NORTHEAST OPTIC NETWORK INC, 10-Q, 2000-11-14

NORTHEAST OPTIC NETWORK INC
10-Q, 2000-11-14
TELEPHONE COMMUNICATIONS (NO RADIOTELEPHONE)

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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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

FORM 10-Q

(MARK ONE)

<TABLE>
<C> <S>
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
</TABLE>

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
OR

<TABLE>
<C> <S>
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
</TABLE>

FOR THE TRANSITION PERIOD ______________ TO ______________

<TABLE>
<CAPTION>
COMMISSION EXACT NAME OF REGISTRANTS AS SPECIFIED IN THEIR CHARTERS; STATES OF INCORPORATION; IRS EMPLOYER
FILE ADDRESSES, INCLUDING ZIP CODE, AND TELEPHONE NUMBERS, INCLUDING AREA CODE, OF IDENTIFICATION
NUMBER REGISTRANTS' PRINCIPAL EXECUTIVE OFFICES NUMBER
--------------------- ---------------------------------------------------------------------------------- --------------
<C> <S> <C>
000-31531 NEON Communications, Inc. (a Delaware corporation) 04-3523408
2200 West Park Drive
Westborough, Massachusetts 01581
(508) 616-7800

000-24653 NEON Optica, Inc. (a Delaware corporation) 04-3056279
04-3056279 c/o NEON Communications, Inc.
2200 West Park Drive
Westborough, Massachusetts 01581
(508) 616-7800
</TABLE>

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

Indicate by check mark whether the registrants: (1) have 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) have been subject to such
filing requirements for the past 90 days.

NEON Communications, Inc.: Yes / / No /X/

NEON Optica, Inc.: Yes /X/ No / /

**As of September 30, 2000, there were 18,730,544 outstanding shares of the
common stock, $0.01 par value per share, of NEON Communications, Inc., and 100
outstanding shares of the common stock, $0.01 par value per share, of NEON
Optica, Inc.

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<PAGE>
TABLE OF CONTENTS

PART I: FINANCIAL INFORMATION

<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
ITEM 1: FINANCIAL STATEMENTS

NEON Communications, Inc. Condensed Consolidated Balance
Sheets (Unaudited)........................................ 2
NEON Communications, Inc. Condensed Consolidated Statements
of Operations (Unaudited)................................. 3
NEON Communications, Inc. Condensed Consolidated Statements
of Cash Flows (Unaudited)................................. 4
Notes to NEON Communications, Inc. Interim Condensed
Consolidated Financial Statements (Unaudited)............. 5
NEON Optica, Inc. Condensed Consolidated Balance Sheets
(Unaudited)............................................... 10
NEON Optica, Inc. Condensed Consolidated Statements of
Operations (Unaudited).................................... 11
NEON Optica, Inc. Condensed Consolidated Statements of Cash
Flows (Unaudited)......................................... 12
Notes to NEON Optica, Inc. Interim Condensed Consolidated
Financial Statements (Unaudited).......................... 13

ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS....................... 17

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK............................................... 30
</TABLE>

PART II: OTHER INFORMATION

<S> <C>
Item 2. Changes in Securities and Use of Proceeds........... 31
Item 4. Submission of Matters to a Vote of Security
Holders................................................... 31
Item 5. Other Information................................... 32
Item 6. Exhibits and Reports on Form 8-K.................... 32

Signatures.................................................. 33
Exhibit Index............................................... 34
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

FINANCIAL STATEMENTS OF NEON COMMUNICATIONS, INC.

NEON COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 40,318,924 $ 4,768,389
Short-term restricted cash and investments................ 24,169,717 22,518,611
Short-term investments.................................... -- 66,803,311
Accounts receivable, net.................................. 2,482,196 1,858,201
Prepaid expenses and other current assets................. 925,425 494,323
------------- ------------
Total current assets.................................. 67,896,262 96,442,835
Property and Equipment, net................................. 141,279,759 94,924,843
Restricted Cash and Investments............................. 10,712,648 31,693,543
Intangible and Other Assets, net............................ 56,428,891 57,572,155
------------- ------------
$ 276,317,560 $280,633,376
============= ============

LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................... $ 2,321,900 $ 3,783,354
Accounts payable--communications network.................. 25,257,610 9,438,350
Accrued expenses.......................................... 7,765,745 13,348,296
Accrued right-of-way fees, related party.................. 679,531 886,322
Deferred revenue.......................................... 77,760 58,380
------------- ------------
Total current liabilities............................. 36,102,546 27,514,702
Deferred Revenue, net of Current Portion.................... 912,321 969,026
Long-Term Accounts Payable--Communications Network.......... 7,733,184 4,682,858
Long-Term Obligations....................................... 180,000,000 180,000,000
Contingencies (Note 6)
Stockholders' Equity:
Common stock, $0.01 par value--
Authorized--60,000,000 shares; 18,753,869 and 16,393,534
shares issued and outstanding as of September 30, 2000
and December 31, 1999, respectively................... 187,539 163,935
Restricted common stock (Note 2).......................... 25,804 --
Subscription receivable (Note 2).......................... (167,431,217) --
Additional paid-in capital................................ 289,660,704 110,072,881
Accumulated deficit....................................... (70,873,321) (42,770,026)
------------- ------------
Total stockholders' equity............................ 51,569,509 67,466,790
------------- ------------
$ 276,317,560 $280,633,376
============= ============
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.

2
<PAGE>
NEON COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- ---------------------------
2000 1999 2000 1999
------------ ----------- ------------ ------------
<S> <C> <C> <C> <C>
Revenues:
Network services...................... $ 3,136,374 $ 949,035 $ 7,109,486 $ 1,980,477
Other services........................ 1,084,915 670,382 3,273,535 1,202,741
------------ ----------- ------------ ------------
Total revenues.................... 4,221,289 1,619,417 10,383,021 3,183,218
------------ ----------- ------------ ------------
Expenses:
Cost of revenues...................... 2,849,806 1,843,655 7,673,304 4,221,186
Selling, general and administrative... 4,850,581 1,614,575 10,413,889 5,047,747
Depreciation and amortization......... 3,078,583 1,904,083 8,419,636 3,904,934
------------ ----------- ------------ ------------
Total expenses.................... 10,778,970 5,362,313 26,506,829 13,173,867
------------ ----------- ------------ ------------
Loss from operations.............. (6,557,681) (3,742,896) (16,123,808) (9,990,649)
------------ ----------- ------------ ------------
Other Income (Expense):
Interest income and other, net........ 1,103,195 1,816,213 3,996,640 6,058,878
Interest expense...................... (5,287,652) (5,356,351) (15,976,127) (15,525,621)
------------ ----------- ------------ ------------
Total other income (expense)...... (4,184,457) (3,540,138) (11,979,487) (9,466,743)
------------ ----------- ------------ ------------
Net Loss................................ $(10,742,138) $(7,283,034) $(28,103,295) $(19,457,392)
============ =========== ============ ============
Basic and Diluted Loss per Share........ $ (0.63) $ (0.45) $ (1.68) $ (1.21)
============ =========== ============ ============
Basic and Diluted Weighted Average
Shares Outstanding.................... 17,056,292 16,222,425 16,729,330 16,124,868
============ =========== ============ ============
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.

3
<PAGE>
NEON COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------
2000 1999
------------ ------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net loss.................................................. $(28,103,295) $(19,457,392)
Adjustments to reconcile net loss to net cash used in
operating activities--
Compensation expense related to the issuance of stock
options to non-employees.............................. -- 293,441
Depreciation and amortization........................... 8,419,636 3,904,934
Amortization of deferred financing costs................ 469,983 469,983
Changes in assets and liabilities--
Accounts receivable................................... (623,995) (1,180,380)
Refundable taxes from related party................... -- 755,838
Prepaid expenses and other current assets............. (431,102) (293,876)
Accounts payable...................................... (1,461,454) 802,678
Accrued expenses...................................... (5,789,342) (6,979,620)
Deferred revenue...................................... (37,325) (114,973)
------------ ------------
Net cash (used in) operating activities............. (27,556,894) (21,799,367)
------------ ------------
Cash Flows from Investing Activities:
Sales (Purchases) of short-term investments, net.......... 66,803,311 (24,945,517)
Purchases of property and equipment....................... (53,577,618) (39,594,012)
Increase in intangible and other assets................... (523,653) (449,504)
------------ ------------
Net cash provided by (used in) investing
activities........................................ 12,702,040 (64,989,033)
------------ ------------
Cash Flows from Financing Activities:
Increase in construction and long-term accounts payable... 18,869,586 13,312,989
Payments on long-term obligations......................... -- (127,619)
Decrease in restricted cash and investments............... 19,329,789 21,019,754
Proceeds from issuance of common stock and restricted
common stock, net....................................... 8,672,561 --
Proceeds from exercise of stock options and warrants...... 3,533,453 631,865
------------ ------------
Net cash provided by financing activities........... 50,405,389 34,836,989
------------ ------------
Net Increase (Decrease) in Cash and Cash Equivalents........ 35,550,535 (51,951,411)
Cash and Cash Equivalents, beginning of period.............. 4,768,389 57,737,792
------------ ------------
Cash and Cash Equivalents, end of period.................... $ 40,318,924 $ 5,786,381
============ ============
Supplemental Disclosure of Cash Flow information:
Cash paid during the period for--
Interest................................................ $ 23,052,502 $ 23,943,837
============ ============
Supplemental Disclosure of Non-Cash Financing Information
Subscription receivable................................. $167,431,217 $ --
============ ============
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.

4
<PAGE>
1. OPERATIONS

NEON Communications, Inc. (the Company or NEON) and its subsidiary are
engaged in the ownership, management, operation and installation of fiber optic
telecommunication networks in the Northeast and Mid-Atlantic regions of the
United States.

To date, the Company has recorded revenues principally from contract and
other services and has incurred cumulative operating losses of approximately
$71,000,000. The market for fiber optic telecommunications in which the Company
operates is changing rapidly due to technological advancements, the introduction
of new products and services and the increasing demands placed on equipment in
worldwide telecommunications networks. The Company is dependent upon a single or
limited source of suppliers for a number of components and parts. Shortages
resulting from a change in arrangements with these suppliers and manufacturers
could cause significant delays in the expansion of the NEON systems and could
have a material adverse effect on the Company.

2. SIGNIFICANT TRANSACTION AND REORGANIZATION

On September 14, 2000, the Company closed agreements with Consolidated
Edison Communications, Inc. (CEC) and Exelon Ventures Corporation (Exelon).
Under the terms of these agreements, the Company received an indefeasible right
to use (IRU) fiber optic facilities on the networks of CEC and Exelon to provide
network transport and carrier services in their service areas, which include New
York and Philadelphia, as well as beyond their service areas to Baltimore and
Washington, DC. At the same time, both CEC and Exelon will also provide
connectivity from NEON's backbone system to their respective local distribution
facilities in CEC and Exelon service areas. This interstate and intrastate
communications network will operate under the NEON brand, expanding NEON's
network into New York and the Mid-Atlantic region. The NEON network will now
extend from Portland, Maine, to Washington, D.C. The term of the CEC agreement
is for no less than 25 years and the term of the Exelon agreement is for
20 years with five-year extension periods.

As part of these agreements, the Company has issued 2,476,735 shares of
common stock to CEC and 2,131,143 shares of common stock to Exelon, of which all
but 44% of this stock was restricted as of September 30, 2000, with such
restrictions to lapse upon the completion of certain milestones over the terms
of the agreements, as detailed in the contracts with CEC and Exelon. This
transaction has resulted in CEC and Exelon owning approximately 10.5% and 9.1%,
respectively, of NEON's fully diluted common stock. In an unrelated transaction,
Consolidated Edison, Inc., the parent holding company of CEC, has previously
announced that it has entered into an agreement to acquire Northeast Utilities,
a holder of approximately 25.6% of the Company's fully diluted common stock.
Pursuant to these agreements, CEC and Exelon have each named a member of the
Company's board of directors.

As of September 30, 2000, the Company has not yet received all of the assets
to be provided by CEC and Exelon under the agreements, and therefore has
recorded a subscription receivable on the accompanying condensed consolidated
balance sheets. The addition of certain tangible and intangible assets received
in consideration for the stock provided to CEC and Exelon under these agreements
will result in significant depreciation and amortization expense and an increase
in the Company's net loss per share over the terms of the related agreements. In
addition to the IRUs, CEC and Exelon have also agreed to contribute to the
Company cash totaling $11,300,000 and $8,050,000, respectively, for the
build-out of local points of presence (POP) and the related opto-electronic
equipment and for the cost of POP rental, POP operating expenses,
opto-electronic equipment maintenance and sales and marketing expenses.

Immediately preceding the closing of the agreements with CEC and Exelon, the
Company completed a reorganization, under the terms of which NEON
Communications, Inc. became the parent holding company of NorthEast Optic
Network, Inc. At the same time, NorthEast Optic Network, Inc. changed its name
to NEON Optica, Inc. The parent holding company is being traded on NASDAQ

5
<PAGE>
under the NOPT symbol, with NEON Optica, Inc., the operating entity, as its
wholly owned subsidiary. The names were changed to reflect the fact that NEON is
now doing business in both the Northeast and the Mid-Atlantic regions. NEON
Optica, Inc. continues to make periodic reports under the Securities Exchange
Act of 1934 in respect of its 12 3/4% Senior Notes Due 2008.

3. SIGNIFICANT ACCOUNTING POLICIES

The accompanying condensed consolidated financial statements reflect the
application of certain accounting policies as described below and elsewhere in
these notes to consolidated financial statements.

(a) PRINCIPLES OF CONSOLIDATION

The accompanying unaudited condensed consolidated financial statements
include the results of operations of NEON Communications, Inc. and its wholly
owned subsidiary, NEON Optica, Inc. and its subsidiaries. All significant
intercompany transactions and balances have been eliminated in consolidation.

(b) BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have
been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission, and reflect all adjustments, consisting of
only normal recurring adjustments, which, in the opinion of management, are
necessary for a fair statement of the results of the interim periods presented.
These financial statements do not include disclosures associated with the annual
financial statements and, accordingly, should be read in conjunction with the
attached Management's Discussion and Analysis of Financial Condition and Results
of Operation and the financial statements and footnotes for the year ended
December 31, 1999 included in the Company's Form 10-K.

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States 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 amounts could differ from those estimates.

(d) REVENUE RECOGNITION

The services the Company provides include long-term leases of dark fiber
(fiber optic transmission lines leased without opto-electronic equipment
installed by the Company) and short-term leases of lit fiber (fixed amounts of
capacity on fiber optic transmission lines that use opto-electronic equipment
installed by the Company) at fixed-cost pricing over multi-year terms. Revenues
on telecommunications network services are recognized ratably over the term of
the applicable agreements with customers, which range from 1 to 20 years.
Amounts billed in advance of the service provided are recorded as deferred
revenue. The Company also leases space at its facilities (collocation services).
Other services revenues in the accompanying condensed consolidated statements of
operations includes these collocation service revenues as well as revenues from
nonrecurring design, engineering and construction services. Revenues for these
nonrecurring services are generally recognized as services are performed as the
Company has no further obligations.

The Company has contracts with customers that provide service level
commitments, which may obligate the Company to provide credits against billings
if service is interrupted or does not meet the

6
<PAGE>
customer's operating parameters. These amounts are accounted for in cost of
sales. To date, credits issued under these arrangements have not been material.

(e) COMPREHENSIVE INCOME (LOSS)

Statement of Financial Accounting Standards (SFAS) No. 130, REPORTING
COMPREHENSIVE INCOME, requires disclosure of all components of comprehensive
income (loss) on an annual and interim basis. Comprehensive income (loss) is
defined as the change in equity of a business enterprise during a period from
transactions and other events and circumstances from nonowner sources.
Comprehensive net loss is the same as reported net loss for all periods
presented.

(f) EARNINGS PER SHARE

In accordance with SFAS No. 128, EARNINGS PER SHARE, basic and diluted loss
per share were computed by dividing net loss by the weighted average number of
common shares outstanding during the first nine months of 2000 and 1999. Diluted
net loss per share excludes 2,550,724 shares of restricted common stock and
1,403,244 shares issuable from the assumed exercise of stock options, as their
effect would be antidilutive.

(g) RECLASSIFICATIONS

Reclassifications were made to previously issued financial statements to
conform in the current year's presentation.

(h) NEW ACCOUNTING STANDARDS

The Securities and Exchange Commission issued Staff Accounting Bulletin
(SAB) No. 101, REVENUE RECOGNITION, in December 1999. The Company is required to
adopt this new accounting guidance, as amended by SAB No. 101A through a
cumulative charge to retained earnings in accordance with Accounting Principles
Board (APB) Opinion No. 20, ACCOUNTING CHANGES, no later than the fourth quarter
of fiscal 2000. Management is currently evaluating the effects that this
guidance is expected to have on the Company's consolidated financial statements.

4. 12 3/4% SENIOR NOTES

In August 1998, the Company sold $180 million of 12 3/4% Senior Notes due
2008 to the public in the debt offering. The Senior Notes were issued by NEON
Optica, Inc. The Senior Notes are due on August 15, 2008 and scheduled interest
payments are due on February 15 and August 15 of each year, commencing
February 15, 1999. Upon closing of the Senior Notes, the Company purchased
approximately $72 million in U.S. government obligations, with an average
maturity of 645 days, to provide for payment in full of the first seven
scheduled interest payments on the Senior Notes. Such securities are pledged as
security for the benefit of the holders of the Senior Notes, are classified as
held-to-maturity and reported at amortized cost and are included as restricted
cash and investments in the accompanying condensed consolidated balance sheets.
The Senior Notes are redeemable in whole or in part at the option of the Company
at any time on or after August 15, 2003 at the following redemption prices
expressed as a percentage of principal plus accrued interest through the date of
redemption:

<TABLE>
<CAPTION>
PERIOD REDEMPTION PRICE
------ ----------------
<S> <C>
2003 106.375%
2004 104.250%
2005 102.125%
Thereafter 100.000%
</TABLE>

7
<PAGE>
In the event of a change in control, as defined, each holder of the notes
will be entitled to require the Company to purchase all or a portion of such
holder's Senior Notes at a purchase price equal to 101% of the principal amount
thereof, plus accrued and unpaid interest, if any, to the date of purchase. The
Senior Notes are unsecured obligations and rank PARI PASSU in right of payment
with all existing and future indebtedness of the Company that is not by its
terms subordinate in right of payment and priority to the Senior Notes and is
senior in right of payment to all future subordinated indebtedness of the
Company.

In connection with this financing, the Company incurred approximately
$6.3 million of issuance costs. These costs have been classified as deferred
financing costs in the accompanying condensed consolidated balance sheets and
are being amortized, as interest expense, over the term of the Notes.

5. PREFERRED STOCK

The Company's Amended and Restated Certificate of Incorporation authorizes
the issuance of up to 2,000,000 shares of preferred stock, $0.01 par value per
share. Under the terms of the Amended and Restated Certificate of Incorporation,
the board of directors is authorized, subject to any limitations prescribed by
law, without stockholder approval, to issue such shares of preferred stock in
one or more series. Each series of preferred stock shall have rights,
preferences, privileges and restrictions, including voting rights, dividend
rights, conversion rights, redemption privileges and liquidation preferences, as
shall be determined by the board of directors. At September 30, 2000, no such
shares are issued and outstanding.

6. CONTINGENCIES

Certain claims arising in the ordinary course of business are pending
against the Company. In the opinion of management, these claims are without
merit and they believe there is no potential liability.

7. CONCENTRATION OF CREDIT RISK

SFAS No. 105, DISCLOSURE OF INFORMATION ABOUT FINANCIAL INSTRUMENTS WITH OFF
BALANCE SHEET RISK AND FINANCIAL INSTRUMENTS WITH CONCENTRATION OF CREDIT RISK,
requires disclosure of any significant off-balance sheet and credit risk
concentration. Financial instruments that potentially expose the Company to
concentrations of credit risk consist primarily of cash and cash equivalents,
short-term investments and accounts receivable. The Company has not experienced
significant losses related to receivables from any individual or groups of
customers or any specific industry or geographic region. Due to these factors,
no additional credit risk is believed by management to be inherent in the
Company's accounts receivable. For the three months ended September 30, 2000 and
September 30, 1999, two and four customers represented 27% and 66% of revenues,
respectively. At September 30, 2000 and December 31, 1999, one and three
customers represented 18% and 56% of accounts receivable, respectively.

8. SEGMENT DISCLOSURE

SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION, requires certain financial and supplementary information to be
disclosed on an annual and interim basis for each reportable operating segment
of an enterprise. Operating segments are defined as components of an enterprise
about which separate financial information is available that is evaluated
regularly by the chief operating decision-maker, or decision-making group, in
deciding how to allocate resources and in assessing performance. The Company's
chief operating decision-maker is the Chief Executive Officer of the Company.

The Company analyzes segment reporting based on dark fiber, lit fiber,
collocation and ancillary network services. Only revenues are separately
reported for dark fiber, lit fiber, collocation and

8
<PAGE>
ancillary network services. Cost of revenues, and property and equipment are
primarily the operating costs and the communications network and equipment that
supports each segment, and are not allocated between the segments for management
reporting, or accordingly segment reporting purposes. Similarly, selling,
general and administrative expenses are not allocated to the segments for
management or segment reporting purposes.

Management utilizes several measurements to evaluate its operations and
allocate resources. However, the principal measurements are consistent with the
Company's financial statements. The accounting policies of the segments are the
same as those described in Note 3.

Financial information for the Company's segments is as follows:

<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
2000 1999 2000 1999
------------ ----------- ------------ -----------
<S> <C> <C> <C> <C>
Revenues:
Dark fiber............ $ 849,870 $ 537,866 $ 2,326,706 $ 1,363,256
Lit fiber............. 2,286,504 411,169 4,782,780 617,221
Ancillary network
services (1)........ 698,670 86,814 2,284,779 157,298
Collocation........... 386,245 583,568 988,756 1,045,443
------------ ----------- ------------ -----------
Total revenues...... 4,221,289 1,619,417 10,383,021 3,183,218
------------ ----------- ------------ -----------
Cost of revenues........ 2,849,806 1,843,655 7,673,304 4,221,186
Selling, general and
administrative........ 4,850,581 1,614,575 10,413,889 5,047,747
Depreciation and
amortization.......... 3,078,583 1,904,083 8,419,636 3,904,934
------------ ----------- ------------ -----------
Loss from operations.... $ (6,557,681) $(3,742,896) $(16,123,808) $(9,990,649)
============ =========== ============ ===========
Property and equipment,
net................... 141,279,759 87,806,020 141,279,759 87,806,020
============ =========== ============ ===========
Capital expenditures.... 21,794,487 10,517,194 53,577,618 39,594,012
============ =========== ============ ===========
</TABLE>

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

(1) Includes nonrecurring revenues associated with design, engineering and
construction services.

9
<PAGE>
FINANCIAL STATEMENTS OF NEON OPTICA, INC.

NEON OPTICA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 40,318,924 $ 4,768,389
Short-term restricted cash and investments................ 24,169,717 22,518,611
Short-term investments.................................... -- 66,803,311
Accounts receivable, net.................................. 2,482,196 1,858,201
Prepaid expenses and other current assets................. 925,425 494,323
------------ ------------
Total current assets.................................... 67,896,262 96,442,835
PROPERTY AND EQUIPMENT, NET................................. 141,279,759 94,924,843
RESTRICTED CASH AND INVESTMENTS............................. 10,712,648 31,693,543
INTANGIBLE AND OTHER ASSETS, NET............................ 56,428,891 57,572,155
------------ ------------
$276,317,560 $280,633,376
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.......................................... $ 2,321,900 $ 3,783,354
Accounts payable--communications network.................. 25,257,610 9,438,350
Accrued expenses.......................................... 7,765,745 13,348,296
Accrued right-of-way fees, related party.................. 679,531 886,322
Due to parent company..................................... 8,672,561 --
Deferred revenue.......................................... 77,760 58,380
------------ ------------
Total current liabilities............................... 44,775,107 27,514,702
DEFERRED REVENUE, NET OF CURRENT PORTION.................... 912,321 969,026
LONG-TERM ACCOUNTS PAYABLE--COMMUNICATIONS NETWORK.......... 7,733,184 4,682,858
LONG-TERM OBLIGATIONS....................................... 180,000,000 180,000,000
CONTINGENCIES (NOTE 5)
STOCKHOLDERS' EQUITY:
Common stock, $0.01 par value--
Authorized--3,000 shares; 100 shares issued and
outstanding........................................... 1 1
Additional paid-in capital................................ 113,770,268 110,238,815
Accumulated deficit....................................... (70,873,321) (42,770,026)
------------ ------------
Total stockholders' equity.............................. 42,896,948 67,466,790
------------ ------------
$276,317,560 $280,633,376
============ ============
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.

10
<PAGE>
NEON OPTICA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.

11
<PAGE>
NEON OPTICA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------
2000 1999
------------ ------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net loss.................................................. $(28,103,295) $(19,457,392)
Adjustments to reconcile net loss to net cash used in
operating activities--
Compensation expense related to the issuance of stock
options to non-employees.............................. -- 293,441
Depreciation and amortization........................... 8,419,636 3,904,934
Amortization of deferred financing costs................ 469,983 469,983
Changes in assets and liabilities--
Accounts receivable................................... (623,995) (1,180,380)
Refundable taxes from related party................... -- 755,838
Prepaid expenses and other current assets............. (431,102) (293,876)
Accounts payable...................................... 7,211,097 802,678
Accrued expenses...................................... (5,789,342) (6,979,620)
Deferred revenue...................................... (37,325) (114,973)
------------ ------------
Net cash (used in) operating activities............. (18,884,333) (21,799,367)
------------ ------------
Cash Flows from Investing Activities:
Sales (Purchases) of short-term investments, net.......... 66,803,311 (24,945,517)
Purchases of property and equipment....................... (53,577,618) (39,594,012)
Increase in intangible and other assets................... (523,653) (449,504)
------------ ------------
Net cash provided by (used in) investing
activities........................................ 12,702,040 (64,989,033)
------------ ------------
Cash Flows from Financing Activities:
Increase in construction and long-term accounts payable... 18,869,586 13,312,989
Payments on long-term obligations......................... -- (127,619)
Decrease in restricted cash and investments............... 19,329,789 21,019,754
Proceeds from issuance of stock........................... 3,533,453 631,865
------------ ------------
Net cash provided by financing activities........... 41,732,828 34,836,989
------------ ------------
Net Increase (Decrease) in Cash and Cash Equivalents........ 35,550,535 (51,951,411)
Cash and Cash Equivalents, beginning of period.............. 4,768,389 57,737,792
------------ ------------
Cash and Cash Equivalents, end of period.................... $ 40,318,924 $ 5,786,381
============ ============
Supplemental Disclosure of Cash Flow information:
Cash paid during the period for--
Interest................................................ $ 23,052,502 $ 23,943,837
============ ============
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.

12
<PAGE>
1. OPERATIONS

NEON Optica, Inc. (NEON Optica) formerly NorthEast Optic Network, Inc. and
its subsidiaries are engaged in the ownership, management, operation and
installation of fiber optic telecommunication networks in the Northeast and
Mid-Atlantic regions of the United States.

To date, NEON Optica has recorded revenues principally from contract and
other services and has incurred cumulative operating losses of approximately
$71,000,000. The market for fiber optic telecommunications in which NEON Optica
operates is changing rapidly due to technological advancements, the introduction
of new products and services and the increasing demands placed on equipment in
worldwide telecommunications networks. NEON Optica is dependent upon a single or
limited source of suppliers for a number of components and parts. Shortages
resulting from a change in arrangements with these suppliers and manufacturers
could cause significant delays in the expansion of the NEON systems and could
have a material adverse effect on NEON Optica.

NEON Communications, Inc. (NEON Communications) was created to become the
parent holding company of NorthEast Optic Network, Inc. pursuant to a
reorganization completed on September 14, 2000. At the same time, NorthEast
Optic Network, Inc. changed its name to NEON Optica, Inc. The parent holding
company is being traded on NASDAQ under the NOPT symbol, with NEON
Optica, Inc., the operating entity, as its wholly owned subsidiary. The names
were changed to reflect the fact that NEON is now doing business in both the
Northeast and the Mid-Atlantic.

2. SIGNIFICANT TRANSACTION AND REORGANIZATION

On September 14, 2000, NEON Communications, our parent company, closed
agreements with Consolidated Edison Communications, Inc. (CEC) and Exelon
Ventures Corporation (Exelon). Under the terms of these agreements, NEON
Communications received an indefeasible right to use (IRU) fiber optic
facilities on the networks of CEC and Exelon to provide network transport and
carrier services in their service areas, which include New York and
Philadelphia, as well as beyond their service areas to Baltimore and Washington,
DC. At the same time, both CEC and Exelon will also provide connectivity from
NEON's backbone system to their respective local distribution facilities in CEC
and Exelon service areas. This interstate and intrastate communications network
will operate under the NEON brand, expanding NEON's network into New York and
the Mid-Atlantic region. The NEON network will now extend from Portland, Maine,
to Washington, D.C. The term of the CEC agreement is for no less than 25 years
and the term of the Exelon agreement is for 20 years with five-year extension
periods.

As part of these agreements, NEON Communications has issued 2,476,735 shares
of common stock to CEC and 2,131,143 shares of common stock to Exelon, of which
all but 44% of this stock was restricted as of September 30, 2000, with such
restrictions to lapse upon the completion of certain milestones over the terms
of the agreements, as detailed in the contracts with CEC and Exelon. This
transaction has resulted in CEC and Exelon owning approximately 10.5% and 9.1%,
respectively, of NEON Communications' fully diluted common stock. In an
unrelated transaction, Consolidated Excelon, Inc., the parent holding company of
CEC, has previously announced that it has entered into an agreement to acquire
Northeast Utilities, a holder of approximately 25.6% of the Company's fully
diluted common stock. Pursuant to these agreements, CEC and Exelon have each
named a member of NEON Communications' board of directors.

As of September 30, 2000, NEON Communications has not yet received all of
the assets to be provided by CEC and Exelon under the agreements, and therefore
has recorded a subscription receivable on their condensed consolidated balance
sheets. The addition of certain tangible and intangible assets received in
consideration for the stock provided to CEC and Exelon under these agreements
will result in significant depreciation and amortization expense and an increase
in NEON Communications' net loss per share over the terms of the related
agreements. In addition to the IRUs,

13
<PAGE>
CEC and Exelon have also agreed to contribute to NEON Communications cash
totaling $11,300,000 and $8,050,000, respectively, for the build-out of local
points of presence (POP) and the related opto-electronic equipment and for the
cost of POP rental, POP operating expenses, opto-electronic equipment
maintenance and sales and marketing expenses.

3. SIGNIFICANT ACCOUNTING POLICIES

(a) PRINCIPLES OF CONSOLIDATION

The accompanying unaudited condensed financial statements include the
results of operations of NEON Optica, Inc. and its wholly owned subsidiaries.
All significant intercompany transactions and balances have been eliminated in
consolidation.

(b) BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have
been prepared by NEON Optica pursuant to the rules and regulations of the
Securities and Exchange Commission, and reflect all adjustments, consisting of
only normal recurring adjustments, which, in the opinion of management, are
necessary for a fair statement of the results of the interim periods presented.
These financial statements do not include disclosures associated with the annual
financial statements and, accordingly, should be read in conjunction with the
attached Management's Discussion and Analysis of Financial Condition and Results
of Operation and the financial statements and footnotes for the year ended
December 31, 1999 included in NEON Optica's Form 10-K.

(d) REVENUE RECOGNITION

The services NEON Optica provides include long-term leases of dark fiber
(fiber optic transmission lines leased without opto-electronic equipment
installed by NEON Optica) and short-term leases of lit fiber (fixed amounts of
capacity on fiber optic transmission lines that use opto-electronic equipment
installed by NEON Optica) at fixed-cost pricing over multi-year terms. Revenues
on telecommunications network services are recognized ratably over the term of
the applicable agreements with customers, which range from 1 to 20 years.
Amounts billed in advance of the service provided are recorded as deferred
revenue. NEON Optica also leases space at its facilities (collocation services).
Other services revenues in the accompanying condensed consolidated statements of
operations includes these collocation service revenues as well as revenues from
nonrecurring design, engineering and construction services. Revenues for these
nonrecurring services are generally recognized as services are performed as NEON
Optica has no further obligations.

NEON Optica has contracts with customers that provide service level
commitments, which may obligate NEON Optica to provide credits against billings
if service is interrupted or does not meet the customer's operating parameters.
These amounts are accounted for in cost of sales. To date, credits issued under
these arrangements have not been material.

14
<PAGE>
(e) COMPREHENSIVE INCOME (LOSS)

Statement of Financial Accounting Standards (SFAS), No. 130, REPORTING
COMPREHENSIVE INCOME, requires disclosure of all components of comprehensive
income (loss) on an annual and interim basis. Comprehensive income (loss) is
defined as the change in equity of a business enterprise during a period from
transactions and other events and circumstances from nonowner sources.
Comprehensive net loss is the same as reported net loss for all periods
presented.

(f) RECLASSIFICATIONS

Reclassifications were made to previously issued financial statements to
conform to the current year's presentation.

(g) NEW ACCOUNTING STANDARDS

4. 12 3/4% SENIOR NOTES

In August 1998, NEON Optica sold $180 million of 12 3/4% Senior Notes due
2008 to the public in the debt offering. The Senior Notes are due on August 15,
2008 and scheduled interest payments are due on February 15 and August 15 of
each year, commencing February 15, 1999. Upon closing of the Senior Notes, NEON
Optica purchased approximately $72 million in U.S. government obligations, with
an average maturity of 645 days, to provide for payment in full of the first
seven scheduled interest payments on the Senior Notes. Such securities are
pledged as security for the benefit of the holders of the Senior Notes, are
classified as held-to-maturity and reported at amortized cost and are included
as restricted cash and investments in the accompanying condensed consolidated
balance sheets. The Senior Notes are redeemable in whole or in part at the
option of NEON Optica at any time on or after August 15, 2003 at the following
redemption prices expressed as a percentage of principal plus accrued interest
through the date of redemption:

<TABLE>
<CAPTION>
PERIOD REDEMPTION PRICE
------ ----------------
<S> <C>
2003 106.375%
2004 104.250%
2005 102.125%
Thereafter 100.000%
</TABLE>

In the event of a change in control, as defined, each holder of the notes
will be entitled to require NEON Optica to purchase all or a portion of such
holder's Senior Notes at a purchase price equal to 101% of the principal amount
thereof, plus accrued and unpaid interest, if any, to the date of purchase. The
Senior Notes are unsecured obligations and rank PARI PASSU in right of payment
with all existing and future indebtedness of NEON Optica that is not by its
terms subordinate in right of payment and priority to the Senior Notes and is
senior in right of payment to all future subordinated indebtedness of NEON
Optica.

In connection with this financing, NEON Optica incurred approximately
$6.3 million of issuance costs. These costs have been classified as deferred
financing costs in the accompanying condensed consolidated balance sheets and
are being amortized, as interest expense, over the term of the Notes.

15
<PAGE>
5. CONTINGENCIES

Certain claims arising in the ordinary course of business are pending
against NEON Optica. In the opinion of management, these claims are without
merit and they believe there is no potential liability.

6. CONCENTRATION OF CREDIT RISK

SFAS No. 105, DISCLOSURE OF INFORMATION ABOUT FINANCIAL INSTRUMENTS WITH OFF
BALANCE SHEET RISK AND FINANCIAL INSTRUMENTS WITH CONCENTRATION OF CREDIT RISK,
requires disclosure of any significant off-balance sheet and credit risk
concentration. Financial instruments that potentially expose NEON Optica to
concentrations of credit risk consist primarily of cash and cash equivalents,
short-term investments and accounts receivable. NEON Optica has not experienced
significant losses related to receivables from any individual or groups of
customers or any specific industry or geographic region. Due to these factors,
no additional credit risk is believed by management to be inherent in NEON
Optica's accounts receivable. For the three months ended September 30, 2000 and
September 30, 1999, two and four customers represented 27% and 66% of revenues,
respectively. At September 30, 2000 and December 31, 1999, one and three
customers represented 18% and 56% of accounts receivable, respectively.

7. SEGMENT DISCLOSURE

SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION requires certain financial and supplementary information to be
disclosed on an annual and interim basis for each reportable operating segment
of an enterprise. Operating segments are defined as components of an enterprise
about which separate financial information is available that is evaluated
regularly by the chief operating decision-maker, or decision-making group, in
deciding how to allocate resources and in assessing performance. NEON Optica's
chief operating decision-maker is the Chief Executive Officer of NEON Optica.

NEON Optica analyzes segment reporting based on dark fiber, lit fiber,
collocation and ancillary network services. Only revenues are separately
reported for dark fiber, lit fiber, collocation and ancillary network services.
Cost of revenues, and property and equipment are primarily the operating costs
and the communications network and equipment that supports each segment, and are
not allocated between the segments for management reporting, or accordingly
segment reporting purposes. Similarly, selling, general and administrative
expenses are not allocated to the segments for management or segment reporting
purposes.

Management utilizes several measurements to evaluate its operations and
allocate resources. However, the principal measurements are consistent with NEON
Optica's financial statements. The accounting policies of the segments are the
same as those described in Note 3.

16
<PAGE>
Financial information for NEON Optica's segments is as follows:

<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
2000 1999 2000 1999
------------ ----------- ------------ -----------
<S> <C> <C> <C> <C>
Revenues:
Dark fiber............................ $ 849,870 $ 537,866 $ 2,326,706 $ 1,363,256
Lit fiber............................. 2,286,504 411,169 4,782,780 617,221
Ancillary network services (1)........ 698,670 86,814 2,284,779 157,298
Collocation........................... 386,245 583,568 988,756 1,045,443
------------ ----------- ------------ -----------
Total revenues...................... 4,221,289 1,619,417 10,383,021 3,183,218
------------ ----------- ------------ -----------
Cost of revenues........................ 2,849,806 1,843,655 7,673,304 4,221,186
Selling, general and administrative..... 4,850,581 1,614,575 10,413,889 5,047,747
Depreciation and amortization........... 3,078,583 1,904,083 8,419,636 3,904,934
------------ ----------- ------------ -----------
Loss from operations.................... $ (6,557,681) $(3,742,896) $(16,123,808) $(9,990,649)
============ =========== ============ ===========
Property and equipment, net............. 141,279,759 87,806,020 141,279,759 87,806,020
============ =========== ============ ===========
Capital expenditures.................... 21,794,487 10,517,194 53,577,618 39,594,012
============ =========== ============ ===========
</TABLE>

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

(1) Includes nonrecurring revenues associated with design, engineering and
construction services.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

CAUTIONARY STATEMENT

This Quarterly Report on Form 10-Q includes forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. All statements, other than statements of
historical facts, included or incorporated in this prospectus regarding our
strategy, future operations, financial position, future revenues, projected
costs, prospects, plans and objectives of management are forward-looking
statements. The words "anticipates," "believes," "estimates," "expects,"
"intends," "may," "plans," "projects," "will," "would" and similar expressions
are intended to identify forward-looking statements, although not all
forward-looking statements contain these identifying words. In particular, but
without limiting the foregoing, our statements about, relating to or dependent
on our agreements with Consolidated Edison Communications and Exelon Ventures
Corporation and the extent of our network under each of those agreements
constitute forward-looking statements. We cannot guarantee that we actually will
achieve the plans, intentions or expectations disclosed in our forward-looking
statements and you should not place undue reliance on our forward-looking
statements. Actual results or events could differ materially from the plans,
intentions and expectations disclosed in the forward-looking statements we make.
We have included important factors in the cautionary statements included in this
report, particularly under the heading "Risk Factors," that we believe could
cause actual results or events to differ materially from the forward-looking
statements that we make. Our forward-looking statements do not reflect the
potential impact of any future acquisitions, mergers, dispositions, joint
ventures or investments we may make. We do not assume any obligation to update
any forward-looking statements.

17
<PAGE>
References in this document to "we," "us," "our" and "the Company" refer, as
the context requires, to (i) NEON Communications, Inc. and its subsidiary, NEON
Optica, Inc., and (ii) NEON Optica, Inc. and its subsidiaries. References in
this document to "NEON Communications" refer to NEON Communications, Inc. and
its subsidiary, NEON Optica, Inc., and references to "NEON Optica" refer to NEON
Optica, Inc. and its subsidiaries.

OVERVIEW

NEON COMMUNICATIONS, INC.

We are a holding company whose principal asset is all of the outstanding
shares of the capital stock of NEON Optica, Inc. In addition, under our
agreements with Consolidated Edison Communications, Inc. and Exelon Ventures
Corporation, which were consummated on September 14, 2000, NEON
Communications, Inc. will be the holder of indefeasible rights of use in certain
fiber optic filaments in the Northeast and Mid-Atlantic regions, as well as
certain interconnections and telecommunications facilities in New York City and
Philadelphia, Pennsylvania, in each case upon delivery of such assets by
Consolidated Edison Communications, Inc. and Exelon Ventures Corporation
pursuant to the terms of their respective agreements.

NEON OPTICA, INC.

NEON Optica, Inc. (formerly NorthEast Optic Network, Inc.) owns and operates
a technologically advanced, high-bandwidth fiber optic network providing
capacity on a wholesale basis to telecommunications service providers, including
local, long distance and wireless telephone companies and Internet service
providers. Our network currently extends from Portland, Maine to New York City,
and, under our agreements with Exelon Ventures Corporation and Consolidated
Edison Communications, Inc., which were consummated on September 14, 2000, we
are working to extend our network to Philadelphia, Baltimore, and Washington
D.C. and expand our network in and around New York City. Our customers can
connect directly to our network at multiple locations in the larger cities we
serve and also in smaller communities along our network's routes.

To date we have experienced net losses and negative cash flow from operating
activities. From our inception to present, our principal activities included
building our network, developing our business plans, hiring management and other
key personnel and negotiating and executing customer contracts. We expect to
continue to generate net losses and negative cash flow as we expand our
operations. Whether or when we will generate positive cash flow from operating
activities will depend on a number of financial, competitive, regulatory,
technical, and other factors. See "Liquidity and Capital Resources".

Our network service revenues include long-term leases of dark fiber and
short-term leases of lit fiber at fixed-cost pricing over multi-year terms.
Other services revenues include collocation services at our facilities as well
as nonrecurring design, engineering, and construction services. We generally
receive fixed monthly payments from our customers for the leasing of capacity on
our network and the use of collocation facilities and recognize revenues ratably
over the term of the applicable customer agreement. Design, engineering, and
construction services revenues are non-refundable and generally recognized as
services are performed.

In the third quarter of 2000, approximately 26% of our revenues consisted of
other services revenues. We anticipate that as we proceed with the deployment of
our network, the percentage of revenues we receive from network services will
increase as a percentage of revenues.

Our costs consist primarily of cost of revenues, selling, general and
administrative expenses, depreciation and amortization, and interest expense.
Cost of revenues relates to lease payments for fiber optic facilities,
operations and maintenance costs, right of way fees and property taxes. Selling,

18
<PAGE>
general and administrative expenses relate to expenses in connection with sales
and marketing infrastructure, including personnel, advertising costs and
promotional activities and management and information technology. Depreciation
and amortization expense is associated with the build-out of our network, as
well as goodwill from our reorganization on July 8, 1998. Interest expense
relates to interest on our $180 million 12 3/4% Senior Notes Due 2008.

RESULTS OF OPERATIONS

NEON COMMUNICATIONS, INC.

Revenues for the quarter ended September 30, 2000 amounted to $4,221,289,
compared to $1,619,417 in the same quarter of 1999, an increase of $2,601,872 or
161%. Revenues were generated by recurring lease services of $3,163,374 during
the third quarter of 2000 compared to $949,035 during the third quarter of 1999,
and other services revenues of $1,084,915 during the third quarter of 2000,
compared to $670,382 during the third quarter of 1999. Other services revenues
consist of collocation revenues and all nonrecurring revenues related to design,
engineering and construction. Revenues for the nine months ended September 30,
2000 amounted to $10,383,021, compared to $3,183,218 for the first nine months
of 1999, an increase of $7,199,803 or 226%. The increase in revenues reflects
the Company's increasing sales to new and existing customers in the Northeast
region, primarily through the provisioning of lit circuits, which represented
54% recurring revenues.

Cost of revenues for the quarter ended September 30, 2000 amounted to
$2,849,806, compared to $1,843,655 for the same quarter in 1999, an increase of
$1,006,151 or 55%. The increase was primarily due to lease payments for fiber
optic facilities, operations and maintenance costs, right of way fees, and
property taxes resulting from the Company's continuing network expansion
throughout its service territory. Cost of revenues for the nine months ended
September 30, 2000 amounted to $7,673,304, compared to $4,221,186 for the first
nine months of 1999, an increase of $3,452,118 or 82%. The increased costs
reflect the continuing build out and expansion of the Company's communications
network into the Northeast and mid-Atlantic regions.

Selling, general and administrative expenses amounted to $4,850,581 for the
quarter ended September 30, 2000, compared to $1,614,575 for the same quarter in
1999, an increase of $3,236,006 or 200%. Selling, general, and administrative
expenses in the nine months ended September 30, 2000 amounted to $10,413,889
compared to $5,047,747 for the first nine months of 1999, an increase of
$5,366,142 or 106%. Increased personnel and related costs continue to grow as
the Company expands its efforts to meet customer requirements. The Company's
headcount has increased to 139 from 40, or 248%, since September 30, 1999,
primarily to support the Company's expansion and growing customer network in the
Northeast region, and the creation and staffing of sales offices in the New York
and Washington, D.C. areas.

Depreciation and amortization expense was $3,078,583 for the quarter ended
September 30, 2000, compared to $1,904,083 for the same quarter in 1999.
Depreciation and amortization for the nine months ended September 30, 2000
amounted to $8,419,636, compared to $3,904,934 for the same nine months in 1999.
The increase resulted from placing additional segments of the NEON system into
service as part of the Company's expansion of its communications network in the
Northeast region.

Interest and other income decreased by 39% to $1,103,195 for the quarter
ended September 30, 2000 from $1,816,213 for the same quarter in 1999. Interest
and other income decreased by 34% to $3,996,640 for the nine months ended
September 30, 2000 from $6,058,878 for the same nine month period in 1999. This
decrease was due primarily to lower cash and investment balances for the quarter
and first nine months, resulting from capital expenditures necessary to place
additional segments of the NEON system into service.

19
<PAGE>
Interest expense was $5,287,652 for the quarter ended September 30, 2000,
compared to $5,356,351 for the same quarter in 1999, a decrease of 1%. The
slight decrease during the third quarter was a result of the effect of
capitalization of the interest cost related to the build out of the Company's
network which remained in-process at quarter end, offsetting the Company's
quarterly financing costs. Interest expense was $15,976,127 for the nine months
ended September 30, 2000 compared to $15,525,621 for the same nine month period
in 1999, an increase of 3%. The overall increase during the first nine months of
2000 relates primarily to interest expense resulting from financing costs
associated with long term network equipment accounts payable, in addition to
interest on our $180.0 million 12 3/4% Senior Notes due in 2008.

The Company's net loss for the quarter ended September 30, 2000 was
$10,742,138, or a loss of $0.63 per share. This compares to a net loss of
$7,283,034, or a loss of $0.45 per share, for the same quarter in 1999. The
Company's net loss for the nine months ended September 30, 2000 was $28,103,295,
or a loss of $1.68 per share. This compares to a net loss of $19,457,392, or a
loss of $1.21 per share, for the same nine month period in 1999. The increase in
net loss is primarily attributable to the factors discussed above.

NEON OPTICA, INC.

Revenues for the quarter ended September 30, 2000 amounted to $4,221,289,
compared to $1,619,417 in the same quarter of 1999, an increase of $2,601,872 or
161%. Revenues were generated by recurring lease services of $3,163,374 during
the third quarter of 2000 compared to $949,035 during the third quarter of 1999,
and other services revenues of $1,084,915 during the third quarter of 2000
compared to $670,382 during the third quarter of 1999. Other services revenues
consist of collocation revenues and all nonrecurring revenues related to design,
engineering and construction. Revenues for the nine months ended September 30,
2000 amounted to $10,383,021, compared to $3,183,218 for the first nine months
of 1999, an increase of $7,199,803 or 226%. The increase in revenues reflects
NEON Optica's increasing sales to new and existing customers in the Northeast
region, primarily through the provisioning of lit circuits, which represented
54% of the third quarter's recurring revenues.

Cost of revenues for the quarter ended September 30, 2000 amounted to
$2,849,806, compared to $1,843,655 for the same quarter in 1999, an increase of
$1,006,151 or 55%. The increase was primarily due to lease payments for fiber
optic facilities, operations and maintenance costs, right of way fees, and
property taxes resulting from NEON Optica's continuing network expansion
throughout its service territory. Cost of revenues for the nine months ended
September 30, 2000 amounted to $7,673,304, compared to $4,221,186 for the first
nine months of 1999, an increase of $3,452,118 or 82%. The increased costs
reflect the continuing build out and expansion of NEON Optica's communications
network into the Northeast and mid-Atlantic regions.

Selling, general and administrative expenses amounted to $4,850,581 for the
quarter ended September 30, 2000, compared to $1,614,575 for the same quarter in
1999, an increase of $3,236,006 or 200%. Selling, general, and administrative
expenses in the nine months ended September 30, 2000 amounted to $10,413,889
compared to $5,047,747 for the first nine months of 1999, an increase of
$5,366,142 or 106%. Increased personnel and related costs continue to grow as
NEON Optica expands its efforts to meet customer requirements. NEON Optica's
headcount has increased to 139 from 40, or 248%, since September 30, 1999,
primarily to support NEON Optica's expansion and growing customer network in the
Northeast region, and the creation and staffing of sales offices in the New York
and Washington, D.C. areas.

20
<PAGE>
months in 1999. The increase resulted from placing additional segments of the
NEON system into service as part of NEON Optica's expansion of its
communications network in the Northeast region.

Interest expense was $5,287,652 for the quarter ended September 30, 2000,
compared to $5,356,351 for the same quarter in 1999, a decrease of 1%. The
slight decrease during the third quarter was a result of the effect of
capitalization of the interest cost related to the build out of NEON Optica's
network which remained in-process at quarter end, offsetting NEON Optica's
quarterly financing costs. Interest expense was $15,976,127 for the nine months
ended September 30, 2000 compared to $15,525,621 for the same nine month period
in 1999, an increase of 3%. The overall increase during the first nine months of
2000 relates primarily to interest expense resulting from financing costs
associated with long term network equipment accounts payable, in addition to
interest on our $180.0 million 12 3/4% Senior Notes due in 2008.

NEON Optica's net loss for the quarter ended September 30, 2000 was
$10,742,138. This compares to a net loss of $7,283,034 for the same quarter in
1999. NEON Optica's net loss for the nine months ended September 30, 2000 was
$28,103,295. This compares to a net loss of $19,457,392 for the same nine month
period in 1999. The increase in net loss is primarily attributable to the
factors discussed above.

LIQUIDITY AND CAPITAL RESOURCES

NEON COMMUNICATIONS, INC.

Our operations have required substantial investment for the design,
construction and engineering of our network and the purchase of
telecommunications equipment. Capital expenditures were approximately
$53,578,000 for the nine months ended September 30, 2000. We expect to require
substantial capital in connection with the following:

- expansion and improvement of our network;

- connection of additional buildings and customers to our network;

- purchase of additional telecommunications equipment

- purchase and development of our operating support systems; and

- operation and maintenance of existing facilities

We have funded a substantial portion of these expenditures through our
completed public offerings on August 5, 1998, resulting in net proceeds to us of
approximately $218 million (after deducting expenses and before deducting
$72 million in escrowed funds to cover the first seven semi-annual interest
payments on our $180 million 12 3/4% Senior Notes due 2008).

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The substantial capital investment required to build our network has
resulted in negative cash flow after investing activities over the last three
years. This negative cash flow after investing activities is a result of the
requirement to build a substantial portion of our network before connecting
revenue-generating customers. We expect to continue to produce negative cash
flow after investing activities for the current year due to the continuous
expansion and development of our network. Our ability to continue this expansion
will be limited by our current capital resources until sufficient cash flow
after investing activities is generated unless we seek and obtain additional
capital.

Net cash used in operating activities was $27,556,894 and $21,799,367 for
the nine months ended September 30, 2000 and 1999, respectively. Net cash used
in operating activities for the nine months ended September 30, 2000 was related
primarily to the growth in the Company's headcount and corresponding operating
costs to facilitate the Company's expansion and servicing of the growing
customer network.

Net cash provided by (used in) investing activities totaled $12,702,040 and
$(64,989,033) for the nine months ended September 30, 2000 and 1999,
respectively. Cash requirements consisted primarily of the cost of network
construction and equipment, offset by net proceeds from the sale of short-term
investments.

Net cash provided by financing activities totaled $50,405,389 and
$34,836,989 for the nine months ended September 30, 2000 and 1999 respectively.
Cash flow from financing activities during the nine months ended September 30,
2000 was generated from the restricted cash placed in escrow in connection with
the proceeds from the sale of our 12 3/4% Senior Notes due in 2008 and proceeds
from financing with an equipment vendor, from the exercise of stock options, and
from the transaction with Consolidated Edison Communications, Inc. and Exelon
Ventures Corporation.

We anticipate that we will continue to experience negative cash flow as we
expand our network, construct networks, deploy telecommunications electronic
equipment and market our services to an expanding customer base. Cash provided
by operations will not be sufficient to fund the expansion and development of
our system in the Northeast and Mid-Atlantic regions. As a result, we intend to
use our cash on hand and the remaining net proceeds of our 1998 public
offerings, and will have to raise additional financing through some combination
of commercial bank borrowings, leasing, vendor financing, strategic alliances
and sale of equity/or debt securities if we are to complete our expansion as
currently planned.

Our capital requirements may vary based upon the timing and the success of
implementation of our business plan and as a result of regulatory, technological
and competitive developments or if:

- demand for our services or cash flow from operations is less than or more
than expected;

- our plans or projections change or prove to be inaccurate;

- we make acquisitions; or

- we accelerate deployment of our network or otherwise alter the schedule or
targets for the implementation of our business plan.

The expectations of required future capital expenditures are based on our
current estimates.

NEON OPTICA, INC.

- expansion and improvement of our network;

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- connection of additional buildings and customers to our network;

- purchase of additional telecommunications equipment

- purchase and development of our operating support systems; and

- operation and maintenance of existing facilities

The substantial capital investment required to build our network has
resulted in negative cash flow after investing activities over the last three
years. This negative cash flow after investing activities is a result of the
requirement to build a substantial portion of our network before connecting
revenue-generating customers. We expect to continue to produce negative cash
flow after investing activities for the current year due to the continuous
expansion and development of our network. Our ability to continue this expansion
will be limited by our current capital resources until sufficient cash flow
after investing activities is generated unless we seek and obtain additional
capital.

Net cash used in operating activities was $18,884,333 and $21,799,367 for
the nine months ended September 30, 2000 and 1999, respectively. Net cash used
in operating activities for the nine months ended September 30, 2000 was related
primarily to the growth in the Company's headcount and corresponding operating
costs to facilitate NEON Optica's expansion and servicing of the growing
customer network, offset by a short-term intercompany payable to NEON
Communications which remained outstanding at September 30, 2000.

Net cash provided by financing activities totaled $41,732,828 and
$34,836,989 for the nine months ended September 30, 2000 1999 respectively. Cash
flow from financing activities during the nine months ended September 30, 2000
was generated from the restricted cash placed in escrow in connection with the
proceeds from the sale of our 12 3/4% Senior Notes due in 2008, proceeds from
financing with an equipment vendor and proceeds from the issuance of common
stock upon the exercise of stock options and an investment by NEON
Communications.

Our capital requirements may vary based upon the timing and the success of
implementation of our business plan and as a result of regulatory, technological
and competitive developments or if:

- demand for our services or cash flow from operations is less than or more
than expected;

- our plans or projections change or prove to be inaccurate;

- we make acquisitions; or

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- we accelerate deployment of our network or otherwise alter the schedule or
targets for the implementation of our business plan.

The expectations of required future capital expenditures are based on our
current estimates.

NEW ACCOUNTING STANDARDS

In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. SFAS No. 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities. SFAS
No. 133, as amended by SFAS No. 137 and SFAS No. 138, is effective for all
fiscal quarters of fiscal years beginning after June 15, 2000. This new standard
is not anticipated to have a significant impact on our consolidated financial
statements based on our current structure and operations.

The Securities and Exchange Commission issued Staff Accounting Bulletin
(SAB) No. 101, REVENUE RECOGNITION, in December 1999. We are required to adopt
this new accounting guidance, as amended by SAB No. 101A through a cumulative
charge to retained earnings in accordance with Accounting Principles Board (APB)
Opinion No. 20, ACCOUNTING CHANGES, no later than the fourth quarter of fiscal
2000. We are currently evaluating the effects that this guidance is expected to
have on the Company's consolidated financial statements.

In March 2000, the FASB issued Interpretation No. 44, ACCOUNTING FOR CERTAIN
TRANSACTIONS INVOLVING STOCK COMPENSATION--AN INTERPRETATION OF APB OPINION
NO. 25. The interpretation clarifies the application of APB Opinion No. 25 in
certain situations, as defined. The interpretation is effective July 1, 2000,
but covers certain events occurring during the period after December 15, 1998
but before the effective date. To the extent that events covered by this
interpretation occur during the period after December 15, 1998 but before the
effective date, the effects of applying this interpretation would be recognized
on a prospective basis from the effective date. Accordingly, upon initial
application of the final interpretation, (i) no adjustments would be made to the
financial statements for periods before the effective date and (ii) no expense
would be recognized for any additional compensation cost measured that is
attributable to periods before the effective date. We expect that the adoption
of this interpretation would not have any effect on our consolidated financial
statements.

RISK FACTORS

There are a number of important factors that could affect the business and
future operating results of NEON Communications and NEON Optica, including,
without limitation, the factors set forth below, and the information contained
in this Quarterly Report on Form 10-Q should be read in light of such factors.
Any of the following factors could have a material adverse effect on our
business and our future operating results.

RISKS RELATING TO OUR BUSINESS STRATEGY

WE HAVE HAD SIGNIFICANT NET LOSSES AND OUR OPERATING RESULTS HAVE VARIED AND
WILL CONTINUE TO VARY SIGNIFICANTLY.

We have incurred net losses since our inception. Our future operating
results will fluctuate annually and quarterly due to several factors, some of
which are outside our control. These factors include pricing strategies for our
services, changes in telecommunications technology, changes in the regulatory
environment, cost and timely availability of equipment, cost of construction and
changes in general and local economic conditions.

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OUR BUSINESS STRATEGY DEPENDS UPON ANTICIPATED CUSTOMER DEMAND FOR OUR
SERVICES, AND OUR FAILURE TO OBTAIN CUSTOMERS FOR OUR SERVICES AT PROFITABLE
RATES WOULD ADVERSELY AFFECT OUR BUSINESS RESULTS.

Our ability to become profitable depends upon our ability to secure a market
for our services and obtain service contracts with our communications customers.
Many of our targeted customers may also be our potential competitors. If our
services are not satisfactory or cost competitive, our targeted customers may
utilize other providers where available, or construct their own networks, which
would reduce their need for our services and create future sources of
competition for us.

INTENSE COMPETITION IN THE TELECOMMUNICATIONS INDUSTRY FROM A BROAD RANGE OF
COMPETITORS MAY PREVENT US FROM OBTAINING CUSTOMERS AND REQUIRE US TO LOWER
PRICES.

The telecommunications industry is highly competitive. We face substantial
competition from companies with significantly greater financial and other
resources whose capacity is interchangeable with the capacity we offer,
including incumbent local telephone companies, competitive local telephone
companies and major long distance companies. In addition, potential competitors
capable of offering services similar to those offered by us include other
communications service providers that own and operate their own networks and
equipment, including cable television companies, electric utilities, microwave
carriers, satellite carriers, wireless communication system operators and
end-users with private communications networks. Four of our principal
stockholders, Northeast Utilities, New England Business Trust (an affiliate of
Energy East Corporation), Consolidated Edison Communications, Inc., and Exelon
Ventures Corporation each own or have rights, through one or more affiliates, to
fibers in the cable that includes a portion of our network, which permits each
of them to compete directly with us in the future if they use these fibers for
purposes other than their corporate requirements. Our rights-of-way are
non-exclusive so that other service providers (including the utilities
themselves) could install competing networks using the same rights-of-way.

BECAUSE WE OFFER A RELATIVELY NARROW RANGE OF SERVICES IN COMPARISON TO SOME
OF OUR COMPETITORS, WE CANNOT ACHIEVE REVENUES COMPARABLE TO COMPANIES OFFERING
A BROADER ARRAY OF SERVICES AND MAY BE AT A COMPETITIVE DISADVANTAGE WITH
RESPECT TO THE SERVICES WE OFFER.

Unlike more diversified telecommunications companies, we derive and expect
to continue to derive substantially all of our revenues from the leasing of
fiber optic capacity on a wholesale basis to our customers, most of whom are
telecommunications companies and Internet service providers serving end-users.
The limited nature of our current services could limit our potential revenues
and result in our having lower revenues than competitors which provide a wider
array of services.

DUE TO RAPIDLY EVOLVING TECHNOLOGIES IN OUR INDUSTRY AND THE UNCERTAINTY OF
FUTURE GOVERNMENT REGULATION, OUR CURRENT BUSINESS PLAN MAY BECOME OBSOLETE AND
WE MAY BE UNABLE TO MAINTAIN A COMPETITIVE POSITION IF WE ARE UNABLE TO
SUCCESSFULLY ADJUST OUR PRODUCTS, SERVICES AND BUSINESS STRATEGIES AS REQUIRED.

In the future, we may become subject to more intense competition due to the
development of new technologies, an increased supply of domestic and
international transmission capacity, the consolidation in the industry among
local and long distance service providers and the effects of deregulation
resulting from the Telecommunications Act of 1996. The introduction of new
services and products or the emergence of new technologies may change the cost
or increase the supply of services and products similar to those which we
provide. We cannot predict which of many possible future product and service
offerings will be crucial to maintain our competitive position or what
expenditures will be required to develop profitably and provide such products
and services. Prices for our services to carriers specifically, and interstate
services in general, may decline over the next several years due primarily to
price competition to the extent that network providers continue to install
networks that compete with our network. We also believe that there will be
technological advances that will permit substantial increases in the
transmission capacity of both new and existing fiber.

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A LIMITED NUMBER OF CUSTOMERS HAS ACCOUNTED FOR A SIGNIFICANT PERCENTAGE OF
OUR REVENUES.

Historically, a limited number of customers has accounted for a significant
percentage of our revenues. In 1998, three customers accounted for 50%, 19% and
12% of revenues, respectively. In 1999, three customers accounted for 18%, 16%
and 13% of revenues, respectively. We anticipate that our results of operations
in any given period will continue to depend to a significant extent upon
revenues of a small number of customers.

RISKS RELATING TO THE EXPANSION AND OPERATION OF OUR FIBER OPTIC NETWORK

THE SUCCESSFUL, TIMELY AND COST-EFFECTIVE EXPANSION OF OUR FIBER OPTIC
NETWORK WITHIN THE NORTHEAST AND INTO THE MID-ATLANTIC REGION IS CRUCIAL TO OUR
BUSINESS PLAN, AND DEPENDS UPON NUMEROUS FACTORS BEYOND OUR CONTROL.

Our ability to achieve our strategic objectives depends in large part upon
the successful, timely and cost-effective expansion of our fiber optic network
within the Northeast and into the Mid-Atlantic region. Among the major factors
that could affect our success are:

- any delay or difficulty experienced by Consolidated Edison Communications
or Exelon Ventures Corporation in the performance of their obligations
under our agreements with them, which were closed on September 14, 2000;
and

- the failure of both affiliated and third-party suppliers or contractors to
meet their obligations to construct and maintain significant portions of
our fiber optic network in a timely and cost-effective manner.

Either of these factors, or other factors, over which we have little
control, could significantly hinder our ability to complete our network and
execute our business plan.

THE EXPENDITURES NECESSARY TO SUFFICIENTLY EXPAND OUR FIBER OPTIC NETWORK
AND DEVELOP OUR SERVICES IN ORDER TO SATISFY THE CURRENT AND FORECASTED DEMANDS
OF OUR CUSTOMERS MAY SURPASS OUR AVAILABLE CASH, AND WE MAY BE UNABLE TO OBTAIN
ADDITIONAL CAPITAL TO DEVELOP OUR SERVICES ON A TIMELY BASIS AND ON ACCEPTABLE
TERMS.

Although we have expended significant resources in building our network and
the development of our customer base, we will require significant additional
cash in order to expand our geographic coverage and the range of services which
we can offer throughout our service area in order to be competitive in our
market. These expenditures for expansion and for more services, together with
associated operating expenses, will reduce our cash flow and profitability until
we establish an adequate customer base throughout all of our coverage areas. To
date, we have expended substantial amounts on construction of our network from
the proceeds of our financing activities and, accordingly, we have generated
negative cash flow. We may need to obtain additional capital to expand our
services and increase our service territory, and cannot guarantee that
additional financing will be available to us or, if available, that we can
obtain it on a timely basis and on acceptable terms.

WE OBTAIN SOME OF THE KEY COMPONENTS USED IN OUR FIBER OPTIC NETWORK FROM A
SINGLE SOURCE OR A LIMITED GROUP OF SUPPLIERS, AND THE PARTIAL OR COMPLETE LOSS
OF ONE OF THESE SUPPLIERS COULD DISRUPT OUR OPERATIONS AND RESULT IN A
SUBSTANTIAL LOSS OF REVENUES.

We depend upon a small group of suppliers for some of the key components and
parts used in our network. In particular, we purchase cable from Lucent-Fitel
and from Corning, and we purchase fiber optic equipment from Nortel Networks,
Cisco Systems and Sycamore Networks. Any delay or extended interruption in the
supply of any of the key components, changes in the pricing arrangements with
our suppliers and manufacturers or delay in transitioning a replacement
supplier's product into our network could disrupt our operations.

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OUR FIBER OPTIC NETWORK, WHICH IS OUR SOLE SOURCE OF REVENUE, IS VULNERABLE
TO PHYSICAL DAMAGE, CATASTROPHIC OUTAGES, POWER LOSS AND OTHER DISRUPTIONS
BEYOND OUR CONTROL, AND THE OCCURRENCE OF ANY OF THESE FAILURES COULD RESULT IN
IMMEDIATE LOSS OF REVENUES, PAYMENT OF OUTAGE CREDITS TO OUR CUSTOMERS AND, MORE
IMPORTANTLY, THE LOSS OF OUR CUSTOMERS' CONFIDENCE AND OUR BUSINESS REPUTATION.

Our success in marketing our services to our customers requires that we
provide high reliability, high bandwidth and a secure network. Our network and
the infrastructure upon which it depends are subject to physical damage, power
loss, capacity limitations, software defects, breaches of security and other
disruptions beyond our control that may cause interruptions in service or
reduced capacity for customers. Our agreements with our customers typically
provide for the payment of outage related credits (a predetermined reduction or
offset against our lease rate when a customer's leased facility is
non-operational or otherwise does not meet certain operating parameters) or
damages in the event of a disruption in service. These credits or damages could
be substantial and could significantly decrease our net revenues. Significant or
lengthy outages would also undermine our customers' confidence in our fiber
optic network and injure our business reputation.

RISKS RELATING TO OUR RIGHTS-OF-WAY

WE COULD LOSE THE CONTRACT RIGHTS UPON WHICH WE RELY TO OPERATE AND MAINTAIN
OUR NETWORK IN THE EVENT OF BANKRUPTCY PROCEEDINGS RELATING TO ONE OR MORE OF
THE THIRD PARTIES THAT HAVE GRANTED TO US THE RIGHT TO BUILD AND OPERATE OUR
NETWORK USING THEIR RIGHTS-OF-WAY.

The construction and operation of significant portions of our fiber optic
network depend upon contract rights known as indefeasible rights-of-use.
Indefeasible rights-of-use are commonly used in the telecommunications industry,
but remain a relatively new concept in property law. Although indefeasible
rights-of-use give the holder a number of rights to control the relevant
rights-of-way or fiber optic filaments, legal title remains with the grantor of
the rights. Therefore, the legal status of indefeasible rights-of-use remains
uncertain, and our indefeasible rights-of-use might be voidable in the event of
bankruptcy of the grantor. If we were to lose an indefeasible right-of-use in a
key portion of our network, our ability to service our customers could become
seriously impaired and we could be required to incur significant expense to
resume the operation of our fiber optic network in the affected areas.

DESPITE OUR EXISTING RIGHTS-OF-WAY, WE MAY BE FORCED TO MAKE SUBSTANTIAL
ADDITIONAL PAYMENTS TO THE AFFECTED LANDOWNERS OR REMOVE OUR NETWORK FROM THEIR
PROPERTY, WHICH WOULD SIGNIFICANTLY HARM OUR BUSINESS AND OUR RESULTS OF
OPERATIONS.

Our indefeasible rights-of-use depend on the grantor's interest in the
property on which our network is located. To the extent that a grantor of an
indefeasible right-of-use has a limited easement in the underlying property and
not full legal title, the adequacy of our indefeasible rights-of-use could be
challenged in court. For example, in May 1999, AT&T entered into a costly
settlement of a class action suit brought by landowners who asserted that the
railroad-based rights-of-way upon which AT&T had relied to build portions of its
fiber optic network were insufficient to permit AT&T to use these rights-of-way
for telecommunications purposes.

We believe that it is likely that a number of landowners may make similar
claims against us based on our use of utility rights-of-way for our
telecommunications purposes. In fact, some landowners have already asserted
claims against us on this basis, and, to date, in two cases, rather than
electing to contest the landowners' interpretation of the scope of the easement,
we have made a payment to such landowners to acquire rights-of-way meeting our
requirements. We believe that the easements granted by a substantial number of
landowners to grantors of our indefeasible rights-of-use are similar in scope to
those with respect to which claims have been asserted, and we cannot guarantee
that additional claims will not be made in the future.

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BECAUSE SIGNIFICANT PORTIONS OF OUR FIBER OPTIC NETWORK ARE CONSTRUCTED UPON
RIGHTS-OF-WAY CONTROLLED BY ELECTRIC UTILITY COMPANIES WHICH GENERALLY PLACE THE
OPERATION OF THEIR ELECTRICAL FACILITIES AHEAD OF THE OPERATION OF OUR FIBER
OPTIC NETWORK, WE MAY BE UNABLE TO CONSTRUCT AND OPERATE OUR FIBER OPTIC NETWORK
IN THE AFFECTED AREAS WITHOUT PERIODIC INTERRUPTIONS AND DELAYS CAUSED BY THE
DAY-TO-DAY OPERATIONS OF THESE UTILITY COMPANIES.

Our rights-of-way agreements with Northeast Utilities, Central Maine Power
Company (a subsidiary of Energy East Corporation), Consolidated Edison
Communications, Inc., and Exelon Ventures Corporation contain provisions which
acknowledge the right of these companies to make the provision of electrical
services to their own customers their top priority. These companies are required
only to exercise "reasonable care" with respect to our facilities and are
otherwise free to take whatever actions they deem appropriate with respect to
ensuring or restoring service to their electricity customers, any of which
actions could impair operation of our network. In addition, some of our ongoing
operational efforts are constrained by the limited ability of the utilities to
de-energize segments of their transmission and distribution facilities in order
to permit construction crews to work safely. We have experienced construction
delays in the past as a result of such inability to timely de-energize certain
segments and we may experience such delays in the future.

RISKS RELATING TO GOVERNMENT REGULATION

FEDERAL REGULATION OF THE TELECOMMUNICATIONS INDUSTRY IS CHANGING RAPIDLY
AND WE COULD BECOME SUBJECT TO UNFAVORABLE NEW RULES AND REQUIREMENTS WHICH
COULD IMPOSE SUBSTANTIAL FINANCIAL AND ADMINISTRATIVE BURDENS ON US AND
INTERFERE WITH OUR ABILITY TO SUCCESSFULLY EXECUTE OUR BUSINESS STRATEGIES.

Regulation of the telecommunications industry is changing rapidly. Existing
and future federal, state, and local governmental regulations will greatly
influence our viability. Consequently, undesirable regulatory changes could
adversely affect our business, financial condition and results of operations.

REVENUES FROM LIT SERVICES TO INTERNET SERVICE PROVIDERS, WHICH REPRESENT A
PORTION OF OUR REVENUES, ARE SUBJECT TO CONTRIBUTIONS TO THE FCC'S UNIVERSAL
SERVICE FUND.

While we generally do not deal directly with end-users of telecommunications
services and are therefore generally exempt from contributing to the FCC's
Universal Service Fund, the FCC treats Internet service providers purchasing lit
services as end-users for these purposes. Our revenues from providing these
services, which represent a portion of our revenues, are therefore subject to an
assessment of 5.8% of gross interstate revenues for the fourth quarter of 1999,
and this assessment could increase.

IF WE BECOME SUBJECT TO REGULATION AS A COMMON CARRIER IN THE FUTURE, WE
WOULD BE SUBJECT TO ADDITIONAL REGULATORY REQUIREMENTS.

We do not believe that we are currently a "common carrier," but that status
could change based on differing interpretations of current regulations,
regulatory changes and changes in the way we conduct our business. If we become
regulated as a common carrier, we would have to file tariffs for our services
with the FCC and submit other reports, and would be required to contribute to
federal funds including, but not limited to, those established for
Telecommunications Relay Services and for the management of the North American
Numbering Plan. These regulatory requirements could impose substantial burdens
on us.

A recent FCC decision requiring incumbent local telephone companies to
provide their dark fiber to third parties may increase competition among
providers of dark fiber services.

The Communications Act of 1934 requires incumbent local telephone companies
to provide elements of their networks to competitors on an unbundled basis. In a
recent decision, the FCC determined that dark fiber is a network element that
incumbent local telephone companies must

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provide to others. The availability of this alternative source of supply could
decrease the demand for our dark fiber.

REGULATORY CHANGES COULD AFFECT RELATIONSHIPS BETWEEN US, OUR COMPETITORS
AND CUSTOMERS IN UNFORESEEABLE WAYS THAT COULD REDUCE OUR BUSINESS
OPPORTUNITIES.

Our relationships with the telecommunications companies with whom we deal
are all affected by our respective positions in the FCC's regulatory scheme.
Accordingly, changes in federal telecommunications law may affect our business
by virtue of the interrelationships that exist among us and many of these
regulated telecommunications entities. It is difficult for us to forecast at
this time how these changes will affect us in light of the complex
interrelationships that exist in the industry and the different levels of
regulation.

STATE REGULATION OF COMPANIES PROVIDING TELECOMMUNICATIONS SERVICES VARIES
SUBSTANTIALLY FROM STATE TO STATE AND WE MAY BECOME SUBJECT TO BURDENSOME AND
RESTRICTIVE STATE REGULATIONS AS WE EXPAND OUR FIBER OPTIC NETWORK INTO A
BROADER GEOGRAPHIC AREA, WHICH COULD INTERFERE WITH OUR OPERATIONS AND OUR
ABILITY TO MEET OUR STRATEGIC OBJECTIVES.

We may be subject to state regulation, which can vary substantially from
state to state. NEON Optica's subsidiaries in New York and Connecticut have
obtained authority to provide intrastate telecommunications services on a
competitive common carrier basis. Therefore, these subsidiaries are subject to
the obligations that applicable law places on all similarly certificated common
carriers including the filing of tariffs, state regulation of certain service
offerings, pricing, payment of regulatory fees and reporting requirements. The
costs of compliance with these regulatory obligations, or any of the regulatory
requirements of other states to which we might become subject, could have a
material adverse effect on our operations. Moreover, some of our rights-of-way
depend on our status as a common carrier in these states, and if that status
were to be successfully challenged, those rights-of-way could be terminated.

MUNICIPAL REGULATION OF OUR ACCESS TO PUBLIC RIGHTS-OF-WAY IS SUBJECT TO
CHANGE AND COULD IMPOSE ADMINISTRATIVE BURDENS THAT WOULD ADVERSELY AFFECT OUR
BUSINESS.

Local governments typically retain the ability to license public
rights-of-way, subject to the federal requirement that local governments may not
prohibit the provision of telecommunications services. Changes in local
government regulation could impose additional costs on our business and limit
our operations. Local authorities affect the timing and costs associated with
our use of public rights-of-way.

RISKS RELATING TO OUR CAPITALIZATION

BECAUSE WE HAVE A LARGE AMOUNT OF DEBT, WE WILL BE REQUIRED TO DEVOTE A
SIGNIFICANT PORTION OF OUR CASH FLOW TO PAY INTEREST AND WE MAY NOT HAVE
SUFFICIENT REMAINING CASH FLOW TO MEET OUR OTHER OBLIGATIONS AND EXECUTE OUR
BUSINESS STRATEGIES.

We are highly leveraged. Our high degree of debt, including NEON Optica's
$180 million 12 3/4% Senior Notes Due 2008, could have adverse consequences to
the holders of NEON Communication's equity securities. Commencing on August 15,
2002, a substantial portion of our cash flow will be dedicated to the payment of
the $22,950,000 per annum of interest expense associated with our debt and such
cash flow may be insufficient to meet our payment obligations on our debt in
addition to paying our other obligations as they become due. In addition, due to
our leverage ratio, our ability to obtain any necessary financing in the future
for completion of our network or other purposes may be impaired. Also, certain
of our future borrowings may be at variable rates of interest that could cause
us to be vulnerable to increases in interest rates. Because we are highly
leveraged, we may be at a competitive disadvantage to our competitors and may be
especially vulnerable to a downturn in our business or the economy generally, or
to delays in or increases in the costs of operating and constructing our
network.

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IN CONNECTION WITH NEON OPTICA'S SUBSTANTIAL PUBLIC DEBT, NEON OPTICA HAS
AGREED TO SIGNIFICANT RESTRICTIONS ON ITS OPERATIONS THAT LIMIT OUR ABILITY TO
ENTER INTO MAJOR CORPORATE TRANSACTIONS, AND AS A RESULT WE MAY BE UNABLE TO
PURSUE POTENTIAL CORPORATE OPPORTUNITIES WHICH WOULD BENEFIT NEON COMMUNICATIONS
AND ITS STOCKHOLDERS.

The indenture under which NEON Optica's debt was issued imposes significant
operating and financing restrictions on us and our present and future
subsidiaries. These restrictions affect, and in certain cases significantly
limit or prohibit, among other things, our ability to incur indebtedness, pay
dividends and make other restricted payments, create liens, issue and sell
capital stock of subsidiaries, guarantee indebtedness, sell assets or
consolidate, merge or transfer all or substantially all of our assets. These
limitations could prevent us from exploiting corporate opportunities as they
arise, which could be detrimental to the interests of our stockholders.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk related to changes in interest rates, but do
not believe that this exposure is material. We do not use derivative financial
instruments for speculative or trading purposes.

We maintain a short-term investment portfolio consisting mainly of corporate
debt securities and U.S. government agency discount notes with an average
maturity of less than six months. These held-to-maturity securities are subject
to interest rate risk and will fall in value if market interest rates increase.
If market interest rates were to increase immediately and uniformly by 10% from
levels that existed at September 30, 2000, the fair value of the portfolio would
decline by an immaterial amount. Because we have the ability to hold our fixed
income investments until maturity, we would not expect our operating results or
cash flows to be materially affected.

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<PAGE>
PART II. OTHER INFORMATION

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

On September 14, 2000, NEON Communications, Inc. issued 2,476,735 shares of
its common stock to Consolidated Edison Corporation, in exchange for
approximately $11,300,000 in cash, to be paid over time, and rights in certain
fiber optic facilities and 2,131,143 shares of its common stock to Exelon
Ventures Corporation, in exchange for approximately $8,050,000 in cash, to be
paid over time, and rights in certain fiber optic facilities. The common stock
was issued in reliance upon the exemptions from registration under Section 4(2)
of the Securities Act or Regulation D promulgated thereunder, relative to sales
by an issuer not involving any public offering.

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

NEON COMMUNICATIONS, INC.

Please see the matters under "NEON OPTICA, INC.", below. With respect to
matters 2 and 4, the stockholders of NEON Optica voted both as stockholders of
NEON Optica and as prospective stockholders of NEON Communications.

NEON OPTICA, INC.

On July 26, 2000, the NEON Optica, Inc. held its Annual Meeting of
Stockholders. Five matters were submitted to a vote of security holders:

1. The election of seven directors to serve for a term of one year and until
his or her successor is elected and qualified. The results of the voting were as
follows:

<TABLE>
<CAPTION>
NOMINEE FOR WITHHELD
------- ---------- ---------
<S> <C> <C>
Vincent C. Bisceglia*...... 15,951,758 26,792
Victor Colantonio.......... 15,951,758 26,792
Katherine Dietz Courage.... 15,925,008 53,542
John H. Forsgren........... 15,951,758 26,792
Arthur W. Adelberg*........ 15,951,758 26,792
F. Michael McClain......... 15,950,758 27,792
Gary D. Simon.............. 15,950,758 27,792
</TABLE>

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

*Resigned in August and September 2000, respectively.

2. Approval of the continuance and amendment of the Company's Amended and
Restated 1998 Stock Incentive Plan.

<TABLE>
<CAPTION>
FOR AGAINST ABSTAIN NON-VOTES
---------- ---------- ---------- ----------
<S> <C> <C> <C>
11,878,020 1,626,343 24,543 2,449,644
</TABLE>

3. Approval of the adoption of an amendment to the Company's Second Amended
and Restated Certificate of Incorporation in order to increase the shares of
Common Stock authorized for issuance from 30,000,000 shares to 60,000,000
shares.

<TABLE>
<CAPTION>
FOR AGAINST ABSTAIN NON-VOTES
---------- ---------- ---------- ----------
<S> <C> <C> <C>
15,756,030 203,123 19,397 0
</TABLE>

31
<PAGE>
4. Approval of the issuance of shares of the Company's common stock to
Consolidated Edison Communications, Inc. and Exelon Ventures Corporation in
exchange for their contribution to the Company of cash and assets consisting of
fiber optic facilities.

<TABLE>
<CAPTION>
FOR AGAINST ABSTAIN NON-VOTES
---------- ---------- ---------- ----------
<S> <C> <C> <C>
13,495,274 16,970 16,662 2,449,644
</TABLE>

5. To ratify the selection of Arthur Andersen LLP as the Company's
independent public accountants for the current year.

<TABLE>
<CAPTION>
FOR AGAINST ABSTAIN
---------- ---------- ----------
<S> <C> <C> <C>
15,964,573 11,119 2,858
</TABLE>

ITEM 5. OTHER INFORMATION

Not Applicable.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

Exhibit 3.1--Amended and Restated Certificate of Incorporation of NEON
Communications, Inc.

Exhibit 3.2--Restated Certificate of Incorporation of NEON Optica, Inc.

+Exhibit 10.46--System Agreement by and between NEON
Communications, Inc., NEON Optica, Inc. and Consolidated Edison
Communications, Inc. dated September 14, 2000.

+Exhibit 10.47--System Agreement by and between NEON
Communications, Inc., NEON Optica, Inc. and Exelon Ventures Corp. dated
September 14, 2000.

Exhibit 10.48--Registration Rights Agreement by and among NEON
Communications, Inc., Consolidated Edison Communications, Inc. and
Exelon Ventures Corp. dated September 14, 2000.

Exhibit 27.1--Financial Data Schedule of NEON Communications, Inc.

Exhibit 27.2--Financial Data Schedule of NEON Optica, Inc.

(b) Reports on Form 8-K

Current Report of NEON Communications, Inc. on Form 8-K dated
September 14, 2000.

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

+ Confidential treatment requested as to certain portions.

32
<PAGE>
SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrants have duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

<TABLE>
<S> <C>
NEON COMMUNICATIONS, INC.
NEON OPTICA, INC.

By: /s/ VICTOR COLANTONIO Date: November 14, 2000
-------------------------------------------
Victor Colantonio
President
NEON Communications, Inc. and
NEON Optica, Inc.

By: /s/ WILLIAM F. FENNELL Date: November 14, 2000
-------------------------------------------
William F. Fennell
Vice President, Finance,
Chief Financial Officer and Treasurer
(Principal Financial Officer)
NEON Communications, Inc. and
NEON Optica, Inc.
</TABLE>

33
<PAGE>
EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT
------ ------------------------------------------------------------
<S> <C>
3.1 Amended and Restated Certificate of Incorporation of NEON
Communications, Inc.
3.2 Restated Certificate of Incorporation of NEON Optica, Inc.
10.46 + System Agreement by and between NEON Communications, Inc.,
NEON Optica, Inc. and Consolidated Edison Communications,
Inc. dated September 14, 2000.
10.47 + System Agreement by and between NEON Communications, Inc.,
NEON Optica, Inc. and Exelon Ventures Corp. dated
September 14, 2000.
10.48 Registration Rights Agreement by and among NEON
Communications, Inc., Consolidated Edison Communications,
Inc. and Exelon Ventures Corp. dated September 14, 2000.
27.1 Financial Data Schedule of NEON Communications, Inc.
27.2 Financial Data Schedule of NEON Optica, Inc.
</TABLE>

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

+ Confidential treatment requested as to certain portions.