FOCAL COMMUNICATIONS CORP, 10-K, 2000-03-10

FOCAL COMMUNICATIONS CORP
10-K, 2000-03-10
RADIOTELEPHONE COMMUNICATIONS

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

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FORM 10-K
(Mark
One)

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

For the fiscal year ended December 31, 1999

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

For the Transition period from to

Commission File No. 333-49397

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FOCAL COMMUNICATIONS CORPORATION
(Exact name of registrant as specified in its charter)

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Delaware 36-4167094
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)

200 North LaSalle Street,
Suite 1100, Chicago, Illinois 60601
(Address of principal executive (Zip Code)
offices)

Registrant's telephone number, including area code: (312) 895-8400

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

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value

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

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

Based on the closing sales price on the Nasdaq National Market on February
29, 2000 of $52.813, the aggregate market value of our voting stock held by
non-affiliates on such date was approximately $1,540,180,819. Shares of common
stock held by each director and executive officer and by each person who owns
or may be deemed to own 10% or more of our outstanding common stock have been
excluded, since such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive
determination for other purposes. As of that date, Focal Communications
Corporation had 60,852,316 shares of common stock issued and outstanding.

Documents Incorporated by Reference: None.

Index of Exhibits is located on page 50.

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INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

We make statements in this Annual Report on Form 10-K that are not
historical facts. These "forward-looking statements" can be identified by the
use of terminology such as "believes," "expects," "may," "will," "should" or
"anticipates" or comparable terminology. These forward-looking statements
include, among others, statements concerning:

. Our business strategy and competitive advantages

. Our anticipation of potential revenues from designated markets or
customers

. Statements regarding the growth of the telecommunications industry and
our business

. The markets for our services and products

. Forecasts of when we will enter particular markets or begin offering
particular services

. Our anticipated capital expenditures and funding requirements

. Anticipated regulatory developments

These statements are only predictions. You should be aware that these
forward-looking statements are subject to risks and uncertainties, including
financial and regulatory developments and industry growth and trend
projections, that could cause actual events or results to differ materially
from those expressed or implied by the statements. The most important factors
that could prevent us from achieving our stated goals include, but are not
limited to, our failure to:

. Prevail in legal and regulatory proceedings regarding reciprocal
compensation for Internet-related calls or changes to laws and
regulations that govern reciprocal compensation

. Successfully expand our operations into new geographic markets on a
timely and cost-effective basis

. Successfully introduce and expand our data and voice service offerings on
a timely and cost-effective basis

. Respond to competitors in our existing and planned markets

. Execute and renew interconnection agreements with incumbent carriers on
terms satisfactory to us

. Maintain our agreements for transport facilities

. Maintain acceptance of our services by new and existing customers

. Attract and retain talented employees

. Obtain and maintain any required governmental authorizations, franchises
and permits, all in a timely manner, at reasonable costs and on
satisfactory terms and conditions

. Respond effectively to regulatory, legislative and judicial developments

. Manage administrative, technical and operational issues presented by our
expansion plans

. Raise sufficient capital on acceptable terms and on a timely basis

. Successfully provision xDSL services

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PART I

ITEM 1. BUSINESS

Except as otherwise required by the context, references in this report to
the "Company," "Focal," "we," "us," or "our" refer to the combined business of
Focal Communications Corporation and all of its subsidiaries. Unless otherwise
indicated, the information in this Annual Report on Form 10-K gives effect to
a recapitalization pursuant to which our Class A common stock, Class B common
stock and Class C common stock were converted into a single class of common
stock and a 500-for-1 stock split. Both the recapitalization and the stock
split were effected on July 30, 1999.

This report contains trademarks of Focal, and may contain trademarks,
tradenames and service marks of other parties.

Introduction

We are a rapidly growing CLEC that provides data, voice and colocation
services to large corporations, ISPs and VARs in large metropolitan markets.
We began operations in 1996, initiated service first in Chicago in May 1997
and as of December 31, 1999 offered service in the following 16 markets:

Chicago New York Seattle
San Francisco Los Angeles Philadelphia
Orange County, California Boston Oakland
Washington, D.C. Dallas Northern Virginia
Detroit Fort Worth Northern New Jersey
San Jose

As part of our expansion, we plan to offer services in Atlanta, Houston,
Minneapolis and Cleveland by September 30, 2000.

When we complete our planned expansion, we will provide service in 20
markets, which encompass a total of 50 metropolitan statistical areas. As of
December 31, 1999, we had sold 237,167 access lines, of which 181,103 were
installed and in service. This compares to 68,184 lines sold and 52,011 lines
installed and in service as of December 31, 1998 and 13,411 lines sold and
7,394 lines installed and in service as of December 31, 1997. Our primary
objective is to become the provider of choice of data and voice services to
communications-intensive customers in our markets.

A majority of our revenue is currently derived from the provision of
switched data services for our targeted customers. Due to customer demand, we
are deploying additional services such as high-speed data access using DSL
technology and nationwide networking using ATM technology. Once these services
are deployed, we believe we will have an advantage over other data and voice
CLECs offering these services due to our established relationships with some
of the largest corporate and ISP customers in the nation, our highly reliable
network, and our ability to package switched and high-speed data connections.
We also believe that by providing these data services, we will appeal to a
broader customer base.

We believe we were the first CLEC to employ the "smart-build" approach to
designing networks. As such, we own and operate our switches, and initially
lease, rather than own, transport capacity. During 1999, we leased facilities
for 100% of our transport requirements. However, based on the increase in
volume of customer traffic in some of our markets, we now believe it is
economically attractive for us to own a portion of our transport capacity. We
have signed agreements with Level 3 Communications and Metromedia Fiber
Network Services to acquire a combined minimum of 10,800 fiber miles of our
own local fiber transport capacity in 16 markets. We activated our own Chicago
transport network in February 2000 and expect to activate our Detroit network
by the end of the first quarter of 2000. By combining leased fiber transport
facilities with owned fiber capacity, we expect to be better able to control
these assets and generate stronger operating results.

To further develop our long distance service offerings, we have signed
agreements with a number of carriers under which we have leased approximately
11,000 DS-3 miles of fiber transport capacity connecting each of our existing
and planned markets. Using these facilities, we are developing a nationwide
ATM network to carry data

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and voice traffic. This will allow us to provide virtual private network
services for both data and voice. We are currently able to price long distance
voice calls that remain on the Focal network as if they were local calls using
our FocaLINC service.

We also offer colocation services. Many of our ISP and some of our VAR
customers house their equipment in colocation space we operate within our
switching centers, and we provide equipment management services to some of
these customers. As of December 31, 1999, we had over 94,000 square feet of
secure and environmentally conditioned colocation space available to our
customers or under development. We believe the proximity of existing and
future colocation customers to our network as well as the concentration of
Internet traffic within our space will provide us with an advantage in
marketing additional services in the future. These services may include high
speed Internet access to ISP and corporate customers, as well as peering and
Internet upstream transport services.

We believe that our management and operations team has been critical to our
initial success and will continue to differentiate Focal from its competitors.
We have built a skilled and experienced management team with extensive prior
work experience at major telecommunications companies, such as MFS
Communications, Sprint, MCI WorldCom, AT&T and Ameritech.

We were re-incorporated in Delaware in June 1997 in connection with a Plan
of Reorganization and Agreement dated June 12, 1997, whereby we became the
holding company of Focal Communications Corporation of Illinois and each of
its subsidiaries.

Market Potential

We believe communications-intensive users in large metropolitan markets are
inadequately supplied with highly reliable, local data and voice services. We
also believe that these types of users will increasingly demand diversity in
local communications providers as they do in long distance and private-line
communications services.

As a result, we have chosen to initially do business only in large
metropolitan markets with a high concentration of communications-intensive
customers. We select our target geographical markets using several criteria:

. Sufficient market size

. Favorable state regulatory environment

. The existence of multiple fiber transport providers with extensive
networks

. The existence of, or ability to obtain, attractive interconnection
agreements with the ILEC

The market potential for CLECs is large and growing for both local switched
services and data communications. According to data published by the FCC,
local communications services in the United States in 1997 generated total
revenues of approximately $102 billion. While this represents total local
service from both residential and business customers, we estimate that
approximately $44 billion, or 43%, of this revenue represented local switched
service by businesses. We also estimate that business usage grew to $50
billion in 1999. A market study done by our management estimates that the
total local switched service from the business segment in the 20 large,
metropolitan markets in which we intend to offer service represented
approximately 36% of total business access lines in the nation and generated
approximately $18 billion in 1999.

Data communications is one of the fastest growing areas of the
telecommunications industry. According to Frost & Sullivan, the total U.S.
market for high-speed and switched data services will grow at an annual rate
of approximately 17% from $18 billion in 1997 to approximately $40 billion by
2002. The DSL portion of this market alone is expected to grow at an annual
rate of approximately 44% over the same time period. Much of the growth is
expected to result from increased demand for e-mail, web hosting services, e-
commerce, collaborative workflow and real-time video services and
applications. We estimate that the addressable market for high-speed and
switched data services in our targeted markets was approximately $9 billion as
of the end of 1999.

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The table below summarizes estimates from our market study regarding our
current and planned markets. You should be aware that, with the exception of
the "Operational Markets," the launch period shown in the second column is our
current estimate of when we will begin providing services in our planned
markets. These estimates are subject to change based upon numerous factors,
including timely performance by third party suppliers and receipt of required
regulatory approvals.

<TABLE>
<CAPTION>
Estimated Addressable
1999 Market Data(1)
--------------------------------------
Number of
Business Switched Revenue from
Launch Period Access Lines Local Business Calls
------------------- ----------------- --------------------
(dollars in
(in thousands) millions)
<S> <C> <C> <C>
Operational Markets:
Chicago, IL............. May 1997 1,899 $ 1,709
New York, NY............ January 1998 2,420 2,178
Philadelphia, PA........ September 1998 1,324 1,191
San Francisco, CA....... September 1998 589 530
San Jose, CA............ September 1998 361 325
Oakland, CA............. September 1998 521 469
Washington, D.C......... December 1998 1,481(2) 1,333(2)
Northern Virginia, VA... December 1998 -- --
Los Angeles, CA......... December 1998 1,778 1,600
Orange County, CA....... December 1998 1,002 902
Northern New Jersey..... January 1999 1,275 1,147
Boston, MA.............. January 1999 1,306 1,176
Detroit, MI............. June 1999 1,059 953
Seattle, WA............. September 1999 699 629
Dallas, TX.............. December 1999 774 697
Fort Worth, TX.......... December 1999 299 269
Planned Markets:
Atlanta, GA............. First Quarter 2000 886 798
Houston, TX............. First Quarter 2000 935 841
Cleveland, OH........... Second Quarter 2000 786 707
Minneapolis, MN......... Third Quarter 2000 674 607
------ -------
Total:................ 20,068 $18,061
====== =======
</TABLE>
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(1) This addressable market data does not include information for non-switched
data and voice services.
(2) Data for Northern Virginia are included in the data for Washington, D.C.

Strategy

Our objective is to become the provider of choice for data and voice
communications services to large, communications-intensive customers in our
target markets. The key elements of our strategy to achieve this objective are
discussed below.

. Leverage Current Customer Relationships--We orient the profile of our
sales teams and customer care processes to meet the very stringent
requirements of our target customer base of communications-intensive
users. As a result, we have built a customer base that includes a
substantial number of large, sophisticated companies and ISPs, some of
which are:

IBM Sony Citigroup United Airlines
E*Trade Merrill Lynch Mindspring PSINet
CompuServe Nortel Networks Sears Motorola

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We believe that this customer base of communications-intensive users
gives us an advantage in successfully marketing additional services.
Consequently, we plan to leverage the relationships we have built with
our customers and increase our share of their total communications
expenditures by expanding our service offerings and market coverage.

. Expand Data Service Offerings--The majority of our access lines are
utilized for switched data services. These typically involve dial-up data
calls utilizing modems for access to a corporate customer's LAN or an ISP
customer's remote access server. We believe we have developed an
excellent reputation among our customers as a provider of reliable
switched data services. Moreover, we believe a significant opportunity
exists with our targeted customers to successfully offer a wider array of
data services. We expect that home workers and Internet users will
increasingly seek higher speed access to their corporate LANs and the
Internet. As a result, we are currently developing high-speed LAN and
Internet access using DSL technology as well as private line data
services. We may offer high speed Internet access to ISP and corporate
customers, as well as peering and Internet upstream transport services.

. Connect our Local Networks Nationally--We believe that the number and
types of services we can provide to communications-intensive customers in
major markets will be greatly enhanced if our networks in these markets
are interconnected. For example, we have begun to sell long distance
calling between our markets for the price of a local phone call to those
customers who utilize our network in each market. In order to facilitate
this connectivity, we are developing a seamless, nationwide backbone
network based on ATM technology that will interconnect our switching and
colocation centers in the U.S. We expect this will give us the necessary
network platform to offer additional services such as virtual private
network and private line data and voice services.

. Design and Install a Highly Capital-Efficient Network--We believe we have
optimized our return on invested capital by initially leasing fiber
capacity and by making most of our capital expenditures in switching
facilities and information systems. Currently, we lease fiber from
multiple vendors in each of our markets. We believe that this strategy
has resulted in a lower, less risky capital investment than that of other
CLECs that build their own fiber facilities right away. Compared to these
other CLECs, a greater proportion of our ultimate capital requirement is
"success-based." As our market penetration and customer base increases,
we intend to purchase fiber transport capacity where it is economically
attractive, as illustrated by our agreements with Level 3 Communications
and Metromedia Fiber Network Services described below. Going forward, we
believe that our hybrid network, which will combine leased and owned
transport capacity, is the best way to balance capital efficiency and
control of network assets.

. Maximize Network Utilization through VARs--We provide service to VARs
such as managers of large multi-dwelling units and companies that market
bundled telecommunications services to small-and medium-sized businesses.
This VAR distribution channel enables us to increase the number of access
lines served by our networks, which further maximizes network
utilization.

Networks

We have installed Nortel DMS-500 SuperNode digital central office switches
in each of our existing markets, and currently plan to deploy similar switches
in our additional markets. As we add customers in a market, it has generally
been cost-effective for us to use leased fiber transport capacity to connect
our customers to our network. We have initially leased local network trunking
facilities from the ILECs in each of our markets in order to connect our
switches to major ILEC central offices serving our central business district
and outlying areas of business concentrations. We have chosen to design our
networks using this "smart-build" approach, which involves purchasing and
maintaining our own switches while leasing our fiber transport facilities on
an as-needed basis. This provides us with added negotiating leverage in
obtaining favorable terms from transport providers and allows us to offer our
customers both redundancy and diversity. In addition, we have designed our
networks to maximize call completion and significantly reduce the likelihood
of blocked calls, which helps us satisfy the needs of our high-volume
customers. This smart-build approach is possible because there are multiple
vendors of local fiber transport facilities in each of our large metropolitan
markets, both current and planned. Our switch-based, leased transport network
architecture has allowed us to:

. Reduce the time and money required to launch a new market

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. Minimize financial risk associated with under-utilized networks

. Generate revenue and cash flow more quickly

We have the flexibility to add or subtract leased local transport capacity
on an incremental basis with the addition or loss of customers. We believe
that the quantity of existing and planned fiber transport facilities available
from numerous carriers will be sufficient to satisfy our need for local leased
transport facilities and permit us to obtain these facilities at competitive
prices for the foreseeable future. The fiber transport providers in our
current and planned markets compete with each other for our business in order
to maximize the return on their fixed-asset networks, which enables us to
obtain competitive pricing. In addition, because each of our fiber transport
capacity providers is a common carrier, they are required to make their
transport services available to us on terms no less favorable than those
provided to similar customers.

Although during 1999 we leased 100% of our transport facilities, we believe
that it is now economically attractive for us to own a portion of our local
transport capacity because of increased volumes of customer traffic between
our switches and specific ILEC central offices in some of our markets. We are
a party to agreements with Level 3 Communications and Metromedia Fiber Network
Services for the acquisition of local fiber transport capacity covering a
combined minimum of 10,800 fiber miles in at least 16 markets.

Our agreement with Level 3 Communications provides us with an indefeasible
right of use, or IRU, for a specified number of fibers being constructed or
acquired by Level 3. The IRU in each covered market has a 20-year term and
covers a total of approximately 8,300 fiber miles in our Chicago, New York,
Philadelphia, San Francisco, Los Angeles, Seattle and Detroit markets. Under
this agreement, we are required to pay fees totaling approximately $18
million, payable in installments based upon achieving certain construction and
installation milestones. We activated our own Chicago transport network in
February 2000 and expect to activate our Detroit network by the end of the
first quarter of 2000. The Level 3 agreement also requires us to pay nominal
quarterly operations and maintenance fees based upon the number of fiber route
miles covered. Focal's 20-year agreement with Metromedia Fiber Network
Services provides for the long-term lease of a minimum of 2,500 fiber miles of
fiber optic capacity for approximately $53 million over the 20-year term. This
agreement also gives us the option to lease additional fiber in Metromedia
Fiber Network Services' markets for lease payments that decrease according to
a sliding scale based on volume.

We have also employed a "smart-build" approach in developing our inter-city
strategy. Initially, we resold long distance transmission service by buying
minutes on a wholesale basis. Going forward, we have decided to lease fiber
optic transport capacity connecting our switches between each of our existing
and planned markets. We will therefore transport our calls from market to
market over our own network and terminate the calls either directly at our
customer's location or at the ILEC switch. For international calls, we have
negotiated agreements with various international carriers for termination of
our international calls throughout the world.

To implement our inter-city network, we have signed agreements with a
number of carriers under which we have leased approximately 11,000 DS-3 miles
of fiber transport capacity connecting each of our existing and planned
markets. This inter-city, DS-3 backbone network will initially be based on
time division multiplexing technology. During 2000, we plan to convert the
inter-city backbone to ATM technology. We believe the use of ATM switches will
provide greater flexibility in creating and managing both data and voice
services over the same physical network. We are currently able to price inter-
city calls that remain on our network as if they were local calls--a service
we call FocaLINC.

In May 1999, we entered into a five-year private line service agreement
with MCI WorldCom providing for the lease of fiber transport capacity that
will be used to connect our existing and planned markets. Under this
agreement, we have agreed to pay total charges for private line services of at
least $70 million in the aggregate over the five-year term, including existing
private lines used within our markets to provide local service. The charges
are payable as minimum annual volume commitments of $10 million in the first
year, $13.2 million in

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the second year and $15.6 million in each of the final three years. If we
terminate the agreement prior to the end of the five-year term, we are
required, with limited exceptions, to pay the difference between the
commitment for the relevant year and our actual charge, as well as 50% of the
commitment for each subsequent year of the five-year term.

In order to support high-speed access to corporate LANs and the Internet,
we began in 1999 to deploy DSL technology in our key markets. We are obtaining
colocation space from the ILECs and installing DSL access multiplexers, or
DSLAMs, in colocation cages in ILEC central offices located in densely
populated regions. Once installed, the DSLAMs terminate into an ATM switch,
which transports high-speed data from end users to Focal's corporate and ISP
customers. These customers then manage the flow of this traffic onto their
corporate LANs or the Internet, as appropriate.

We are a party to a products purchase agreement with Nortel Networks that
expires December 31, 2002. This agreement establishes favorable terms and
conditions for our purchase of Nortel Networks products, including switches,
related software and services. This contract requires us to place orders for
the delivery and installation of Nortel Networks products, including DMS-500
SuperNode central office switches, in a minimum aggregate amount over the term
of the agreement of $75 million, at pre-established prices.

Products and Services

Data Services

Focal Virtual Office is designed to allow a corporate customer's employees
to dial-in to the corporate customer's local area network using a telephone
number in the employee's local calling area. This allows the employee to
access the local area network for the price of a local call and enables our
corporate customer to avoid the higher cost of maintaining region-wide 800
service for local area network access. In addition, our Virtual Office
customers are able to use the Focal Finder(TM) service, an interactive tool
placed on the customer's web site that automatically provides a telecommuting
employee with the local calling number to be used for server access.

Focal Multi-Exchange Service, a variant of the Focal Virtual Office service
marketed to ISPs, allows an ISP's customers to cost-effectively access the
ISP's remote access servers. The combination of the multi-exchange service
capacity and our high level of customer care has resulted in strong demand for
our Multi-Exchange Service from ISPs.

We also offer our customers the ability to colocate equipment in our
switching and operations centers. Equipment colocation benefits the customer
by allowing it to inexpensively house its data equipment without having to
maintain secure, environmentally controlled space. In addition, customers that
colocate are eligible for special discounts on our monthly line rates. We also
offer them equipment maintenance services. These services are particularly
well-suited to our ISP customers, who frequently operate remote access servers
and routers in conjunction with our switched services. As of December 31, 1999
we had over 94,000 square feet of customer colocation space available or under
development. We may offer expanded colocation services along with our planned
high speed Internet access services.

We are currently deploying DSL access services to provide high-speed,
dedicated access to corporate LANs and the Internet. This service is being
marketed to each of our targeted customer segments-- large corporations, ISPs
and VARs. DSL service is or will be available in a variety of speeds ranging
from 144 kilobits per second to up to 52 megabits per second. We believe DSL
access service is a natural extension of the switched data services that we
have provided since inception.

On July 2, 1999, Focal entered into a five-year Joint Marketing and Service
Agreement with Splitrock Services, Inc., a provider of advanced data
communications services to ISPs, telecommunications carriers and other
businesses. Under this agreement, Splitrock has agreed to purchase a minimum
of 10,000 DSL lines as

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may be needed by Splitrock to provide service to Splitrock's wholesale
customers or retail end-users in Focal's markets, subject to service
availability on a timely basis. Focal also has been granted a right of first
refusal to provide DSL service to Splitrock within Focal's service territory
to the extent Splitrock is not providing DSL services over its own network. In
turn, Splitrock has been granted a right of first refusal to offer specified
data communications and network services if Focal itself does not offer these
services within the relevant geographic market. The parties have also agreed
to cooperate in selected network planning functions.

With the purchase of our own fiber capacity, we believe we can offer both
intra-city and inter-city private line data services at attractive prices.
Consequently, we plan to more aggressively market private lines for data
applications to new and existing customers.

Voice Services

Inbound Services. Our basic, inbound service allows for the completion of
calls to a new phone number we supply to our customer. Alternatively, local
number portability, or LNP, allows us to provide inbound services using a
customer's existing phone number. While LNP is occasionally unavailable and
cumbersome to implement, it permits us to serve customers without altering
their existing phone numbers. Consequently, we expect LNP to become
increasingly useful to us in taking existing business from our primary
competitors, the ILECs.

Direct inward dial service allows inbound calls to reach a particular
station on a customer's phone system without operator intervention. We market
direct inward dial service to our corporate customers as both a primary and
backup service. As a primary service, the customer uses Focal numbers where a
new line and number are needed, as when a customer hires a new employee. As a
backup service, we can implement an alternative numbering plan for the
customer in case the customer's primary service from the ILEC or another CLEC
is interrupted.

Outbound Services. Our basic outbound services allow local and toll calls
to be completed within a metropolitan region and long distance calls to be
completed worldwide. This direct outward dial service is utilized by end users
in several ways. As a primary service, a customer uses Focal as a replacement
for the ILEC in placing calls to destinations within the region. In our least
cost routing application, a customer can utilize our service in conjunction
with its existing ILEC service to route calls using whichever carrier is least
expensive for that particular type of call or time of day.

Other outbound applications include outbound 800 calling and long distance
overflow service. In order to encourage customers to use our service, we offer
customers an incentive for letting us provide their outbound 800 calls. In the
case of long distance overflow service, we act as a backup to the customer's
existing long distance carrier in order to optimize the number of direct,
special access lines installed from the customer's premises to the long
distance carrier's network.

Our FocaLINC service is designed to price inter-city calls that remain on
our network as if they were local calls. This product provides a cost-
effective way for our customers in one market to make calls to their offices
in other Focal markets.

All of the services described above are commonly provisioned over a high-
speed digital communications circuit called a T-1 facility and interface
directly with our customers' private branch exchange or other customer-owned
equipment. Direct interfacing averts our need to provide multiplexing
equipment, which combines a number of communications paths onto one path, at
the customer's location. This is possible due to the high call volume
generated by the large communications-intensive customers we target. Our
ability to directly interface with existing customer equipment further
minimizes our capital investment and maximizes our overall return on capital.
We also believe our installation of DSL equipment utilizing HDSL2 technology
will allow us to more cost-effectively provision T-1 facilities needed for
voice customers. In addition DSL technology will allow us to reach more
customers in areas not currently served by fiber.

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Advanced Services

CDR Express provides our VAR customers with automated delivery of daily
call detail records, or CDRs, via the Internet. This system enables these
customers to accurately bill their customers in a secure environment. CDR
Express, as well as some other Focal products, are located in Your Domain--a
section of our web site specifically dedicated to each customer. Your Domain
enables our customers to access their most recent invoices, call detail
records and the customer order entry forms. Your Domain is protected by a
customer's user name and password. Your Domain can also inform customers of
new product offerings being developed by us. Our Form View product, located in
Your Domain, allows our customers to download order forms and other important
documents through the Internet at their convenience.

Focal FLOW is an outbound service marketed to VARs that need to be able to
switch outbound traffic among multiple long distance or international
carriers. We partition our central office switch so VARs can utilize the core
switching capability of our equipment at reasonable per minute or per port
cost.

Sales and Marketing

Our primary objective is to satisfy the need for highly reliable
communications services for communications-intensive users in the large
metropolitan markets in which we operate by providing diverse, reliable and
sophisticated services. We believe that we have a competitive advantage in
satisfying this need since we are focused on delivering a specific set of
innovative services to our target customers.

Diversity. Focal provides diversity to communications-intensive users by
delivering highly reliable, local communications services as an alternative to
the ILEC. This type of diversity already exists in other areas of
communications services, such as long distance. Communications-intensive
customers clearly embrace the benefits of diversity, particularly because
redundancy minimizes the effects of facilities failures and maximizes
competitive pricing. As a result, most of our target customers typically have
multiple long distance providers, multiple equipment vendors and multiple
local private-line providers. Because of our focused strategy, we believe that
we are uniquely positioned to become the provider of choice for data and voice
communications services for large, communications-intensive corporate users,
VARs and ISPs. Our focused strategy is based on our ability to deliver the
superior level of diverse, reliable and sophisticated services that our
customers require.

Reliability. We provide reliable service to communications-intensive users,
who are highly sensitive to the potential effects of facilities failures, by
designing our networks around the same theme of diversity that we advocate for
our customers. Although local services are perceived as simple, basic
services, the delivery of highly reliable, local services requires
sophisticated systems. We have engineered our switching and transport networks
to meet the demanding traffic and reliability requirements of our target
customers. Our network strategy is based on developing and operating a robust,
reliable, high-throughput local network relative to the ILECs and other CLECs.
Because we are a relatively new entrant to the markets we serve, we must meet
or exceed the performance quality of the existing local networks in order to
attract communications-intensive users to our networks. Unlike smaller users
that tend to pre-qualify vendors based on price, we believe that
communications-intensive users choose vendors based on the performance of
their networks, and specifically, their reliability. As a result, the design
and operation of our network are key success factors in our business
development process.

In choosing our equipment, we conducted extensive research to identify the
best hardware for the high-volume users that we serve. As a result of this
research, we selected Nortel DMS-500 SuperNode central office switches, which
we have engineered to reduce significantly the likelihood of blocked calls and
to maximize call completion. As such, our customers are unlikely to find
themselves unable to complete or receive calls due to limitations inherent in
our switches. We typically connect to a large number of switches in the ILEC's
network. As of December 31, 1999, we had connected to a total of 1,209 ILEC
switches. We believe this is a competitive advantage because it increases call
completion even if a portion of the ILEC's trunking network becomes blocked.
We optimize the configuration of our network by implementing overflow routing
between the ILEC's

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<PAGE>

network and ours, where available. Because the customer base of the ILECs and
other CLECs is not typically as communications-intensive as ours, we
specifically engineered our network to accommodate traffic volumes per
customer far in excess of that which the ILECs or other CLECs typically
experience. We believe that our design is unique among ILECs and CLECs and is
attractive to our target customer base of communications-intensive users. In
addition, we enhance our reliability by delivering service from our switches
to customers over multiple fiber transport systems.

We have also implemented safeguards in our network design to maximize
reliability. The DMS-500 SuperNode switch allows us to distribute customer
traffic across multiple bays of equipment, thus minimizing the effects of any
customer outage. In addition, these switches were engineered by Nortel
Networks with fully redundant processors and memory in the event of a
temporary failure. Our disaster prevention strategy includes service from
multiple power sources where available, on-site battery backup and diesel
generator power at each switching facility to protect against failures of our
electrical service.

Sophistication. Our target customers are knowledgeable, sophisticated
buyers of communications services that demand a high level of professionalism
throughout a vendor's organization. We believe that the technical
sophistication of our management and operations team has been a critical
factor in our initial success and will continue to differentiate us from our
competitors. Execution of our strategy of penetrating communications-intensive
accounts requires a well-experienced team of sales professionals. As a result,
attracting and retaining experienced sales professionals is important to our
overall success. Our sales professionals' compensation is structured to retain
these valuable employees through the grant of stock options and cash
compensation incentives based on our revenue and operating cash flow
objectives.

We divide our direct sales force into three groups:

. The data services group

. The corporate services group

. The telecom services group

The data services group is responsible for selling to information services
providers, DSL providers and other data carriers, including ISPs. We are able
to offer several innovative services to ISPs, such as environmentally
conditioned colocation space, virtually non-blocking switching and transport
facilities and firm installation times. Servicing ISPs also maximizes our
network utilization by bringing traffic onto our network during periods, such
as evenings or weekends, when the network would otherwise be under-utilized.

The corporate services group is responsible for selling to large corporate
users. Our sales strategy for these corporate customers is to complement the
customer's service from the ILEC. Our initial sale to a corporate customer
typically involves installing incremental lines for specialized inbound
services, such as Virtual Office, or replacing only a limited number of
outbound lines. After we build the service relationship, we anticipate
increasing our overall penetration of the customer's local service. Over a
period of time, we hope to dominate a corporate customer's local switched
traffic. We emphasize the diversity, reliability and sophistication of our
services in order to earn our place as the local provider of choice for our
corporate customers.

The telecom services group markets directly to VARs and other carriers by
positioning us as a highly-reliable, responsive and cost-effective source of
wholesale local communications services. We believe a wide array of
communications service providers, including long distance companies, will seek
to provide bundled communications services in the large metropolitan markets
we target. We are well-positioned to be the provider of choice for re-bundled
local service. Because we do not intend to directly distribute our services to
residential or small- and medium-sized business customers, we believe that
VARs and other carriers looking to purchase the local service portion of their
bundled service offerings are more likely to purchase service from us rather
than from other ILECs or CLECs that compete with them.

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<PAGE>

Superior customer service is critical to achieving our goal of capturing
market share. We are continually enhancing our service approach, which
utilizes a trained team of customer sales and service representatives to
coordinate customer installation, billing and service. Comprehensive support
systems are also a critical component of our service delivery. We have
installed systems designed to address all aspects of our business, including
service order, network provisioning, end-user and carrier billing, and trouble
reporting. The efficiency of our operating processes contributes to our
ability to rapidly initiate service to new accounts. Our installation desk
follows a customer's order, ensuring the installation date is met.
Additionally, our customer sales representatives respond to all other customer
service inquiries, including billing questions and repair calls.

We believe automation of internal processes contributes to the overall
success of a service provider and that billing is a critical element of any
telephone company's operation. We deliver billing information in a number of
media besides paper, including electronic files and Internet inquiry. Our
Invoice Domain service allows customers to securely access and view their
monthly invoices over the Internet. In addition, this service allows customers
to download call detail records. Similarly, our VAR customers can download
call records on a daily basis through our secure web site. This allows them to
efficiently process invoices for their end-user customers.

Significant Relationships

We have no customers that accounted for more than 10% of our revenues
during the three years ended December 31, 1999.

Our relationships with Ameritech and Bell Atlantic are mandatory, co-
carrier relationships and are not that of a customer and supplier.
Nevertheless, Ameritech and Bell Atlantic are shown here due to their
contribution to our revenues for the three years ended December 31, 1999.
Ameritech Illinois and Bell Atlantic New York accounted for approximately 43%
and 20%; and 59% and 16%, of our consolidated revenues in 1999 and 1998,
respectively. Ameritech Illinois accounted for approximately 81% of our
consolidated revenues in 1997. The revenues from these carriers for the three
years ended December 31, 1999 are the result of interconnection agreements we
have entered into with them relating to the transport and termination of
communications traffic. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" for further discussion regarding
reciprocal compensation.

Competition

Portions of our industry are highly competitive. We face a variety of
existing and potential competitors, including:

. The ILECs in our current and target markets

. Other voice and data CLECs

. Long distance carriers

. Potential market entrants, including cable television companies, value
added resellers, electric utilities, microwave carriers, wireless
telephone system operators and private networks built by large end-users

. Foreign carriers

Our primary competitor in each of our existing and planned markets is the
ILEC. Examples include BellSouth, Bell Atlantic, U S WEST, SBC (including its
subsidiaries Ameritech Illinois and Pacific Bell) and GTE. These ILECs are
generally required to file their prices with the state regulatory agencies in
their service areas. Any price changes must be reflected in these filings. The
ILECs have also generally been given the flexibility to respond to competition
with lower pricing. In most cases, proposals for lower pricing must also be
filed with the state utility commissions and the pricing must be made
available to similarly situated customers. We believe this provides a
disincentive for the ILECs to significantly vary or discount prices even in
competitive situations. However, as a CLEC, similar obligations apply to us.
See "--Regulation--State Regulation."

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<PAGE>

Some of the ILECs recently requested, among other things, that the FCC
relax regulation of their provision of advanced data networks, which may also
be used for voice traffic. While the FCC has denied those requests, it has
initiated a rule-making that is intended to establish the procedures and
safeguards necessary before these ILECs could, through separate subsidiary
companies, provide these services on a largely deregulated basis. If adopted,
these rules may provide additional opportunities for competition from these
ILECs. SBC and Ameritech received authority from the FCC to create such a
subsidiary in the FCC's approval of their merger. The FCC recently released an
order addressing, among other things, colocation rights of carriers offering
advanced data services, but deferred action on the separate subsidiary issue.
Bills have been introduced in Congress that would grant Regional Bell
Operating Companies permission to provide data services in areas where they
are currently restricted from doing so. Although we cannot predict the outcome
of any proposed or pending legislation, the ability of Regional Bell Operating
Companies to provide data services on a broader basis could have a material
adverse effect on us. In addition, the FCC recently acted to enable Internet
service providers to buy DSL services in bulk from ILECs, which could result
in additional competition for Internet service provider business.

The ILECs offer a wider variety of services in a broader geographic area
than ours and have much greater resources than we do. This may encourage an
ILEC to subsidize the pricing for services with which we compete with the
profits of other services in which the ILEC remains the dominant provider. We
believe competition has limited the number of services dominated by ILECs. In
addition, state regulators have exercised their enforcement powers in a way
that makes it unlikely the ILECs would be able to successfully pursue this
type of protective pricing strategy for an extended period.

In addition to competition from ILECs, we also face competition from a
growing number of other CLECs. Although CLECs overall have only captured
approximately 5% of total revenue of the U.S. local telecommunications market,
we nevertheless compete to some extent with other CLECs in our customer
segments. There are typically several other CLECs competing in each
metropolitan market we serve or plan to enter. Examples of data and voice
CLECs in our markets include Allegiance Telecom, Covad Communications Group,
NEXTLINK Communications, NorthPoint Communications Group, Rhythms
NetConnections and Winstar. In some instances, these CLECs have resources
greater than ours and offer a wider range of services. Many of the CLECs in
our markets target small- and medium-sized business customers, which differs
from our target customer base of large, communications-intensive users.

In addition to ILECs and other CLECs, we are increasingly competing with
long distance carriers, such as MCI WorldCom and AT&T. A number of long
distance carriers have introduced local telecommunications services to compete
with us and the ILECs. These services include toll calling and other local
calling services, which are often packaged with the carrier's long distance
service. While we do not believe the packaging aspect of the service is
particularly attractive to the communications-intensive customers we target,
large long distance carriers enjoy certain competitive advantages due to their
vast financial resources and brand name recognition. In addition, we believe
there is a risk the long distance carriers may subsidize the pricing of their
local services with profits from long distance services. We anticipate that
the entry of some of the ILECs into the long distance market will reduce the
risk of this type of activity by reducing the profitability of the long
distance carrier's long distance minutes. Further, to the extent the long
distance carrier purchases our service on a wholesale basis and rebundles it
at a subsidized rate, we may benefit as the subsidized, wholesale service
could result in higher market penetration than we would otherwise have
achieved. In addition, we have displaced long distance carriers where the
customer was dissatisfied with the quality of the long distance carrier's
local service. We expect our reputation for exceptional service quality and
customer care will continue to result in us displacing the long distance
carrier as the primary alternative to the ILEC in competitive situations. In
addition, we expect that some of our recent and proposed service offerings,
which enable long distance calls to be priced like local calls, will increase
our competitiveness.

For a description of how we compete, see "--Sales and Marketing."

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<PAGE>

Regulation

The following summary of regulatory developments and legislation is not
complete. It does not describe all present and proposed federal, state and
local regulation and legislation affecting the telecommunications industry.
Existing federal and state regulations are currently subject to judicial
proceedings, legislative hearings and administrative proposals that could
change, in varying degrees, the manner in which our industry operates. We
cannot predict the outcome of these proceedings or their impact on the
telecommunications industry or us.

Overview. Our services are subject to varying degrees of federal, state and
local regulation. The FCC exercises jurisdiction over all the facilities of,
and services offered by, telecommunications common carriers like us to the
extent we use our facilities to provide, originate or terminate interstate or
international communications. State regulatory commissions retain jurisdiction
over most of the same facilities and services to the extent they are used to
provide, originate or terminate intrastate communications. The decisions of
these regulatory bodies are often subject to judicial review, which makes it
difficult for us to predict outcomes in this area.

Federal Regulation. We must comply with the requirements of common carriage
under the Communications Act of 1934. Comprehensive amendments to the
Communications Act of 1934 were made by the Telecommunications Act of 1996,
referred to as the Telecom Act, which substantially altered both federal and
state regulation of the telecommunications industry. The purpose of this
legislation was to deregulate the telecommunications industry to a significant
degree, thereby fostering increased competition among carriers. Because
implementation of the Telecom Act is subject to numerous federal and state
policy rule-making and judicial review, we cannot predict with certainty what
its ultimate effect on us will be.

Under the Telecom Act, any entity may enter a telecommunications market,
subject to reasonable state safety, quality and consumer protection
regulations. The Telecom Act makes local markets accessible by requiring the
ILEC to permit interconnection to its network and establishing ILEC
obligations with respect to:

. Colocation of equipment. This allows companies like us to install and
maintain our own network equipment, including DSLAMs, ATM switches, and
fiber optic equipment, in ILEC central offices.

. Interconnection. This requires the ILECs to permit their competitors to
interconnect with ILEC facilities at any technically feasible point in
the ILECs' networks.

. Reciprocal compensation. This requires the ILECs and CLECs to compensate
each other for telecommunications traffic that originates on the network
of one carrier and is sent to the network of the other.

. Resale of service offerings. This requires the ILEC to establish
wholesale rates for services it provides to end-users at retail rates to
promote resale by CLECs.

. Access to unbundled network elements. This requires the ILECs to unbundle
and provide access to some components of their local service network to
other local service providers. Unbundled network elements are portions of
an ILEC's network, such as copper lines or "loops," that CLECs can lease
in order to create their own facilities networks.

. Number portability. This requires the ILECs and CLECs to allow a customer
to retain an existing phone number within the same local area even if the
customer changes telecommunications services providers. All
telecommunications carriers will be required to contribute to the shared
industry costs of number portability, with the first payments being due
in the fourth quarter of 1999.

. Dialing parity. This requires the ILECs and CLECs to establish dialing
parity so that customers do not perceive a quality difference between
networks when dialing.

. Access to rights-of-way. This requires the ILECs and CLECs to establish
non-discriminatory access to telephone poles, ducts, conduits and rights-
of-way.

ILECs are required to negotiate in good faith with other carriers that
request any or all of the arrangements discussed above. If a requesting
carrier is unable to reach agreement with the ILEC within a prescribed time,

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<PAGE>

either carrier may request arbitration by the applicable state commission. If
an agreement still cannot be reached, carriers are forced to abide by the
obligations established by the FCC and the applicable state commission.

We have entered into a number of interconnection agreements with the ILECs
in our markets and will enter into additional agreements as our build-out
progresses. We have existing interconnection agreements in each of our
existing markets and in several of our planned markets. Nine of the
interconnection agreements covering our existing markets, including the
agreement covering Chicago, expired in 1999. Eight of the interconnection
agreements covering our existing markets, including the agreement covering New
York, expire in 2000. The expiration of these agreements will require that we
negotiate new interconnection terms with the ILECs. Pending conclusion of
these negotiations, several existing interconnection agreements should
continue to govern the payment of reciprocal compensation and other
interconnection terms while other renegotiated agreements will be given
retroactive effect from the expiration date of the superceded agreement
following the conclusion of negotiations and arbitrations. Failing to reach
agreement on renegotiations, we have filed for arbitration in states in Bell
Atlantic and Ameritech territory.

The FCC is charged with establishing guidelines to implement the Telecom
Act. In August 1996, the FCC released a decision, known as the Interconnection
Decision, that established rules for the interconnection requirements outlined
above and provided guidelines for interconnection agreements by state
commissions. The U.S. Court of Appeals for the Eighth Circuit vacated portions
of the Interconnection Decision. On January 25, 1999, the U.S. Supreme Court
reversed the Eighth Circuit and upheld the FCC's authority to issue
regulations governing pricing of unbundled network elements provided by the
ILECs in interconnection agreements, including regulations governing
reciprocal compensation, which are discussed in more detail below. In
addition, the Supreme Court affirmed an FCC rule that allows requesting
carriers to "pick and choose" the most attractive portions of existing
interconnection agreements with other carriers. The Supreme Court did not,
however, address other challenges raised about the FCC's rules at the Eighth
Circuit because those challenges were not decided by the Eighth Circuit. These
challenges will have to be addressed by the Eighth Circuit in light of the
Supreme Court's decision. In addition, the Supreme Court disagreed with the
standard applied by the FCC for determining whether an ILEC should be required
to provide a competitor with particular unbundled network elements.

The FCC adopted a new standard in November 1999 for analyzing unbundled
network elements as required by the Supreme Court's order. Applying this
standard to the existing network elements, the FCC concluded that ILECs would
no longer be required to provide directory assistance and operator services as
network elements, though they will continue to be available pursuant to tariff
at different prices. The FCC also removed unbundled switching as an element in
urban areas where the incumbents are also providing certain other combinations
of elements in a non-discriminatory fashion. However the FCC declined, except
in limited circumstances, to require ILECs to unbundle certain facilities used
to provide high speed Internet access and other data services.

The Supreme Court's decision and the FCC's order on remand do not remove
all uncertainty concerning the pricing terms and conditions of interconnection
agreements. The Eighth Circuit could set aside the FCC's rules concerning the
pricing of unbundled network elements, and the incumbents may challenge the
FCC's order on remand from the Supreme Court for not removing additional
network element obligations. Furthermore, the complexity of the revised rules
creates uncertainty as to how they might be enforced by the states. The
resulting uncertainty makes it difficult to predict whether we will be able to
continue to rely on our existing interconnection agreements or have the
ability to negotiate acceptable interconnection agreements in the future.

In addition to requiring the ILECs to open their networks to competitors
and reducing the level of regulation applicable to CLECs, the Telecom Act also
reduces the level of regulation that applies to the ILECs, thereby increasing
their ability to respond quickly in a competitive market. For example, the FCC
has applied "streamlined" tariff regulation of the ILECs, which shortens the
requisite waiting period before which tariff changes may take effect. These
developments enable the ILECs to change rates more quickly in response to
competitive pressures. The FCC has also adopted heightened price flexibility
for the ILECs, subject to specified caps. If exercised by the ILECs, this
flexibility may decrease our ability to effectively compete with the ILECs in
our markets.

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<PAGE>

The Telecom Act also gives the FCC authority to determine not to regulate
carriers if it believes regulation would not serve the public interest. The
FCC is charged with reviewing its regulations for continued relevance on a
regular basis. As a result of this mandate, a number of regulations that apply
to CLECs have been and may in the future continue to be eliminated. We cannot,
however, guarantee that any regulations that are now or will in the future be
applicable to us will be eliminated.

In March 1999, the FCC issued an order requiring ILECs to provide unbundled
loops and colocation on more favorable terms than had previously been
available. The order permits colocation of equipment that could be used to
more efficiently provide advanced data services such as high-speed DSL
service, and requires less expensive "cageless" colocation. In the March
order, the FCC deferred action on its previous proposal to permit ILECs to
offer advanced data services through separate affiliates, free from some of
the obligations of the Telecom Act. In an August order, the FCC determined
that advanced services are telecommunication services subject to regulation
under Sections 251 and 252 of the Telecom Act. In the same order the FCC
issued a notice of proposed rule making on terms for the provision of such
services on a separate subsidiary basis. That decision is on appeal. In an FCC
decision on voluntary remand, the FCC affirmed and clarified its position that
advanced services are subject to the interconnection, resale, and unbundling
requirements of the Act. Permitting ILECs to provision data services through
separate affiliates with fewer regulatory requirements could have a material
adverse impact on our ability to compete in the data services sector. The FCC
imposed conditions on the merger of SBC with Ameritech in October that permit
the provisioning of advanced data services via separate subsidiaries pursuant
to various requirements, some of which expire in the near term. We cannot
predict whether these requirements are enforceable, nor whether they will
deter anticompetitive behavior if they are enforceable. Bell Atlantic's
application for long distance service in New York has been approved subject to
similar separate subsidiary provisions. These areas of regulation are subject
to change through additional proceedings at the FCC or judicial challenge.

On December 9, 1999, the FCC released its line sharing order that requires
ILECs to offer line sharing as an unbundled network element by June 6, 2000.
Line sharing permits CLECs to use a customer's existing line to provide DSL
services while the ILEC continues to use the same line to provide voice
service. Prices for line sharing will be set by the states.

Reciprocal Compensation. We expect that reciprocal compensation payments
will make up a significant portion of our initial revenues in each of our
markets. Reciprocal compensation is the compensation paid by one carrier to
complete particular calls on another local exchange carrier's network. Because
a significant portion of our customers typically receive more calls than they
make, we expect to receive more reciprocal compensation than we pay for calls
that originate on our networks. As a result of the current regulatory
environment and several trends in our business, which are discussed below, we
expect our revenues from reciprocal compensation to decline significantly.

Some ILECs have refused to pay reciprocal compensation charges that they
estimate are the result of inbound ISP traffic because they believe that this
type of traffic is outside the scope of existing interconnection agreements.
For example, Ameritech disputed a portion of the reciprocal compensation
charges billed to it by us, which it believed were related to Internet
charges. In March of 1998, the Illinois Commerce Commission ruled in favor of
Focal and other CLECs regarding this dispute. In October 1998, Ameritech
complied with the ruling and we received payment for past reciprocal
compensation charges that represent substantially all of the disputed amounts.
Reciprocal compensation payments from Ameritech comprised approximately 81% of
our revenues for the year ended December 31, 1997 and payments from Ameritech
and Bell Atlantic comprised approximately 60% and 75% of our revenues for the
year ended December 31, 1999 and 1998, respectively. On June 18, 1999, the
Seventh Circuit affirmed the Illinois Commerce Commission's order requiring
the payment of reciprocal compensation for ISP-bound traffic. On August 19,
1999, the Seventh Circuit modified its prior order by providing that Ameritech
is free to raise in state courts any state claims concerning reciprocal
compensation, and by deferring any ruling on the petitions for rehearing
pending the Court's resolution in other cases of procedural issues concerning
the participation of state commissioners. Ameritech had previously filed such
a state complaint which at its request had been held in abeyance pending the
outcome of the federal case.

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Some states in which our current and planned markets are located have
ordered the ILECs to pay reciprocal compensation for Internet-related calls.
The majority of states that have addressed the question have ruled that
compensation is owed for this traffic. However, these states and other states
that have not considered the issue to date may yet determine that no
compensation is owed. A finding that reciprocal compensation is not payable
for ISP traffic in Illinois, New York or Pennsylvania would have a material
adverse effect on us.

In addition, on February 26, 1999, the FCC issued a declaratory ruling and
Notice of Proposed Rulemaking concerning inbound ISP traffic. The FCC
concluded in its ruling that ISP traffic is jurisdictionally mixed and largely
interstate in nature, and thus within the FCC's jurisdiction. The FCC has
requested comment as to what reciprocal compensation rules should govern this
traffic upon expiration of existing interconnection agreements. The FCC also
determined that no federal rule existed that governed reciprocal compensation
for ISP traffic at the time existing interconnection agreements were
negotiated and concluded that it should permit states to determine whether
reciprocal compensation should be paid for calls to ISPs under existing
interconnection agreements. The FCC order has been appealed by several
parties. Oral argument was heard on November 22.

In light of the FCC's order, state commissions, which previously addressed
this issue and required reciprocal compensation to be paid for ISP traffic,
may reconsider and may modify their prior rulings. Several ILECs, including
Ameritech, are seeking to overturn prior orders that they claim are
inconsistent with the FCC's February 26, 1999 order. Relief sought could
include repayment of reciprocal compensation amounts previously paid by the
ILECs. Of the 25 state commissions that have considered the issue since the
FCC's February 26, 1999 order, 20 of these states have upheld the requirement
to pay reciprocal compensation for ISP-bound traffic. Only Massachusetts, New
Jersey, South Carolina and Louisiana are not requiring reciprocal compensation
for this traffic, at least pending negotiations and a further FCC decision.
Missouri and Ohio are not requiring current payment, but are requiring a true-
up based on the FCC's future decision. In addition, of the seven Federal
District Courts and the two Courts of Appeals that have reviewed this issue on
the merits to date, all have upheld state decisions requiring that reciprocal
compensation be paid for ISP-bound traffic.

The New York Public Service Commission (the "NYPSC") determined that in
certain circumstances, Bell Atlantic can pay a lower reciprocal compensation
for calls terminated by a CLEC in excess of a ratio of three terminating calls
to each originating call. The NYPSC also provided an opportunity to a CLEC
having a ratio in excess of three-to-one, such as Focal, to demonstrate that
its network is such that the higher rate should be applied. The NYPSC also
permitted Bell Atlantic to file a tariff seeking to reduce the end office rate
by thirty percent from its current level of $0.0034/MOU. Focal and other CLECs
have protested this filing, and the NYPSC is expected to rule on this issue in
early 2000. We have also received notice from Bell Atlantic that it intends to
reduce the reciprocal compensation rate in the New York market from July 1,
1999 on a going forward basis, which we intend to vigorously challenge in
connection with the NYPSC proceeding described above. Bell Atlantic has also
informed us that it intends to unilaterally escrow these payments in two
smaller markets, New Jersey and Delaware.

Upon expiration of our existing interconnection agreements, we must
negotiate new rates for reciprocal compensation with each carrier. Pending
conclusion of these negotiations, the existing interconnection agreements are
expected to continue to govern the payment of reciprocal compensation. We
expect rates for reciprocal compensation will be lower under new
interconnection agreements than under our existing agreements. A reduction in
rates payable for reciprocal compensation could have a material adverse effect
on us, as could any requirement to refund reciprocal compensation paid to
date.

In addition to charging other carriers reciprocal compensation for
terminating local traffic, Focal also collects access charges from carriers
for originating and terminating interexchange traffic. Two interexchange
carriers, AT&T and Sprint, have stated that they will not pay the portion of
Focal's traffic-sensitive access charges that exceed ILEC traffic-sensitive
access charges. The Company is considering litigation to recover these
amounts.

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Tariff and Filing Requirements. Non-dominant carriers, including Focal,
must file tariffs with the FCC listing the rates, terms and conditions of
interstate and international services provided by the carrier. On October 29,
1996, the FCC adopted an order in which it eliminated the requirement that
non-dominant interstate carriers maintain tariffs on file with the FCC for
domestic interstate services. The FCC's order was issued pursuant to authority
granted in the Telecom Act to forebear from regulating any telecommunications
services provider if specified statutory analyses are satisfied. The FCC's
order, however, has been stayed by a federal court. Accordingly, non-dominant
interstate carriers, including Focal, currently must continue to file
interstate tariffs with the FCC until final determination of the issue. Any
challenges to these tariffs by regulators or third parties could cause us to
incur substantial legal and administrative expenses.

In addition, periodic reports concerning carriers' interstate circuits and
deployment of network facilities also are required to be filed with the FCC.
The FCC generally does not exercise direct oversight over cost justification
and the level of charges for services of non-dominant carriers, although it
has the power to do so. The FCC may also impose prior approval requirements on
transfers of control and assignments of operating authorizations. Fines or
other penalties also may be imposed for violations of FCC rules or
regulations. The FCC also requires that certified carriers like Focal notify
the FCC of foreign carrier affiliations and secure a determination that such
affiliations, if in excess of a specified amount, are in the public interest.

State Regulation. Most states regulate entry into the markets for local
exchange and other intrastate services, and states' regulation of CLECs vary
in their regulatory intensity. The majority of states require that companies
seeking to provide local exchange and other intrastate services to apply for
and obtain the requisite authorization from a state regulatory body, such as a
state commission. This authorization process generally requires the carrier to
demonstrate that it has sufficient financial, technical and managerial
capabilities and that granting the authorization will serve the public
interest. As of December 31, 1999, we had obtained local exchange
certification or were otherwise authorized to provide local exchange service
in:

<TABLE>
<S> <C> <C> <C>
California Illinois Minnesota Texas
Delaware Indiana Missouri Virginia
District of
Columbia Maryland New Jersey Washington
Florida Massachusetts New York
Georgia Michigan Pennsylvania
</TABLE>

As of December 31, 1999, we also had an application pending for local
exchange certification in Ohio. To the extent that an area within a state in
which we provide service is served by a small or rural exchange carrier not
currently subject to competition, we may not currently have authority to
provide service in those areas at this time.

As a CLEC, we are and will continue to be subject to the regulatory
directives of each state in which we are and will be certified. Most states
require that CLECs charge just and reasonable rates and not discriminate among
similarly situated customers. Some other state requirements include:

. The filing of periodic reports

. The payment of various regulatory fees and surcharges

. Compliance with service standards and consumer protection rules

States also often require prior approvals or notifications for certain
transfers of assets, customers, or ownership of a CLEC and for issuances by
certified carriers of equity securities, notes or indebtedness, although the
terms of this offering do not require any prior approval. States generally
retain the right to sanction a carrier or to revoke certifications if a
carrier violates relevant laws and/or regulations. Delays in receiving
required regulatory approvals could also have a material adverse effect on us.
We cannot assure you that regulators or third parties will not raise material
issues with regard to our compliance or non-compliance with applicable laws or
regulations.

18
<PAGE>

In most states, certificated carriers like us are required to file tariffs
setting forth the terms, conditions, and prices for services which are
classified as intrastate. In some states, the required tariff may list a range
of prices for particular services, and in others, such prices can be set on an
individual customer basis. We may, however, be required to file tariff addenda
of the contract terms.

Under the Telecom Act, implementation of our plans to compete in local
markets is and will continue to be, to a certain extent, controlled by the
individual states. The states in which we operate or intend to operate have
taken regulatory and legislative action to open local communications markets
to various degrees of local exchange competition.

Local Regulation. We are also subject to numerous local regulations, such
as building code requirements, franchise and local public rights of way. These
regulations may vary greatly from state to state and from city to city.

Employees

As of December 31, 1999, we employed 592 full-time employees, none of whom
were covered by a collective bargaining agreement. We believe that our future
success will depend on our continued ability to attract and retain highly
skilled and qualified employees. We believe that our relations with our
employees are good.

ITEM 2. DESCRIPTION OF PROPERTY

We are headquartered in Chicago, Illinois and lease office space in a
number of locations, primarily for network equipment installations and sales
and administrative offices. Our material leased switching and network
properties are located in:

Chicago, Illinois New York, New York San Francisco,
Philadelphia, Pennsylvania Washington, D.C. California
Southfield, Michigan Seattle, Washington Los Angeles,
Houston, Texas Dallas, Texas California
Jersey City, New Jersey Cambridge,
Massachusetts

and cover approximately 377,000 square feet of leased space. These leases
expire in years ranging from 2004 to 2013 and have varying renewal options. We
also own approximately 13 acres of real property in Arlington Heights,
Illinois. This property, which includes a 52,000 square foot building, houses
our second Chicago-area switching center, national data center and national
network operations center.
Atlanta, Georgia

19
<PAGE>

ITEM 3. LEGAL PROCEEDINGS

With the exception of the matters discussed below, we are not aware of any
litigation against us. In the ordinary course of our business, we are involved
in a number of regulatory proceedings before various state commissions and the
FCC.

On September 16, 1997, we filed a complaint and request for temporary
injunction against Ameritech Illinois with the Illinois Commerce Commission.
The complaint claimed breach of the terms of the interconnection agreement
between us and Ameritech Illinois because Ameritech Illinois refused to pay
reciprocal compensation for our transport and termination of calls to our end-
users that Ameritech Illinois believed were ISPs. In the interests of
obtaining a more timely judgment, we withdrew our complaint without prejudice
on October 17, 1997 and filed to intervene in a consolidated suit that
included similar complaints against Ameritech Illinois by several other CLECs.
On March 11, 1998, the Illinois Commerce Commission issued an order that
required Ameritech Illinois to pay reciprocal compensation for calls made to
ISPs. On March 15, 1998, Ameritech Illinois filed a motion with the Illinois
Commerce Commission to stay the order pending an appeal, which was denied on
March 23, 1998. On March 27, 1998, Ameritech Illinois filed suit in the United
States District Court for the Northern District of Illinois seeking reversal
of the Illinois Commerce Commission order. Ameritech Illinois also sought a
stay of this order from the District Court, which was granted while the case
was decided. On July 21, 1998, the District Court upheld the Illinois Commerce
Commission's order, finding that calls to ISPs are local calls and therefore
subject to the reciprocal compensation rules contained in the Telecom Act. The
District Court stayed the decision to permit any party to appeal. Ameritech
Illinois then appealed the decision to the U.S. Court of Appeals for the
Seventh Circuit on August 25, 1998, and was denied a stay while the appeal is
pending. In October 1998, Ameritech Illinois complied with the order and we
received payment for past reciprocal compensation charges that represent
substantially all of the disputed amounts. On June 18, 1999, the Seventh
Circuit affirmed the Illinois Commerce Commission's order requiring the
payment of reciprocal compensation for ISP-bound traffic. On August 19, 1999,
the Seventh Circuit modified its prior order to permit Ameritech to raise in
state courts any state claims concerning reciprocal compensation, and deferred
any ruling on the petitions for rehearing pending the Court's resolution in
other cases of procedural issues concerning the participation of state
commissioners. Ameritech had previously filed such a complaint which at its
request had been held in abeyance pending the outcome of the federal case. See
"Business--Regulation" for a description of federal rule-making and other
developments affecting reciprocal compensation.

We were named as a defendant, along with other parties, in a case filed in
March 1998 in the Supreme Court of the State of New York, County of New York
involving the wrongful death of an electrician who died while working at our
leased premises in New York. The plaintiffs, the decedent's wife and his
estate, are seeking damages from the defendants of $20 million. The decedent
was not under contract with us, nor was he working at our request. We tendered
the defense of this claim to, and it has been accepted by, our insurance
carrier. The aggregate amount of our insurance coverage is $7 million. We do
not believe that we were the cause of the injuries and subsequent death that
gave rise to this lawsuit.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Focal did not submit any matter to a vote of its stockholders during the
fourth quarter of 1999.

20
<PAGE>

PART II

ITEM 5. MARKET FOR FOCAL'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS AND
MARKET INFORMATION

Focal's common stock is traded on the Nasdaq National Market. Focal's
ticker symbol is "FCOM." Focal completed the initial public offering of its
common stock in August 1999. Prior to August 1, 1999, no established public
trading market for the common stock existed.

The following table sets forth on a per share basis, the high and low bid
information per share for our common stock as reported on the Nasdaq National
Market for the periods indicated:

<TABLE>
<CAPTION>
High Low
------ ------
<S> <C> <C>
Year ended December 31, 1999:
Third quarter (from July 28, 1999)....................... $29.75 $15.50
Fourth quarter........................................... $26.88 $18.50
</TABLE>

There were approximately 128 owners of record of Focal common stock as of
February 29, 2000. This number excludes stockholders whose stock is held in
nominee or street name by brokers and Focal believes that it has a
significantly larger number of beneficial holders of common stock. A recently
reported sale price of our common stock on the Nasdaq National Market is set
forth on the front cover of this report.

Dividends

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
arrangements effectively prohibit us from paying cash dividends for the
foreseeable future.

Recent Sales of Unregistered Securities

Focal did not sell any equity securities during the period covered by this
report that were not registered under the Securities Act of 1933 and that were
not previously reported on Form 10-Q.

21
<PAGE>

ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA

The selected consolidated financial data presented below for the three
years ended December 31, 1999, have been derived from our Consolidated
Financial Statements and the accompanying notes related thereto. Our
Consolidated Financial Statements for the three years ended December 31, 1999
have been audited by Arthur Andersen LLP, our independent public accountants.
The balance sheet data as of December 31, 1997 has been derived from our
audited consolidated financial statements not included in this report. You
should read the information in this table in conjunction with Item 7A,
"Quantitative and Qualitative Disclosures About Market Risk", Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and our Consolidated Financial Statements and the accompanying
notes related thereto appearing elsewhere in this report.
<TABLE>
<CAPTION>
Period from
Commencement of
Operations (May
Years Ended December 31, 31, 1996)
------------------------------------- to December 31,
1999 1998 1997 1996
----------- ----------- ----------- ---------------
(Dollars in thousands, except share data)
<S> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues................ $ 126,861 $ 43,532 $ 4,024 $ --
Expenses:
Customer service and
network operations... 70,910 15,284 2,155 --
Selling, general and
administrative....... 32,486 12,210 2,887 422
Depreciation and
amortization......... 23,763 6,671 616 1
Non-cash compensation
expense.............. 7,186 3,070 1,300 108
----------- ----------- ----------- ----------
Operating income (loss). (7,484) 6,297 (2,934) (531)
Other income (expense),
net.................... (14,302) (9,606) 68 17
Provision for income
taxes.................. (600) (4,660) -- --
Accretion to redemption
value of Class A common
stock.................. -- -- (104) --
----------- ----------- ----------- ----------
Net loss applicable to
common stockholders.... $ (22,386) $ (7,969) $ (2,970) $ (514)
=========== =========== =========== ==========
Basic net loss per
share.................. $ (0.45) $ (0.18) $ (0.07) $ (0.06)
=========== =========== =========== ==========
Diluted net loss per
share.................. $ (0.45) $ (0.18) $ (0.07) $ (0.06)
=========== =========== =========== ==========
Basic weighted average
common stock
outstanding............ 50,066,315 43,763,000 42,186,500 8,498,000
=========== =========== =========== ==========
Diluted weighted average
common stock
outstanding............ 50,066,315 43,763,000 42,186,500 8,498,000
=========== =========== =========== ==========
Other Financial Data:
EBITDA.................. $ 23,465 $ 16,038 $ (1,018) $ (422)
Capital expenditures.... 128,550 64,229 11,655 82
Summary Cash Flow Data:
Net cash provided by
(used in) operating
activities............. $ 18,549 $ 22,507 $ (1,634) $ (153)
Net cash used in
investing activities... (130,590) (72,189) (11,655) (82)
Net cash provided by
financing activities... 164,142 173,466 11,756 4,025
Operating Data:
Access lines in service. 181,103 52,011 7,394 --
Minutes of use
(millions)............. 13,362 3,568 282 --
</TABLE>

<TABLE>
<CAPTION>
As of December 31,
--------------------------------
1999 1998 1997 1996
-------- -------- ------ ------
<S> <C> <C> <C> <C>
Balance Sheet Data:
Cash, cash equivalents and short-term
investments................................. $188,142 $134,001 $2,257 $3,790
Current assets............................... 219,932 144,637 4,738 3,807
Property, plant and equipment, net........... 196,301 69,973 11,177 81
Total assets................................. 420,986 219,574 15,915 3,888
Long-term debt, including current portion.... 253,786 185,296 3,537 --
Total stockholders' equity (deficit)......... 142,487 19,328 (2,075) (405)
</TABLE>

22
<PAGE>

You should not assume that the results of operations above are indicative
of the financial results we can achieve in the future. You should also keep
the following matters in mind when you read this information:

. Non-cash compensation expense consists of:

--charges totaling $0.1 million for 1996, $1.3 million for each of 1997
and 1998 and $2.5 million for 1999, which resulted from the vesting over
time of shares of common stock issued to some of our executive officers
in November 1996

--charges of $1.8 million and $0.3 million for 1998 and 1999, which
resulted from the vesting and cancellation of shares of common stock in
connection with the September 30, 1998 amendment of vesting agreements
with some of our executive officers

--charges of $4.4 million in 1999, which resulted from our 1999 stock
option grants to employees, directors and an outside consultant, and
common stock issued to a director

. EBITDA represents earnings before interest, income taxes, depreciation
and amortization and other non-cash charges, including non-cash
compensation expense. 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 applicable to common
stockholders as an indicator of our operating performance or to cash
flows as a measure of liquidity. We believe that EBITDA is widely used by
analysts, investors and other interested parties in the
telecommunications industry. EBITDA is not necessarily comparable to
similarly titled measures for other companies.

. We count access lines as of the end of the period indicated and on a one-
for-one basis using DS-0 equivalents.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Overview

General. We provide data, voice and colocation services to large,
communications-intensive users in major cities. We began operations in 1996
and initiated service first in Chicago in May 1997. As of December 31, 1999 we
offered service in a total of 16 markets, which encompass a total of 42
metropolitan statistical areas, or MSAs, and plan to serve 20 markets, or 50
MSAs, by the end of 2000. We believe our market expansion will allow us to
reach a critical mass of geographic coverage and service capability for our
target customer base of communications-intensive users. As of December 31,
1999, we had sold 237,167 access lines, of which 181,103 were installed and in
service. During 2000, we estimate that we will install over 225,000 additional
access lines as our existing markets continue to mature and as we launch
service in additional new markets.

Our operating results are expected to change during 2000 as a result of
several trends in our business and in the regulatory environment. First, we
anticipate that the mix of lines we sell will shift from being dominated by
ISP customer lines to being more evenly balanced among ISP, corporate and VAR
customer lines due to expanded marketing efforts. Second, we expect our
revenue from, and margin on, ISP lines to decline due to the impact of
regulatory developments on the potential collection of reciprocal compensation
in certain markets and the renegotiation of our interconnection agreements in
each state in which we operate described below. In connection with these
trends, we intend to emphasize the sale of new products that leverage our
network to maximize revenues per line and operating margins. These products
include high-speed access to the Internet and LANs connected via DSL
technology. Third, our continued expansion may result in continued negative
operating cash flows and operating losses for a period of time. We expect to
again produce positive operating cash flows during the fourth quarter of 2000
once these trends stabilize and operating activities in our newer markets are
established and mature. If, however, these trends do not stabilize or our
operating activities are not established or do not mature as expected, we may
continue to sustain negative operating cash flows and net losses.

23
<PAGE>

Revenues. Our revenues are comprised of monthly recurring charges, usage
charges and initial, non-recurring charges. Monthly recurring charges include
the fees paid by our customers for lines in service, additional features on
those lines, and colocation space. Monthly recurring charges are derived only
from end user customers. Usage charges consist of fees paid by end users for
each call made, fees paid by the ILEC and other CLECs as reciprocal
compensation, and access charges paid by the IXCs for long distance traffic
that we originate and terminate. Non-recurring revenues are typically derived
from fees charged to install new customer lines.

We earn reciprocal compensation revenues for calls made by customers of
another local exchange carrier to our customers. Conversely, we incur
reciprocal compensation expense to other local exchange carriers for calls by
our customers to their customers. Reciprocal compensation has historically
been a significant component of our total revenue due to the preponderance of
inbound applications utilized by our customers. On July 1, 1999, we began
excluding certain reciprocal compensation revenues generated from our
operations in a number of states where recent regulatory developments have
impeded the potential collection of reciprocal compensation receivables in
those states. Reciprocal compensation revenues represented approximately 81%,
75%, 55%, and 36% of total revenues for 1997, 1998, 1999 and December of 1999,
respectively.

We expect the proportion of revenues represented by reciprocal compensation
to modestly decrease in the future as a result of the expiration and
subsequent renegotiation of our existing interconnection agreements with the
ILECs, impact of recent and future regulatory developments and as a result of
our focus on increasing the percentage of our lines that are sold to non-ISP
customers. The most significant impact of the reduction in reciprocal
compensation occurred on October 28, 1999 when our existing interconnection
agreement with Ameritech Illinois expired. As of November 1, 1999, revenues
from reciprocal compensation are being recognized at an average rate of $.0033
per minute of use on a company wide basis. While per minute of use rates are
expected to decline further, we believe that such a decline will be modest.
See "Business--Regulation." We expect to generate additional revenues from
other services which will offset this anticipated decrease in reciprocal
compensation revenues. A reduction in or elimination of reciprocal
compensation revenues that are not offset by increases in other revenues
generated by us could have a material adverse effect on us and our results of
operations. See "Business--Regulation."

Operating Expenses. Our operating expenses are categorized as customer
service and network operations, selling, general and administrative,
depreciation and amortization, and non-cash compensation expense. Settlement
costs are a significant portion of customer service and network operations
expense and are comprised of leased transport charges and reciprocal
compensation payments. Leased transport charges are the lease payments we make
for the use of fiber transport facilities connecting our customers to our
switches and for our connection to the ILECs' and other CLECs' networks. Our
strategy of initially leasing rather than building our own fiber transport
facilities has resulted in our cost of service being a significant component
of total costs. To date, we have been successful in negotiating lease
agreements that match the duration of our customer contracts, thereby allowing
us to avoid the risk of incurring expenses associated with transport
facilities that are not being used by revenue generating customers.

Historically, leasing rather than building our transport network has
resulted in capital expenditures which we believe are lower than those of
CLECs of similar size that own their fiber networks. Our capital expenditures
have been driven by customer service demands and projected near-term revenue
streams from our established markets. In addition, we believe that the
percentage of these "success-based" capital expenditures is higher than those
of fiber-based CLECs. In contrast, we incur operating expenses for leased
facilities that are proportionately higher than those incurred by fiber-based
CLECs.

In the second quarter of 1999, we entered into a number of agreements to
own fiber transport capacity in 16 markets as well as lease transport
facilities for combined minimum commitments of $98.6 million over five years
and $42.6 million over the next fifteen years. These commitments will result
in increased operating expenses for

24
<PAGE>

future periods, which we believe should be more than offset by future revenues
associated with new services made possible, in part, by these agreements. We
activated our own Chicago transport network in February 2000 and expect to
activate our Detroit transport network by the end of the first quarter of
2000.

Other customer service and network operations expense consists of the costs
of operating our network and the costs of providing customer care activities.
Major components include wages, rent, power, equipment maintenance, supplies
and contract employees.

Selling, general and administrative ("SG&A") expense consists of sales
force compensation and promotional expenses as well as the cost of corporate
activities related to regulatory, finance, human resources, legal, executive,
and other administrative activities. We expect our selling, general and
administrative expense to be lower as a percentage of revenue than that of our
competitors because we have relatively high sales productivity associated with
our strategy of serving communications-intensive customers. These customers
generally utilize a large number of switched access lines relative to the
average business customer, resulting in more revenue per sale. Further, fewer
sales representatives are required to service the relatively smaller number of
communications-intensive customers in a given region.

We record monthly non-cash compensation expense related to shares issued to
some of our executive officers in November 1996, in connection with the
September 30, 1998 amendments to vesting agreements with some of our executive
officers, in connection with stock options granted to employees, an outside
consultant, and directors during 1999 and shares issued to a director during
the first quarter of 1999. We will continue to record non-cash compensation
expense in future periods relating to these events through the third quarter
of 2003. See notes to our Consolidated Financial Statements.

Quarterly Results

The following table sets forth unaudited financial, operating and
statistical data for each of the specified quarters of 1999 and 1998. The
unaudited quarterly financial information has been prepared on the same basis
as our Consolidated Financial Statements and, in our opinion, contains all
normal recurring adjustments necessary to fairly state this information. The
operating results for any quarter are not necessarily indicative of results
for any future period.

<TABLE>
<CAPTION>
1999 1998
-------------------------------------- -------
Fourth Third Second First Fourth
Quarter Quarter Quarter Quarter Quarter
-------- ------- -------- ------- -------
<S> <C> <C> <C> <C> <C>
Revenues...................... $36,046 $34,484 $30,327 $26,004 $17,596
EBITDA........................ $ (708) $5,783 $8,422 $9,968 $6,393
Lines Sold to Date............ 237,167 169,122 133,536 85,329 68,184
Lines Installed to Date....... 181,103 137,033 106,749 70,572 52,011
Estimated ISP Lines (% of
installed lines)............. 72% 72% 72% 71% 71%
Lines on Switch (%)........... 100% 100% 100% 100% 100%
ILEC Central Offices
Interconnected............... 1,209 948 771 443 340
ILEC Central Office
Colocations in Service or
Under Development............ 221 201 58 23 --
Average Monthly Revenue Per
Line......................... $76 $94 $114 $141 $138
Quarterly Minutes of use
switched (in millions)....... 5,158 3,514 2,657 2,033 1,444
Markets in Operation.......... 16 14 13 12 10
MSAs Served................... 40 38 34 31 29
Switches Operational.......... 11 10 9 7 6
Focal Customer Colocation
Space in Service
(Sq. Ft.).................... 70,105 53,478 41,081 29,282 23,302
Capital Expenditures ($ in
millions).................... $34 $34 $57(1) $24 $21
Employees..................... 592 478 418 312 233
Sales Force (2)............... 116 105 93 65 47
</TABLE>

25
<PAGE>

- --------
(1) Includes approximately $21 million of assets acquired under a capital
lease during the second quarter of 1999.
(2) Quota bearing sales professionals. Does not include sales engineers or
customers support personnel.

Year Ended December 31, 1999 Compared to Year Ended December 31, 1998

Our total revenues for the year ended 1999 were $126.9 million compared to
$43.5 million for the year ended 1998. This increase of 192% is primarily due
to the generation of revenues from numerous markets during 1999 compared to
revenues from primarily two markets, Chicago and New York, in the comparable
period of 1998. We installed approximately 129,000 access lines during 1999,
which exceeded the lines installed in the comparable period of 1998 by
approximately 187% or 84,000 lines. Customer service and network operations
expense was $70.9 million for 1999 and $15.3 million for 1998. This $55.6
million increase resulted primarily from our rapid expansion into an
additional six new markets during 1999 and the related increase in operational
costs associated with the growth of our existing markets. SG&A expense
increased by $20.3 million to $32.5 million for 1999 as a result of our
planned expansion. In addition, our overall customer service, network
operations, and SG&A expenses increased from 1998 to 1999 due to a
corresponding increase in our employee base by 359 employees, to 592 employees
as of December 31, 1999.

Depreciation and amortization increased from $6.7 million to $23.8 million
in the comparative year to year periods. This increase of $17.1 million is a
result of our 1999 expansion into six new markets and due to our fixed asset
base increase for our existing markets. Our 1999 capital expenditures of
approximately $128.5 million (excluding $21.0 million of assets acquired under
capital lease) were $64.3 million greater than that of the comparable period
of 1998. Non-cash compensation expense was $7.2 million for the year ended
December 31, 1999 compared to $3.1 million for comparable period in 1998. This
$4.1 million increase in non-cash compensation expense is the result of
September 30, 1998 amendments of vesting agreements with some of our executive
officers, stock options granted to employees, an outside consultant, and
directors during 1999, and stock issued to a director during the first quarter
of 1999.

Interest income was $7.9 million and $6.5 million for the years ended 1999
and 1998, respectively. This increase of $1.4 million is primarily due to our
cash, cash equivalents, and short-term investments increasing from $134.0
million at the end of 1998 to $188.1 million at the end of 1999. This increase
is the result of our net proceeds of approximately $137 million raised in our
August 1999 initial public offering. Interest expense increased from $16.1
million during 1998 to $21.6 million for 1999. This net increase of $5.5
million is due to an additional $4.6 million of amortization of our
outstanding senior discount notes, $3.4 million of interest expense on our
secured equipment term loan, and $1.1 million of non-cash interest expense
relating to our capital lease obligation for dark fiber transport capacity.
This increase of $9.1 million was partially offset by approximately $3.6
million of interest capitalized during 1999 in connection with the
construction of our major facilities and networks.

We incurred U.S. income tax expense of $0.6 million for the year ended 1999
compared to $4.7 million in the same period of 1998. This decrease of $4.1
million in our tax expense between years is primarily due to the $18.5 million
of additional pre-tax losses incurred during 1999 and the realization of a net
operating loss at the end of 1999. We are obligated to pay federal and state
income taxes due to the application of the alternative minimum tax.

We had a net loss of $22.4 million for 1999 compared to a net loss of $8.0
million in 1998. This $14.4 million of additional losses in 1999 is a direct
result of an increase in costs related to our planned expansion to 16 markets
at the end of 1999, an additional $5.5 million of net interest expense, and an
additional $4.1 million in non-cash compensation expense.

26
<PAGE>

Year Ended December 31, 1998 Compared to Year Ended December 31, 1997

Total revenues for 1998 were $43.5 million compared to $4.0 million for
1997. The significant increase was due to the rapid growth in our Chicago and
New York markets during 1998 and the fact that service was first initiated in
Chicago in May 1997. Customer service and network operations expense was $15.3
million in 1998 compared to $2.2 million during 1997. The increase resulted
from our rapid expansion and the related costs of leased facilities, usage
settlements, customer care and operations personnel, equipment maintenance and
other operating expenses. Selling, general and administrative expense also
increased from $2.9 million for 1997 to $12.2 million for 1998 due to our
expansion. Similarly, depreciation and amortization increased from $0.6
million in 1997 to $6.7 million in 1998 as a result of a significant increase
in the level of fixed assets put into service. Non-cash compensation expense
associated with the vesting over time of shares of common stock issued to some
of our executive officers in November 1996, and the vesting and cancellation
of shares of common stock in connection with the September 30, 1998 amendments
to vesting agreements with some of our executive officers, was $3.1 million
for 1998 compared to $1.3 million for 1997. The increase of $1.8 million is
due to the September 30, 1998 amendment to these vesting agreements.

Interest income increased from $0.2 million in 1997 to $6.5 million for
1998 due primarily to the investment of the proceeds received in February 1998
from the sale of the 1998 Notes. Interest expense for 1998 was $16.1 million
compared to $0.1 million for 1997. The increase was primarily due to the
amortization of the discount on the 1998 Notes.

Year Ended December 31, 1997 Compared to Seven-Month Period Ended December
31, 1996

We had total revenues of $4.0 million in 1997. We had no revenues in 1996.
The increase was due to the recording of our first revenue during May 1997.
Prior to May 1997, we incurred start-up and operating expenses in advance of
revenue as we prepared to launch our network services in the Chicago market.
Customer service and network operations expense increased from zero in 1996 to
$2.2 million in 1997. There were no customer service or network activities
during 1996. Such activities began as we initiated construction of our first
network in January 1997 and as we began to provide service in May 1997.
Selling, general and administrative expense increased from $0.4 million in
1996 to $2.9 million in 1997, largely due to a rapid increase in sales and
administrative personnel in 1997. Depreciation and amortization increased from
near zero in 1996 to $0.6 million in 1997 due to the increase in assets put
into service during 1997. Non-cash compensation expense associated with
certain shares issued to some of our executive officers in November 1996
increased from $0.1 million in 1996 to $1.3 million in 1997 based on a full
year's impact of this expense during 1997 as compared to one month of non-cash
compensation expense during 1996.

Interest income increased from $0.02 million in 1996 to $0.2 million in
1997 as a result of significantly greater cash balances we maintained after
receiving additional equity contributions during 1997. Interest expense was
$0.1 million in 1997 due to debt financing incurred by one of our
subsidiaries. We did not have any interest expense during 1996.

Liquidity and Capital Resources

We intend to continue to increase our coverage of major U.S. cities by
expanding our services to four additional markets in 2000. Our business plan
will require that we expand our existing networks and services, deploy our own
fiber capacity in a majority of our markets and fund our initial operating
losses. We will require significant capital to fund the purchase and
installation of telecommunications switches, equipment, infrastructure and
fiber facilities and/or long-term rights to use fiber transport capacity. The
implementation of this plan requires significant capital expenditures, a
substantial portion of which will be incurred before significant related
revenues from our new markets are expected to be realized. These expenditures,
together with associated early operating expenses, may result in our having
substantial negative operating cash flow and substantial net operating losses
for the foreseeable future, including 2000 and 2001. Although we believe that
our cost estimates and the scope and timing of our build-out are reasonable,
we cannot assure you that actual costs or the timing of the expenditures, or
that the scope and timing of our build-out, will be consistent with current
estimates.

27
<PAGE>

Our capital expenditures were approximately $128.5 million (excluding $21.0
million of assets acquired under capital lease) in 1999 compared to $64.2
million in 1998, primarily reflecting capital spending for the build-out of
our markets. We estimate that our capital expenditures in connection with our
current business plan will be approximately $230 million for 2000. The 2000
capital expenditures are expected to be made primarily for the build-out of
additional markets, the expansion of our existing markets and services,
including high-speed data services, and the purchase of local dark fiber
transport capacity in a majority of our markets. Our capital expenditures may
increase above current estimates in order to support the offering of high
speed Internet access, peering and enhanced colocation services, which are
currently under consideration.

Our expectations of our future capital requirements and cash flows from
operations are based on current estimates. If our plans or assumptions change
or prove to be inaccurate, we may be required to seek additional sources of
capital or seek additional capital sooner than currently anticipated. We may
also choose to raise additional capital to take advantage of favorable
conditions in the capital markets.

Net cash provided by operating activities for 1999 was $18.5 million, a
decrease of $4.0 million from the same period in 1998. This decrease is
primarily the result of a $17.1 million increase in depreciation and
amortization, a $4.1 million increase in non-cash compensation expense, and a
additional $4.6 million of amortization of our senior discount notes, which
was offset by additional net losses of $14.4 million and the increase in our
1999 accounts receivable exceeded 1998 by approximately $16.4 million. Net
cash used in operating activities was $1.6 million for 1997 and net cash
provided by operations was $22.5 million in 1998, an increase of $24.1 million
from 1997. This increase was primarily due to an increase in non-cash
reconciling items for depreciation and amortization, non-cash compensation
expense, amortization of discount on the 1998 Notes and an increase in
accounts payable and accrued liabilities.

Net cash used in investing activities was $130.6 million for 1999 compared
to $72.2 million in 1998. This increase of $58.4 million is primarily the
result of our 1999 expansion into 6 new markets and the continued expansion of
our existing markets. Our capital expenditures of $128.5 million in 1999
exceeded 1998 by $64.3 million. Short-term investments primarily consist of
debt securities, which typically mature between three months and one year. Net
cash used in investing activities was $72.2 million for 1998 and $11.7 million
for 1997. The increase of $60.5 million from 1997 represents a $52.6 million
increase in capital expenditures due to our 1998 expansion into new markets
and the purchase of short-term investments of $8.0 million. Short-term
investments primarily consist of debt securities, which typically mature
between three months and one year.

Net cash provided by financing activities for 1999 was $164.1 million, a
decrease of $9.3 million from 1998. This decrease is primarily the net result
of our debt and equity proceeds between comparable periods. Net cash provided
by financing activities consisted of $173.5 million in 1998 and $11.8 million
in 1997. The increase of $161.7 million from 1997 to 1998 was mainly the
result of net proceeds from the Notes offering of $143.9 million after $6.1
million in issuance costs and $19.2 million in borrowings under a secured
equipment term loan facility (the "Credit Agreement") during 1998.

The Credit Agreement provides that NTFC Capital Corporation will make term
loans to us solely for the purchase of telecommunications equipment and
related software licenses. To secure the loans, we have granted NTFC a
security interest in the assets acquired with the loans. Loans must be repaid
over a five-year period from the date of the borrowing. Principal and interest
payments are due monthly, and interest accrues based on the five-year swap
rate, plus additional basis points. Interest will accrue at a lower rate if we
meet specified financial tests. As of December 31, 1999, there are no
borrowings available to us under this facility and we had $44.2 million
outstanding under this term loan facility.

We have historically incurred net losses and have an accumulated deficit of
$33.7 million and $11.3 million as of December 31, 1999 and 1998,
respectively. We funded a large portion of our future operating losses and
capital expenditures through the offering of the 1998 Notes, the August 1999
equity offering, the January 2000 offering of our 11 7/8% Senior Notes (see
below), and other financings. On February 18, 1998, we received $150 million
in gross proceeds from the sale of the 1998 Notes. The 1998 Notes will accrete
to an aggregate stated

28
<PAGE>

principal amount of $270 million by February 15, 2003. As of December 31,
1999, the principal amount of the 1998 Notes had accreted to approximately
$186.8 million. No interest is payable on the 1998 Notes prior to August 15,
2003. Thereafter, cash interest will be payable semiannually on August 15 and
February 15 of each year. During August 1999, we raised net proceeds of
approximately $137 million in our initial public offering in which we sold
11,442,500 shares of our common stock at a price of $13 per share, which
includes the underwriter's exercise of their over-allotment option to purchase
1,492,500 common shares at $13 per share.

On January 12, 2000, we received approximately $265.7 million in net
proceeds from the issue of our $275 million aggregate principal amount of 11
7/8% Senior Notes due January 15, 2010. The Senior Notes interest payment
dates are July 15 and January 15, commencing July 15, 2000. The net proceeds,
together with amounts available from our existing cash balances and future
cash flow from ongoing operations, will be used to finance the cost to acquire
equipment and network assets, to fund operation losses, for working capital
and potential acquisitions, and for general corporate purposes. In addition,
we may choose to obtain future debt or equity financing to fund the new
products and services that are currently under consideration.

Year 2000 Compliance

We did not experience any significant malfunctions or errors in our
operating or business systems when the date changed from 1999 to 2000. Based
on operations since January 1, 2000, we do not expect any significant impact
to our on-going business as a result of the "Year 2000 issue." However, it is
possible that the full impact of the date change, which was of concern due to
computer programs that use two digits instead of four digits to define years,
has not been fully recognized. For example, it is possible that Year 2000 or
similar issues such as leap year-related problems may occur with billing,
payroll or financial closings at month, quarterly or year end. We believe that
any such problems are likely to be minor and correctable. In addition, we
could still be negatively impacted if our customers or suppliers are adversely
affected by the Year 2000 or similar issues. We are not currently aware of any
significant Year 2000 or similar problems that have arisen for our customers
and suppliers. We expended an aggregate of $0.3 million on Year 2000 readiness
efforts in 1998 and 1999. All of these costs were expensed as they were
incurred.

The discussions under "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contain forward-looking statements. Our
future performance is subject to a number of risks and uncertainties that
could cause actual results to differ substantially from our projections.
Factors that could impact the variability of future results include those
described under "Information Regarding Forward-Looking Statements."

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to minimal market risks. We manage sensitivity of our
results of operations to these risks by maintaining a conservative investment
portfolio, which primarily consists of debt securities, typically maturing
within one year, and entering into long-term debt obligations with appropriate
pricing and terms. We do not hold or issue derivative, derivative commodity or
other financial instruments for trading purposes. Financial instruments held
for other than trading purposes do not impose a material market risk on us.

We are exposed to interest rate risk, as additional debt financing is
periodically needed due to the large operating losses and capital expenditures
associated with establishing and expanding our network coverage. The interest
rate that we will be able to obtain on debt financing will depend on market
conditions at that time, and may differ from the rates we have secured on our
current debt.

While all of Focal's long-term debt bears fixed interest rates, the fair
market value of our fixed rate long-term debt is sensitive to changes in
interest rates. We have no cash flow or earnings exposure due to market
interest rate changes for our fixed long-term debt obligations. The table
below provides additional information about our 1998 Notes. For additional
information about our long-term debt obligations, see our Consolidated
Financial Statements and accompanying notes related thereto appearing
elsewhere in this report.

29
<PAGE>

<TABLE>
<CAPTION>
As of
December 31, 1999
(in thousands)
-----------------
Average
Fixed Interest
Expected Maturity Debt Rate
----------------- -------- --------
<S> <C> <C>
1999................................................... $ -- --
2000................................................... -- --
2001................................................... -- --
2002................................................... -- --
2003................................................... -- --
Thereafter............................................. 270,000 12.125%
-------- ------
$270,000 12.125%
======== ======
Fair Market Value...................................... $176,850
========
</TABLE>

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Company's Consolidated Financial Statements required by Item 8,
together with the notes thereto and the report thereon of the independent
public accountants dated February 9, 2000, are set forth on pages F-1-F-20 of
this report. The financial statement schedule listed under Item 14(a) 2,
together with the report thereon of the independent public accountants dated
February 9, 2000, are set forth on pages F-21 and F-22 of this report and
should be read in conjunction with our Consolidated Financial Statements.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

30
<PAGE>

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The table below contains information about the ages and positions of
Focal's executive officers, selected key employees, and directors, as of
January 15, 2000.

<TABLE>
<CAPTION>
Name Age Position(s)
- ---- --- -----------
<S> <C> <C>
Robert C. Taylor, Jr. .. 40 Director, President and Chief Executive Officer
John R. Barnicle........ 35 Director, Executive Vice President and Chief Operating Officer
Joseph A. Beatty........ 36 Executive Vice President and Chief Financial Officer
Renee M. Martin......... 44 Senior Vice President, General Counsel and Secretary
Robert M. Junkroski..... 35 Vice President and Treasurer
Gregory J. Swanson...... 32 Controller
Leonard A. Dedo......... 47 Senior Vice President of Marketing and Alternate Channels
Richard J. Metzger...... 51 Vice President of Regulatory Affairs and Public Policy
James E. Crawford, III.. 54 Director
John A. Edwardson....... 50 Director
Paul J. Finnegan........ 46 Director
Richard D. Frisbie...... 50 Director
James N. Perry, Jr. .... 39 Director
Paul G. Yovovich........ 46 Director
</TABLE>

Robert C. Taylor, Jr. Robert Taylor is Chief Executive Officer and
President for Focal Communications Corporation. He was appointed to this
position in August 1996. Taylor is also the company's co-founder and director.
Taylor is the Chairman of the Association for Local Telecommunications
Services (ALTS), the nation's leading organization representing facilities-
based competitive local exchange carriers (CLECs). In addition, Taylor sits on
the board of directors for IPLAN Networks, a CLEC based in Argentina. With
over 15 years of telecommunications experience, Taylor has held positions with
MFS Communications, most recently as Vice President of Global Accounts, where
he worked with the company's 50 largest customers and executed market
development activities in Mexico and Canada. Prior to joining MFS in 1994,
Taylor was one of the original senior executives at McLeod Communications
Group. Taylor has also held management positions with MCI, Bellcore and
Ameritech. Taylor received his M.B.A. from the University of Chicago Graduate
School of Business and holds a Bachelor of Science degree in Mechanical
Engineering.

John R. Barnicle. Mr. Barnicle has been Executive Vice President and Chief
Operating Officer and a director since June 1996. Mr. Barnicle is a co-founder
of Focal and is responsible for day-to-day operations, engineering, marketing
and long-term planning. In 1996, Mr. Barnicle was Vice President of Marketing
for MFS Telecom Companies, a subsidiary of MFS Communications. From 1994 to
1996, Mr. Barnicle was a Vice President of Duff & Phelps Credit Rating Company
and before that held various marketing, operations and engineering positions
with MFS Telecom (1992-1994) and Centel Corporation, a local exchange carrier
(1986-1992). Mr. Barnicle received his M.B.A. with Distinction from DePaul
University and holds a Bachelor of Science degree in Electrical Engineering.

Joseph A. Beatty. Mr. Beatty has been Executive Vice President and Chief
Financial Officer since November 1996 and was also Treasurer from November
1996 through January 1999 and Secretary from November 1996 through April 1998.
He was also a director from May 1996 to November 1996. Mr. Beatty is a co-
founder of Focal and is responsible for all financial operations and
information systems. From 1994 to 1996, Mr. Beatty was a Vice President with
NationsBanc Capital Markets, where he was responsible for investment research
coverage of the telecommunications industry. From 1992 to 1994, Mr. Beatty was
a Vice President of Duff & Phelps Credit Rating Company with responsibility
for credit ratings in the telecommunications and electric utility sectors.
From 1985 to 1992, Mr. Beatty held various technical management positions with
Centel Corporation's

31
<PAGE>

local exchange carrier division. Mr. Beatty received his M.B.A. with a
concentration in Finance from the University of Chicago Graduate School of
Business and is a Chartered Financial Analyst. In addition, Mr. Beatty holds a
Bachelor of Science degree in Electrical Engineering.

Renee M. Martin. Ms. Martin has been Senior Vice President, General Counsel
and Secretary since March 1998. Ms. Martin is responsible for our legal,
regulatory, real estate and human resources functions. From 1984 to 1998, Ms.
Martin held various executive positions at Ameritech, most recently as Vice
President and General Counsel Small Business Services, where she directed
corporate legal resources to address contract negotiations, employment issues,
regulatory affairs and litigation, and managed outside legal counsel. From
1982 to 1984, Ms. Martin was an attorney at the law firm of Cook and Franke,
S.C. where she concentrated on general business and corporate law. Ms. Martin
received her J.D. from the University of Wisconsin and holds a Bachelor of
Arts degree in Journalism.

Robert M. Junkroski. Mr. Junkroski has been Vice President and Treasurer
since January 1999 and was Controller from January 1997 to January 1999. He is
responsible for all our accounting, revenue assurance, audit, cash and risk
management and customer credit functions. From 1995 to 1997, Mr. Junkroski was
Controller for Brambles Equipment Services, Inc., an equipment leasing
company, where he was responsible for establishing and maintaining the
divisional accounting, financial reporting and budgeting functions. From 1987
to 1995, Mr. Junkroski was Controller for Focus Leasing Corporation, an
equipment leasing company, where he was responsible for the development and
implementation of the accounting and financial reporting functions of several
emerging companies. Mr. Junkroski is a Certified Public Accountant, received
his M.B.A. with honors from Roosevelt University concentrating in Finance and
Accounting and holds a Bachelor of Business Administration degree.

Gregory J. Swanson. Mr. Swanson has been Controller since January 1999 and
is our principal accounting officer. He is responsible for all internal and
external accounting and reporting functions. From June 1998 to December 1998,
Mr. Swanson was Director of External Reporting for Allegiance Corporation, a
health care manufacturing and distribution company. Before that he spent
approximately nine years at Arthur Andersen LLP, a public accounting firm,
where he was responsible for audit and business advisory services to
technology and manufacturing companies. Mr. Swanson is a Certified Public
Accountant and holds a Bachelor of Science degree in Accounting.

Leonard A. Dedo. Leonard Dedo is the Senior Vice President of Marketing and
Alternative Channels for Focal Communications Corporation. He joined Focal in
1998. Dedo is responsible for marketing, product development, business
analysis and public relations. He also oversees sales for select vertical
markets. From 1997 to 1998, Dedo was Vice President of Marketing for Billing
Concepts Corporation, a billing solution provider for the telecommunications
industry. From 1985 to 1997, he held various executive management positions in
sales, marketing and strategic planning with MCI Communications Corporation.
Dedo received his Masters in Management with distinction and his Bachelor of
Arts Degree from Northwestern University.

Richard J. Metzger. Mr. Metzger has been Vice President of Regulatory
Affairs and Public Policy since September 1998. He is responsible for our
regulatory and public policy activities. From 1994 to 1998, he served as the
Vice President and General Counsel of the Association for Local
Telecommunications Services. From 1984 to 1993, he held various legal
positions with Ameritech including serving as Vice President and General
Counsel of Wisconsin Bell and Michigan Bell. From 1976 to 1984, he was an
attorney at the law firm of Sidley & Austin. Mr. Metzger received his J.D.
from the University of Chicago and holds a Bachelor of Arts degree in
Philosophy of Science.

James E. Crawford, III. Mr. Crawford has served as a director of Focal
since November 1996. Since August 1992, he has been a general partner of
Frontenac Company, a venture capital firm. From February 1984 to August 1992,
Mr. Crawford was a general partner of William Blair Venture Management Co., a
venture capital fund. He was also a general partner of William Blair &
Company, an investment bank and brokerage firm affiliated with William Blair
Venture Management Co., from January 1987 to August 1992. Mr. Crawford serves
as a director of Optika, Inc., Input Software, Inc., Allegiance Telecom and
several private companies.

32
<PAGE>

John A. Edwardson. Mr. Edwardson has served as a director of Focal since
February 1999. He has been Chairman of Burns International Services Corp.
("Burns International"), a security services company, since June 1999 and
President and Chief Executive Officer of Burns International since March 1999.
From 1994 to 1998, Mr. Edwardson was President of UAL Corporation, the holding
company for United Airlines and also served as UAL's Chief Operating Officer
from April 1995 through September 1998. He previously was Executive Vice
President and Chief Financial Officer of Ameritech and held executive
positions with Northwest Airlines. Mr. Edwardson also serves as a director of
Burns International and Household International, Inc.

Paul J. Finnegan. Mr. Finnegan has served as a director of Focal since
November 1996. Since January 1993, Mr. Finnegan has been Managing Director of
Madison Dearborn Partners, Inc., the general partner of Madison Dearborn.
Previously, he served in various positions at First Capital Corporation of
Chicago and its affiliates. Mr. Finnegan currently serves on the Board of
Trustees of The Skyline Fund and the Board of Directors or Managers, as
applicable, of CompleTel, LLC and Allegiance Telecom.

Richard D. Frisbie. Mr. Frisbie has served as a director of Focal since
November 1996. Mr. Frisbie is a founder and has been Managing Partner of
Battery Ventures since 1983. He is responsible for management of the Battery
Funds and focuses principally on communications opportunities. Mr. Frisbie
serves as a director of Allegiance Telecom.

James N. Perry, Jr. Mr. Perry has been a director of Focal since November
1996. From January 1993 to January 1999, he served as Vice President of
Madison Dearborn Partners, Inc., and since January of 1999 has served as
Managing Director of Madison Dearborn Partners, Inc. Previously, Mr. Perry
served in various positions at First Capital Corporation of Chicago and its
affiliates. Mr. Perry currently serves as a director or manager, as
applicable, of Clearnet Communications, Inc., Omnipoint Corporation,
CompleTel, LLC, CompleTel Holdings and Allegiance Telecom.

Paul G. Yovovich. Mr. Yovovich has served as a director of Focal since
March 1997. Mr. Yovovich served as President of Advance Ross Corporation, an
international transaction services and manufacturing company, from 1993 to
1996. He is a private investor. He served in several executive positions with
Centel Corporation from 1982 to 1992, where his last position was that of
President of its Central Telephone Company unit. Mr. Yovovich also serves as a
director of 3Com Corporation, APAC TeleServices, Inc., Van Kampen Open End
Funds, Comarco, Inc., American Media Operations, Inc., Lante Corporation, and
several private companies.

How Our Directors Are Elected

The Board of Directors presently consists of eight members. The Board of
Directors is divided into three classes, as nearly equal in number as
possible. Each director serves a three-year term and one class is elected at
each year's annual meeting of stockholders. Mr. Finnegan and Mr. Frisbie are
in the class of directors whose term will expire at our 2000 annual meeting of
stockholders. Mr. Barnicle, Mr. Crawford and Mr. Yovovich are in the class of
directors whose term will expire at our 2001 annual meeting of stockholders.
Mr. Edwardson, Mr. Perry and Mr. Taylor are in the class of directors whose
term will expire at our 2002 annual meeting of stockholders. At each annual
meeting of stockholders, successors to the class of directors whose terms
expire at the meeting are elected to serve for three-year terms and until
their successors are elected and qualified.

Our Board Committees

The Board has established three committees. They are the:

. Compensation Committee

. Audit Committee

. Nominating Committee

33
<PAGE>

The Compensation Committee establishes salaries, incentives and other forms
of compensation for our directors, executive officers and key employees and
administers our equity incentive plans and other incentive and benefit plans.
The members of the Compensation Committee are Mr. Crawford, Mr. Edwardson, Mr.
Perry and Mr. Yovovich.

The Audit Committee oversees the work of our independent auditors, reviews
internal audit controls and evaluates conflict of interest issues. The members
of the Audit Committee are Mr. Edwardson, Mr. Finnegan and Mr. Yovovich.

The Nominating Committee identifies nominees to stand for election to our
Board of Directors. The members of the Nominating Committee are Mr. Taylor,
Mr. Perry, Mr. Crawford and Mr. Yovovich.

Compensation of Our Directors

We presently pay our non-employee directors, other than designees of our
institutional investors, in lieu of a cash retainer, annual director
compensation in the form of an annual grant of stock options. The number of
shares subject to each stock option granted to each of these directors on an
annual basis is equal to $60,000 divided by the option exercise price, which
will be the fair market value per share on the date of grant. All directors
are reimbursed for expenses incurred to attend Board of Directors or committee
meetings. See "Executive Compensation--Director Plan."

In April 1997, Mr. Yovovich was granted an option to purchase 130,000
shares of our common stock under our 1997 Nonqualified Stock Option Plan (The
"1997 Plan"). Ten percent of the shares covered by the option vested
immediately and an additional 15% of the shares vest every six months
thereafter. In January 1999, Mr. Yovovich was granted an additional option to
purchase 20,000 shares of common stock under the 1997 Plan, which has the same
vesting terms as his earlier grant. In February 1999, Mr. Edwardson was
granted an option under our 1997 Plan to purchase 130,000 shares of our common
stock on the same vesting terms as the options previously granted to Mr.
Yovovich. We reimburse directors for out-of-pocket expenses incurred in
connection with attendance at meetings of the Board of Directors or committees
of the Board of Directors.

Potential Conflicts of Interest of Some of Our Directors

In addition to serving as members of our Board of Directors, Mr. Crawford,
Mr. Finnegan, Mr. Frisbie and Mr. Perry each serve as directors of other
telecommunications services companies and other private companies. As a
result, these four directors may be subject to conflicts of interest during
their tenure on our Board of Directors. Accordingly, they may be periodically
required to inform us and the other companies to which they owe fiduciary
duties of financial or business opportunities. We do not currently have any
standard procedures for resolving potential conflicts of interest relating to
corporate opportunities or otherwise. Conflict of interest issues are reviewed
by our Audit Committee. Mr. Finnegan currently serves on the Audit Committee.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934 requires our directors
and officers and persons who own more than 10 percent of a registered class of
our equity securities to file with the Securities and Exchange Commission
initial reports of ownership and reports in changes in ownership in our common
stock, and to furnish us with copies of all the reports they file. To our
knowledge, based solely on a review of the copies of such reports furnished to
us and written representations that no other Forms 5 were required, during the
fiscal year ended December 31, 1999, all Section 16(a) filing requirements
applicable to our directors, officers and greater than 10 percent beneficial
owners were complied with, except that Messrs. Crawford and Yovovich, two of
our directors, inadvertently failed to report acquisitions of our common stock
on Forms 4 during July and August 1999, which acquisitions were subsequently
reported on Forms 5.

34
<PAGE>

ITEM 11. EXECUTIVE COMPENSATION

The table below presents information about compensation earned by our Chief
Executive Officer and each of our four other most highly compensated executive
officers whose combined salary and bonus for 1999 exceeded $100,000 for
services rendered in all capacities for our last three fiscal years. The
officers listed in the following table are referred to as the Named Executive
Officers:

Summary Compensation Table
<TABLE>
<CAPTION>
Long-term
Compensation
------------
Awards(1)
------------
Securities
Underlying
------------
Annual
Compensation
----------------- All Other
Salary Bonus Compensation
Name and Principal Position Year ($) ($) Options (#) ($)
- --------------------------- ---- -------- -------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Robert C. Taylor, Jr. 1997 $120,000 $ 50,000 $ -- $ --
Chief Executive Officer 1998 150,000 100,000 -- --
1999 191,923 200,000 -- --

John R. Barnicle 1997 $120,000 $ 47,000 $ -- $ --
Chief Operating Officer 1998 140,000 75,000 -- --
1999 178,269 144,000 -- --

Joseph A. Beatty 1997 $120,000 $ 45,000 $ -- $25,000(2)
Chief Financial Officer 1998 140,000 75,000 -- --
1999 175,577 138,000 -- --

Brian F. Addy 1997 $120,000 $ 38,000 $ -- $ --
Executive Vice President of
Market Development 1998 125,000 50,000 -- --
(3) 1999 157,801 -- -- --

Renee M. Martin 1997 $ -- $ -- $ -- $ --
Senior Vice President and
General Counsel 1998 127,000 45,000 127,000 --
1999 150,562 78,000 33,500 --
</TABLE>
- --------
(1) Does not include 2,500,000 shares of common stock issued to each of Mr.
Taylor, Mr. Barnicle, Mr. Beatty and Mr. Addy in 1996 that were subject to
time-vesting requirements set forth in their Employment Agreements, of
which 500,000 shares vested in 1996, 1997 and 1998 and 1,000,000 shares
vested in 1999. See "--Employment Agreements." Also does not include
1,838,943 shares of common stock issued to each of Mr. Taylor, Mr.
Barnicle, Mr. Beatty and Mr. Addy in 1996 that were subject to performance-
vesting requirements set forth in their Vesting Agreements with some of our
institutional investors. Of these shares, 1,588,943 were canceled in
connection with the September 30, 1998 amendments to the Vesting
Agreements. The remaining 250,000 shares were subject to time-vesting
requirements set forth in Restricted Stock Agreements signed at the time of
the September 30, 1998 amendments to these Vesting Agreements. Of these
shares, 175,000 held by Messrs. Taylor, Barnicle and Beatty remain subject
to future vesting requirements. Based upon the closing price of our Common
Stock on February 29, 2000, these 175,000 shares have an aggregate market
value of $9,242,275. See "--Vesting Agreements." We do not anticipate
paying any dividends on any of these shares.
(2) Represents reimbursement of moving expenses.
(3) Mr. Addy resigned from Focal on January 7, 2000.

35
<PAGE>

Stock Option Grants

The table below provides information regarding stock options granted to the
Named Executive Officers during the year ended December 31, 1999. None of the
Named Executive Officers received stock appreciation rights, or SARs.
<TABLE>
<CAPTION>

Potential
Realizable
Value at
Assumed Annual
Individual Grants(1) Rates
------------------------------------------------- of Stock Price
Number of % of Total Appreciation
Securities Options for Option
Underlying Granted to Exercise or Term(2)
Options Employees in Base Price Expiration ---------------
Name Granted Fiscal Year (per share) Date 5% 10%
- ---- ---------- ------------ ----------- ------------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Robert C. Taylor, Jr.... -- -- -- -- -- --
John R. Barnicle........ -- -- -- -- -- --
Joseph A. Beatty........ -- -- -- -- -- --
Brian F. Addy........... -- -- -- -- -- --
Renee M. Martin......... 16,750 0.5% $3.73 April 1, 2009 $39,293 $99,574
16,750 0.5% $3.73 May 21, 2009 $39,293 $99,574
</TABLE>

- --------
(1) The options granted to Ms. Martin were granted under the 1997 Plan (as
defined below). See "--1997 Plan." No stock option grants were made to any
of the Named Executive Officers in years prior to the year ended December
31, 1998. The 16,750 options were granted on April 1, 1999 and vest 25% on
the first anniversary of the date of grant and 12.5% every six months
thereafter. The 16,750 options were granted on May 21, 1999 and vest 25%
on April 1, 2001 and 12.5% every six months thereafter.
(2) Based on a ten-year option term and annual compounding, the 5% and 10%
calculations are set forth in compliance with the rules of the Securities
and Exchange Commission. The appreciation calculations do not take into
account any appreciation in the price of the common stock to date and are
not necessarily indicative of future values of stock options or the common
stock.

Exercise of Stock Options and Year-End Values

The following table sets forth information regarding the number and value
of unexercised stock options held by each of the Named Executive Officers as
of December 31, 1999. None of the Named Executive Officers holds SARs.

<TABLE>
<CAPTION>
Value of
Number of Unexercised In-the-
Unexercised Money
Options at Options ($) at
Number of Shares Value Fiscal Year End Fiscal Year End(2)
Acquired Upon Realized Exercisable/ Exercisable/
Name Exercise of Option Upon Exercise Unexercisable(1) Unexercisable
---- ------------------ ------------- ---------------- -------------------
<S> <C> <C> <C> <C>
Robert C. Taylor, Jr.... -- -- -- $ --
John R. Barnicle........ -- -- -- --
Joseph A. Beatty........ -- -- -- --
Brian F. Addy........... -- -- -- --
Renee M. Martin......... 20,000 $455,500 23,125/117,375 $481,681/$2,434,791
</TABLE>
- --------
(1) These shares represent shares issuable pursuant to stock options granted
under our 1997 Plan. See "--1997 Plan."
(2) In accordance with the SEC's rules, values are calculated by subtracting
the exercise price from the fair market value of the underlying common
stock. For purposes of this table, fair market value is deemed to be
$23.63, the average of the high and low common stock price reported for
Nasdaq National Market on December 31, 1999. Based upon the closing price
of our Common Stock on February 29, 2000, the exercisable and
unexercisable options would have aggregate values equal to $546,444 and
$6,198,926, respectively.

36
<PAGE>

1997 Plan

Our 1997 Plan permits our Board of Directors broad discretion to grant non-
qualified stock options to directors, officers and other key employees. The
total number of shares of common stock that may be issued or transferred under
the 1997 Plan may not exceed 8,530,000 shares of common stock. The maximum
share number can be adjusted if Focal undertakes a stock split, stock dividend
or other similar transactions. The Board of Directors determines who will
receive options and what the terms of the options will be.

The option agreements between us and each existing optionee provide that,
upon the occurrence of a Change in Control (as defined in the 1997 Plan), the
portion of the option that would have vested in the 12 month period following
the Change in Control (if the optionee remained employed by us during that
period) will automatically become vested as of the date of the Change in
Control. In addition, if we terminate the optionee's employment, actually or
constructively, in connection with or in anticipation of a Change in Control,
or within two years after a Change in Control, all of the optionee's remaining
options will automatically become vested and exercisable as of the date of
termination.

As of February 29, 2000, there were options covering 5,838,735 shares of
Focal's common stock outstanding under the 1997 Plan with a weighted average
exercise price of $2.63 per share.

1998 Plan

We also have the 1998 Equity Performance and Incentive Plan (the "1998
Plan") that permits the Board of Directors to grant a variety of awards to
officers and other key employees. The Board of Directors can grant:

. Incentive and non-qualified stock options

. SARs, which are rights to receive an amount equal to a specified portion
of the increase in market value of a common stock over a specified
exercise price between the date of grant and the date of exercise

. Restricted shares, which involve the immediate transfer of shares of
common stock for the performance of services. Restricted shares must be
subject to a "substantial risk of forfeiture" within the meaning of
Section 83 of the Internal Revenue Code

. Deferred shares, which involve an agreement to deliver shares of common
stock in the future in consideration for the performance of services

. Performance shares, each of which is a bookkeeping unit equivalent to one
share of common stock

. Performance units, each of which is a bookkeeping unit equivalent to
$1.00

The total number of shares of common stock that may be issued or
transferred under the 1998 Plan may not exceed 1,768,000. The maximum share
number is subject to adjustment in the event of a stock split, stock dividend
or other similar transactions.

The Board of Directors has broad discretion in granting and establishing
the terms of awards under the 1998 Plan, subject to the limitations contained
in the 1998 Plan.

As of February 29, 2000, there were options covering 1,138,093 shares of
Focal common stock outstanding under the 1998 Plan with a weighted average
exercise price of $26.53 per share.

Director Plan

We also have a 1998 Equity Plan for Non-Employee Directors that permits our
non-employee directors ("Non-Employee Directors") who are not employees,
representatives or affiliates of any of Madison Dearborn, Frontenac or Battery
Ventures (collectively, the "Institutional Investors") to elect to receive all
or a portion of their compensation as directors in the form of shares of
common stock. The Director Plan also permits us to issue to Non-Employee
Directors options to purchase shares of common stock.

37
<PAGE>

The number of shares of common stock that may be issued or transferred
under the Director Plan, plus the number of shares of common stock covered by
outstanding awards, may not in the aggregate exceed 150,000 shares. The
maximum number of shares may be adjusted if Focal undertakes a stock split,
stock dividend or other similar transactions.

As of February 29, 2000, there were no options outstanding under the
Director Plan.

Employment Agreements

Focal is a party to identical Executive Stock Agreement and Employment
Agreements ("Employment Agreements") with each of Mr. Taylor, Mr. Barnicle,
Mr. Beatty and Mr. Addy (the "Executive Investors"). The Employment Agreements
provide that each Executive Investor will receive a minimum base salary of
$120,000 (or any greater amount approved by a majority of the Board of
Directors, including the Madison Dearborn designee and one of the Frontenac or
Battery Ventures designees) and bonuses determined by the Board of Directors
and based upon our achievement of performance goals set in advance of each
year in the sole discretion of the Board of Directors. Unless he is terminated
for cause, each Executive Investor is entitled for a period of between six and
12 months following termination of his employment with us (depending on the
basis for termination) to continue to receive his salary and medical benefits,
less any amounts the Executive Investor receives as compensation for other
employment.

We entered into an employment agreement with Ms. Martin on March 20, 1998,
on substantially the same employment terms as the Executive Investors. Each
Employment Agreement and Ms. Martin's agreement also require the Executive
Investor or Ms. Martin, as applicable, to assign to us all inventions
developed in the course of employment, maintain the confidentiality of our
proprietary information and refrain from competing with and soliciting
employees from Focal during his or her employment and for a period of up to
eighteen months after his or her termination. During this period, after any
applicable severance pay period has expired, the Executive Investor or Ms.
Martin, as applicable, is entitled to receive noncompetition compensation
equal to his or her salary and medical benefits (net of any amounts he or she
receives as compensation for other employment), unless he or she breaches his
or her non-disclosure, non-compete or non-solicitation obligations.

Pursuant to the Employment Agreements and in exchange for shares of common
stock held by the Executive Investors prior to November 27, 1996:

. 2,500,000 shares of common stock subject to time-vesting requirements set
forth in the Employment Agreements were issued to each of the Executive
Investors on November 27, 1996

and

. 1,838,943 shares of common stock subject to performance-vesting
requirements set forth in the Vesting Agreements (as defined below) were
issued to each of the Executive Investors on November 27, 1996. Of these
shares, 1,588,943 were canceled in connection with the September 30, 1998
amendments to the Vesting Agreements. The remaining 250,000 shares are
subject to time-vesting requirements set forth in Restricted Stock
Agreements signed on September 30, 1998. Of these shares, 175,000 shares
issued to Messrs. Taylor, Barnicle and Beatty remain subject to future
vesting requirements. See "--Vesting Agreements."

All of the 2,500,000 shares issued on November 27, 1996 that were subject
to time-vesting requirements under the Employment Agreements have vested.

Each Employment Agreement and Ms. Martin's agreement also require the
Executive Investor, or Ms. Martin, as applicable, to assign to us all
inventions developed in the course of employment, maintain the confidentiality
of our proprietary information and refrain from competing with and soliciting
employees from Focal during his or her employment and for a period of up to
eighteen months after his or her termination. During this period, after any
applicable severance pay period has expired, the Executive Investor, or Ms.
Martin, as applicable, is entitled to receive noncompetition compensation
equal to his or her salary and medical benefits (net of any amounts he or she
receives as compensation for other employment), unless he or she breaches his
or her non-disclosure, non-compete or non-solicitation obligations.

38
<PAGE>

Vesting Agreements

Pursuant to the original terms of three separate Vesting Agreements (the
"Vesting Agreements"), each dated November 27, 1996, among Focal, the
Executive Investors and each of our Institutional Investors, each of the
Executive Investors was entitled to earn 1,838,943 shares of common stock if
specified financial performance criteria were satisfied. If any of these
shares of common stock vested, an equal number of shares of common stock held
by the Institutional Investors would be forfeited by the Institutional
Investors.

Pursuant to amendments to the Vesting Agreements, on September 30, 1998,
the Vesting Agreements terminated and:

. The Institutional Investors collectively forfeited 2,500,000 shares of
common stock

. The Executive Investors each forfeited 1,588,943 shares of common stock
held by them (or a total of 6,355,770 shares for all Executive Investors)

. 250,000 shares of common stock held by each Executive Investor were
vested and became subject to new time-vesting requirements based on
periods of continuous service with us (the "Restricted Shares").

Twenty percent of the Restricted Shares immediately vested and the remaining
Restricted Shares vest 10% on September 30, 1999, 15% on September 30, 2000,
20% on September 30, 2001 and 35% on September 30, 2002. The Executive
Investors are entitled to voting, dividend and other ownership rights with
respect to the Restricted Shares, but the Restricted Shares are subject to
restrictions on transfer until they vest. Vesting of the Restricted Shares is
accelerated under specified circumstances, including upon a Change in Control
or the Executive Investor's death or disability. Change in Control has the
same definition as in the 1997 Plan.

Compensation Committee Interlocks and Insider Participation

The Compensation Committee of the Board of Directors consists of four
directors, Messrs. Crawford, Edwardson, Perry and Yovovich. All matters
concerning executive compensation in 1999 were addressed by the full Board of
Directors, including Messrs. Taylor and Barnicle, who were executive officers
of Focal during 1999. None of our executive officers served as a member of the
compensation committee or as a director of any other entity.

39
<PAGE>

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The table below sets forth information regarding beneficial ownership of
our common stock as of February 29, 2000 for:

. Each of the Named Executive Officers

. Each of our directors

. All of our executive officers and directors as a group

. Each other person who we know beneficially owns 5% or more of our common
stock

Unless otherwise noted, the address of each Named Executive Officer and
director of Focal is 200 North LaSalle Street, Suite 1100, Chicago, Illinois
60601.

<TABLE>
<CAPTION>
Number of Shares Percent
Name Beneficially Owned (1) Beneficially Owned
- ---- ---------------------- ------------------
<S> <C> <C>
Named Executive Officers
Robert C. Taylor, Jr. (2)............ 2,865,385 4.7%
John R. Barnicle (3)................. 2,794,585 4.6%
Joseph A. Beatty (4)................. 2,865,385 4.7%
Renee M. Martin (5).................. 35,687 *
Directors
James N. Perry, Jr. (6).............. 21,606,425 35.5%
Paul J. Finnegan (7)................. 21,606,425 35.5%
James E. Crawford III (8)............ 10,084,010 16.6%
Richard D. Frisbie (9)............... 5,041,365 8.3%
Paul G. Yovovich (10)................ 289,850 *
John A. Edwardson (11)............... 202,134 *
All Executive Officers and Directors
as a Group (13 persons) (12)........ 45,986,983 75.6%
Other Owners
Madison Dearborn Capital Partners,
L.P. (13)........................... 21,606,425 35.5%
Frontenac VI, L.P. (14).............. 10,082,980 16.6%
Battery Ventures III, L.P. (15)...... 5,041,365 8.3%
Brian F. Addy (16)................... 2,690,385 4.4%
</TABLE>
- --------
*Less than 1% of the issued and outstanding shares of our common stock.
(1) In accordance with the rules of the Securities and Exchange Commission,
each beneficial owner's holding has been calculated assuming full
exercise of outstanding warrants and options exercisable by the holder
within 60 days after February 29, 2000, but no exercise of outstanding
warrants and options held by any other person. Unless otherwise indicated
below, the persons and entities named in the table have sole voting and
sole investment power with respect to all shares beneficially owned by
them, subject to applicable community property laws.
(2) Includes 175,000 shares of common stock subject to vesting provisions
contained in the executive's Restricted Stock Agreement. Also includes
1,115,385 shares of common stock held by Mistral Partners, L.P., a family
limited partnership. Mr. Taylor exercises sole voting and investment
power over shares held by this partnership.
(3) Includes 175,000 shares of common stock subject to vesting provisions
contained in the executive's Restricted Stock Agreement, respectively.
Also includes 350,000 shares of common stock held by JRB Partners, L.P.,
a family limited partnership. Mr. Barnicle exercises sole voting and
investment power over shares held by this partnership.
(4) Includes 175,000 shares of common stock subject to vesting provisions
contained in the executive's Restricted Stock Agreement. Also includes
865,000 shares of common stock held by Coventry Court Partners, L.P., a
family limited partnership. Mr. Beatty exercises sole voting and
investment power over shares held by this partnership.

40
<PAGE>

(5) Consists of shares of common stock subject to options which are
exercisable within 60 days of February 29, 2000.
(6) Mr. Perry, a director, owns no shares in his own name. Consists of shares
of common stock owned by Madison Dearborn. See footnote 13 below. Mr.
Perry's address is c/o Madison Dearborn Partners, Inc., Three First
National Plaza, Suite 3800, Chicago, IL 60602.
(7) Mr. Finnegan, a director, owns no shares in his own name. Consists of
shares of common stock owned by Madison Dearborn. See footnote 13 below.
Mr. Finnegan's address is c/o Madison Dearborn Partners, Inc., Three
First National Plaza, Suite 3800, Chicago, IL 60602.
(8) Mr. Crawford, a director, owns no shares in his own name. Consists of
shares of common stock owned by Frontenac and 1,030 shares of common
stock owned by Mr. Crawford's son. See footnote 14 below. Mr. Crawford's
address is c/o Frontenac Company, 135 S. LaSalle Street, Suite 3800,
Chicago, IL 60603.
(9) Mr. Frisbie, a director, owns no shares in his own name. Consists of
shares of common stock owned by Battery. See footnote 15 below. Mr.
Frisbie's address is c/o Battery Ventures, 20 William Street, Wellesley,
MA 02481.
(10) Includes 151,719 shares of common stock and an additional 138,134 shares
of common stock subject to options which are exercisable within 60 days
of February 29, 2000.
(11) Includes 150,000 shares of common stock and an additional 52,134 shares
of common stock subject to options which are exercisable within 60 days
of February 29, 2000.
(12) Includes 45,740,841 shares of common stock and an additional 246,142
shares of common stock subject to options which are exercisable within 60
days of February 29, 2000.
(13) Consists of shares of common stock owned by Madison Dearborn. Messrs.
Perry and Finnegan, directors of Focal, are principals of Madison
Dearborn Capital Partners, Inc., the ultimate general partner of Madison
Dearborn. Because of these positions, Messrs. Perry and Finnegan share
voting and investment power with respect to the shares owned by Madison
Dearborn. The address of Madison Dearborn is Three First National Plaza,
Suite 3800, Chicago, IL 60602. See "Directors and Executive Officers of
the Registrant--Potential Conflicts of Interest of Some of Our
Directors."
(14) Consists of shares of common stock owned by Frontenac. Mr. Crawford, a
director, is a general partner of Frontenac Company, the general partner
of Frontenac. Because of this position, Mr. Crawford shares voting and
investment power with respect to the shares owned by Frontenac. The
address of Frontenac is 135 S. LaSalle Street, Suite 3800, Chicago, IL
60603. See "Directors and Executive Officers of the Registrant--Potential
Conflicts of Interest of Some of Our Directors."
(15) Consists of shares of common stock owned by Battery Ventures. Mr.
Frisbie, a director, is a managing general partner of Battery Ventures.
Because of this position, Mr. Frisbie shares voting and investment power
with respect to the shares owned by Battery Ventures. The address of
Battery Ventures is 20 William Street, Wellesley, MA 02481. See
"Directors and Executive Officers of the Registrant--Potential Conflicts
of Interest of Some of Our Directors."
(16) Mr. Addy is a "named Executive Officer." He resigned from the Company,
effective January 7, 2000. Includes 1,115,385 shares of common stock held
by Ad-Venture Capital Partners, L.P., a family limited partnership. Mr.
Addy exercises sole voting and investment power over shares held by this
partnership.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

The Stock Purchase Agreement and Stockholders' Agreement

We have entered into a Stock Purchase Agreement with some of our
stockholders, dated as of November 27, 1996 and amended after that date.
Pursuant to the Stock Purchase Agreement and additional related agreements,
our existing stockholders were granted registration rights described below.

The Stock Purchase Agreement also requires us to:

. Deliver financial information to the Institutional Investors and certain
of their transferees in a private sale of shares of common stock

41
<PAGE>

. Provide access by the Institutional Investors, and certain of their
transferees in a private sale of shares of common stock, to our physical
properties, books and records

. Comply with the periodic reporting requirements under the Exchange Act to
enable holders of "restricted shares" of common stock to sell those
shares of common stock pursuant to Rule 144 under the Securities Act of
1933 or a short-form registration statement under the Securities Act of
1933.

See "Executive Compensation--Employment Agreements" and "--Vesting
Agreements" for a more detailed discussion of the various provisions of the
Employment Agreements and Vesting Agreements.

Registration Rights

Focal has granted registration rights to some holders of its common stock.
These holders of common stock have the benefit of the following demand
registration:

. Subject to minimum dollar amounts, Madison Dearborn may demand two
registrations on Form S-1

. Frontenac and Battery may each demand one registration on Form S-1

. The holders of 8% of all shares of common stock subject to the
registration agreement may demand an unlimited number of registrations on
Form S-2 or Form S-3

In addition, stockholders that have been granted registration rights have
unlimited "piggyback" registration rights under which they have the right to
request that we register their shares of common stock whenever we register any
of our securities under the Securities Act of 1933 and the registration form
to be used may be used for the registration of their shares of common stock.
These piggyback registration rights will not, however, be available:

. If the piggyback registration is in connection with an underwritten
registration and the managing underwriter concludes that including shares
of common stock owned by holders of "piggyback" registration rights would
have an adverse impact on the marketing of the securities to be sold in
the underwritten offering

. For registrations undertaken because of a demand registration

Stock Purchases by Our Directors

In May 1997, Mr. Yovovich purchased 115,385 shares of common stock for a
purchase price of $75,000. In October 1998, he purchased an additional 33,334
shares of common stock for himself and members of his family for a purchase
price of $100,000. In March 1999, Mr. Edwardson purchased 150,000 shares of
common stock for a purchase price of $472,500.

Some of Our Directors are also Directors of our Competitors

Some of our directors, who serve as representatives of the Institutional
Investors, also serve on the boards of directors of companies with which we
may compete or enter into agreements. Specifically, Mr. Crawford, Mr.
Finnegan, Mr. Frisbie and Mr. Perry are directors of Allegiance Telecom, a
Dallas-based CLEC. Allegiance Telecom is one of our competitors. See
"Directors and Executive Officers of the Registrant--Potential Conflicts of
Interest of Some of Our Directors."

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) (1) Financial Statements

The consolidated financial statements of Focal Communications
Corporation and Subsidiaries for the year ended December 31, 1999, together
with the Report of Independent Public Accountants, are set forth

42
<PAGE>

on pages F-1 through F-20 of this report. The supplemental financial
information listed and appearing hereafter should be read in conjunction
with the consolidated financial statements included in the report.

(2) Financial Statement Schedules

The following are included in Part IV of this report for each of the
years ended December 31, 1997, 1998 and 1999 as applicable:

Report of Independent Public Accountants F-21

Schedule II--Valuation and Qualifying Accounts F-22

Financial statement schedules not included in this report have been omitted
either because they are not applicable or because the required information is
shown in the consolidated financial statements or notes thereto, included in
this report.

(3) The exhibits listed below are filed as part of this report:

<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description
------- -------------------
<C> <S> <C>
2.1 Plan of Reorganization and Agreement by and among Focal
Communications Corporation and its Subsidiaries, dated
June 12, 1997. (Incorporated by reference to Exhibit No.
2.1 to the Registrant's Registration Statement on Form S-4
originally filed with the Securities and Exchange
Commission on August 13, 1998 (Registration No. 333-49397)
(the "S-4"))

3.1 Form of Amended and Restated Certificate of Incorporation.
(Incorporated by reference to Exhibit No. 3.3 of the
Registrant's Registration Statement on Form S-1 originally
filed with the Securities and Exchange Commission on May
7, 1999, as amended (Registration No. 333-77995) (the "S-
1"))

3.2 Form of Amended and restated By-Laws. (Incorporated by
reference to Exhibit No. 3.5 of the S-1)

4.1 Indenture with Harris Trust and Savings Bank, dated
February 18, 1998. (Incorporated by reference to Exhibit
No. 4.1 of the S-4)

4.2 Initial Global 12.125% Senior Discount Note Due February
15, 2008, dated February 18, 1998. (Incorporated by
reference to Exhibit No. 4.2 of the S-4)

4.3 Stock Purchase Agreement with Madison Dearborn Capital
Partners, L.P., Frontenac VI, L.P., Battery Ventures III,
L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty, and
Robert C. Taylor Jr., dated November 27, 1996.
(Incorporated by reference to Exhibit No. 4.5 of the S-4)

4.4 Amendment No. 1 to Stock Purchase Agreement with Madison
Dearborn Capital Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty, and Robert C. Taylor Jr., dated
January 23, 1998. (Incorporated by reference to Exhibit
No. 4.6 of the S-4)

4.5 Amendment No. 2 to Stock Purchase Agreement with Madison
Dearborn Capital Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty and Robert C. Taylor, Jr., dated
as of August 21, 1998. (Incorporated by reference to
Exhibit No. 4.8 to the Registrant's Quarterly Report on
Form 10-Q for the period ending September 30, 1998,
originally filed with the Securities and Exchange
Commission on November 16, 1998 (the "3rd Quarter 10-Q"))

4.6 Vesting Agreement with Madison Dearborn Capital Partners,
L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty and
Robert C. Taylor, Jr., dated as of November 27, 1996.
(Incorporated by reference to Exhibit No. 4.1 of the 3rd
Quarter 10-Q)

4.7 Vesting Agreement with Frontenac VI, L.P., Brian F. Addy,
John R. Barnicle, Joseph Beatty and Robert C. Taylor, Jr.,
dated as of November 27, 1996. (Incorporated by reference
to Exhibit No. 4.2 of the 3rd Quarter 10-Q)
</TABLE>

43
<PAGE>

<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description
------- -------------------
<C> <S> <C>
4.8 Vesting Agreement with Battery Ventures III, L.P., Brian
F. Addy, John R. Barnicle, Joseph Beatty and Robert C.
Taylor, Jr., dated as of November 27, 1996. (Incorporated
by reference to Exhibit No. 4.3 of the 3rd Quarter 10-Q)

4.9 Amendment No. 1 to Vesting Agreement and Consent as of
August 21, 1998, between Focal Communications Corporation
with Madison Dearborn Capital Partners, L.P., Frontenac
VI, L.P., Battery Ventures III, L.P., Brian F. Addy, John
R. Barnicle, Joseph Beatty and Robert C. Taylor, Jr.,
dated as of August 21, 1998. (Incorporated by reference to
Exhibit No. 4.4 of the 3rd Quarter 10-Q)

4.10 Amendment No. 1 to Vesting Agreement and Consent as of
August 21, 1998, between Focal Communications Corporation
with Madison Dearborn Capital Partners, L.P., Frontenac
VI, L.P., Battery Ventures III, L.P., Brian F. Addy, John
R. Barnicle, Joseph Beatty and Robert C. Taylor, Jr.,
dated as of August 21, 1998. (Incorporated by reference to
Exhibit No. 4.5 of the 3rd Quarter 10-Q)

4.11 Amendment No. 1 to Vesting Agreement and Consent as of
August 21, 1998, between Focal Communications Corporation
with Madison Dearborn Capital Partners, L.P., Frontenac
VI, L.P., Battery Ventures III, L.P., Brian F. Addy, John
R. Barnicle, Joseph Beatty and Robert C. Taylor, Jr.,
dated as of August 21, 1998. (Incorporated by reference to
Exhibit No. 4.6 of the 3rd Quarter 10-Q)

4.12 Form of Restricted Stock Agreement, dated September 30,
1998 between Focal Communications Corporation and each of
Brian F. Addy, John R. Barnicle, Joseph Beatty, and Robert
C. Taylor, Jr. (Incorporated by reference to Exhibit No.
4.7 of the 3rd Quarter 10-Q)

4.13 Stockholders Agreement with Madison Dearborn Capital
Partners, L.P., Frontenac VI, L.P., Battery Ventures III,
L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty, and
Robert C. Taylor Jr., dated November 27, 1996.
(Incorporated by reference to Exhibit No. 4.11 of the S-4)

4.14 Amendment No. 1 to Stockholders Agreement with Madison
Dearborn Capital Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty and Robert C. Taylor, Jr., dated
as of July 7, 1998. (Incorporated by reference to Exhibit
No. 4.9 of the 3rd Quarter 10-Q)

4.15 Amendment No. 2 to Stockholders Agreement with Madison
Dearborn Capital Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty and Robert C. Taylor, Jr., dated
as of August 21, 1998. (Incorporated by reference to
Exhibit No. 4.10 of the 3rd Quarter 10-Q)

4.16 Amendment No. 3 to Stockholders Agreement with Madison
Dearborn Capital Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty, and Robert C. Taylor, Jr., dated
February 16, 1999. (Incorporated by reference to Exhibit
4.16 of the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1999 originally filed with the
Securities and Exchange Commission on March 31, 1999 (the
"1998 10-K"))

4.17 Amendment No. 4 to Stockholders Agreement with Madison
Dearborn Capital Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty, and Robert C. Taylor, Jr., dated
May 21, 1999. (Incorporated by reference to Exhibit No.
4.27 of the S-1)

4.18 Executive Stock Agreement and Employment Agreement with
Brian F. Addy, dated November 27, 1996. (Incorporated by
reference to Exhibit No. 4.12 of the S-4)
</TABLE>

44
<PAGE>

<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description
------- -------------------
<C> <S> <C>
4.19 Executive Stock Agreement and Employment Agreement with
John R. Barnicle, dated November 27, 1996. (Incorporated
by reference to Exhibit No. 4.13 of the S-4)+

4.20 Executive Stock Agreement and Employment Agreement with
Joseph A. Beatty, dated November 27, 1996. (Incorporated
by reference to Exhibit No. 4.14 of the S-4)+

4.21 Executive Stock Agreement and Employment Agreement with
Robert C. Taylor, Jr., dated November 27, 1996.
(Incorporated by reference to Exhibit No. 4.15 of the S-
4)+

4.22 Amendment No. 1 to Executive Employment Agreement and
Consent with Brian F. Addy, dated as of August 21, 1998.
(Incorporated by reference to Exhibit No. 4.11 of the 3rd
Quarter 10-Q)+

4.23 Amendment No. 1 to Executive Employment Agreement and
Consent with John R. Barnicle, dated as of August 21,
1998. (Incorporated by reference to Exhibit No. 4.12 of
the 3rd Quarter 10-Q)+

4.24 Amendment No. 1 to Executive Employment Agreement and
Consent with Joseph Beatty, dated as of August 21, 1998.
(Incorporated by reference to Exhibit No. 4.13 of the 3rd
Quarter 10-Q)+

4.25 Amendment No. 1 to Executive Employment Agreement and
Consent with Robert C. Taylor, dated as of August 21,
1998. (Incorporated by reference to Exhibit No. 4.14 of
the 3rd Quarter 10-Q)+

4.26 Registration Agreement with Madison Dearborn Capital
Partners, L.P., Frontenac VI, L.P., Battery Ventures III,
L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty, and
Robert C. Taylor Jr., dated November 27, 1996.
(Incorporated by reference to Exhibit No. 4.16 of the S-4)

4.27 Amendment No. 1 to Registration Agreement with Madison
Dearborn Capital Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty and Robert C. Taylor, Jr., dated
as of August 21, 1998. (Incorporated by reference to
Exhibit No. 4.15 of the 3rd Quarter 10-Q)

10.1 Interconnection Agreement with Ameritech Information
Industry Services, dated October 28, 1996. (Incorporated
by reference to Exhibit No. 10.1 of the S-4)

10.2 Interconnection Agreement with Ameritech Information
Industry Services, dated October 24, 1997. (Incorporated
by reference to Exhibit No. 10.2 of the S-4)

10.3 Interconnection Agreement with New York Telephone Company,
dated November 10, 1997. (Incorporated by reference to
Exhibit No. 10.3 of the S-4)

10.4 Amended and Restated Interconnection Agreement with
Ameritech Information Industry Services, dated March 16,
1998. (Incorporated by reference to Exhibit No. 10.4 of
the 1998 S-4)

10.5 Interconnection Agreement with Bell Atlantic-Pennsylvania,
dated April 27, 1998. (Incorporated by reference to
Exhibit No. 10.26 of the S-4)

10.6 Interconnection Agreement with Bell Atlantic-Delaware,
dated April 27, 1998. (Incorporated by reference to
Exhibit No. 10.25 of the S-4)

10.7 Interconnection Agreement with Bell Atlantic-New Jersey,
dated April 27, 1998. (Incorporated by reference to
Exhibit No. 10.24 of the S-4)

10.8 Interconnection Agreement with GTE--California, dated June
12, 1998. (Incorporated by reference to Exhibit No. 10.23
of the S-4)

10.9 Interconnection Agreement with Pacific Bell, dated June
15, 1998. (Incorporated by reference to Exhibit No. 10.22
of the S-4)
</TABLE>

45
<PAGE>

<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description
------- -------------------
<C> <S> <C>
10.10 Interconnection Agreement with Bell Atlantic-District of
Columbia dated October 1, 1998. (Incorporated by reference
to Exhibit No. 10.1 to the Registrant's Quarterly Report
on Form 10-Q for the Period Ended March 31, 1999 (the "1st
Quarter 1999 10-Q"))

10.11 Interconnection Agreement with Bell Atlantic-Maryland
dated October 2, 1998. (Incorpo-
rated by reference to Exhibit No. 10.2 to the 1st Quarter
1999 10-Q)

10.12 Interconnection Agreement with Bell Atlantic-Virginia
dated October 2, 1998. (Incorporated by reference to
Exhibit No. 10.3 to the 1st Quarter 1999 10-Q)

10.13 Interconnection Agreement with U.S. West-Washington State
dated January 15, 1999. (Incorporated by reference to
Exhibit No. 10.4 to the 1st Quarter 1999 10-Q)

10.14 Interconnection Agreement with Ameritech Information
Industry Services, on behalf of and as agent for Ameritech
Michigan dated February 10, 1999. (Incorporated by
reference to Exhibit No. 10.5 to the 1st Quarter 1999 10-
Q)

10.15 Interconnection Agreement with Bell Atlantic-Massachusetts
dated February 15, 1999. (Incorporated by reference to
Exhibit No. 10.6 to the 1st Quarter 1999 10-Q)

10.16 First Amendment to the Interconnection Agreement with
Ameritech Information Industry Services, dated September
8, 1998. (Incorporated by reference to Exhibit No. 10.1 of
the 3rd Quarter 10-Q)

10.17 Network Products Purchase Agreement with Northern Telecom
Inc., dated January 21, 1997. (Incorporated by reference
to Exhibit No. 10.5 of the S-4)

10.18 Amendments No. 1 and No. 2 to Network Products Purchase
Agreement with Northern Telecom Inc., both dated March 6,
1998. (Incorporated by reference to Exhibit No. 10.6 of
the S-4)*
10.19 Amendment No. 3 to Network Products Purchase Agreement
with Northern Telecom Inc., dated March 25, 1999.
(Incorporated by reference to Exhibit No. 10.7 to the 1st
Quarter 1999 10-Q)*

10.20 Software License with DPI/TFS, Inc., dated April 10, 1997.
(Incorporated by reference to Exhibit No. 10.17 of the S-
4)*

10.21 Second Amendment to Lease Agreement for property located
at 200 North LaSalle, Chicago, IL, dated November 15,
1997. (Incorporated by reference to Exhibit No. 10.9 of
the S-4)

10.22 Lease Agreement for property located at 200 North LaSalle,
Chicago, IL, dated December 31, 1996. (Incorporated by
reference to Exhibit No. 10.7 of the S-4)

10.23 First Amendment to Lease Agreement for property located at
200 North LaSalle, Chicago, IL, dated May 14, 1997.
(Incorporated by reference to Exhibit No. 10.8 of the S-4)

10.24 Loan and Security Agreement with NTFC Capital Corporation
dated December 30, 1998.*
10.25 Amendment No. 1 to Loan and Security Agreement with NTFC
Capital Corporation dated as of April 15, 1999.
(Incorporated by reference to Exhibit No. 10.25 of the S-
1)

10.26 Purchase Agreement with XCOM Technologies, Inc., dated
January 6, 1999. (Incorporated by reference to Exhibit No.
10.8 to the 1st Quarter 1999 10-Q)*

10.27 Third Amendment to Lease Agreement for property located at
200 North LaSalle, Chicago, IL, dated March 2, 1998.
(Incorporated by reference to Exhibit No. 10.10 of the S-
4)
</TABLE>

46
<PAGE>

<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description
------- -------------------
<C> <S> <C>
10.28 Fourth Amendment to Lease Agreement for property located
at 200 North LaSalle, Chicago, IL, dated April 4, 1998.
(Incorporated by reference to Exhibit No. 10.18 of the S-
4)

10.29 Fifth Amendment to Lease Agreement for property located at
200 North LaSalle, Chicago, IL, dated October 14, 1998.
(Incorporated by reference to Exhibit No. 10.9 to the 1st
Quarter 1999 10-Q)

10.30 Sixth Amendment to Lease Agreement for property located at
200 North LaSalle, Chicago, IL, dated February 18, 1999.
(Incorporated by reference to Exhibit No. 10.10 to the 1st
Quarter 1999 10-Q)

10.31 Lease Agreement for property located at 32 Old Slip, New
York, NY, dated May 20, 1997. (Incorporated by reference
to Exhibit No. 10.11 of the S-4)

10.32 Lease Agreement for property located at 650 Townsend
Street, San Francisco, CA, dated January 26, 1998.
(Incorporated by reference to Exhibit No. 10.12 of the S-
4)

10.33 First Amendment to Lease Agreement for property located at
650 Townsend Street, San Francisco, CA, dated March 3,
1998. (Incorporated by reference to Exhibit No. 10.11 to
the 1st Quarter 1999 10-Q)

10.34 Second Amendment to Lease Agreement for property located
at 650 Townsend Street, San Francisco, CA, dated June 16,
1998. (Incorporated by reference to Exhibit No. 10.12 to
the 1st Quarter 1999 10-Q)

10.35 Third Amendment to Lease Agreement for property located at
650 Townsend Street, San Francisco, CA, dated February 16,
1999. (Incorporated by reference to Exhibit No. 10.13 to
the 1st Quarter 1999 10-Q)

10.36 Lease Agreement for property located at 701 Market Street,
Philadelphia, Pennsylvania, dated March 10, 1998.
(Incorporated by reference to Exhibit No. 10.13 of the S-
4)

10.37 Lease Agreement for property located at 1120 Vermont
Avenue, NW., Washington, D.C., dated as of May 4, 1998.
(Incorporated by reference to Exhibit No. 10.19 of the S-
4)

10.38 First Amendment to Lease Agreement for property located at
1120 Vermont, NW, Washington, D.C., dated July 23, 1998.
(Incorporated by reference to Exhibit No. 10.6 of the 3rd
Quarter 10-Q)

10.39 Lease Agreement for property located at 1200 West Seventh
Street, Los Angeles, California, dated as of May 19, 1998.
(Incorporated by reference to Exhibit No. 10.20 of the
1998 S-4)

10.40 First Amendment to Lease Agreement for property located at
1200 West 7th Street, Los Angeles, CA, dated July 8, 1998.
(Incorporated by reference to Exhibit No. 10.5 of the 3rd
Quarter 10-Q)

10.41 Lease Agreement for property located at 1511 6th Avenue,
Seattle, WA, dated August 7, 1998. (Incorporated by
reference to Exhibit No. 10.2 of the 3rd Quarter 10-Q)

10.42 Lease Agreement for property located at 23800 West Ten
Mile Road, Southfield, MI, dated August 31, 1998.
(Incorporated by reference to Exhibit No. 10.3 of the 3rd
Quarter 10-Q)

10.43 Lease Agreement for property located at One Penn Plaza,
New York, NY, dated September 25, 1998. (Incorporated by
reference to Exhibit No. 10.4 of the 3rd Quarter 10-Q)

10.44 Lease Agreement for property located at 1950 Stemmons
Freeway, Dallas, TX, dated December 15, 1998.
(Incorporated by reference to Exhibit No. 10.14 to the 1st
Quarter 1999 10-Q)

</TABLE>

47
<PAGE>

<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description
------- -------------------
<C> <S> <C>
10.45 Lease Agreement for property located at One Main Street,
Cambridge, MA, dated January 6, 1999. (Incorporated by
reference to Exhibit No. 10.15 to the 1st Quarter 1999 10-
Q)

10.46 Lease Agreement for property located at 250 Williams
Street, Atlanta, GA, dated February 5, 1999. (Incorporated
by reference to Exhibit No. 10.16 to the 1st Quarter 1999
10-Q)

10.47 Lease Agreement for property located at Christopher
Columbus Drive & Washington Street, Jersey City, NJ, dated
February 19, 1999. (Incorporated by reference to Exhibit
No. 10.17 to the 1st Quarter 1999 10-Q)

10.48 Employment Agreement with Renee M. Martin, dated March 20,
1998. (Incorporated by reference to Exhibit No. 10.16 of
the S-4)+

10.49 Amendment No. 1 to Executive Employment Agreement with
Renee M. Martin, dated as of August 21, 1998.
(Incorporated by reference to Exhibit No. 10.10 of the 3rd
Quarter 10-Q)

10.50 1997 Nonqualified Stock Option Plan, amended and restated
as of August 21, 1998. (Incorporated by reference to
Exhibit No. 10.7 of the 3rd Quarter 10-Q)+

10.51 Amendment to 1997 Nonqualified Stock Option Plan (amended
and restated as of August 21, 1998), dated as of May 21,
1999. (Incorporated by reference to Exhibit No. 10.58 of
the S-1)

10.52 Form of Amended and Restated Stock Option Agreement.
(Incorporated by reference to Exhibit No. 10.33 of the
1998 10-K)+

10.53 1998 Equity and Performance Incentive Plan. (Incorporated
by reference to Exhibit No. 10.8 of the 3rd Quarter 10-Q)+

10.54 1998 Equity Plan for Non-Employee Directors. (Incorporated
by reference to Exhibit No. 10.9 of the 3rd Quarter 10-Q)+

10.55 Agreement for Sale of Real Property between Focal
Communications Corporation and United Air Lines, Inc.
dated August 13, 1998.
10.56 IRU Agreement dated April 28, 1999, by and between Focal
Financial Services, Inc. and Level 3 Communications, LLC.
(Incorporated by reference to Exhibit No. 10.55 of the
S-1)*

10.57 Private Line Service Agreement, dated May 4, 1999, by and
between Focal Communications Corporation and WorldCom
Technologies, Inc. (Incorporated by reference to Exhibit
No. 10.56 of the S-1)*

10.58 Fiber Optic Network leased Fiber Agreement between
Metromedia Fiber Network Services, Inc. and Focal
Financial Services, Inc., dated as of May 24, 1999.
(Incorporated by reference to Exhibit No. 10.57 of the S-
1)*

21.1 Subsidiaries of the Registrant.

23.1 Consent of Arthur Andersen LLP.

27.1 Financial Data Schedule.
</TABLE>
- --------
*Portions of these exhibits have been omitted pursuant to a request for
confidential treatment, and the omitted portions have been filed separately
with the Securities and Exchange Commission.
+Management contract or compensatory plan.

(b) Reports on Form 8-K. The Company did not file any reports on Form 8-K
during the period covered by this report.

(c) Financial Statement Schedules. The financial statement schedules filed
as part of this Annual Report on Form 10-K are as specified in item 14(a)(2)
herein.

48
<PAGE>

SIGNATURES

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

Focal Communications Corporation

/s/ Robert C. Taylor, Jr.
By:__________________________________
Robert C. Taylor, Jr.
President and Chief Executive
Officer
March 10, 2000

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated. Each Director whose
signature appears below authorizes and appoints Robert C. Taylor, Jr., John R.
Barnicle, Joseph A. Beatty and Renee M. Martin, or any of them, as his
attorney-in-fact to sign and file on his behalf any and all amendments to this
report.

<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----

<S> <C> <C>
/s/ Robert C. Taylor, Jr. President, Chief Executive March 10, 2000
____________________________________ Officer and Director
Robert C. Taylor, Jr. (Principal Executive
Officer)

/s/ John R. Barnicle Executive Vice President, March 10, 2000
____________________________________ Chief Operating Officer,
John R. Barnicle and Director

/s/ Joseph A. Beatty Executive Vice President and March 10, 2000
____________________________________ Chief Financial Officer
Joseph A. Beatty (Principal Financial
Officer)

/s/ Gregory J. Swanson Controller (Principal March 10, 2000
____________________________________ Accounting Officer)
Gregory J. Swanson

/s/ James E. Crawford, III Director March 10, 2000
____________________________________
James E. Crawford, III

/s/ John A. Edwardson Director March 10, 2000
____________________________________
John A. Edwardson

/s/ Paul J. Finnegan Director March 10, 2000
____________________________________
Paul J. Finnegan

/s/ Richard D. Frisbie Director March 10, 2000
____________________________________
Richard D. Frisbie

/s/ James N. Perry, Jr. Director March 10, 2000
____________________________________
James N. Perry, Jr.

/s/ Paul G. Yovovich Director March 10, 2000
____________________________________
Paul G. Yovovich
</TABLE>

49
<PAGE>

EXHIBIT INDEX

<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description Location
------- ------------------- --------
<C> <S> <C>
2.1 Plan of Reorganization and Agreement by Incorporated by reference
and among Focal Communications
Corporation and its Subsidiaries, dated
June 12, 1997. (Incorporated by
reference to Exhibit No. 2.1 to the
Registrant's Registration Statement on
Form S-4 originally filed with the
Securities and Exchange Commission on
August 13, 1998 (Registration No. 333-
49397)

3.1 Form of Amended and Restated Certificate Incorporated by reference
of Incorporation. (Incorporated by
reference to Exhibit No. 3.3 of the
Registrant's Registration Statement on
Form S-1 originally filed with the
Securities and Exchange Commission on
May 7, 1999, as amended (Registration
No. 333-77995)

3.2 Form of Amended and restated By-Laws. Incorporated by reference

4.1 Indenture with Harris Trust and Savings Incorporated by reference
Bank, dated February 18, 1998.

4.2 Initial Global 12.125% Senior Discount Incorporated by reference
Note Due February 15, 2008, dated
February 18, 1998.

4.3 Stock Purchase Agreement with Madison Incorporated by reference
Dearborn Capital Partners, L.P.,
Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty, and Robert C.
Taylor Jr., dated November 27, 1996.

4.4 Amendment No. 1 to Stock Purchase Incorporated by reference
Agreement with Madison Dearborn Capital
Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F.
Addy, John R. Barnicle, Joseph Beatty,
and Robert C. Taylor Jr., dated January
23, 1998.

4.5 Amendment No. 2 to Stock Purchase Incorporated by reference
Agreement with Madison Dearborn Capital
Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F.
Addy, John R. Barnicle, Joseph Beatty
and Robert C. Taylor, Jr., dated as of
August 21, 1998. (Incorporated by
reference to Exhibit No. 4.8 to the
Registrant's Quarterly Report on Form
10-Q for the period ending September 30,
1998, originally filed with the
Securities and Exchange Commission on
November 16, 1998.

4.6 Vesting Agreement with Madison Dearborn Incorporated by reference
Capital Partners, L.P., Brian F. Addy,
John R. Barnicle, Joseph Beatty and
Robert C. Taylor, Jr., dated as of
November 27, 1996.

4.7 Vesting Agreement with Frontenac VI, Incorporated by reference
L.P., Brian F. Addy, John R. Barnicle,
Joseph Beatty and Robert C. Taylor, Jr.,
dated as of November 27, 1996.

4.8 Vesting Agreement with Battery Ventures Incorporated by reference
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty and Robert C.
Taylor, Jr., dated as of November 27,
1996.

4.9 Amendment No. 1 to Vesting Agreement and Incorporated by reference
Consent as of August 21, 1998, between
Focal Communications Corporation with
Madison Dearborn Capital Partners, L.P.,
Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty and Robert C.
Taylor, Jr., dated as of August 21,
1998.
</TABLE>

50
<PAGE>

<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description Location
------- ------------------- --------
<C> <S> <C>
4.10 Amendment No. 1 to Vesting Agreement and Incorporated by reference
Consent as of August 21, 1998, between
Focal Communications Corporation with
Madison Dearborn Capital Partners, L.P.,
Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty and Robert C.
Taylor, Jr., dated as of August 21,
1998.

4.11 Amendment No. 1 to Vesting Agreement and Incorporated by reference
Consent as of August 21, 1998, between
Focal Communications Corporation with
Madison Dearborn Capital Partners, L.P.,
Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty and Robert C.
Taylor, Jr., dated as of August 21,
1998.

4.12 Form of Restricted Stock Agreement, Incorporated by reference
dated September 30, 1998 between Focal
Communications Corporation and each of
Brian F. Addy, John R. Barnicle, Joseph
Beatty, and Robert C. Taylor, Jr.

4.13 Stockholders Agreement with Madison Incorporated by reference
Dearborn Capital Partners, L.P.,
Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty, and Robert C.
Taylor Jr., dated November 27, 1996.

4.14 Amendment No. 1 to Stockholders Incorporated by reference
Agreement with Madison Dearborn Capital
Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F.
Addy, John R. Barnicle, Joseph Beatty
and Robert C. Taylor, Jr., dated as of
July 7, 1998.

4.15 Amendment No. 2 to Stockholders Incorporated by reference
Agreement with Madison Dearborn Capital
Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F.
Addy, John R. Barnicle, Joseph Beatty
and Robert C. Taylor, Jr., dated as of
August 21, 1998.

4.16 Amendment No. 3 to Stockholders Incorporated by reference
Agreement with Madison Dearborn Capital
Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F.
Addy, John R. Barnicle, Joseph Beatty,
and Robert C. Taylor, Jr., dated
February 16, 1999.

4.17 Amendment No. 4 to Stockholders Incorporated by reference
Agreement with Madison Dearborn Capital
Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F.
Addy, John R. Barnicle, Joseph Beatty,
and Robert C. Taylor, Jr., dated May 21,
1999.

4.18 Executive Stock Agreement and Employment Incorporated by reference
Agreement with Brian F. Addy, dated
November 27, 1996.

4.19 Executive Stock Agreement and Employment Incorporated by reference
Agreement with John R. Barnicle, dated
November 27, 1996.

4.20 Executive Stock Agreement and Employment Incorporated by reference
Agreement with Joseph A. Beatty, dated
November 27, 1996.

4.21 Executive Stock Agreement and Employment Incorporated by reference
Agreement with Robert C. Taylor, Jr.,
dated November 27, 1996.

4.22 Amendment No. 1 to Executive Employment Incorporated by reference
Agreement and Consent with Brian F.
Addy, dated as of August 21, 1998.
</TABLE>

51
<PAGE>

<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description Location
------- ------------------- --------
<C> <S> <C>
4.23 Amendment No. 1 to Executive Employment Incorporated by reference
Agreement and Consent with John R.
Barnicle, dated as of August 21, 1998.

4.24 Amendment No. 1 to Executive Employment Incorporated by reference
Agreement and Consent with Joseph
Beatty, dated as of August 21, 1998.

4.25 Amendment No. 1 to Executive Employment Incorporated by reference
Agreement and Consent with Robert C.
Taylor, dated as of August 21, 1998.

4.26 Registration Agreement with Madison Incorporated by reference
Dearborn Capital Partners, L.P.,
Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty, and Robert C.
Taylor Jr., dated November 27, 1996.

4.27 Amendment No. 1 to Registration Incorporated by reference
Agreement with Madison Dearborn Capital
Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F.
Addy, John R. Barnicle, Joseph Beatty
and Robert C. Taylor, Jr., dated as of
August 21, 1998.

10.1 Interconnection Agreement with Ameritech Incorporated by reference
Information Industry Services, dated
October 28, 1996.

10.2 Interconnection Agreement with Ameritech Incorporated by reference
Information Industry Services, dated
October 24, 1997.

10.3 Interconnection Agreement with New York Incorporated by reference
Telephone Company, dated November 10,
1997.

10.4 Amended and Restated Interconnection Incorporated by reference
Agreement with Ameritech Information
Industry Services, dated March 16, 1998.

10.5 Interconnection Agreement with Bell Incorporated by reference
Atlantic-Pennsylvania, dated April 27,
1998.

10.6 Interconnection Agreement with Bell Incorporated by reference
Atlantic-Delaware, dated April 27, 1998.

10.7 Interconnection Agreement with Bell Incorporated by reference
Atlantic-New Jersey, dated April 27,
1998.

10.8 Interconnection Agreement with GTE-- Incorporated by reference
California, dated June 12, 1998.

10.9 Interconnection Agreement with Pacific Incorporated by reference
Bell, dated June 15, 1998.

10.10 Interconnection Agreement with Bell Incorporated by reference
Atlantic-District of Columbia dated
October 1, 1998.

10.11 Interconnection Agreement with Bell Incorporated by reference
Atlantic-Maryland dated October 2, 1998.

10.12 Interconnection Agreement with Bell Incorporated by reference
Atlantic-Virginia dated October 2, 1998.

10.13 Interconnection Agreement with U.S. Incorporated by reference
West-Washington State dated January 15,
1999.

</TABLE>

52
<PAGE>

<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description Location
------- ------------------- --------
<C> <S> <C>
10.14 Interconnection Agreement with Ameritech Incorporated by reference
Information Industry Services, on behalf
of and as agent for Ameritech Michigan
dated February 10, 1999.

10.15 Interconnection Agreement with Bell Incorporated by reference
Atlantic-Massachusetts dated February
15, 1999.

10.16 First Amendment to the Interconnection Incorporated by reference
Agreement with Ameritech Information
Industry Services, dated September 8,
1998.

10.17 Network Products Purchase Agreement with Incorporated by reference
Northern Telecom Inc., dated January 21,
1997.

10.18 Amendments No. 1 and No. 2 to Network Incorporated by reference
Products Purchase Agreement with
Northern Telecom Inc., both dated March
6, 1998.

10.19 Amendment No. 3 to Network Products Incorporated by reference
Purchase Agreement with Northern Telecom
Inc., dated March 25, 1999.

10.20 Software License with DPI/TFS, Inc., Incorporated by reference
dated April 10, 1997.

10.21 Second Amendment to Lease Agreement for Incorporated by reference
property located at 200 North LaSalle,
Chicago, IL, dated November 15, 1997.

10.22 Lease Agreement for property located at Incorporated by reference
200 North LaSalle, Chicago, IL, dated
December 31, 1996.

10.23 First Amendment to Lease Agreement for Incorporated by reference
property located at 200 North LaSalle,
Chicago, IL, dated May 14, 1997.

10.24 Loan and Security Agreement with NTFC Incorporated by reference
Capital Corporation dated December 30,
1998.
10.25 Amendment No. 1 to Loan and Security Incorporated by reference
Agreement with NTFC Capital Corporation
dated as of April 15, 1999.

10.26 Purchase Agreement with XCOM Incorporated by reference
Technologies, Inc., dated January 6,
1999.

10.27 Third Amendment to Lease Agreement for Incorporated by reference
property located at 200 North LaSalle,
Chicago, IL, dated March 2, 1998.

10.28 Fourth Amendment to Lease Agreement for Incorporated by reference
property located at 200 North LaSalle,
Chicago, IL, dated April 4, 1998.

10.29 Fifth Amendment to Lease Agreement for Incorporated by reference
property located at 200 North LaSalle,
Chicago, IL, dated October 14, 1998.

10.30 Sixth Amendment to Lease Agreement for Incorporated by reference
property located at 200 North LaSalle,
Chicago, IL, dated February 18, 1999.

10.31 Lease Agreement for property located at Incorporated by reference
32 Old Slip, New York, NY, dated May 20,
1997.

10.32 Lease Agreement for property located at Incorporated by reference
650 Townsend Street, San Francisco, CA,
dated January 26, 1998.

10.33 First Amendment to Lease Agreement for Incorporated by reference
property located at 650 Townsend Street,
San Francisco, CA, dated March 3, 1998.

</TABLE>

53
<PAGE>

<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description Location
------- ------------------- --------
<C> <S> <C>
10.34 Second Amendment to Lease Agreement for Incorporated by reference
property located at 650 Townsend Street,
San Francisco, CA, dated June 16, 1998.

10.35 Third Amendment to Lease Agreement for Incorporated by reference
property located at 650 Townsend Street,
San Francisco, CA, dated February 16,
1999.

10.36 Lease Agreement for property located at Incorporated by reference
701 Market Street, Philadelphia,
Pennsylvania, dated March 10, 1998.

10.37 Lease Agreement for property located at Incorporated by reference
1120 Vermont Avenue, NW., Washington,
D.C., dated as of May 4, 1998.

10.38 First Amendment to Lease Agreement for Incorporated by reference
property located at 1120 Vermont, NW,
Washington, D.C., dated July 23, 1998.

10.39 Lease Agreement for property located at Incorporated by reference
1200 West Seventh Street, Los Angeles,
California, dated as of May 19, 1998.

10.40 First Amendment to Lease Agreement for Incorporated by reference
property located at 1200 West 7th
Street, Los Angeles, CA, dated July 8,
1998.

10.41 Lease Agreement for property located at Incorporated by reference
1511 6th Avenue, Seattle, WA, dated
August 7, 1998.

10.42 Lease Agreement for property located at Incorporated by reference
23800 West Ten Mile Road, Southfield,
MI, dated August 31, 1998.

10.43 Lease Agreement for property located at Incorporated by reference
One Penn Plaza, New York, NY, dated
September 25, 1998.

10.44 Lease Agreement for property located at Incorporated by reference
1950 Stemmons Freeway, Dallas, TX, dated
December 15, 1998.

10.45 Lease Agreement for property located at Incorporated by reference
One Main Street, Cambridge, MA, dated
January 6, 1999.

10.46 Lease Agreement for property located at Incorporated by reference
250 Williams Street, Atlanta, GA, dated
February 5, 1999.

10.47 Lease Agreement for property located at Incorporated by reference
Christopher Columbus Drive & Washington
Street, Jersey City, NJ, dated February
19, 1999.

10.48 Employment Agreement with Renee M. Incorporated by reference
Martin, dated March 20, 1998.

10.49 Amendment No. 1 to Executive Employment Incorporated by reference
Agreement with Renee M. Martin, dated as
of August 21, 1998.

10.50 1997 Nonqualified Stock Option Plan, Incorporated by reference
amended and restated as of August 21,
1998.

10.51 Amendment to 1997 Nonqualified Stock Incorporated by reference
Option Plan (amended and restated as of
August 21, 1998), dated as of May 21,
1999.

10.52 Form of Amended and Restated Stock Incorporated by reference
Option Agreement.

10.53 1998 Equity and Performance Incentive Incorporated by reference
Plan.

10.54 1998 Equity Plan for Non-Employee Incorporated by reference
Directors.

10.55 Agreement for Sale of Real Property Incorporated by reference
between Focal Communications Corporation
and United Air Lines, Inc. dated August
13, 1998.

</TABLE>

54
<PAGE>

<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description Location
------- ------------------- --------
<C> <S> <C>
10.56 IRU Agreement dated April 28, 1999, by Incorporated by reference
and between Focal Financial Services,
Inc. and Level 3 Communications, LLC.

10.57 Private Line Service Agreement, dated Incorporated by reference
May 4, 1999, by and between Focal
Communications Corporation and WorldCom
Technologies, Inc.

10.58 Fiber Optic Network leased Fiber Incorporated by reference
Agreement between Metromedia Fiber
Network Services, Inc. and Focal
Financial Services, Inc., dated as of
May 24, 1999.

21.1 Subsidiaries of the Registrant. Incorporated by reference

23.1 Consent of Arthur Andersen LLP. Filed herewith

27.1 Financial Data Schedule. Filed herewith
</TABLE>

55
<PAGE>

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
Page
----
<S> <C>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS.................................. F-2

CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of December 31, 1999 and 1998............ F-3
Consolidated Statements of Operations for the Three Years Ended December
31, 1999............................................................... F-4
Consolidated Statements of Stockholders' Equity (Deficit) for the Three
Years Ended December 31, 1999.......................................... F-5

Consolidated Statements of Cash Flows for the Three Years Ended December
31, 1999................................................................. F-6

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS................................ F-7

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS.................................. F-21

SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS............................. F-22
</TABLE>

F-1
<PAGE>

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors of
Focal Communications Corporation:

We have audited the accompanying consolidated balance sheets of FOCAL
COMMUNICATIONS CORPORATION AND SUBSIDIARIES (a Delaware corporation) as of
December 31, 1999 and 1998, and the related consolidated statements of
operations, stockholders' equity (deficit) and cash flows for the three years
in the period ended December 31, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Focal
Communications Corporation and Subsidiaries as of December 31, 1999 and 1998,
and the results of its operations and its cash flows for the three years in
the period ended December 31, 1999, in conformity with generally accepted
accounting principles.

ARTHUR ANDERSEN LLP

Chicago, Illinois
February 9, 2000

F-2
<PAGE>

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

As of December 31, 1999 and 1998
(Dollars in thousands, except share amounts)

<TABLE>
<CAPTION>
1999 1998
-------- --------
ASSETS
------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................ $178,142 $126,041
Short-term investments................................... 10,000 7,960
Accounts receivable, net of allowance for doubtful
accounts of $7,700 and $1,189 at December 31, 1999 and
1998, respectively...................................... 27,247 9,792
Other current assets..................................... 4,543 844
-------- --------
Total current assets................................... 219,932 144,637
-------- --------
Property, Plant and Equipment, at cost..................... 224,470 76,120
Less--Accumulated depreciation and amortization.......... 28,169 6,147
-------- --------
Property, Plant and Equipment, net..................... 196,301 69,973
-------- --------
Other noncurrent assets.................................... 4,753 4,964
-------- --------
$420,986 $219,574
======== ========
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
<S> <C> <C>
Current liabilities:
Accounts payable......................................... $ 15,324 $ 12,421
Accrued liabilities...................................... 7,560 1,941
Current maturities of long-term debt..................... 9,252 2,887
-------- --------
Total current liabilities.............................. 32,136 17,249
-------- --------
Long-term debt, net of current maturities.................. 244,534 182,409
-------- --------
Other noncurrent liabilities............................... 1,829 588
-------- --------
Commitments and contingencies
Stockholders' equity:
Common Stock, $.01 par value; 100,000,000 shares
authorized; 60,748,981 and 48,687,000 shares issued and
outstanding at December 31, 1999 and 1998, respectively. 607 487
Additional paid-in capital............................... 177,535 34,927
Deferred compensation.................................... (1,919) (4,736)
Accumulated deficit...................................... (33,736) (11,350)
-------- --------
Total stockholders' equity............................. 142,487 19,328
-------- --------
$420,986 $219,574
======== ========
</TABLE>

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

F-3
<PAGE>

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

For the Three Years Ended December 31, 1999
(Dollars in thousands, except share amounts)

<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
REVENUES................................ $ 126,861 $ 43,532 $ 4,024
----------- ----------- -----------
EXPENSES:
Customer service and network
operations........................... 70,910 15,284 2,155
Selling, general and administrative... 32,486 12,210 2,887
Depreciation and amortization......... 23,763 6,671 616
Non-cash compensation expense......... 7,186 3,070 1,300
----------- ----------- -----------
Total expenses...................... 134,345 37,235 6,958
----------- ----------- -----------
OPERATING INCOME (LOSS)................. (7,484) 6,297 (2,934)
----------- ----------- -----------
OTHER INCOME (EXPENSE):
Interest income....................... 7,946 6,528 196
Interest expense, net................. (21,639) (16,134) (128)
Other income (expense)................ (609) -- --
----------- ----------- -----------
Total other income (expense)........ (14,302) (9,606) 68
----------- ----------- -----------
LOSS BEFORE INCOME TAXES................ (21,786) (3,309) (2,866)
PROVISION FOR INCOME TAXES.............. (600) (4,660) --
----------- ----------- -----------
Net loss................................ (22,386) (7,969) (2,866)
ACCRETION TO REDEMPTION VALUE OF CLASS A
COMMON STOCK........................... -- -- (104)
----------- ----------- -----------
Net loss applicable to Common
stockholders........................... $ (22,386) $ (7,969) $ (2,970)
=========== =========== ===========
BASIC NET LOSS PER SHARE OF COMMON
STOCK.................................. $ (0.45) $ (0.18) $ (0.07)
=========== =========== ===========
DILUTED NET LOSS PER SHARE OF COMMON
STOCK.................................. $ (0.45) $ (0.18) $ (0.07)
=========== =========== ===========
BASIC WEIGHTED AVERAGE NUMBER OF SHARES
OF COMMON STOCK OUTSTANDING............ 50,066,315 43,763,000 42,186,500
=========== =========== ===========
DILUTED WEIGHTED AVERAGE NUMBER OF
SHARES OF COMMON STOCK OUTSTANDING..... 50,066,315 43,763,000 42,186,500
=========== =========== ===========
</TABLE>

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

F-4
<PAGE>

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

For the Three Years Ended December 31, 1999
(Dollars in thousands, except common shares)

<TABLE>
<CAPTION>
Additional
Common paid -in Deferred Accumulated
Shares Amount Capital Compensation Deficit Total
---------- ------ ---------- ------------ ----------- --------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31,
1996................... 17,355,500 $174 $ 5,027 $(5,092) $ (515) $ (406)
Accretion of redeemable
Common Stock........... -- -- (104) -- -- (104)
Amortization of deferred
compensation........... -- -- -- 1,300 -- 1,300
Net loss................ -- -- -- -- (2,866) (2,866)
---------- ---- -------- ------- -------- --------
BALANCE, December 31,
1997................... 17,355,500 174 4,923 (3,792) (3,381) (2,076)
Reclassification
resulting from
amendment to stock
purchase agreement..... 40,153,500 401 12,002 -- -- 12,403
Issuance of Common
Stock.................. 33,500 -- 13,900 -- -- 13,900
Cancellation and
conversion of Common
Stock.................. (8,855,500) (88) 4,102 (4,014) -- --
Amortization of deferred
compensation........... -- -- -- 3,070 -- 3,070
Net loss................ -- -- -- -- (7,969) (7,969)
---------- ---- -------- ------- -------- --------
BALANCE, December 31,
1998................... 48,687,000 487 34,927 (4,736) (11,350) 19,328
Issuance of Common Stock 11,592,500 116 137,377 -- -- 137,493
Stock options exercised. 469,481 4 862 -- -- 866
Non-cash compensation... -- -- 4,369 -- -- 4,369
Amortization of deferred
compensation........... -- -- -- 2,817 -- 2,817
Net loss................ -- -- -- -- (22,386) (22,386)
---------- ---- -------- ------- -------- --------
BALANCE, December 31,
1999................... 60,748,981 $607 $177,535 $(1,919) $(33,736) $142,487
========== ==== ======== ======= ======== ========
</TABLE>

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

F-5
<PAGE>

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Three Years Ended December 31, 1999
(Dollars in thousands except share amounts)

<TABLE>
<CAPTION>
1999 1998 1997
--------- -------- -------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss....................................... $( 22,386) $ (7,969) $(2,866)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities--
Depreciation and amortization................ 23,763 6,671 616
Amortization of obligation under capital
lease....................................... 1,077 -- --
Non-cash compensation expense................ 7,186 3,070 1,300
Amortization of discount on senior discount
notes....................................... 20,713 16,080 --
Loss on disposal of fixed assets............. 609 -- --
Provision for losses on accounts receivable.. 7,090 720 469
Changes in operating assets and liabilities--
Accounts receivable......................... (24,545) (8,157) (2,825)
Related-party receivables................... -- 35 (18)
Other current assets........................ (3,699) (753) (91)
Accounts payable and accrued liabilities.... 8,522 12,491 1,602
Other non-current assets and liabilities,
net........................................ 219 319 179
--------- -------- -------
Net cash provided by (used in) operating
activities................................ 18,549 22,507 (1,634)
--------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures........................... (128,550) (64,229) (11,655)
Change in short-term investments............... (2,040) (7,960) --
--------- -------- -------
Net cash used in investing activities...... (130,590) (72,189) (11,655)
--------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt....... 31,768 163,103 3,697
Payments on long-term debt..................... (5,985) (3,537) (216)
Net proceeds from the issuance of Common Stock. 138,359 13,900 8,275
--------- -------- -------
Net cash provided by financing activities.. 164,142 173,466 11,756
--------- -------- -------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS..................................... 52,101 123,784 (1,533)
CASH AND CASH EQUIVALENTS
Beginning of period............................ 126,041 2,257 3,790
--------- -------- -------
CASH AND CASH EQUIVALENTS
End of period.................................. $ 178,142 $126,041 $ 2,257
========= ======== =======
</TABLE>

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

F-6
<PAGE>

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except share amounts)

1. ORGANIZATION AND OPERATIONS

Focal Communications Corporation began operations on May 31, 1996. Focal
Communications Corporation and Subsidiaries is a competitive local exchange
carrier ("CLEC") in the United States and offers a range of telecommunications
services. We compete with incumbent local exchange carriers ("ILECs") by
providing high-quality, local telecommunications services to meet the data,
voice and colocation transmission needs of its customers. Our customers
include large corporations, Internet service providers and value-added
resellers.

2. SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The 1999 and 1998 consolidated balance sheets include the accounts of all
our wholly owned subsidiaries. All material intercompany transactions and
balances have been eliminated in consolidation.

Basis of Accounting

The accompanying consolidated financial statements have been prepared in
accordance with U.S. generally accepted accounting principles ("GAAP").

Use of Estimates and Assumptions

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

Risks and Uncertainties

Reciprocal compensation payments are amounts paid by one carrier to send
particular traffic to another carrier's network. Reciprocal compensation is
currently a significant component of our total revenues representing
approximately 81%, 75%, 55%, and 36% of total revenues for 1997, 1998, 1999
and December of 1999, respectively. On July 1, 1999, we began to exclude
certain reciprocal compensation revenues generated from our operations in a
number of states where recent regulatory developments have impacted the
potential collection of reciprocal compensation receivables in those states.
We will recognize these revenues once we become certain that they are
collectible.

Ameritech is disputing its obligation to pay the reciprocal compensation
owed to us. This dispute was ruled on in our favor by the Illinois Commerce
Commission in March 1998, and by federal court in July 1998, and most recently
in June 1999 by the Seventh Circuit Court of Appeals. Substantially all of the
disputed amounts have since been collected. There is a risk that prior
decisions and any future appeal regarding the settlement of this dispute in
our favor could be revisited, which could allow Ameritech to obtain a refund
of prior reciprocal compensation payments.

As a result of several trends in our business and the current regulatory
environment, we expect revenues from reciprocal compensation to decline as a
percentage of total revenues. A reduction in or elimination of revenues
attributable to reciprocal compensation which is not offset by increases in
other revenues generated by us may have a material adverse effect on us and
our results of operations.

F-7
<PAGE>

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Concentration of Suppliers

We currently lease our transport capacity from a limited amount of
suppliers and are dependent upon the availability of fiber transmission
facilities owned by the suppliers. We are currently vulnerable to the risk of
renewing favorable supplier contracts, timeliness of the supplier in
processing our orders for customers and we are at risk to regulatory
agreements that govern the rates to be charged to us.

Financial Instruments

We consider all liquid interest-earning investments with a maturity of
three months or less at the date of purchase to be cash equivalents. Short-
term investments primarily consist of debt securities, which typically mature
between three months and one year from the purchase date and are held to
maturity and valued at amortized cost, which approximates fair value. The
carrying value for current assets and current liabilities as of December 31,
1999 and 1998 reasonably approximates fair value due to the nature of the
financial instrument and the short maturity of these items. Fair value for our
long-term debt is based on market quotes, where available or by discounting
expected cash flows at the rates currently offered to us for debt of the same
remaining maturities. The fair value of our long-term debt is approximately
$176,850 and $165,000 as of December 31, 1999 and 1998, respectively.

Revenue Recognition

Revenue is recognized as we provide services to our customers. Monthly
recurring charges include fees paid by customers for lines in service,
additional features on those lines and colocation space. These charges are
billed monthly, in advance, and are fully earned during the month. Usage
charges, initial, nonrecurring charges and reciprocal compensation charges are
billed in arrears and are fully earned when billed.

Depreciation and Amortization

Depreciation is provided on a straight-line basis over the estimated useful
lives of the assets as follows:

<TABLE>
<CAPTION>
Asset Description Useful Life
----------------- --------------------------------------
<S> <C>
Buildings and improvements......... 20 years
Communications network............. 3-8 years
Computer equipment................. 3 years
Leasehold improvements............. Shorter of asset life or life of lease
Furniture and fixtures............. 2-5 years
Motor vehicles..................... 2-3 years
</TABLE>

When depreciable assets are replaced or retired, the amounts at which such
assets were carried are removed from the respective accounts and charged to
accumulated depreciation and any gains or losses on disposition are recorded
currently in the consolidated statements of operations.

Maintenance and repairs are charged to expense as incurred, while major
replacements and improvements are capitalized.

Impairment of Long-Lived Assets

We periodically assess the recoverability of the carrying cost of our long-
lived assets based on a review of projected undiscounted cash flows related to
the asset held for use. If assets are determined to be impaired, then the
asset is written down to its fair value based on the present value of the
discounted cash flows of the

F-8
<PAGE>

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

related asset or other relevant measures (quoted market prices, third-party
offers, etc.). Based on our review, management does not believe that an
impairment of the long-lived assets has occurred.

Income Taxes

We account for income taxes in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes," pursuant
to which deferred income tax assets and liabilities are determined based on
the difference between the financial statement and tax bases of assets and
liabilities, using enacted tax rates currently in effect. State and local
taxes may be based on factors other than income.

Segment Information

In 1998, we adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information which requires a "management approach" to
segment information. The management approach designates the internal reporting
that is used by management for making operating decisions and assessing
performance as the source of our reportable segments. We operate in a single
industry segment, "Communication Services." Operations are managed and
financial performance is evaluated based on the delivery of multiple
communications services to customers over fiber networks. The adoption of SFAS
No. 131 did not affect our results of operations or financial position but did
affect the disclosure of segment information (Note 14).

Accretion to Redemption Value of Class A Common Stock

Accretion to redemption value of redeemable Class A Common Stock represents
the change in the redemption value of all outstanding Class A Common Stock
allocable to each period. The redemption values for all Class A Common shares
are based on fair market value and accretion is calculated using the effective
interest method (Note 12).

Comprehensive Income

In June, 1997, the Financial Accounting Standards Board issued SFAS No.
130, "Reporting Comprehensive Income." SFAS No. 130 established reporting and
disclosure requirements for comprehensive income and its components within the
financial statements. Other than net loss applicable to Common stockholders,
we had no comprehensive income components for the three years ended December
31, 1999.

Software Costs

Certain costs incurred in the development of internal use software are
capitalized in accordance with the Statement of Position 98-1, "Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use" and are
amortized over their appropriate useful lives.

Accounting for Derivative Instruments and Hedging Activities

In June, 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No.
133 requires that all derivatives be recognized at fair value as either assets
or liabilities. SFAS No. 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 standard must be adopted for years beginning after June 15, 2000. We
will adopt SFAS No. 133 during 2001, although adoption is not expected to have
a material effect on us based on the fact that we are not currently using
derivatives or participating in hedging activities.

Reclassifications

Certain prior-year amounts have been reclassified to conform to the 1999
and 1998 presentation. These changes had no impact on our previously reported
financial position or our results of operations.

F-9
<PAGE>

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

3. PROPERTY, PLANT AND EQUIPMENT

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, 1999
was $25,272 before the capitalization of $3,633 related to construction in
progress.

Property, plant and equipment consists of the following:
<TABLE>
<CAPTION>
December 31,
----------------
1999 1998
-------- -------
<S> <C> <C>
Building and improvements............................... $ 8,365 $ 2,350
Communications network.................................. 106,723 44,775
Computer equipment...................................... 11,646 3,503
Leasehold improvements.................................. 24,756 8,578
Furniture and fixtures.................................. 5,020 1,791
Motor vehicles.......................................... 152 19
Assets under capital lease.............................. 20,917 --
Construction in progress................................ 46,891 15,104
-------- -------
224,470 76,120
Less--Accumulated depreciation and amortization......... 28,169 6,147
-------- -------
Total............................................... $196,301 $69,973
======== =======
</TABLE>

4. LONG-TERM DEBT

In February 1998, we completed our offering of $270 million stated
principal amount at maturity of our 12.125% senior discount notes due 2008
(the "Notes"), which resulted in gross proceeds of $150,028. The Notes bear
interest at the rate of 12.125% per annum (computed on a semi-annual Note
equivalent basis) with an effective interest rate of approximately 11.81% for
1999 and 1998. In the period prior to February 15, 2003, interest will accrue
but will not be payable in cash.

From February 15, 2003, interest on the stated principal amount at maturity
of the Notes will be payable in cash semiannually on August 15 and February 15
of each year, beginning on August 15, 2003. Total interest expense for the
notes was $20,713 in 1999 and $16,080 in 1998.

The Notes are senior unsecured obligations of Focal's ranking pari passu in
right of payment with all other existing and future senior indebtedness of
ours, if any, and will rank senior in right of payment to all existing and
future subordinated indebtedness of Focal's, if any. Holders of secured
indebtedness of Focal's, however, will have claims that are prior to the
claims of the holders of the Notes with respect to the assets securing such
other indebtedness. The Notes will be effectively subordinated to all existing
and future indebtedness and other liabilities of our subsidiaries (including
accounts payable).

The Notes are redeemable, at our option, in whole or in part, at any time
or from time to time, on or after February 15, 2003, at 106.063% of their
stated principal amount at maturity, plus accrued and unpaid current interest,
declining ratably to 100% of their stated principal amount at maturity, plus
accrued and unpaid current interest, on or after February 15, 2006. In
addition, at any time and from time to time, prior to February 15, 2001, we
may redeem in the aggregate up to 35% of the original aggregate stated
principal amount at maturity of the Notes with the proceeds from one or more
public equity offerings, at a redemption price (expressed as a percentage of
accreted value on the redemption date) of 112.125%, plus additional interest,
if any, so long as at least 65% of the original aggregate stated principal
amount at maturity of the Notes remains outstanding after each such
redemption.

F-10
<PAGE>

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The Notes indenture contains certain covenants which, among other things,
restrict our ability and certain of our subsidiaries to incur additional
indebtedness (and, in the case of certain subsidiaries, issue preferred
stock), pay dividends or make distributions in respect of Focal's or such
subsidiaries' capital stock, make other restricted payments, enter into sale
and leaseback transactions, incur liens, cause encumbrances or restrictions to
exist on the ability of certain subsidiaries to pay dividends or make
distributions in respect of their capital stock, issue and sell capital stock
of certain subsidiaries, enter into transactions with affiliates, sell assets,
or amalgamate, consolidate, merge or sell or otherwise dispose of all or
substantially all of their property and assets. These covenants are subject to
exceptions and qualifications. We were in compliance with these covenants as
of December 31, 1999 and 1998.

We utilize a secured equipment term loan (the "Facility") from a third
party with a maximum borrowing level of $50,000. The Facility provides for,
among other things, equipment drawdowns through December 30, 1999, and
requires repayment based on 60 equal monthly installments of principal and
interest for each drawdown. All drawdowns under the Facility bear interest at
the five-year swap rate percent plus additional basis points, as defined in
the Facility. Total drawdowns of $44,214 and $19,193 were outstanding under
the Facility as of December 31, 1999 and 1998, respectively. The effective
interest rate for the drawdowns under the Facility was approximately 9.68% and
0% for 1999 and 1998, respectively. The Facility provides for certain
restrictive financial and non-financial covenants. Among other things, these
covenants require the maintenance of minimum cash flow and revenue levels. We
were in compliance with these covenants as of December 31, 1999 and 1998.
Total interest expense was $3,374 for 1999 and $0 for 1998.

On January 12, 2000, we completed our sale of $275 million of 11.875%
senior notes due 2010 (Note 16).

Long-term debt at December 31, 1999 and 1998, consists of the following:
<TABLE>
<CAPTION>
December 31,
-----------------
1999 1998
-------- --------
<S> <C> <C>
12.125% senior discount notes due 2008, net of unamortized
discount of $83,184 and $103,897 at December 31, 1999 and
1998, respectively......................................... $186,816 $166,103
Secured equipment term loan, maximum borrowing level at
$50,000.................................................... 44,214 19,193
Obligations under capital lease............................. 21,994 --
Term loan payable in monthly installments through June 2001
at an interest rate of 6.5%................................ 762 --
-------- --------
253,786 185,296
Less--Current maturities.................................... 9,252 2,887
-------- --------
Total................................................... $244,534 $182,409
======== ========
</TABLE>

Aggregate maturities of long-term debt outstanding as of December 31, 1999,
are as follows:

<TABLE>
<S> <C>
2000............................................................. $ 9,252
2001............................................................. 9,912
2002............................................................. 10,638
2003............................................................. 11,728
2004............................................................. 3,447
Thereafter....................................................... 199,557
--------
Total........................................................ $244,534
========
</TABLE>

F-11
<PAGE>

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

5. STOCK OPTIONS

We established the Focal Communications Corporation 1997 Non Qualified
Stock Option Plan (the "1997 Plan") effective February 27, 1997. The 1997 Plan
is administered by the compensation committee of our Board of Directors (the
"Board").

We adopted the Focal Communications Corporation 1998 Equity and Performance
Incentive Plan (the "1998 Plan") on August 21, 1998. The Board has sole and
complete authority to select participants and grant options, and other equity-
based instruments for our common stock.

On August 21, 1998, we also adopted the 1998 Equity Plan for Non-Employee
Directors of Focal Communications Corporation (the "1998 Non-Employee Plan").
The Board has sole and complete authority to select participants and grant
options for our common stock, as defined in the 1998 Non-Employee Plan.

The total number of shares available under the amended 1997 Plan, the 1998
Plan and the 1998 Non-Employee Plan shall not exceed 10,448,000 shares.

Under our stock option plans, the Board has complete discretion in
determining vesting periods and terms of each participant's options granted.
The options granted to participants under our stock option plans typically
vest at 25% on the first-year anniversary from grant date and vesting at 12.5%
every six months for the remainder of vesting years. The term of each option
has a life of 10 years. In addition, the plans provide for accelerated vesting
upon certain events, as defined.

The following summarizes option activity:

<TABLE>
<CAPTION>
Weighted
Average
Shares of Exercise Exercise
Common Stock Prices Price
------------ ------------ --------
<S> <C> <C> <C>
Outstanding at December 31, 1996........... -- $ -$ $ --
Granted during 1997........................ 611,000 0.58- 0.64 0.59
--------- ------------ -----
Outstanding at December 31, 1997........... 611,000 $0.58-$ 0.64 $0.59
Granted during 1998........................ 3,055,000 0.67- 3.00 2.46
Canceled during 1998....................... (71,000) 0.63- 3.00 1.28
--------- ------------ -----
Outstanding at December 31, 1998........... 3,595,000 $0.58-$ 3.00 $2.18
Activity for the year ended December 31,
1999:
Options Granted.......................... 3,570,775 $3.15-$25.00 $5.83
Options Exercised........................ (469,481) 0.58- 3.73 1.85
Options Canceled......................... (342,474) 2.21- 25.00 4.25
--------- ------------ -----
Outstanding at December 31, 1999........... 6,353,820 $0.58-$25.00 $4.14
========= ============ =====
</TABLE>

F-12
<PAGE>

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The following table summarizes information about fixed stock options
outstanding at December 31, 1998 and 1999:

<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------- --------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Options Contractual Exercise Options Exercise
Range of Exercise Prices Outstanding Life Price Exercisable Price
- ------------------------ ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$0.58-$0.67.............. 899,500 8.6 $ 0.62 284,500 $ 0.60
$2.10-$3.00.............. 2,695,500 9.6 2.70 252,000 3.00
--------- --- ------ ------- ------
At December 31, 1998..... 3,595,000 9.3 $ 2.18 536,500 $ 1.73
========= === ====== ======= ======
$0.58-$2.50.............. 1,550,873 7.9 $ 1.45 507,205 $ 1.25
$2.51-$5.00.............. 4,466,447 9.0 3.50 435,818 3.14
$22.00-$25.00............ 336,500 9.2 25.00 -- --
--------- --- ------ ------- ------
At December 31, 1999..... 6,353,820 8.7 $ 4.14 943,023 $ 2.12
========= === ====== ======= ======
</TABLE>

We have chosen to account for stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion ("APB") No. 25,
"Accounting for Stock Issued to Employees." Under APB No. 25, the exercise
price of the employee stock options equals the fair value of the underlying
stock on the date of grant and no compensation expense is recorded. We have
adopted the disclosure only provisions of the SFAS No. 123, "Accounting for
Stock-Based Compensation."

We utilize the Black-Scholes option pricing model to estimate the fair
value of options at the date of grant during 1999, 1998 and 1997. Had we
adopted SFAS No. 123, pro forma net loss and basic and diluted net loss per
share of Common Stock would have been approximately $(27,487) and $(.55),
$(8,603) and $(.20), and $(3,010) and $(.07) for the three years ended
December 31, 1999, respectively. The pro forma disclosure is not likely to be
indicative of pro forma results which may be expected in future years because
of the fact that options vest over several years, compensation expense is
recognized over the vesting period and additional awards may also be granted.

The Black-Scholes option model estimated the weighted average fair value at
the date of grant of options granted in 1999, 1998, and 1997 to be
approximately $5.76, $2.23 and $0.33 per option, respectively. The remaining
contractual life of all options was approximately nine years. Principal
assumptions used in applying the Black-Scholes model were as follows:

<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Risk-free interest rates.................... 5.6%-6.3% 4.4%-5.6% 5.6%-6.7%
Expected life............................... 5 years 5 years 5 years
Expected volatility......................... 92.3% 142.0% 41.7%
Expected dividend yield..................... -- -- --
======== ======== ========
</TABLE>

6. EQUITY TRANSACTIONS

During 1999, we granted 3,570,775 stock options to employees, directors,
and an outside consultant. Giving effect to our initial public offering, the
fair market value of our common stock exceeded the exercise price for
3,192,500 of the total stock options granted. In addition, we also sold
150,000 shares of common stock to a director during 1999, which was
retrospectively determined to be at a price below the fair market value. Total
non-cash compensation related to these 1999 transactions of approximately
$20,776 will be recognized, of which

F-13
<PAGE>

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

$1,505 was initially recorded during 1999 on the dates of each respective
transaction and the remaining $19,271 will be ratably charged to operations
over the respective vesting periods for the stock option grants. Total non-
cash compensation related to the grant to a consultant was charged to
operations over the consultant's service period through November 1999 in
accordance with SFAS No. 123. Non-cash expense relating to these transactions
totaling approximately $4,368 has been recorded during 1999.

On August 2, 1999, we sold 9,950,000 shares of our common stock in an
initial public offering ("IPO") at a price of $13 per share, which resulted in
net proceeds to us of approximately $119 million. In connection with the IPO,
our Board of Directors and stockholders authorized: (1) a recapitalization of
our existing Class A common stock, Class B common stock, and Class C common
stock into a single class of common stock; (2) an increase in the number of
authorized shares of common stock to 100,000,000 and the authorization of
2,000,000 shares of preferred stock; and (3) a 500 for-one stock split.

On August 19, 1999 pursuant to the terms of the underwriting agreement,
among us and our underwriters, our underwriters elected their option to
purchase an additional 1,492,500 shares of our common stock at $13 per share
which resulted in additional net proceeds to us of approximately $18 million.

During January 2000, we granted 150,000 shares of restricted stock to an
executive in connection with an employment agreement. The restricted stock
granted resulted in total non-cash compensation of approximately $6,000, which
will be ratably charged to operations over a three year vesting period.

7. INCOME TAXES

For the year ended December 31, 1999 and 1998, we recorded an income tax
provision of $600 and $4,660, respectively. Even though we reported a loss
before income taxes, we had positive taxable income and are paying income
taxes. This is primarily the result of the nondeductibility, for tax purposes,
of the interest accrued on our 12.125% discount Notes. This interest expense
is subject to the high yield discount obligation ("HYDO") rules which limits
the amount of original issue discount ("OID") which can be deducted in the
current taxable period. This interest will become deductible for tax purposes
in the period in which the Notes are redeemed or when the interest is paid.
There is no current or deferred tax expense for the year ended December 31,
1997. The deferred tax consequences related to the interest accrued and other
temporary differences in reporting items for financial statement and income
tax purposes are recognized, if appropriate. Realization of future tax
benefits related to the deferred tax assets is dependent on many factors,
including our ability to generate future taxable income. Management has
considered these factors and has concluded that a full valuation allowance for
financial reporting purposes is required for the deferred tax assets for these
periods.

F-14
<PAGE>

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The income tax provision for the year ended December 31, 1999 and 1998,
consists of the following:

<TABLE>
<CAPTION>
1999 1998
------ ------
<S> <C> <C>
Current taxes--
Federal................................................... $1,386 $4,100
State and local........................................... 114 560
------ ------
1,500 4,660
Deferred taxes--
Federal................................................... 900 --
State and local........................................... -- --
------ ------
Income tax provision.................................... $ 600 $4,660
====== ======
</TABLE>

Our federal income tax benefit at the statutory tax rate (34%) is
reconciled below to our overall provision for income taxes for the year ended
December 31, 1999 and 1998:

<TABLE>
<CAPTION>
1999 1998
------- -------
<S> <C> <C>
Benefit at U.S. statutory rate......................... $(7,407) $(1,125)
State and local taxes, net of U.S. federal tax benefit. (1,170) 560
Permanent items........................................ 1,250 1,044
Utilization of net operating loss carryback............ (900) --
Increase in valuation allowance........................ 7,019 4,005
Alternative minimum tax................................ 1,364 --
Other, net............................................. 444 176
------- -------
Provision for income taxes........................... $ 600 $ 4,660
======= =======
</TABLE>

The income tax effect of temporary differences comprising the net deferred
tax assets and tax liabilities as of December 31, 1999 and 1998 consists of
the following:

<TABLE>
<CAPTION>
1999 1998
------- -------
<S> <C> <C>
Deferred income tax liabilities--
Depreciation......................................... $(4,009) $(2,331)
Other................................................ (3,778) --
------- -------
(7,787) (2,331)
Deferred income tax assets--
Net operating loss carryback......................... 900 --
Interest on 12.125% discount notes................... 14,715 6,432
Allowance for doubtful accounts...................... 3,080 476
Employment related accruals.......................... 525 130
Other................................................ 1,193 --
------- -------
20,413 7,038
Less--Valuation allowance.............................. (11,726) (4,707)
------- -------
Net deferred tax assets............................ $ 900 $ --
======= =======
</TABLE>

We have a net operating loss which may be carried back and a alternative
minimum tax ("AMT") credit carryforward as of December 31, 1999, totaling
approximately $900 and $1,364, respectively. The AMT benefit has not been
recorded as an asset due to the uncertainty of its realization. The AMT credit
does not expire and will be used to offset our future regular federal income
tax liability. We expect to realize the $900 net operating loss during 1999
which will be carried back to recover a portion of our 1998 regular federal
income taxes paid.

F-15
<PAGE>

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

8. INCOME (LOSS) PER SHARE

We compute basic earnings per common share based on the weighted average
number of shares of common stock outstanding for the period. This calculation
excludes certain unvested shares of common stock held by our executives.
Diluted earnings per common share are adjusted for the assumed exercise of
dilutive stock options and unvested shares of common stock. Since the
adjustments required for the calculation of diluted weighted average common
shares outstanding are anti-dilutive, this calculation has been excluded from
the loss per share calculation for the three years ended December 31, 1999.
Our basic and diluted weighted average number of shares outstanding at
December 31, 1999, 1998, and 1997 are as follows:

<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Basic Weighted Average Number of Common
Shares Outstanding..................... 50,066,315 43,763,000 42,186,500
Dilutive Stock Options and Unvested
Common Shares.......................... 4,735,604 5,521,500 6,024,000
---------- ---------- ----------
Dilutive Weighted Average Number of
Common Shares Outstanding.............. 54,801,919 49,284,500 48,210,500
========== ========== ==========
</TABLE>

9. EMPLOYEE BENEFIT PLAN

We have a 401(k) Plan (the "Plan") covering substantially all eligible
employees. Under the Plan, participants may make pretax contributions from 1%
to 15% of eligible earnings, as defined. We may elect to contribute to the
Plan at our discretion. We made no contributions to the Plan for the year
ended December 31, 1997. In February, 1998, we elected to match 30% of the
first 10% that an employee contributes to the Plan. Our matching contributions
totaled approximately $430, $145 and $0 for 1999, 1998, and 1997,
respectively.

10. COMMITMENTS AND CONTINGENCIES

Under the terms of various short- and long-term contracts, we are obligated
to make payments for office rents and for leasing components of our
communications network through 2019. The office rent contracts provide for
certain scheduled increases and for possible escalation of basic rentals based
on a change in the cost of living or on other factors. We expect to enter into
other contracts for additional components of our communications network,
office space, other facilities, equipment and maintenance services in the
future.

A summary of such fixed commitments at December 31, 1999, are as follows:

<TABLE>
<CAPTION>
Year Amount
---- --------
<S> <C>
2000............................................................. $ 29,351
2001............................................................. 24,370
2002............................................................. 26,259
2003............................................................. 26,140
2004............................................................. 18,370
Thereafter....................................................... 71,358
--------
Total........................................................ $195,848
========
</TABLE>

Rent expense under operating leases for office rent and rent for leasing
components of our communications network was approximately $5,093, $1,522 and
$651 for 1999, 1998, and 1997, respectively.

F-16
<PAGE>

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

During 1999, we entered into agreements with carriers for the acquisition
of indefeasible rights of use for dark fiber transport capacity for a minimum
of 10,800 fiber miles. The terms of the agreements are for 20 years with a
total minimum commitment of approximately $71 million. One of these agreements
has been accounted for as a capital lease (Note 4). We also signed an
agreement with a carrier for the lease of fiber transport capacity for a five
year term and a minimum commitment of $70 million. We have committed to $10
million in year one; $13.2 million in year two; and $15.6 million for each of
the remaining three years of the agreement.

We are party to a products purchase agreement with a vendor that expires
December 31, 2002. This agreement requires us to place orders for certain
network products in a minimum aggregate amount over the term of the agreement
of $75 million.

11. STOCK PURCHASE AGREEMENT

On November 27, 1996, we entered into a Stock Purchase Agreement (the
"Agreement") with Institutional Investors and Executives ("Investors"), as
defined. The Agreement resulted in 39,692,000 shares of Class A Common Stock,
par value $.01 per share being issued for an aggregate purchase price of
$4,000 and subsequent transactions in which Investors were required to make
pro rata contributions to our capital (with no additional shares being issued)
of up to an additional $21,800 (total investment of up to $25,800). Total
capital contributions received by us for the issuance of Class A Common were
$4,000, $8,280 and $13,900, respectively, for the period from May 31, 1996, to
December 31, 1996, and for the years ended December 31, 1998 and 1997,
respectively.

Subsequent to the closing of the Agreement, we sold 38,500 shares and
423,000 shares of Class A Common shares to Designees (as defined in the
Agreement) of the Institutional Investors, for a total purchase price of $25
and $275 for the period from May 31, 1996 to December 31, 1996 and for the
year ended December 31, 1997, respectively.

As part of the Agreement, the existing Common Stock held by the Executives
was converted into newly issued Class B Common and Class C Common shares (the
"Exchange"). The closing of the Exchange and issuance of Class B Common and
Class C Common shares took place simultaneously with the initial closing of
the issuance of Class A Common shares under the Agreement. In connection with
this transaction, compensation expense totaling approximately $5,200 will be
charged to income over the vesting period of the Class B Common shares issued
that did not vest immediately. Total non-cash compensation expense of $1,300,
$1,300, and $2,492 was recorded for the three years ended December 31, 1999,
respectively.

We amended certain vesting agreements of the Executives and Institutional
Investors on September 30, 1998, which effected the cancellation of 6,355,500
shares of our Class C Common Stock then outstanding, cancellation of 2,500,000
shares of the Company's Class A Common Stock held by certain institutional
shareholders and the conversion of 1,000,000 shares of the Company's Class C
Common Stock into Class B Common Stock. The new converted Class B Common Stock
is subject to certain restrictions, and was issued to our executives (founding
shareholders) in satisfaction of the obligations of Focal and such
shareholders set forth in certain vesting agreements as defined in the
Agreement. In connection with such transactions, non-cash compensation expense
totaling approximately $4,000 will be charged to income over the vesting
period of the restricted Class B Common shares issued. Total non-cash
compensation expense relating to this matter of $326 and $1,770 was recorded
during 1999 and 1998, respectively.

In connection with our IPO that was completed on August 2, 1999 (Note 6),
our Board of Directors and stockholders authorized, among other things, a
recapitalization of our existing Class A common stock, Class B common stock,
and Class C common stock into a single class of common stock.

A summary of the Company's Class A and B Common Stock before our
recapitalization on August 2, 1999 is as follows:

Class A Common--A total of 50,000,000 shares are authorized, of which
37,687,000 were issued and outstanding as of December 31, 1998.
Institutional Investors, as defined, who hold Class A Common shares

F-17
<PAGE>

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

had the right to put the shares to us at fair market value but the
Agreement was amended and the put right was replaced by a provision which
would require us to voluntarily liquidate (Note 12). The Class A Common
Stock held by Institutional Investors have demand registration rights; all
Class A Common stockholders have voting rights, piggyback registration
rights, participate in earnings and dividends and other preference
features, as defined.

Class B Common--A total of 17,500,000 shares have been authorized and
11,000,000 shares are issued and outstanding as of December 31, 1998. Class
B Common stockholders have demand registration rights, voting rights,
piggyback registration rights, participate in earnings and dividends and
other preference features, as defined. The Class B Common issued upon the
Exchange will vest 20% on the closing of the Agreement and 20% on each of
the four anniversaries of the closing date of the Agreement. Accelerated
vesting will occur on the dates of certain (as defined) events: (a)
qualified sale of the Company; (b) qualified reorganization; and (c) public
offering of the Company's stock. The vesting of the Class B Common
accelerated by an additional 20% in connection with our IPO on August 2,
1999 (Note 6). For the Class B Common converted from Class C Common, the
Restricted Stock Agreement ("RSA") provides, among other things, vesting of
20% at the closing of the RSA (September 30, 1998), 10%, 15%, 20% and 35%
on each of the consecutive anniversaries of the closing of the RSA,
respectively, with immediate vesting upon a Change in Control, as defined
in the RSA.

12. REDEEMABLE COMMON STOCK

As defined in the Agreement (Note 11), Institutional Investors which hold
an aggregate of 39,230,500 shares of Class A Common shares had the right to
put the shares to Focal on or after November 27, 2003, at the greater of the
initial purchase price per share of Class A Common owned by the Institutional
Investors or fair market value, as defined in the Agreement. On January 23,
1998, the Agreement was amended and the aforementioned put right was replaced
by a provision which would allow the Class A Common Institutional Investors,
Executive Investors and Designees of Institutional Investors, as defined, to
require us to voluntarily liquidate. The Institutional Investors at any time
and from time to time on or after November 27, 2003, but not after the
consummation of a public offering, shall have the right to require us to
voluntarily liquidate our assets. Upon receipt of notice of the required
liquidation, we may elect to purchase all but not less than all of the
Institutional Investors' Class A Common shares.

Although management had not obtained an appraisal of the fair market value
of Focal during 1997, certain public equity transactions have occurred within
the industry upon which management has based its estimate on the potential
redemption value of the aforementioned shares to be $0.67 per share as of
December 31, 1997. We recorded accretion totaling $104 for the year ended
December 31, 1997.

13. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Cash paid for interest and non-cash investing and financing activities for
the three years ended December 31, 1999 was as follows:

<TABLE>
<CAPTION>
1999 1998 1997
------- ---- ----
<S> <C> <C> <C>
Cash paid during the year for interest.................. $ 3,398 $ 69 $ 94
Fixed assets acquired under capital leases.............. $20,917 $-- $ 69
Payments made under capital leases...................... $ -- $ 52 $ 13
Accretion to redemption value of Class A Common Stock... $ -- $-- $104
Cash paid for income taxes.............................. $ 3,217 $605 $--
</TABLE>

14. SEGMENT INFORMATION

We are organized primarily on the basis of strategic geographic operating
segments that provide communications services in each respective geographic
region. All of our geographic operating segments have

F-18
<PAGE>

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

been aggregated into one reportable segment, "Communications Services," for
the year and as of December 31, 1999 and 1998.

The accounting policies of the segments are the same as those described in
the "Summary of Significant Accounting Policies." Our chief operating decision
maker views earnings before interest, taxes, depreciation and amortization
("EBITDA") as the primary measure of profit and loss. The following represents
information about revenues and EBITDA which excludes non-cash compensation,
total assets and capital expenditures for the Communications Services
reportable segment as of and for the years ended December 31, 1999, 1998 and
1997:

<TABLE>
<CAPTION>
1999 1998 1997
-------- ------- ------
<S> <C> <C> <C>
Revenues......................................... $126,861 $43,532 $4,024
EBITDA........................................... 18,996 15,161 (987)
Total assets..................................... 202,324 73,437 13,007
Capital expenditures............................. 128,550 64,229 11,655
======== ======= ======
</TABLE>

The following reconciles total segment EBITDA to our consolidated net loss
before income taxes for the three years ended December 31, 1999:

<TABLE>
<CAPTION>
1999 1998 1997
-------- ------- -------
<S> <C> <C> <C>
Total EBITDA for reportable segment.......... $ 18,996 $15,161 $ (986)
Corporate EBITDA............................. 4,469 877 (32)
Depreciation and amortization................ (23,763) (6,671) (616)
Interest expense............................. (21,639) (16,134) (128)
Interest income.............................. 7,946 6,528 196
Other income (expense)....................... (609) -- --
Non-cash compensation........................ (7,186) (3,070) (1,300)
-------- ------- -------
Net loss before income
Taxes..................................... $(21,786) $(3,309) $(2,866)
======== ======= =======
</TABLE>

The following reconciles our total segment assets to our consolidated total
assets as of December 31, 1999 and 1998:

<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
Total assets for reportable segment..................... $202,324 $ 73,437
Cash, cash equivalents and short-term investments....... 188,142 133,307
Other current assets.................................... 3,745 1,125
Fixed assets, net....................................... 22,022 6,741
Other noncurrent assets................................. 4,753 4,964
-------- --------
Total consolidated assets............................. $420,986 $219,574
======== ========
</TABLE>

We currently operate solely in the United States. Revenues by major
customer for the years ended December 31, 1999, 1998 and 1997 are as follows:

<TABLE>
<CAPTION>
1999 1998 1997
------- ------- ------
<S> <C> <C> <C>
Revenues from major customer A.................... $54,380 $25,747 $3,267
Revenues from major customer B.................... $25,562 $ 6,736 $ --
======= ======= ======
</TABLE>

F-19
<PAGE>

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

15. SELECTED QUARTERLY INFORMATION (UNAUDITED)

<TABLE>
<CAPTION>
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
1997--
Revenues.................. $ -- $ 87 $ 1,226 $ 2,711
Loss from operations...... (757) (1,146) (786) (245)
Net loss applicable to
Common stockholders...... (741) (1,119) (791) (319)
======= ======= ======= =======
Basic and diluted net loss
per share................ $ (0.02) $ (0.03) $ (0.02) $ (0.01)
======= ======= ======= =======
1998--
Revenues.................. $ 5,103 $ 8,078 $12,755 $17,596
Income from operations.... 753 1,886 419 3,239
Net loss.................. (341) (583) (4,654) (2,391)
======= ======= ======= =======
Basic and diluted net loss
per share................ $ (0.01) $ (0.01) $ (0.11) $ (0.06)
======= ======= ======= =======
1999--
Revenues.................. $26,004 $30,327 $34,484 $36,046
Income (loss) from
operations............... 4,381 2,673 (4,123) (10,415)
Net income (loss)......... 284 ( 2,302) (10,834) (9,534)
======= ======= ======= =======
Basic net income per
share.................... $ 0.01 $ (0.05) $ (0.20) $ (0.16)
======= ======= ======= =======
Diluted net income per
share.................... $ 0.01 $ (0.05) $ (0.20) $ (0.16)
======= ======= ======= =======
</TABLE>

We calculated earnings per share on a quarter-by-quarter basis in
accordance with GAAP. Quarterly EPS figures may not total EPS for the year due
to the weighted average number of shares outstanding.

16. SUBSEQUENT EVENT

On January 12, 2000, we received $265.7 million in gross proceeds from the
issue of our $275 million aggregate principal amount of 11 7/8% Senior Notes
("Senior Notes") due January 15, 2010 in a private placement to qualified
institutional investors. The proceeds, together with amounts available from
our existing cash balances and future cash flow from ongoing operations, will
be used to finance the cost to acquire equipment and network assets, to fund
operating losses, for working capital and potential acquisitions, and for
general corporate purposes. The Senior Notes Interest Payment Dates are July
15 and January 15, commencing July 15, 2000.

F-20
<PAGE>

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors of Focal Communications Corporation:

Our audits were made for the purpose of forming an opinion on the
consolidated financial statements taken as a whole. The schedule of Valuation
and Qualifying Accounts as of and for the three years ended December 31, 1999,
is presented for purposes of additional analysis and is not a required part of
the consolidated financial statements of Focal Communications Corporation and
Subsidiaries. Such information has been subjected to the auditing procedures
applied in the audits of the consolidated financial statements and, in our
opinion, is fairly stated in all material respects in relation to the
consolidated financial statements taken as a whole.

ARTHUR ANDERSEN LLP

Chicago, Illinois
February 9, 2000

F-21
<PAGE>

Schedule II

FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
Balance at
the
Beginning Charged to Balance at
of the Cost and the End of
Accounts Period Expense Deductions the Period
- -------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
1997:
Allowance for Doubtful Accounts... $ -- $ 469 $ -- $ 469
1998:
Allowance for Doubtful Accounts... $ 469 $1,348 $628 $1,189
1999:
Allowance for Doubtful Accounts... $1,189 $7,090 $579 $7,700
</TABLE>

F-22

<PAGE>

Exhibit 23.1

CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

As independent public accountants, we hereby consent to the incorporation of
our reports included in this Form 10-K into Focal Communications Corporation's
previously filed Registration Statement Files No. 333-49397 on Form S-4 and No.
333-77995 on Form S-1.

<PAGE>

<ARTICLE> 5
<LEGEND> This schedule contains summary financial information extracted from
consolidated balance sheets as of December 31, 1999 and 1998 and statement of
operations for the years ended December 31, 1999 and 1998 and is qualified in
its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000

<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1998
<PERIOD-START> JAN-01-1999 JAN-01-1998
<PERIOD-END> DEC-31-1999 DEC-31-1998
<CASH> 178,142 126,041
<SECURITIES> 10,000 7,960
<RECEIVABLES> 34,947 10,981
<ALLOWANCES> (7,700) (1,189)
<INVENTORY> 0 0
<CURRENT-ASSETS> 219,932 144,637
<PP&E> 224,470 76,120
<DEPRECIATION> (28,169) (6,147)
<TOTAL-ASSETS> 420,986 219,574
<CURRENT-LIABILITIES> 32,136 17,249
<BONDS> 253,786 185,296
0 0
0 0
<COMMON> 607 487
<OTHER-SE> 141,880 18,841
<TOTAL-LIABILITY-AND-EQUITY> 420,986 219,574
<SALES> 126,861 43,532
<TOTAL-REVENUES> 126,861 43,532
<CGS> 0 0
<TOTAL-COSTS> 134,345 37,235
<OTHER-EXPENSES> 609 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 21,639 16,134
<INCOME-PRETAX> (21,786) (3,309)
<INCOME-TAX> (600) (4,660)
<INCOME-CONTINUING> (22,386) (7,969)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (22,386) (7,969)
<EPS-BASIC> (.45) (.18)
<EPS-DILUTED> (.45) (.18)

</TABLE>