, and none have been granted. However, it is
likely that additional petitions will be filed in 1999 and it is possible that
regional Bell operating companies may receive approval to offer long distance
services in one or more states. This may have an unfavorable effect on
Allegiance's business. Allegiance is legally able to offer its customers both
long distance and local exchange services, which the regional Bell operating
companies currently may not do. This ability to offer "one-stop shopping" gives
Allegiance a marketing advantage that it would no longer enjoy. See
"-- Competition."

On May 8, 1997, the FCC released an order establishing a significantly
expanded federal universal service subsidy regime. For example, the FCC
established new subsidies for telecommunications and information services
provided to qualifying schools and libraries with an annual cap of $2.25 billion
and for services provided to rural health care providers with an annual cap of
$400 million. The FCC also expanded the federal subsidies for local exchange
telephone services provided to low-income consumers. Providers of interstate
telecommunications service, such as Allegiance must pay for a portion of these
programs. Allegiance's share of these federal subsidy funds will be based on its
share of certain defined telecommunications end user revenues. Currently, the
FCC is assessing such payments on the basis of a provider's revenue for the
previous year. The FCC announced that it intends, effective July 1, 1999, to
revise its rules for subsidizing service provided to consumers in high cost
areas, which may result in further substantial increases in the overall cost of
the subsidy program. Several parties have appealed the May 8th order. Such
appeals have been consolidated and transferred to the United States Court of
Appeals for the Fifth Circuit where they are currently pending.

For the first half of 1999, Allegiance expects to incur a contribution
liability equal to approximately 1.5% of its 1998 operating revenues. With
respect to subsequent periods, however, Allegiance is currently unable to
quantify the amount of subsidy payments that it will be required to make or the
effect that these required payments will have on its financial condition.

Under authority granted by the FCC, Allegiance will resell the
international telecommunications services of other common carriers between the
United States and international points. In connection with such authority,
Allegiance's subsidiary, Allegiance Telecom International, Inc., has filed
tariffs with the FCC stating the rates, terms and conditions for its
international services.

With respect to its domestic service offerings, various subsidiaries of
Allegiance have filed tariffs with the FCC stating the rates, terms and
conditions for their interstate services. Allegiance's tariffs are generally not
subject to pre-effective review by the FCC, and can be amended on one day's
notice. Allegiance's interstate services are provided in competition with
interexchange carriers and, with respect to access services, the ILECs. With
limited exceptions, the current policy of the FCC for most interstate access
services dictates that ILECs charge all customers the same price for the same
service. Thus, the ILECs generally cannot lower prices to those customers likely
to contract for their services without also lowering charges for the same
service to all customers in the same geographic area, including those whose
telecommunications requirements would not justify the use of such lower prices.
The FCC may, however,

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alleviate this constraint on the ILECs and permit them to offer special rate
packages to very large customers, as it has done in a few cases, or permit other
forms of rate flexibility. The FCC has adopted some proposals that significantly
lessen the regulation of ILECs that are subject to competition in their service
areas and provide such ILECs with additional flexibility in pricing their
interstate switched and special access on a central office specific basis; and,
as discussed in the following paragraph, is considering expanding such
flexibility.

In two orders released on December 24, 1996, and May 16, 1997, the FCC made
major changes in the interstate access charge structure. In the December 24th
order, the FCC removed restrictions on ILECs' ability to lower access prices and
relaxed the regulation of new switched access services in those markets where
there are other providers of access services. If this increased pricing
flexibility is not effectively monitored by federal regulators, it could have a
material adverse effect on Allegiance's ability to compete in providing
interstate access services. The May 16th order substantially increased the costs
that ILECs subject to the FCC's price cap rules recover through monthly,
non-traffic sensitive access charges and substantially decreased the costs that
these carriers recover through traffic sensitive access charges. In the May 16th
order, the FCC also announced its plan to bring interstate access rate levels
more in line with cost. The plan will include rules that may grant these
carriers increased pricing flexibility upon demonstrations of increased
competition or potential competition in relevant markets. The manner in which
the FCC implements this approach to lowering access charge levels could have a
material effect on Allegiance's ability to compete in providing interstate
access services. Several parties appealed the May 16th order. On August 19,
1998, the May 16th order was affirmed by the Eighth Circuit U.S. Court of
Appeals. The FCC is now considering public comments on pricing flexibility
proposals submitted by two regional Bell operating companies and on changing the
productivity factor (currently 6.5%), which is applied annually to reduce ILECs'
price cap indices.

ILECs around the country have been contesting whether the obligation to pay
reciprocal compensation to competitive local exchange carriers should apply to
local telephone calls from an ILEC's customers to Internet service providers
served by competitive local exchange carriers. The ILECs claim that this traffic
is interstate in nature and therefore should be exempt from compensation
arrangements applicable to local, intrastate calls. Competitive local exchange
carriers have contended that the interconnection agreements provide no exception
for local calls to Internet service providers and reciprocal compensation is
therefore applicable. Currently, over 25 state commissions and several federal
and state courts have ruled that reciprocal compensation arrangements do apply
to calls to Internet service providers, and no jurisdiction has ruled to the
contrary. Certain of these rulings are subject to appeal. Additional disputes
over the appropriate treatment of Internet service provider traffic are pending
in other states.

On February 26, 1999, the FCC released a Declaratory Ruling determining
that Internet service provider traffic is interstate for jurisdictional
purposes, but that its current rules neither require nor prohibit the payment of
reciprocal compensation for such calls. In the absence of a federal rule, the
FCC determined that state commissions have authority to interpret and enforce
the reciprocal compensation provisions of existing interconnection agreements,
and to determine the appropriate treatment of Internet service provider traffic
in arbitrating new agreements. The FCC also requested comment on alternative
federal rules to govern compensation for such calls in the future. In response
to the FCC ruling, some regional Bell operating companies have asked state
commissions to reopen previous decisions requiring the payment of reciprocal
compensation on Internet service provider calls.

Allegiance anticipates that Internet service providers will be among its
target customers, and adverse decisions in state proceedings could limit its
ability to service this group of customers profitably. Allegiance limits the
switch capacity used for Internet service provider lines to 20%. In addition,
given the uncertainty as to whether reciprocal compensation should be payable in
connection with calls to Internet service providers, Allegiance recognizes such
revenue only when realization of it is certain, which in most cases will be upon
receipt of cash.

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<PAGE> 50

State Regulation

The Telecommunications Act is intended to increase competition in the
telecommunications industry, especially in the local exchange market. With
respect to local services, ILECs are required to allow interconnection to their
networks and to provide unbundled access to network facilities, as well as a
number of other procompetitive measures. Because the implementation of the
Telecommunications Act is subject to numerous state rulemaking proceedings on
these issues, it is currently difficult to predict how quickly full competition
for local services, including local dial tone, will be introduced.

State regulatory agencies have regulatory jurisdiction when Allegiance
facilities and services are used to provide intrastate services. A portion of
Allegiance's current traffic may be classified as intrastate and therefore
subject to state regulation. Allegiance expects that it will offer more
intrastate services, including intrastate switched services, as its business and
product lines expand and state regulations are modified to allow increased local
services competition. To provide intrastate services, Allegiance generally must
obtain a certificate of public convenience and necessity from the state
regulatory agency and comply with state requirements for telecommunications
utilities, including state tariffing requirements.

State agencies, like the FCC, require Allegiance to file periodic reports,
pay various fees and assessments, and comply with rules governing quality of
service, consumer protection, and similar issues. Although the specific
requirements vary from state to state, they tend to be more detailed than the
FCC's regulation because of the strong public interest in the quality of basic
local exchange service. Allegiance intends to comply with all applicable state
regulations, and as a general matter does not expect that these requirements of
industry-wide applicability will have a material adverse effect on its business.
However, no assurance can be given that the imposition of new regulatory burdens
in a particular state will not affect the profitability of Allegiance's services
in that state.

Local Regulation

Allegiance's networks are subject to numerous local regulations such as
building codes and licensing. Such regulations vary on a city by city and county
by county basis. If Allegiance decides in the future to install its own fiber
optic transmission facilities, it will need to obtain rights-of-way over private
and publicly owned land. There can be no assurance that such rights-of-way will
be available to Allegiance on economically reasonable or advantageous terms.

Competition

The telecommunications industry is highly competitive. Allegiance believes
that the principal competitive factors affecting its business will be pricing
levels and clear pricing policies, customer service, accurate billing and, to a
lesser extent, variety of services. The ability of Allegiance to compete
effectively will depend upon its continued ability to maintain high quality,
market-driven services at prices generally equal to or below those charged by
its competitors. To maintain its competitive posture, Allegiance believes that
it must be in a position to reduce its prices in order to meet reductions in
rates, if any, by others. Any such reductions could adversely affect Allegiance.
Many of Allegiance's current and potential competitors have financial, personnel
and other resources, including brand name recognition, substantially greater
than those of Allegiance, as well as other competitive advantages over
Allegiance.

Local Exchange Carriers. In each of the markets targeted by Allegiance,
Allegiance will compete principally with the ILEC serving that area, such as
Ameritech, BellSouth, Southwestern Bell, Bell Atlantic or US West. Allegiance
believes the regional Bell operating companies' primary agenda is to be able to
offer long distance service in their service territories. The independent
telephone companies have already achieved this goal with good early returns.
Many experts expect the regional Bell operating companies to be successful in
entering the long distance market in a few states sometime in 1999. Allegiance
believes the regional Bell operating companies expect to offset share losses in
their local markets by capturing a significant percentage of the in-region long
distance market, especially in the residential segment where the regional Bell
operating companies' strong regional brand names and extensive advertising
campaigns may be very successful. See "-- Regulation."
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<PAGE> 51

As a recent entrant in the integrated telecommunications services industry,
Allegiance has not achieved and does not expect to achieve a significant market
share for any of its services. In particular, the ILECs have long-standing
relationships with their customers, have financial, technical and marketing
resources substantially greater than those of Allegiance, have the potential to
subsidize competitive services with revenues from a variety of businesses and
currently benefit from certain existing regulations that favor the ILECs over
Allegiance in certain respects. While recent regulatory initiatives, which allow
CLECs such as Allegiance to interconnect with ILEC facilities, provide increased
business opportunities for Allegiance, such interconnection opportunities have
been and likely will continue to be accompanied by increased pricing flexibility
for and relaxation of regulatory oversight of the ILECs.

ILECs have long-standing relationships with regulatory authorities at the
federal and state levels. While recent FCC administrative decisions and
initiatives provide increased business opportunities to telecommunications
providers such as Allegiance, they also provide the ILECs with increased pricing
flexibility for their private line and special access and switched access
services. In addition, with respect to competitive access services as opposed to
switched access services, the FCC recently proposed a rule that would provide
for increased ILEC pricing flexibility and deregulation for such access services
either automatically or after certain competitive levels are reached. If the
ILECs are allowed by regulators to offer discounts to large customers through
contract tariffs, engage in aggressive volume and term discount pricing
practices for their customers, and/or seek to charge competitors excessive fees
for interconnection to their networks, the income of competitors to the ILECs,
including Allegiance, could be materially adversely affected. If future
regulatory decisions afford the ILECs increased access services pricing
flexibility or other regulatory relief, such decisions could also have a
material adverse effect on competitors to the ILEC, including Allegiance.

Competitive Access Carriers/Competitive Local Exchange
Carriers/Interexchange Carriers/ Other Market Entrants. Allegiance also faces,
and expects to continue to face, competition from other current and potential
market entrants, including long distance carriers seeking to enter, reenter or
expand entry into the local exchange market such as AT&T, MCI WorldCom, and
Sprint, and from other CLECs, resellers of local exchange services, competitive
access providers, cable television companies, electric utilities, microwave
carriers, wireless telephone system operators and private networks built by
large end users. In addition, a continuing trend toward consolidation of
telecommunications companies and the formation of strategic alliances within the
telecommunications industry, as well as the development of new technologies,
could give rise to significant new competitors to Allegiance. For example,
WorldCom acquired MFS Communications in December 1996, acquired another CLEC,
Brooks Fiber Properties, Inc. in 1997, and recently merged with MCI. AT&T
recently acquired Teleport Communications Group Inc., a CLEC, and
TeleCommunications, Inc., a cable, telecommunications and high-speed Internet
services provider. Ameritech Corporation has agreed to merge with SBC
Communications; and Bell Atlantic has agreed to merge with GTE Corporation.
These types of consolidations and strategic alliances could put Allegiance at a
competitive disadvantage.

The Telecommunications Act includes provisions which impose certain
regulatory requirements on all local exchange carriers, including competitors
such as Allegiance, while granting the FCC expanded authority to reduce the
level of regulation applicable to any or all telecommunications carriers,
including ILECs. The manner in which these provisions of the Telecommunications
Act are implemented and enforced could have a material adverse effect on
Allegiance's ability to successfully compete against ILECs and other
telecommunications service providers. Allegiance also competes with equipment
vendors and installers, and telecommunications management companies with respect
to certain portions of its business.

The changes in the Telecommunications Act radically altered the market
opportunity for traditional competitive access providers and CLECs. Due to the
fact that most existing competitive access providers/ CLECs initially entered
the market providing dedicated access in the pre-1996 era, these companies had
to build a fiber infrastructure before offering services. Switches were added by
most competitive access providers/CLECs in the last year to take advantage of
the opening of the local market. With the Telecommunications Act requiring
unbundling of the local exchange carrier networks, competitive access
48
<PAGE> 52

providers/CLECs will now be able to more rapidly enter the market by installing
switches and leasing trunk and loop capacity until traffic volume justifies
building facilities. New CLECs will not have to replicate existing facilities
and can be more opportunistic in designing and implementing networks.

A number of CLECs have entered or announced their intention to enter into
one or more of the same markets as Allegiance. Allegiance believes that not all
CLECs however, are pursuing the same target customers as Allegiance.
Demographically, business customers are divided into three segments: small,
medium and large. Targeted cities are divided into three segments by population:
Tier 1, Tier 2 and Tier 3. As would be expected, each CLEC may focus on
different combinations of primary and secondary target customers.

Allegiance has chosen to focus primarily on small and medium-sized business
customers in large "Tier 1" markets. To help distinguish itself from other
competitors who have adopted a similar strategy, Allegiance uses a direct sales
approach to offer potential customers "one-stop shopping" services through a
single point of contact. In addition, Allegiance is actively pursuing
collocations throughout all of its target markets which, in combination with its
smart build strategy, is expected to allow Allegiance to access its markets and
provide a greater array of services more quickly than if it were able to use a
traditional build approach.

Allegiance believes the major interexchange carriers, such as AT&T, MCI
WorldCom and Sprint, have a two pronged strategy:

- keep the regional Bell operating companies out of in-region long distance
as long as possible, and

- develop facilities-based and unbundled local service, an approach already
being pursued by MCI WorldCom with the acquisition of MFS Communications,
and more recently by AT&T with its acquisitions of Teleport
Communications and TeleCommunications, Inc.

Competition for Provision of Long Distance Services. The long distance
telecommunications industry has numerous entities competing for the same
customers and a high average turnover rate, as customers frequently change long
distance providers in response to the offering of lower rates or promotional
incentives by competitors. Prices in the long distance market have declined
significantly in recent years and are expected to continue to decline.
Allegiance expects to increasingly face competition from companies offering long
distance data and voice services over the Internet. Such companies could enjoy a
significant cost advantage because they do not currently pay carrier access
charges or universal service fees.

Data/Internet Service Providers. The Internet services market is highly
competitive, and Allegiance expects that competition will continue to intensify.
Allegiance's competitors in this market will include Internet service providers,
other telecommunications companies, online services providers and Internet
software providers. Many of these competitors have greater financial,
technological and marketing resources than those available to Allegiance.

Competition from International Telecommunications Providers. Under the
recent World Trade Organization agreement on basic telecommunications services,
the United States and 72 other members of the World Trade Organization committed
themselves to opening their respective telecommunications markets and/or foreign
ownership and/or to adopting regulatory measures to protect competitors against
anticompetitive behavior by dominant telecommunications companies, effective in
some cases as early as January 1998. Although Allegiance believes that this
agreement could provide Allegiance with significant opportunities to compete in
markets that were not previously accessible and to provide more reliable
services at lower costs than Allegiance could have provided prior to
implementation of this agreement, it could also provide similar opportunities to
Allegiance's competitors and facilitate entry by foreign carriers into the U.S.
market. There can be no assurance that the pro-competitive effects of the World
Trade Organization agreement will not have a material adverse effect on
Allegiance's business, financial condition and results of operations or that
members of the World Trade Organization will implement the terms of this
agreement.

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<PAGE> 53

EMPLOYEES

As of December 31, 1998, Allegiance had approximately 649 full-time
employees. Allegiance believes that its future success will depend on its
continued ability to attract and retain highly skilled and qualified employees.
None of Allegiance's employees are currently represented by a collective
bargaining agreement. Allegiance believes that it enjoys good relationships with
its employees.

LEGAL PROCEEDINGS

On August 29, 1997, WorldCom sued Allegiance and two of its Senior Vice
Presidents. In its complaint, WorldCom alleges that these employees violated
noncompete and nonsolicitation agreements by accepting employment with
Allegiance and by soliciting then-current WorldCom employees to leave WorldCom's
employment and join Allegiance. In addition, WorldCom claims that Allegiance
tortiously interfered with WorldCom's relationships with its employees, and that
Allegiance's behavior constituted unfair competition. WorldCom seeks injunctive
relief, including barring two of Allegiance's executives from continued
employment with Allegiance, and monetary damages, although it has filed no
motion for a temporary restraining order or preliminary injunction. Allegiance
denies all claims and is vigorously defending itself. Allegiance does not expect
the ultimate outcome of this matter to have a material adverse effect on the
results of operations or financial condition of Allegiance.

On October 7, 1997, Allegiance filed a counterclaim against WorldCom for,
among other things, attempted monopolization of the "one-stop shopping"
telecommunications market, abuse of process, and unfair competition. WorldCom
did not move to dismiss the attempted monopolization claim, but moved to dismiss
the abuse of process and unfair competition claims. On March 4, 1998, the court
dismissed the claim for unfair competition.

Allegiance is not party to any other pending legal proceedings that
Allegiance believes would, individually or in the aggregate, have a material
adverse effect on Allegiance's financial condition or results of operations.

FACILITIES

Allegiance is headquartered in Dallas, Texas and leases offices and space
in a number of locations, primarily for sales offices and network equipment
installations. The table below lists Allegiance's current leased facilities:

<TABLE>
<CAPTION>
APPROXIMATE
LOCATION LEASE EXPIRATION SQUARE FOOTAGE
- -------- ---------------- --------------
<S> <C> <C>
Dallas, TX............................................ February 2008 76,000
Atlanta, GA........................................... February 2003 7,400
Atlanta, GA........................................... November 2001 7,300
Boston, MA............................................ September 2003 12,000
Boston, MA............................................ September 2008 18,000
Chicago, IL........................................... March 2009 11,000
Chicago, IL........................................... July 2008 14,000
Fort Worth, TX........................................ June 2003 3,900
Houston, TX........................................... December 2005 11,700
Houston, TX........................................... November 2008 18,000
Los Angeles, CA....................................... June 2008 11,700
Los Angeles, CA....................................... June 2008 14,585
Newport, CA........................................... April 2006 7,800
New York, NY.......................................... August 2006 8,700
New York, NY.......................................... March 2008 19,500
New York, NY.......................................... June 2008 12,400
Oakland, CA........................................... December 2006 2,000
</TABLE>

50
<PAGE> 54

<TABLE>
<CAPTION>
APPROXIMATE
LOCATION LEASE EXPIRATION SQUARE FOOTAGE
- -------- ---------------- --------------
<S> <C> <C>
Philadelphia, PA...................................... April 2002 8,900
Philadelphia, PA...................................... October 2008 18,000
San Diego, CA......................................... March 2008 14,000
San Francisco, CA..................................... April 2002 8,100
San Francisco, CA..................................... June 2008 16,000
San Jose, CA.......................................... February 2004 4,500
Washington, DC........................................ November 2008 15,000
Washington, DC........................................ November 2006 8,200
Westchester, IL....................................... January 2001 10,700
Westchester, IL....................................... April 2001 5,700
</TABLE>

Allegiance believes that its leased facilities are adequate to meet its
current needs in the markets in which it has begun to deploy networks, and that
additional facilities are available to meet its development and expansion needs
in existing and projected target markets for the foreseeable future.

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<PAGE> 55

MANAGEMENT

DIRECTORS, EXECUTIVE OFFICERS AND OTHER KEY EMPLOYEES

The following table sets forth information concerning the directors,
executive officers and other key personnel of Allegiance, including their ages
as of December 31, 1998:

<TABLE>
<CAPTION>
NAME AGE POSITION(S)
- ---- --- -----------
<S> <C> <C>
Royce J. Holland..................... 50 Chairman of the Board and Chief Executive
Officer
C. Daniel Yost....................... 50 President and Chief Operating Officer and
Director
Thomas M. Lord....................... 42 Executive Vice President of Corporate
Development, Chief Financial Officer and
Director
John J. Callahan..................... 49 Senior Vice President of Sales and Marketing
and Director
Dana A. Crowne....................... 38 Senior Vice President and Chief Engineer
Stephen N. Holland................... 47 Senior Vice President and Chief Information
Officer
Patricia E. Koide.................... 50 Senior Vice President of Human Resources, Real
Estate, Training, Facilities and
Administration
Gregg A. Long........................ 45 Senior Vice President of Development and
Regulatory
Mark B. Tresnowski................... 39 Senior Vice President, General Counsel and
Secretary
Anthony J. Parella................... 39 National Vice President of Field Sales
Paul D. Carbery...................... 37 Director
James E. Crawford, III............... 53 Director
John B. Ehrenkranz................... 33 Director
Paul J. Finnegan..................... 46 Director
Richard D. Frisbie................... 49 Director
Alan E. Goldberg..................... 44 Director
Reed E. Hundt........................ 51 Director
James N. Perry, Jr................... 38 Director
</TABLE>

Royce J. Holland, Allegiance's Chairman of the Board and Chief Executive
Officer, has more than 25 years of experience in the telecommunications,
independent power and engineering/construction industries. Prior to founding
Allegiance in April 1997, Mr. Holland was one of several co-founders of MFS
Communications, where he served as President and Chief Operating Officer from
April 1990 until September 1996 and as Vice Chairman from September 1996 to
February 1997. In January 1993, Mr. Holland was appointed by President George
Bush to the National Security Telecommunications Advisory Committee. Mr. Holland
was recently named Chairman of the Association for Local Telecommunications
Services, the industry trade organization for the competitive telephone sector.
Mr. Holland also presently serves on the board of directors of CSG Systems, a
publicly held billing services company. Mr. Holland's brother, Stephen N.
Holland, is employed as Allegiance's Senior Vice President and Chief Information
Officer.

C. Daniel Yost, who joined Allegiance as President and Chief Operating
Officer in February 1998, was elected to Allegiance's board of directors in
March 1998. Mr. Yost has more than 26 years of experience in the
telecommunications industry. From July 1997 until he joined Allegiance, Mr. Yost
was the President and Chief Operating Officer for U.S. Operations of Netcom
On-Line Communications Services, Inc., a leading Internet service provider. Mr.
Yost served as the President, Southwest Region of AT&T Wireless Services, Inc.
from June 1994 to July 1997. Prior to that, from July 1991 to June 1994, Mr.
Yost was the President, Southwest Region of McCaw Cellular Communications/LIN
Broadcasting.

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<PAGE> 56

Thomas M. Lord, a co-founder and director of Allegiance and its Executive
Vice President of Corporate Development and Chief Financial Officer, is
responsible for overseeing Allegiance's mergers and acquisitions, corporate
finance and investor relations functions. Mr. Lord is an 18-year veteran in
investment banking, securities research and portfolio management, including
serving as a managing director of Bear, Stearns & Co. Inc. from January 1986 to
December 1996. In the five-year period ending December 1996, Mr. Lord oversaw 43
different transactions valued in excess of $6.2 billion for the
telecommunications, information services and technology industries.

John J. Callahan, who joined Allegiance as Senior Vice President of Sales
and Marketing in December 1997, has more than 18 years of experience in the
telecommunications industry. Most recently, Mr. Callahan was President of the
Western Division for MFS Communications from December 1991 to November 1997,
where he was responsible for the company's sales and operations in Arizona,
California, Georgia, Florida, Illinois, Michigan, Missouri, Ohio, Oregon, Texas
and Washington. Prior to joining MFS Communications, Mr. Callahan was Vice
President and General Manager, Southwest Division for Sprint. Mr. Callahan also
held sales positions with Data Switch and North American Telecom. Mr. Callahan
was elected to Allegiance's board of directors in March 1998.

Dana A. Crowne became Allegiance's Senior Vice President and Chief Engineer
in August 1997. Prior to joining Allegiance, Mr. Crowne held various management
positions at MFS Communications from the time of its founding in 1988, where his
responsibilities included providing engineering support and overseeing budgets
for the construction of MFS Communications' networks. Mr. Crowne ultimately
became Vice President, Network Optimization for MFS Communications from January
1996 to May 1997 and managed the company's network expenses and planning and its
domestic engineering functions. Prior to joining MFS Communications, Mr. Crowne
designed and installed fiber optic transmission systems for Morrison-Knudsen and
served as a consultant on the construction of private telecommunications
networks with JW Reed and Associates.

Stephen N. Holland joined Allegiance as its Senior Vice President and Chief
Information Officer in September 1997. Prior to that time, Mr. Holland held
several senior level positions involving management of or consulting on
information systems, accounting, taxation and finance. Mr. Holland's experience
includes serving as Practice Manager and Information Technology Consultant for
Oracle Corporation from June 1995 to September 1997, as Chief Financial Officer
of Petrosurance Casualty Co. from September 1992 to June 1995, as Manager of
Business Development for Electronic Data Systems, and as a partner of Price
Waterhouse. Mr. Holland's brother, Royce J. Holland, presently serves as
Allegiance's Chairman of the Board and Chief Executive Officer.

Patricia E. Koide has been Allegiance's Senior Vice President of Human
Resources, Real Estate, Training, Facilities and Administration since August
1997. Before then, Ms. Koide was Vice President of Corporate Services,
Facilities and Administration for WorldCom from March 1997 to August 1997. Ms.
Koide also held various management positions within MFS Communications and its
subsidiaries since 1989, including Senior Vice President of Facilities,
Administration and Purchasing for MFS Communications North America from 1996 to
1997, Senior Vice President of Human Resources, Facilities and Administration
for MFS Communications Telecom from 1994 to 1996, and Vice President of Human
Resources and Administration for MFS Communications North America from 1989 to
1993. Prior to MFS Communications, Ms. Koide was with Sprint for eight years
where she managed the company's human resources, real estate and facilities for
the Midwest.

Gregg A. Long, who became Allegiance's Senior Vice President of Regulatory
and Development in September 1997, spent 11 years at Destec Energy, Inc. as
Project Development Manager -- Partnership Vice President and Director. In that
position, he was responsible for the development of gas-fired power plants from
conceptual stages through project financing. Prior to joining Destec, Mr. Long
was Manager of Project Finance at Morrison-Knudsen, where he was responsible for
analyzing and arranging finance packages for various industrial, mining and
civil projects and also served as financial consultant and analyst.

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<PAGE> 57

Mark B. Tresnowski became Allegiance's Senior Vice President and General
Counsel in February 1999. Mr. Tresnowski has been Allegiance's Secretary since
September 1997. Mr. Tresnowski practiced law at Kirkland & Ellis for 13 years
and was a partner of that firm from October 1992 to January 1999. In private
practice, Mr. Tresnowski specialized in private and public financings, mergers
and acquisitions and securities law.

Anthony J. Parella, who joined Allegiance as its Regional Vice
President -- Central Division in August 1997 and became its National Vice
President of Field Sales in August 1998, has more than 10 years of experience in
the telecommunications industry. Prior to joining Allegiance, Mr. Parella was
Vice President and General Manager for MFS Intelenet, Inc., an operating unit of
MFS Communications, from February 1994 to January 1997, where he was responsible
for the company's sales and operations in Texas. Mr. Parella also served as
Director of Commercial Sales for Sprint from 1991 to January 1994.

Paul D. Carbery, who was elected to Allegiance's board of directors in
August 1997, is a general partner of Frontenac Company, a Chicago-based private
equity investing firm, where he specializes in investing in companies in the
telecommunications and technology industries. Mr. Carbery also presently serves
on the boards of directors of Whittman Hart, Inc., a publicly traded information
services company.

James E. Crawford, III, who was elected to Allegiance's board of directors
in August 1997, is a general partner of Frontenac Company, a Chicago-based
private equity investing firm, where he specializes in investing in companies in
the telecommunications and technology industries. Mr. Crawford also presently
serves on the boards of directors of Focal Communications Corporation, a
privately held CLEC that will compete with Allegiance, as well as of Optika
Incorporated, a publicly held imaging software document company, and Input
Software Incorporated, a publicly held document imaging software company.

John B. Ehrenkranz, who was elected to Allegiance's board of directors in
March 1998, is a Principal of Morgan Stanley & Co. Incorporated where he has
been employed since 1987. Mr. Ehrenkranz also presently serves on the board of
directors of Choice One, a privately held CLEC that may compete with Allegiance.
Mr. Ehrenkranz is also a Principal of Morgan Stanley Capital Partners III, Inc.

Paul J. Finnegan, who was elected to Allegiance's board of directors in
August 1997, is a managing director of Madison Dearborn Partners, Inc., a
Chicago-based private equity investing firm, where he specializes in investing
in companies in the telecommunications industry. Mr. Finnegan also presently
serves on the boards of directors of Focal Communications Corporation, a
privately held CLEC that competes with Allegiance in certain markets, and
Omnipoint Corporation, a publicly traded PCS provider.

Richard D. Frisbie, who was elected to Allegiance's board of directors in
August 1997, is a Managing Partner of Battery Partners IV, LLC, which is the
general partner of Battery Ventures IV, a Boston-based private equity investing
firm, where he specializes in investing in companies in the telecommunications
industry. Mr. Frisbie also presently serves on the board of directors of Focal
Communications Corporation, a privately held CLEC that competes with Allegiance
in certain markets.

Alan E. Goldberg was elected to Allegiance's board of directors in March
1999. Mr. Goldberg has been Chairman, Chief Executive Officer and Director of
Morgan Stanley Dean Witter Capital Partners III, Inc. since February 1998. Prior
to that time, he was co-head of MSDW Capital Partners. He has been a Managing
Director of Morgan Stanley & Co. Incorporated since January 1988. Mr. Goldberg
also serves as a director of Amerin Corporation, Catalytica, Inc., Smurfit-Stone
Container Corporation, Equant, N.V., a provider of international data network
services, and several private companies.

Reed E. Hundt was elected to Allegiance's board of directors in March 1998.
Mr. Hundt served as chairman of the Federal Communications Commission from 1993
to 1997. He currently serves as chairman of The Forum on Communications and
Society at The Aspen Institute, is a senior advisor on information industries to
McKinsey & Company, a worldwide management consulting firm, and a special
advisor to Madison Dearborn Partners, Inc., a Chicago-based private equity
investing firm. Mr. Hundt is a venture partner at Benchmark Capital, a venture
capital firm and a principal of Charles Ross Partners, LLC, a consulting firm.
Mr. Hundt also presently serves on the boards of directors of Ascend
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<PAGE> 58

Communications, Inc., a publicly traded manufacturer of wide area networking
solutions, and Novell, Inc., a publicly traded network software and Internet
solutions provider, and NorthPoint Communications Holdings, Inc., a privately
held CLEC that competes with Allegiance in certain markets. Prior to joining the
FCC, Mr. Hundt was a partner at Latham & Watkins, an international law firm.

James N. Perry, Jr., who was elected to Allegiance's board of directors in
August 1997, is a managing director of Madison Dearborn Partners, Inc., a
Chicago-based private equity investing firm, where he specializes in investing
in companies in the telecommunications industry. Mr. Perry also presently serves
on the boards of directors of Focal Communications Corporation, a privately held
CLEC that competes with Allegiance in certain markets, as well as Omnipoint
Corporation, a publicly traded PCS provider, and Clearnet Communications, a
Canadian publicly traded PCS and enhanced specialized mobile radio company.

ELECTION OF DIRECTORS; VOTING AGREEMENT

Allegiance's by-laws provide that the number of directors shall be
determined by resolution of the board of directors. The board currently consists
of 12 directors. Allegiance's by-laws provide that its directors will be elected
by plurality vote of Allegiance's stockholders, without cumulative voting. No
director may be removed from office without cause and without the vote of the
holders of a majority of the outstanding voting stock.

The board of directors is divided into three classes, as nearly equal in
number as possible, with each director serving a three year term and one class
being elected at each year's annual meeting of stockholders. Messrs. Callahan,
Finnegan, Carbery and Ehrenkranz are in the class of directors whose term
expires at the 1999 annual meeting of Allegiance's stockholders. Messrs. Lord,
Yost, Crawford and Frisbie are in the class of directors whose term expires at
the 2000 annual meeting of Allegiance's stockholders. Messrs. Holland, Hundt,
Perry and Goldberg are in the class of directors whose term expires at the 2001
annual meeting of Allegiance's stockholders. At each annual meeting of
Allegiance's stockholders, successors to the class of directors whose term
expires at such meeting will be elected to serve for three-year terms and until
their successors are elected and qualified.

Certain of Allegiance's stockholders have each agreed to vote all of their
shares in such a manner as to elect the following persons to serve as directors:
Madison Dearborn Capital Partners, Morgan Stanley Capital Partners, and
Frontenac Company each have the right to designate two directors; Battery
Ventures has the right to designate one director; Allegiance's Chief Executive
Officer has the right to serve as a director; our original management investors
have the right to designate three directors; and the final two directorships may
be filled by representatives designated by the fund investors and acceptable to
the management investors.

COMMITTEES OF THE BOARD OF DIRECTORS

The board of directors currently has three committees:

- an Executive Committee,

- an Audit Committee, and

- a Compensation Committee.

The Executive Committee is currently comprised of Messrs. Holland,
Crawford, Goldberg and Perry. The Executive Committee is authorized, subject to
certain limitations, to exercise all of the powers of the board of directors
during periods between board meetings.

The Audit Committee is currently comprised of Messrs. Yost, Hundt, Carbery,
Ehrenkranz and Finnegan. The Audit Committee is responsible for making
recommendations to the board of directors regarding the selection of independent
auditors, reviewing the results and scope of the audit and other

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<PAGE> 59

services provided by Allegiance's independent accountants and reviewing and
evaluating Allegiance's audit and control functions and year 2000 issues.

The Compensation Committee is currently comprised of Messrs. Holland,
Frisbie, Crawford, Goldberg and Perry. The Compensation Committee is responsible
for reviewing, and as it deems appropriate, recommending to the board of
directors, policies, practices and procedures relating to the compensation of
the officers and other managerial employees of Allegiance and the establishment
and administration of employee benefit plans. The Compensation Committee
exercises all authority under any stock option or stock purchase plans of
Allegiance, unless the board appoints any other committee to exercise such
authority, and advises and consults with the officers of Allegiance as may be
requested regarding managerial personnel policies.

COMPENSATION OF DIRECTORS

Allegiance will reimburse the members of its board of directors for their
reasonable out-of-pocket expenses incurred in connection with attending board or
committee meetings. Additionally, Allegiance is obligated to maintain its
present level of directors' and officers' insurance. Members of Allegiance's
board of directors receive no other compensation for services provided as a
director or as a member of any board committee.

EXECUTIVE COMPENSATION

The following table sets forth compensation paid to the Chief Executive
Officer and the four other executive officers of Allegiance who, based on salary
and bonus compensation from Allegiance, were the most highly compensated
officers of Allegiance for the year ended December 31, 1998.

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
ANNUAL COMPENSATION
------------------------------------------------
OTHER ANNUAL ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) COMPENSATION($)(A) COMPENSATION($)
- --------------------------- ---- --------- -------- ------------------ ---------------
<S> <C> <C> <C> <C> <C>
Royce J. Holland.................... 1998 $207,693 $150,000 $-- $--
Chairman of the Board and 1997 $ 72,308 $ -- $-- $--
Chief Executive Officer
C. Daniel Yost...................... 1998 $165,385 $100,000 $-- $--
President and Chief 1997 $ -- $ -- $-- $--
Operating Officer
Thomas M. Lord...................... 1998 $181,731 $150,000 $-- $--
Executive Vice President of 1997 $ 63,942 $ -- $-- $--
Corporate Development and
Chief Financial Officer
John J. Callahan.................... 1998 $181,731 $ 70,000 $-- $--
Senior Vice President of 1997 $ 10,096 $ -- $-- $--
Sales and Marketing
Dana A. Crowne...................... 1998 $152,052 $ 51,058 $-- $--
Senior Vice President and Chief 1997 $ 45,192 $ -- $-- $--
Engineer
</TABLE>

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

(a) Includes perquisites and other benefits paid to the named executive officer
in excess of 10% of the total annual salary and bonus received by the named
executive officer during the last fiscal year.

Prior to April 1998, the board did not have a Compensation Committee and
decisions concerning the compensation of executive officers and other key
employees of Allegiance were determined by Allegiance's board of directors.

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<PAGE> 60

STOCK PLANS

1997 Nonqualified Stock Option Plan

On November 13, 1997, Allegiance's board of directors adopted the 1997
Nonqualified Stock Option Plan, under which Allegiance may issue to its
directors, consultants, and executive and other key employees, stock options
exercisable for shares of Allegiance's common stock. Options to acquire an
aggregate of 1,037,474 shares of common stock have been granted under such
option plan and Allegiance will not grant options for any additional shares
under the option plan.

The option plan is administered by the Compensation Committee and
authorizes the Compensation Committee to issue options in such forms and amounts
and on such terms as determined by the Compensation Committee. The per-share
exercise price for options is set by the Compensation Committee, but may not be
less than the fair market value of a share of Allegiance's common stock on the
date of grant, as determined in good faith by the Compensation Committee. The
terms of the options issued under the option plan to date are summarized below.

Three years' amount of options will be issued on the first business day of
the quarter succeeding the date which a participant joins Allegiance. Such
options will vest over a three-year period, with 1/3 vesting on the first
anniversary of the date of grant and 1/12 vesting on each of the first eight
quarter-ends thereafter. Subject to available options under the option plan, one
year's amount of options will be issued on each anniversary of the initial
grant, and such options will vest in the third year after grant, with 1/4
vesting on each of the 27-, 30-, 33-, and 36-month anniversaries of the date of
grant. Through this mechanism, a participant will at any given time have three
years' amount of options unvested. Vesting is accelerated 100% upon an
employee's death or permanent physical disability. If there is a sale of
Allegiance and the participant is terminated or constructively terminated within
the two-year period following the sale, vesting is accelerated 100% upon such
termination.

Options are nontransferable during the life of the participant and
generally expire if not exercised within six years after the date of grant.
Shares of common stock issued upon exercise of options are subject to various
restrictions on transferability, holdback periods in the event of a public
offering of Allegiance's securities and provisions requiring the holder of such
shares to approve and, if requested by Allegiance, sell its shares in any sale
of Allegiance that is approved by the board.

1998 Stock Incentive Plan

On June 18, 1998, the board and stockholders of Allegiance approved
Allegiance's 1998 Stock Incentive Plan. This stock incentive plan is
administered by the Compensation Committee. Certain employees, directors,
advisors and consultants of Allegiance will be eligible to participate in this
plan. The Compensation Committee is authorized to select the participants and
determine the terms and conditions of the awards under this plan. The stock
incentive plan provides for the issuance of the following types of incentive
awards: stock options, stock appreciation rights, restricted stock, performance
grants and other types of awards that the Compensation Committee deems
consistent with the purposes of the stock incentive plan.

On March 2, 1999, Allegiance's board approved amending this plan to
increase the number of shares available under this plan by 2,500,000 shares. An
aggregate of 6,155,778 shares of common stock of Allegiance have been reserved
for issuance under the stock incentive plan, subject to certain adjustments
reflecting changes in Allegiance's capitalization.

Options granted under the stock incentive plan may be either incentive
stock options or such other forms of non-qualified stock options as the
Compensation Committee may determine. Incentive stock

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<PAGE> 61

options are intended to qualify as "incentive stock options" within the meaning
of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code").
The exercise price of

- an incentive stock option granted to an individual who owns shares
possessing more than 10% of the total combined voting power of all
classes of stock of Allegiance will be at least 110% of the fair market
value of a share of common stock on the date of grant, and

- an incentive stock option granted to an individual other than such a 10%
owner will be at least 100% of the fair market value of a share of common
stock on the date of grant.

Options granted under the stock incentive plan may be subject to time
vesting and certain other restrictions at the sole discretion of the
Compensation Committee.

The board generally will have the power and authority to amend the stock
incentive plan at any time without approval of Allegiance's stockholders,
subject to applicable federal securities and tax laws limitations and to the
regulations of the Nasdaq National Market.

Stock Purchase Plan

On June 18, 1998, Allegiance's Employee Stock Discount Purchase Plan was
approved by the board and stockholders. The stock purchase plan is intended to
give employees desiring to do so a convenient means of purchasing shares of
common stock through payroll deductions. The stock purchase plan is intended to
provide an incentive to participate by permitting purchases at a discounted
price. Allegiance believes that ownership of stock by employees will foster
greater employee interest in the success, growth and development of Allegiance.

Subject to certain restrictions, each employee of Allegiance who is a U.S.
resident or a U.S. citizen temporarily on location at a facility outside of the
United States will be eligible to participate in the stock purchase plan if he
or she has been employed by Allegiance for more than three continuous months.
Participation will be discretionary with each eligible employee. Allegiance has
reserved 2,305,718 shares of common stock for issuance in connection with the
stock purchase plan.

Elections to participate and purchases of stock will be made on a quarterly
basis. Each participating employee contributes to the stock purchase plan by
choosing a payroll deduction in any specified amount, with a specified minimum
deduction per payroll period. A participating employee may increase or decrease
the amount of such employee's payroll deduction, including a change to a zero
deduction as of the beginning of any calendar quarter. Elected contributions
will be credited to participants' accounts at the end of each calendar quarter.

Each participating employee's contributions will be used to purchase shares
for the employee's share account as promptly as practicable after each calendar
quarter. The cost per share will be 85% of the lower of the closing price of
Allegiance's common stock on the Nasdaq National Market on the first or the last
day of the calendar quarter. The number of shares purchased on each employee's
behalf and deposited in his/her share account will be based on the amount
accumulated in such participant's cash account and the purchase price for shares
with respect to any calendar quarter. Shares purchased under the stock purchase
plan carry full rights to receive dividends declared from time to time. A
participating employee will have full ownership of all shares in such employee's
share account and may withdraw them for sale or otherwise by written request to
the Compensation Committee following the close of each calendar quarter.

Subject to applicable federal securities and tax laws, the board will have
the right to amend or to terminate the stock purchase plan. Amendments to the
stock purchase plan will not affect a participating employee's right to the
benefit of the contributions made by such employee prior to the date of any such
amendment. In the event the stock purchase plan is terminated, the Compensation
Committee will be required to distribute all shares held in each participating
employee's share account plus an amount of cash equal to the balance in each
participating employee's cash account.

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<PAGE> 62

401(k) Plan

Allegiance has adopted a tax-qualified employee savings and retirement plan
covering all of Allegiance's full-time employees. Under the 401(k) plan,
employees may elect to reduce their current compensation up to the statutorily
prescribed annual limit and have the amount of such reduction contributed to the
401(k) plan. The 401(k) plan is intended to qualify under Section 401 of the
Code so that contributions by employees to the 401(k) plan, and income earned on
plan contributions, are not taxable to employees until withdrawn from the 401(k)
plan. The trustees under the 401(k) plan, at the direction of each participant,
invest such participant's assets in the 401(k) plan in selected investment
options.

EXECUTIVE AGREEMENTS

Royce J. Holland Executive Agreement

In August 1997, Allegiance, Allegiance Telecom, LLC, and Mr. Holland
entered into an Executive Purchase Agreement that includes, among others, the
following terms:

Vesting. The Allegiance Telecom, LLC securities purchased by Mr.
Holland, as well as any Allegiance securities distributed with respect to
such Allegiance Telecom, LLC securities are subject to vesting over a
four-year period, with 20% vesting on the date of grant and 20% vesting on
each of the first four anniversaries of the grant date. Vesting was
accelerated by one year upon the consummation of the initial public
offering of common stock, and will be accelerated 100% in the event of Mr.
Holland's death or disability, and 100% upon a sale of Allegiance where at
least 50% of the consideration for such sale is cash or marketable
securities.

Repurchase of Securities. If Mr. Holland's employment is terminated
for any reason other than a termination by Allegiance without cause,
Allegiance will have the right to repurchase all vested Holland executive
securities at fair market value, and all unvested Holland executive
securities at the lesser of fair market value and original cost.

Restrictions on Transfer; Holdback and "Drag Along" Agreements. The
Holland executive securities are subject to various restrictions on
transferability, holdback periods in the event of a public offering of
Allegiance's securities and provisions requiring the holder of such shares
to approve and, if requested by Allegiance, sell its shares in any sale of
Allegiance that is approved by the board.

Terms of Employment. Mr. Holland is an "at will" employee of
Allegiance and, thus, may be terminated by Allegiance at any time and for
any reason. Mr. Holland is not entitled to receive any severance payments
upon any such termination, other than payments in consideration of the
noncompetition and nonsolicitation agreements discussed below.

Noncompetition and Nonsolicitation Agreements. During the noncompete
period defined below, Mr. Holland may not hire or attempt to induce any
employee of Allegiance to leave Allegiance's employ, nor attempt to induce
any customer or other business relation of Allegiance to cease doing
business with Allegiance, nor in any other way interfere with Allegiance's
relationships with its employees, customers, and other business relations.
Also, during this noncompete period, Mr. Holland may not participate in any
business engaged in the provision of telecommunications services in the
markets specified below.

The noncompete period in this agreement is the period of employment
and the following additional period: (a) if Mr. Holland is terminated prior
to August 13, 2000, the period ending on the later of August 13, 2001 and
the second anniversary of termination; (b) if Mr. Holland is terminated at
any time on or after August 13, 2000 but prior to August 13, 2001, the
period ending on August 13, 2002; and (c) if Mr. Holland is terminated at
any time on or after August 13, 2001, the one-year period following
termination. However, this period ends if at any time Allegiance ceases to

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<PAGE> 63

pay Mr. Holland his base salary and benefits in existence at the time of
termination. The markets covered by this noncompete provision are:

- any market in which Allegiance is conducting business or preparing
under a business plan approved by the board of directors to conduct
business;

- Dallas, New York City, Atlanta, Chicago, Los Angeles and 15 additional
markets; and

- any market for which Allegiance has prepared a business plan unless
such business plan has been rejected by the board of directors.

C. Daniel Yost Executive Agreement

In February 1998, Allegiance Telecom, Allegiance Telecom, LLC, and Mr. Yost
entered into an Executive Purchase Agreement, containing the same terms as those
in Mr. Holland's executive agreement.

Thomas M. Lord Executive Agreement

In August 1997, Allegiance, Allegiance Telecom, LLC, and Mr. Lord entered
into an Executive Purchase Agreement, containing the same terms as those in Mr.
Holland's executive agreement.

EXECUTIVE AGREEMENTS ENTERED INTO BY OTHER MANAGEMENT INVESTORS

Each of the original management investors has entered into an Executive
Purchase Agreement which includes the following terms:

Vesting. The Allegiance Telecom, LLC securities purchased by a
management investor, as well as any securities distributed with respect to
such Allegiance Telecom, LLC securities are subject to vesting over a
four-year period, with 25% vesting on each of the first four anniversaries
of the grant date. Vesting was accelerated by one year upon the
consummation of the initial public offering of common stock, and will be
accelerated 100% in the event of such management investor's death or
disability, and 100% upon a sale of Allegiance where at least 50% of the
consideration for such sale is cash or marketable securities.

Repurchase of Securities. If a management investor's employment is
terminated for any reason, Allegiance will have the right to repurchase all
such management investor's vested executive securities at fair market
value, and all unvested executive securities at the lesser of fair market
value and original cost.

Restrictions on Transfer; Holdback and "Drag Along" Agreements. The
executive securities are subject to various restrictions on
transferability, holdback periods in the event of a public offering of
Allegiance's securities and provisions requiring the holder of such shares
to approve and, if requested by Allegiance, sell its shares in any sale of
Allegiance that is approved by the board.

Terms of Employment. Each management investor is an "at will" employee
of Allegiance and, thus, may be terminated by Allegiance at any time and
for any reason. No management investor is entitled to receive any severance
payments upon any such termination.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

Prior to April 1998, Allegiance did not have a Compensation Committee and
the compensation of executive officers and other key employees of Allegiance was
determined by its board of directors. Royce J. Holland, Allegiance's Chairman
and Chief Executive Officer, Thomas M. Lord, Allegiance's Executive Vice
President of Corporate Development and Chief Financial Officer, C. Daniel Yost,
Allegiance's President and Chief Operating Officer, and John J. Callahan,
Allegiance's Senior Vice President of Sales and Marketing, are all currently
members of Allegiance's board of directors. The board of directors has
established a Compensation Committee, which is responsible for decisions
regarding

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<PAGE> 64

salaries, incentive compensation, stock option grants and other matters
regarding executive officers and key employees of Allegiance. See "-- Committees
of the Board of Directors."

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

LIMITED LIABILITY COMPANY AGREEMENT

On August 13, 1997, Allegiance's original fund investors and management
investors entered into a limited liability company agreement to govern the
affairs of Allegiance Telecom, LLC, which immediately prior to the initial
public offering, held the one outstanding share of Allegiance's common stock and
substantially all of the outstanding shares of Allegiance's preferred stock.

Upon consummation of Allegiance's initial public offering of common stock,
Allegiance Telecom, LLC dissolved and its assets, which consisted almost
entirely of Allegiance stock, were distributed to the fund investors and the
management investors in accordance with its limited liability company agreement.
Under the terms of this agreement, the equity allocation between the fund
investors and the management investors could range between 95.0%/5.0% and
66.7%/33.3% based upon the valuation of Allegiance's common stock implied by the
initial public offering of common stock. Based upon the valuation of
Allegiance's common stock implied by the initial public offering of common
stock, the equity allocation was 66.7% to the fund investors and 33.3% to the
management investors. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Results of Operations."

SECURITYHOLDERS AGREEMENT

The fund investors, the management investors, and Allegiance, are parties
to a Securityholders Agreement dated as of August 13, 1997. Under the terms of
this agreement, in the event of an approved sale of Allegiance, each of the fund
investors and their transferees agrees to approve and, if requested, to sell its
shares in such sale of Allegiance. Most of the provisions of this agreement
terminated upon the consummation of the initial public offering of common stock.

REGISTRATION AGREEMENT

The fund investors, the management investors, and Allegiance are parties to
a Registration Agreement dated as of August 13, 1997. See "Description of
Capital Stock -- Registration Rights."

VOTING AGREEMENT

Certain of Allegiance's stockholders have each agreed to vote all of their
shares in such a manner as to elect the following persons to serve as directors:
Madison Dearborn Capital Partners, Morgan Stanley Capital Partners, and
Frontenac Company each have the right to designate two directors; Battery
Ventures has the right to designate one director; Allegiance's Chief Executive
Officer has the right to serve as a director; the management investors have the
right to designate three directors; and the final two directorships may be
filled by representatives designated by the fund investors and acceptable to the
management investors.

GRANT OF OPTIONS

In March 1998, prior to Reed E. Hundt joining the board of directors,
Allegiance issued:

- options to purchase 50,623 shares of common stock to Reed E. Hundt, and

- 50,623 shares of common stock to Charles Ross Partners, LLC, of which Mr.
Hundt is a member.

The options were issued with an exercise price of $2.47 per share. 33.33%
of such options vested on March 13, 1999, and an additional 8.34% of such
options will vest every three months after this date, until March 13, 2001, when
all such options become exercisable. These numbers take into account
Allegiance's initial public offering of common stock and related
426.2953905-for-one stock split.
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<PAGE> 65

OTHER

Morgan Stanley & Co. Incorporated, an affiliate of Morgan Stanley Capital
Partners, one of the fund investors, acted as a placement agent in connection
with Allegiance's offering of the 11 3/4% notes and redeemable warrants and
received fees of approximately $4.4 million. In addition, Morgan Stanley & Co.
Incorporated was one of the underwriters in Allegiance's initial public offering
of common stock and 12 7/8% notes offering and received fees of approximately
$6.9 million in connection with such offerings.

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<PAGE> 66

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth certain information regarding the beneficial
ownership of the outstanding common stock of Allegiance as of March 15, 1999 by:

- each of the directors and the executive officers of Allegiance;

- all directors and executive officers as a group, and

- each owner of more than 5% of the equity securities of Allegiance.

The percentages specified below are based on 50,360,866 shares of common
stock outstanding as of March 15, 1999. Unless otherwise noted, the address for
each director and executive officer of Allegiance is c/o Allegiance Telecom,
Inc., 1950 Stemmons Freeway, Suite 3026, Dallas, Texas 75207.

<TABLE>
<CAPTION>
PERCENT
NAME AND ADDRESS OF BENEFICIAL OWNER NUMBER OF CLASS
- ------------------------------------ ---------- --------
<S> <C> <C>
DIRECTORS AND EXECUTIVE OFFICERS:
Royce J. Holland(1)......................................... 3,907,683 7.8%
C. Daniel Yost.............................................. 1,619,940 3.2
Thomas M. Lord(2)........................................... 1,822,432 3.6
John J. Callahan............................................ 608,477 1.2
Dana A. Crowne.............................................. 404,985 0
Paul D. Carbery(3).......................................... 4,262,999 8.5
James E. Crawford, III(3)(4)................................ 4,274,499 8.5
John B. Ehrenkranz.......................................... -- --
Paul J. Finnegan(5)......................................... -- --
Richard D. Frisbie(6)....................................... 2,131,499 4.2
Alan E. Goldberg(7)......................................... -- --
Reed E. Hundt(8)............................................ 101,246 *
James N. Perry, Jr.(5)...................................... -- --
All directors and executive officers as a group (13
persons).................................................. 14,870,761 29.6
5% OWNERS:
Madison Dearborn Capital Partners(9)........................ 10,302,247 20.5
Morgan Stanley Capital Partners(10)......................... 10,302,247 20.5
Frontenac Company(11)....................................... 4,262,999 8.5
</TABLE>

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

* Denotes less than one percent.

(1) Includes 1,940,552 shares of common stock owned by the Royce J. Holland
Family Limited Partnership, of which Royce J. Holland is the sole general
partner, 1,000 shares of common stock owned by Mr. Holland's wife, 2,600
shares of common stock held by Mr. Holland as custodian for his children,
as to which 2,600 shares Mr. Holland disclaims beneficial ownership.
3,881,105 of the shares of common stock owned by Mr. Holland and the Royce
J. Holland Family Limited Partnership are subject to vesting, with 20% of
such shares of common stock vested on August 13, 1997, 20% vested upon the
consummation of the initial public offering of common stock and an
additional 20% vesting on each of August 13, 1998, 1999 and 2000. See
"Management -- Executive Agreements."

(2) Includes 683,412 shares of common stock owned by Mr. Lord's wife and
children, as to which Mr. Lord disclaims beneficial ownership. All of the
shares of common stock owned by Mr. Lord and his family are subject to
vesting with 20% of such shares of common stock vested on August 13, 1997,
20% vested upon the consummation of the initial public offering of common
stock and an additional 20% vesting on each of August 13, 1998, 1999 and
2000. See "Management -- Executive Agreements."

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<PAGE> 67

(3) 4,262,999 shares of common stock shown are owned by Frontenac VII Limited
Partnership and Frontenac Masters VII Limited Partnership. Messrs. Carbery
and Crawford are members of Frontenac Company, VII, L.L.C., the general
partner of Frontenac VII Limited Partnership and Frontenac Masters VII
Limited Partnership and their address is c/o Frontenac Company, 135 S.
LaSalle Street, Suite 3800, Chicago, IL 60603. They disclaim beneficial
ownership of these shares of common stock.

(4) Includes 500 shares of common stock owned by Mr. Crawford's spouse, 100
shares of common stock owned by Mr. Crawford's son, and 600 shares held by
Mr. Crawford as custodian for his son, as to which 600 shares Mr. Crawford
disclaims beneficial ownership.

(5) Messrs. Finnegan and Perry are managing directors of Madison Dearborn
Partners, Inc., the general partner of the general partner of Madison
Dearborn Capital Partners II, L.P. and their address is c/o Madison
Dearborn Partners, Inc., Three First National Plaza, Suite 3800, Chicago,
IL 60602.

(6) All shares of common stock shown are owned by Battery Ventures IV, L.P. and
Battery Investment Partners IV, LLC. Mr. Frisbie is a managing partner of
Battery Partners IV, LLC, the general partner of these funds and his
address is c/o Battery Ventures, 20 William Street, Wellesley, MA 02181. He
disclaims beneficial ownership of these shares of common stock.

(7) Mr. Goldberg is Chairman, Chief Executive Officer and Director of Morgan
Stanley Capital Partners III, Inc., the general partner of the general
partner of the funds described in footnote (10) below and their address is
c/o Morgan Stanley Capital Partners, 1221 Avenue of the Americas, New York,
NY 10020.

(8) Mr. Hundt owns options to acquire 50,623 shares of common stock and Charles
Ross Partners, LLC, a Delaware limited liability company, of which Mr.
Hundt is a member, owns 50,623 shares of common stock.

(9) These shares of common stock are owned by Madison Dearborn Capital Partners
II, L.P.

(10) These shares of common stock are owned by Morgan Stanley Capital Partners
III, L.P., MSCP III 892 Investors, L.P. and Morgan Stanley Capital
Investors, L.P.

(11) These shares of common stock are owned by Frontenac VII Limited Partnership
and Frontenac Masters VII Limited Partnership.

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<PAGE> 68

DESCRIPTION OF CERTAIN INDEBTEDNESS

11 3/4% NOTES

On February 3, 1998, we issued $445.0 million aggregate principal amount at
maturity of 11 3/4% Senior Discount Notes. They will mature on February 15,
2008. The 11 3/4% notes were issued in units, with each unit consisting of one
11 3/4% note and one redeemable warrant.

No cash interest is payable on the 11 3/4% notes prior to August 15, 2003.
From and after February 15, 2003, interest on the 11 3/4% notes will accrue at
the rate of 11 3/4% per annum. Interest on the 11 3/4% notes is payable
semiannually on February 15 and August 15 of each year, commencing August 15,
2003. Payment of interest will be made to holders of record at the close of
business on the February 1 or August 1 immediately preceding the interest
payment date.

The 11 3/4% notes are not secured by any of our assets and rank equally in
right of payment with all of our unsubordinated and unsecured indebtedness,
including the 12 7/8% notes described below. The 11 3/4% notes are senior in
right of payment to all of our future subordinated indebtedness.

We may redeem the 11 3/4% notes at our option, in whole or in part, at any
time on or after February 15, 2003. The initial redemption price is 105.8750% of
their principal amount at maturity, plus accrued interest. The redemption price
will decline each year and will be 100% of their principal amount at maturity,
plus accrued interest, beginning on February 15, 2006. In addition, at any time
on or before February 15, 2001, we may redeem up to 35% of the aggregate
principal amount at maturity of the 11 3/4% notes with the proceeds of certain
public equity offerings at a redemption price equal to 111.75% of their accreted
value of the 11 3/4% notes on the redemption date. We may make this redemption
only so long as at least $289.3 million aggregate principal amount at maturity
of the 11 3/4% notes remains outstanding immediately after such redemption.

The 11 3/4% notes indenture contains certain restrictive covenants,
including among others, limitations on the ability of Allegiance and its
restricted subsidiaries to:

- incur indebtedness,

- pay dividends,

- prepay subordinated indebtedness,

- repurchase capital stock,

- make investments,

- engage in transactions with affiliates,

- create liens,

- sell assets, and

- engage in mergers and consolidations and certain other events which could
cause an event of default.

Events of default under the 11 3/4% notes indenture include, among other
things:

- payment defaults,

- covenant defaults,

- cross-defaults to certain other indebtedness,

- judgment defaults, and

- certain events of bankruptcy and insolvency.

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<PAGE> 69

12 7/8% NOTES

On July 7, 1998, we issued $205.0 million aggregate principal amount at
maturity of 12 7/8% Senior Notes. They will mature on May 15, 2008.

Interest on the 12 7/8% notes accrues at the rate of 12 7/8% per annum,
payable semiannually on May 15 and November 15 of each year. Payment of interest
will be made to holders of record at the close of business on the May 1 or
November 1 immediately preceding the interest payment date.

In connection with the sale of the 12 7/8 notes, we purchased approximately
$69.0 million of U.S. Government securities and placed such securities in a
pledge account to be used for payment in full of the first six scheduled
interest payments due on the 12 7/8 notes.

The 12 7/8% notes are not secured by any of our assets other than the
pledge of the U.S. Government securities described above, and rank equally in
right of payment with all of our unsubordinated and unsecured indebtedness,
including the 11 3/4% notes described above. The 12 7/8% notes are senior in
right of payment to all of our future subordinated indebtedness.

We may redeem the 12 7/8% notes at our option, in whole or in part, at any
time on or after May 15, 2003. The initial redemption price is 106.438% of their
principal amount at maturity, plus accrued interest. The redemption price will
decline each year and will be 100% of their principal amount at maturity, plus
accrued interest, beginning on May 15, 2006. In addition, at any time on or
before May 15, 2001, we may redeem up to 35% of the aggregate principal amount
at maturity of the 12 7/8% notes with the proceeds of certain public equity
offerings at a redemption price equal to 112.875% of the principal amount plus
accrued interest. We may make this redemption only so long as at least $133.25
million aggregate principal amount at maturity of the 12 7/8% notes remains
outstanding immediately after such redemption.

The 12 7/8% notes indenture contains certain restrictive covenants and
events of default that are substantially similar to those contained in the
11 3/4% indenture.

REVOLVING CREDIT FACILITY

Goldman Sachs Credit Partners L.P., TD Securities (USA) Inc. and Morgan
Stanley Senior Funding, Inc. have agreed to arrange a senior secured revolving
credit facility maturing December 31, 2005. These banks have received
commitments for this facility aggregating in excess of $200.0 million from
various lenders. This revolving facility would be available, subject to
satisfaction of certain terms and conditions, to provide purchase money
financing for the acquisition, construction and improvement of
telecommunications assets by Allegiance's operating subsidiaries. The following
is a summary of material terms of the revolving credit facility, which may
change and is subject to the execution of definitive agreements.

The borrower under the facility will be Allegiance Finance Company, Inc., a
wholly owned subsidiary of Allegiance Telecom, Inc. that will own Allegiance's
operating subsidiaries. The facility will be structurally senior to all of
Allegiance's 12 7/8% notes and 11 3/4% notes issued in 1998. The facility will
be secured by all of Allegiance's subsidiaries' assets and a pledge of the stock
of Allegiance Finance Company. The facility will also be guaranteed by
Allegiance Telecom, Inc. Based on Allegiance's current business plan, the
facility is expected to be undrawn until 2000. Interest rates under the facility
will be tied to the level of debt compared to consolidated EBITDA and is
initially expected to be the London Interbank Offering Rate + 3.75%. The
commitment fee on the undrawn portion of the facility is initially expected to
be 1.50% of the total amount of the facility, with step-downs based on
utilization.

Allegiance's ability to borrow under the facility will fluctuate according
to Allegiance's ability to meet the financial covenants and the ability of
Allegiance's geographic markets to generate cash. Allegiance may borrow under
the facility at such time as Allegiance Telecom, Inc. has invested a minimum of
$250 million in the operations of the borrower and/or its subsidiaries, and
certifies that, in at least one market which operates as an independent business
unit, Allegiance has achieved positive earnings before deducting interest,
taxes, depreciation and amortization and before deducting overhead charges. The

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facility refers to this measurement as "pre-overhead EBITDA." Allegiance must
also certify that it projects such market to remain pre-overhead EBITDA positive
through the maturity of the facility. The actual amount available under the
initial availability test will be equal to one-third of the total amount of the
facility, plus three times the annualized pre-overhead EBITDA for such market.
Thus, for example, if the Allegiance Dallas market operations turn pre-overhead
EBITDA positive for one month and Allegiance projects that this market will
remain positive through the maturity of the facility on December 31, 2005, the
initial availability under the facility will be equal to one third of the total
amount of the facility plus three times the annualized pre-overhead EBITDA for
the Dallas market. The one-month results are annualized by multiplying these
results by twelve. Allegiance would not be able to borrow if the market fails to
remain pre-overhead EBITDA positive and is required to repay loans at such time
in an amount equal to the availability created by such market.

The availability derived from any single pre-overhead EBITDA positive
market, however, will not exceed $100 million. At present, it is anticipated
that Dallas will be the first market to turn positive on a pre-overhead EBITDA
basis. Management expects this to occur in April 1999, however, there can be no
assurance that this will be the case.

The amount available will increase when two or more markets generate
positive pre-overhead EBITDA for a given month. This incremental availability
will equal three times the annualized pre-overhead EBITDA generated by each
market other than the first market.

The availability test will also serve as a financial covenant, and
Allegiance will be required to maintain levels of pre-overhead EBITDA from
individual markets that would support amounts outstanding under the facility.
The commitments of the lenders under the facility will reduce in twelve
consecutive quarterly installments, beginning on March 31, 2003, in annual
amounts equal to the following respective percentages of the initial amount of
the facility:

<TABLE>
<CAPTION>
FACILITY
YEAR REDUCTION
- ---- ---------
<S> <C>
2003.............................................. 20%
2004.............................................. 30%
2005.............................................. 50%
</TABLE>

A comprehensive covenant package as well as the availability tests
described above will govern the facility. During the initial network
construction phase from closing of the facility through June 30, 2001,
Allegiance's performance will be tested by one set of covenants. Another set of
covenants will take effect July 1, 2001. Allegiance must be in compliance with
each covenant in order to borrow under the facility and a failure to satisfy any
of the covenants would enable the lender to declare outstanding amounts to be
due and payable. The covenants for these periods will include:

<TABLE>
<CAPTION>
COVENANTS THROUGH JUNE 30, 2001 COVENANTS FROM JULY 1, 2001 TO DECEMBER 31, 2005
------------------------------- ------------------------------------------------
<S> <C>
- - Minimum Revenues - Senior Secured Debt to Annualized Consolidated
EBITDA
- - Maximum Consolidated EBITDA Loss/
Minimum Consolidated EBITDA - Total Debt to Annualized Consolidated EBITDA
- - Senior Secured Debt to Total - Annualized Consolidated EBITDA/Interest
Capitalization Expense
- - Maximum Capital Expenditures - Annualized Pro Forma Consolidated EBITDA/Pro
Forma Debt Service
- - Maximum Unsecured Subordinated Debt
- Maximum Capital Expenditures
</TABLE>

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Allegiance will have flexibility under the facility to make unlimited
acquisitions using equity consideration, or if financed with indebtedness,
acquisitions totaling up to $75 million. There will be an additional $25 million
sub-limit with respect to acquisitions of entities generating negative free cash
flow for the trailing twelve-month period, stepping up to $45 million at such
time as the borrower generates positive pre-overhead EBITDA in two or more
markets, all of which limits are subject to increase as additional equity is
raised and contributed as common equity to the borrower and its subsidiaries.

In addition, the borrower will be subject to limitations, to be determined,
with respect to investments in more than 24 initial markets. The borrower will
be permitted to make distributions to Allegiance Telecom, Inc. to enable the
payment of interest and principal on the existing indebtedness of Allegiance
Telecom, Inc.

The facilities will be also be subject to certain representations,
warranties, covenants and events of default customary for credits of this nature
and otherwise agreed upon by the parties.

DESCRIPTION OF CAPITAL STOCK

GENERAL MATTERS

The total amount of authorized capital stock of Allegiance consists of
150,000,000 shares of common stock, par value $.01 per share, and 1,000,000
shares of preferred stock, par value $.01 per share. As of March 15, 1999,
50,360,866 shares of common stock were issued and outstanding and no shares of
preferred stock were issued and outstanding. The following discussion describes
Allegiance's capital stock, its charter and by-laws. This summary describes all
material provisions of Allegiance's charter and by-laws. If you would like to
read copies of these documents, we have filed copies with the SEC.

Allegiance's charter and by-laws contain certain provisions that are
intended to enhance the likelihood of continuity and stability in the
composition of the board of directors. These provisions may have the effect of
delaying, deferring or preventing a future takeover or change in control of
Allegiance unless the takeover or change in control is approved by the board of
directors.

COMMON STOCK

Subject to the prior rights of the holders of any preferred stock, the
holders of outstanding shares of common stock are entitled to receive dividends
out of assets legally available at such time and in such amounts as the board of
directors may from time to time determine. The shares of common stock are not
convertible and the holders have no preemptive or subscription rights to
purchase any securities of Allegiance. Upon liquidation, dissolution or winding
up of Allegiance, the holders of common stock are entitled to receive pro rata,
the assets of Allegiance which are legally available for distribution, after
payment of all debts and other liabilities and subject to the prior rights of
any holders of preferred stock then outstanding. Each outstanding share of
common stock is entitled to one vote on all matters submitted to a vote of
stockholders. There is no cumulative voting.

PREFERRED STOCK

Allegiance's board of directors may, without further action by Allegiance's
stockholders, from time to time, direct the issuance of shares of preferred
stock in series and may, at the time of issuance, determine the rights,
preferences and limitations of each series. Satisfaction of any dividend
preferences of outstanding shares of preferred stock would reduce the amount of
funds available for the payment of dividends on shares of common stock. Holders
of shares of preferred stock may be entitled to receive a preference payment in
the event of any liquidation, dissolution or winding-up of Allegiance before any
payment is made to the holders of shares of common stock. Under certain
circumstances, the issuance of shares of preferred stock may render more
difficult or tend to discourage a merger, tender offer or proxy

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contest, the assumption of control by a holder of a large block of Allegiance's
securities or the removal of incumbent management. Upon the affirmative vote of
a majority of the total number of directors then in office, the board of
directors of Allegiance, without stockholder approval, may issue shares of
preferred stock with voting and conversion rights which could adversely affect
the holders of shares of common stock. There are no shares of preferred stock
currently outstanding, and Allegiance has no present intention to issue any
shares of preferred stock.

CERTAIN PROVISIONS OF ALLEGIANCE'S CHARTER AND BY-LAWS

Allegiance's charter provides for the board of directors to be divided into
three classes, as nearly equal in number as possible, serving staggered terms.
Approximately one-third of the board of directors will be elected each year. See
"Management." Under the Delaware General Corporation Law, directors serving on a
classified board can only be removed for cause. The provision for a classified
board could prevent a party who acquires control of a majority of the
outstanding voting stock from obtaining control of the board of directors until
the second annual stockholders meeting following the date the acquiror obtains
the controlling stock interest. The classified board provision could have the
effect of discouraging a potential acquiror from making a tender offer or
otherwise attempting to obtain control of Allegiance and could increase the
likelihood that incumbent directors will retain their positions.

Allegiance's charter provides that stockholder action can be taken only at
an annual or special meeting of stockholders and cannot be taken by written
consent in lieu of a meeting. Allegiance's charter and the by-laws provides
that, except as otherwise required by law, special meetings of the stockholders
can only be called under a resolution adopted by a majority of the board of
directors or by the Chief Executive Officer of Allegiance. Stockholders will not
be permitted to call a special meeting or to require the board of directors to
call a special meeting.

Allegiance's by-laws establish an advance notice procedure for stockholder
proposals to be brought before an annual meeting of stockholders of Allegiance,
including proposed nominations of persons for election to the board of
directors.

Stockholders at an annual meeting may only consider proposals or
nominations specified in the notice of meeting or brought before the meeting by
or at the direction of the board of directors or by a stockholder who was a
stockholder of record on the record date for the meeting, who is entitled to
vote at the meeting and who has given to Allegiance's Secretary timely written
notice, in proper form, of the stockholder's intention to bring that business
before the meeting. Although the by-laws do not give the board of directors the
power to approve or disapprove stockholder nominations of candidates or
proposals regarding other business to be conducted at a special or annual
meeting, the by-laws may have the effect of precluding the conduct of certain
business at a meeting if the proper procedures are not followed or may
discourage or defer a potential acquiror from conducting a solicitation of
proxies to elect its own slate of directors or otherwise attempting to obtain
control of Allegiance.

Allegiance's charter and by-laws provide that the affirmative vote of
holders of at least 66 2/3% of the total votes eligible to be cast in the
election of directors is required to amend, alter, change or repeal certain of
their provisions. This requirement of a super-majority vote to approve
amendments to its charter and by-laws could enable a minority of Allegiance's
stockholders to exercise veto power over any such amendments.

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CERTAIN PROVISIONS OF DELAWARE LAW

Allegiance is subject to the "Business Combination" provisions of the
Delaware General Corporation Law. In general, such provisions prohibit a
publicly held Delaware corporation from engaging in various "business
combination" transactions with any "interested stockholder" for a period of
three years after the date of the transaction which the person became an
"interested stockholder," unless:

- the transaction is approved by the board of directors prior to the date
the "interested stockholder" obtained such status;

- upon consummation of the transaction which resulted in the stockholder
becoming an "interested stockholder," the "interested stockholder," owned
at least 85% of the voting stock of the corporation outstanding at the
time the transaction commenced, excluding for purposes of determining the
number of shares outstanding those shares owned by:

(a) persons who are directors and also officers, and

(b) employee stock plans in which employee participants do not have the
right to determine confidentially whether shares held subject to the
plan will be tendered in a tender or exchange offer; or

- on or subsequent to such date the "business combination" is approved by
the board of directors and authorized at an annual or special meeting of
stockholders by the affirmative vote of at least 66 2/3% of the
outstanding voting stock which is not owned by the "interested
stockholder."

A "business combination" is defined to include mergers, asset sales and
other transactions resulting in financial benefit to a stockholder. In general,
an "interested stockholder" is a person who, together with affiliates and
associates, owns or within three years did own, 15% or more of a corporation's
voting stock. The statute could prohibit or delay mergers or other takeover or
change in control attempts with respect to Allegiance and, accordingly, may
discourage attempts to acquire Allegiance.

LIMITATIONS ON LIABILITY AND INDEMNIFICATION OF OFFICERS AND DIRECTORS

Allegiance's charter limits the liability of directors to the fullest
extent permitted by the Delaware General Corporation Law. In addition, the
charter provides that Allegiance will indemnify directors and officers of
Allegiance to the fullest extent permitted by such law. Allegiance anticipates
entering into indemnification agreements with its current directors and
executive officers and any new directors or executive officers.

WARRANTS

In connection with the offering of our 11 3/4% notes, Allegiance issued
445,000 redeemable warrants under a warrant agreement between Allegiance and The
Bank of New York. See "Description of the Warrants."

REGISTRATION RIGHTS

The fund investors, the management investors, and Allegiance are parties to
a Registration Agreement dated as of August 13, 1997. Each of Morgan Stanley
Capital Partners, Madison Dearborn Capital Partners, and Frontenac Company is
entitled to demand two long-form registrations and unlimited short-form
registrations, and Battery Ventures is entitled to demand one long-form
registration, such as registration on Form S-1, and unlimited short-form
registrations, such as registration on Form S-3. In addition, the fund investors
and the management investors may "piggyback" on primary or secondary registered
public offerings of Allegiance's securities. Allegiance has agreed to pay the
registration expenses in connection with these demand and "piggyback"
registrations. Each fund investor and management

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investor is subject to holdback restrictions in the event of a public offering
of Allegiance securities. The parties to the Registration Agreement have agreed
to permit the holders of redeemable warrants to "piggyback" on any registrations
under the Registration Agreement. The parties to the Registration Agreement have
waived their right to "piggyback" on the registration statement relating to this
offering.

Allegiance and The Bank of New York are parties to a Warrant Registration
Rights Agreement dated as of February 3, 1998. The holders of the redeemable
warrants are entitled to "piggyback" registration rights in connection with
certain public offerings of the common stock. In addition, Allegiance is
required to use its best efforts to cause to become effective under the
Securities Act, within 180 days after the closing of the initial public offering
of common stock, a shelf registration statement with respect to the issuance of
the common stock issuable upon exercise of the redeemable warrants; except that
such shelf registration statement may not be declared effective prior to the
first anniversary of the issuance of the redeemable warrants. Once the shelf
registration statement is declared effective, Allegiance is required to maintain
the effectiveness of such registration statement until all redeemable warrants
have expired or been exercised. Allegiance is required to pay the expenses
associated with such registration. Allegiance is seeking a waiver by the parties
to the Warrant Registration Rights Agreement of their rights to "piggyback" on
the registration statement relating to Allegiance's anticipated offering of
10,000,000 shares of its common stock.

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DESCRIPTION OF THE WARRANTS

In connection with Allegiance's sale of its 11 3/4% notes, on February 3,
1998, Allegiance issued the warrants pursuant to the warrant agreement between
Allegiance and The Bank of New York, as warrant agent.

The following description of the warrants summarizes all material
provisions of the warrant agreement. It does not restate the warrant agreement
and excludes definitions and other legal terminology contained in that
agreement. The warrant agreement, and not this summary, defines the rights of
the holders of warrants. If you would like to read the warrant agreement, we
have filed a copy of it with the SEC.

EXERCISE PRICE AND SHARES ISSUABLE

Each warrant is evidenced by a warrant certificate which entitles the
holder thereof to purchase 1.45898399509 shares of Allegiance's common stock, at
a price of $.01 per share. The exercise price and the number of shares of common
stock issuable upon exercise of a warrant are both subject to adjustment, as
later described in this section.

EXPIRATION DATE

The warrants are currently exercisable and may be exercised at any time
prior to the close of business on February 3, 2008. Warrants not exercised by
such date will expire.

REPURCHASE OF THE WARRANTS

Following the occurrence of a "repurchase event," Allegiance must make an
offer to repurchase for cash all outstanding warrants. The holders of the
warrants may, until 5:00 p.m., New York City time, on the date at least 30 but
not more than 60 days following the date on which Allegiance gives notice of
such repurchase offer to such holders, surrender all or part of their warrants
for repurchase by Allegiance. Except as otherwise provided in the warrant
agreement, warrants received by the warrant agent in proper form for purchase
during a repurchase offer prior to this time are to be repurchased by Allegiance
at a price in cash equal to the "relevant value" on the specified valuation date
of the warrant shares, had the warrants then been exercised, less the exercise
price.

The "relevant value" of the common stock or other securities means:

- if the common stock is registered under the Exchange Act, the average of
the closing sales prices of the common stock for the 20 consecutive
trading days immediately preceding such valuation date or, if the common
stock has been registered under the Exchange Act for less than 20 days
trading days before such date, then the average of the closing sales
prices for all of the trading days before such date for which closing
sales prices are available; or

- if the common stock is not registered under the Exchange Act or if the
value cannot be computed under the prior clause, the value determined by
an independent financial expert, without giving effect to any discount
for lack of liquidity, the fact that Allegiance has no class of equity
securities registered under the Exchange Act or the fact that the common
stock issuable upon exercise of the warrants represent a minority in
Allegiance. The board of directors of Allegiance is required to select an
independent financial expert not more than five business days following a
repurchase event. Within two days after its selection of the independent
financial expert, Allegiance must deliver to the warrant agent a notice
setting forth the name of such independent financial expert. The
Allegiance must use its best efforts to cause the independent financial
expert to deliver to Allegiance, with a copy to the warrant agent, a
value report which states the relevant value of the common stock being
valued as of the valuation date and contains a brief statement as to the
nature and scope of the methodologies upon which the determination was
made. The warrant agent will have no duty with respect to such value
report of any independent financial expert, except to keep it on file
available for inspection by the holders of the warrants. The
determination of the independent
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financial expert as to the relevant value in accordance with the
provisions of the warrant agreement is binding on all persons.

A "repurchase event" is defined to occur on any date when Allegiance:

- consolidates with or merges into or with another person, but only where
the holders of common stock receive consideration in exchange for all or
part of such common stock, if the common stock thereafter issuable upon
exercise of the warrants is not registered under the Exchange Act; or

- sells all or substantially all of its assets to another person, if the
common stock thereafter issuable upon exercise of the warrants is not
registered under the Exchange Act;

provided that, in each case, a "repurchase event" shall not be deemed to have
occurred if the consideration for such transaction consists solely of cash.

EXERCISE PROCEDURES

To exercise all or any of the warrants represented by a warrant
certificate, the holder thereof must surrender to the warrant agent:

- the warrant certificate,

- a duly executed copy of the subscription form set forth in the warrant
certificate, and

- payment in full of the exercise price for each share of common stock or
other securities issuable upon exercise of such warrants, which payment
may be made in cash or by certified or official bank or bank cashier's
check payable to the order of Allegiance or through the surrender of
warrant certificates.

Upon the exercise of any warrant in accordance with the warrant agreement,
the warrant agent will instruct Allegiance to:

- transfer promptly to or

- upon the written order of the holder of such warrant certificate
appropriate evidence of ownership,

of any shares of common stock or other security or property to which it is
entitled as a result of such exercise, registered or otherwise placed in such
name or names as it may direct in writing. Allegiance will deliver such evidence
of ownership to the person or persons entitled to receive the same and
fractional shares, if any, or an amount in cash, in lieu of any fractional
shares, if any. All shares of common stock or other securities issuable by
Allegiance upon the exercise of the warrants must be validly issued, fully paid
and nonassessable.

ADJUSTMENTS TO THE EXERCISE PRICE AND NUMBER OF SHARES OF COMMON STOCK

The warrant agreement contains provisions adjusting the exercise price and
the number of shares of common stock or other securities issuable upon exercise
of a warrant in the event of:

- a division, consolidation or reclassification of the shares of common
stock;

- the issuance of rights, options, warrants or convertible or exchangeable
securities to all holders of shares of common stock entitling such
holders to subscribe for or purchase shares of common stock at a price
per share which is lower than the then current value per share of common
stock, subject to certain exceptions;

- the issuance of shares of common stock at a price per share that is lower
than the then current value of such shares, except for issuances in
connection with an acquisition, merger or similar transaction with a
third party;

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- certain distributions to all holders of shares of common stock of
evidences of indebtedness or assets; and

- in the discretion of Allegiance's board of directors, in certain other
circumstances.

No adjustment in the number of shares of common stock purchasable upon
exercise of the warrants will be made, however, for:

- certain bona fide public offerings or private placements,

- certain grants or exercises of options or other rights to purchase or the
exercise of such rights granted to employees, directors or certain
investors of Allegiance,

- issuances of shares of common stock to employees of Allegiance,

- grants or exercises of options, warrants or other agreements or rights to
purchase capital stock of Allegiance existing on the date of original
issuance of the warrants, and in certain other circumstances,

- adjustments that would require an increase or decrease of less than one
percent in the number of shares of common stock purchasable upon the
exercise of a warrant, and

- certain additional limited exceptions.

WARRANT HOLDERS DO NOT HAVE RIGHTS AS STOCKHOLDERS

The warrants do not give the holders the right to:

- receive dividends or other distributions,

- receive notice of any meeting of the stockholders,

- consent to any action of the stockholders,

- receive notice of any other stockholder proceedings, or

- any other rights as stockholders of Allegiance.

MERGERS, CONSOLIDATIONS, ETC.

Except as provided below, if Allegiance:

- consolidates with,

- merges with or into, or

- sells all or substantially all of its property and assets to another
person,

each warrant will entitle the holder to receive upon exercise the number of
shares of capital stock or other securities or property which the holder of
common stock is entitled to receive upon completion of such consolidation,
merger or sale of assets. If Allegiance merges or consolidates with, or sells
all or substantially all of the property and assets of Allegiance to another
person and the consideration to the holders of common stock in exchange for
their shares is payable solely in cash, or in the event of the dissolution,
liquidation or winding-up of Allegiance, then the holders of the warrants will
be entitled to receive distributions on an equal basis with the holders of
common stock or other securities issuable upon exercise of the warrants assuming
the warrants had been exercised immediately prior to such event, less the
exercise price. Upon receipt of such payment, if any, the warrants will expire
and the rights of the

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holders will cease. If Allegiance has made a repurchase offer that has not
expired at the time of such transaction, the holders of the warrants will be
entitled to receive the higher of:

- the amount payable to the holders of the warrants described above and

- the repurchase price payable to the holders of the warrants pursuant to
such repurchase offer.

In case of any such merger, consolidation or sale of assets, the surviving
or acquiring person and, in the event of any dissolution, liquidation or
winding-up of Allegiance, Allegiance must deposit promptly with the warrant
agent the funds, if any, necessary to pay to the holders of the warrants. After
such funds and the surrendered warrant certificate are received, the warrant
agent must make payment by delivering a check in such amount as is appropriate
or, in the case of consideration other than cash, such other consideration as is
appropriate, to such person or persons as it may be directed in writing by the
holders surrendering such warrants.

REGISTRATION REQUIREMENTS

Under the terms of the warrant registration rights agreement, dated as of
January 29, 1998, between Allegiance and the warrant agent, Allegiance has filed
a registration statement with the SEC, of which this prospectus forms a part.
Allegiance is required to use reasonable efforts to maintain the effectiveness
of this registration statement until the expiration date of the warrants, or if
earlier, such time as all warrants have been exercised. During any consecutive
365-day period while the warrants are exercisable, Allegiance will have the
ability to suspend the availability of such registration statement for:

- up to two 30-consecutive-day periods, except during the 30 days
immediately prior to the expiration of the warrants, if Allegiance's
board of directors determines in good faith that there is a valid purpose
for the suspension and provides notice of such determination to the
holders at their addresses appearing in the register of warrants
maintained by the warrant agent; and

- five additional, non-consecutive three-day periods, except during the
30-day period immediately prior to the expiration date of the warrants,
if Allegiance's board of directors determines in good faith that
Allegiance cannot provide adequate disclosure during such period due to
circumstances beyond its control.

Allegiance will pay the expenses associated with the registration of the common
stock issued upon exercise of the warrants, excluding fees of counsel retained
by the holders of the warrants. Allegiance and the holders of the warrants have
agreed to indemnify each other against certain liabilities, including certain
liabilities arising under the Securities Act.

RESERVATION OF SHARES

Allegiance has authorized and will reserve for issuance such number of
shares of common stock as will be issuable upon the exercise of all outstanding
warrants. Such shares of common stock, when issued and paid for in accordance
with the warrant agreement, will be duly and validly issued, fully paid and
nonassessable, free of preemptive rights and free from all taxes, liens, charges
and security interests.

AMENDMENT OF WARRANT AGREEMENT

Without the consent of the holders of the warrants, Allegiance and the
warrant agent may:

- make changes or corrections in the warrant agreement that are required to
cure any ambiguities, defects or inconsistencies; and

- add additional Allegiance covenants or agreements or surrender any rights
or powers reserved to Allegiance.

Any changes or corrections that adversely affect the rights, privileges or
immunities of the holders of the warrants will require the concurrence of the
holders of the warrants.

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CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS

The following discussion is based upon the provisions of the Code, the
applicable Treasury Regulations promulgated and proposed thereunder, judicial
authority and current administrative rulings and practice, all of which are
subject to change, possibly with retroactive effect.

This discussion does not purport to deal with all aspects of U.S. Federal
income taxation that might be relevant to particular holders in light of their
personal investment circumstances or status, nor does it discuss the U.S.
Federal income tax consequences to certain types of holders subject to special
treatment under the U.S. Federal income tax laws, such as financial
institutions, insurance companies, dealers in securities, tax-exempt
organizations, or taxpayers holding the warrants or the warrant shares as part
of a "straddle," "hedge," "conversion transaction" or other integrated
transaction. Moreover, the effect of any applicable state, local, foreign, gift,
estate or other tax laws generally is not discussed.

Except as otherwise indicated below, this discussion assumes that the
warrants and warrant shares are held as capital assets, as defined in Section
1221 of the Code, by the holders of such assets. This discussion is limited to
the material U.S. Federal income tax consequences to initial holders of the
warrants and warrant shares.

U.S. HOLDERS

Except as specifically provided below, the immediately following discussion
is limited to the U.S. Federal income tax consequences relevant to a holder of
the warrants and warrant shares who or which is (each a "U.S. Holder"):

- an individual who is a citizen or resident, or is treated as a citizen or
resident under the Code, of the United States,

- a corporation, partnership or other entity created or organized, or
treated as created or organized under the Code, under the laws of the
United States, or any political subdivision thereof,

- an estate the income of which is subject to U.S. Federal income taxation
regardless of its source,

- a trust with respect to which a court within the United States is able to
exercise primary supervision of the administration of such trust and one
or more United States persons have authority to control all substantial
decisions of such trust, or

- a person whose worldwide income or gain is otherwise subject to U.S.
Federal income taxation on a net income basis.

Potential Federal income tax consequences to persons who are not U.S. Holders
are discussed in detail below under "-- Non-U.S. Holders."

Tax Treatment of The Warrants

The U.S. Federal income tax consequences of the purchase and the exercise
or sale of the warrants will depend, to some extent, on whether they are viewed,
for U.S. Federal income tax purposes, as equivalent to common stock. There is no
authority directly dealing with that issue. Because nominal consideration is
required to exercise the warrants and the exercise of the warrants is therefore
economically compelled, Allegiance believes that, if presented with the issue,
it is likely that the IRS would treat the warrants as issued and outstanding
shares of common stock of Allegiance for U.S. Federal income tax purposes.

An initial holder's adjusted tax basis with respect to warrants will be an
amount equal to the portion of the issue price of the "unit," comprised of
warrants and 11 3/4% notes, allocated to such warrants. The issue price for a
unit is equal to the first price at which a substantial amount of the units were
sold for money. That issue price is then allocated among the warrants and the
11 3/4% notes based on the relative fair market values of each at the time of
issuance. Moreover, Allegiance's allocation among the components of the units is
binding on the holders unless the holder discloses that his, her or its
allocation
76
<PAGE> 80

differs on a statement attached to the holder's U.S. federal income tax return
for the year in which he, she or it acquired the unit. Allegiance intends to
take the position, based on the advice of the initial purchasers of the units,
that the portion of the issue price of a unit allocable to a warrant at the time
of issuance was $18.39 per warrant. This allocation, however, is not binding on
the IRS and, therefore, there can be no assurance that the IRS will respect such
allocation.

Exercise. A holder may receive warrant shares upon a payment in cash of the
exercise price. In the case of a cash exercise, a holder will not recognize gain
or loss as a result of such holder's receipt of warrant shares, except with
respect to cash received in lieu of fractional shares, regardless of whether the
warrants are treated as stock or as warrants for U.S. Federal income tax
purposes. Upon such a cash exercise, a holder's adjusted tax basis in the
warrant shares will be an amount equal to the holder's adjusted tax basis in the
warrants plus the amount paid in cash to Allegiance as the exercise price for
the warrants.

A holder of warrants that receives cash in lieu of fractional shares of
Allegiance's common stock upon a cash exercise will be treated as having
received such cash in exchange for such fractional shares. Such holder generally
will recognize capital gain or loss on such deemed exchange in an amount equal
to the difference between the amount of cash received and such holder's adjusted
tax basis in the fractional shares.

If the warrants lapse without exercise, the holder should recognize a loss
in an amount equal to the holder's adjusted tax basis in the warrants. If the
warrants are treated as stock of Allegiance for U.S. Federal income tax
purposes, it is unclear whether such loss should be an ordinary or a capital
loss. If the warrants are treated as warrants for U.S. Federal income tax
purposes, such loss should be a capital loss. Any such capital loss will be
long-term capital loss if the holding period for the warrants exceeds one year.

Sale or Redemption. In the event that a warrant is sold or otherwise
disposed of in a taxable transaction, other than a redemption or repurchase of a
warrant by Allegiance, the holder will recognize capital gain or loss in an
amount equal to the difference between the amount realized in the transaction
and the holder's adjusted tax basis in the warrant. If the warrant has been held
for more than one year, any capital gain or loss recognized by the holder will
be long-term capital gain or loss. Long-term capital gain recognized by
taxpayers who are individuals, estates or trusts on warrants held for more than
one year will generally be subject to a 20% maximum rate of tax.

In general, upon redemption or repurchase by Allegiance of the warrants a
holder will recognize capital gain or loss in an amount equal to the difference
between the amount realized in the redemption or repurchase and the holder's
adjusted tax basis in such warrants. If the warrants are treated as stock of
Allegiance for U.S. Federal income tax purposes, however, then in certain
limited circumstances, upon redemption or repurchase by Allegiance of warrants,
a holder will be required to treat the redemption or repurchase price, without
offset by the holder's adjusted tax basis in the warrants, as a dividend to the
extent of Allegiance's undistributed current and accumulated earnings and
profits. In such a case, a holder will not be entitled to recognize a loss. The
limited circumstances in which a redemption or repurchase will result in
dividend income primarily involve holders whose proportionate interests in
Allegiance remain the same or increase after the redemption or repurchase and,
in the case of a holder with a significant percentage equity interest in
Allegiance, whose interest in Allegiance is not materially reduced by the
redemption or repurchase.

Warrant Shares. If the warrants are exercised and warrant shares are
thereafter sold or disposed of in a taxable transaction, other than pursuant to
a redemption or repurchase by Allegiance, holders of warrant shares will
recognize capital gain or loss in an amount equal to the difference between the
amount realized in the transaction and the holder's adjusted tax basis in the
warrant shares. The gain or loss recognized will be long-term capital gain or
loss if the holding period with respect to the warrant shares is more than one
year. Long-term capital gain recognized by taxpayers who are individuals,
estates or trusts on warrant shares held for more than one year will generally
be subject to a 20% maximum rate of tax. Where the warrant shares are redeemed
or repurchased by Allegiance, a holder may recognize dividend income in a
77
<PAGE> 81

manner similar to that described above with respect to a redemption or
repurchase by Allegiance of warrants that are treated as stock for U.S. Federal
income tax purposes.

The holding period of warrant shares will depend on whether the warrants
are treated for U.S. Federal income tax purposes as warrants or as stock. If the
warrants are treated as stock of Allegiance, the holding period of the warrant
shares will include the holding period of the warrants. On the other hand, if
the warrants are treated as warrants, the holding period for the warrant shares
will commence on the day after the date the warrants are exercised.

Adjustments. The conversion ratio of the warrants is subject to adjustment
under certain circumstances. If an adjustment increases the proportionate
interest of a holder of a warrant in the fully diluted common stock, such as an
adjustment to reflect a taxable dividend paid to holders of common stock,
Section 305 of the Code may treat holders of the warrants as having received a
constructive dividend distribution.

Backup Withholding and Information Reporting

Under the Code, U.S. Holders may be subject, under certain circumstances,
to information reporting and "backup withholding" at a 31% rate with respect to
cash payments with respect to dividends on the warrant shares and the gross
proceeds from dispositions of the warrants or warrant shares. Backup withholding
applies only if the U.S. Holder:

- fails to furnish its social security or other taxpayer identification
number within a reasonable time after a request therefor,

- furnishes an incorrect taxpayer identification number,

- fails properly to report interest or dividends, or

- fails under certain circumstances to provide a certified statement,
signed under penalty of perjury, that the taxpayer identification number
provided is its correct number and that it is not subject to backup
withholding.

Any amount withheld from a payment to a U.S. Holder under the backup withholding
rules is allowable as a credit and may entitle such holder to a refund against
such U.S. Holder's U.S. Federal income tax liability, provided that the required
information is furnished to the IRS. Certain persons are exempt from backup
withholding, including corporations and financial institutions. U.S. Holders of
warrants or warrant shares should consult their tax advisors as to their
qualification for exemption from backup withholding and the procedure for
obtaining such exemption.

Allegiance will furnish annually to the IRS and to record holders of the
warrants or warrant shares to whom it is required to furnish such information,
information relating to the amount of dividends, as applicable.

NON-U.S. HOLDERS

The following discussion is limited to the U.S. Federal income tax
consequences relevant to a holder of warrants or warrant shares that is not a
U.S. Holder (a "Non-U.S. Holder").

For purposes of the following discussion, gain on the sale, exchange or
other disposition of warrants or warrant shares will be considered to be "U.S.
trade or business income" if such income or gain is:

- effectively connected with the conduct of a U.S. trade or business, or

- in the case of a treaty resident, attributable to a permanent
establishment or, in the case of an individual, a fixed base, in the
United States.

Dividends. Generally, any dividends on warrant shares to a Non-U.S. Holder
will be subject to withholding of U.S. Federal income tax at a rate of 30%
unless the dividend is effectively connected with the conduct of a trade or
business within the United States by the Non-U.S. Holder, in which case the
78
<PAGE> 82

dividend will be subject to U.S. Federal income tax on a net basis at the rates
applicable to U.S. persons generally and, with respect to corporate holders
under certain circumstances, may also be subject to a 30% branch profits tax.
The rate of withholding may be reduced to the extent provided by a tax treaty to
which the United States is a party if the recipient of the dividends is entitled
to the benefits of the treaty. Non-U.S. Holders seeking a reduction in the rate
of withholding under an income tax treaty and Non-U.S. Holders seeking an
exemption for dividends effectively connected with a trade or business carried
on by such Non-U.S. Holder in the United States will be required to comply with
certain certification and other requirements.

Sale, Exchange or Redemption of Warrants or Warrant Shares. Except as
described below and subject to the discussions concerning backup withholding and
"FIRPTA", any gain realized by a Non-U.S. Holder on the sale, exchange,
redemption or other disposition of a warrant or warrant share generally will not
be subject to U.S. Federal income tax, unless:

- such gain is U.S. trade or business income,

- subject to certain exceptions, the Non-U.S. Holder is an individual who
holds the warrant or warrant share as a capital asset, is present in the
United States for 183 days or more in the taxable year of the disposition
and certain other conditions are satisfied, or

- the Non-U.S. Holder is subject to tax pursuant to the provisions of U.S.
tax law applicable to certain U.S. expatriates, including certain former
citizens or residents of the United States.

FIRPTA. Under certain rules added to the Code by the Foreign Investment in
Real Property Tax Act ("FIRPTA"), Allegiance would be classified as a U.S. real
property holding corporation if the fair market value of its U.S. real property
interests were to exceed 50% of the fair market value of its real property
interests and other assets held for use in its trade or business. A Non-U.S.
Holder of warrants or warrant shares would be subject to U.S. Federal income tax
on gain arising from a sale or other disposition of such warrants or warrant
shares if Allegiance is or has been a U.S. real property holding corporation
within the preceding five years or the period of such holder's ownership of such
warrants or warrant shares, if shorter. However, if the common stock is
regularly traded on an established securities market, within the meaning of the
applicable Treasury Regulations, a Non-U.S. Holder of warrants or warrant
shares, other than certain 5% holders, within the meaning of applicable Treasury
Regulations, would not be subject to FIRPTA tax on any gain arising from a sale
or other disposition of such warrants or warrant shares. If a Non-U.S. Holder is
subject to FIRPTA tax on gain arising from a sale or other disposition of
warrants or warrant shares, a required withholding in respect of such tax will
be imposed at a rate of 10% of the amount realized.

Management believes that Allegiance is not, has not been, and does not
presently expect to become a USRPHC.

Information Reporting And Backup Withholding. Allegiance must report
annually to the IRS and to each Non-U.S. Holder any dividend income that is
subject to withholding, or that is exempt from U.S. withholding tax pursuant to
a tax treaty. Copies of these information returns may also be made available
under the provisions of a specific treaty or agreement to the tax authorities of
the country in which the Non-U.S. Holder resides.

Under current law, backup withholding at a rate of 31% will not apply to
dividends paid a Non-U.S. Holder at an address outside the United States. Under
recently promulgated Treasury Regulations, however, dividend payments will
generally be subject to information reporting and backup withholding unless
applicable certification requirements are satisfied. These regulations generally
will be effective with respect to dividend payments made after December 31,
1999.

The payment of the proceeds from the disposition of the warrants or warrant
shares to or through the United States office of any broker, U.S. or foreign,
will be subject to information reporting and possibly backup withholding unless
the owner certifies as its non-U.S. status under penalty of perjury or otherwise
establishes an exemption, provided that the broker does not have actual
knowledge that the holder is a
79
<PAGE> 83

U.S. person or that the conditions of any other exemption are not, in fact,
satisfied. The payment of the proceeds from the disposition of warrants or
warrant shares to or through a non-U.S. office of a non-U.S. broker that is not
a U.S. related person will not be subject to information reporting or backup
withholding. For this purpose, a "U.S. related person" is:

- a "controlled foreign corporation" for U.S. Federal income tax purposes,
or

- a foreign person 50% or more of whose gross income from all sources for
the three-year period ending with the close of its taxable year preceding
the payment, or for such part of the period that the broker has been in
existence is derived from activities that are effectively connected with
the conduct of a United States trade or business.

In the case of the payment of proceeds from the disposition of warrants or
warrant shares to or through a non-U.S. office of a broker that is either a U.S.
person or a U.S. related person, the Treasury Regulations require information
reporting on the payment unless the broker has documentary evidence in its files
that the owner is a Non-U.S. Holder and the broker has no knowledge to the
contrary. Backup withholding will not apply to payments made through foreign
offices of a broker that is not a U.S. person or a U.S. related person, absent
actual knowledge that the payee is a U.S. person.

Any amounts withheld under the backup withholding rules from a payment to a
Non-U.S. Holder will be allowed as a refund or a credit against such Non-U.S.
Holder's U.S. Federal income tax liability, provided that the requisite
procedures are followed.

THE FOREGOING DISCUSSION IS BASED ON THE PROVISIONS OF THE CODE,
REGULATIONS, RULINGS AND JUDICIAL DECISIONS NOW IN EFFECT, ALL OF WHICH ARE
SUBJECT TO CHANGE. ANY SUCH CHANGES MAY BE APPLIED RETROACTIVELY IN A MANNER
THAT COULD ADVERSELY AFFECT HOLDERS OF WARRANTS OR WARRANT SHARES. EACH HOLDER
OF WARRANTS SHOULD CONSULT ITS OWN TAX ADVISOR WITH RESPECT TO THE TAX
CONSEQUENCES TO IT, INCLUDING THE TAX CONSEQUENCES UNDER STATE, LOCAL, FOREIGN
AND OTHER TAX LAWS, OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF THE WARRANTS
OR WARRANT SHARES.

LEGAL MATTERS

The validity of the common stock offered hereby will be passed upon for
Allegiance by Mark B. Tresnowski, Senior Vice President, General Counsel and
Secretary of Allegiance Telecom, Inc. Mr. Tresnowski (a) owns 3,000 shares of
common stock and (b) holds options to purchase 330,000 shares of common stock at
an exercise price of $1.00 per share.

EXPERTS

The consolidated balance sheets of Allegiance as of December 31, 1998 and
December 31, 1997, and the related consolidated statements of operations,
stockholders' equity (deficit) and cash flows for the year ended December 31,
1998 and for the period from inception on April 22, 1997 to December 31, 1997,
have been audited by Arthur Andersen LLP, independent public accountants, as
indicated in their report with respect thereto and are included in this
prospectus in reliance upon the authority of said firm as experts in giving said
report.

WHERE YOU CAN FIND MORE INFORMATION

We file annual, quarterly and current reports and other information with
the SEC. You may read and copy any document we file at the SEC's public
reference rooms in Washington, D.C., New York, New York, and Chicago, Illinois.
Please call the SEC at 1-800-SEC-0330 for further information on the public
reference rooms. Our SEC filings are also available to the public on the SEC
internet site at http://www.sec.gov.

80
<PAGE> 84

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Report of Independent Public Accountants.................... F-2

Consolidated Balance Sheets as of December 31, 1998, and
December 31, 1997......................................... F-3

Consolidated Statements of Operations for the year ended
December 31, 1998, and for the Period from Inception
(April 22, 1997) through December 31, 1997................ F-4

Consolidated Statements of Stockholders' Equity (Deficit)
for the year ended December 31, 1998, and for the Period
from Inception (April 22, 1997) through December 31,
1997...................................................... F-5

Consolidated Statements of Cash Flows for the year ended
December 31, 1998, and for the Period from Inception
(April 22, 1997) through December 31, 1997................ F-6

Notes to Consolidated Financial Statements.................. F-7
</TABLE>

F-1
<PAGE> 85

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Stockholders of Allegiance Telecom, Inc.:

We have audited the accompanying consolidated balance sheets of Allegiance
Telecom, Inc. (a Delaware corporation) and subsidiaries (the "Company") as of
December 31, 1998 and 1997, and the related consolidated statements of
operations, stockholders' equity (deficit), and cash flows for the year ended
December 31, 1998, and for the period from inception (April 22, 1997), to
December 31, 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Allegiance Telecom, Inc. and
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for the year ended December 31, 1998, and for
the period from inception (April 22, 1997), to December 31, 1997, in conformity
with generally accepted accounting principles.

ARTHUR ANDERSEN LLP

Dallas, Texas,
February 3, 1999

F-2
<PAGE> 86

ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS -- DECEMBER 31, 1998 AND 1997

(in thousands, except share and per share data)

<TABLE>
<CAPTION>
1998 1997
----------- ---------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 262,501.7 $ 5,726.4
Short-term investments.................................... 143,389.7 --
Short-term investments, restricted........................ 25,542.8 --
Accounts receivable (net of allowance for doubtful
accounts of $577.2 and $0, at December 31, 1998 and
1997, respectively)..................................... 6,186.6 4.3
Prepaid expenses and other current assets................. 1,243.2 245.2
----------- ---------
Total current assets................................ 438,864.0 5,975.9
PROPERTY AND EQUIPMENT (net of accumulated depreciation and
amortization of $9,015.4 and $12.7 at December 31, 1998
and 1997, respectively)................................... 144,860.0 23,899.9
OTHER NONCURRENT ASSETS:
Deferred debt issuance costs (net of accumulated
amortization of $733.7 and $0, at December 31, 1998 and
1997, respectively)..................................... 16,078.4 --
Long-term investments, restricted......................... 36,699.2 --
Other assets.............................................. 1,372.7 171.2
----------- ---------
Total other noncurrent assets....................... 54,150.3 171.2
----------- ---------
Total assets........................................ $ 637,874.3 $30,047.0
=========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable.......................................... $ 20,981.7 $ 2,261.7
Accrued liabilities and other current liabilities......... 26,176.8 1,668.0
----------- ---------
Total current liabilities........................... 47,158.5 3,929.7
LONG-TERM DEBT.............................................. 471,652.1 --
REDEEMABLE CUMULATIVE CONVERTIBLE PREFERRED STOCK,
$.01 par value, 0 and 40,498,062 shares authorized, 0 and
40,498,062 shares issued and outstanding at December 31,
1998 and 1997, respectively............................. -- 33,409.4
REDEEMABLE WARRANTS......................................... 8,634.1 --
COMMITMENTS AND CONTINGENCIES (see Notes 6 and 8)
STOCKHOLDERS' EQUITY (DEFICIT):
Preferred stock, $.01 par value, 1,000,000 and 0 shares
authorized, no shares issued or outstanding at December
31, 1998 and 1997, respectively......................... -- --
Common stock, $.01 par value, 150,000,000 and 42,629,965
shares authorized, 50,341,554 and 426 shares issued and
outstanding at December 31, 1998 and 1997,
respectively............................................ 503.4 --
Additional paid-in capital................................ 416,729.9 3,008.4
Deferred compensation..................................... (14,617.3) (2,798.4)
Deferred management ownership allocation charge........... (26,224.7) --
Accumulated deficit....................................... (265,961.7) (7,502.1)
----------- ---------
Total stockholders' equity (deficit)................ 110,429.6 (7,292.1)
----------- ---------
Total liabilities and stockholders' equity
(deficit)........................................... $ 637,874.3 $30,047.0
=========== =========
</TABLE>

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

F-3
<PAGE> 87

ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except share and per share data)

<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(APRIL 22, 1997),
YEAR ENDED THROUGH
DECEMBER 31, DECEMBER 31,
1998 1997
------------ -----------------
<S> <C> <C>
REVENUE..................................................... $ 9,786.2 $ 0.4
OPERATING EXPENSES:
Network................................................... 9,528.8 151.2
Selling, general, and administrative...................... 46,089.4 3,425.9
Management ownership allocation charge.................... 167,311.9 --
Noncash deferred compensation............................. 5,307.2 209.9
Depreciation and amortization............................. 9,002.8 12.7
----------- -----------
Total operating expenses.......................... 237,240.1 3,799.7
----------- -----------
Loss from operations.............................. (227,453.9) (3,799.3)
OTHER (EXPENSE) INCOME:
Interest income........................................... 19,917.4 111.4
Interest expense.......................................... (38,951.7) --
----------- -----------
Total other (expense) income...................... (19,034.3) 111.4
----------- -----------
NET LOSS.................................................... (246,488.2) (3,687.9)
ACCRETION OF REDEEMABLE PREFERRED STOCK AND WARRANT
VALUES.................................................... (11,971.4) (3,814.2)
----------- -----------
NET LOSS APPLICABLE TO COMMON STOCK......................... $(258,459.6) $ (7,502.1)
=========== ===========
NET LOSS PER SHARE, basic and diluted....................... $ (10.53) $(17,610.68)
=========== ===========
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING, basic and
diluted................................................... 24,550,346 426
=========== ===========
</TABLE>

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

F-4
<PAGE> 88

ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

For the Year Ended December 31, 1998, and for

the Period from Inception (April 22, 1997), through December 31, 1997

(in thousands, except share and per share data)

<TABLE>
<CAPTION>
DEFERRED
PREFERRED STOCK COMMON STOCK MANAGEMENT
-------------------- ------------------- ADDITIONAL OWNERSHIP
NUMBER OF NUMBER OF PAID-IN DEFERRED ALLOCATION ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION CHARGE DEFICIT
--------- -------- ---------- ------ ---------- ------------ ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, April 22, 1997
(date of inception)....... -- $ -- -- $ -- $ -- $ -- $ -- $ --
Issuance of common stock
at $.23 per share....... -- -- 426 -- 0.1 -- -- --
Accretion of redeemable
preferred stock and
warrant values.......... -- -- -- -- -- -- -- (3,814.2)
Deferred compensation..... -- -- -- -- 3,008.3 (3,008.3) -- --
Amortization of deferred
compensation............ -- -- -- -- -- 209.9 -- --
Net loss.................. -- -- -- -- -- -- -- (3,687.9)
------- -------- ---------- ------ ---------- ---------- ----------- -----------
BALANCE, December 31,
1997...................... -- -- 426 -- 3,008.4 (2,798.4) -- (7,502.1)
Accretion of redeemable
preferred stock and
warrant values.......... -- -- -- -- -- -- -- (11,971.4)
Initial public offering... -- -- 10,000,000 100.0 137,656.8 -- -- --
Conversion of redeemable
preferred stock......... -- -- 40,341,128 403.4 65,402.0 -- -- --
Deferred compensation..... -- -- -- -- 210,662.7 (17,126.1) (193,536.6) --
Amortization of deferred
compensation............ -- -- -- -- -- 5,307.2 167,311.9 --
Net loss.................. -- -- -- -- -- -- -- (246,488.2)
------- -------- ---------- ------ ---------- ---------- ----------- -----------
BALANCE, December 31,
1998...................... -- $ -- 50,341,554 $503.4 $416,729.9 $(14,617.3) $ (26,224.7) $(265,961.7)
======= ======== ========== ====== ========== ========== =========== ===========

TOTAL
-----------
<S> <C>
BALANCE, April 22, 1997
(date of inception)....... $ --
Issuance of common stock
at $.23 per share....... 0.1
Accretion of redeemable
preferred stock and
warrant values.......... (3,814.2)
Deferred compensation..... --
Amortization of deferred
compensation............ 209.9
Net loss.................. (3,687.9)
-----------
BALANCE, December 31,
1997...................... (7,292.1)
Accretion of redeemable
preferred stock and
warrant values.......... (11,971.4)
Initial public offering... 137,756.8
Conversion of redeemable
preferred stock......... 65,805.4
Deferred compensation..... --
Amortization of deferred
compensation............ 172,619.1
Net loss.................. (246,488.2)
-----------
BALANCE, December 31,
1998...................... $ 110,429.6
===========
</TABLE>

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

F-5
<PAGE> 89

ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Year Ended December 31, 1998, and for

the Period from Inception (April 22, 1997), through December 31, 1997

(in thousands)

<TABLE>
<CAPTION>
1998 1997
----------- ----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(246,488.2) $ (3,687.9)
Adjustments to reconcile net loss to cash used in
operating activities --
Depreciation and amortization........................... 9,002.8 12.7
Provision for uncollectible accounts receivable......... 577.2 --
Accretion of senior discount notes...................... 27,762.7 --
Amortization of original issue discount................. 569.9 --
Amortization of deferred debt issuance costs............ 733.7 --
Amortization of management ownership allocation charge
and deferred compensation.............................. 172,619.1 209.9
Changes in assets and liabilities --
Accounts receivable................................... (6,759.5) (4.3)
Prepaid expenses and other current assets............. (998.0) (245.2)
Other assets.......................................... (1,201.5) (171.2)
Accounts payable...................................... 4,703.9 275.1
Accrued liabilities and other current liabilities..... 22,208.1 1,668.0
----------- ----------
Net cash used in operating activities.............. (17,269.8) (1,942.9)
----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment....................... (113,538.7) (21,926.0)
Purchases of investments.................................. (294,688.8) --
Proceeds from redemption of investments................... 89,057.1 --
----------- ----------
Net cash used in investing activities.............. (319,170.4) (21,926.0)
----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from senior notes................................ 443,212.1 --
Proceeds from issuance of redeemable warrants............. 8,183.5 --
Deferred debt issuance costs.............................. (16,812.1) --
Proceeds from issuance of redeemable preferred stock...... -- 5,000.0
Proceeds from redeemable capital contributions............ 20,875.2 24,595.2
Proceeds from issuance of common stock.................... -- 0.1
Proceeds from initial public offering..................... 137,756.8 --
----------- ----------
Net cash provided by financing activities.......... 593,215.5 29,595.3
----------- ----------
INCREASE IN CASH AND CASH EQUIVALENTS....................... 256,775.3 5,726.4
CASH AND CASH EQUIVALENTS, beginning of period.............. 5,726.4 --
----------- ----------
CASH AND CASH EQUIVALENTS, end of period.................... $ 262,501.7 $ 5,726.4
=========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for --
Interest................................................ $ 9,384.4 $ --
=========== ==========
</TABLE>

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

F-6
<PAGE> 90

ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997

(in thousands, except share and per share data)

1. GENERAL:

Allegiance Telecom, Inc., a competitive local exchange carrier (CLEC), was
incorporated on April 22, 1997, as a Delaware corporation, for the purpose of
providing voice, data, and Internet services to business, government, and other
institutional users in major metropolitan areas across the United States.
Allegiance Telecom, Inc. and its subsidiaries are referred to herein as the
"Company."

The Company's business plan is focused on offering services in 24 of the largest
metropolitan areas in the United States. As of December 31, 1998, the Company
was operational in nine markets: Atlanta, Boston, Chicago, Dallas, Fort Worth,
Los Angeles, New York City, Oakland and San Francisco and is in the process of
deploying networks in seven other markets: Houston, Northern New Jersey, Orange
County, Philadelphia, San Diego, San Jose and Washington, D.C.

Until December 16, 1997, the Company was in the development stage. From its
inception on April 22, 1997, through December 31, 1997, the Company's principal
activities included developing its business plans, procuring governmental
authorizations, raising capital, hiring management and other key personnel,
working on the design and development of its local exchange telephone networks
and operations support systems (OSS), acquiring equipment and facilities, and
negotiating interconnection agreements. Also, the Company initiated resale
services to customers in the Dallas market in December 1997. During 1998, the
Company began providing facilities-based services to customers in its markets.
During 1998, the Company concentrated on building out the markets it is
currently operating in, as well as developing its future markets. Accordingly,
the Company has incurred substantial operating losses and operating cash flow
deficits.

The Company's success will be affected by the problems, expenses, and delays
encountered in connection with the formation of any new business and by the
competitive environment in which the Company operates. The Company's performance
will further be affected by its ability to assess potential markets, secure
financing or raise additional capital, implement expanded interconnection and
collocation with incumbent local exchange carrier (ILEC) facilities, lease
adequate trunking capacity from ILECs or other CLECs, purchase and install
switches in additional markets, implement efficient OSS and other back office
systems, develop a sufficient customer base, and attract, retain, and motivate
qualified personnel. The Company's networks and the provisions of
telecommunications services are subject to significant regulation at the
federal, state, and local levels. Delays in receiving required regulatory
approvals or the enactment of new adverse regulation or regulatory requirements
may have a material adverse effect upon the Company. Although management
believes that the Company will be able to successfully mitigate these risks,
there is no assurance that the Company will be able to do so or that the Company
will ever operate profitably.

Expenses are expected to exceed revenues in each market in which the Company
offers service until a sufficient customer base is established. It is
anticipated that obtaining a sufficient customer base will take a number of
years, and positive cash flows from operations are not expected in the near
future.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

CONSOLIDATION

The accompanying financial statements include the accounts of Allegiance
Telecom, Inc. and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated.

F-7
<PAGE> 91
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CASH AND CASH EQUIVALENTS

For purposes of reporting cash flows, the Company includes as cash and cash
equivalents, cash, marketable securities, and commercial paper with original
maturities of three months or less at date of purchase.

SHORT-TERM INVESTMENTS

Short-term investments consist primarily of commercial paper with original
maturities at date of purchase beyond three months and less than 12 months. Such
short-term investments are carried at their accreted value, which approximates
fair value, due to the short period of time to maturity.

RESTRICTED INVESTMENTS

Restricted investments consist primarily of U.S. government securities
purchased in connection with the Company's outstanding 12 7/8% Notes (see Note
4) to secure the first three years' (six semiannual) interest payments on the
12 7/8% Notes. Such investments are stated at their accreted value, which
approximates fair value, and are shown in both current and other noncurrent
assets, based upon the maturity dates of each of the securities at the balance
sheet date.

Restricted investments also includes $787.2 in certificates of deposit held
as collateral for letters of credit issued on behalf of the Company. These
investments are classified as other noncurrent assets.

ACCOUNTS RECEIVABLE

Accounts receivable consist of end-user receivables, interest receivable,
and at December 31, 1997, a receivable from an employee.

PREPAID EXPENSES AND OTHER CURRENT ASSETS

Prepaid expenses and other current assets consist of prepaid rent, prepaid
insurance, and refundable deposits. Prepayments are expensed on a straight-line
basis over the life of the underlying agreements.

PROPERTY AND EQUIPMENT

Property and equipment includes network equipment, leasehold improvements,
software, office equipment, furniture and fixtures, construction-in-progress,
and other. These assets are stated at cost, which includes direct costs and
capitalized interest, and are depreciated once placed in service using the
straight-line method. Interest expense for the year ended December 31, 1998, was
$41,749.9 before the capitalization of $2,798.2 of interest related to
construction-in-progress. No interest expense was incurred during the period
ended December 31, 1997. Repair and maintenance costs are expensed as incurred.

F-8
<PAGE> 92
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Property and equipment at December 31, 1998 and 1997, consist of the
following:

<TABLE>
<CAPTION>
USEFUL
LIVES
1998 1997 (IN YEARS)
---------- --------- ----------
<S> <C> <C> <C>
Network equipment..................................... $ 67,303.8 $ -- 5-7
Leasehold improvements................................ 24,483.2 37.5 5-10
Software.............................................. 7,840.0 -- 3
Office equipment and other............................ 4,384.3 89.9 2
Furniture and fixtures................................ 2,419.6 150.2 5
---------- ---------
Property and equipment, in service.................... 106,430.9 277.6
Less -- accumulated depreciation...................... (9,015.4) (12.7)
---------- ---------
Property and equipment, in service, net............... 97,415.5 264.9
Construction-in-progress.............................. 47,444.5 23,635.0
---------- ---------
Property and equipment, net........................... $144,860.0 $23,899.9
========== =========
</TABLE>

REVENUE RECOGNITION

Revenue is recognized in the month in which the service is provided, except
for reciprocal compensation generated by calls placed to Internet service
providers connected to the Company's network. The propriety of CLECs (such as
the Company) to earn local reciprocal compensation is the subject of numerous
regulatory and legal challenges. Until this issue is ultimately resolved, the
Company has determined to recognize this revenue only when realization of it is
certain, which in most cases will be upon receipt of cash.

COMPREHENSIVE INCOME

In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 130 (SFAS 130),
"Reporting Comprehensive Income." SFAS 130 established reporting and disclosure
requirements for comprehensive income and its components within the financial
statements. The Company's comprehensive income components were immaterial as of
December 31, 1998, and the Company had no comprehensive income components as of
December 31, 1997; therefore, comprehensive income/loss is the same as net
income/loss for both periods.

LOSS PER SHARE

The Company calculates net loss per share under the provisions of SFAS No.
128, "Earnings per Share." The net loss per share amounts reflected on the
statements of operations and the number of shares outstanding on the balance
sheets reflect a 426.2953905-for-one stock split, which occurred in connection
with the initial public offering (see Note 3). The net loss applicable to common
stock includes the accretion of redeemable cumulative convertible preferred
stock and warrant values of $11,971.4 for the year ended December 31, 1998, and
$3,814.2 for the period from inception (April 22, 1997), through December 31,
1997.

F-9
<PAGE> 93
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The securities listed below were not included in the computation of diluted
loss per share, since the effect from the conversion would be antidilutive.

<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1998 1997
-------- -----------
<S> <C> <C>
Redeemable Cumulative Convertible Preferred Stock........... -- 40,498,062
Redeemable Warrants......................................... 649,248 --
1997 Nonqualified Stock Option Plan......................... 886,127 189,127
1998 Stock Incentive Plan................................... 365,526 --
Employee Stock Discount Purchase Plan....................... 44,624 --
</TABLE>

RECOGNITION OF THE COST OF START-UP ACTIVITIES

On April 3, 1998, the American Institute of Certified Public Accountants
issued Statement of Position No. 98-5 (SOP 98-5), "Reporting on the Costs of
Start-up Activities." SOP 98-5 requires that start-up activities and
organization costs be expensed as incurred and that start-up costs capitalized
prior to the adoption of SOP 98-5 be reported as a cumulative effect of a change
in accounting principle. The Company adopted SOP 98-5 during the second quarter
of 1998. Adoption of SOP 98-5 did not have an effect on the Company, inasmuch as
the Company had previously expensed all such costs.

ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS 133). SFAS 133 requires that all
derivatives be recognized at fair value as either assets or liabilities. SFAS
133 also requires an entity that elects to apply hedge accounting to establish
the method to be used in assessing the effectiveness of the hedging derivatives
and the measurement approach for determining the ineffectiveness of the hedge at
the inception of the hedge. The methods chosen must be consistent with the
entity's approach to managing risk. The Company adopted SFAS 133 at the
beginning of the fourth quarter of 1998. Adoption of SFAS 133 did not have an
effect on the Company, inasmuch as the Company has historically not invested in
derivatives or participated in hedging activities.

USE OF ESTIMATES IN FINANCIAL STATEMENTS

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

RECLASSIFICATIONS

Certain amounts in the prior period's consolidated financial statements
have been reclassified to conform with the current period presentation.

3. CAPITALIZATION:

In connection with its initial public offering of common stock (the "IPO")
on July 7, 1998 (see below), the Company effected a 426.2953905-for-one stock
split, which is retroactively reflected within these financial statements.

F-10
<PAGE> 94
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

STOCK PURCHASE AGREEMENT AND SECURITY HOLDERS AGREEMENT

On August 13, 1997, the Company entered into a stock purchase agreement
with Allegiance Telecom, LLC ("Allegiance LLC") (see Note 7). Allegiance LLC
purchased 40,498,062 shares of 12% redeemable cumulative convertible preferred
stock ("Redeemable Preferred Stock"), par value $.01 per share, for aggregate
consideration of $5,000.0 (the "Initial Closing"). Allegiance LLC agreed to make
additional contributions as necessary to fund expansion into new markets
("Subsequent Closings"). In order to obtain funds through Subsequent Closings,
the Company submitted a proposal to Allegiance LLC detailing the funds necessary
to build out the Company's business in a new market. Allegiance LLC was not
required to make any contributions until it approved the proposal. The maximum
commitment of Allegiance LLC was $100,000.0. No capital contributions were
required to be made after the Company consummated an initial public offering of
its stock (which occurred on July 7, 1998).

Allegiance LLC contributed a total of $50,132.9 and $29,595.2 prior to the
Company's initial public offering and as of December 31, 1997, respectively.
Each security holder in Allegiance LLC had the right to require Allegiance LLC
to repurchase all of the outstanding securities held by such security holder at
the greater of the original cost (including interest at 12% per annum) for such
security or the fair market value, as defined in the security holders agreement,
at any time and from time to time after August 13, 2004, but not after the
consummation of a public offering or sale of the Company. If repurchase
provisions had been exercised, the Company had agreed, at the request and
direction of Allegiance LLC, to take any and all actions necessary, including
declaring and paying dividends and repurchasing preferred or common stock, to
enable Allegiance LLC to satisfy its repurchase obligations.

Because of the redemption provisions, the Company has recognized the
accretion of the value of the Redeemable Preferred Stock to reflect management's
estimate of the potential future fair market value of the Redeemable Preferred
Stock payable in the event the repurchase provisions were exercised. Amounts
were accreted using the effective interest method, assuming the Redeemable
Preferred Stock is redeemed at a redemption price based on the estimated
potential future fair market value of the equity of the Company in August 2004.
The accretion was recorded each period as an increase in the balance of
Redeemable Preferred Stock outstanding and a noncash increase in the net loss
applicable to common stock.

In connection with the IPO, the Redeemable Preferred Stock was converted
into common stock, and the amounts accreted were reclassified as a component of
additional paid-in capital. In addition, the redemption provisions and the
obligation of Allegiance LLC to make additional contributions to the Company
(and the obligation of the members of Allegiance LLC to make capital
contributions) have terminated.

REDEEMABLE CUMULATIVE CONVERTIBLE PREFERRED STOCK

Each share of the Company's Redeemable Preferred Stock was convertible into
shares of the Company's common stock (the "Common Stock") on a one-for-one
basis, subject to certain antidilution provisions. No dividends were declared in
1998 or 1997.

In 1998, prior to the conversion of the Redeemable Preferred Stock, the
Company recorded accretion of $11,520.8. Accretion recorded in the period ended
December 31, 1997, was $3,814.2.

Capital contributed in the Subsequent Closings occurring in October 1997
and January 1998 and other capital contributions totaled approximately
$45,132.9.

In February and March 1998, the Company issued 273,361.92 shares of
Redeemable Preferred Stock for aggregate consideration of $337.5.

F-11
<PAGE> 95
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In connection with the consummation of the IPO, the outstanding shares of
the Redeemable Preferred Stock were converted into 40,341,128 shares of Common
Stock. Upon the conversion of the Redeemable Preferred Stock, the obligation of
the Company to redeem the Redeemable Preferred Stock also terminated and,
therefore, the accretion of the Redeemable Preferred Stock value recorded to the
date of the IPO, $15,335.0, was reclassified to additional paid-in capital along
with $50,470.4 proceeds from the issuance of the Redeemable Preferred Stock and
redeemable capital contributions.

PREFERRED STOCK

In connection with the IPO, the Company authorized 1,000,000 shares of
preferred stock ("Preferred Stock") with a $.01 par value. At December 31, 1998,
no shares of Preferred Stock were issued and outstanding.

COMMON STOCK

On July 7, 1998, the Company raised $150,000.0 of gross proceeds in the
Company's IPO. The Company sold 10,000,000 shares of its Common Stock at a price
of $15 per share. In connection with the IPO, the outstanding shares of
Redeemable Preferred Stock were converted in to 40,341,128 shares of Common
Stock, and the Company increased the number of authorized Common Stock to
150,000,000. At December 31, 1998, 50,341,554 shares were issued and
outstanding. Of the authorized but unissued Common Stock, 6,998,970 shares are
reserved for issuance upon exercise of options issued under the Company's stock
option, stock incentive, and stock purchase plans (see Note 10) and 649,248
shares are reserved for issuance, sale, and delivery upon the exercise of
warrants (see Note 4).

DEFERRED COMPENSATION

Allegiance LLC sold to certain management investors (the "Management
Investors") membership units of Allegiance LLC at amounts less than their
estimated fair market value; therefore, the Company has recognized deferred
compensation of $10,090.2 and $977.6 at December 31, 1998 and 1997,
respectively, of which $2,726.1 and $40.7 have been amortized to expense at
December 31, 1998 and 1997, respectively. In connection with the IPO, the
Redeemable Preferred Stock was converted into Common Stock, and Allegiance LLC
was dissolved. The deferred compensation charge is amortized based upon the
period over which the Company has the right to repurchase certain of the
securities (at the lower of fair market value or the price paid by the employee)
in the event the management employee's employment with the Company is
terminated.

DEFERRED MANAGEMENT OWNERSHIP ALLOCATION CHARGE

On July 7, 1998, in connection with the IPO, certain venture capital
investors (the "Fund Investors") and certain Management Investors owned 95.0%
and 5.0%, respectively, of the ownership interests of Allegiance LLC, which
owned substantially all of the Company's outstanding capital stock. As a result
of the successful IPO, Allegiance LLC was dissolved, and its assets (which
consisted almost entirely of such capital stock) have been distributed to the
Fund Investors and Management Investors in accordance with Allegiance LLC's
Limited Liability Company Agreement (the "LLC Agreement"). The LLC Agreement
provided that the equity allocation between the Fund Investors and the
Management Investors be 66.7% and 33.3%, respectively, based upon the valuation
implied by the IPO. Under generally accepted accounting principles, the Company
recorded the increase in the assets of Allegiance LLC allocated to the
Management Investors as a $193,536.6 increase in additional paid-in capital, of
which $122,475.5 was recorded as a noncash, nonrecurring charge to operating
expense and $71,061.1 was recorded as a deferred management ownership allocation
charge. The deferred charge was amortized at $44,836.4 as of December 31, 1998,
and will be further amortized at $18,870.2, $7,175.7, and $178.8 during the
years

F-12
<PAGE> 96
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

1999, 2000, and 2001, respectively, which is the period over which the Company
has the right to repurchase certain of the securities (at the lower of fair
market value or the price paid by the employee) in the event the management
employee's employment with the Company is terminated.

4. LONG-TERM DEBT:

Long-term debt consisted of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
---------- -------
<S> <C> <C>
Series B 11 3/4% Notes, face amount $445,000.0 due February
15, 2008, effective interest rate of 12.45%, at accreted
value..................................................... $270,526.1 $ --
12 7/8% Senior Notes, face amount $205,000.0 due May 15,
2008, effective interest rate of 13.24%, at accreted
value..................................................... 201,018.6 --
Other....................................................... 107.4 --
---------- -------
Total long-term debt.............................. $471,652.1 $ --
========== =======
</TABLE>

On February 3, 1998, the Company raised gross proceeds of approximately
$250,477.1 in an offering of 445,000 Units (the "Unit Offering"), each of which
consists of one 11 3/4% Senior Discount Note due 2008 of the Company (the
"11 3/4% Notes") and one warrant to purchase .0034224719 shares of Common Stock
(the "Redeemable Warrants") at an exercise price of $.01 per share, subject to
certain antidilution provisions. Of the gross proceeds, $242,293.6 was allocated
to the 11 3/4% Notes and $8,183.5 was allocated to the Redeemable Warrants. The
Redeemable Warrants became exercisable in connection with the IPO (see Note 3)
in July 1998, and each warrant may now purchase 1.45898399509 shares of Common
Stock as a result of the stock split (see Note 3).

A Registration Statement on Form S-4 (File No. 333-49013), registering the
Company's 11 3/4% Notes and offering to exchange (the "Exchange Offer") any and
all of the outstanding 11 3/4% Notes for Series B 11 3/4% Notes due 2008 (the
"Series B Notes"), was declared effective by the Securities and Exchange
Commission on May 22, 1998. The Exchange Offer terminated after all of the
outstanding 11 3/4% Notes were exchanged. The terms and conditions of the Series
B Notes are identical to those of the 11 3/4% Notes in all material respects.

The Series B Notes have a principal amount at maturity of $445,000.0 and an
effective interest rate of 12.45%. The Series B Notes mature on February 15,
2008. From and after February 15, 2003, interest on the Series B Notes will be
payable semiannually in cash at the rate of 11 3/4% per annum.

The Company must make an offer to purchase the Redeemable Warrants for cash
at the relevant value upon the occurrence of a repurchase event. A repurchase
event is defined to occur when (i) the Company consolidates with or merges into
another person if the Common Stock thereafter issuable upon exercise of the
Redeemable Warrants is not registered under the Securities Exchange Act of 1934,
as amended (the "Exchange Act") or (ii) the Company sells all or substantially
all of its assets to another person, if the Common Stock thereafter issuable
upon the exercise of the Redeemable Warrants is not registered under the
Exchange Act, unless the consideration for such a transaction is cash. The
relevant value is defined to be the fair market value of the Common Stock as
determined by the trading value of the securities if publicly traded or at an
estimated fair market value without giving effect to any discount for lack of
liquidity, lack of registered securities, or the fact that the securities
represent a minority of the total shares outstanding. As a result of the warrant
redemption provisions, the Company is recognizing the potential future
redemption value of the Redeemable Warrants by recording accretion of the
Redeemable

F-13
<PAGE> 97
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Warrants to their estimated fair market value at February 3, 2008, using the
effective interest method. Accretion recorded in the year ended December 31,
1998, was $450.6.

The Series B Notes are redeemable by the Company, in whole or in part,
anytime on or after February 15, 2003, at 105.875% of their principal amount at
maturity, plus accrued and unpaid interest, declining to 100% of their principal
amount at maturity, plus accrued and unpaid interest on and after February 15,
2006. In addition, at any time prior to February 15, 2001, the Company may, at
its option, redeem up to 35% of the principal amount at maturity of the Series B
Notes in connection with one or more public equity offerings at 111.750% of the
accreted value on the redemption date, provided that at least $289,250.0
aggregate principal amount at maturity of the Series B Notes remains outstanding
after such redemption.

On July 7, 1998, the Company raised approximately $200,918.5 of gross
proceeds from the sale of its 12 7/8% Senior Notes due 2008 (the "12 7/8%
Notes"), of which approximately $69,033.4 was used to purchase U.S. government
securities, which were placed in a pledged account to secure and fund the first
six scheduled payments of interest on the notes (see Note 2).

The 12 7/8% Notes have a principal amount at maturity of $205,000.0 and an
effective interest rate of 13.24%. The 12 7/8% Notes mature on May 15, 2008.
Interest on the 12 7/8% Notes is payable semiannually in cash at the rate of
12 7/8% on May 15 and November 15 of each year. As of December 31, 1998, the
Company has recorded accrued interest associated with the 12 7/8% Notes of
$3,470.2, which is included in other current liabilities.

The 12 7/8% Notes are redeemable by the Company, in whole or in part, at
any time on or after May 15, 2003, at 106.438% of their principal amount,
declining to 100% of their principal amount, plus accrued interest, on or after
May 15, 2006. In addition, prior to May 15, 2001, the Company may redeem up to
35% of the aggregate principal amount of the 12 7/8% Notes with the proceeds of
one or more public offerings (as defined in the indenture relating to the
12 7/8% Notes) at 112.875% of their principal amount, plus accrued interest,
provided, however, that after any such redemption at least 65% of the aggregate
principal amount of the 12 7/8% Notes originally issued remains outstanding.

The Series B and the 12 7/8% Notes carry certain restrictive covenants
that, among other things, limit the ability of the Company to incur
indebtedness, create liens, engage in sale-leaseback transactions, pay dividends
or make distributions in respect to their capital stock, redeem capital stock,
make investments or certain other restricted payments, sell assets, issue or
sell stock of restricted subsidiaries (as defined in the indentures relating to
the Series B Notes and the 12 7/8% Notes), enter into transactions with any
holder of 5% or more of any class of capital stock of the Company, or effect a
consolidation or merger. In addition, upon a change of control, the Company is
required to make an offer to purchase each series of notes at a purchase price
of 101% of the accreted value thereof (in the case of the Series B Notes) and
101% of the principal amount thereof (in the case of the 12 7/8% Notes),
together with accrued interest, if any. However, these limitations are subject
to a number of qualifications and exceptions (as defined in the indentures
relating to each series of notes). The Company was in compliance with all such
restrictive covenants of each series of notes at December 31, 1998.

5. CAPITAL LEASES:

On May 29, 1998, the Company signed a capital lease agreement for three,
four-fiber rings, with a term of 10 years and a renewal term of 10 years, at an
expected total cost of $3,485.0; $871.3 was paid as of December 31, 1998. The
remainder is expected to be paid in 1999 and is not reflected in the financial
statements, since the payment is contingent upon the timing of completion of
network segments.

F-14
<PAGE> 98
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

On December 4, 1998, the Company signed a capital lease agreement for 12
optical fibers configured in two separate rings, with a term of 15 years and two
renewal terms of five years each. Total cost associated with the capital lease
is dependent upon the timing of completion of connectivity of the optical fibers
with the Company's network, which is to be completed in two phases. The Company
will incur recurring monthly charges of $29.4 after the completion of phase one.
After completion of phase two, the Company will pay a one-time fee of $76.5 and
the recurring monthly charge will increase to $76.5. This capital lease is not
reflected in the financial statements, since the total cost and timing of
payments are contingent upon the timing of completion of the phases.

6. LEGAL MATTERS:

On August 29, 1997, WorldCom, Inc. ("WorldCom") sued the Company and two
individual employees. In its complaint, WorldCom alleges that these employees
violated certain noncompete and nonsolicitation agreements by accepting
employment with the Company and by soliciting then-current WorldCom employees to
leave WorldCom's employment and join the Company. In addition, WorldCom claims
that the Company tortiously interfered with WorldCom's relationships with its
employees and that the Company's behavior constituted unfair competition.
WorldCom seeks injunctive relief and damages, although it has filed no motion
for a temporary restraining order or preliminary injunction. The Company denies
all claims and will vigorously defend itself. An estimate of possible loss
cannot be made at this time.

On October 7, 1997, the Company filed a counterclaim against WorldCom for,
among other things, attempted monopolization of the "one-stop shopping"
telecommunications market, abuse of process, and unfair competition. WorldCom
moved to dismiss the abuse of process and unfair competition claims. The court
dismissed the unfair competition claim on March 4, 1998. Thus, the Company's
counterclaim for attempted monopolization and abuse of power are still being
litigated.

7. RELATED PARTIES:

From inception (April 22, 1997) through July 7, 1998, the Company was a
wholly owned subsidiary of Allegiance LLC. On July 7, 1998, the Fund Investors
and the Management Investors owned 95.0% and 5.0%, respectively, of the
ownership interest of Allegiance LLC, which owned substantially all of the
Company's outstanding capital stock. As a result of the successful IPO (see Note
3), Allegiance LLC was dissolved, and its assets (which consisted almost
entirely of such capital stock) have been distributed to the Fund Investors and
the Management Investors in accordance with the LLC Agreement (see Note 3).

As of July 7, 1998 and 1997, Allegiance LLC had made aggregate capital
contributions to the Company of approximately $50,132.9 and $29,595.2,
respectively.

During 1998 and 1997, the Company paid all organizational and legal fees of
Allegiance LLC, the amount of which was not material. No amounts are due from
Allegiance LLC at December 31, 1998, or December 31, 1997.

In connection with the Unit Offering (see Note 4), the IPO (see Note 3),
and the sale of the 12 7/8% Notes (see Note 4), the Company incurred
approximately $11,331.5 in fees to an affiliate of an investor in the Company.

F-15
<PAGE> 99
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

8. COMMITMENTS AND CONTINGENCIES:

The Company has entered into various operating lease agreements, with
expirations through 2009, for network facilities, office space, and equipment.
Future minimum lease obligations related to the Company's operating leases as of
December 31, 1998, are as follows:

<TABLE>
<S> <C>
1999........................................ $10,984.8
2000........................................ 11,201.6
2001........................................ 10,436.7
2002........................................ 8,600.8
2003........................................ 7,940.7
Thereafter.................................. 30,083.5
</TABLE>

Total rent expense for the year ended December 31, 1998, was $2,991.8 and
for the period from inception (April 22, 1997) through December 31, 1997, was
$212.1.

In October 1997, the Company entered into a five-year general agreement
with Lucent Technologies, Inc. ("Lucent") establishing terms and conditions for
the purchase of Lucent products, services, and licensed materials. This
agreement includes a three-year exclusivity commitment for the purchase of
products and services related to new switches. The agreement contains no minimum
purchase requirements.

9. FEDERAL INCOME TAXES:

The Company accounts for income tax under the provisions of SFAS No. 109,
"Accounting for Income Taxes" (SFAS 109). SFAS 109 requires an asset and
liability approach that requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of events that have been
recognized in the Company's financial statements. The Company had approximately
$53,572.5 and $460.5 of net operating loss carryforwards for federal income tax
purposes at December 31, 1998 and 1997, respectively. The net operating loss
carryforwards will expire in the years 2012 and 2018 if not previously utilized.
The Company has recorded a valuation allowance equal to the net deferred tax
assets at December 31, 1998 and 1997, due to the uncertainty of future operating
results. The valuation allowance will be reduced at such time as management
believes it is more likely than not that the net deferred tax assets will be
realized. Any reductions in the valuation allowance will reduce future
provisions for income tax expense.

The Company's deferred tax assets and liabilities and the changes in those
assets are:

<TABLE>
<CAPTION>
1997 CHANGE 1998
--------- ---------- ----------
<S> <C> <C> <C>
Start-up costs capitalized for tax purposes.......... $ 1,025.9 $ (213.7) $ 812.2
Net operating loss carryforward...................... 156.6 18,058.1 18,214.7
Amortization of original issue discount.............. -- 9,663.6 9,663.6
Depreciation......................................... -- (2,392.4) (2,392.4)
Valuation allowance.................................. (1,182.5) (25,115.6) (26,298.1)
--------- ---------- ----------
$ -- $ -- $ --
========= ========== ==========
</TABLE>

Amortization of the original issue discount on the Series B Notes and
12 7/8% Notes as interest expense is not deductible in the income tax return
until paid.

F-16
<PAGE> 100
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Under existing income tax law, all operating expenses incurred prior to a
company commencing its principal operations are capitalized and amortized over a
five-year period for tax purposes.

10. STOCK OPTION/STOCK INCENTIVE/STOCK PURCHASE PLANS:

At December 31, 1998, the Company had three stock-based compensation plans:
the 1997 Nonqualified Stock Option Plan (the "1997 Option Plan"), the 1998 Stock
Incentive Plan, and the Employee Stock Discount Purchase Plan (the "Stock
Purchase Plan"). The Company applies the provisions of Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees," and the
related interpretations in accounting for the Company's plans. Had compensation
cost for the Company's plans been determined based on the fair value of the
options as of the grant dates for awards under the plans, consistent with the
method prescribed in SFAS No. 123, "Accounting for Stock-Based Compensation,"
the Company's net loss applicable to common stock and net loss per share would
have increased to the pro forma amounts indicated below. The Company utilized
the following assumptions in calculating the estimated fair value of each option
on the date of grant, using the Black-Scholes option-pricing model with the
following weighted-average assumptions for grants in 1998 and 1997: dividend
yield of 0%, expected volatility of 89.1%, and expected lives of six years for
both years: risk-free interest rates of 5.63% in 1998 and 6.06% in 1997 for the
1997 Option Plan and 4.70% in 1998 for the 1998 Stock Incentive Plan.

<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Net loss applicable to common stock -- as reported.......... $258,459.6 $ 7,502.1
Net loss applicable to common stock -- pro forma............ 259,796.6 7,512.2
Net loss per share, basic and diluted -- as reported........ 10.53 17,610.68
Net loss per share, basic and diluted -- pro forma.......... 10.58 17,634.27
</TABLE>

As the 1998 Stock Incentive Plan and the Stock Purchase Plan were adopted
in 1998, the December 31, 1997, pro forma balances do not include expenses for
these plans.

1997 OPTION PLAN AND 1998 STOCK INCENTIVE PLAN

Under the 1997 Option Plan, the Company granted options to key employees, a
director, and a consultant of the Company for an aggregate of 1,037,474 shares
of the Company's Common Stock. The Company will not grant options for any
additional shares under the 1997 Option Plan.

Under the 1998 Stock Incentive Plan, the Company may grant options to
certain employees, directors, advisors, and consultants of the Company. The 1998
Stock Incentive Plan provides for issuance of the following types of incentive
awards: stock options, stock appreciation rights, restricted stock, performance
grants, and other types of awards that the Compensation Committee of the Board
of Directors (the "Compensation Committee") deems consistent with the purposes
of the 1998 Stock Incentive Plan. The Company has reserved 3,655,778 shares of
Common Stock for issuance under the 1998 Stock Incentive Plan.

Options granted under both plans have a term of six years and vest over a
three-year period, and the Compensation Committee administers both option plans.

F-17
<PAGE> 101
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

A summary of the status of the 1997 Option Plan as of December 31, 1998 and
1997, is presented in the table below:

<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
--------------------------- --------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
-------- ---------------- ------- ----------------
<S> <C> <C> <C> <C>
Outstanding, beginning of period.... 189,127 $2.47 -- $ --
Granted............................. 848,347 2.76 189,127 2.47
Exercised........................... -- -- -- --
Forfeited........................... (151,347) 2.60 -- --
-------- -------
Outstanding, end of period.......... 886,127 2.73 189,127 2.47
======== =======
Options exercisable at period-end... 44,481 --
======== =======
Weighted average fair value of
options granted................... $ 2.82 $ 0.68
======== =======
</TABLE>

As of December 31, 1998 and 1997, options outstanding under the 1997 Option
Plan have a weighted average remaining contractual life of 5.2 and 5.8 years,
respectively.

A summary of the status of the 1998 Stock Incentive Plan as of December 31,
1998, is presented in the table below:

<TABLE>
<CAPTION>
DECEMBER 31, 1998
--------------------------
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
------- ----------------
<S> <C> <C>
Outstanding, beginning of period............................ -- $ --
Granted..................................................... 399,974 10.21
Exercised................................................... -- --
Forfeited................................................... (34,448) 10.47
-------
Outstanding, end of period.................................. 365,526 10.19
=======
Options exercisable at period-end........................... --
=======

Weighted average fair value of options granted.............. $ 10.22
=======
</TABLE>

As of December 31, 1998, options outstanding under the 1998 Stock Incentive
Plan have a weighted average remaining contractual life of 5.7 years.

As the estimated fair market value of the Company's Common Stock (as
implied by the IPO price) exceeded the exercise price of the options granted,
the Company has recognized deferred compensation of $7,635.0 and $2,030.7 at
December 31, 1998 and 1997, respectively, of which $2,581.1 and $169.2 have been
amortized to expense at December 31, 1998 and 1997, respectively, over the
vesting period of the options. As of December 31, 1998, the Company has reversed
$599.1 of unamortized deferred compensation related to options forfeited.

F-18
<PAGE> 102
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

STOCK PURCHASE PLAN

The Company's Stock Purchase Plan is intended to give employees a
convenient means of purchasing shares of Common Stock through payroll
deductions. Each participating employee's contributions will be used to purchase
shares for the employee's share account as promptly as practicable after each
calendar quarter. The cost per share will be 85% of the lower of the closing
price of the Company's Common Stock on the Nasdaq National Market on the first
or the last day of the calendar quarter. The Company has reserved 2,305,718
shares of Common Stock for issuance under the Stock Purchase Plan. As of
December 31, 1998, no shares have been issued under the Stock Purchase Plan;
however, participants have contributed $303.4 and will be issued 44,624 shares
of Common Stock in January 1999. The Compensation Committee administers the
Stock Purchase Plan.

F-19
<PAGE> 103

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.

The following is a statement of estimated expenses, to be paid solely by
Allegiance, in connection with the distribution of the securities being
registered:

<TABLE>
<S> <C>
Securities and Exchange Commission registration fee......... $ 4,974.78
Printing expenses........................................... $ 10,000
Accounting fees and expenses................................ $ 50,000
Legal fees and expenses..................................... $ 5,000
Miscellaneous expenses...................................... $ 5,000
----------
Total............................................. $69,974.78
==========
</TABLE>

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

All amounts are estimated.

ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS

GENERAL CORPORATION LAW

Allegiance is incorporated under the laws of the State of Delaware. Section
145 ("Section 145") of the General Corporation Law of the State of Delaware, as
the same exists or may hereafter be amended (the "General Corporation Law"),
among other things, provides that a Delaware corporation may indemnify any
persons who were, are or are threatened to be made, parties to any threatened,
pending or completed action, suit or proceeding, whether civil, criminal,
administrative or investigative, other than an action by or in the right of such
corporation, by reason of the fact that such person is or was an officer,
director, employee or agent of such corporation, or is or was serving at the
request of such corporation as a director, officer employee or agent of another
corporation or enterprise. The indemnity may include expenses (including
attorneys' fees), judgments, fines and amounts paid in settlement actually and
reasonably incurred by such person in connection with such action, suit or
proceeding, so long as such person acted in good faith and in a manner he
reasonably believed to be in or not opposed to the corporation's best interests
and, with respect to any criminal action or proceeding, had no reasonable cause
to believe that his conduct was illegal. A Delaware corporation may indemnify
any persons who are, were or are threatened to be made, a party to any
threatened, pending or completed action or suit by or in the right of the
corporation by reasons of the fact that such person was a director, officer,
employee or agent of such corporation, or is or was serving at the request of
such corporation as a director, officer, employee or agent of another
corporation or enterprise. The indemnity may include expenses (including
attorneys' fees) actually and reasonably incurred by such person in connection
with the defense or settlement of such action or suit, so long as such person
acted in good faith and in a manner he reasonably believed to be in or not
opposed to the corporation's best interests, except that no indemnification is
permitted without judicial approval if the officer, director, employee or agent
is adjudged to be liable to the corporation. Where an officer, director,
employee or agent is successful on the merits or otherwise in the defense of any
action referred to above, the corporation must indemnify him against the
expenses which such officer or director has actually and reasonably incurred.

Section 145 further authorizes a corporation to purchase and maintain
insurance on behalf of any person who is or was a director, officer, employee or
agent of the corporation, or is or was serving at the request of the corporation
as a director, officer, employee or agent of another corporation or enterprise,
against any liability asserted against him and incurred by him in any such
capacity, arising out of his status as such, whether or not the corporation
would otherwise have the power to indemnify him under Section 145.

II-1
<PAGE> 104

CERTIFICATE OF INCORPORATION

Allegiance's charter and by-laws provides for the indemnification of
officers and directors to the fullest extent permitted by the General
Corporation Law.

All of Allegiance's directors and officers are covered by insurance
policies maintained by it against certain liabilities for actions taken in their
capacities as such, including liabilities under the Securities Act.

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.

Since its inception, Allegiance has issued the following securities without
registration under the Securities Act (the number of shares set forth below does
not give effect to the stock split of Allegiance's common stock in the initial
public offering of common stock).

On August 13, 1997, in connection with Allegiance's formation, Allegiance
issued one share of common stock to Allegiance Telecom, LLC for consideration of
$1,000.

On August 13, 1997, Allegiance issued 95,000 shares of redeemable
convertible preferred stock to Allegiance Telecom, LLC for an aggregate initial
purchase price of approximately $5 million.

On February 25, 1998, Allegiance issued: (a) 71.25 shares of redeemable
convertible preferred stock to Richard Fields for an aggregate initial purchase
price of $37,500; (b) 95 shares of redeemable convertible preferred stock to
Roger Curry for an aggregate initial purchase price of $50,000; (c) 23.75 shares
of redeemable convertible preferred stock to Northwestern University for an
aggregate initial purchase price of $12,500; (d) 237.5 shares of redeemable
convertible preferred stock to MKW Partners, L.P. for an aggregate initial
purchase price of $125,001; (e) 47.5 shares of redeemable convertible preferred
stock to Tom Shattan for an aggregate initial purchase price of $25,000; (f)
28.5 shares of redeemable convertible preferred stock to Greg Mendel for an
aggregate initial purchase price of $15,000; and (g) 19 shares of redeemable
convertible preferred stock to Kevin Fechtmeyer for an aggregate initial
purchase price of $10,000.

On March 13, 1998, Allegiance issued 118.75 shares of redeemable
convertible preferred stock to Charles Ross Partners, LLC for an aggregate
initial purchase price of $62,500.

The above-described transactions were exempt from registration under the
Securities Act under Section 4(2) of the Securities Act, as transactions not
involving any public offering.

On February 3, 1998, Allegiance issued 445,000 units, with each unit
consisting of one 11 3/4% Senior Discount Note due 2008 and one redeemable
warrant to purchase .0034224719 shares of Allegiance's common stock. Allegiance
received approximately $240.7 million of net proceeds, after deducting
underwriting discounts and commissions of approximately $8.75 million and other
expenses payable by Allegiance of approximately $1.0 million, from the issuance
of the units. Such units were issued to (a) "qualified institutional buyers" (as
defined in Rule 144A of the Securities Act), (b) other institutional "accredited
investors" (as defined in Rule 501(a) of the Securities Act), and (c) outside
the United States in compliance with Regulation S under the Securities Act, and
therefore, the issuance of such units was exempt from registration under the
Securities Act. Morgan Stanley & Co. Incorporated, Salomon Brothers Inc, Bear,
Stearns & Co. Inc. and Donaldson, Lufkin & Jenrette Securities Corporation were
the initial purchasers of the units.

II-2
<PAGE> 105

ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.

(a) Exhibits.

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<C> <S>
1.1 Form of Underwriting Agreement (incorporated by reference to
Exhibit 1.1 to Allegiance Telecom, Inc.'s Registration
Statement on Form S-1 (Registration No. 333-53479), filed
on May 22, 1998 and as amended (the "Form S-1
Registration Statement")).
3.1 Amended and Restated Certificate of Incorporation of
Allegiance Telecom, Inc. (incorporated by reference to
Exhibit 3.1 to Allegiance Telecom's Form 10-Q for the
period ended June 30, 1998 (the "Form 10-Q")).
3.2 Certificate of Correction to Amended and Restated
Certificate of Incorporation (incorporated by reference
to Exhibit 3.2 to Allegiance Telecom, Inc.'s Form 10-K
for the period ended December 31, 1998 (the "1998 Form
10-K")).
3.3 Amended and Restated By-Laws of Allegiance Telecom, Inc.
(incorporated by reference to Exhibit 3.2 to the Form
10-Q).
4.1 Indenture, dated as of July 7, 1998, by and between
Allegiance Telecom, Inc. and The Bank of New York, as
trustee (including the Form of Notes) (incorporated by
reference to Exhibit 4.1 to Allegiance Telecom, Inc.'s
Registration Statement on Form S-1 (Registration No.
333-69543) filed on December 23, 1998 and as amended (the
"Form S-1 Notes")).
4.2 Indenture, dated as of February 3, 1998, by and between
Allegiance Telecom, Inc. and The Bank of New York, as
trustee (incorporated by reference to Exhibit 4.2 to
Allegiance Telecom, Inc.'s Registration Statement on Form
S-4 (Registration No. 333-49013), filed on March 31, 1998
and as amended (the "Form S-4 Registration Statement")).
4.3 Form of 11 3/4% Senior Discount Notes (incorporated by
reference to Exhibit 4.3 to the Form S-4 Registration
Statement).
4.4 Collateral Pledge and Security Agreement, dated as of July
7, 1998, by and between Allegiance Telecom, Inc. and The
Bank of New York, as trustee (incorporated by reference
to Exhibit 4.4 to Form S-1 Notes).
*5.1 Opinion of Mark B. Tresnowski (including consent).
10.1 Stock Purchase Agreement, dated August 13, 1997, among the
Fund Investors, the Management Investors, Allegiance
Telecom, LLC and Allegiance Telecom, Inc. (incorporated
by reference to Exhibit 10.1 to the Form S-4 Registration
Statement).
10.2 Securityholders Agreement, dated August 13, 1997, among the
Fund Investors, the Management Investors and Allegiance
Telecom, Inc. (incorporated by reference to Exhibit 10.2
to the Form S-4 Registration Statement).
10.3 Registration Agreement, dated August 13, 1997, among the
Fund Investors, the Management Investors and Allegiance
Telecom, Inc. (incorporated by reference to Exhibit 10.3
to the Form S-4 Registration Statement).
10.4 Warrant Registration Rights Agreement, dated as of January
29, 1998, by and among Allegiance Telecom, Inc. and
Morgan Stanley & Co. Incorporated, Salomon Brothers Inc,
Bear, Stearns & Co. Inc. and Donaldson, Lufkin & Jenrette
Securities Corporation, as initial purchasers of the
11 3/4% Senior Discount Notes (incorporated by reference
to Exhibit 10.11 to the Form S-4 Registration Statement).
</TABLE>

II-3
<PAGE> 106

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<C> <S>
10.5 Allegiance Telecom, Inc. 1997 Nonqualified Stock Option Plan
(incorporated by reference to Exhibit 10.4 to the Form
S-4 Registration Statement).
10.6 Allegiance Telecom, Inc. 1998 Stock Incentive Plan
(incorporated by reference to Exhibit 10.6 to the Form
S-1 Registration Statement).
10.7 First Amendment to the Allegiance Telecom, Inc. 1998 Stock
Incentive Plan (incorporated by reference to Exhibit 10.7
to the 1998 Form 10-K).
10.8 Executive Purchase Agreement, dated August 13, 1997, among
Allegiance Telecom, LLC, Allegiance Telecom, Inc. and
Royce J. Holland (incorporated by reference to Exhibit
10.5 to the Form S-4 Registration Statement).
10.9 Executive Purchase Agreement, dated August 13, 1997, among
Allegiance Telecom, LLC, Allegiance Telecom, Inc. and
Thomas M. Lord (incorporated by reference to Exhibit 10.6
to the Form S-4 Registration Statement).
10.10 Executive Purchase Agreement, dated January 28, 1998, among
Allegiance Telecom, LLC, Allegiance Telecom, Inc. and C.
Daniel Yost (incorporated by reference to Exhibit 10.7 to
the Form S-4 Registration Statement).
10.11 Form of Executive Purchase Agreement among Allegiance
Telecom, LLC, Allegiance Telecom, Inc. and each of the
other Management Investors (incorporated by reference to
Exhibit 10.8 to the Form S-4 Registration Statement).
10.12 Warrant Agreement, dated February 3, 1998, by and between
Allegiance Telecom, Inc. and The Bank of New York, as
Warrant Agent (including the form of the Warrant
Certificate) (incorporated by reference to Exhibit 10.9
to the Form S-4 Registration Statement).
10.13 General Agreement, dated October 16, 1997, as amended,
between Allegiance Telecom, Inc. and Lucent Technologies
Inc. (incorporated by reference to Exhibit 10.10 to the
Form S-4 Registration Statement).
10.14 Form of Indemnification Agreement by and between Allegiance
Telecom, Inc. and its directors and officers
(incorporated by reference to Exhibit 10.13 to the Form
S-1 Registration Statement).
11.1 Statement Regarding Computation of Per Share Earnings (Loss)
for the year ended December 31, 1998 (incorporated by
reference to Exhibit 11.1 to Form S-1 Notes).
11.2 Statement Regarding Computation of Pro Forma Per Share
Earnings (Loss) for the year ended December 31, 1998
(incorporated by reference to Exhibit 11.2 to Form S-1
Notes).
11.3 Statement Regarding Computation of Pro Forma Per Share
Earnings (Loss) for the period from inception (April 22,
1997) through December 31, 1997 (incorporated by
reference to Exhibit 11.3 to Form S-1 Notes).
12.1 Statement Regarding Computation of Ratios of Earnings (Loss)
to Fixed Charges (incorporated by reference to Exhibit
12.1 to Form S-1 Notes).
21.1 Subsidiaries of Allegiance Telecom, Inc. (incorporated by
reference to Exhibit 21.1 to the 1998 Form 10-K).
*23.1 Consent of Arthur Andersen LLP.
23.2 Consent of Mark B. Tresnowski (included in Exhibit 5.1).
24.1 Powers of Attorney (included in Part II to the Registration
Statement).
</TABLE>

II-4
<PAGE> 107

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<C> <S>
27.1 Financial Data Schedule for the year ended December 31, 1998
(incorporated by reference to Exhibit 27.1 to Form S-1
Notes).
27.2 Financial Data Schedule for the period from inception (April
22, 1997) through December 31, 1997 (incorporated by
reference to Exhibit 27.2 to the Form S-4 Registration
Statement).
</TABLE>

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

* Filed herewith

(b) Financial Statement Schedules.

All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required
under the related instructions, are inapplicable or not material, or the
information called for thereby is otherwise included in the financial
statements and therefore has been omitted.

ITEM 17. UNDERTAKINGS.

The undersigned registrant hereby undertakes to provide to the underwriter
at closing specified in the underwriting agreement certificates in such
denominations and registered in such names as requested by the underwriter to
permit prompt delivery to each purchaser.

The undersigned registrant hereby undertakes:

(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon Rule 430A and contained in
a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.

(2) For purposes of determining any liability under the Securities Act
of 1933, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.

(3)(a) To file, during any period in which offers or sales are being
made, a post-effective amendment to this registration statement:

(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act;

(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement; and

(iii) To include any material information with respect to the plan
of distribution not previously disclosed in the registration statement
or any material change to such information in the registration
statement.

(b) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.

Insofar as indemnification for liabilities arising under the Securities Act of
1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the

II-5
<PAGE> 108

payment by the registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.

II-6
<PAGE> 109

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Dallas, State of Texas,
on March 30, 1999.

ALLEGIANCE TELECOM, INC.

By: *

----------------------------------
Royce J. Holland
Chief Executive Officer

* * * *

Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons on March 30,
1999, in the capacities indicated:

<TABLE>
<CAPTION>
SIGNATURE CAPACITY
--------- --------
<C> <S>

* Chairman of the Board and Chief Executive
- ----------------------------------------------------- Officer (Principal Executive Officer)
Royce J. Holland

* President, Chief Operating Officer and
- ----------------------------------------------------- Director
C. Daniel Yost

* Executive Vice President, Chief Financial
- ----------------------------------------------------- Officer and Director (Principal Financial
Thomas M. Lord Officer)

/s/ DENNIS M. MAUNDER Vice President and Controller (Principal
- ----------------------------------------------------- Accounting Officer)
Dennis M. Maunder

* Senior Vice President of Sales and
- ----------------------------------------------------- Marketing and Director
John J. Callahan

* Director
- -----------------------------------------------------
Paul D. Carbery

* Director
- -----------------------------------------------------
James E. Crawford, III

* Director
- -----------------------------------------------------
John B. Ehrenkranz

* Director
- -----------------------------------------------------
Paul J. Finnegan

* Director
- -----------------------------------------------------
Richard D. Frisbie
</TABLE>

II-7
<PAGE> 110

<TABLE>
<CAPTION>
SIGNATURE CAPACITY
--------- --------
<C> <S>

* Director
- -----------------------------------------------------
Reed E. Hundt

* Director
- -----------------------------------------------------
Alan E. Goldberg

* Director
- -----------------------------------------------------
James N. Perry, Jr.
</TABLE>

THE UNDERSIGNED, BY SIGNING HIS NAME HERETO, DOES SIGN AND EXECUTE THIS
AMENDMENT TO REGISTRATION STATEMENT ON BEHALF OF THE ABOVE NAMED OFFICERS AND
DIRECTORS OF ALLEGIANCE TELECOM, INC. PURSUANT TO THE POWER OF ATTORNEY EXECUTED
BY SUCH OFFICERS AND DIRECTORS AND PREVIOUSLY FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION.

By: /s/ DENNIS M. MAUNDER

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

Dennis M. Maunder

Attorney-in-Fact

II-8
<PAGE> 111

INDEX TO EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<C> <S>
1.1 Form of Underwriting Agreement (incorporated by reference to
Exhibit 1.1 to Allegiance Telecom, Inc.'s Registration
Statement on Form S-1 (Registration No. 333-53479), filed
on May 22, 1998 and as amended (the "Form S-1
Registration Statement").
3.1 Amended and Restated Certificate of Incorporation of
Allegiance Telecom, Inc. (incorporated by reference to
Exhibit 3.1 to Allegiance Telecom's Form 10-Q for the
period ended June 30, 1998 (the "Form 10-Q")).
3.2 Certificate of Correction to Amended and Restated
Certificate of Incorporation (incorporated by reference
to Exhibit 3.2 to Allegiance Telecom, Inc.'s Form 10-K
for the period ended December 31, 1998 (the "1998 Form
10-K")).
4.1 Indenture, dated as of July 7, 1998, by and between
Allegiance Telecom, Inc. and The Bank of New York, as
trustee (including the Form of Notes) (incorporated by
reference to Exhibit 4.1 to Allegiance Telecom, Inc.'s
Registration Statement on Form S-1 (Registration No.
333-69543) filed on December 23, 1998 and as amended (the
"Form S-1 Notes")).
4.2 Indenture, dated as of February 3, 1998, by and between
Allegiance Telecom, Inc. and The Bank of New York, as
trustee (incorporated by reference to Exhibit 4.2 to
Allegiance Telecom, Inc.'s Registration Statement on Form
S-4 (Registration No. 333-49013), filed on March 31, 1998
and as amended (the "Form S-4 Registration Statement")).
4.3 Form of 11 3/4% Senior Discount Notes (incorporated by
reference to Exhibit 4.3 to the Form S-4 Registration
Statement).
4.4 Collateral Pledge and Security Agreement, dated as of July
7, 1998, by and between Allegiance Telecom, Inc. and The
Bank of New York, as trustee (incorporated by reference
to Exhibit 4.4 to Form S-1 Notes).
*5.1 Opinion of Mark B. Tresnowski (including consent).
10.1 Stock Purchase Agreement, dated August 13, 1997, among the
Fund Investors, the Management Investors, Allegiance
Telecom, LLC and Allegiance Telecom, Inc. (incorporated
by reference to Exhibit 10.1 to the Form S-4 Registration
Statement).
10.2 Securityholders Agreement, dated August 13, 1997, among the
Fund Investors, the Management Investors and Allegiance
Telecom, Inc. (incorporated by reference to Exhibit 10.2
to the Form S-4 Registration Statement).
10.3 Registration Agreement, dated August 13, 1997, among the
Fund Investors, the Management Investors and Allegiance
Telecom, Inc. (incorporated by reference to Exhibit 10.3
to the Form S-4 Registration Statement).
10.4 Warrant Registration Rights Agreement, dated as of January
29, 1998, by and among Allegiance Telecom, Inc. and
Morgan Stanley & Co. Incorporated, Salomon Brothers Inc,
Bear, Stearns & Co. Inc. and Donaldson, Lufkin & Jenrette
Securities Corporation, as initial purchasers of the
11 3/4% Senior Discount Notes (incorporated by reference
to Exhibit 10.11 to the Form S-4 Registration Statement).
10.5 Allegiance Telecom, Inc. 1997 Nonqualified Stock Option Plan
(incorporated by reference to Exhibit 10.4 to the Form
S-4 Registration Statement).
10.6 Allegiance Telecom, Inc. 1998 Stock Incentive Plan
(incorporated by reference to Exhibit 10.6 to the Form
S-1 Registration Statement).
</TABLE>

<PAGE> 112

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<C> <S>
10.7 First Amendment to the Allegiance Telecom, Inc. 1998 Stock
Incentive Plan (incorporated by reference to Exhibit 10.7
to the 1998 Form 10-K).
10.8 Executive Purchase Agreement, dated August 13, 1997, among
Allegiance Telecom, LLC, Allegiance Telecom, Inc. and
Royce J. Holland (incorporated by reference to Exhibit
10.5 to the Form S-4 Registration Statement).
10.9 Executive Purchase Agreement, dated August 13, 1997, among
Allegiance Telecom, LLC, Allegiance Telecom, Inc. and
Thomas M. Lord (incorporated by reference to Exhibit 10.6
to the Form S-4 Registration Statement).
10.10 Executive Purchase Agreement, dated January 28, 1998, among
Allegiance Telecom, LLC, Allegiance Telecom, Inc. and C.
Daniel Yost (incorporated by reference to Exhibit 10.7 to
the Form S-4 Registration Statement).
10.11 Form of Executive Purchase Agreement among Allegiance
Telecom, LLC, Allegiance Telecom, Inc. and each of the
other Management Investors (incorporated by reference to
Exhibit 10.8 to the Form S-4 Registration Statement).
10.12 Warrant Agreement, dated February 3, 1998, by and between
Allegiance Telecom, Inc. and The Bank of New York, as
Warrant Agent (including the form of the Warrant
Certificate) (incorporated by reference to Exhibit 10.9
to the Form S-4 Registration Statement).
10.13 General Agreement, dated October 16, 1997, as amended,
between Allegiance Telecom, Inc. and Lucent Technologies
Inc. (incorporated by reference to Exhibit 10.10 to the
Form S-4 Registration Statement).
10.14 Form of Indemnification Agreement by and between Allegiance
Telecom, Inc. and its directors and officers
(incorporated by reference to Exhibit 10.13 to the Form
S-1 Registration Statement).
11.1 Statement Regarding Computation of Per Share Earnings (Loss)
for the year ended December 31, 1998 (incorporated by
reference to Exhibit 11.1 to Form S-1 Notes).
11.2 Statement Regarding Computation of Pro Forma Per Share
Earnings (Loss) for the year ended December 31, 1998
(incorporated by reference to Exhibit 11.2 to Form S-1
Notes).
11.3 Statement Regarding Computation of Pro Forma Per Share
Earnings (Loss) for the period from inception (April 22,
1997) through December 31, 1997 (incorporated by
reference to Exhibit 11.3 to Form S-1 Notes).
12.1 Statement Regarding Computation of Ratios of Earnings (Loss)
to Fixed Charges (incorporated by reference to Exhibit
12.1 to Form S-1 Notes).
21.1 Subsidiaries of Allegiance Telecom, Inc. (incorporated by
reference to Exhibit 21.1 to the 1998 Form 10-K).
*23.1 Consent of Arthur Andersen LLP.
23.2 Consent of Mark B. Tresnowski (included in Exhibit 5.1).
24.1 Powers of Attorney (included in Part II to the Registration
Statement).
27.1 Financial Data Schedule for the year ended December 31, 1998
(incorporated by reference to Exhibit 27.1 to Form S-1
Notes).
27.2 Financial Data Schedule for the period from inception (April
22, 1997) through December 31, 1997 (incorporated by
reference to Exhibit 27.2 to the Form S-4 Registration
Statement).
</TABLE>

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

* Filed herewith

<PAGE> 1
EXHIBIT 5.1

[Allegiance Telecom, Inc. Law Department Letterhead]

March 30, 1999

Allegiance Telecom, Inc.
1950 Stemmons Freeway, Suite 3026
Dallas, Texas 75207

Re: Allegiance Telecom, Inc.
Registration Statement on Form S-1

Ladies and Gentlemen:

I am the Senior Vice President, General Counsel and Secretary of Allegiance
Telecom, Inc., a Delaware corporation (the "Company"). I am issuing this
opinion in connection with the proposed registration by the Company of 649,248
shares of its common stock, par value $.01 per share, that may be issued from
time to time by the Company upon the exercise of its warrants (the "Warrant
Shares"), pursuant to a Registration Statement on Form S-1, filed with the
Securities and Exchange Commission on the date hereof under the Securities Act
of 1933, as amended (the "Act") (such Registration Statement, as amended or
supplemented, is hereinafter referred to as the "Registration Statement"). The
Warrant Shares are issuable upon exercise of the Company's 445,000 warrants in
accordance with the Warrant Agreement, dated as of February 3, 1998, between the
Company and The Bank of New York, as the warrant agent.

In that connection, I have examined such corporate proceedings, documents,
records and matters of law as I have deemed necessary to enable me to render
this opinion.

For purposes of this opinion, I have assumed the authenticity of all
documents submitted to me as originals, the conformity to the originals of all
documents submitted to me as copies and the authenticity of the originals of all
documents submitted to me as copies. I have also assumed the legal capacity of
all natural persons, the genuineness of the signatures of persons signing all
documents in connection with which this opinion is rendered, the authority of
such persons signing on behalf of the parties thereto other than the Company and
the due authorization, execution and delivery of all documents by the parties
thereto other than the Company. As to any facts material to the opinions
expressed herein, I have relied upon the statements and representations of the
Company's officers and other representations of the Company and others.

My opinion expressed below is subject to the qualifications that I express
no opinion as to the applicability of, compliance with, or effect of (a) any
bankruptcy, insolvency, reorganization, fraudulent transfer, fraudulent
conveyance, moratorium or other similar law affecting the enforcement of
creditors' rights generally, (b) general principles of equity (regardless of
whether enforcement is considered in a proceeding in equity or at law), or (c)
public policy considerations which may limit the rights of parties to obtain
certain remedies.

Based upon and subject to the foregoing qualifications, assumptions and
limitations and the further limitations set forth below, I hereby advise you
that in my opinion:
<PAGE> 2
Allegiance Telecom, Inc.
March 30, 1999
Page 2

(1) The warrants are duly authorized and validly issued in accordance with
the terms of the Warrant Agreement.

(2) The issuance of the Warrant Shares has been duly authorized by all
necessary corporate action on the part of the Company, and when (a)
the Warrant Shares are issued in accordance with the terms of the
Warrant Agreement, (b) the full consideration has been paid for such
Warrant Shares as required by the terms of the Warrant Agreement, and
(c) certificates representing the Warrant Shares have been duly
executed and delivered on behalf of the Company and duly countersigned
by the Company's transfer agent/registrar, the Warrant Shares will be
validly issued, fully paid and nonassessable.

I hereby consent to the filing of this opinion with the Securities and
Exchange Commission as Exhibit 5.1 to the Registration Statement. In giving
this consent, I do not hereby admit that I am in the category of persons whose
consent is required under Section 7 of the Act or the rules and regulations of
the Securities and Exchange Commission.

I express no opinion as to any laws other than the General Corporation Law
of the State of Delaware and the federal law of the United States of America. I
do not find it necessary for the purposes of this opinion, and accordingly I do
not purport to cover herein, the application of the securities or "Blue Sky"
laws of the various states or securities laws of foreign jurisdictions to the
issuance and sale of the Shares.

This opinion is limited to the specific issues addressed herein, and no
opinion may be inferred or implied beyond that expressly stated herein. I
assume no obligation to revise or supplement this opinion should the applicable
law be changed by legislative action, judicial decision or otherwise.

This opinion is furnished to you in connection with the filing of the
Registration Statement and is not to be used, circulated, quoted or otherwise
relied upon for any other purpose.

Very truly yours,

/s/ Mark B. Tresnowski

MARK B. TRESNOWSKI
Senior Vice President,
General Counsel and Secretary

<PAGE> 1
EXHIBIT 23.1

CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

As independent public accountants, we hereby consent to the use of our report
(and to all references to our Firm) included in or made a part of this
Registration Statement File No. 333-74765.

ARTHUR ANDERSEN LLP

Dallas, Texas
March 30, 1999