As filed with the Securities and Exchange Commission on February 13, 1998
Registration No. 333-
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
---------------
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------
US LEC Corp.
(Exact Name of Registrant as Specified in Its Charter)
<TABLE>
<CAPTION>
Delaware 4813 56-2065535
<S> <C> <C>
(State or Other Jurisdiction (Primary Standard Industrial (IRS Employer
of Incorporation or Organization) Classification Code Number) Identification No.)
</TABLE>
212 South Tryon Street, Suite 1540
Charlotte, North Carolina 28281
(704) 319-1000
(Address, Including Zip Code, and Telephone Number
Including Area Code, of Registrant's Principal Executive Offices)
Tansukh V. Ganatra
President and Chief Operating Officer
US LEC Corp.
212 South Tryon Street, Suite 1540
Charlotte, North Carolina 28281
(704) 319-1000
(Name, Address, Including Zip Code, and Telephone Number,
Including Area Code, of Agent for Service)
Copies to:
<TABLE>
<S> <C>
Barney Stewart III, Esq. Barry A. Brooks, Esq.
Aaron D. Cowell, Jr., Esq. Paul, Hastings, Janofsky & Walker LLP
Moore & Van Allen, PLLC 399 Park Avenue
100 North Tryon Street, Floor 47 New York, New York 10022-4697
Charlotte, North Carolina 28202-4003
</TABLE>
Approximate date of proposed sale to the public: To commence as soon as
practicable after this Registration Statement becomes effective.
If any of the securities registered on this form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
CALCULATION OF REGISTRATION FEE
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<TABLE>
<CAPTION>
Title Of Class Of Proposed Maximum Proposed Maximum
Securities To Be Amount To Be Offering Aggregate Offering Amount of
Registered Registered Price Per Share Price(1)(2) Registration Fee
<S> <C> <C> <C> <C>
Class A Common Stock,
$.01 par value....... $80,000,000 $23,600
</TABLE>
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- --------------------------------------------------------------------------------
(1) Includes Class A Common Stock that may be sold pursuant to the
Underwriters' over-allotment option.
(2) Estimated pursuant to Rule 457(o) under the Securities Act of 1933, as
amended, solely for purposes of calculating the registration fee.
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Securities and Exchange Commission, acting
pursuant to said Section 8(a), may determine.
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<PAGE>
Information contained herein is subject to completion or amendment. A
registration statement relating to securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor may
offers to buy be accepted prior to the time the registration statement becomes
effective. This prospectus shall not constitute an offer to sell or the
soliciation of an offer to buy nor shall there be any sale of these securities
in any state in which such offer, solicitation or sale would be unlawful prior
to qualification under the securities laws of any such state.
SUBJECT TO COMPLETION DATED FEBRUARY 13, 1998
PROSPECTUS
[US LEC LOGO]
Shares
US LEC Corp.
Class A Common Stock
------------
The shares of Class A Common Stock offered hereby are being sold by
US LEC Corp. (the "Company" or "US LEC"). Prior to this offering (the
"Offering"), there has not been a public market for the Class A Common Stock of
the Company. It is currently estimated that the initial public offering price
of the Class A Common Stock will be between $ and $ per share. See
"Underwriting" for information relating to factors to be considered in
determining the initial public offering price. Application has been made to
have the Class A Common Stock listed on the Nasdaq National Market under the
symbol "CLEC." The Company has two classes of common stock, the Class A
Common Stock and the Class B Common Stock (collectively, the "Common Stock").
The rights of the holders of the Class A Common Stock and the Class B Common
Stock are substantially identical, except that (i) holders of the Class A
Common Stock are entitled to one vote per share and holders of the Class B
Common Stock are entitled to 10 votes per share and, except as provided in
clause (ii), holders of both classes vote together as one class on all matters
submitted to a vote of stockholders, including the election of directors; (ii)
holders of the Class B Common Stock vote as a separate class to elect two
members of the Company's Board of Directors; and (iii) the Class B Common
Stock, subject to the terms of an agreement among the holders of Class B Common
Stock, is fully convertible at any time into Class A Common Stock, at the
option of the holder, or automatically upon transfer to a third person, on a
one-for-one basis. See "Description of Capital Stock."
After the Offering, Richard T. Aab, the Chairman, Chief Executive Officer
and a founder of US LEC, will beneficially own or otherwise control the vote of
100% of the outstanding Class B Common Stock, representing approximately %
of the total voting power of the outstanding Common Stock. See "Risk Factors --
Control by Single Stockholder," "Security Ownership of Management" and
"Description of Capital Stock."
See "Risk Factors" beginning on page 7 for a discussion of certain factors
which should be considered by potential investors.
------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Price to Underwriting Discounts Proceeds to
Public and Commissions (1) Company (2)
<S> <C> <C> <C>
Per Share $ $ $
Total (3) $ $ $
</TABLE>
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(1) For information regarding indemnification of the Underwriters, see
"Underwriting."
(2) Before deducting expenses, estimated at $ , which are payable by
the Company.
(3) The Company has granted the Underwriters a 30-day option to purchase up
to additional shares of Class A Common Stock solely to cover
over-allotments, if any. If such option is exercised in full, the total
Price to Public, Underwriting Discounts and Commissions and Proceeds to
Company will be $ , $ and $ , respectively. See
"Underwriting."
------------
The shares of Class A Common Stock are being offered by the several
Underwriters named herein, subject to prior sale, when, as and if accepted by
them and subject to certain conditions. It is expected that certificates for
the shares of Class A Common Stock offered hereby will be available for
delivery on or about , 1998, at the office of Smith Barney Inc., 333 West
34th Street, New York, New York 10001 or through the facilities of The
Depository Trust Company.
------------
Salomon Smith Barney
Bear, Stearns & Co. Inc.
Wheat First Union , 1998.
<PAGE>
[MAP OF US LEC'S NETWORK APPEARS HERE]
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT
STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE CLASS A COMMON STOCK,
INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING TRANSACTIONS IN SUCH
SECURITIES, AND THE IMPOSITION OF A PENALTY BID, IN CONNECTION WITH THE
OFFERING. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
<PAGE>
PROSPECTUS SUMMARY
The following is a summary of certain information contained elsewhere in
this Prospectus. Reference is made to, and this Prospectus Summary is qualified
in its entirety by, the more detailed information, including the consolidated
financial statements and notes thereto contained herein. The Company is the
successor to US LEC L.L.C., a Delaware limited liability company, that merged
into the Company on December 31, 1997. Unless the context otherwise requires,
the terms "US LEC" and the "Company" refer to US LEC Corp., a Delaware
corporation and its consolidated subsidiaries and the Company's predecessor, US
LEC L.L.C. Capitalized terms used in this Prospectus which are not otherwise
defined herein, have the meaning ascribed to them in the Glossary included in
this Prospectus. References herein to "EBITDA" refer to net earnings (loss)
before interest expense, income taxes, depreciation and amortization.
Information in this Prospectus, unless otherwise indicated, assumes that the
over-allotment option that has been granted to the Underwriters in the Offering
will not be exercised.
The Company
US LEC is a rapidly growing competitive local exchange carrier ("CLEC")
that provides switched local, long distance and enhanced telecommunications
services primarily to medium and large-sized organizations located in selected
markets in the southeastern United States. The Company was founded in June 1996
after passage of the Telecommunications Act of 1996 (the "Telecom Act"), which
enhanced the competitive environment for local exchange services. The Company
initiated service in Charlotte, North Carolina in March 1997, becoming one of
the first CLECs in North Carolina to provide switched local exchange services,
and subsequently initiated service in Raleigh and Greensboro, North Carolina
and in Atlanta, Georgia. As of February 28, 1998, the Company had Equivalent
Access Lines (as defined in the Glossary) in service. US LEC plans to enter 15
new markets in Tennessee, Florida, South Carolina, Virginia and North Carolina
by the end of 1999. US LEC's objective is to become the primary provider of
switched local telecommunications services to its existing and target
customers.
Network Strategy
US LEC purchases and deploys switching equipment and leases fiber optic
transmission capacity from competitive access providers ("CAPs"), other CLECs
and incumbent local exchange carriers ("ILECs"). Management believes that this
switch-based, leased-transport strategy provides the Company with significant
competitive advantages. By owning its switches, the Company is able to better
configure its network to provide cost-effective and customized solutions for
its customers' telecommunications needs. By leasing transmission capacity, the
Company is able to (i) reduce the up-front capital expenditures required to
enter new markets, (ii) avoid the risk of "stranded" investment in
under-utilized fiber networks and (iii) enter markets and generate revenue and
positive cash flow more rapidly than if the Company first constructed its own
transmission facilities. Management believes that the availability of several
suppliers of fiber optic transmission facilities in each of the Company's
markets provides US LEC with negotiating leverage, vendor diversity and the
ability to offer customers enhanced reliability at a competitive price.
Market Opportunity
The Company focuses its primary sales efforts on
telecommunications-intensive organizations with at least 100 access lines,
including businesses, government agencies, other telecommunications companies
and value-added resellers ("VARs"). After completing its planned expansion, US
LEC will operate in 19 markets located in six contiguous states in the
southeastern United States -- one of the fastest growing regional markets for
business telecommunications services in the country. Within the Southeast, the
Company has selected its target markets based on a number of considerations,
including the number of potential customers and other competitors in such
markets and the presence of multiple transmission facility suppliers. Based on
the Company's study of state regulatory filings (the "Market Study"), in the
four markets presently served by the Company there were approximately 1.4
million business lines that generated approximately $2.1 billion in local
exchange and long distance revenues in 1996. The Market Study indicates that
the 19 markets in which management expects the
1
<PAGE>
Company to be operating by the end of 1999 had a total of approximately 4.1
million business lines that generated approximately $5.7 billion in local
exchange and long distance revenues in 1996. These local and long distance
revenue figures do not include revenue associated with enhanced services and
carrier access fees, which US LEC is pursuing as part of its business plan.
Since commencing network operations, US LEC has achieved significant
growth in its Equivalent Access Lines in service and in the number of switched
minutes of use ("MOUs") carried over the Company's network. As indicated in the
following table, from March 1997 through February 1998, the Company increased
its number of Equivalent Access Lines in service at month-end from 288 to
and increased its monthly number of MOUs during the same period from
approximately 40,000 to :
<TABLE>
<CAPTION>
1997
------------------------------------------------------------------------------------
Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec.
------ ------ ------- ------- -------- -------- -------- -------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Cumulative Equivalent
Access Lines in Service (1):
Charlotte ....................... 288 757 2,204 2,881 4,571 5,157 9,789 10,863 12,824 16,724
Raleigh ......................... -- 168 624 1,206 1,948 3,012 5,715 9,590 13,935 19,017
Greensboro ...................... -- -- -- -- -- -- -- -- 3,168 13,488
Atlanta ......................... -- -- -- -- -- -- -- -- -- --
--- --- ----- ----- ------ ------ ------ ------ ------ -------
Totals ......................... 288 925 2,828 4,087 6,519 8,169 15,504 20,453 29,927 49,229
=== === ===== ===== ====== ====== ====== ====== ====== =======
MOUs (in thousands) (2) ......... 40 500 3,118 5,000 16,323 20,024 33,383 54,273 95,542 243,637
=== === ===== ===== ====== ====== ====== ====== ====== =======
<CAPTION>
1998
---------------
Jan. Feb.
--------- -----
<S> <C> <C>
Cumulative Equivalent
Access Lines in Service (1):
Charlotte ....................... 24,943
Raleigh ......................... 19,800
Greensboro ...................... 14,203
Atlanta ......................... --
-------
Totals ......................... 58,946
=======
MOUs (in thousands) (2) ......... 446,386
=======
</TABLE>
- ----------
(1) As of the end of the month indicated. "Equivalent Access Lines" is a term
used by management to quantify the size of the Company's network. For a
detailed definition, see Glossary.
(2) MOUs indicate the number of local and long distance switched minutes of use
carried over the Company's network during the month indicated.
The Company's existing North Carolina operations generated positive EBITDA
of $200,264 during the month of December 1997, ten months after the Company
first initiated service in Charlotte. While EBITDA does not represent cash flow
or results of operations in accordance with generally accepted accounting
principles, it is a measure of financial performance commonly used in the
telecommunications industry. Management expects the Company to achieve similar
operating results in each of its new markets within a comparable time frame.
Management attributes US LEC's ability to achieve this performance primarily to
two factors. First, the Company's capital-efficient network strategy eliminates
the lengthy "build-out" period usually required to construct a fiber optic
transmission network, permitting the Company to quickly enter new markets and
rapidly generate revenue and positive cash flow. Second, US LEC's
telecommunications-intensive customers typically transmit a large amount of
switched traffic over the Company's network, resulting in efficient network
utilization and attractive operating margins.
Management
US LEC believes that the quality of its management team has been a
critical factor in the successful rollout of existing markets and will be a key
to the implementation of its strategy in additional markets. The Company has
assembled a proven management team with extensive telecommunications experience
in the deployment of local exchange, long distance, cellular and international
gateway services in emerging competitive environments. The Company's seven
executive officers have an average of over 15 years of experience in the
telecommunication services industry. In 1982, Richard T. Aab, US LEC's Chairman
and Chief Executive Officer, co-founded ACC Corp., a publicly traded
international telecommunications company, and served that company in various
capacities, including Chairman and Chief Executive Officer, through mid-1997.
Tansukh V. Ganatra, US LEC's President and Chief Operating Officer, served as
ACC Corp.'s President, Chief Operating Officer, and Vice President of
Engineering and Operations over a ten-year period ending in 1997. Prior to
joining ACC Corp., Mr. Ganatra spent 19 years at Rochester Telephone Corp. (now
part of Frontier Corp.), most recently serving as Director of Network
Engineering. Other key US LEC executives have extensive experience in
telecommunications engineering, marketing, sales, operations and regulation.
2
<PAGE>
Business Strategy
US LEC's objective is to become the primary provider of switched local
telecommunications services to its existing and target customers. The principal
elements of US LEC's strategy include:
o Deploy a Capital-Efficient Network. Management believes that US LEC is one of
the first CLECs to utilize a strategy of purchasing and deploying switching
equipment in each target market and leasing the required fiber optic
transmission capacity from CAPs, other CLECs and ILECs. Management believes
the Company's switch-based, leased-transport strategy enables it to enter
markets and generate revenue and positive cash flow more rapidly than if the
Company first constructed its own transmission facilities. This strategy
also reduces the up-front capital expenditures required to enter new markets
and avoids the risk of "stranded" investment in under-utilized fiber
networks. Management also believes that the Company's ability to align its
leased transmission costs with customer orders permits a higher return on
invested capital.
o Focus on a Southeastern Cluster of Operations. After completing its planned
expansion, the Company will operate in 19 markets located in six contiguous
states in the southeastern United States -- one of the fastest growing
regional markets for business telecommunications services in the country.
Within the Southeast, the Company has selected its target markets based on a
number of considerations, including the number of potential customers and
other competitors in such markets and the presence of multiple transmission
facility suppliers. Management believes that the Company's clustered network
will enable it to take advantage of regional calling patterns and capture an
increasing portion of customer traffic on its network. Management also
believes that by originating and terminating calls on its network, the
Company can achieve significant cost savings and potential pricing
advantages over its competition.
o Target Telecommunications-Intensive Customers. The Company focuses its primary
sales efforts on telecommunications-intensive organizations with at least 100
access lines, including businesses, government agencies, other
telecommunications companies and VARs. The volume of usage generated by the
Company's target customers allows the Company to efficiently concentrate the
telecommunications traffic of its customers on one or more leased T-1 lines.
In addition, the Company frequently is able to sell enhanced and long distance
services to complement its core local services. This further enhances network
utilization and improves margins, as fixed network costs are spread over a
larger base of MOUs.
o Install a Robust, Uniform Technology Platform. The Company has chosen the
5ESS(R)-2000 digital switch manufactured by Lucent Technologies, Inc.
("Lucent") to provide a consistent technology platform throughout its network.
The Lucent switch enables the Company to provide both local and long distance
services from a single platform. This uniform and advanced switching platform
enables the Company to (i) deploy features and functions quickly throughout
its entire network, (ii) expand switch capacity in a cost effective manner,
(iii) lower maintenance costs through reduced training and spare part
requirements and (iv) achieve direct connectivity to cellular and personal
communication system applications in the future.
o Employ a Direct Sales Force with Extensive Local Market Experience. Management
believes that the Company's success in a particular market is enhanced by
employing a direct sales force with extensive local market and
telecommunications sales experience. The Company employed this strategy in
building its existing sales forces in North Carolina and Georgia and intends
to continue implementing this strategy in other markets. Salespeople with
experience in a particular market provide the Company with extensive knowledge
of the Company's target customer base and in many cases already have existing
relationships with target customers. The experience and relationships of these
salespeople enable them to pre-sell the Company's products and services prior
to initiating network operations in a particular market.
o Implement Efficient Provisioning Processes. Management believes that a
critical aspect of the success of a CLEC is timely and effective provisioning
systems, which includes the process of transitioning ILEC customers to the
Company's network. The Company focuses on implementing effective and timely
provisioning practices in each of its markets to rapidly and efficiently
transition customers from the ILEC to the Company without disruption of the
customer's operations. Management believes that these practices provide the
Company with a long-term competitive advantage and enable it to implement
services in its markets rapidly and to shorten the time between receipt of the
customer order and the generation of revenue.
3
<PAGE>
The Offering
Class A Common Stock offered by
the Company. shares(1)
Common Stock to be outstanding after the Offering:
Class A Common Stock........... shares(1)(2)
Class B Common Stock........... shares
Total........................ shares(1)(2)
Use of Proceeds.................... The Company intends to use substantially
all of the net proceeds from the Offering
for capital expenditures and working
capital relating to its expansion into new
markets. See "Use of Proceeds."
Nasdaq National Market Symbol...... CLEC
- ----------
(1) Excludes up to shares of Class A Common Stock that may be sold
pursuant to the Underwriters' over-allotment option.
(2) Excludes shares of Class A Common Stock issuable upon exercise of
warrants held having exercise prices ranging from $ to $ per share,
and shares issuable upon exercise of options granted under the US LEC
Corp. 1998 Omnibus Stock Plan (the "Stock Plan") with an exercise price of
$ per share.
Risk Factors
See "Risk Factors" for a discussion of certain factors which should be
considered by prospective purchasers of the Class A Common Stock.
4
<PAGE>
SUMMARY HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA
The summary historical consolidated financial data presented below as of
December 31, 1996 and 1997, for the period from June 6, 1996 (inception) to
December 31, 1996 and for the year ended December 31, 1997 are derived from and
qualified by reference to the audited consolidated financial statements and
notes thereto of US LEC contained elsewhere in this Prospectus. The Company's
consolidated financial statements as of December 31, 1996 and 1997, for the
period from June 6, 1996 (inception) to December 31, 1996 and for the year
ended December 31, 1997, have been audited by Deloitte & Touche LLP,
independent public accountants. The summary historical financial data for each
quarter of 1997 have been derived from the unaudited interim consolidated
financial statements of the Company. In the opinion of management, the
unaudited interim consolidated financial statements have been prepared on the
same basis as the audited consolidated financial statements and include all
adjustments, which consist only of normal recurring adjustments, necessary for
a fair presentation of the financial position and the results of operations for
these periods. All of the data should be read in conjunction with and are
qualified by reference to "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the audited consolidated financial
statements and notes thereto of the Company contained elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
Period from Quarter Ended
June 6, 1996 ---------------------------------------------------------------
(Inception) to
December 31, March 31, June 30, September 30, December 31,
1996 1997 1997 1997 1997
---------------- --------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenue ....................................... $ -- $ 1,141 $ 228,620 $ 1,529,745 $ 4,698,155
Cost of services .............................. -- 423,093 314,828 1,075,183 2,387,897
------------- ------------ ----------- ------------ -------------
Gross margin .................................. -- (421,952) (86,208) 454,562 2,310,258
Selling, general and administrative ........... 941,743 1,049,130 1,047,940 1,294,115 2,679,052
Depreciation and amortization ................. 4,059 14,046 88,406 124,994 215,468
------------- ------------ ----------- ------------ -------------
Loss from operations .......................... (945,802) (1,485,128) (1,222,554) (964,547) (584,262)
Interest expense, net ......................... 16,861 66,556 108,021 101,326 78,953
------------- ------------ ----------- ------------ -------------
Net loss ...................................... $ (962,663) $ (1,551,684) ($ 1,330,575) $ (1,065,873) $ (663,215)
============= ============ =========== ============ =============
Net loss per share ............................ $ $ $ $ $
============= ============ =========== ============ =============
Weighted average shares outstanding ...........
Other Financial Data:
Capital expenditures .......................... $ 279,634 $ 1,798,152 $ 634,122 $ 828,903 $ 9,793,930
EBITDA (1) .................................... (941,743) (1,471,082) (1,134,148) (839,553) (368,794)
Net cash flow used in operating
activities ................................... (1,079,069)
Net cash flow used in investing activities..... (465,792)
Net cash flow provided by financing
activities ................................... 2,271,000
Operating Data:
Cumulative Equivalent Access Lines in
service (2) .................................. -- 288 4,087 15,504 49,229
MOUs (3) ...................................... -- 40,000 8,618,000 69,730,000 393,452,000
<CAPTION>
Year Ended
December 31,
1997
---------------
<S> <C>
Statement of Operations Data:
Revenue ....................................... $ 6,457,661
Cost of services .............................. 4,201,001
------------
Gross margin .................................. 2,256,660
Selling, general and administrative ........... 6,070,237
Depreciation and amortization ................. 442,914
------------
Loss from operations .......................... (4,256,491)
Interest expense, net ......................... 354,856
------------
Net loss ...................................... $ (4,611,347)
============
Net loss per share ............................ $
============
Weighted average shares outstanding ...........
Other Financial Data:
Capital expenditures .......................... $ 13,055,107
EBITDA (1) .................................... (3,813,577)
Net cash flow used in operating
activities ................................... (5,594,093)
Net cash flow used in investing activities..... (5,951,231)
Net cash flow provided by financing
activities ................................... 14,008,395
Operating Data:
Cumulative Equivalent Access Lines in
service (2) .................................. 49,229
MOUs (3) ...................................... 471,840,000
</TABLE>
<TABLE>
<CAPTION>
As of December 31, 1997
--------------------------------------------------------
As of
December 31, Pro Forma
1996 Actual Pro Forma (4) As Adjusted (4) (5)
------------- --------------- --------------- --------------------
<S> <C> <C> <C> <C>
Balance Sheet Data:
Current assets .................................. $1,067,662 $ 9,654,993
Working capital (deficiency) .................... 936,884 (2,268,883)
Property and equipment, net ..................... 276,097 12,889,335
Total assets .................................... 1,466,835 22,680,681
Notes payable -- stockholders ................... 1,671,000 5,000,000
Total stockholders' equity (deficiency) ......... (334,943) 5,756,805
</TABLE>
5
<PAGE>
- ----------
(1) EBITDA consists of net earnings (loss) before interest expense, income
taxes, depreciation and amortization. It is a measure commonly used by
analysts, investors and other interested parties in the telecommunications
industry and is presented to assist in understanding the Company's
operating results. However, EBITDA is not a measurement of financial
performance under generally accepted accounting principles and should not
be considered an alternative to net income or (loss) as a measure of
performance or to cash flow as a measure of liquidity. EBITDA is not
necessarily comparable with similarly titled measures for other companies.
(2) As of the end of the period indicated. "Equivalent Access Lines" is a term
used by management to quantify the size of the Company's network. For a
detailed definition, see Glossary.
(3) MOUs indicate the number of local and long distance switched minutes of use
carried over the Company's network during the period indicated.
(4) Reflects the exchange of a note payable to a stockholder in the amount of
$5.0 million for shares of Class B Common Stock on February , 1998.
See "Certain Relationships and Related Transactions."
(5) Adjusted to reflect the sale of Class A Common Stock offered hereby
assuming no exercise of the Underwriters' over-allotment option, and after
deducting the Underwriters' Discounts and Commissions and estimated
expenses of the Offering.
6
<PAGE>
RISK FACTORS
Prospective investors should consider carefully the following factors
together with the other information contained in this Prospectus:
Limited Operating History
US LEC was formed in June 1996, began generating revenue in March 1997 and
has a relatively small number of customers. Accordingly, prospective investors
have very limited historical operating and financial information upon which to
base an evaluation of the Company's performance and an investment in the Class
A Common Stock. Given the Company's limited operating history, there can be no
assurance that it will be able to compete successfully in the
telecommunications business, achieve or sustain profitability or generate
sufficient positive cash flow in the future to meet debt service, working
capital or other cash requirements. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
Risks Associated with Implementation of Growth Strategy
The expansion and development of US LEC's operations will depend on, among
other things, the Company's ability to (i) accurately assess potential new
markets, (ii) identify, hire and retain qualified personnel, (iii) lease access
to suitable fiber optic networks, (iv) purchase, install and operate switches
and (v) obtain any required government authorizations, all in a timely manner,
at reasonable costs and on satisfactory terms and conditions. In addition, US
LEC has experienced rapid growth since its inception, and management believes
that sustained growth will place a strain on operational, human and financial
resources. The Company's ability to manage its expansion effectively will also
depend on the continued development of plans, systems and controls for its
operational, financial and management needs. Given the Company's limited
operating history, there can be no assurance that the Company will be able to
satisfy these requirements or otherwise manage its growth effectively. The
failure of US LEC to satisfy these requirements could have a material adverse
effect on the Company's financial condition and its ability to fully implement
its expansion plans.
The Company's growth strategy also involves the following risks:
Qualified Personnel. A critical component for US LEC's success will be
hiring and retaining additional qualified managerial, sales and technical
personnel. Since its inception, the Company has experienced significant
competition in hiring and retaining personnel possessing necessary skills and
telecommunications experience. Although management believes the Company has
been successful in hiring and retaining qualified personnel, there can be no
assurance that US LEC will be able to do so in the future.
Switch and Equipment Installation. An essential element of the Company's
current strategy is the provision of switched local service. There can be no
assurance that installation of the switches and associated electronics
necessary to implement the Company's business plan will continue to be
completed on a timely basis or that, during the testing of this equipment, the
Company will not experience technological problems that cannot be resolved. The
failure of the Company to install and operate successfully additional switches
and other network equipment could have a material adverse effect on the
Company's financial condition and its ability to enter additional markets.
Interconnection Agreements. The Company has agreements for the
interconnection of its networks with the networks of the ILECs covering each
market in which US LEC either has or is currently installing a switching
platform. US LEC may be required to negotiate new, or renegotiate existing,
interconnection agreements as it enters new markets in the future, such as in
Virginia and Florida. In addition, as its existing interconnection agreements
expire, it will be required to negotiate extension or replacement agreements.
There can be no assurance that the Company will successfully negotiate such
other agreements for interconnection with the ILECs or renewals of existing
interconnection agreements on terms and conditions acceptable to the Company. A
recent decision by the United States Court of Appeals for the Eighth Circuit
vacating several of the FCC's rules creates uncertainty about the rules
governing pricing, terms and conditions of interconnection agreements. As a
result of this decision, which has been appealed to the U.S. Supreme Court, and
a pending review of this issue by the FCC, negotiating and enforcing such
agreements could become more difficult and protracted, and renegotiation of
existing agreements could be required. See "Business -- Regulation -- Eighth
Circuit Court of Appeals Decision." The failure to negotiate and obtain
required interconnection agreements on terms and conditions
7
<PAGE>
acceptable to the Company could have a material adverse effect on the Company's
ability to rapidly enter a particular market and on its operations in its
existing markets.
Ordering, Provisioning and Billing. The Company has developed processes
and procedures and is working with external vendors, including the ILECs, in
the implementation of customer orders for services, the provisioning,
installation and delivery of such services and monthly billing for those
services. The failure to manage effectively processes and systems for these
service elements or the failure of the Company's current vendors or the ILECs
to deliver ordering, provisioning and billing services on a timely and accurate
basis could have a material adverse effect upon the Company's ability to
achieve its growth strategy.
Products and Services. The Company currently focuses its efforts on
providing local and long distance telecommunications services. In order to
address the needs of its target customers, the Company will be required to
emphasize and develop additional products and services. No assurance can be
given that the Company will be able to provide the range of telecommunication
services that its target customers need or desire.
Acquisitions. US LEC may acquire other businesses as a means of expanding
into new markets or developing new services. The Company is unable to predict
whether or when any prospective acquisitions will occur or the likelihood of a
material transaction being completed on favorable terms and conditions. Such
transactions involve certain risks including, but not limited to, (i)
difficulties assimilating acquired operations and personnel; (ii) potential
disruptions of the Company's ongoing business; (iii) the diversion of resources
and management time; (iv) the possibility that uniform standards, controls,
procedures and policies may not be maintained; (v) risks associated with
entering new markets in which the Company has little or no experience; and (vi)
the potential impairment of relationships with employees or customers as a
result of changes in management. If an acquisition were to be made, there can
be no assurance that the Company would be able to obtain the financing to
consummate any such acquisition on terms satisfactory to it or that the
acquired business would perform as expected.
Uncertainties Related to Reciprocal Compensation
The Telecom Act requires ILECs to provide reciprocal compensation to a
CLEC for local traffic terminated on such CLEC's network. Notwithstanding this
requirement, a number of Regional Bell Operating Companies ("RBOCs") have taken
the position that traffic terminated to enhanced service providers ("ESPs"),
including information service providers such as internet service providers
("ISPs"), is not local traffic. CLECs have been generally successful in
challenging the RBOCs in public utility commission ("PUC") proceedings in
several states, including Virginia (one of the states that the Company has
targeted for expansion). However, an arbitrator in Oklahoma is reported to have
ruled that ISP traffic is not entitled to reciprocal compensation based upon an
arbitrator's decision in Texas that has since been overruled by the Texas PUC.
Other than Virginia, the Company is not aware of any circumstance where a PUC
in the Company's current and proposed operating territory (North Carolina,
Georgia, Tennessee, Florida and South Carolina) has issued a ruling on this
issue.
Recently, BellSouth Telecommunications, Inc. ("BellSouth") notified the
Company and other CLECs that it would not pay or collect reciprocal
compensation under interconnection agreements for traffic terminated to an ESP
or an ISP. The Company petitioned the North Carolina PUC to resolve this issue.
This matter is currently pending before the North Carolina PUC. See "Business
- -- Regulation -- BellSouth North Carolina PUC Proceeding." In addition, a
similar proceeding has been initiated against BellSouth before the Georgia PUC
by another CLEC. Although the Company believes that the PUCs in the states that
it has targeted for operation will require ILECs to pay reciprocal compensation
for traffic terminated to ESPs and ISPs, no assurance can be given that one or
more of the PUCs will not rule in favor of the ILECs. A final decision in favor
of the ILECs may have a material adverse effect on the Company. Moreover, even
if the PUCs rule in favor of the Company and other CLECs on this issue, the
ILECs could appeal any adverse decision. In addition, this issue is under
general review by the FCC. There can be no assurance that the payment of
reciprocal compensation for ESP and ISP or other traffic types will be
maintained at the existing rates or at all.
A significant portion of the Company's estimated total revenue for 1998
and 1999 is expected to be derived from reciprocal compensation from BellSouth
for traffic terminated on US LEC's network to ESPs and ISPs in North Carolina.
If a decision adverse to the Company is issued in the North Carolina PUC
proceeding, by the FCC or by one or more PUCs in other southeastern states in
which the Company currently operates or plans to operate in the future, the
ability of the Company to serve existing and future ESP and ISP customers
profitably
8
<PAGE>
would be limited and thus could have a material adverse affect on US LEC's
operating results, financial condition and current strategy.
Dependence on Key Personnel
The Company's business is managed by a small number of key executive
officers, most notably Richard T. Aab, Chairman and Chief Executive Officer,
and Tansukh V. Ganatra, President and Chief Operating Officer. The loss of the
services of one or more of these key people, particularly Mr. Aab or Mr.
Ganatra, could materially and adversely affect US LEC's business and its
prospects. None of the Company's executive officers have employment agreements
or are subject to noncompetition agreements, and the Company does not maintain
key man life insurance on any of its officers. The competition for qualified
managers in the telecommunications industry is intense. Accordingly, there can
be no assurance that US LEC will be able to hire and retain necessary personnel
in the future to replace any of its key executive officers, if any of them were
to leave US LEC or be otherwise unable to provide services to US LEC.
Reliance on Leased Capacity
A key element of US LEC's business and growth strategy is leasing fiber
optic transmission capacity instead of constructing its own transport
facilities. In implementing this strategy, the Company relies upon its ability
to lease capacity from CAPs, other CLECs and ILECs operating in its markets. In
order for this strategy to be successful, the Company must be able to negotiate
and renew satisfactory agreements with its fiber optic network providers, and
the providers must process provisioning requests on a timely basis, maintain
their networks in good working order and provide adequate capacity. Although US
LEC enters into agreements with its network providers that are intended to
ensure access to adequate capacity and timely processing of provisioning
requests, (and although US LEC's interconnection agreements with ILECs
currently provide that the Company's connection and maintenance orders will
receive attention at parity with the ILECs and other CLECs and that adequate
capacity will be provided), there can be no assurance that the ILECs and other
network providers will comply with their contractual (and, in the case of the
ILECs, legally required) network provisioning obligations, or that the
provisioning process will be completed for the Company's customers on a timely
and otherwise satisfactory basis. Furthermore, there can be no assurance that
the rates to be charged to US LEC under future interconnection agreements or
lease agreements with other providers will allow the Company to offer usage
rates low enough to attract a sufficient number of customers and operate its
networks at satisfactory margins.
Competition
The telecommunications industry is highly competitive. In each of the
Company's existing and target markets, the Company competes and will continue
to compete principally with the ILECs serving that area. ILECs are established
providers of local telephone services to all or virtually all telephone
subscribers within their respective service areas. ILECs also have greater
financial and personnel resources, brand name recognition and long-standing
relationships with regulatory authorities at the federal and state levels.
The Company also faces, and expects to continue to face, competition from
other current and potential market entrants, including long distance carriers
seeking to enter, reenter or expand entry into the local exchange marketplace,
and from other CLECs, CAPs, cable television companies, electric utilities,
microwave carriers, wireless telephone system operators and private networks
built by large end-users. In addition, a continuing trend toward combinations
and strategic alliances in the telecommunications industry could give rise to
significant new competitors. Many of these current and potential competitors
have financial, personnel and other resources, including brand name
recognition, substantially greater than those of the Company, as well as other
competitive advantages over the Company.
The Company also competes with long distance carriers in the provision of
long distance services. Although the long distance market is dominated by four
major competitors, hundreds of other companies also compete in the long
distance marketplace.
In addition, the regulatory environment in which the Company operates is
undergoing significant change. As this regulatory environment evolves, changes
may occur which could create greater or unique competitive advantages for all
or some of the Company's current or potential competitors, or could make it
easier for additional parties to provide services. See "Business --
Competition."
9
<PAGE>
Regulation
Although passage of the Telecom Act has resulted in increased
opportunities for companies that are competing with the ILECs, no assurance can
be given that changes in current or future regulations adopted by the FCC or
state regulators or other legislative or judicial initiatives relating to the
telecommunications industry would not have a material adverse effect on the
Company. In addition, although the Telecom Act conditions RBOCs' provision of
in-region long distance service on a showing that the local market has been
opened to competition, there can be no assurance that these ILECs will
negotiate quickly with competitors such as the Company for the required
interconnection of the competitor's networks with those of the ILEC or
provisioning of services on a timely basis. Moreover, there have been numerous
challenges to various provisions of the Telecom Act relating to these matters.
If successful, these challenges may have an unfavorable effect on the Company's
business because they could (i) remove the incentive RBOCs have to cooperate
with companies like US LEC to foster competition within their service areas so
that they can qualify to offer in-region long distance by allowing RBOCs to
offer such services immediately and (ii) give the RBOCs the ability to offer
"one-stop shopping" for both long distance and local service.
On May 8, 1997, the FCC released an order establishing a significantly
expanded federal telecommunications universal service program which both
increased the size of existing subsidies and created new subsidy funds to which
the Company may be required to contribute. These funds relate to subsidies for
certain services offered in high-cost areas or to low income subscribers,
schools, libraries and rural healthcare providers. Although the FCC order
describes a method for determining the amount the Company must contribute to
support these subsidies, the Company is currently unable to quantify the amount
of these payments that it will be required to make, or the effect that these
required payments will have on its financial condition. In the May 8 order, the
FCC also announced that it will soon revise its rules for subsidizing service
provided to consumers in high cost areas. The Company also may be required to
contribute to state-established funds.
The Telecom Act also governs interconnection, resale of ILEC services by
CLECs, lease of unbundled network elements and termination of traffic. On July
18, 1997, the United States Court of Appeals for the Eighth Circuit overturned
many of the rules the FCC had established pursuant to the Telecom Act. The
Eighth Circuit decision substantially limits the FCC's jurisdiction and expands
the state regulators' jurisdiction to set and enforce rules governing the
development of local competition. As a result, it is more likely that the rules
governing local competition will vary substantially from state to state. Most
states, however, have already begun to establish rules for local competition
that are consistent with the FCC rules overturned by the Eighth Circuit. If a
patchwork of state regulations were to develop, it could increase the Company's
costs of regulatory compliance and could make entry into, and conducting
business, in some markets more difficult and expensive than in others. The U.S.
Supreme Court has decided to review the Eighth Circuit's decision. There can be
no assurance as to how or when the U.S. Supreme Court will act on the appeals
or that the outcome of the appeals will not have a material adverse affect on
the Company. See "Business -- Regulation."
Negative Cash Flow and Operating Losses
The Company intends to satisfy most of its working capital needs through
cash generated from operations. To date, the Company has not generated positive
cash flow from its operations on a consolidated basis. Moreover, US LEC's
operations have resulted in net losses of $962,663 for the period from
inception (June 6, 1996) through December 31, 1996 and approximately $4.6
million for the year ended December 31, 1997. There can be no assurance that
the Company will achieve or sustain profitability or generate positive cash
flow in the future. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Future Capital Requirements
Implementation of the Company's expansion plans will require significant
capital expenditures. The Company's principal capital expenditures relate to
the purchase and installation of its switching platform. The Company estimates
that the capital expenditures required to fund its expansion plans will
approximate $40 million in 1998 and $30 million in 1999. Management expects to
satisfy these capital requirements primarily with the net proceeds of this
Offering, although there can be no assurance that the actual capital
expenditures required to complete the Company's proposed expansion will not
exceed such estimated amounts. In addition, the actual amount and timing of the
Company's future capital expenditures may differ materially from the Company's
estimates as a result of, among other things, the ability of the Company to
10
<PAGE>
meet its planned expansion schedule, the number of its customers and the
services for which they subscribe and regulatory, technological and competitive
developments in the Company's industry. Due to the uncertainty of these factors,
actual revenues and costs may vary from expected amounts, possibly to a material
degree, and such variations are likely to affect the Company's planned capital
expenditures.
The Company also will continue to evaluate revenue opportunities in other
southeastern markets as well as potential acquisitions and, as and when
attractive opportunities develop, the Company may elect to pursue such
opportunities. The Company expects to obtain the capital required to pursue
such opportunities from credit facilities and other borrowings, the sale of
additional equity or debt securities or cash generated from operations. There
can be no assurance, however, that the Company would be successful in raising
sufficient additional capital on acceptable terms or that the Company's
operations would produce sufficient positive cash flow to pursue such
opportunities should they arise. Failure to raise and generate sufficient funds
or unanticipated increases in capital requirements may require the Company to
delay or curtail its expansion plans, which could have a material adverse
effect on the Company's growth and its ability to compete in the
telecommunications services industry. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Liquidity and Capital
Resources."
Variability of Quarterly Operating Results
As a result of the significant expenses associated with the Company's
expansion into new markets, the Company anticipates that its operating results
will vary significantly from period to period.
Control by Single Stockholder
As of the date of this Prospectus, Richard T. Aab beneficially owns or
otherwise controls 100% of the outstanding shares of Class B Common Stock
representing approximately 97.8% of the Company's total voting power, without
giving effect to the Offering, and approximately % of the Company's total
voting power after giving effect to the Offering. In addition, holders of Class
B Common Stock are entitled to vote as a separate class to elect two members of
the Board of Directors and to vote with the holders of Class A Common Stock for
the election of other members of the Board of Directors. As a result, Mr. Aab
will be able to control the board and all stockholder decisions and, in
general, to determine (without the consent of the Company's other stockholders)
the outcome of any corporate transaction or other matter submitted to the
stockholders for approval, including mergers, consolidations and the sale of
all or substantially all of the Company's assets. Mr. Aab also has the power to
prevent or cause a change in control of the Company. See "Security Ownership of
Management" and "Description of Capital Stock."
Absence of Prior Public Market; Possible Volatility of Stock Price
Prior to the Offering, there has been no public market for the Class A
Common Stock, and there can be no assurance that an active trading market for
the Class A Common Stock will develop or be sustained after the Offering. The
initial public offering price of the Class A Common Stock will be determined
through negotiations with the representatives of the Underwriters. There can be
no assurance that future market prices for the Class A Common Stock will equal
or exceed the initial public offering price set forth on the cover page of this
Prospectus. The market prices of securities of early stage telecommunications
companies similar to the Company have historically been highly volatile. See
"Underwriting." Future announcements concerning the Company or its competitors,
including quarterly results, technological innovations, services, government
legislation or regulation, and general market, economic and political
conditions, may have a significant effect on the market price of the Class A
Common Stock.
Potential Effect on Market Price of Future Sales of Shares
Upon completion of the Offering shares of Common Stock will be
outstanding. Of these shares, the shares of Class A Common Stock
expected to be sold in the Offering will be freely tradable without restriction
under the Securities Act of 1933, as amended (the "Securities Act"), except for
any such shares which may be acquired by an "affiliate" of the Company as that
term is defined in Rule 144 ("Rule 144") under the Securities Act. The
remainder of the outstanding shares of Class A Common Stock, and all of the
shares of Class B Common Stock outstanding after the Offering, will be
"restricted securities" as that term is defined in Rule 144. These shares of
Class A Common Stock (and shares of Class A
11
<PAGE>
Common Stock acquired upon the conversion of Class B Common Stock by the
current holders thereof) will begin to become eligible for sale in the public
market after December 31, 1998, subject to the volume, manner of sale and other
limitations of Rule 144.
The Company, its directors and executive officers, who, as of January 31,
1998 beneficially owned a total of shares of Common Stock, have agreed
not to offer, sell or contract to sell, or otherwise dispose of, directly or
indirectly, or announce an offering of, any shares of Class A Common Stock or
any securities convertible into, or exchangeable for, shares of Class A Common
Stock for a period of 180 days from the date of this Prospectus, without the
prior written consent of Smith Barney Inc., except under limited circumstances.
See "Underwriting."
Promptly after completion of the Offering, the Company intends to file a
Registration Statement on Form S-8 with the Commission to register shares
of Class A Common Stock reserved for issuance or sale under the Stock Plan.
No prediction can be made as to the effect, if any, that future sales of
shares, or the availability of shares for future sale, will have on the market
price of the Class A Common Stock prevailing from time to time. Sales of
substantial amounts of Class A Common Stock (including shares issued upon the
exercise of outstanding stock options and warrants and conversion of shares of
Class B Common Stock), or the perception that such sales could occur, could
adversely affect the prevailing market prices of the Class A Common Stock. See
"Shares Eligible for Future Sale."
Risks Regarding Forward Looking Statements
The statements contained in this Prospectus and in associated filings by
the Company with the Securities and Exchange Commission (the "Commission")
which are not historical facts are "forward-looking statements" (as such term
is defined in the Private Securities Litigation Reform Act of 1995). These
statements are identified by the use of forward-looking terminology such as
"believes," "expects," "may," "will," "should," "estimates" or "anticipates" or
the negative thereof or other variations thereon or comparable terminology, or
by discussions of strategy that involve risks and uncertainties. Management
wishes to caution the reader that these forward-looking statements, such as
those relating to the Company's plans to enter new markets, its anticipation of
revenues from new markets, and statements regarding the development of the
Company's businesses, the markets for the Company's services and products, the
Company's anticipated capital expenditures, regulatory reform and other
statements contained herein regarding matters that are not historical facts,
are only predictions. No assurance can be given that the future results covered
by the forward-looking statements will be achieved. Such statements are subject
to risks, uncertainties and other factors which could cause actual events or
results to differ materially from future results indicated, expressed or
implied by such forward-looking statements. The most significant of such risks,
uncertainties and other factors are discussed under the heading "Risk Factors"
beginning on page 7 of this Prospectus, and prospective investors are urged to
carefully consider such factors as a result of risks facing the Company.
12
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of the Class A Common Stock
in this Offering are estimated to be approximately $ million ($
million if the Underwriters' over-allotment option is exercised in full) after
deduction of the Underwriters' Discounts and Commissions and estimated expenses
payable by the Company. The Company intends to use substantially all of the net
proceeds from the Offering for capital expenditures and working capital
relating to its expansion into new markets. In addition, the Company may use a
portion of the proceeds of the Offering for acquisitions, although the Company
is not currently involved in any acquisition negotiations. Pending such uses,
the net proceeds to the Company will be invested in short-term, investment
grade securities.
DIVIDEND POLICY
The Company has not paid any cash dividends on its Common Stock. The
Company intends to retain future earnings, if any, to finance the expansion of
its businesses and, therefore, does not anticipate paying any dividends on the
Common Stock in the foreseeable future.
DILUTION
As of December 31, 1997, the net tangible book value of the Company was a
deficit of $ million or $ per share of Common Stock. Net tangible
book value per share represents the Company's net worth divided by
shares of Common Stock outstanding as of December 31, 1997. After
giving effect to the sale by the Company of shares of Class A Common
Stock pursuant to the Offering (at an assumed initial public offering price of
$ per share) and after deducting the Underwriters' Discounts and
Commissions and estimated expenses of the Offering, the pro forma net tangible
book value of the Company at December 31, 1997, is $ million, or $ per
share of Common Stock. Such amount represents an immediate increase in pro
forma net tangible book value of $ per share of Common Stock to the
existing stockholders and an immediate dilution to new investors of $ per
share of Common Stock. The following table illustrates the dilution in pro
forma net tangible book value per share to new investors:
<TABLE>
<S> <C>
Assumed initial public offering price ........................ $
Net tangible book value before the Offering ................
Increase in net tangible book value attributable to net
proceeds of the Offering ................................
Pro forma net tangible book value after the Offering .........
Dilution to new investors .................................... $
</TABLE>
The following table sets forth as of December 31, 1997, on a pro forma
basis, the difference between the existing holders of Common Stock and the
purchasers of shares of Class A Common Stock in the Offering, with respect to
the number of shares of Common Stock purchased, the total consideration paid
and the average price per share of Common Stock paid (assuming an initial
public offering price of $ per share):
<TABLE>
<CAPTION>
Total
Shares Purchased Consideration Average
-------------------- -------------------- Price
Number Percent Amount Percent Per Share
-------- --------- -------- --------- ----------
<S> <C> <C> <C> <C> <C>
Existing stockholders ......... % $ % $
New investors .................
Total ...................... % $ % $
</TABLE>
The foregoing tables and discussions exclude shares of Class A Common
Stock issuable upon the exercise of outstanding warrants and options. See
"Management -- Omnibus Stock Plan," "Security Ownership of Management" and
"Notes to Consolidated Financial Statements." To the extent that outstanding
warrants or options are exercised in the future, there will be further dilution
to new investors.
13
<PAGE>
CAPITALIZATION
The following table sets forth certain information with respect to the
capitalization of the Company as of December 31, 1997. This table should be
read in conjunction with the Selected Historical Consolidated Financial and
Operating Data and the audited consolidated financial statements and notes
thereto of US LEC included elsewhere in this Prospectus. See "Use of Proceeds,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Description of Capital Stock."
<TABLE>
<CAPTION>
As of December 31, 1997
-------------------------------------------------------
Pro Forma
Actual Pro Forma (1) As Adjusted (1)(2)
--------------- --------------- -------------------
<S> <C> <C> <C>
Cash and cash equivalents ......................... $ 3,189,210 $ $
============ =============== ===================
Long-term debt (3) ................................ $ 5,000,000 $ $
------------ --------------- -------------------
Stockholders' equity:
Class A Common Stock, $.01 par value, 73,405,498
shares authorized; shares issued and
outstanding, actual; and shares, as adjusted
for the Offering (4) ........................... 38,550
Class B Common Stock, $.01 par value, 16,594,502
shares authorized; shares issued and
outstanding, actual; and shares issued and
outstanding, pro forma ......................... 165,945
Additional paid-in capital ...................... 11,126,320
Accumulated deficit ............................. (5,574,010)
------------
Total stockholders' equity (deficiency) ........... 5,756,805
------------
Total capitalization .............................. $ 10,756,805 $ $
============ =============== ===================
</TABLE>
- ----------
(1) Reflects the exchange of a note payable to a stockholder in the amount of
$5.0 million for shares of Class B Common Stock on February , 1998.
See "Certain Relationships and Related Transactions."
(2) Adjusted to reflect the sale of Class A Common Stock offered hereby
assuming no exercise of the Underwriters' over-allotment option and after
deducting the estimated Underwriters' Discounts and Commissions and
estimated expenses of the Offering.
(3) Consists of indebtedness to stockholder. See Note 4 to the audited
consolidated financial statements.
(4) Issued and outstanding Class A Common Stock excludes (i) shares
issuable upon the exercise of outstanding options, none of which are
vested, (ii) shares issuable upon the exercise of outstanding and
presently exercisable warrants, and (iii) shares issuable upon
conversion of outstanding shares of Class B Common Stock which, subject to
the terms of the Class B Stockholders Agreement, are fully convertible at
any time.
14
<PAGE>
SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA
The selected historical consolidated financial data presented below as of
December 31, 1996 and 1997, for the period from June 6, 1996 (inception) to
December 31, 1996 and for the year ended December 31, 1997 are derived from and
qualified by reference to the audited consolidated financial statements and
notes thereto of US LEC contained elsewhere in this Prospectus. The Company's
consolidated financial statements as of December 31, 1996 and 1997, for the
period from June 6, 1996 (inception) to December 31, 1996 and for the year
ended December 31, 1997, have been audited by Deloitte & Touche LLP,
independent public accountants. The selected historical financial data for each
quarter of 1997 have been derived from the unaudited interim consolidated
financial statements of the Company. In the opinion of management, the
unaudited interim consolidated financial statements have been prepared on the
same basis as the audited consolidated financial statements and include all
adjustments, which consist only of normal recurring adjustments, necessary for
a fair presentation of the financial position and the results of operations for
these periods. All of the data should be read in conjunction with and are
qualified by reference to "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the audited consolidated financial
statements and notes thereto of the Company contained elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
Period from Quarter Ended
June 6, 1996 ---------------------------------------------------------------
(Inception) to
December 31, March 31, June 30, September 30, December 31,
1996 1997 1997 1997 1997
---------------- --------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenue ..................................... $ -- $ 1,141 $ 228,620 $ 1,529,745 $ 4,698,155
Cost of services ............................ -- 423,093 314,828 1,075,183 2,387,897
------------- ------------ ------------ ------------ -------------
Gross margin ................................ -- (421,952) (86,208) 454,562 2,310,258
Selling, general and administrative ......... 941,743 1,049,130 1,047,940 1,294,115 2,679,052
Depreciation and amortization ............... 4,059 14,046 88,406 124,994 215,468
------------- ------------ ------------ ------------ -------------
Loss from operations ........................ (945,802) (1,485,128) (1,222,554) (964,547) (584,262)
Interest expense, net ....................... 16,861 66,556 108,021 101,326 78,953
------------- ------------ ------------ ------------ -------------
Net loss .................................... $ (962,663) $ (1,551,684) $ (1,330,575) $ (1,065,873) $ (663,215)
============= ============ ============ ============ =============
Net loss per share .......................... $ $ $ $ $
============= ============ ============ ============ =============
Weighted average shares outstanding .........
============= ============ ============ ============ =============
Other Financial Data:
Capital expenditures ........................ $ 279,634 $ 1,798,152 $ 634,122 $ 828,903 $ 9,793,930
EBITDA (1) .................................. (941,743) (1,471,082) (1,134,148) (839,553) (368,794)
Net cash flow used in operating
activities ................................. (1,079,069)
Net cash flow used in investing
activities ................................. (465,792)
Net cash flow provided by financing
activities ................................. 2,271,000
Operating Data:
Cumulative Equivalent Access Lines
in service (2) ............................. -- 288 4,087 15,504 49,229
MOUs (3) .................................... -- 40,000 8,618,000 69,730,000 393,452,000
<CAPTION>
Year Ended
December 31,
1997
---------------
<S> <C>
Statement of Operations Data:
Revenue ..................................... $ 6,457,661
Cost of services ............................ 4,201,001
------------
Gross margin ................................ 2,256,660
Selling, general and administrative ......... 6,070,237
Depreciation and amortization ............... 442,914
------------
Loss from operations ........................ (4,256,491)
Interest expense, net ....................... 354,856
------------
Net loss .................................... $ (4,611,347)
============
Net loss per share .......................... $
============
Weighted average shares outstanding .........
============
Other Financial Data:
Capital expenditures ........................ $ 13,055,107
EBITDA (1) .................................. (3,813,577)
Net cash flow used in operating
activities ................................. (5,594,093)
Net cash flow used in investing
activities ................................. (5,951,231)
Net cash flow provided by financing
activities ................................. 14,008,395
Operating Data:
Cumulative Equivalent Access Lines
in service (2) ............................. 49,229
MOUs (3) .................................... 471,840,000
</TABLE>
<TABLE>
<CAPTION>
As of As of December 31, 1997
December 31, -------------------------------------------------------
1996 Actual Pro Forma (4) As Adjusted (4)(5)
------------- --------------- --------------- -------------------
<S> <C> <C> <C> <C>
Balance Sheet Data:
Current assets .................................. $1,067,662 $ 9,654,993
Working capital (deficiency) .................... 936,884 (2,268,883)
Property and equipment, net ..................... 276,097 12,889,335
Total assets .................................... 1,466,835 22,680,681
Notes payable--stockholders ..................... 1,671,000 5,000,000
Total stockholders' equity (deficiency) ......... (334,943) 5,756,805
</TABLE>
- ----------
(1) EBITDA consists of net earnings (loss) before interest expense, income
taxes, depreciation and amortization. It is a measure commonly used by
analysts, investors, and other interested parties in the
telecommunications industry and is presented to assist in understanding
the Company's operating results. However,
15
<PAGE>
EBITDA is not a measurement of financial performance under generally
accepted accounting principles and should not be considered an alternative
to net income or loss as a measure of performance or to cash flow as a
measure of liquidity. EBITDA is not necessarily comparable with similarly
titled measures for other companies.
(2) As of the end of the period indicated. "Equivalent Access Lines" is a term
used by management to quantify the size of the Company's network. For a
detailed definition, see Glossary.
(3) MOUs indicate the number of local and long distance switched minutes of use
carried over the Company's network during the period indicated.
(4) Reflects the exchange of a note payable to a stockholder in the amount of
$5.0 million for shares of Class B Common Stock on February , 1998.
See "Certain Relationships and Related Transactions."
(5) Adjusted to reflect the sale of Class A Common Stock offered hereby
assuming no exercise of the Underwriters' over-allotment option and after
deducting the Underwriters' Discounts and Commissions and estimated
expenses of the Offering.
16
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
US LEC is a rapidly growing CLEC that provides switched local, long
distance and enhanced telecommunications services primarily to medium and
large-sized organizations located in selected markets in the southeastern
United States. The Company was founded in June 1996 after passage of the
Telecom Act, which enhanced the competitive environment for local exchange
services. The Company initiated service in Charlotte, North Carolina in March
1997, becoming one of the first CLECs in North Carolina to provide switched
local exchange services, and subsequently initiated service in Raleigh and
Greensboro, North Carolina and in Atlanta, Georgia. As of February 28, 1998,
the Company had Equivalent Access Lines in service. US LEC plans to enter 15
new markets in Tennessee, Florida, South Carolina, Virginia and North Carolina
by the end of 1999.
Since commencing network operations, US LEC has achieved significant
growth in its Equivalent Access Lines in service and in the number of MOUs
carried over the Company's network. As indicated in the following table, from
March 1997 through February 1998, the Company increased its number of
Equivalent Access Lines in service at month-end from 288 to and increased
its monthly number of MOUs during the same period from approximately 40,000 to
:
<TABLE>
<CAPTION>
1997
-------------------------------------------------------------------------------------
Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec.
------ ------ ------- ------- -------- -------- --------- -------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Cumulative Equivalent
Access Lines in Service (1):
Charlotte ....................... 288 757 2,204 2,881 4,571 5,157 9,789 10,863 12,824 16,724
Raleigh ......................... -- 168 624 1,206 1,948 3,012 5,715 9,590 13,935 19,017
Greensboro ...................... -- -- -- -- -- -- -- -- 3,168 13,488
Atlanta ......................... -- -- -- -- -- -- -- -- -- --
--- --- ----- ----- ----- ----- ----- ------ ------ ------
Totals ......................... 288 925 2,828 4,087 6,519 8,169 15,504 20,453 29,927 49,229
=== === ===== ===== ===== ===== ====== ====== ====== ======
MOUs (in thousands) (2) ......... 40 500 3,118 5,000 16,323 20,024 33,383 54,273 95,542 243,637
=== === ===== ===== ====== ====== ====== ====== ====== =======
<CAPTION>
1998
---------------
Jan. Feb.
--------- -----
<S> <C> <C>
Cumulative Equivalent
Access Lines in Service (1):
Charlotte ....................... 24,943
Raleigh ......................... 19,800
Greensboro ...................... 14,203
Atlanta ......................... --
------
Totals ......................... 58,946
======
MOUs (in thousands) (2) ......... 446,386
=======
</TABLE>
- ----------
(1) As of the end of the month indicated. "Equivalent Access Lines" is a term
used by management to quantify the size of the Company's network. For a
detailed description of the manner in which the Company determines its
Equivalent Access Lines, see the definition of this term in the Glossary
included as an Annex hereto.
(2) MOUs indicate the number of local and long distance switched minutes of use
carried over the Company's network during the month indicated.
The Company's existing North Carolina operations generated positive EBITDA
of $200,264 during the month of December 1997, ten months after the Company
first initiated service in Charlotte. While EBITDA does not represent cash flow
or results of operations in accordance with generally accepted accounting
principles, it is a measure of financial performance commonly used in the
telecommunications industry. Management expects the Company to achieve similar
operating results in each of its new markets within a comparable time frame.
Management attributes US LEC's ability to achieve this performance primarily to
two factors. First, the Company's capital-efficient network strategy eliminates
the lengthly "build-out" period usually required to construct a fiber optic
transmission network, permitting the Company to quickly enter new markets and
rapidly generate revenue and positive cash flow. Second, US LEC's
telecommunications-intensive customers typically transmit a large amount of
switched traffic over the Company's network, resulting in efficient network
utilization and attractive operating margins. See "Risk Factors -- Limited
Operating History," " -- Risks Associated With Implementation of Growth
Strategy" and " -- Negative Cash Flow and Operating Losses."
Factors Affecting Future Operations
Revenue. The Company's revenue is comprised of monthly recurring charges,
usage charges, and initial, non-recurring charges. Monthly recurring charges
include the fees paid by customers for lines in service and additional features
on those lines. Monthly recurring charges are derived only from end user
customers. Usage charges consist of fees paid by end users for each call made,
fees paid by the ILEC as reciprocal compensation (which results from US LEC
terminating calls made by ILEC customers), and access charges paid by carriers
17
<PAGE>
for long distance traffic originated and terminated by US LEC. Usage charges
are derived from both end user customers and from other carriers. Initial
non-recurring charges are paid by end users, if applicable, for the
installation of service by the Company. See "Risk Factors -- Regulation."
A majority of the Company's revenue currently consists of reciprocal
compensation. This is the result of an imbalance of inbound and outbound
traffic due to the preponderance of inbound applications utilized by the
Company's customers. Specifically, the Company's customers have been generating
an increasing number of inbound MOUs as the demand for Internet services
continues to grow.
Reciprocal compensation and carrier access invoices are sent monthly to
the appropriate ILECs and long distance carriers according to standard industry
practices and in standard industry formats. BellSouth disputes that portion of
the reciprocal compensation charges billed to it which it believes are related
to Internet access services. Due to uncertainty regarding the outcome of this
dispute, the Company has deferred $1,141,386 of revenue as of December 31,
1997. The resolution of this dispute is currently pending before the North
Carolina PUC. However, there can be no assurance that the North Carolina PUC
will support the Company's position. While the Company does not believe the
long-term effects of an adverse North Carolina PUC decision would be material,
an adverse decision would have a material adverse effect on the Company's
projected near-term operating results. See "Risk Factors -- Uncertainties
Related to Reciprocal Compensation" and "Business --
Regulation."
Cost of Services. Cost of services is currently comprised primarily of
leased transport charges and, to a lesser extent, reciprocal compensation
related to calls that originate with a US LEC customer and terminate on the
network of the ILEC or another CLEC. The Company's leased transport charges are
the lease payments incurred by US LEC for the fiber optic transmission
facilities used to connect the Company's customers to its switch and to connect
to the ILEC and other CLEC networks. The Company's strategy of leasing rather
than building its own fiber transport facilities results in the Company's cost
of services being a significant component of total costs. In addition, the
Company has to date been successful in negotiating lease agreements which
generally match the duration of its customer contracts, thereby allowing the
Company to avoid the risk of continuing expenses associated with transmission
facilities that are not being used by revenue generating customers. While the
majority of the Company's cost of services is comprised of leased transport
charges, management expects that over time outbound traffic and other usage
sensitive charges will become the major component of cost of services as the
Company begins to carry more of its customers' outbound calls.
Selling, General and Administrative Expenses. The Company's selling,
general and administrative expenses include selling and marketing costs,
customer service, billing, corporate administration, personnel and network
maintenance. Management expects the Company to incur significant selling and
marketing costs as it continues to expand its operations, a significant amount
of which will be incurred in a particular market before the switch becomes
operational and begins to generate revenue. Consequently, selling and marketing
expenses are expected to increase as a percentage of revenue until
implementation of the Company's expansion plan is substantially complete. US
LEC will incur other costs and expenses, including the costs associated with
the maintenance of its networks, administrative overhead, office leases and bad
debts. Management expects that these costs will grow significantly as the
Company expands its operations and that administrative overhead will be a large
portion of these expenses during the start-up phase in each of the Company's
new markets. However, management expects these expenses to become smaller as a
percentage of the Company's revenue as the Company increases its customer base.
Results of Operations
Although US LEC began operations on June 6, 1996, it did not generate
revenue in 1996, and, accordingly, any comparison of operating results between
1996 and 1997 would not be meaningful.
Year Ended December 31, 1997. During the year ended December 31, 1997, the
Company generated $6,457,661 of revenue. Cost of services totaled $4,201,001
and selling, general and administrative expenses during the period were
$6,070,237. Cost of services consisted primarily of leased transport and usage
based charges. Selling, general and administrative expenses were largely
comprised of payroll, selling and marketing costs, rents and professional fees.
18
<PAGE>
Depreciation and amortization expense during the period was $442,914,
resulting primarily from network assets placed in service in the Company's
operational markets. Net interest expense for the year ended December 31, 1997
was $354,856, as interest incurred on the Company's borrowings exceeded
interest earned on investments. The Company's net loss for the year ended
December 31, 1997 totaled $4,611,347. This was primarily due to the incurrence
of operating expenses prior to realizing any significant revenue, since the
Company was developing its markets during the year.
Period from June 6, 1996 (Inception) to December 31, 1996. During the
period ended December 31, 1996, the Company did not generate operating revenue.
Selling, general and administrative expenses were $941,743 resulting primarily
from payroll costs. The Company's net loss for the period ended December 31,
1996 was $962,663, resulting from operating expenses incurred for the initial
development of the Company's business.
Liquidity and Capital Resources
The competitive telecommunications services business is capital intensive.
The Company's existing operations have required and will continue to require
substantial capital expenditures for the purchase and installation of network
switches and related electronic equipment in order to provide switch-based
local exchange and long distance services in its markets, and will continue to
require cash to fund operating losses during the start-up phase of each market.
Specifically, the Company estimates that the cash required to fund capital
expenditures for its expansion plans will approximate $40 million and $30
million in 1998 and 1999, respectively. When the Company enters a new market,
the majority of its capital expenditures are related to acquiring and
installing the Lucent 5ESS(R)-2000 switch and paying the associated site
preparation costs (including air conditioning, power supply, backup generators
and fire suppression). Once the Company begins selling services on a particular
switch, there are incremental capital expenditures associated with expanding
the switch, primarily in the form of additional line cards. These expenditures
are "success-based" in that they are incurred only in response to customer
orders, thereby ensuring a high level of utilization of the Company's network
infrastructure. The Company's capital expenditure requirements over the next
two years could change materially if the Company places in service
significantly more or significantly fewer access lines than it currently
anticipates.
In each fiscal quarter since its inception, the Company has generated
negative EBITDA and incurred net losses, although the Company's North Carolina
operations generated positive EBITDA of $200,264 during the month of December
1997. Management attributes the rapid generation of positive EBITDA in these
markets primarily to the Company's switch-based, leased transport network
strategy. Management expects that the Company will generate positive EBITDA on
a consolidated basis in the first quarter of 1998 and that positive cash flow
from existing markets will be greater than the operating losses incurred from
initiating service in new markets thereafter. However, there can be no
assurance that the Company will realize positive consolidated EBITDA or cash
flow in this or future periods. Until sufficient cash flow is generated, the
Company will continue to rely on financing activities for its cash
requirements.
Management expects its available cash, including the net proceeds from the
Offering and operating cash flow, will be sufficient to fund its capital
expenditures and working capital requirements through 1999, although there can
be no assurance that the amount of funds required to complete the Company's
expansion plans through the end of 1999 will not exceed its currently estimated
expenditures. See "Risk Factors -- Negative Cash Flow and Operating Losses" and
" -- Future Capital Requirements." To date, the Company has funded its capital
and liquidity requirements with approximately $11.3 million in cash equity
investments by Messrs. Aab and Ganatra, certain other executive officers and
private investors. In addition, Mr. Aab, Melrich Associates, L.P. (an entity of
which Mr. Aab is a general partner) and Mr. Ganatra have loaned the Company
$8.3 million, of which approximately $5.0 million was advanced in 1996 and 1997
and approximately $3.3 million was advanced in January 1998. These loans are
secured by substantially all of the assets of the Company's operating
subsidiaries in North Carolina and Georgia which, as of December 31, 1997,
represented substantially all of the Company's assets. On February , 1998,
Mr. Aab exchanged $5.0 million of these loans for shares of Class B
Common Stock. The balance of the loans mature on January 16, 2003, subject to
possible acceleration in the event of a change in control of the Company, and
bear interest, payable quarterly, at an annual rate of 12%. As of December 31,
1997, the Company had cash and investments of $3.5 million and $ million on
a pro forma basis after giving effect to the Offering. The Company will
continue to evaluate revenue opportunities in other southeastern markets as
well as potential acquisitions, and as attractive opportunities emerge, the
Company may elect to pursue such opportunities. The Company expects to obtain
the capital required to pursue such
19
<PAGE>
opportunities from credit facilities and other borrowings, the sale of
additional equity or debt securities or cash generated from operations. There
can be no assurance, however, that the Company would be successful in raising
sufficient additional capital on acceptable terms or that the Company's
operations would produce sufficient positive cash flow to pursue such
opportunities should they arise. Failure to raise and generate sufficient funds
or unanticipated increases in capital requirements may require the Company to
delay or curtail its expansion plans, which could have a material adverse
effect on the Company's growth and its ability to compete in the
telecommunications services industry.
20
<PAGE>
BUSINESS
General
US LEC is a rapidly growing CLEC that provides switched local, long
distance and enhanced telecommunications services primarily to medium and
large-sized organizations located in selected markets in the southeastern
United States. The Company was founded in June 1996 after passage of the
Telecom Act, which enhanced the competitive environment for local exchange
services. The Company initiated service in Charlotte, North Carolina in March
1997, becoming one of the first CLECs in North Carolina to provide switched
local exchange services, and subsequently initiated service in Raleigh and
Greensboro, North Carolina and in Atlanta, Georgia. As of February 28, 1998,
the Company had Equivalent Access Lines in service. US LEC plans to enter 15
new markets in Tennessee, Florida, South Carolina, Virginia and North Carolina
by the end of 1999.
Market Opportunity
According to FCC statistics, total revenue from local exchange services in
the United States was approximately $101 billion in 1996. Two years after the
Telecom Act established a competitive framework for local competition, more
than 100 CLECs have raised approximately $14 billion in capital and have signed
2,400 interconnection agreements. Although CLECs as a whole tripled their
customer lines in service in 1997 to 1.5 million, CLECs currently account for
only 2.6% of all local telephone revenues.
After completing its planned expansion, US LEC will operate in 19 markets
located in six contiguous states in the southeastern United States -- one of
the fastest growing regional markets for business telecommunications services
in the country. Based on the Company's Market Study, in the four markets
presently served by the Company there were approximately 1.4 million business
lines in the four markets presently served by the Company that generated
approximately $2.1 billion in local exchange and long distance revenues in
1996. The Market Study indicates that the 19 markets in which management
expects the Company to be operating by the end of 1999 had a total of
approximately 4.1 million business lines that generated approximately $5.7
billion in local exchange and long distance revenues in 1996. These local and
long distance revenue figures do not include revenues associated with enhanced
services and carrier access fees, which US LEC is pursuing as part of its
business plan. The table below sets forth certain information from the Market
Study regarding the markets in which US LEC currently operates and the markets
it plans to enter by the end of 1999.
21
<PAGE>
<TABLE>
<CAPTION>
1996 Market Data
-------------------------------------------------------
Revenue ($) (millions)
Number of ---------------------------------------
Launch Period Business Lines Local Long Distance Total
------------------ ---------------- ------- --------------- --------
(thousands)
<S> <C> <C> <C> <C> <C>
Current Markets:
Charlotte, NC ................... March 1997 203 119 186 305
Raleigh, NC ..................... April 1997 196 115 180 295
Greensboro, NC .................. October 1997 138 81 127 208
Atlanta, GA ..................... February 1998 847 497 777 1,274
--- --- --- -----
Subtotal ....................... 1,384 812 1,270 2,082
Planned Markets:
Tennessee
Memphis ......................... 2nd Quarter 1998 192 102 160 262
Knoxville ....................... 2nd Quarter 1998 72 39 60 99
Nashville ....................... 2nd Quarter 1998 155 83 129 212
Florida
Orlando ......................... 3rd Quarter 1998 355 170 266 436
Ft. Lauderdale .................. 3rd Quarter 1998 329 150 234 384
Tampa ........................... 4th Quarter 1998 421 208 325 533
Miami ........................... 4th Quarter 1998 482 219 343 562
Jacksonville .................... 1st Quarter 1999 187 85 133 218
South Carolina
Charleston/Myrtle Beach ......... 1st Quarter 1999 90 59 93 152
Greenville/Spartanburg .......... 1st Quarter 1999 96 62 97 159
Columbia ........................ 3rd Quarter 1999 95 62 96 158
Virginia
Richmond ........................ 2nd Quarter 1999 154 91 142 233
Roanoke ......................... 2nd Quarter 1999 46 27 42 69
North Carolina
Wilmington ...................... 3rd Quarter 1999 35 21 32 53
Asheville ....................... 4th Quarter 1999 29 17 27 44
----- --- ----- -----
Subtotal ....................... 2,738 1,395 2,179 3,574
----- ----- ----- -----
Total ........................ 4,122 2,207 3,449 5,656
===== ===== ===== =====
</TABLE>
Business Strategy
US LEC's objective is to become the primary provider of switched local
telecommunications services to its existing and target customers. The principal
elements of US LEC's strategy include:
o Deploy a Capital-Efficient Network. Management believes that US LEC is one of
the first CLECs to utilize a strategy of purchasing and deploying switching
equipment in each target market and leasing the required fiber optic
transmission capacity from CAPs, other CLECs and ILECs. Management believes
the Company's switch-based, leased-transport strategy enables it to enter
markets and generate revenue and positive cash flow more rapidly than if the
Company first constructed its own transmission facilities. This strategy
also reduces the up-front capital expenditures required to enter new markets
and avoids the risk of "stranded" investment in under-utilized fiber
networks. Management also believes that the Company's ability to align its
leased transmission costs with customer orders permits a higher return on
invested capital.
o Focus on a Southeastern Cluster of Operations. After completing its planned
expansion, the Company will operate in 19 markets located in six contiguous
states in the southeastern United States -- one of the fastest growing
regional markets for business telecommunications services in the country.
Within the Southeast, the Company has selected its target markets based on a
number of considerations, including the number of potential customers and
other competitors in such markets and the presence of multiple transmission
facility suppliers. Management believes that the Company's clustered network
will enable it to take advantage of regional
22
<PAGE>
calling patterns and capture an increasing portion of customer traffic on its
network. Management also believes that by originating and terminating calls on
its network, the Company can achieve significant cost savings and potential
pricing advantages over its competition.
o Target Telecommunications-Intensive Customers. The Company focuses its
primary sales efforts on telecommunications-intensive organizations with at
least 100 access lines, including businesses, government agencies, other
telecommunications companies and VARs. The volume of usage generated by the
Company's target customers allows the Company to efficiently concentrate the
telecommunications traffic of its customers on one or more leased T-1 lines.
In addition, the Company frequently is able to sell enhanced and long distance
services to complement its core local services. This further enhances network
utilization and thereby improves margins, as fixed network costs are spread
over a larger base of MOUs.
o Install a Robust, Uniform Technology Platform. The Company has chosen the
5ESS(R)-2000 digital switch manufactured by Lucent to provide a consistent
technology platform throughout its network. The Lucent switch enables the
Company to provide both local and long distance services from a single
platform. This uniform and advanced switching platform will enable the
Company to (i) deploy features and functions quickly throughout its entire
network, (ii) expand switch capacity in a cost effective manner, (iii) lower
maintenance costs through reduced training and spare part requirements and
(iv) achieve direct connectivity to cellular and personal communication
system applications in the future.
o Employ a Direct Sales Force with Extensive Local Market Experience.
Management believes that the Company's success in a particular market is
enhanced by employing a direct sales force with extensive local market and
telecommunications sales experience. The Company employed this strategy in
building its existing sales forces in North Carolina and Georgia and intends
to continue implementing this strategy in other markets. Salespeople with
experience in a particular market provide the Company with extensive
knowledge of the Company's target customer base and in many cases already
have existing relationships with target customers. The experience and
relationships of these salespeople enable them to pre-sell the Company's
products and services prior to initiating network operations in a particular
market.
o Implement Efficient Provisioning Processes. Management believes that a
critical aspect of the success of a CLEC is timely and effective
provisioning systems, which includes the process of transitioning ILEC
customers to the Company's network. The Company focuses on implementing
effective and timely provisioning practices in each of its markets to
rapidly and efficiently transition customers from the ILEC to the Company
without disruption of the customer's operations. Management believes that
these practices provide the Company with a long-term competitive advantage
and enable it to implement services in its markets rapidly and to shorten
the time between receipt of the customer order and the generation of
revenue.
US LEC's Network
After completing its planned expansion, the Company will operate in 19
markets located in six contiguous states in the southeastern United States --
one of the fastest growing regional markets for business telecommunications
services in the country. Within the Southeast, the Company has selected its
target markets based on a number of considerations, including the number of
potential customers and other competitors in such markets and the presence of
multiple transmission facility suppliers. Management believes that the
Company's clustered network will enable it to take advantage of regional
calling patterns and capture an increasing portion of customer traffic on its
network. Management also believes that by originating and terminating calls on
its network, the Company can achieve significant cost savings and potential
pricing advantages over its competition.
US LEC purchases and deploys switching equipment and leases fiber optic
transmission capacity from CAPS, other CLECs and ILECs. Management believes
that this switch-based, leased-transport strategy provides the Company with
significant competitive advantages. By owning its switches, the Company is able
to better configure its network to provide cost-effective and customized
solutions for its customers' telecommunications needs. By leasing transmission
capacity, the Company is able to (i) reduce the up-front capital expenditures
required to enter new markets, (ii) avoid the risk of "stranded" investment in
under-utilized fiber networks and (iii) enter markets and generate revenue and
positive cash flow more rapidly than if the Company constructed its own
transmission facilities. Management believes that the availability of several
suppliers of fiber optic transmission facilities in each of the Company's
markets provides US LEC with negotiating leverage, vendor diversity and the
ability to offer customers enhanced reliability at a competitive price.
23
<PAGE>
US LEC provides its customers with inbound and outbound telecommunications
services over its switch-based, leased-transport network. Calls originating
with a US LEC customer are transported over leased lines to the US LEC switch
and can either be terminated directly on the Company's network or they can be
routed to a long distance carrier or the ILEC, depending on the location of the
call recipient. Similarly, calls originating from the public switched telephone
network and destined for a US LEC customer are routed through the US LEC switch
and delivered to call recipients via leased transmission facilities. A diagram
of the Company's typical network layout is presented in the following figure:
[GRAPHIC OMITTED]
24
<PAGE>
Uniform Technology Platform. The Company is implementing a consistent
technology platform based on the Lucent 5ESS(R)-2000 digital switch throughout
its network. Unlike traditional long distance or local switches deployed by
many of the Company's competitors, the Lucent switch enables the Company to
provide local and long distance services from a single platform. This uniform
and advanced switch platform enables the Company to (i) deploy features and
functions quickly in all of its networks, (ii) expand switch capacity in a cost
effective manner and (iii) lower maintenance costs through reduced training and
spare parts requirements. In addition, the scalability and capacity of the
Lucent switches enable the Company to accommodate the increased volume of
on-net traffic that is anticipated to result from the Company's clustered
network strategy and will facilitate direct connectivity to cellular and
personal communication system applications in the future.
Leasing of Transmission Capacity. As part of its capital efficient network
structure, the Company's transmission facilities are leased from CAPs, other
CLECs and ILECs. In general, US LEC seeks to lease fiber optic transmission
facilities from multiple sources in each of its current and target markets.
Management believes that this type of broad coverage of the markets in which it
operates results in the following advantages:
o an increased number of buildings that can be directly connected to the
Company's switching network, which should maximize the number of customers
to which the Company can offer its services;
o a higher volume of telecommunications traffic both originating and
terminating on the Company's network, which should result in improved
operating margins;
o enhanced reliability at competitive prices;
o the ability to leverage its investment in high capacity switching
equipment and electronics; and
o the opportunity for the Company's network to provide backhaul carriage
for other telecommunications service providers, such as long distance and
wireless carriers.
Interconnection. The Company has executed interconnection agreements for
all of its current operating networks: in North Carolina, with BellSouth (which
expires in November 1998), GTE (which expires in March 1999) and Sprint (which
expires in October 1999), and in Georgia, with BellSouth (which expires in
November 1998). The Company is currently negotiating interconnection agreements
with GTE and Sprint for Florida. Furthermore, the Company is currently
negotiating with BellSouth to extend its interconnection agreement for an
additional three years. In addition, the Company believes that interconnection
arrangements between the ILECs and other CLECs or the Company will be in place
in other markets that the Company may enter. Interconnection agreements between
the Company (or other CLECs) and ILECs are subject to approval of the relevant
PUC, and under the terms of the Telecom Act, each ILEC which is subject to the
Telecom Act is required to negotiate an interconnection agreement with the
Company (and with other CLECs). See "Business -- Regulation." Where an
interconnection agreement cannot be reached on terms and conditions
satisfactory to the Company, the Company may pursue binding arbitration of any
disputes before the state utility commissions as provided under the Telecom
Act. There can be no assurance, however, that the Company will be able to
negotiate interconnection agreements on terms and conditions satisfactory to
the Company or to renew existing interconnection agreements as they expire.
However, a decision by the United States Court of Appeals for the Eighth
Circuit vacating several of the FCC's rules creates uncertainty about the rules
governing pricing, terms and conditions of interconnection agreements. As a
result of this decision, which has been appealed to the Supreme Court, and a
pending review of this issue by the FCC, negotiation and enforcement of such
agreements could become more difficult and protracted, and renegotiation of
existing agreements could be required.
Products and Services
The Company's products and services are designed to appeal to the
sophisticated telecommunications needs of its target customers.
Local Services. The Company provides local dial-tone services to
customers, which allows them to complete calls in a free calling area and to
access a long distance calling area. Local services and long distance services
can be bundled together using the same transport facility. The Company's
network is designed to allow a customer to easily increase or decrease capacity
and alter enhanced services as the telecommunications requirements of the
business change. In addition to its core local services, the Company also
provides access to third party directory assistance and operator services.
25
<PAGE>
Long Distance Services. US LEC provides domestic and international long
distance services for completing intrastate, interstate and international
calls. Long distance service is offered as an additional service to the
Company's local exchange customers. Long distance calls which do not terminate
on the Company's network are passed to long distance carriers which route the
remaining portion of the call. The Company's ability to integrate local and
long distance services allows it to aggregate customers' monthly recurring,
local usage and long distance charges on a single, consolidated invoice.
Enhanced Services. In addition to providing typical enhanced services such
as voicemail, call transfer and conference calling, US LEC offers additional
value-added enhanced services to complement its core local and long distance
services. These enhanced service offerings include:
o Access to Internet Services -- Enables customers to use their
available capacity for access to ISPs.
o Data Networking Services -- The Company can provide high-speed,
broadband services to use for data and internet access such as
Integrated Services Digital Network (ISDN) and Primary Rate
Interface (PRI).
o Specialized Application Services -- The Company can create products
and services that are tailored for target industries with special
telecommunications needs such as the hospitality industry. These
services typically include non-measured rate local calling, expanded
local calling area, discounted long distance rates and tailored
trunking configurations.
Sales and Marketing
Sales. US LEC is building a highly motivated and experienced direct sales
force. The Company recruits salespeople with strong sales backgrounds in its
existing and target markets, including salespeople from long distance
companies, telecommunications equipment manufacturers, network systems
integrators and ILECs. The Company expanded its sales force from four
salespeople at December 31, 1996 to 23 salespeople at December 31, 1997, and
management expects to further increase the Company's sales force to over 100
salespeople by the end of 1998. The Company plans to continue to attract and
retain highly qualified salespeople by offering them an opportunity to work
with an experienced management team in an entreprenurial environment and to
participate in the potential economic rewards made available through a
results-oriented compensation program that emphasizes sales commissions.
During the months prior to initiating service in a new market, the
Company's salespeople begin pre-selling the Company's services to target
customers. This pre-selling effort is designed to shorten the period between
the availability of service and the receipt of a customer order and to generate
customers in each market who may enter into service agreements before the local
US LEC network becomes operational.
The Company also retains an independent sales agent to identify ISPs and
other potential users of the Company's services. If one of these potential
users becomes a US LEC customer, the Company pays the sales agent a commission
based on the reciprocal compensation that US LEC receives from traffic
terminated to that customer.
Marketing. In its existing markets, US LEC seeks to position itself as a
high quality alternative to ILECs for local telecommunication services by
offering network reliability and superior customer support at competitive
prices. The Company intends to build its reputation and brand identity by
working closely with its customers to develop services tailored to their
particular needs and by implementing targeted advertising and promotional
efforts, which will be gradually expanding to mass media.
Customer Service. Management believes that the Company's ability to
provide superior customer service is a key factor in acquiring new customers
and reducing churn of existing customers. The Company has developed a customer
service strategy that is designed to effectively meet the service requirements
of its target customers. The principal salesperson for each customer provides
the first line of customer service by identifying and resolving any customer
concerns. An account development representative is assigned to each customer to
supervise all aspects of customer relations, including account collections and
complaint resolution, and to provide a single
26
<PAGE>
point of contact for all customer service issues. The Company also employs a
staff of locally-based customer service representatives who efficiently provide
real time problem identification and resolution and superior customer service.
Billing. US LEC outsources the preparation of customer bills, which are
available in a variety of formats that can be tailored to a customer's specific
needs. For example, the Company can provide accounting codes that enable a
customer to track expenses by employee, department or division. Codes also can
be used to restrict calling by individuals to help the customer manage costs.
The Company plans to implement an internal computerized billing system during
the second quarter of 1998 that is expected to enhance flexibility and reduce
costs associated with the billing function.
Regulation
The following summary of regulatory developments and legislation does not
purport to describe all present and proposed federal, state and local
regulations and legislation affecting the telecommunications industry. Other
existing federal and state regulations are currently the subject of judicial
proceedings, legislative hearings and administrative proposals which could
change, in varying degrees, the manner in which this industry operates. Neither
the outcome of these proceedings, nor their impact upon the telecommunications
industry or the Company, can be predicted at this time. This section also sets
forth a brief description of regulatory and tariff issues pertaining to the
operation of the Company.
Overview. The Company's services are subject to varying degrees of
federal, state and local regulation. The FCC generally exercises jurisdiction
over the facilities of, and services offered by, telecommunications common
carriers that provide interstate or international communications. The state
regulatory commissions retain jurisdiction over the same facilities and
services to the extent they are used to provide intrastate communications.
Federal Legislation. The Company must comply with the requirements of
common carriage under the Communications Act of 1934, as amended ( the
"Communications Act"). The Telecom Act, enacted on February 8, 1996,
substantially revised the Communications Act. The Telecom Act establishes a
regulatory framework for the introduction of local competition throughout the
United States and is intended to reduce unnecessary regulation to the greatest
extent possible. Among other things, the Telecom Act preempts, after notice and
an opportunity for comment, any state or local government from prohibiting any
entity from providing telecommunications service. This provision invalidated
prohibitions on entry found in almost half of the states in the country at the
time the Telecom Act was passed.
The Telecom Act also establishes a dual federal-state regulatory scheme
for eliminating other barriers to competition faced by competitors to the ILECs
and other new entrants into the local telephone market. Specifically, the
Telecom Act imposes on ILECs certain interconnection obligations, some of which
are to be implemented by FCC regulations. The Telecom Act contemplates that
states will apply the federal regulations and oversee the implementation of all
aspects of interconnection not subject to FCC jurisdiction as they oversee
interconnection negotiations between ILECs and their new competitors.
The FCC has significant responsibility in the manner in which the Telecom
Act will be implemented especially in the areas of universal service, access
charges and price caps. The details of the rules adopted by the FCC will have a
significant effect in determining the extent to which barriers to competition
in local services are removed, as well as the time frame within which such
barriers are eliminated.
The state PUCs have an even more significant responsibility in
implementing the Telecom Act. Specifically, the states have authority to
establish interconnection pricing, including unbundled loop charges, reciprocal
compensation and wholesale pricing. The states are also charged under the
Telecom Act with overseeing the arbitration process for resolving
interconnection negotiation disputes between CLECs and the ILECs. See " --
BellSouth North Carolina PUC Proceeding" for a discussion of the Company's
action before the North Carolina PUC related to its interconnection agreement
with BellSouth.
The Telecom Act imposes on ILECs certain interconnection obligations that,
taken together, grant competitive entrants such as the Company what is commonly
referred to as "co-carrier status." It is anticipated that co-carrier status
and the preemption of state and local prohibitions on entry could permit the
Company to become a full service provider of switched telecommunications
services anywhere in the United States. The following
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<PAGE>
table summarizes the interconnection rights granted by the Telecom Act that are
most important to the achievement of the Company's goals and the Company's
belief as to the anticipated effect of the new requirements, if implemented in
the manner in which the Company believes Congress intended. There can be no
assurance that these statutory provisions will be implemented in this fashion
due to the currently-pending appeals of the FCC's implementing rules and court
decisions regarding those rules.
<TABLE>
<CAPTION>
Issue Definition Anticipated Effect
- -------------------- ----------------------------------------------- ---------------------------------------------
<S> <C> <C>
Interconnection Efficient network interconnection, through Allows a CLEC to service and terminate calls
physical or virtual co-location or purchase to and from customers connected to other
of network elements to transfer calls back networks
and forth between ILECs and competitive
networks (including 911, 0 +, directory assis-
tance, etc.)
Local Loop Allows competitors to selectively gain access Reduces the capital and operating costs of a
Unbundling to ILEC wires which connect ILEC central CLEC to serve customers not directly con-
offices with customer premises or CLEC's nected to its networks
central office (if applicable)
Reciprocal Mandates payment for local traffic exchanges Enables CLECs to recover cost of terminat-
Compensation between ILECs and competitors ing ILEC-originated traffic
Number Portability Allows customers to change local carriers Allows customers to switch to a CLEC's local
without changing numbers; true portability service without changing phone numbers
allows incoming calls to be routed directly
to a competitor. Interim portability allows
incoming calls to be routed through the ILEC
to a competitor at the economic equivalent
of true portability
Dialing Parity Allows customers to access CLEC without Allows customers to access CLEC on same
dialing access codes basis as ILEC
Access to Phone Mandates assignment of new telephone num- Allows CLECs to provide telephone num-
Numbers bers to competitive telecommunications pro- bers to new customers on the same basis as
vider's customers on non-discriminatory terms the ILEC
Resale ILECs must establish wholesale rates for the Promotes resale activities by CLECs
services they offer at retail
</TABLE>
The Company expects to receive a significant portion of its initial
revenue in a given market from the ILEC in the form of reciprocal compensation
payments due to the Company's ESP and ISP customers receiving more calls than
they make. Several ILECs have challenged the applicability of the reciprocal
compensation scheme to ISP traffic. For a discussion see " -- State Regulation"
and " -- BellSouth North Carolina PUC Proceeding."
Certain of the obligations in the table above, including the obligations
to establish number portability, dialing parity and reciprocal compensation
arrangements, and to provide non-discriminatory access to telephone poles,
ducts, conduits and rights-of-way also apply to CLECs, including the Company.
As a result of the Telecom Act's applicability to other telecommunications
carriers, it may provide the Company with the ability to reduce its own
interconnection costs by interconnecting directly with non-ILECs, but may also
cause the Company to incur additional administrative and regulatory expenses in
responding to interconnection requests. At the same time, the Telecom Act also
makes competitive entry into other service or geographic markets more
attractive to RBOCs, other ILECs, long distance carriers and other companies
and likely will increase the level of competition the Company faces.
In addition, the Telecom Act, as passed, provided that ILECs that are
subsidiaries of RBOCs could not offer in-region, long distance services across
LATAs until they had demonstrated that (i) they have entered into an
28
<PAGE>
approved interconnection agreement with a facilities-based CLEC or that no such
CLEC has requested interconnection as of a statutorily determined deadline,
(ii) they have satisfied a 14-element checklist designed to ensure that the
ILEC is offering access and interconnection to all local exchange carriers on
competitive terms and (iii) the FCC has determined that in-region, inter-LATA
approval is consistent with the public interest, convenience and necessity.
Recently, a U.S. District Court ruled that these RBOC-specific provisions were
unconstitutional. See " -- U.S. District Court Decision."
Federal Regulation and Related Proceedings. The Telecom Act gives the FCC
the authority to forebear from regulating companies if it finds such regulation
does not serve the public interest, and directs the FCC to review its
regulations for continued relevance on a regular basis. As a result of this
directive, a number of the regulations that historically applied to CLECs have
been and may continue to be eliminated in the future. While it is therefore
expected that a number of regulations that were developed prior to the Telecom
Act will be eliminated in time, those which apply to the Company at present are
discussed below. Pursuant to its authority to forebear, the FCC has adopted
orders eliminating tariff filing requirements for non-dominant carriers
providing interstate access and domestic interstate long distance services.
However, on February 13, 1997, the United States Court of Appeals for the
District of Columbia granted motions for stay of the FCC order detariffing
domestic interstate long distance service pending judicial review of that
order. The result of this stay is that carriers must continue to file tariffs
for interstate long distance services. Tariff filing requirements remain in
place for international traffic. US LEC has filed federal interstate long
distance, interstate access and international tariffs.
In addition to its forbearance activities, the FCC also has proposed
reducing the level of regulation that applies to the ILECs, and increasing
their ability to respond quickly to competition from the Company and others.
For example, in accordance with the Telecom Act, the FCC has applied
"streamlined" tariff regulation to the ILECs, which greatly accelerates the
time prior to which changes to tariffed service rates may take effect, and has
eliminated the requirement that ILECs obtain FCC authorization before
constructing new domestic facilities. These actions will allow ILECs to change
service rates more quickly in response to competition. Similarly, the FCC has
proposed affording significant new pricing flexibility to ILECs subject to
price cap regulation. To the extent such increased pricing flexibility is
provided, the Company's ability to compete with ILECs for certain service may
be adversely affected. In addition, a U.S. District Court in Texas recently
invalidated certain provisions of the Telecom Act which prohibited the RBOCs
from engaging in certain manufacturing and marketing activities and conditioned
RBOC provision of in-region long distance service upon a demonstration that the
local market had been opened to competition. See " -- U.S. District Court
Decision."
The FCC has taken several actions related to the assignment of telephone
numbers, first in July 1995 mandating the responsibility for administering and
assigning local telephone numbers be transferred from the RBOCs and a few other
ILECs to a neutral entity, and second in July 1996 adopting a regulatory
structure under which a wide range of number portability issues would be
resolved. In March 1997, the FCC affirmed its number portability rules, but it
extended slightly certain deadlines for the implementation of true number
portability. The FCC plans to establish cost recovery rules for long-term
number portability.
On August 8, 1996, the FCC issued an order containing rules providing
guidance to the ILECs, CLECs, long distance companies and state PUCs regarding
several provisions of the Telecom Act. The rules include, among other things,
FCC guidance on: (i) discounts for end-to-end resale of ILEC retail local
exchange services (which the FCC has suggested should be in the range of
17%-25%); (ii) availability of unbundled local loops and other unbundled ILEC
network elements; (iii) the use of Total Element Long Run Incremental Costs in
the pricing of these unbundled network elements; (iv) average default proxy
prices for unbundled local loops in each state; (v) mutual compensation proxy
rates for termination of ILEC/CLEC local calls; and (vi) the ability of CLECs
and other interconnectors to opt into portions of previously-approved
interconnection agreements negotiated by the ILECs with other parties on a most
favored nation (or a "pick and choose") basis. See " --
Eighth Circuit Court of Appeals Decision" for a discussion of the Eighth
Circuit Court of Appeals decision invalidating several pertinent aspects of
this August 8 order.
On May 8, 1997, the FCC released an order establishing a significantly
expanded federal universal service program which subsidized certain eligible
services. For example, the FCC established new subsidies for services provided
to qualifying schools and libraries with an annual cap of $2.25 billion and for
services provided to rural health care providers with an annual cap of $400
million. The FCC also expanded the federal subsidies to low-income consumers
and consumers in high-cost areas. Providers of interstate telecommunications
service, such as
29
<PAGE>
the Company, as well as certain other entities, must pay for these programs.
The Company's share of the schools, libraries and rural health care funds will
be based on its share of the total industry telecommunications service and
certain defined telecommunications end user revenues. The Company's share of
all other federal subsidy funds will be based on its share of the total
interstate telecommunications service and certain defined telecommunications
end user revenues. Although the FCC order describes a method for determining
the amount the Company must contribute to support these subsidies, the Company
is currently unable to quantify the amount of these payments that it will be
required to make, and the effect that these required payments will have on its
financial condition. In the May 8 order, the FCC also announced that it will
soon revise its rules for subsidizing service provided to consumers in high
cost areas. Several parties have appealed the May 8 order. Such appeals have
been consolidated and transferred to the United States Court of Appeals for the
Fifth Circuit where they are currently pending. In addition, on July 3, 1997,
several ILECs filed a petition for stay of the May 8 order with the FCC. That
petition is also pending.
In a combined Report and Order and Notice of Proposed Rulemaking released
on December 24, 1996, the FCC made changes and proposed further changes in the
interstate access charge structure. In the Report and Order, the FCC removed
restrictions on an ILEC's ability to lower access prices and relaxed the
regulation of new switched access services in those markets where there are
other providers of access services. If this increased pricing flexibility is
not effectively monitored by federal regulators, it could have a material
adverse effect on the Company's ability to compete in providing interstate
access services. On May 16, 1997, the FCC released an order revising its access
charge rate structure. The new rules substantially increase the costs that
ILECs subject to the FCC's price cap rules ("price cap LECs") recover through
monthly, non-traffic sensitive access charges and substantially decrease the
costs that price cap LECs recover through traffic sensitive access charges. In
the May 16 order, the FCC also announced its plan to bring interstate access
rate levels more in line with cost. The plan will include rules to be
established sometime this year that grant price cap LECs increased pricing
flexibility upon demonstrations of increased competition (or potential
competition) in relevant markets. The manner in which the FCC implements this
approach to lowering access charge levels will have a material effect on the
Company's ability to compete in providing interstate access services. Several
parties have appealed the May 16 order. Those appeals have been consolidated
and transferred to the United States Court of Appeals for the Eighth Circuit
where they are currently pending.
As part of its overall plan to lower interstate access rates, the FCC also
released an order on May 21, 1997, in which the FCC revised its price cap
rules. In the May 21 order, the FCC increased the so-called X-Factor (the
percentage by which price cap LECs must lower their interstate access charges
every year, net of inflation and exogenous cost increases) and made it uniform
for all price cap LECs. The results of these rule changes will be both a
one-time overall reduction in price cap ILEC interstate access charges and an
increase in the rate at which those charges will be reduced in the future.
Several parties have appealed the May 21 order. Those appeals were consolidated
and transferred to the United States Court of Appeals for the Tenth Circuit.
They have been subsequently transferred to the United States Court of Appeals
for the District of Columbia where they are currently pending.
The Company anticipates that the FCC will initiate a number of additional
proceedings, of its own volition and as a result of requests from CLECs and
others, as a result of the Telecom Act. While the Eighth Circuit's recent
decision in the appeal of the August 8, 1996 order limits the FCC's
jurisdiction over the local competition provisions of the Telecom Act and while
the decision of the U.S. District Court for the Northern District of Texas has
held that the RBOC-specific provisions of the Telecom Act are unconstitutional
and this issue has been raised in other proceedings (see above and below), such
proceedings may nonetheless further define and construe the Telecom Act's
terms.
The FCC also requires carriers to file periodic reports concerning
carriers interstate circuits and deployment of network facilities. The FCC
generally does not exercise direct oversight over cost justification and the
level of charges for services of non-dominant carriers, although it has the
power to do so. The FCC also imposes prior approval requirements on transfers
of control and assignments of operating authorizations. The FCC has the
authority to generally condition, modify, cancel, terminate, or revoke
operating authority for failure to comply with federal laws or rules,
regulations and policies of the FCC. Fines or other penalties also may be
imposed for such violations. There can be no assurance that the FCC or third
parties will not raise issues with regard to the Company's compliance with
applicable laws and regulations.
30
<PAGE>
Eighth Circuit Court of Appeals Decision. Various parties, including ILECs
and state PUCs, requested that the FCC reconsider its own rules and/or filed
appeals of the FCC's August 8, 1996 order in various U.S. Courts of Appeal.
Also, several parties petitioned the FCC and the courts to stay the
effectiveness of the FCC's rules included in the FCC's order, pending a ruling
on the appeals. The appeals were consolidated and transferred to the U.S. Court
of Appeals for the Eighth Circuit.
On July 18, 1997, the Eighth Circuit overturned the pricing rules
established in the August 8, 1996 order, except those applicable to commercial
mobile radio service providers. The Eighth Circuit held that, in general, the
FCC does not have jurisdiction over prices for interconnection, resale, leased
unbundled network elements and traffic termination. The Eighth Circuit also
overturned the FCC's "pick and choose" rules as well as certain other FCC rules
implementing the Telecom Act's local competition provisions. In addition, the
Eighth Circuit decision substantially limits the FCC's authority to enforce the
local competition provisions of the Telecom Act. The FCC and others have
appealed the Eight Circuit decision to the U.S. Supreme Court, and the U.S.
Supreme Court granted certiorari on January 26, 1998.
In the short term, management believes that the Eighth Circuit decision
will not have a material adverse effect on the Company, because it already has
interconnection agreements in place, or expects to have such agreements in
place, under the provisions of the FCC's order and the Telecom Act which were
not invalidated by the Court. The decision does not delay the implementation of
the Telecom Act by the parties and by the state PUCs, but rather eliminates the
guidance on pricing and most favored nation procedures as well as other issues
that the FCC sought to provide to the parties and the state PUCs. However,
since the Eighth Circuit decision creates uncertainty about the rules governing
pricing, terms and conditions of interconnection agreements, it could make
negotiation and enforcement of such agreements more difficult and protracted,
and may require renegotiation of existing agreements. In the long term, the
Eighth Circuit's decision makes it more likely that the rules governing local
competition will vary from state to state. Most states have already begun to
establish rules for local competition that are consistent with the FCC rules
overturned by the Eighth Circuit. If a patchwork of state regulations were to
develop, it could increase the Company's costs of regulatory compliance and
could make competitive entry in some markets more difficult and expensive than
in others.
U.S. District Court Decision. On July 2, 1997, SBC and its local exchange
carrier subsidiaries filed a lawsuit in the United States District Court for
the Northern District of Texas challenging on U.S. Constitutional grounds the
Telecom Act restrictions applicable to the RBOCs only. The plaintiffs in the
case sought both a declaratory judgment and an injunction against the
enforcement of the challenged provisions. On December 31, 1997, this U.S.
District Court ruled that Sections 271-275 of the Telecom Act were
unconstitutional on the grounds that these sections constituted a "bill of
attainder." Based on this U.S. District Court ruling, the RBOCs that are
parties to this preceding could technically re-enter the inter-LATA long
distance market immediately. The FCC and long distance carriers requested a
stay of the decision, which has been granted. The Company expects that the
decision of the U.S. District Court will be appealed to the U.S. Court of
Appeals for the Fifth Circuit and, likely, to the U.S. Supreme Court. In
addition, BellSouth has appealed to the U.S. Court of Appeals for the D.C.
Circuit the FCC's prior decision denying BellSouth's application to provide
in-region long distance service in South Carolina. BellSouth challenged the
decision on the same grounds on which SBC challenged Sections 271-275 of the
Telecom Act. On January 14, 1998, the North Carolina PUC gave BellSouth
approval to file with the FCC to provide long distance services in North
Carolina, provided it first improves its operating support systems and
performance measures.
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<PAGE>
State Regulation. The Company is certified by the appropriate state PUCs as
follows:
<TABLE>
<CAPTION>
State Order Dated Telecommunication Services
- ----------------- -------------------- -----------------------------------------------------------------------
<S> <C> <C>
North Carolina September 27, 1996 local exchange, exchange access, and intrastate interexchange long
distance
Georgia August 5, 1997 local exchange and long distance
Virginia September 8, 1997 intrastate local exchange; no certification required for long distance
Tennessee September 18, 1997 local exchange, exchange access and interexchange
South Carolina November 10, 1997 resale and facilities-based local exchange, exchange access and
intrastate interexchange
Florida December 2, 1997 local exchange; long distance application approved, pending
final order
</TABLE>
These are all of the states in which the Company operates or currently
intends to begin operations in 1998 or 1999. To the extent that an area within
a state in which the Company operates is served by a small (in line counts) or
rural ILEC not currently subject to competition, the Company may not have
authority to service those areas at this time. Most states regulate entry into
local exchange and other intrastate service markets, and states' regulation of
CLECs vary in their regulatory intensity. The majority of these states mandate
that companies seeking to provide local exchange and other intrastate services
apply for and obtain the requisite authorization from a PUC. This authorization
process generally requires the carrier to demonstrate that it has sufficient
financial, technical, and managerial capabilities and that granting the
authorization will serve the public interest.
As a CLEC, the Company is subject to the regulatory directives of each
state in which the Company is certified. In addition to tariff filing
requirements (described in greater detail below), most states require that
CLECs charge just and reasonable rates and not discriminate among similarly
situated customers. Some states also require the filing of periodic reports,
the payment of various regulatory fees and surcharges, and compliance with
service standards and consumer protection rules. States also often require
prior approvals or notifications for certain transfers of assets, customers, or
ownership of a CLEC. States generally retain the right to sanction a carrier or
to revoke certifications if a carrier materially violates relevant laws and/or
regulations.
In all of the states where US LEC is certified, the Company is required to
file tariffs or price lists setting forth the terms, conditions and/or prices
for services which are classified as intrastate. In some states, the Company's
tariff may list a range of prices or a ceiling price for particular services,
and in others, such prices can be set on an individual customer basis, although
the Company may be required to file tariff addenda of the contract terms. The
Company is not subject to price cap or to rate of return regulation in any
state in which it currently provides services.
As noted above, the states have the primary regulatory role over
intrastate services under the Telecom Act. The Telecom Act allows state
regulatory authorities to continue to impose competitively neutral and
nondiscriminitory requirements designed to promote universal service, protect
public safety and welfare, maintain quality of service and safeguard the rights
of consumers. State PUCs will implement and enforce most of the Telecom Act's
local competition provisions, including those governing the specific charges
for local network interconnection. In some states, those charges are being
determined by generic cost proceedings and in other states they are being
established through arbitration proceedings.
BellSouth North Carolina PUC Proceeding. The Company has petitioned the
North Carolina Utilities Commission ("NC PUC") to resolve a dispute between the
Company and BellSouth related to their interconnection agreement, dated
November 29, 1996 and approved in North Carolina by the NC PUC by an order
dated January 29, 1997 (effective November 20, 1996). In August 1997, BellSouth
issued a memorandum to the Company in which BellSouth announced its unilateral
decision to neither bill nor pay reciprocal charges for traffic terminated by a
CLEC or BellSouth to ESPs including ISPs. The Company believes this memorandum
was sent to all CLECs who have an interconnection agreement with BellSouth.
BellSouth based its announcement on the theory that such traffic is not
"local," and therefore not subject to reciprocal compensation. On October 24,
1997, the Company filed a petition with the NC PUC seeking an order which,
among other things, would direct BellSouth to pay reciprocal compensation for
all local traffic terminated on the Company's network, including traffic
terminated by US LEC to its customers which are ESPs or ISPs. The petition,
among other things, also noted that similar positions recently had been taken
by other RBOCs in other states; that disputes between those
32
<PAGE>
RBOCs and the CLECs regarding ESP and ISP traffic had been the subject of
arbitration and/or complaint proceedings in at least eight states; and that, as
of the date of the petition, the respective PUCs in all eight states had
ordered the payment of reciprocal compensation for traffic terminated by the
CLEC to ESPs and ISPs. As of February 13, 1998, twelve states (including
Virginia) have ordered the payment by an RBOC of reciprocal compensation for
traffic terminated by a CLEC to an ESP or ISP. The FCC is also generally
considering the issue of reciprocal compensation to ISPs/ESPs, and the Eighth
Circuit is considering an appeal of the FCC's decision not to impose access
charges on ISPs. There can be no assurance that the payment of reciprocal
compensation for ISP traffic will be maintained. A determination that such
traffic is not subject to reciprocal compensation would have a material adverse
effect on the Company.
By its order entered on December 3, 1997, the NC PUC required BellSouth to
file a responsive pleading on or before December 12, 1997, in anticipation of a
hearing scheduled for December 17, 1997. By the time BellSouth filed its
responsive filing on December 12, 1997, the NC PUC had entered orders allowing
other CLECs to intervene in the proceeding and to present arguments at the
hearing on December 17, 1997. All intervenors supported the position of the
Company. At the conclusion of the hearing, the NC PUC directed the parties to
file proposed orders and briefs within 21 days after the mailing of the
transcript of the hearing, which was mailed on January 5, 1998. The proposed
orders and briefs were filed January 26, 1998, and the Company supplemented its
brief on February 10, 1998.
Although there is no specific time within which the NC PUC is required to
rule, it is likely that a ruling will be entered during the first quarter of
1998. Any party aggrieved by any ruling of the NC PUC in this proceeding may
ask that the matter become the subject of hearing by the full NC PUC (unless
the NC PUC acts as the full NC PUC in the ruling), or appeal from the NC PUC
ruling pursuant to state law of the North Carolina Court of Appeals, or seek
review by a judge of the United State District Court for the Eastern District
of North Carolina pursuant to the Telecom Act.
While the Company believes that it will ultimately be successful in this
proceeding, there can be no assurances in this regard, and it is possible that
an adverse result could occur. A final determination that such traffic is not
eligible for reciprocal compensation would have a material adverse effect on
the Company. See "Risk Factors -- Uncertainties Related to Reciprocal
Compensation."
Competition
As noted above, the regulatory environment in which the Company operates
is changing rapidly. The passage of the Telecom Act combined with other actions
by the FCC and state regulatory authorities continues to promote competition in
the provision of telecommunications services.
ILECs. In each market served by its networks, the Company faces, and
expects to continue to face, significant competition from the ILECs, which
currently dominate their local telecommunications markets.
The Company competes with the ILECs in its markets for local exchange
services on the basis of product offerings, reliability, state-of-the-art
technology, price, route diversity, ease of ordering and customer service.
However, the ILECs have long-standing relationships with their customers and
provide those customers with various transmission and switching services that
the Company, in a few cases, does not currently offer. In addition, ILECs enjoy
a competitive advantage due to their vast financial resources. The Company has
sought, and will continue to seek, to achieve parity with the ILECs in order to
become able to provide a full range of local telecommunications services. See
"Business -- Regulation" for additional information concerning the regulatory
environment in which the Company operates. Because US LEC leases fiber optic
transmission capacity to link its customers with its networks, and uses
state-of-the-art technology in its switch platforms, the Company may have cost
and service quality advantages over some currently available ILEC networks.
Other Competitors. The Company also faces, and expects to continue to
face, competition from other potential competitors in certain of the markets in
which the Company offers its services. In addition to the ILECs and CAPs,
potential competitors capable of offering switched local and long distance
services include long distance carriers, cable television companies, electric
utilities, microwave carriers, wireless telephone system operators and private
networks built by large end-users. Many of these potential competitors enjoy
competitive advantages based upon existing relationships with subscribers and
vast financial resources.
33
<PAGE>
The Company believes that the Telecom Act as well as a recent series of
completed and proposed transactions between ILECs and long distance companies
and cable companies increase the likelihood that barriers to local exchange
competition will be removed. The Telecom Act, as passed, conditioned the
provision of in-region, inter-LATA services by RBOCs upon a demonstration that
the market had been opened to competition. When ILECs that are RBOC
subsidiaries are permitted to provide such services, they will be in a position
to offer single source service. ILECs that are not RBOC subsidiaries may offer
single source service presently. As a result of a U.S. District Court's
invalidation of Sections 271-275 of the Telcom Act, RBOCs that were parties to
that proceeding also may have this ability presently. In addition, BellSouth
has appealed the FCC's prior decision denying BellSouth's application to
provide in-region long distance service in South Carolina. BellSouth challenged
the decision on the same basis used by SBC to invalidate Sections 271-275 of
the Telecom Act. See "Business -- Regulation -- U.S. District Court Decision."
A continuing trend toward business combinations and alliances in the
telecommunications industry may create significant new competitors to the
Company. In addition, many of the Company's existing and potential competitors
have financial, personnel and other resources, including brand name
recognition, significantly greater than those of the Company.
The Company also competes with long distance carriers in the provision of
long distance services. Although the long distance market is dominated by four
major competitors, hundreds of other companies also compete in the long
distance marketplace.
Properties
The Company leases all of its administrative and sales offices and its
switch sites. The various leases expire in years ranging from 2000 to 2003. All
have renewal options. Additional office space and switch sites will be leased
or otherwise acquired as the Company's operations and networks are expanded and
as new networks are constructed.
Employees
As of December 31, 1997, the Company employed 78 people. The Company
expects to employ approximately 250 people by the end of 1998. The Company
considers its employee relations to be good. None of the employees of the
Company is covered by a collective bargaining agreement.
Servicemarks, Trademarks and Trade Names
The Company uses "US LEC" as its primary servicemark and has developed a
proprietary logo. In October 1996, the Company filed for federal servicemark
and trademark protection of US LEC and its logo. The application for the
servicemark "US LEC" has matured to federal registration on the supplemental
register. The Company expects that the servicemark application for the logo
will mature to registration on the principal register in the near future.
Legal Proceedings
The Company is not currently a party to any legal proceedings, other than
the NC PUC proceeding relating to reciprocal compensation from BellSouth for
ISP and ESP traffic. See "Business -- Regulation --
BellSouth North Carolina PUC Proceeding."
34
<PAGE>
MANAGEMENT
Directors and Executive Officers
The following table sets forth certain information regarding the executive
officers and directors of US LEC. Directors of the Company are elected annually
at the annual meeting of stockholders. The backgrounds and business experience
of the Company's executive officers and directors are described following the
table.
<TABLE>
<CAPTION>
Name Age Position
- ---------------------------- ----- ---------------------------------------------------------
<S> <C> <C>
Richard T. Aab 48 Chairman, Chief Executive Officer and Director (Class B
Director)
Tansukh V. Ganatra 54 President, Chief Operating Officer and Director (Class B
Director)
David N. Vail 41 Executive Vice President -- Finance and Chief Financial
Officer
David C. Conner 40 Executive Vice President -- Engineering and Operations
Gary D. Grefrath 56 Executive Vice President -- Customer Service, Regulation
and Administration
Michael K. Simmons 39 Executive Vice President -- Sales
Craig K. Simpson 34 Senior Vice President -- Corporate Development
David M. Flaum * 45 Director (Class A Director)
Steven L. Schoonover * 52 Director (Class A Director)
</TABLE>
- ----------
* Indicates a member of the Audit Committee.
Richard T. Aab co-founded US LEC in June 1996 and has served as its
Chairman and Chief Executive Officer and as a Director since that time. In
1982, he co-founded ACC Corp., which is a publicly-traded international
telecommunications company currently under agreement to be acquired by Teleport
Communications Group, Inc. for approximately $1.1 billion. Between 1982 and
1997, Mr. Aab held various positions with ACC Corp. including Chairman, Chief
Executive Officer and Director. Under Mr. Aab's leadership, ACC Corp.
participated in the introduction of competition into local and long distance
telecommunications markets in the United States, Canada and the United Kingdom.
Tansukh V. Ganatra co-founded US LEC in June 1996 and has served as its
President and Chief Operating Officer and as a Director since that time. Mr.
Ganatra is a specialist in the field of intelligent switching technology and
transport network systems. From 1987 to 1997, Mr. Ganatra held various
positions with ACC Corp., including serving as its President and Chief
Operating Officer. Prior to joining ACC Corp., Mr. Ganatra held various
positions during a 19-year career with Rochester Telephone Corp. (now Frontier
Corp.), culminating with the position of Director of Network Engineering.
David N. Vail has been US LEC's Executive Vice President -- Finance and
Chief Financial Officer since August 1997. Prior to joining US LEC, Mr. Vail
served as the controller for Harris Beach & Wilcox LLP, a multi-state law firm
based in Rochester, New York, from 1986 to May 1997. From 1984 to 1986, Mr.
Vail served as Controller for Voit Corporation, a publicly-traded sporting
goods manufacturer. Prior to his tenure with Voit Corporation, Mr. Vail spent
six years in public accounting with Naramore, Niles and Company, CPAs and
Deloitte & Touche LLP. Mr. Vail is a Certified Public Accountant.
David C. Conner has been US LEC's Executive Vice President -- Engineering
and Operations since November 1996. From 1990 until he joined US LEC, Mr.
Conner served in various positions with ACC Corp. including Vice President of
Engineering and Operations for one of its cellular operations and Operations
Director for its long distance operations in the United Kingdom. From May 1985
until October 1990, Mr. Conner served in various positions with Rochester
Telephone Corp. (now Frontier Corp.), including several positions in operations
and management information systems. At Rochester Telephone Corp., Mr. Conner
had significant responsibility in the development of operational support
systems, the development and operation of its network control center and the
coordination of installation and repair of facilities.
Gary D. Grefrath has been US LEC's Executive Vice President -- Customer
Service, Regulation and Administration since August 1996. Prior to joining US
LEC, Mr. Grefrath was employed by Rochester Telephone Corp.
35
<PAGE>
(now Frontier Corp.) since 1969, where he held various positions and most
recently was responsible for management of most major areas of administration
for that company. He was also responsible for the preparation of tariff filings
with the State of New York and the FCC and for all service and contractual
relations with interexchange carriers.
Michael K. Simmons has been US LEC's Executive Vice President -- Sales
since October 1996. Prior to joining US LEC, Mr. Simmons was employed by Time
Warner Communications from December 1993 to October 1996 as its Vice President
and General Manager of western North Carolina operations. From August 1993 to
December 1993, Mr. Simmons was branch manager for MCI Communications Corp's.
("MCI") western North Carolina region and also held various sales, marketing
and management positions in four states.
Craig K. Simpson joined US LEC in February 1997 as its Vice President --
Marketing, was promoted to Senior Vice President -- Corporate Development in
August 1997 and has since served in this capacity. Prior to joining US LEC, Mr.
Simpson was employed by MCI from 1989 to February 1997, where he most recently
served as carrier manager for its North Carolina operations. In that capacity,
Mr. Simpson was responsible for sales to interexchange carriers, CLECs and
independent telephone companies. From 1982 to 1987, Mr. Simpson was employed by
Unisys Corporation in its computer mainframe sales and marketing division.
Steven L. Schoonover was elected to US LEC's Board of Directors in January
1998. Mr. Schoonover is President and Chief Executive Officer of CellXion,
Inc., which specializes in construction, installation and management of
cellular telephone and personal communications systems. From 1990 until its
sale in November 1997 to Telephone Data Systems, Inc., Mr. Schoonover served as
President of Blue Ridge Cellular, Inc., a full-service cellular telephone
company. From 1983 to 1996, he served in various positions, including President
and Chief Executive Officer, with Fibrebond Corporation, a firm involved in
site development, shelter and tower construction for the cellular
telecommunications industry.
David M. Flaum was elected to US LEC's Board of Directors in January 1998.
Mr. Flaum has served as President of Flaum Management Company, Inc. ("Flaum
Management"), a real estate development firm based in Rochester, New York,
since 1985, and President of The Hague Corporation, a commercial real estate
management firm, since 1993. Flaum Management is active in the development of
retail centers, office buildings and high technology facilities in the eastern
United States.
Election of Directors
The Company's Bylaws provide that the Board of Directors shall consist of
at least three members and no more than eleven members. Pursuant to the
Company's Certificate of Incorporation, so long as there are any shares of
Class B Common Stock outstanding, holders of Class B Common Stock will have the
right to elect two members to the Company's Board of Directors. In addition,
the holders of Class A Common Stock and Class B Common Stock vote together as
one class for the election of the other members of the Company's Board of
Directors.
36
<PAGE>
Executive Compensation
The following table sets forth, for the year ended December 31, 1997,
individual compensation information for the Chairman and Chief Executive
Officer, the President and Chief Operating Officer and each of the other
executive officers of US LEC who received compensation in excess of $100,000
during the year (the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Annual Compensation
-----------------------------------------------
Other Annual All Other
Name and Principal Position Year Salary ($) Bonus ($) Compensation ($) Compensation ($) (1)
- -------------------------------------- ------ ------------ ----------- ------------------ ---------------------
<S> <C> <C> <C> <C> <C>
Richard T. Aab
Chairman and Chief
Executive Officer .................. 1997 -- -- -- --
Tansukh V. Ganatra
President and Chief
Operating Officer .................. 1997 6,750 -- 7,968 (2) 423
Michael K. Simmons
Executive Vice President --
Sales .............................. 1997 129,459 37,500 -- 423
Gary D. Grefrath
Executive Vice
President -- Customer
Service, Regulation and
Administration ..................... 1997 81,012 25,000 -- 264
David C. Conner
Executive Vice President --
Engineering and Operations ......... 1997 79,785 25,000 -- 260
</TABLE>
- ----------
(1) Consists of premiums paid by the Company for term life insurance for the
Named Executive Officer.
(2) Consists of automobile lease payments.
The Board of Directors has determined that base salaries for the Company's
executive officers for 1998 will be as follows: Mr. Aab -- $160,000; Mr.
Ganatra -- $150,000; Mr. Simmons -- $125,000; Mr. Grefrath --
$95,000; Mr. Conner -- $95,000; Mr. Vail -- $95,000; and Mr. Simpson --
$90,000. See "Certain Relationships and Related Transactions."
Compensation of Directors
Following completion of the Offering, US LEC intends to pay its directors
who are not officers or employees ("Outside Directors") an annual retainer of
$5,000 and a fee of $1,000 for each meeting of the Board of Directors and $500
for each meeting of any committee thereof attended. The Company also will
reimburse each director for reasonable out-of-pocket expenses incurred in
attending meetings of the Board of Directors and any of its committees.
Immediately upon completion of the Offering, each of the Company's two Outside
Directors will be granted nonqualified stock options under the Stock Plan
covering shares of Class A Common Stock with an exercise price equal to the
initial public offering price of the Class A Common Stock.
Omnibus Stock Plan
The Company adopted the US LEC Corp. 1998 Omnibus Stock Plan in January
1998 (the "Stock Plan"). The Stock Plan is intended to enable the Company to
recruit, reward, retain and motivate employees and to attract and retain
outside directors, agents and consultants on a basis competitive with industry
practices. The Company has reserved shares of Class A Common Stock for
issuance under the Stock Plan.
The Stock Plan will be administered by the Board of Directors or the
Compensation Committee of the Board of Directors (such committee or the Board
of Directors itself, as applicable, is hereinafter referred to as the
"Committee"). Awards under the Stock Plan may include, but are not limited to,
stock options, stock appreciation rights, restricted stock, performance awards,
or other stock-based awards, such as stock units, securities
37
<PAGE>
convertible into stock, phantom securities and dividend equivalents. The
Committee has sole authority and discretion under the Stock Plan to (i)
designate eligible participants and (ii) determine the types of awards to be
granted and the conditions and limitations applicable to such awards, if any,
including the acceleration of vesting or exercise rights upon a Change in
Control of the Company (as defined in the Stock Plan). The awards may be
granted singly or together with other awards, or as replacement of, in
combination with, or as alternatives to, grants or rights under the Stock Plan
or other employee benefit plans of US LEC. Awards under the Stock Plan may be
issued based on past performance, as an incentive for future efforts or
contingent upon the future performance of the Company.
Options granted under the Stock Plan must be exercised within the period
fixed by the Committee, which may not exceed 10 years from the date of the
option grant, or in the case of incentive stock options granted to any 10%
stockholder, five years from the date of the option grant. Options may be made
exercisable in whole or in installments, as determined by the Committee. Except
as authorized by the Committee, options will not be transferable other than by
will or the laws of descent and distribution and, during the lifetime of an
optionee, may be exercised only by the optionee. The option price will be
determined by the Committee. However, the option price for incentive stock
options may not be less than the market value of the Class A Common Stock on
the date of grant of the option and the option price for incentive stock
options granted to any 10% stockholder may not be less than 110% of the market
value of the Class A Common Stock on the date of grant. Unless otherwise
designated by the Committee as "incentive stock options" intended to qualify
under Section 422 of the Internal Revenue Code of 1986, as amended, options
granted under the Stock Plan are intended to be "nonqualified stock options."
The Committee has granted incentive stock options covering shares of
Class A Common Stock to substantially all employees of the Company who are not
executive officers. These options vest annually in four equal installments
beginning in January 1999 and the exercise price is $ per share. Immediately
upon completion of the Offering, the Committee intends to grant nonqualified
stock options covering shares of Class A Common Stock to each of the
Company's two Outside Directors at an exercise price equal to the initial
public offering price of the Class A Common Stock.
Promptly after completion of the Offering, the Company intends to register
the shares of Class A Common Stock reserved for issuance under the Stock Plan
under the Securities Act. See "Shares Eligible for Future Sale."
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
At January 31, 1998, the Company's indebtedness to Messrs. Aab and
Ganatra, and Melrich Associates, L.P. ("Melrich"), an entity of which Mr. Aab
is a general partner, was $8,289,150. The borrowings were allocated as follows:
Mr. Aab ($5,000,000), Mr. Ganatra ($1,000,000) and Melrich ($2,289,150). On
February , 1998, the entire principal amount of the loan payable to Mr. Aab
was exchanged for shares of Class B Common Stock. The terms of the loans
outstanding to Mr. Ganatra and Melrich currently provide for interest at an
annual rate of 12% per annum, payable quarterly and a due date of January 16,
2003. The Company's operating subsidiaries in North Carolina and Georgia have
guaranteed the payment of the loans and granted to Mr. Ganatra and Melrich a
security interest in substantially all of such subsidiaries' assets. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
Under a consulting agreement between US LEC and a limited liability
company owned in its entirety by Mr. Aab, the limited liability company
provided strategic, financial planning and other consulting services to US LEC
in 1997 for a fee $125,000. Under a consulting agreement with a limited
partnership controlled by Mr. Ganatra, the limited partnership provided general
business and operations advice to the Company in exchange for a fee of $50,000.
These agreements were terminated on December 31, 1997.
In January 1998, the Company agreed to purchase a carrier access billing
system and related software and support systems from Global Vista
Communications, LLC ("Global") for $397,500. Mr. Aab owns a 44% equity interest
in Global, but does not control the company and is not active in its
management.
38
<PAGE>
SECURITY OWNERSHIP OF MANAGEMENT
As of January 31, 1998, there were 53 holders of record of the Common
Stock. The following table sets forth certain information with respect to the
beneficial ownership of shares of Common Stock as of January 31, 1998 and as
adjusted to reflect the sale of shares of Class A Common Stock in the Offering,
by (i) each director of the Company, (ii) each of the Named Executive Officers,
(iii) each person known by the Company to beneficially own 5% or more of the
outstanding shares of any class of Common Stock and (iv) all directors and
executive officers of US LEC as a group.
<TABLE>
<CAPTION>
Prior to the Offering (1)
----------------------------------------
Amount and Percent of Percent of
Name and Address Title of Nature of Percent Total Shares Total Voting
of Beneficial Owner Class Ownership (2) of Class Outstanding Power
- ----------------------------------------- ---------- --------------- ---------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Richard T. Aab .......................... Class B (3) 76.3% 62.3% 74.6%
Joyce M. Aab ............................ Class B (3) 25.2% 20.6% 24.7%
Tansukh V. Ganatra ...................... Class B (4) 23.7% 19.3% 23.2%
David C. Conner ......................... Class A (5) 17.1% 3.2% *
Gary D. Grefrath ........................ Class A 13.1% 2.4% *
Michael K. Simmons ...................... Class A (6) 14.7% 2.7% *
David N. Vail ........................... Class A (7) 6.0% * *
David M. Flaum .......................... Class A 4.7% * *
Steven L. Schoonover .................... Class A -- -- -- --
Craig K. Simpson ........................ Class A (8) 4.3% * *
All directors and executive officers as a
group (9 persons) ...................... Class A 55.6% 11.0% 1.3%
Class B 100.0% 81.6% 97.8%
<CAPTION>
After the Offering (1)
---------------------------------------
Percent of Percent of
Name and Address Percent Total Shares Total Voting
of Beneficial Owner of Class Outstanding Power
- ----------------------------------------- ---------- -------------- -------------
<S> <C> <C> <C>
Richard T. Aab ..........................
Joyce M. Aab ............................
Tansukh V. Ganatra ......................
David C. Conner .........................
Gary D. Grefrath ........................
Michael K. Simmons ......................
David N. Vail ...........................
David M. Flaum ..........................
Steven L. Schoonover ....................
Craig K. Simpson ........................
All directors and executive officers as a
group (9 persons) ......................
</TABLE>
- ----------
(1) An "*" indicates less than one percent.
(2) In accordance with Commission rules, each beneficial owner's holdings have
been calculated assuming full exercise of outstanding warrants and options
exercisable by such holder within 60 days after January 31, 1998, but no
exercise of outstanding warrants and options held by any other person. The
table set forth above assumes that the over-allotment option is not
exercised by the Underwriters. Except as otherwise indicated, each person
named in this table has sole voting and dispositive power with respect to
the shares of Common Stock beneficially owned by such person.
(3) Includes shares held by Melrich. Mr. Aab and his wife, Joyce M. Aab,
are the sole general partners of Melrich and share voting and dispositive
power with respect to these shares. Mr. and Mrs. Aab's address is 212
South Tryon Street, Suite 1540, Charlotte, NC 28281.
(4) Includes shares held by Super STAR Associates Limited Partnership.
Mr. Ganatra, the majority general partner, has voting and dispositive
power with respect to these shares. Mr. Ganatra's address is 212 South
Tryon Street, Suite 1540, Charlotte, NC 28281.
(5) Includes shares owned by Mr. Connor's wife, as to which he is deemed
to share voting and dispositive power.
(6) Includes shares held by Michael K. Simmons Family Limited Partnership
as to which Mr. Simmons, the sole general partner, has voting and
dispositive power.
(7) Includes shares subject to a presently exercisable warrant held by Mr.
Vail.
(8) Includes shares subject to a presently exercisable warrant held by Mr.
Simpson.
39
<PAGE>
DESCRIPTION OF CAPITAL STOCK
General
The authorized capital stock of the Company consists of: (i) 90,000,000
shares of common stock, $.01 par value per share (the "Common Stock"), which is
divided into two classes consisting of 73,405,498 shares of Class A Common
Stock ( shares of which were outstanding as of the date of this
Prospectus) and 16,594,502 shares of Class B Common Stock ( shares of which
were outstanding as of the date of this Prospectus); and (ii) 10,000,000 shares
of preferred stock, $.01 par value per share (the "Preferred Stock"), none of
which are issued and outstanding. Effective upon completion of the Offering,
shares of Class A Common Stock will be issued and outstanding, shares
of Class B Common Stock will be issued and outstanding and no shares of
Preferred Stock will be issued and outstanding. In addition, shares of Class
A Common Stock are reserved for issuance under the Stock Plan, shares of
Class A Common Stock are reserved for issuance under presently exercisable
warrants and shares of Class A Common Stock are reserved for issuance upon
conversion of the Class B Common Stock.
The following summary of certain provisions of the Company's Certificate
of Incorporation ("Certificate") and Bylaws does not purport to be complete and
is subject to, and qualified in its entirety by, reference to the Certificate
and Bylaws of the Company, copies of which have been filed as exhibits to the
registration statement of which this Prospectus is a part.
Common Stock
The shares of Class A Common Stock and Class B Common Stock are identical
in all respects, except for voting rights and certain conversion rights with
respect to the shares of Class B Common Stock which are described herein.
Shares of Class B Common Stock may be owned only by the holders of Class B
Common Stock as of the date of this Prospectus and their Permitted Transferees
(as defined in the Certificate). Any shares of Class B Common Stock transferred
to any other person automatically convert into shares of Class A Common Stock
on a one-for-one basis. Each share of Class B Common Stock may be converted, at
any time at the option of the holder thereof, into one share of Class A Common
Stock, subject to the rights of other holders of Class B Common Stock under the
Class B Stockholders Agreement. The Class A Common Stock and the Class B Common
Stock are entitled to vote on all matters which come before the stockholders,
voting together as a single class on all matters, except as described below and
as otherwise required by law. Each share of Class A Common Stock has one vote
and each share of Class B Common Stock has 10 votes on all matters on which
holders of Common Stock are entitled to vote. Holders of the Class B Common
Stock are also entitled by the Certificate and Bylaws to approve certain
amendments to the Certificate or the Bylaws.
The Certificate provides that the Board of Directors shall have two
classes of directors: (i) "Class B Directors," of which there shall be two at
all times during which shares of Class B Common Stock are issued and
outstanding, and (ii) "Class A Directors," who are all directors other than the
Class B Directors. The Class B Directors are elected solely by majority vote of
the holders of Class B Common Stock voting as a separate class. The Class A
Directors are elected by holders of all shares of the Company's capital stock
entitled to vote thereon, voting as a single class, including both shares of
Class A Common Stock and shares of Class B Common Stock. Any Class A Director
may be removed, with or without cause (except as otherwise provided by law), by
the vote of a majority of all votes entitled to be cast in the election of
Class A Directors. However, Class B Directors may be removed only by the
holders of a majority of the shares of Class B Common Stock, and may be removed
with or without cause.
Holders of Common Stock are entitled to receive ratably such dividends, if
any, as may be declared by the Board of Directors out of funds legally
available therefor, subject to the preferential dividend rights of any
outstanding shares of Preferred Stock. Any dividends declared which are payable
on the Common Stock shall be payable at the same rate on both classes of Common
Stock. Upon the liquidation, dissolution or winding-up of the Company, the
holders of Common Stock are entitled to receive ratably the net assets of the
Company available after the payment of all debts and other liabilities and
subject to the prior rights of any outstanding shares of Preferred Stock.
Holders of Common Stock have no preemptive, subscription or redemption rights.
All the outstanding shares of Common Stock are fully paid and nonassessable.
The rights, preferences and privileges of holders of Common Stock are subject
to, and may be adversely affected by, the rights of the holders of shares of
any series of Preferred Stock that the Company may designate and issue in the
future.
40
<PAGE>
Agreement Among Class B Stockholders
The holders of the Class B Common Stock entered into an agreement on
January 1, 1998 (the "Class B Stockholders Agreement") pursuant to which, among
other things, they agreed to grant to Mr. Aab an irrevocable proxy to vote all
of their shares of Class B Common Stock, and Mr. Aab has agreed to vote the
shares of Class B Common Stock covered by the proxy to elect Mr. Ganatra as a
director. In addition, the Class B Stockholders Agreement provides that if a
party to the agreement proposes to sell or otherwise transfer shares of Class B
Common Stock to anyone other than a Permitted Transferee (such as lineal
descendants of the Class B Stockholders, trusts for the benefit of such holders
and descendants, and corporations, partnerships and other entities and business
organizations controlled by the Class B Stockholders), the other holders of
Class B Common Stock who are parties to the Class B Stockholders Agreement
would have a right to acquire the shares of Class B Common Stock that are
proposed to be sold or transferred. The Class B Stockholders Agreement also
provides that if a party to the agreement proposes to convert his, her or its
shares of Class B Common Stock into shares of Class A Common Stock, the other
parties to the Class B Stockholders Agreement have the right to purchase the
shares of Class B Common Stock proposed to be converted or to exchange shares
of Class A Common Stock for such shares. The Class B Stockholders Agreement has
an initial term of ten years.
Preferred Stock
Under the terms of the Certificate, the Board of Directors of the Company
is authorized to issue shares of Preferred Stock in one or more series without
stockholder approval, subject to any limitations prescribed by law. Each series
of Preferred Stock shall have such rights, preferences, privileges and
restrictions, including voting rights, dividend rights, conversion rights,
redemption privileges and liquidation privileges, as shall be determined by the
Board of Directors. The purpose of authorizing the Board of Directors to issue
Preferred Stock and determine its rights and preferences is to eliminate delays
associated with a stockholder vote on specific issuances. The issuance of
Preferred Stock, while providing desirable flexibility in connection with
possible acquisitions and other corporate purposes, could have the effect of
making it more difficult for a third party to acquire, or of discouraging a
third party from acquiring, a majority of the outstanding voting stock of the
Company. No shares of Preferred Stock have been issued or authorized for
issuance, and there are no agreements or undertakings relating to the issuance
of shares of Preferred Stock.
Board of Directors
Under the terms of the Certificate and the Bylaws, the Board of Directors
consists of at least three directors and no more than eleven directors. As
noted above, at all times when shares of Class B Common Stock are outstanding,
the two directors who are designated as "Class B Directors" are elected by the
holders of a majority of the shares of the Class B Common Stock voting as a
separate class, and Class B Directors may only be removed by the affirmative
vote of a majority of the holders of the Class B Common Stock.
The Bylaws provide that if at any time the number of directors is seven or
more, the terms of the Class A Directors shall be staggered and the Class A
Directors shall be grouped into three classes of nearly equal size. If the
Class A Directors are staggered, the first staggered class shall be elected for
an initial three year term, the second staggered class shall be elected for an
initial two year term and the third staggered class shall be elected for an
initial one year term. Thereafter, at each annual meeting of stockholders,
directors shall be elected to fill the seats of the staggered class of Class A
Directors whose term then expires shall be elected for three year terms. If the
terms of office of the Class A Directors are staggered, then the Class A
Directors may be removed only for cause during the term for which they have
been elected.
Warrants
The Company has issued warrants to three of its employees which entitle
them to acquire an aggregate of shares of Class A Common Stock at an
exercise price of $ per share. These warrants may be exercised, in whole or
in part, at any time prior to August 4, 2000 (with respect to shares) or
prior to November 10, 2000 (with respect to shares). The Company has also
issued a warrant to a sales agent which entitles him to acquire shares of
Class A Common Stock at an exercise price of $ per share with an expiration
date of August 1, 2000 and a warrant to a consultant which entitles him to
acquire
41
<PAGE>
shares of Class A Common Stock at an exercise price of $ per share
with an expiration date of January 1, 2001. These warrants may be exercised, in
whole or in part, at any time prior to their expiration dates.
Certain Charter and Statutory Provisions
Article VIII of the Certificate provides that the Company shall indemnify
all directors and officers to the full extent permitted by the General
Corporation Law of the State of Delaware (the "Delaware Law"), or any other
applicable laws as now or hereafter in effect. In addition, the Certificate
authorizes the Company to enter into one or more agreements with any person
which provide for indemnification greater or different than that provided in
its Certificate.
Section 145 of the Delaware Law permits a corporation to indemnify its
directors and officers against expenses (including attorney's fees), judgments,
fines and amounts paid in settlements actually and reasonably incurred by them
in connection with any action, suit or proceeding, whether criminal or civil,
brought by a third party if such directors or officers acted in good faith and
in a manner they reasonably believed to be in or not opposed to the best
interests of the corporation and, with respect to any criminal action or
proceeding, had no reason to believe their conduct was unlawful.
In addition, Section 102 of the Delaware Law provides that a corporation
may include in its certificate of incorporation a provision eliminating or
limiting the personal liability of directors for monetary damages for breach of
fiduciary duty, provided that such provision shall not eliminate or limit the
liability of a director: (i) for any breach of the director's duty of loyalty
to the corporation or its stockholders; (ii) for acts or omissions not in good
faith that involve intentional misconduct or a knowing violation of the law;
(iii) for conduct leading to unlawful distributions by the corporation; or (iv)
for any transaction from which the director derived an improper personal
benefit. The Certificate includes such a provision. The effect of this
provision is to eliminate the rights of the Company and its stockholders
(through stockholder's derivative suits on behalf of the Company) to recover
monetary damages against a director for breach of fiduciary duty of care as a
directory (including breaches resulting from negligent or grossly negligent
behavior) except in situations described in clauses (i) through (iv) above.
This provision does not limit or eliminate the rights of the Company or any
stockholder to seek nonmonetary relief (such as an injunction or rescission) in
the event of a breach of a director's duty of care.
Following the Offering, the Company will also be subject to the provisions
of Section 203 of the Delaware Law. In general, the statute prohibits a
publicly-held Delaware corporation from engaging in a "business combination"
with an "interested stockholder" for a period of three years after the date of
the transaction in which the person became an interested stockholder, unless
(i) prior to such date the board of directors of the corporation approved
either the business combination or the transaction that resulted in the
stockholder becoming an interested stockholder, (ii) upon consummation of the
transaction that resulted in such person becoming an interested stockholder,
the interested stockholder owned at least 85% of the voting stock of the
corporation outstanding at the time the transaction commenced (excluding, for
purposes of determining the number of shares outstanding, shares owned by
certain directors or certain employee stock plans), or (iii) on or after the
date the stockholder became an interested stockholder, the business combination
is approved by the board of directors and authorized by the affirmative vote
(and not by written consent) of at least two-thirds of the outstanding voting
stock excluding that stock owned by the interested stockholder. For the
purposes of Section 203, a "business combination" includes a merger, asset sale
or other transaction resulting in a financial benefit to the interested
stockholder, as well as any transaction that has the effect of increasing the
interested stockholder's proportionate share ownership in the corporation. An
"interested stockholder" is a person who (other than the corporation and any
direct or indirect majority-owned subsidiary of the corporation) together with
affiliates and associates owns (or, as an affiliate or associate, within three
years prior, did own) 15% or more of the corporation's outstanding voting
stock.
Section 203, however, expressly exempts from the requirements described
above any business combination by a corporation with an interested stockholder
who became an interested stockholder at a time when the section did not apply
to the corporation. It further provides that its provisions shall not apply if
the corporation does not have a class of voting stock that (i) is listed on a
national securities exchange, (ii) authorized for quotation on the Nasdaq
National Market or (iii) held of record by more than 2,000 stockholders (unless
any of the foregoing results from a transaction in which a person becomes an
interested stockholder). Mr. Aab, Melrich, Mr.
42
<PAGE>
Ganatra and Super STAR Associates Limited Partnership became interested
stockholders prior to the Offering at a time when such exemption from the
provisions of Section 203 applied to the Company. Accordingly, future
transactions between the Company and such persons and entities will not be
subject to the requirements of Section 203.
Listing
Application has been made to have the Class A Common Stock qualified for
inclusion in the Nasdaq National Market under the symbol "CLEC."
Transfer Agent and Registrar
First Union National Bank, Charlotte, North Carolina will be the transfer
agent and registrar for the Class A Common Stock (the "Transfer Agent").
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Offering, shares of Class A Common Stock will
be outstanding, excluding (i) shares reserved for issuance upon exercise
of options that have been granted under the Stock Plan, none of which are
currently vested, (ii) shares reserved for issuance upon exercise of
presently exercisable warrants and (iii) shares reserved for issuance
upon conversion of Class B Common Stock. Of these shares, the
shares of Class A Common sold in the Offering will be freely
tradable without restriction or further registration under the Securities Act,
except for any shares purchased by an "affiliate" (as defined in the Securities
Act) of the Company, which will be subject to the resale limitations of Rule
144 ("Rule 144") under the Securities Act. The remaining shares of Class A
Common Stock outstanding and all of the shares of Class B Common Stock
outstanding will be "restricted securities" as that term is defined in Rule
144, and may in the future be sold without restriction under the Securities Act
to the extent permitted by Rule 144 or any applicable exemption under the
Securities Act.
In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this Prospectus a person (or persons whose shares are aggregated)
who has beneficially owned its, his or her restricted securities (as that term
is defined in Rule 144) for at least one year from the date such securities
were acquired from the Company or an affiliate of the Company would be entitled
to sell within any three-month period a number of shares that does not exceed
the greater of (i) one percent of the then outstanding shares of the Class A
Common Stock and (ii) the average weekly trading volume of the Class A Common
Stock during the four calendar weeks preceding a sale by such person. Sales
under Rule 144 are also subject to certain manner-of-sale provisions, notice
requirements and the availability of current public information about the
Company. Under Rule 144, however, a person who has held restricted securities
for a minimum of two years from the later of the date such securities were
acquired from the Company or an affiliate of the Company and who is not, and
for the three months prior to the sale of such restricted securities has not
been, an affiliate of the Company, is free to sell such shares of Class A
Common Stock without regard to the volume, manner-of-sale and the other
limitations contained in Rule 144. The foregoing summary of Rule 144 is not
intended to be a complete discussion thereof.
Of the outstanding shares of Class A Common Stock that will be "restricted
securities," of such shares will be eligible for sale in the public market
subject to the volume, manner of sale and other limitations of Rule 144
described below after December 31, 1998 and the remainder of such shares will
be eligible for sale in the public market pursuant to Rule 144 at various times
in 1999. The shares of Class B Common Stock outstanding upon completion of
the Offering will also be restricted securities. Each share of Class B Common
Stock may be converted at any time by the holder thereof into one share of
Class A Common Stock, subject to the rights of other holders of Class B Common
Stock under the Class B Stockholders Agreement. If any shares of Class B Common
Stock are converted by the current holders into shares of Class A Common Stock,
the holding period of the shares of Class A Common Stock could, under the
provisions of Rule 144, be tacked with the holding period of the Class B Common
Stock such that the shares of Class A Common Stock acquired upon any such
conversion would become eligible for sale in the public market after December
31, 1998 subject to the volume, manner of sale and other limitations of Rule
144.
The Company, its directors and executive officers, who will hold, as of
the completion of this Offering, an aggregate of shares of Class A Common
Stock (or presently exercisable warrants to purchase Class
43
<PAGE>
A Common Stock) and shares of Class B Common Stock (which, subject to the
terms of the Class B Stockholders Agreement, may be converted at any time into
shares of Class A Common Stock and, pursuant to the Certificate, automatically
convert into shares of Class A Common Stock as a result of certain transfers),
have each agreed not to offer, sell or contract to sell, or otherwise dispose
of, directly or indirectly, or announce an offering of, any shares of Class A
Common Stock or any securities convertible into, or exchangeable for, shares of
Class A Common Stock for a period of 180 days from the date of this Prospectus,
without the prior written consent of Smith Barney Inc. except under limited
circumstances.
Promptly upon completion of the Offering, the Company intends to file a
Registration Statement on Form S-8 with the Commission to register shares of
Class A Common Stock reserved for issuance or sale under the Stock Plan. As of
January 31, 1998, there were outstanding options to purchase a total of
shares of Class A Common Stock, none of which were vested, and
outstanding and presently exercisable warrants to purchase a total of
shares of Class A Common Stock. Following such registration, all shares
of Class A Common Stock issuable upon the exercise of options granted under the
Stock Plan will be freely tradable without restriction under the Securities
Act, unless such shares are held by an affiliate of the Company.
Prior to the Offering, there has been no established market for the Class
A Common Stock, and no predictions can be made about the effect, if any, that
market sales of shares of Class A Common Stock or the availability of such
shares for sale will have on the market price prevailing from time to time.
Nevertheless, the actual sale of, or the perceived potential for the sale of,
Class A Common Stock in the public market may have an adverse effect on the
market price for the Class A Common Stock.
UNDERWRITING
Subject to the terms and conditions set forth in an underwriting agreement
among the Company and the Underwriters (the "Underwriting Agreement"), the
Company has agreed to sell to each of the Underwriters named below (the
"Underwriters"), for whom Smith Barney Inc., Bear, Stearns & Co. Inc. and Wheat
First Union, a division of Wheat First Securities, Inc., are acting as
representatives (the "Representatives"), and each of the Underwriters has
severally agreed to purchase from the Company the aggregate number of shares of
Class A Common Stock set forth opposite its name below:
<TABLE>
<CAPTION>
Number of
Underwriters Shares
- ---------------------------------------------- ----------
<S> <C>
Smith Barney Inc. ....................
Bear, Stearns & Co. Inc. .............
Wheat First Securities, Inc. .........
Total ............................
</TABLE>
The Company has been advised by the Representatives that the several
Underwriters propose initially to offer the shares of Class A Common Stock to
the public at the Price to Public set forth on the cover page of this
Prospectus, and to certain dealers at such price less a discount not in excess
of $ per share. The Underwriters may allow, and such dealers may reallow,
a discount not in excess of $ per share on sales to certain other dealers.
After the initial public offering, the public offering price and such
concessions may be changed.
The Company has granted the Underwriters an option, exercisable within 30
days of the date of this Prospectus, to purchase up to additional
shares of Class A Common Stock to cover over-allotments, if any, at the Price to
the Public set forth on the cover page of this Prospectus less the Underwriting
Discount. To the extent that the Underwriters exercise such option, in whole or
in part, each Underwriter will have
44
<PAGE>
a firm commitment, subject to certain conditions, to purchase a number of option
shares proportionate to such Underwriter's initial commitment.
The Underwriting Agreement provides that the obligations of the
Underwriters to purchase the Class A Common Stock listed above are subject to
certain conditions set forth therein. The Underwriters are committed to
purchase all of the Class A Common Stock offered by this Prospectus (other than
those covered by the Underwriters' overallotment option described in the
immediately preceding paragraph), if any are purchased. In the event of default
by any Underwriter, the Underwriting Agreement provides that, in certain
circumstances, the purchase commitments of the non-defaulting Underwriters may
be increased or the Underwriting Agreement may be terminated. The obligations
of the Underwriters under the Underwriting Agreement are several and may be
terminated in their discretion upon the occurrence of certain stated events
including if certain events have occurred the effect of which on financial
markets is such as to make it, in the judgment of the Underwriters,
impracticable or inadvisable to proceed with the Offering.
The Underwriting Agreement provides that the Company will indemnify the
several Underwriters against certain liabilities, including liabilities under
the Securities Act, or contribute to payments the Underwriters may be required
to make in respect thereof.
The Company and its directors and executive officers have each agreed with
the Underwriters that they will not offer, sell or contract to sell, or
otherwise dispose of, directly or indirectly, or announce an offering of, any
shares of Class A Common Stock or any securities convertible into, or
exchangeable for, shares of Class A Common Stock for a period of 180 days from
the date of this Prospectus, without the prior written consent of Smith Barney
Inc., except (a) in the case of the Company, (i) grants of options and
issuances and sales of Class A Common Stock issued pursuant to the Stock Plan,
(ii) issuances of Class A Common Stock upon the conversion of shares of Class B
Common Stock or the exercise of warrants outstanding on the date of the
Underwriting Agreement or (iii) issuance of Common Stock or securities
convertible into Common Stock in connection with acquisitions; provided that
the recipients of such shares of Common Stock agree in writing with Smith
Barney Inc. to be bound by the unexpired term of such agreement not to sell;
and (b) in the case of directors and executive officers, shares of Class A
Common Stock disposed of as bona fide gifts or pledges where the recipients of
such gifts or the pledgees, as the case may be, agree in writing with Smith
Barney Inc. to be bound by the terms of such agreement.
At the request of the Company, the Underwriters have reserved up to
shares of Class A Common Stock for sale at the Price to Public set forth on
the cover page of this Prospectus to certain officers, directors, employees and
other persons designated by the Company. The number of shares of Class A Common
Stock available for sale to the general public will be reduced to the extent
such persons purchase such reserved shares. Any reserved shares not so
purchased will be offered by the Underwriters to the general public on the same
basis as the other shares offered hereby.
The Representatives have informed the Company that they do not expect
sales to accounts over which they exercise discretionary authority to exceed
five percent of the total number of shares of Class A Common Stock sold in the
Offering.
Prior to the Offering, there has been no public market for the Class A
Common Stock. Accordingly, the initial public offering price for the Class A
Common Stock will be determined by negotiation among the Company and the
Representatives. Among the factors considered in determining the initial public
offering price of the Class A Common Stock, in addition to prevailing market
conditions, will be the Company's historical performance, estimates of the
business potential and earnings prospects of the Company, an assessment of the
Company's management and the consideration of the above factors in relation to
market valuation of companies in related businesses. There can be no assurance
that the price at which shares of Class A Common Stock will sell in the public
market after the Offering will not be lower than the price at which they are
sold in the Offering by the Underwriters.
Application has been made to have the Class A Common Stock qualified for
inclusion in the Nasdaq National Market under the symbol "CLEC."
In connection with the Offering, the Underwriters may purchase and sell the
Class A Common Stock in the open market in accordance with Regulation M under
the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These
transactions may include over-allotment and stabilizing transactions and
purchases to
45
<PAGE>
cover syndicate short positions created in connection with the Offering.
Stabilizing transactions consist of certain bids or purchases for the purpose of
preventing or retarding a decline in the market price of the Class A Common
Stock; and syndicate short positions involve the sale by the Underwriters of a
greater number of shares of Class A Common Stock than they are required to
purchase from the Company in the Offering. The Underwriters also may impose a
penalty bid, whereby selling discounts allowed to syndicate members or other
broker-dealers in respect of the securities sold in the Offering for their
account may be reclaimed by the syndicate if such securities are repurchased by
the syndicate in stabilizing or covering transactions. These activities may
stabilize, maintain or otherwise affect the market price of the Class A Common
Stock, which may be higher than the price that might otherwise prevail in the
open market; and these activities, if commenced, may be discontinued at any
time. These transactions may be effected on the Nasdaq National Market in the
over-the-counter market or otherwise.
LEGAL MATTERS
The validity of the Class A Common Stock will be passed upon for the
Company by Moore & Van Allen, PLLC, Charlotte, North Carolina and for the
Underwriters by Paul, Hastings, Janofsky & Walker LLP, New York, New York.
EXPERTS
The financial statements included in this Prospectus have been audited by
Deloitte & Touche LLP, independent public accountants, as stated in their
report appearing herein; and are included in reliance upon the report of said
firm given upon their authority as experts in accounting and auditing.
AVAILABLE INFORMATION
The Company has filed a Registration Statement on Form S-1, Commission
File No. 333- , under the Securities Act with the Commission with respect
to the shares of Class A Common Stock offered by the Offering. This Prospectus,
which is part of the Registration Statement, does not contain all of the
information set forth in the Registration Statement and the exhibits and
schedules thereto. For further information with respect to the Company and the
Class A Common Stock, reference is made to the Registration Statement and the
exhibits and schedules filed therewith. Statements contained in this Prospectus
as to the contents of any contract or any other document to which reference is
made are necessarily summaries thereof, and in each instance reference is made
to the copy of such contract or other document filed as an exhibit to the
Registration Statement, each such statement being qualified in all respects by
such reference.
The Company has not previously been subject to the reporting requirements
of the Exchange Act. Upon completion of the Offering, the Company will be
subject to the informational requirements of the Exchange Act and in accordance
therewith will be required to file periodic reports and other information with
the Commission. Copies of the Registration Statement, periodic reports and
other information filed by the Company with the Commission may be inspected
without charge. Copies of such material may also be obtained at prescribed
rates at the Public Reference Section of the Commission at 450 Fifth Street,
N.W., Washington, DC 20549, or at its regional offices located at Northwestern
Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and
Seven World Trade Center, Suite 1300, New York, New York 10048. In addition,
the Commission maintains a website that contains periodic reports and other
information filed by the Company via the Commission's Electronic Data Gathering
and Retrieval System. This website can be accessed at www.sec.gov. Copies of
such material can be also be obtained from the Company upon request by
contacting the Company at its principal executive office.
The Company intends to furnish its stockholders with annual reports
containing financial statements audited by an independent public accounting
firm and quarterly reports for the first three quarters of each fiscal year
containing unaudited interim financial information.
46
<PAGE>
GLOSSARY
DS-0, DS-1, DS-3, T-1, T-3 -- These are the standard circuit capacity
classifications which are distinguishable by bit rate. Each of these
transmission services can be provided using the same type of fiber optic cable
or other transmission medium, but offer different bandwidth (that is,
capacity), depending upon the individual needs of the end-user. A DS-0 is a
dedicated circuit that is considered to meet the requirements of usual business
communications, with transmission capacity of up to 64 kilobits of bandwidth
per second (that is, a voice grade equivalent circuit). This service offers a
basic low capacity dedicated digital line for connecting telephones, fax
machines, personal computers and other telecommunications equipment. A DS-1 is
a high speed digital circuit typically linking high volume customer locations
to long distance carriers or other customer locations. Typically utilized for
voice transmissions as well as the interconnection of local area networks, DS-1
service accommodates transmission speeds of up to 1.544 megabits per second,
which is equivalent to 24 DS-0 circuits or 24 voice grade equivalent circuits.
DS-3 service provides a very high capacity digital circuit with transmission
capacity of 45 megabits per second, which is equivalent to 28 DS-1 circuits or
672 voice grade equivalent circuits. This is a digital service used by long
distance carriers for central office connections and by some large commercial
users to link multiple sites. T-1 is synonymous with DS-1 and T-3 is synonymous
with DS-3.
Equivalent Access Lines -- This term is used by management to quantify the
size of the Company's network. It is based on the number of customer lines and
Trunks and the utilization of those lines and Trunks during the "busy hour."
The "busy hour" refers to the hour of the day when line usage is at its highest
level. The Company calculates its Equivalent Access Lines by multiplying the
number of its Trunks in service by six and adding to the result to the number
of its separate access lines in service. The decision to use six as the
multiplier is based on management's experience, which indicates that the
typical business access line is in use for approximately 400 seconds during the
busy hour (or approximately 11.1% of capacity during the busy hour) and a
typical business Trunk is in use for approximately 2,400 seconds during the
busy hour (or approximately 66.7% of capacity during the busy hour), or
approximately six times use during the busy hour of a typical business line.
FCC -- The United States Federal Communications Commission.
Interconnect -- Connection of a telecommunications device or service to
the public switched telephone network.
Inter-LATA -- Telecommunications services originating in a LATA and
terminating outside of that LATA.
LATA (Local Access and Transport Area) -- one of approximately 200 local
geographic areas in the US within which a local telephone company may offer
telecommunications services.
Local Exchange -- A geographic area determined by the appropriate state
regulatory authority in which calls generally are transmitted without toll
charges to the calling or called party.
Long Distance Carriers (Interexchange Carriers) -- Long distance carriers
provide services between local exchanges on an interstate or intrastate basis.
A long distance carrier may offer services over its own or another carrier's
facilities.
Reciprocal Compensation -- The compensation paid to and from a CLEC and
the ILEC for termination of a local call on each other's networks.
Switch -- A device that opens or closes circuits or selects the paths or
circuits to be used for transmission of information. Switching is the process
of interconnecting circuits to form a transmission path between users. It also
captures information for billing purposes.
Switched Services -- Transmission of switched calls through the local
switched network.
Trunk -- A DS-0 which concentrates subscriber lines. A trunked system
combines multiple channels with unrestricted access in such a manner that user
demands for channels are automatically "queued" and then allocated to the first
available channel.
47
<PAGE>
INDEX TO FINANCIAL STATEMENTS
US LEC CORP. AND SUBSIDIARIES
<TABLE>
<CAPTION>
Page
-----
<S> <C>
INDEPENDENT AUDITORS' REPORT ............................................................ F-2
FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of December 31, 1996 and 1997 ........................... F-3
Consolidated Statements of Operations for the Period From June 6, 1996 (Inception) to
December 31, 1996 and the Year Ended December 31, 1997 ................................ F-4
Consolidated Statements of Stockholders' Equity (Deficiency) for the Period From June
6, 1996
(Inception) to December 31, 1996 and the Year Ended December 31, 1997 ................. F-5
Consolidated Statements of Cash Flows for the Period From June 6, 1996 (Inception) to
December 31, 1996 and the Year Ended December 31, 1997 ................................ F-6
Notes to Consolidated Financial Statements ............................................. F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors
US LEC Corp.
Charlotte, North Carolina
We have audited the accompanying consolidated balance sheets of US LEC
Corp. (the "Company") and subsidiaries as of December 31, 1996 and 1997, and
the related consolidated statements of operations, stockholders' equity
(deficiency), and cash flows for the period from June 6, 1996 (inception) to
December 31, 1996 and the year ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform our audits to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of US LEC Corp. and subsidiaries as of
December 31, 1996 and 1997, and the results of their operations and their cash
flows for the period from June 6, 1996 (inception) to December 31, 1996 and the
year ended December 31, 1997 in conformity with generally accepted accounting
principles.
February 4, 1998
Charlotte, North Carolina
F-2
<PAGE>
US LEC CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1996 and 1997 (Note 1)
<TABLE>
<CAPTION>
1996 1997
------------- ---------------
<S> <C> <C>
ASSETS (Note 4)
CURRENT ASSETS:
Cash and cash equivalents (Note 2) ............................ $ 726,139 $ 3,189,210
Certificates of deposit (Note 2) .............................. -- 349,473
Accounts receivable (Note 2) .................................. -- 6,005,742
Due from stockholder (Note 6) ................................. 200,000 --
Prepaid expenses and other assets ............................. 141,523 110,568
---------- ------------
Total current assets ...................................... .. 1,067,662 9,654,993
PROPERTY AND EQUIPMENT, NET (Notes 2 and 3) ..................... 276,097 12,889,335
OTHER ASSETS .................................................... 123,076 136,353
---------- ------------
TOTAL ASSETS .................................................... $1,466,835 $ 22,680,681
========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
CURRENT LIABILITIES:
Accounts payable .............................................. $ 48,125 $ 8,200,926
Deferred revenue .............................................. -- 1,141,386
Accrued network costs ......................................... -- 1,864,659
Accrued interest payable -- related party ..................... 16,861 282,311
Accrued expenses -- other ..................................... 65,792 434,594
---------- ------------
Total current liabilities ................................. .. 130,778 11,923,876
---------- ------------
NOTES PAYABLE -- STOCKHOLDERS (Note 4) .......................... 1,671,000 5,000,000
---------- ------------
COMMITMENTS AND CONTINGENCIES (Note 5)
STOCKHOLDERS' EQUITY (DEFICIENCY) (Note 8):
Common stock -- Class A, $.01 par value (73,405,498 authorized
shares, 3,855,000 outstanding at December 31, 1997) .......... -- 38,550
Common stock -- Class B, $.01 par value (16,594,502 authorized
shares, 16,594,500 outstanding at December 31, 1997) ......... -- 165,945
Members' units -- voting (10,000 units outstanding as of
December 31, 1996) ........................................... 600,000 --
Members' units -- nonvoting (1,540 units outstanding as of
December 31, 1996) ........................................... 27,720 --
Additional paid-in capital .................................... -- 11,126,320
Accumulated deficit ........................................... (962,663) (5,574,010)
---------- ------------
Total stockholders' equity (deficiency) ................... .. (334,943) 5,756,805
---------- ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
(DEFICIENCY) $1,466,835 $ 22,680,681
========== ============
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
US LEC CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
The Period from June 6, 1996 (Inception)
to December 31, 1996 and the Year Ended December 31, 1997 (Note 1)
<TABLE>
<CAPTION>
1996 1997
------------- ---------------
<S> <C> <C>
Revenue (Note 2) .......................................... $ -- $ 6,457,661
Cost of Services .......................................... -- 4,201,001
---------- ------------
Gross Margin .............................................. -- 2,256,660
Selling, General and Administrative ....................... 941,743 6,070,237
Depreciation and Amortization ............................. 4,059 442,914
---------- ------------
Loss from Operations ...................................... (945,802) (4,256,491)
Interest Income ........................................... -- (65,660)
Interest Expense (Note 4) ................................. 16,861 420,516
---------- ------------
Net Loss .................................................. $ (962,663) $ (4,611,347)
========== ============
Net Loss Per Share -- Basic and diluted (Note 2) .......... $ (.06) $ (.25)
========== ============
Weighted Average Shares Outstanding ....................... 17,310,000 18,653,308
========== ============
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
US LEC CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)
The Period from June 6, 1996 (Inception)
to December 31, 1996 and the Year Ended December 31, 1997 (Notes 1 and 8)
<TABLE>
<CAPTION>
Common Stock Common Stock Common Stock/
Class A Class B Voting Units(1)
----------------------- ------------------------ ----------------------------
Shares Amount Shares Amount Shares Amount
------------ ---------- ------------- ---------- ------------ ---------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, JUNE 6, 1996
(INCEPTION) -- $ -- -- $ -- -- $ --
Issuance of voting shares/units ....... -- -- -- -- 10,000 600,000
Shares/units granted to employees ..... -- -- -- -- -- --
Net loss .............................. -- -- -- -- -- --
-- ------- -- -------- ------ -------------
BALANCE (DEFICIENCY),
DECEMBER 31, 1996 ..................... -- -- -- -- 10,000 600,000
Issuance of nonvoting units ........... -- -- -- -- -- --
Issuance of voting units .............. -- -- -- -- 1,063 4,554,995
Issuance of warrants .................. -- -- -- -- -- --
Contribution to capital ............... -- -- -- -- -- --
Exchange of limited liability
company units for C Corporation
shares ............................... 3,855,000 38,550 16,594,500 165,945 (11,063) (5,154,995)
Net loss .............................. -- -- -- -- -- --
--------- ------- ---------- -------- ------- -------------
BALANCE, DECEMBER 31, 1997 ............ 3,855,000 $38,550 16,594,500 $165,945 -- $ --
========= ======= ========== ======== ======= =============
<CAPTION>
Common Stock/
Nonvoting Units(1) Additional
--------------------------- Paid-in Accumulated
Shares Amount Capital Deficit Total
----------- --------------- -------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
BALANCE, JUNE 6, 1996
(INCEPTION) -- $ -- $ -- $ -- $ --
Issuance of voting shares/units ....... -- -- -- -- 600,000
Shares/units granted to employees ..... 1,540 27,720 -- -- 27,720
Net loss .............................. -- -- -- (962,663) (962,663)
----- ------------- ----------- ------------ ----------
BALANCE (DEFICIENCY),
DECEMBER 31, 1996 ..................... 1,540 27,720 -- (962,663) (334,943)
Issuance of nonvoting units ........... 1,030 4,413,550 -- -- 4,413,550
Issuance of voting units .............. -- -- -- -- 4,554,995
Issuance of warrants .................. -- -- 23,700 -- 23,700
Contribution to capital ............... -- -- 1,710,850 -- 1,710,850
Exchange of limited liability
company units for C Corporation
shares ............................... (2,570) (4,441,270) 9,391,770 -- --
Net loss .............................. -- -- -- (4,611,347) (4,611,347)
------ ------------- ----------- ------------ ----------
BALANCE, DECEMBER 31, 1997 ............ -- $ -- $11,126,320 $ (5,574,010) $5,756,805
====== ============= =========== ============ ==========
</TABLE>
- -------
(1) On December 31, 1996, all S Corporation common shares were converted into
limited liability company units based on a one-for-one conversion ratio of
units for each share. On December 31, 1997, all limited liability units
were converted into C Corporation common shares based upon a conversion
ratio of 1,500 shares for each unit.
See notes to consolidated financial statements.
F-5
<PAGE>
US LEC CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
The Period from June 6, 1996 (Inception)
to December 31, 1996 and the Year Ended December 31, 1997 (Note 1)
<TABLE>
<CAPTION>
1996 1997
-------------- ----------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss ..................................................................... $ (962,663) $ (4,611,347)
------------ ------------
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization .............................................. 4,059 442,914
Stock compensation ......................................................... 27,720 23,700
Changes in assets and liabilities which provided (used) cash:
Accounts receivable ....................................................... -- (6,005,742)
Prepaid expenses and other assets ......................................... (141,523) 30,955
Other assets .............................................................. (123,598) (14,322)
Accounts payable .......................................................... 34,283 899,452
Deferred revenue .......................................................... -- 1,141,386
Accrued expenses -- other ................................................. 65,792 368,802
Accrued network costs ..................................................... -- 1,864,659
Accrued interest payable -- related party ................................. 16,861 265,450
------------ ------------
Total adjustments ........................................................ (116,406) (982,746)
------------ ------------
Net cash used in operating activities .................................... (1,079,069) (5,594,093)
------------ ------------
INVESTING ACTIVITIES:
Purchase of property and equipment ........................................... (265,792) (5,801,758)
Certificates of deposit ...................................................... -- (349,473)
(Advances to) repayments from stockholder .................................... (200,000) 200,000
------------ ------------
Net cash used in investing activities .................................... (465,792) (5,951,231)
------------ ------------
FINANCING ACTIVITIES:
Issuance of common shares and limited liability company units ................ 600,000 8,968,545
Contribution to capital ...................................................... -- 1,710,850
Proceeds from notes payable -- stockholders .................................. 1,671,000 4,289,150
Repayment of notes payable -- stockholders ................................... -- (960,150)
------------ ------------
Net cash provided by financing activities ................................ 2,271,000 14,008,395
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS ..................................... 726,139 2,463,071
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ................................ -- 726,139
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD ...................................... $ 726,139 $ 3,189,210
============ ============
SUPPLEMENTAL CASH FLOW DISCLOSURES -- Cash paid for interest .................. $ -- $ 672
============ ============
SUPPLEMENTAL NON CASH INVESTING AND FINANCING
ACTIVITIES -- During 1997, accrued interest of $54,544 due to stockholders
was converted into voting equity. At December 31, 1996 and 1997, $13,842
and $7,267,191, respectively, of property and equipment additions are
included in outstanding accounts payable.
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE>
US LEC CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Period From June 6, 1996 (Inception) to December 31, 1996 and Year Ended
December 31, 1997
1. ORGANIZATION AND NATURE OF BUSINESS
The consolidated financial statements include the accounts of US LEC Corp.
(the "Company") and its six subsidiaries, of which two are wholly owned and
four are 99% owned. All significant intercompany transactions and balances have
been eliminated. The Company was incorporated in 1996 as an S Corporation.
Effective December 31, 1996, US LEC Corp. was converted to a limited liability
company ("US LEC L.L.C.") through an exchange of the S Corporation common stock
for voting and nonvoting units of US LEC L.L.C. On December 31, 1997, in
anticipation of a planned initial public offering of common stock, the Company
became a C Corporation through a merger of US LEC L.L.C. into the Company and
the exchange of all of the limited liability company units into shares of Class
A and Class B Common Stock.
The Company, through its subsidiaries, provides switched local, long
distance and enhanced telecommunications services primarily to medium and
large-sized organizations in selected markets in the southeastern United
States. The Company was a development stage enterprise from inception until
March 1997, when it began generating telecommunications revenues.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition -- The Company recognizes revenue on
telecommunications and enhanced communications services in the period that the
service is provided. Revenue is presented net of amounts which are rebated to
end user customers and outside sales agents pursuant to telecommunications
service contracts. Revenue on billings to customers in advance of providing
services is deferred and recognized when earned. At December 31, 1997, deferred
revenue primarily represents billings which are subject to review by a state
public utilities commission (see Note 5).
Cash and Cash Equivalents -- Cash equivalents consist of highly liquid
investments with original maturities of three months or less at the time of
purchase.
Certificates of Deposit -- Certificates of deposit are carried at cost.
These certificates mature during 1998, and serve as collateral for letters of
credit related to certain office leases.
Property and Equipment -- Property and equipment is stated at cost less
accumulated depreciation. Depreciation is computed using the straight-line
method over the estimated useful lives of the assets.
The estimated useful lives of the Company's principal classes of property
and equipment are as follows:
<TABLE>
<S> <C>
Telecommunications switching and other
equipment ................................... 5 - 9 years
Office equipment, furniture and other ......... 5 years
Leasehold improvements ........................ The lesser of the estimated useful lives
or the term of the lease
</TABLE>
Long-Lived Assets -- The Company reviews the carrying value of its
long-lived assets for impairment whenever events or changes in circumstances
indicate that the carrying value of these assets may not be recoverable.
Measurement of any impairment would include a comparison of estimated future
operating cash flows anticipated to be generated during the remaining life of
the assets with their net carrying value. An impairment loss would be
recognized as the amount by which the carrying value of the assets exceeds
their fair value.
Fair Value of Financial Instruments -- As of December 31, 1996 and 1997,
the fair values of the Company's financial instruments, including cash
equivalents, certificates of deposit, receivables, accounts payable and notes
payable to stockholders approximate their carrying values.
Income Taxes -- The Company was organized as an S Corporation for the
period from inception to December 31, 1996, and as a limited liability company
for the period from January 1, 1997 to December 31, 1997, on which date it was
converted to C Corporation status. Accordingly, no provision (benefit) for
income taxes is
F-7
<PAGE>
US LEC CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued
necessary for 1996 and 1997 since income taxes were the responsibility of the
individual S Corporation stockholders or limited liability company members. On
a pro forma basis, had the Company been structured as a C Corporation since
inception, there would have been no change in the net loss or net loss per
share for each period presented. At December 31, 1997, deferred tax assets and
liabilities related to the conversion to a C Corporation are not significant.
Concentration of Risk -- The Company is exposed to concentration of credit
risk principally from trade accounts receivable. At December 31, 1997, the
Company's trade customers are located in North Carolina. The Company performs
ongoing credit evaluations of its customers but does not require collateral to
support customer receivables. Credit risk is reduced by the fact that the
Company's most significant trade receivables are from large, well-established
telecommunications entities. At December 31, 1997, no allowance for doubtful
receivables is considered necessary.
The Company is dependent upon certain suppliers for the provision of
telecommunications services to its customers. The Company has executed
interconnection agreements for all of its current operating networks, and these
agreements expire at various dates in 1998 and 1999. Management believes that
suitable interconnection agreements can be negotiated in the future and,
accordingly, does not expect any disruption of services.
Use of Estimates -- The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements. Actual results could differ from those estimates.
A significant estimate relates to the accrual of network costs payable to other
telecommunications entities. Any difference between the ultimate payments made
and the accrual would be recorded at the time of payment.
Advertising -- The Company expenses advertising costs in the period
incurred. Advertising expense amounted to $22,311 and $136,935 for 1996 and
1997, respectively.
Net Loss Per Share -- Net loss per share has been calculated in accordance
with Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings Per
Share. The weighted average shares outstanding used in the calculation have
been determined by giving retroactive effect to the conversion to C Corporation
status which occurred on December 31, 1997 (based on the share conversion
ratios utilized in the conversion from a limited liability company). The effect
on diluted loss per share of outstanding stock warrants to purchase 444,000
common shares is antidilutive for the year ended December 31, 1997. Securities
and Exchange Staff Accounting Bulletin No. 98 requires that equity instruments
granted at nominal amounts for periods prior to the filing of the registration
statement be included in the calculation of per share data as if outstanding
for all periods presented. Accordingly, the weighted average shares used in the
calculation of basic and diluted loss per share in 1996 includes 2,310,000
shares granted in 1996 to employees, as if such shares were outstanding for the
entire period.
3. PROPERTY AND EQUIPMENT
<TABLE>
<CAPTION>
December 31,
----------------------------
1996 1997
----------- --------------
<S> <C> <C>
Telecommunications switching and other equipment ......... $212,259 $11,790,370
Office equipment, furniture and other .................... 67,375 774,536
Leasehold improvements ................................... -- 769,835
-------- -----------
279,634 13,334,741
Less accumulated depreciation and amortization ........... (3,537) (445,406)
-------- -----------
Total .................................................... $276,097 $12,889,335
======== ===========
</TABLE>
F-8
<PAGE>
US LEC CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
4. NOTES PAYABLE -- STOCKHOLDERS
The Company's majority stockholder has loaned an aggregate of $5,000,000
to the Company as of December 31, 1997 ($710,850 as of December 31, 1996).
Interest charged through 1997 was at prime plus 2% (10.5% per annum at December
31, 1997). In January 1998, an entity controlled by this stockholder loaned an
additional $2,289,150 to the Company. Interest on both loans will be at 12% per
annum, payable on a quarterly basis, with principal due in January 2003.
Another stockholder loaned the Company an aggregate of $960,150 in 1996,
with interest at prime plus 2%. These loans were repaid in 1997. In January
1998, this stockholder loaned $1,000,000 to the Company, with interest at 12%
per annum, payable on a quarterly basis, with principal due in January 2003.
Substantially all of the Company's assets are pledged as collateral on
such stockholder loans. Interest expense to related parties was $16,861 in 1996
and $419,814 in 1997.
5. COMMITMENTS AND CONTINGENCIES
Leases -- The Company leases office premises in various locations under
operating lease arrangements. Most of these leases have renewal options. Total
rent expense amounted to $12,331 and $180,414 in 1996 and 1997, respectively.
Future minimum rental payments under operating leases having initial or
remaining noncancelable lease terms in excess of one year (including leases
entered into in 1998) are as follows:
<TABLE>
<S> <C>
1998 $ 795,000
1999 901,000
2000 813,000
2001 700,000
2002 609,000
Thereafter ........... 578,000
----------
Total ................ $4,396,000
==========
</TABLE>
Purchase Commitments -- At December 31, 1997, the Company has outstanding
commitments to purchase network equipment with an aggregate cost of $8,844,880.
FCC Subsidy -- On May 8, 1997, the FCC released an order establishing a
significantly expanded federal telecommunications universal service program
which both increased the size of existing subsidies and created new subsidy
funds with respect to certain services offered in high-cost areas or to low
income subscribers, schools, libraries, and rural healthcare providers.
Although the FCC order describes a method for determining the amount the
Company must contribute to support these subsidies, the Company is currently
unable to quantify the amount of these payments that it will be required to
make, or the effect that these required payments will have on its financial
condition. In the May 8 order, the FCC also announced that it will soon revise
its rules for subsidizing service provided to consumers in high cost areas. The
Company also may be required to contribute to state-established funds. As of
December 31, 1997, the Company has made no subsidy payments and none have been
accrued in the accompanying consolidated financial statements.
BellSouth Proceeding -- A portion of the Company's revenue is derived from
reciprocal compensation payments from incumbent local exchange carriers
("ILEC's") such as BellSouth Telecommunications, Inc. ("BellSouth"). Management
believes that such payments are due pursuant to its ILEC interconnection
agreements when, in the aggregate, the Company's customers receive more calls
from the ILEC's customers than they make to the ILEC's customers. However, in
August 1997 BellSouth indicated that it was not obligated to make such payments
to the Company with respect to calls made to certain customers, principally
internet service providers. In October 1997, the Company filed a petition with
the public utilities commission ("PUC") in North Carolina seeking an order to
compel BellSouth to make the reciprocal compensation payments. It is expected
that the PUC will issue a
F-9
<PAGE>
US LEC CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
5. COMMITMENTS AND CONTINGENCIES -- Continued
ruling in the first quarter of 1998, but such ruling may be subject to appeal.
Management believes that the Company will ultimately be successful in this
proceeding, but a final determination that the Company is not eligible for
reciprocal compensation with respect to such calls could have a material
adverse effect on the Company's financial condition and future results of
operations.
Since reciprocal compensation earned during 1997 is subject to the ruling
to be issued by the PUC in North Carolina, the Company has deferred recognition
of a significant portion ($1,141,386) of such revenue at December 31, 1997.
6. RELATED PARTIES
During the year ended December 31, 1997, the Company received services
under consulting agreements with two entities each controlled by Company
stockholders. Payments under these agreements totaled $175,000, comprised of
$125,000 and $50,000, respectively. Company management believes that these
transactions were under terms no less favorable to the Company than could be
arranged with unrelated parties. In 1996 the Company advanced $200,000 to its
majority stockholder. The amount was repaid in January 1997.
7. EMPLOYEE BENEFIT PLAN
The Company has a 401(k) profit-sharing plan under which employees can
contribute up to 15% of their annual salary. Employees are eligible for
participation after completing 1,000 hours of service within a 12-month period.
The Company may make a discretionary contribution. However, no such
contributions have been made for the period from inception to December 31,
1997.
8. STOCKHOLDERS' EQUITY
Common Stock -- The Company has authorized two classes of common stock,
Class A and Class B. The rights of holders of the Class A Common Stock and the
Class B Common Stock are substantially identical, except that (i) holders of
the Class A Common Stock are entitled to one vote per share and holders of the
Class B Common Stock are entitled to 10 votes per share; (ii) holders of the
Class B Common Stock vote as a separate class to elect two members of the
Company's Board of Directors in addition to voting with the holders of Class A
Common Stock in the election of the other members of the Board of Directors;
and (iii) the Class B Common Stock is fully convertible at any time into Class
A Common Stock, at the option of the holder, or automatically upon transfer to
certain third persons, on a one-for-one basis. Pursuant to an agreement among
the Class B stockholders, if a Class B stockholder proposes to sell or transfer
Class B Common Stock to anyone other than a permitted transferee (as defined in
the agreement), the other Class B stockholders who are parties to the agreement
would have a right to acquire the Class B Common Stock that is proposed to be
sold or transferred.
Preferred Stock -- The Company is authorized to issue 10,000,000 shares of
preferred stock ($.01 par value) in one or more series without stockholder
approval, subject to any limitations prescribed by law. Each series of
preferred stock shall have such rights and preferences as shall be determined
by the Company's Board of Directors. No shares of preferred stock have been
issued.
Capital Contribution -- During 1997, the Company's majority stockholder
contributed an aggregate of $1,710,850 to additional paid-in capital.
Employee Stock Grants -- In 1996, as part of the Company's organizational
activities, an aggregate of 1,540 non-voting limited liability company units
were issued to induce certain employees to join the Company. The Company
recorded compensation expense of $27,720 in 1996 for these units, based on the
estimated fair value at the time the units were issued.
Warrants -- During 1997, the Company issued warrants to three employees to
purchase an aggregate of 345,000 shares of Class A Common Stock and a warrant to
an outside sales agent to purchase 99,000 shares of
F-10
<PAGE>
US LEC CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
8. STOCKHOLDERS' EQUITY -- Continued
Class A Common Stock. All of these warrants are fully vested and are exercisable
at $2.86 per share for a three-year period from the date of issuance. None of
these warrants have been exercised at December 31, 1997. In addition, in January
1998 the Company issued a warrant to a consultant to purchase 25,000 shares of
Class A Common Stock at $10 per share, exercisable at any time through January
1, 2001.
Management believes that the employee warrants issued in 1997 are
noncompensatory based upon an internal valuation of their fair value. The
exercise price of these warrants is the same as the issuance price in 1997 of
shares to numerous outside investors.
Had compensation cost for the employee warrants issued in 1997 been
determined based on the fair value at the grant date in accordance with SFAS
No. 123, Accounting for Stock-Based Compensation, the Company's 1997 net loss
and net loss per share would have been $4,693,829 and $.25, respectively. The
Company estimated the fair value of the warrants using the Black-Scholes model
assuming no dividend yield or volatility, a risk-free interest rate of 6.0% and
an expected life of 18 months for each of the warrants. For the warrant issued
in 1997 to the outside sales agent, the fair value charged to expense was
$23,700. The weighted average remaining contractual life of warrants
outstanding at December 31, 1997 is 32 months.
Stock Option Plan -- In January 1998, the Company adopted the US LEC
Corp. 1998 Omnibus Stock Plan (the "Stock Plan"). Under this plan, 650,000
shares of Class A Common Stock have been reserved for issuance of stock
options, stock appreciation rights, restricted stock, performance awards or
other stock-based awards. Options granted under the Stock Plan are to be at
exercise prices as determined by the Compensation Committee of the Board of
Directors. For incentive stock options the option price may not be less than
the market value of the Class A Common Stock on the date of grant (110% of
market value for greater than 10% stockholders).
In January 1998, the Company granted incentive stock options to
substantially all employees to purchase 182,800 shares of Class A Common Stock
at $10 per share. These options vest annually in four equal installments
beginning in January 1999. Also, upon completion of a planned initial public
offering of the Class A Common Stock, the Company intends to grant nonqualified
options to purchase 5,000 shares of Class A Common Stock at the initial public
offering price to each of the Company's two outside directors.
********
F-11
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
No dealer, salesperson or any other person has been authorized to give
any information or to make any representations other than those contained in
this Prospectus in connection with the offer contained herein, and, if given or
made, such information or representations must not be relied upon as having
been authorized by the Company or by any of the Underwriters. This Prospectus
does not constitute an offer of any securities other than those to which it
relates or an offer to sell, or a solicitation of an offer to buy, those to
which it relates in any state to any person to whom it is not lawful to make
such offer in such state. The delivery of this Prospectus at any time does not
imply that the information herein is correct as of any time subsequent to its
date.
--------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
---------
<S> <C>
Prospectus Summary ........................................ 1
Risk Factors .............................................. 7
Use of Proceeds ........................................... 13
Dividend Policy ........................................... 13
Dilution .................................................. 13
Capitalization ............................................ 14
Selected Historical Consolidated Financial and
Operating Data ......................................... 15
Management's Discussion and Analysis of
Financial Condition and Results of Operations .......... 17
Business .................................................. 21
Management ................................................ 35
Certain Relationships and Related Transactions ............ 38
Security Ownership of Management .......................... 39
Description of Capital Stock .............................. 40
Shares Eligible for Future Sale ........................... 43
Underwriting .............................................. 44
Legal Matters ............................................. 46
Experts ................................................... 46
Available Information ..................................... 46
Glossary .................................................. 47
Index to Financial Statements ............................. F-1
</TABLE>
Until , 1998 (25 days after the commencement of the Offering), all
dealers effecting transactions in the Class A Common Stock, whether or not
participating in this distribution, may be required to deliver a Prospectus.
This is in addition to the obligation of dealers to deliver a Prospectus when
acting as Underwriters and with respect to their unsold allotments or
subscriptions.
Shares
US LEC Corp.
Class A Common Stock
[logo]
-----------------
PROSPECTUS
Dated , 1998
-----------------
Salomon Smith Barney
Bear, Stearns & Co. Inc.
Wheat First Union
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II. INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance And Distribution.
The following is a list of the estimated expenses to be incurred by US LEC
Corp. (the "Company" or the "Registrant") in connection with the distribution
of the Class A Common Stock being registered hereby. Except for the Securities
and Exchange Commission Registration Fee, the NASD Filing Fee and the Nasdaq
National Market Listing Fee, all amounts are estimates.
<TABLE>
<S> <C>
Securities and Exchange Commission Registration Fee ......... $23,600
NASD Filing Fee ............................................. 8,500
Nasdaq National Market Listing Fee .......................... *
Printing and Engraving Costs ................................ *
Accounting Fees and Expenses ................................ *
Legal Fees and Expenses (excluding Blue Sky) ................ *
Blue Sky Fees and Expenses .................................. *
Transfer Agent and Registrar Fees ........................... *
Miscellaneous ............................................... *
--------
Total ....................................................... $
========
* To be filed by amendment.
</TABLE>
Item 14. Indemnification of Directors and Officers.
Certain provisions of the Company's Certificate of Incorporation (the
"Certificate") and Bylaws provide that the Company shall indemnify all of its
directors and officers to the fullest extent permitted by the General
Corporation Law of the State of Delaware (the "Delaware Law"). In addition, the
Certificate authorizes the Registrant to enter into one or more agreements with
any person which provide for indemnification greater or different than that
provided in its Certificate.
Section 145 of the Delaware Law permits a corporation to indemnify its
directors and officers against expenses (including attorney's fees), judgments,
fines and amounts paid in settlements actually and reasonably incurred by them
in connection with any action, suit or proceeding, whether criminal or civil,
brought by a third party if such directors or officers acted in good faith and
in a manner they reasonably believed to be in or not opposed to the best
interests of the corporation and, with respect to any criminal action or
proceeding, had no reason to believe their conduct was unlawful. In a
derivative action, indemnification may be made only for expenses actually and
reasonably incurred by directors and officers in connection with the defense or
settlement of an action or suit and only with respect to a matter as to which
they shall have acted in good faith and in a manner they reasonably believed to
be in or not opposed to the best interest of the corporation, except that no
indemnification shall be made if such person shall have been adjudged liable to
the corporation, unless and only to the extent that the court in which the
action or suit was brought shall determine upon application that the defendant
officers or directors are reasonably entitled to indemnity for such expenses
despite such adjudication of liability.
In addition, Section 102 of the Delaware Law provides that a corporation
may include in its certificate of incorporation a provision eliminating or
limiting the personal liability of directors for monetary damages for breach of
fiduciary duty, provided that such provision shall not eliminate or limit the
liability of a director: (i) for any breach of the director's duty of loyalty
to the corporation or its stockholders; (ii) for acts or omissions not in good
faith that involve intentional misconduct or a knowing violation of the law;
(iii) conduct in violation of Section 174 of the Delaware Law (which section
relates to unlawful distributions); or (iv) for any transaction from which the
director derived an improper personal benefit. The Certificate currently
includes such provisions.
Reference is also hereby made to Section of the Underwriting Agreement,
a copy of which is filed as Exhibit 1 to this Registration Statement, for
information concerning indemnification arrangements among the Company and the
Underwriters.
II-1
<PAGE>
Item 15. Recent Sales of Unregistered Securities.
On December 31, 1997, US LEC L.L.C., a Delaware limited liability company,
was merged into the Company (the "Merger"). As a result of the Merger, the
Company issued (i) shares of Class A Common Stock to the holders of all
outstanding nonvoting units of membership interest in US LEC L.L.C (the
"Nonvoting Units"), (ii) shares of Class B Common Stock to the holders of
all outstanding voting units of membership interest in US LEC L.L.C. (the
"Voting Units") and (iii) warrants to purchase shares of Class A Common
Stock to the holders of all outstanding warrants to purchase Nonvoting Units
(the "Warrants"). Immediately prior to the Merger, the outstanding Nonvoting
Units were beneficially owned by a total of persons, of which were
employees of US LEC L.L.C., the outstanding Voting Units were beneficially
owned by Messrs. Aab and Ganatra and the Warrants were held by two employees of
US LEC L.L.C. The transaction was not registered under the Securities Act
pursuant to the exemption provided by Section 4(2) thereof for transactions not
involving any public offering.
In January 1998, the Company granted incentive stock options to 96
employees covering 182,800 shares of Class A Common Stock. These transactions
were not registered under the Securities Act pursuant to the exemption provided
by Rule 701 promulgated thereunder for sales of securities pursuant to
compensatory benefit plans.
Item 16. Exhibits and Financial Statement Schedules.
(a) Exhibits:
<TABLE>
<CAPTION>
Exhibit No. Description
- ------------- ------------------------------------------------------------------------------------
<S> <C>
1 Form of Underwriting Agreement*
3.1 Certificate of Incorporation of the Company*
3.2 Bylaws of the Company*
4 Form of Class A Common Stock Certificate*
5 Opinion of Moore & Van Allen, PLLC*
10.1 US LEC Corp. 1998 Omnibus Stock Plan
10.2 Promissory Note, dated January 16, 1998, made by the Company to Richard T. Aab*
10.3 Security Agreement, dated January 16, 1998, by and between the Company and Richard
T. Aab*
10.4 Promissory Note, dated January 16, 1998, made by the Company to Melrich Associates,
L.P*
10.5 Security Agreement, dated January 16, 1998, by and between the Company and Melrich
Associates, L.P.*
10.6 Promissory Note, dated January 16, 1998, made by the Company to Tansukh V.
Ganatra*
10.7 Security Agreement, dated January 16, 1998, by and between the Company and Tansukh
V. Ganatra*
10.8 Guaranty and Suretyship Agreement, dated January 16, 1998, by and among the
Company and Richard T. Aab, Melrich Associates, L.P. and Tansukh V. Ganatra*
10.9 Non-transferable Warrant, dated August 4, 1997, issued to David N. Vail
10.10 Non-transferable Warrant, dated August 4, 1997, issued to Craig K. Simpson
10.11 Class B Stockholders Agreement, dated as of January 1, 1998*
10.12 Consulting Agreement, dated December 18, 1997 by and between the Company and
RTA Associates, LLC*
10.13 Consulting Agreement, dated December 18, 1997 by and between the Company and
Super STAR Associates Limited Partnership*
21 Subsidiaries of the Registrant
23.1 Consent of Deloitte & Touche LLP
23.2 Consent of Moore & Van Allen, PLLC (included in its opinion filed as Exhibit 5)*
24 Power of Attorney (included on the Signature Page)
- -----------------
*To be filed by amendment.
</TABLE>
II-2
<PAGE>
Item 17. Undertakings.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of Prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form of
Prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act shall be deemed to be part of this Registration
Statement as of the time it was declared effective;
(2) For the purpose of determining any liability under the Securities Act
of 1933, each post-effective amendment that contains a form of Prospectus shall
be deemed to be a new Registration Statement relating to the securities offered
therein, and the offering of such securities at that item shall be deemed to be
the initial bona fide public offering thereof; and
(3) The undersigned Registrant hereby undertakes to provide to the
Underwriters at the closing specified in the Underwriting Agreement,
certificates in such denominations and registered in such names as required by
the Underwriters to permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the Registrant pursuant to the foregoing provisions, or otherwise, the
Registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act of 1933 and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the Registrant of expenses incurred or paid by a director, officer or
controlling person of the Registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the Registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act of 1933 and will be governed by the final adjudication of such
issue.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Charlotte, State of
North Carolina, on February 13, 1998.
US LEC Corp.
By: /s/ TANSUKH V. GANATRA
--------------------------------
Tansukh V. Ganatra,
President and Chief Operating
Officer
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Richard T. Aab, Tansukh V. Ganatra and
David N. Vail, and each of them, as his attorney-in-fact, with power of
substitution, for him in any and all capacities, to sign any amendments or
supplements to this Registration Statement or any other instruments he deems
necessary or appropriate, and to file the same, with the exhibits thereto, and
other documents in connection therewith, with the Securities and Exchange
Commission, hereby ratifying and confirming all that said attorney-in-fact or
his substitute or substitutes may do or cause to be done by virtue hereof.
In accordance with the requirements of the Securities Act of 1933, this
Registration Statement was signed by the following persons in the capacities
and on the dates stated:
<TABLE>
<CAPTION>
Signature Title Date
- --------------------------------- ----------------------------------------- ------------------
<S> <C> <C>
/s/ RICHARD T. AAB Chairman of the Board of Directors, February 13, 1998
- -------------------------------
Richard T. Aab Chief Executive Officer and Director
/s/ TANSUKH V. GANATRA President, Chief Operating Officer and February 13, 1998
- -------------------------------
Tansukh V. Ganatra Director
/s/ DAVID N. VAIL Executive Vice President -- Finance and February 13, 1998
- ------------------------------- Chief Financial Officer (Principal
David N. Vail Accounting Officer)
/s/ DAVID M. FLAUM Director February 13, 1998
- -------------------------------
David M. Flaum
/s/ STEVEN L. SCHOONOVER Director February 13, 1998
- -------------------------------
Steven L. Schoonover
</TABLE>
II-4
<PAGE>
US LEC CORP.
1998 OMNIBUS STOCK PLAN
<PAGE>
US LEC CORP.
1998 OMNIBUS STOCK PLAN
ARTICLE I
NAME, PURPOSE, AND DEFINITIONS
SECTION 1.1. NAME. The Plan shall be known as the "US LEC Corp. 1998
Omnibus Stock Plan" (the "Plan").
SECTION 1.2. PURPOSE. The purpose of the Plan is to benefit the
Company, Subsidiaries, and their stockholders by encouraging and enabling key
Employees and such other persons as are eligible to participate herein to
acquire a financial interest in the Company. The Plan is intended to aid the
Company and Subsidiaries in attracting and retaining directors, officers and key
employees and in attracting and retaining persons in key relationships with the
Company and Subsidiaries, to stimulate the efforts of those individuals, and to
strengthen their desire to remain in the office or in the employ of, or in a
beneficial relationship with, the Company and Subsidiaries.
SECTION 1.3. DEFINITIONS. Whenever used in the Plan, unless the context
clearly indicates otherwise, the following terms shall have the following
meanings:
(a) "AWARD" or "AWARDS" means an award granted pursuant to
Article III.
(b) "AWARD DOCUMENT" means a document described in Article IV
hereof setting forth the terms, conditions, and limitations applicable
to the Award granted to the Participant.
(c) "BENEFICIARY," with respect to a Participant, means (i)
one or more persons as the Participant may designate as primary or
contingent beneficiary in a writing delivered to the Company or
Committee or, (ii) if there is no such valid designation in effect at
the Participant's death, either (A) the Participant's spouse or (B) if
the Participant is not married at the date of the Participant's death,
the Participant's estate. This definition shall not, however, supersede
or adversely affect any definition or designation of beneficiary which
may be included in any Award.
(d) "BOARD" means the Board of Directors of the Company as it
may be comprised from time to time.
(e) "CODE" means the Internal Revenue Code of 1986, as amended
from time to time, or any successor statute, and applicable
regulations.
(f) "COMMITTEE" means the committee appointed by the Board
from among its members and shall be comprised of not less than two (2)
persons. Unless and until
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<PAGE>
otherwise appointed, the Committee shall be the Compensation Committee
of the Board or any successor committee with substantially the same
responsibilities if the members of that committee satisfy the
requirements of the following sentence. A member of the Committee must
not be an Employee and must otherwise satisfy Rule 16b-3 with respect
to grants to executive officers and directors. If at any time there
shall be no Compensation Committee of the Board or any successor
committee with substantially the same responsibilities whose members
satisfy the requirements of the foregoing sentence or if the Board
shall not have otherwise appointed a committee to administer the Plan,
the Board shall have the responsibilities assigned to the Committee
herein and references to the Committee herein shall refer to the Board.
In addition, the Board shall have the right to exercise, in whole or in
part, authority of the Committee hereunder with respect to certain
persons or classes of persons as Participants, in which case as to
those persons and as to such authority taken or retained by the Board,
references to the Committee herein shall refer to the Board.
(g) "COMPANY" means US LEC Corp., a Delaware corporation, and
any successor corporation.
(h) "DIRECTOR" means any individual who is a member of the
Board.
(i) "DISABILITY" shall mean the inability, in the opinion of
the Company's group health insurance carrier (or claims processor, if
applicable), of a Participant, because of injury or sickness, to work
at a reasonable occupation which is available with the Participant's
employer (the Company or a Subsidiary) or at any gainful occupation for
which the Participant is or may become fitted.
(j) "EMPLOYEE" means any individual who is an employee of the
Company or any Subsidiary, whether or not he or she is a Director.
(k) "EXCHANGE ACT" means the Securities Exchange Act of 1934,
as amended and in effect from time to time, or any successor statute.
(l) "FAIR MARKET VALUE" in reference to the Stock of the
Company means as of a given date either:
(i) The closing price of a share of Stock on the
National Market System or national securities exchange on
which the Stock is then trading as of the day immediately
prior to such date, or if Stock was not traded on that day,
then on the next preceding trading day during which a sale
occurred; or
(ii) if the Stock is not traded on the National
Market System or listed on a national securities exchange, the
mean between the bid and asked prices per share last reported
by the National Association of Securities Dealers, Inc., for
the over-the-counter market on the day immediately prior to
such date, or in the absence of any bid and asked
2
<PAGE>
prices on that day, the mean of the bid and asked prices per
share of such Stock quoted on the next preceding day for which
there were such quotations; or
(iii) if the Stock is not traded on the National
Market System or listed on a national securities exchange, and
quotations for the Stock are not reported by the National
Association of Securities Dealers, Inc., the fair market value
determined by the Committee on the day immediately preceding
such date on the basis of available prices for the Stock or in
such manner as the Committee shall agree.
The Committee shall determine the Fair Market Value of any security
that is not publicly traded, using such criteria as it shall determine,
in its sole discretion, to be appropriate for such valuation.
(m) "INSIDER" means any person who is subject to Section 16.
(n) "PARTICIPANT" means an Employee, Director, or other person
designated by the Committee to be eligible for an Award pursuant to
this Plan.
(o) "RESTRICTED STOCK" means shares of Stock which have
certain restrictions attached to the ownership thereof, which may be
issued under Section 3.4.
(p) "RETIREMENT" means termination of employment with the
Company or a Subsidiary for any reason other than death or Disability
on or after age 65.
(q) "RULE 16B-3" means Rule 16b-3 as promulgated by the
Securities and Exchange Commission on May 31, 1996, effective August
15, 1996, as such regulation or successor regulation shall be hereafter
amended.
(r) "SECTION 16" means Section 16 of the Exchange Act or any
successor regulation and the rules promulgated thereunder as they may
be amended from time to time.
(s) "SPOUSE" means the person of the opposite sex to whom the
Participant is married, as determined by the law of the Participant's
legal domicile, on the date of the Participant's death.
(t) "STOCK" means shares of the Class A Common Stock of the
Company.
(u) "STOCK APPRECIATION RIGHT" means a right, the value of
which is determined relative to the appreciation in value of shares of
Stock, which may be issued under Section 3.3.
(v) "STOCK OPTION" means a right to purchase shares of Stock
granted pursuant to Section 3.2 and includes Incentive Stock Options
and Non-Qualified Stock Options as defined in Section 3.2(a).
3
<PAGE>
(w) "SUBSIDIARY" means any corporation (other than the
Company), limited liability company, or other business organization in
an unbroken chain of entities beginning with the Company in which each
of such entities other than the last one in the unbroken chain owns
stock, units or other interests possessing 50 percent or more of the
total combined voting power of all classes of stock, units or other
interests in one of the other entities in that chain.
(x) "SUBSTANTIAL STOCKHOLDER" means an Employee who is, at the
time of the grant to the Employee of an Award, an "owner" (as defined
in Section 422(b)(6) of the Code, modified as provided in Section 424
of the Code) of more than ten percent (10%) of the total combined
voting power of all classes of stock of the Company or any Subsidiary.
ARTICLE II
ELIGIBILITY
Awards may be granted to any Employee who is or class of Employees who
are designated as Participants from time to time by the Committee and to such
other person, such as a non-Employee Director or consultant, whose relationship
with the Company or a Subsidiary is deemed by the Committee to be sufficiently
important to the Company or Subsidiary as to warrant receipt by such person of
an Award or such person that the Company or a Subsidiary or the Committee wishes
to secure as a key employee or director of the Company or a Subsidiary for whom
the grant of an Award will, in the Committee's judgment, act as an inducement to
such person to accept such position. The Committee shall determine which
Employees, Directors, or other eligible persons shall be Participants, the types
of Awards to be made to Participants, and the terms, conditions, and limitations
applicable to the Awards.
ARTICLE III
AWARDS
SECTION 3.1. GENERAL. Awards may include, but are not limited to, those
described in this Article III, including its sections. The Committee may grant
Awards singly, in tandem, or in combination with other Awards, as the Committee
may in its sole discretion determine. Subject to the other provisions of this
Plan, Awards also may be granted in combination or in tandem with, in
replacement of, or as alternatives to, grants or rights under this Plan and any
other employee plan of the Company.
SECTION 3.2. STOCK OPTIONS. A Stock Option is a right to purchase a
specified number of shares of Stock at a specified price during such specified
time as the Committee shall determine, subject to the following:
(a) An option granted may be either of a type that complies
with the requirements of incentive stock options as defined in Section
422 of the Code ("Incentive Stock Option") or of a type that does not
comply with such requirements ("Non-Qualified Option").
4
<PAGE>
(b) The exercise price per share of any Incentive Stock Option
shall be no less than the Fair Market Value per share of the Stock
subject to the option on the date such Stock Option is granted, except
that, if an Incentive Stock Option is granted to a Substantial
Stockholder, the exercise price per share shall be no less than one
hundred ten percent (110%) of the Fair Market Value per share of Stock
subject to the option on the date such Stock Option is granted.
(c) The exercise price per share of any Non-Qualified Option
may be less than the Fair Market Value per share of Stock subject to
the option on the date such Stock Option is granted.
(d) No Incentive Stock Option shall be exercisable after the
expiration of ten (10) years from the date on which the Incentive Stock
Option is granted, except that, if an Incentive Stock Option is granted
to a Substantial Stockholder, such Stock Option shall not be
exercisable after the expiration of five (5) years from the date on
which the Incentive Stock Option is granted.
(e) A Stock Option may be exercised, in whole or in part, by
giving written notice of exercise to the Company specifying the number
of shares of Stock to be purchased and complying with such other terms
and conditions as the Committee may specify.
(f) The exercise price of the Stock subject to the Stock
Option may be paid in cash or, at the discretion of the Committee, may
also be paid by the tender of shares of Stock already owned by the
Participant, or through a combination of cash and shares of Stock, or
through such other means that the Committee determines are consistent
with the Plan's purpose and applicable law. No fractional shares of
Stock will be issued or accepted.
(g) The exercise price of the Stock subject to the Stock
Option may be paid, at the discretion of the Committee, by delivery to
the Company or its designated agent of an irrevocable written notice of
exercise form together with irrevocable instructions to a broker-dealer
to sell or margin a sufficient portion of the shares as to which the
Stock Option is to be exercised and to deliver the sale or margin loan
proceeds directly to the Company to pay the exercise price.
SECTION 3.3. STOCK APPRECIATION RIGHTS. A Stock Appreciation Right is a
right to receive, upon surrender of the right, but without payment of an
exercise price, an amount payable in cash and/or shares of Stock under such
terms and conditions as the Committee shall determine, subject to the following:
(a) A Stock Appreciation Right may be granted in tandem with
all or part of a Stock Option, in addition to a Stock Option, or
completely independent of a Stock Option or any other Award under this
Plan. A Stock Appreciation Right issued in tandem with a
5
<PAGE>
Stock Option may be granted at the time of grant of the related Stock
Option or at any time thereafter during the term of the Stock Option.
(b) The amount payable by the Company or Subsidiary in cash
and/or shares of Stock with respect to each right shall be equal in
value to a percent of the amount by which the Fair Market Value per
share of Stock on the exercise date exceeds the base value per share
established for the Stock Appreciation Right. The applicable percent
shall be established by the Committee. The amount payable in shares of
Stock, if any, is determined with reference to the Fair Market Value on
the date of exercise.
(c) Stock Appreciation Rights issued in tandem with Stock
Options shall be exercisable only to the extent that the Stock Options
to which they relate are exercisable. Upon the exercise of the Stock
Appreciation Right, the Participant shall surrender to the Company the
underlying Stock Option. Stock Appreciation Rights issued in tandem
with Stock Options shall automatically terminate upon the exercise of
such Stock Options.
(d) A Stock Appreciation Right may be a "limited" Stock
Appreciation Right, such as, for example, a Stock Appreciation Right
exercisable upon the occurrence of a certain event or certain events.
SECTION 3.4. RESTRICTED STOCK. Restricted Stock is shares of Stock that
are issued to a Participant or awarded to a Participant as "phantom stock" and
are subject to such terms, conditions, and restrictions as the Committee deems
appropriate, which may include, but are not limited to, restrictions upon the
sale, assignment, transfer, or other disposition of the Restricted Stock and the
requirement of forfeiture of the Restricted Stock upon termination of employment
or membership on the Board under certain specified conditions. The Committee may
provide for the lapse of any such term or condition based on such factors or
criteria as the Committee may determine. If the shares subject to a Restricted
Stock Award are issued to a Participant, the Participant shall have, with
respect to the Restricted Stock, all of the rights of a stockholder of the
Company, including, but not limited to, the right to vote the Restricted Stock
and the right to receive any cash or stock dividends on such Stock.
SECTION 3.5 PERFORMANCE AWARDS. Performance Awards may be granted under
this Plan from time to time based on such terms and conditions as the Committee
deems appropriate provided that such Awards shall not be inconsistent with the
terms and purposes of this Plan. Performance Awards are Awards which are
contingent upon the performance of all or a portion of the Company and/or
subsidiaries or which are contingent upon the individual performance of the
Participant. Performance Awards may be in the form of performance units,
performance shares, and such other forms of performance Awards which the
Committee shall determine. The Committee shall determine the performance
measurements and criteria for such performance Awards.
SECTION 3.6 OTHER AWARDS. The Committee may from time to time grant
other Stock and Stock-based Awards under the Plan, including, but not limited
to, those Awards pursuant to which shares of Stock are or may in the future be
acquired, Awards denominated in Stock units, securities convertible into shares
of Stock, and dividend equivalents. The Committee shall
6
<PAGE>
determine the terms and conditions of such other Stock and Stock-based Awards
provided that such Awards shall not be inconsistent with the terms and purpose
of this Plan.
ARTICLE IV
AWARD DOCUMENTS
SECTION 4.1 GENERAL. Each Award under this Plan shall be evidenced by
an Award Document issued by the Company or the Committee setting forth the
number of shares of Stock or other security, Stock Appreciation Rights, or units
subject to the Award and such other terms and conditions applicable to the Award
as are determined by the Committee. When deemed required or desirable by the
Committee, the Award Document shall be signed by the Participant.
SECTION 4.2 REQUIRED TERMS. In any event, Award Documents shall
include, at a minimum, explicitly or by reference, the following terms:
(a) Assignability. Provisions defining the conditions under
which and transferees to whom an Award may be assigned, pledged, or
otherwise transferred. In the absence of any such provision, an Award
may not be assigned, pledged, or otherwise transferred except by will
or by the laws of descent and distribution and, during the lifetime of
a Participant, the Award may be exercised only by such Participant or
by the Participant's guardian or legal representative.
(b) Termination of Employment. A provision describing the
treatment of an Award in the event of the Retirement, Disability,
death, or other termination of an Employee Participant's employment
with the Company, including but not limited to terms relating to the
vesting, time for exercise, forfeiture, or cancellation of an Award in
such circumstances.
(c) Rights of Stockholder. A provision that a Participant
shall have no rights as a stockholder with respect to any securities
covered by an Award until the date the Participant becomes the holder
of record. Except as provided in Article VII hereof, no adjustment
shall be made for dividends or other rights, unless the Award Document
specifically requires such adjustment, in which case grants of dividend
equivalents or similar rights shall not be considered to be a grant of
any other stockholder right.
(d) Withholding. A provision requiring the withholding of
applicable taxes required by law from all amounts paid in satisfaction
of an Award. In the case of an Award paid in cash, the withholding
obligation shall be satisfied by withholding the applicable amount and
paying the net amount in cash to the Participant. In the case of Awards
paid in shares of Stock or other securities of the Company, a
Participant may satisfy the withholding obligation by paying the amount
of any taxes in cash or, with the approval of the Committee, shares of
Stock or other securities may be deducted from the payment to satisfy
the obligation in full or in part as long as such withholding of shares
does not violate any applicable laws, rules or regulations of federal,
state, or local authorities. The number of shares to be deducted shall
be determined by reference to the
7
<PAGE>
Fair Market Value of such shares of Stock on the applicable date (the
"given" date of Section 1.3(l)).
SECTION 4.3 OPTIONAL TERMS. Award Documents may include the following
terms:
(a) Replacement, Substitution, and Reloading. Any provisions:
(i) Permitting the surrender of outstanding Awards or
securities held by the Participant in order to exercise or
realize rights under other Awards, under similar or different
terms (including the grant of reload options); or
(ii) requiring holders of Awards to surrender
outstanding Awards as a condition precedent to the grant of
new Awards under the Plan.
(b) Holding Period. In the case of an Award to an Insider:
(i) of an equity security, a provision stating (or
the effect of which is to require) that such security must be
held for at least six months (or such longer period as the
Committee in its discretion specifies) from the date of
acquisition;
(ii) of a derivative security with a fixed exercise
price within the meaning of Section 16, a provision stating
(or the effect of which is to require) that at least six
months (or such longer period as the Committee in its
discretion specifies) must elapse from the date of acquisition
of the derivative security to the date of disposition of the
derivative security (other than upon exercise or conversion)
or its underlying equity security; or
(iii) of a derivative security without a fixed
exercise price within the meaning of Section 16, a provision
stating (or the effect of which is to require) that at least
six months (or such longer period as the Committee in its
discretion specifies) must elapse from the date upon which
such price is fixed to the date of disposition of the
derivative security (other than by exercise or conversion) or
its underlying equity security.
(c) Other Terms. Such other terms as are necessary and
appropriate to effect an Award to the Participant including, but not
limited to, the term of the Award, vesting provisions, deferrals, any
requirements for continued employment with the Company or a Subsidiary,
any other restrictions or conditions (including performance
requirements) on the Award and the method by which restrictions or
conditions lapse, the effect on the Award of a Change of Control as
defined in Section 8.2, or the price, amount, or value of Awards.
8
<PAGE>
ARTICLE V
SHARES OF STOCK
SUBJECT TO THE PLAN
SECTION 5.1 GENERAL. Subject to the adjustment provisions of Article
VII hereof, the number of shares of Stock for which Awards may be granted under
the Plan shall not exceed Six Hundred Fifty Thousand (650,000) shares.
SECTION 5.2 ADDITIONAL SHARES. Any unexercised or undistributed portion
of the terminated, expired, exchanged, or forfeited Award or Awards settled in
cash in lieu of shares of Stock shall be available for further Awards in
addition to those available under Section 5.1.
SECTION 5.3 COMPUTATION RULES. For the purpose of computing the total
number of shares of Stock granted under the Plan, the following rules shall
apply to Awards payable in shares of Stock or other securities, where
appropriate:
(a) Except as provided in subsection (e) of this Section, each
Stock Option shall be deemed to be the equivalent of the maximum number
of shares that may be issued upon exercise of the particular Stock
Option;
(b) except as provided in subsection (e) of this Section, each
other Stock-based Award payable in some other security shall be deemed
to be equal to the number of shares to which it relates;
(c) except as provided in subsection (e) of this Section,
where the number of shares available under the Award is variable on the
date it is granted, the number of shares shall be deemed to be the
maximum number of shares that could be received under that particular
Award;
(d) where one or more types of Awards (both of which are
payable in shares of Stock or another security) are granted in tandem
with each other, such that the exercise of one type of Award with
respect to a number of shares cancels an equal number of shares of the
other, the number of shares under each type of Award shall be deemed to
be equivalent to the number of shares under the other type of Award;
and
(e) each share awarded or deemed to be awarded under the
preceding subsections shall be treated as share(s) of Stock, even if
the Award is for a security other than Stock.
Additional rules for determining the number of shares of Stock granted under the
Plan may be made by the Committee, as it deems necessary or appropriate.
SECTION 5.4 SHARES TO BE USED. The shares of Stock which may be issued
pursuant to an Award under the Plan may be authorized but unissued Stock or
Stock that is or has been acquired by the Company.
9
<PAGE>
ARTICLE VI
ADMINISTRATION
SECTION 6.1 GENERAL. The Plan and all Awards pursuant thereto shall be
administered by the Committee so as to permit the Plan and any Award to comply
with Rule 16b-3. A majority of the members of the Committee shall constitute a
quorum. The vote of a majority of a quorum shall constitute action by the
Committee.
SECTION 6.2 DUTIES. The Committee shall have the duty to administer the
Plan, and to determine periodically the Participants in the Plan and the nature,
amount, pricing, timing, and other terms of Awards to be made to such
individuals.
SECTION 6.3 POWERS. The Committee shall have all powers necessary to
enable it to carry out its duties under the Plan properly, including, but not
limited to, the power to interpret and administer the Plan. All questions of
interpretation with respect to the Plan, the number of shares of Stock or other
security, Stock Appreciation Rights, or units granted, the terms of any Award
Documents, and other matters arising hereunder shall be determined by the
Committee, and its determination shall be final and conclusive upon all parties
in interest. In the event of any conflict between an Award Document and the
Plan, the terms of the Plan shall govern. In addition, the Committee may
delegate to the officers or employees of the Company the authority to execute
and deliver such instruments and documents, to do all such acts and things, and
to take all such other steps deemed necessary, advisable or convenient for the
effective administration of the Plan in accordance with its terms and purpose,
except that the Committee may not delegate any discretionary authority with
respect to substantive decisions or functions regarding the Plan or Awards
thereunder as those relate to Insiders including, but not limited to, decisions
regarding the timing, eligibility, pricing, amount or other material term of
such Awards. The Committee may, in its discretion and consistent with the terms
of the Plan, the requirements of Section 16 and Rule 16b-3 with respect to
Insiders, the requirements of other applicable law, and the terms of an Award
Document, amend, modify, or waive the provisions of an Award Document or grant a
new Award with respect to or in replacement of an existing Award; provided,
however, that no such amendment, modification, or waiver shall, without the
Participant's consent, alter or impair any rights or obligations under an Award
Document unless that is specifically permitted by the Award Document.
SECTION 6.4 INTENT TO AVOID INSIDER TRADING. It is the intent of the
Company that the Plan and Awards hereunder satisfy and be interpreted in a
manner, that, in the case of Participants who are or may be Insiders, satisfies
the applicable requirements of Rule 16b-3, so that such persons will be entitled
to the benefits of Rule 16b-3 or other exemptive rules under Section 16 and will
not be subjected to avoidable liability thereunder. If any provision of the Plan
or of any Award would otherwise frustrate or conflict with the intent expressed
in this Section 6.4, that provision to the extent possible shall be interpreted
and deemed amended so as to avoid such conflict. To the extent of any remaining
irreconcilable conflict with such intent, the provision shall be deemed void as
applicable to Insiders.
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ARTICLE VII
ADJUSTMENTS UPON CHANGES
IN CAPITALIZATION
In the event of a reorganization, recapitalization, Stock split, Stock
dividend, exchange of Stock, combination of Stock, merger, consolidation or any
other change in corporate structure of the Company affecting the Stock, or in
the event of a sale by the Company of all or a significant part of its assets,
or any distribution to its stockholders other than a normal cash dividend, the
Committee shall make appropriate adjustment in the number, kind, price and value
of shares of Stock authorized by this Plan and any adjustments to outstanding
Awards as it determines appropriate so as to prevent dilution or enlargement of
rights, unless the Award or Award Document provides otherwise.
ARTICLE VIII
CHANGES OF CONTROL
SECTION 8.1 GENERAL. In the event of a Change of Control of the
Company, in addition to any action required or authorized by the terms of an
Award Document, the Committee may, in its discretion, recommend that the Board
of Directors take any of the following actions as a result of, or in
anticipation of, any such event to assure fair and equitable treatment of the
Plan Participants:
(a) Accelerate time periods for purposes of vesting in, or
realizing gain from, any outstanding Award made pursuant to the Plan;
(b) offer to purchase any outstanding Award made pursuant to
this Plan from the holder for its equivalent cash value, as determined
by the Committee, as of the date of the Change of Control; or
(c) make adjustments or modifications to outstanding Awards as
the Committee deems appropriate to maintain and protect the rights and
interests of Plan Participants following such Change of Control.
Any such action approved by the Board of Directors shall be conclusive and
binding on the Company, a Subsidiary, and all Participants.
SECTION 8.2 "CHANGE OF CONTROL". For the purposes of this Section, a
"Change of Control" shall mean the earliest date on which one of the following
events shall occur:
(a) Any Person (as defined hereafter) or Persons as a group
beneficially own more than 50% of the combined voting power of all
classes of the Company's outstanding capital stock;
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(b) The Company shall be merged into another corporation or
shall be consolidated with another corporation and immediately
following the effective date of any such merger or consolidation, the
Founding Group members do not, as a group, beneficially own more than
50% of the combined voting power of all classes of the outstanding
capital stock of the surviving corporation in any such merger or
consolidation;
(c) The Company shall sell substantially all of its assets to
another entity which is not a wholly-owned Subsidiary; or
(d) The persons who were directors of the Company on the date
30 days after the effective date of the Plan (Article XI), together
with those who subsequently become directors of the Company and whose
election, or nomination for election by the Company's stockholders, is
approved by the vote of at least a majority of the directors who were
directors on the date 30 days after the effective date of the Plan
(Article XI) or directors whose nomination or election is approved as
provided above, shall cease to constitute a majority of the Board or of
its successor by merger, consolidation or sale of assets.
SECTION 8.3 DEFINITIONS APPLICABLE TO CHANGE OF CONTROL.
(a) "PERSON" means any individual, firm, corporation,
partnership, limited liability company, trust, or other entity;
PROVIDED, HOWEVER, that "Person" does not include:
(i) Any member of the Founding Group (as defined in
this Section);
(ii) a Permitted Transferee (as defined in Exhibit A
hereto);
(iii) the Company or any Subsidiary; or
(iv) any employee benefit plan of the Company or any
Subsidiary or any entity appointed or established by the
Company or Subsidiary as a fiduciary for or pursuant to the
terms of any such employee benefit plan.
(b) "FOUNDING GROUP" means Richard T. Aab, Melrich Associates,
L.P., Tansukh V. Ganatra, and Super STAR Associates Limited
Partnership.
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ARTICLE IX
AMENDMENT AND TERMINATION
SECTION 9.1 AMENDMENT OF PLAN. The Company expressly reserves the
right, at any time and from time to time, to amend in whole or in part any of
the terms and provisions of the Plan and any or all Award Documents under the
Plan to the extent permitted by law for whatever reason(s) the Company may deem
appropriate; provided, however, no amendment may be effective, without the
approval of the stockholders of the Company, if approval of such amendment is
required in order that transactions in Company securities under the Plan be
exempt from the operation of Section 16(b) of the Securities Exchange Act of
1934 or if such amendment, with respect to the issuance of Incentive Stock
Options, either:
(a) Materially increases the number of shares of Stock which
may be issued under the Plan, except as provided for in Article VII; or
(b) materially modifies the requirements as to eligibility for
participation in the Plan (unless designed to comport with the Code,
the Employee Retirement Security Act of 1974, or other laws).
SECTION 9.2 TERMINATION OF PLAN. The Company expressly reserves the
right, at any time, to suspend or terminate the Plan and any or all Award
Documents under the Plan to the extent permitted by law for whatever reason(s)
the Company may deem appropriate, including, but not limited to, suspension or
termination as to the Company, any participating Subsidiary, any Participant, or
any class of Participants.
SECTION 9.3. PROCEDURE FOR AMENDMENT OR TERMINATION. Any amendment to
the Plan or termination of the Plan shall be made by the Company by resolution
of the Board and shall not require the approval or consent of any Subsidiary,
Participant, or Beneficiary in order to be effective, to the extent permitted by
law. Any amendment to the Plan or termination of the Plan may be retroactive to
the extent not prohibited by applicable law.
ARTICLE X
MISCELLANEOUS
SECTION 10.1 RIGHTS OF EMPLOYEES. Status as an eligible Employee shall
not be construed as a commitment that any Award will be made under the Plan to
such eligible Employee or to eligible Employees generally. Nothing contained in
the Plan (or in any other documents related to this Plan or to any Award) shall
confer upon any Employee or Participant any right to continue in the employ or
other service of or relationship with the Company or constitute any contract or
limit in any way the right of the Company to change such person's compensation
or other benefits or to terminate the employment or relationship of such person
with or without cause.
SECTION 10.2 COMPLIANCE WITH LAW. No certificate for Stock
distributable pursuant to this Plan shall be issued and delivered unless the
issuance of such certificate complies with all
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applicable legal requirements including, without limitation, compliance with the
provisions of applicable state securities laws, the Securities Act of 1933, as
amended from time to time or any successor statute, the Exchange Act and the
requirements of the market systems or exchanges on which the Stock may, at the
time, be traded or listed.
SECTION 10.3 UNFUNDED STATUS. The Plan shall be unfunded. Neither the
Company nor the Board of Directors shall be required to segregate any assets
that may at any time be represented by Awards made pursuant to the Plan. Neither
the Company, the Committee, nor the Board of Directors shall be deemed to be a
trustee of any amounts to be paid under the Plan.
SECTION 10.4 LIMITS ON LIABILITY. Any liability of the Company to any
Participant with respect to an Award shall be based solely upon contractual
obligations created by the Plan and the Award Document. Neither the Company nor
any member of the Board of Directors or the Committee, nor any other person
participating in any determination of any question under the Plan, or in the
interpretation, administration or application of the Plan, shall have any
liability to any party for any action taken or not taken, in good faith under
the Plan and that do not constitute willful misconduct. To the extent permitted
by applicable law, the Company shall indemnify and hold harmless each member of
the Board of Directors and the Committee from and against any and all liability,
claims, demands, costs, and expenses (including, but not limited to, the costs
and expenses of attorneys incurred in connection with the investigation or
defense of claims) in any manner connected with or arising out of any actions or
inactions in connection with the administration of the Plan except for such
actions or inactions which are not in good faith or which constitute willful
misconduct.
SECTION 10.5 SECTION REFERENCES. All references in this Plan to
sections or articles shall refer to sections and articles of this Plan unless
specifically noted otherwise.
ARTICLE XI
EFFECTIVE DATE OF PLAN
This Plan shall become effective on the date of its adoption by the
Board; provided, however, the effectiveness of this Plan is subject to its
approval and ratification by the stockholders of the Company within one year
from the date of adoption hereof by the Board. The Committee shall have
authority to grant Awards hereunder until one day before the ten year
anniversary of the date of adoption of the Plan by the Board, subject to the
ability of the Company to terminate the Plan as provided in Article IX.
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NON-TRANSFERABLE WARRANT
This Warrant is issued as of August 4, 1997, by US LEC L.L.C., a Delaware
limited liability company (the "Company"), to David Vail, a resident of
Charlotte, North Carolina (the "Holder").
1. Issuance of Warrant. For and in consideration of the Holder's employment
with the Company, and other good and valuable consideration the receipt and
sufficiency of which are hereby acknowledged, the Company hereby grants to the
Holder the right to purchase and acquire, at the times and subject to the
conditions hereinafter set forth, 110 non-voting units ("Non-Voting Units") of
ownership interest in the Company for the Exercise Price (as hereinafter
defined). In the event the Company merges with and into any other entity such
that the Company is not the surviving entity, the Holder shall be entitled to
purchase that number of shares or other equity interests of the surviving entity
that the Holder would have been entitled to receive as a result of the merger
had the Holder exercised its rights under this Warrant prior to such merger.
2. Exercise; Term. Subject to the terms and conditions hereinafter set
forth, the Holder shall be entitled to purchase and acquire up to 110 Non-Voting
Units (in minimum increments of 5 Non-Voting Units at a time) at any time and
from time to time from the date of this Warrant until 5:00 p.m. E.S.T., on
August 4, 2000. The Holder shall exercise its rights to purchase Non-Voting
Units under this Warrant by providing written notice of exercise to the Company
at the following address: 212 South Tryon Street, Suite 1540, Charlotte, North
Carolina 28281, Attention: Chairman, or such other address as the Company shall
designate in a written notice to the Holder. In addition, the Holder shall
deliver to the Company this Warrant (or any replacement warrant issued by the
Company pursuant to Paragraph 3 below), an executed copy of the signature page
of the Operating Agreement of the Company (but only with respect to the first
exercise of the Warrant), and a certified check representing payment to the
Company of the aggregate Exercise Price of the Non-Voting Units to be purchased.
The exercise by the Holder of any rights granted hereunder shall be
conditioned on the continued employment of the Holder by the Company at the time
of any such exercise. In addition, the exercise of this Warrant shall be
conditioned on compliance with all applicable laws and regulations, including,
without limitation, obtaining all requisite approvals, if any, which may then be
required under applicable law.
This Warrant, and all rights of the Holder to purchase or acquire
Non-Voting Units hereunder, shall expire automatically and without any further
action by the Company at 5:00 p.m. E.S.T., on August 4, 2000, or upon
termination of the Holder's employment with the Company, whichever is sooner.
3. Effect of Exercise. The exercise of this Warrant (or any replacement
warrant issued by the Company as provided herein), shall become effective on the
first day of the month immediately following the month in which notice of
exercise is given to the Company. Upon the
1
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exercise of this Warrant or any replacement warrant the Company shall, as
promptly as practicable, deliver to the Holder a certificate or certificates
representing the number of Non-Voting Units purchased by the Holder. If this
Warrant shall be exercised with respect to less than all of the Non-Voting Units
to which the Holder is entitled to purchase hereunder, the Holder shall be
entitled to receive a replacement warrant covering the number of Non-Voting
Units in respect of which this Warrant shall not have been exercised, which new
warrant shall in all other respects be identical to this Warrant.
4. Exercise Price. The exercise price (the "Exercise Price") per each Unit
purchased pursuant to the terms of this Warrant shall be FOUR THOUSAND TWO
HUNDRED EIGHTY-FIVE DOLLARS ($4,285.00).
5. No Transfer Rights. Neither this Warrant nor the Non-Voting Units have
been registered under the Securities Act of 1933, as amended ("Securities Act"
or any state securities laws "Blue Sky Laws"). This Warrant has been acquired
for investment purposes and not with a view to distribution or resale and may
not be pledged, hypothecated, sold, made subject to a security interest, or
otherwise transferred (voluntarily or involuntarily) without (a) the prior
written consent of the Company and (b) (i) an effective registration statement
for such Warrant under the Securities Act and such applicable Blue Sky Laws, or
(ii) an opinion of counsel, which opinion and counsel shall be reasonably
satisfactory to the Company and its counsel, that registration is not required
under the Securities Act or under any applicable Blue Sky Laws. Any attempted
transfer of this Warrant in violation of this Paragraph 5. shall render this
Warrant null and void and of no further force and effect. In addition, any
Non-Voting Units issued upon the exercise of this Warrant shall be subject to
the restrictions on transfer set forth in the Operating Agreement of the
Company, and shall bear substantially the following legend:
THE UNITS REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933, AS
AMENDED, OR UNDER THE SECURITIES LAWS OF ANY STATE. THE
UNITS HAVE BEEN ACQUIRED FOR INVESTMENT AND MAY NOT BE
SOLD OR OFFERED FOR SALE IN THE ABSENCE OF AN EFFECTIVE
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF
1933, AS AMENDED, OR AN OPINION OF COUNSEL SATISFACTORY
TO THE COMPANY AND ITS COUNSEL TO THE EFFECT THAT THE
PROPOSED TRANSACTION DOES NOT INVOLVE A VIOLATION OF
THE SECURITIES ACT OF 1933, AS AMENDED.
THE UNITS REPRESENTED BY THIS CERTIFICATE, AND THE
TRANSFER HEREOF, ARE SUBJECT TO THE TERMS AND
CONDITIONS OF THAT CERTAIN OPERATING AGREEMENT DATED
JANUARY 1, 1997, AS AMENDED FROM TIME TO TIME, A COPY
OF WHICH IS ON FILE IN THE PRINCIPAL OFFICE OF THE
COMPANY.
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6. Additional Actions. The Holder and the Company agree to execute such
other documents and instruments as counsel for the Company reasonably deems
necessary to effect the compliance of the issuance of this Warrant and any
Non-Voting Units issued upon exercise hereof with applicable federal and state
securities laws.
7. Governing Law. This Warrant shall be governed by the laws of the State
of North Carolina applicable to agreements made entirely within the State of
North Carolina.
IN WITNESS WHEREOF, the parties hereto have set their hands as of the date
first above written.
COMPANY:
US LEC L.L.C.,
a Delaware limited liability company
By: ______________________________
Richard T. Aab, Chairman
HOLDER: __________________________
_________________________________
David Vail
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NON-TRANSFERABLE WARRANT
This Warrant is issued as of August 4, 1997, by US LEC L.L.C., a Delaware
limited liability company (the "Company"), to Craig Simpson, a resident of
Charlotte, North Carolina (the "Holder").
1. Issuance of Warrant. For and in consideration of the Holder's employment
with the Company, and other good and valuable consideration the receipt and
sufficiency of which are hereby acknowledged, the Company hereby grants to the
Holder the right to purchase and acquire, at the times and subject to the
conditions hereinafter set forth, 110 non-voting units ("Non-Voting Units") of
ownership interest in the Company for the Exercise Price (as hereinafter
defined). In the event the Company merges with and into any other entity such
that the Company is not the surviving entity, the Holder shall be entitled to
purchase that number of shares or other equity interests of the surviving entity
that the Holder would have been entitled to receive as a result of the merger
had the Holder exercised its rights under this Warrant prior to such merger.
2. Exercise; Term. Subject to the terms and conditions hereinafter set
forth, the Holder shall be entitled to purchase and acquire up to 110 Non-Voting
Units (in minimum increments of 5 Non-Voting Units at a time) at any time and
from time to time from the date of this Warrant until 5:00 p.m. E.S.T., on
August 4, 2000. The Holder shall exercise its rights to purchase Non-Voting
Units under this Warrant by providing written notice of exercise to the Company
at the following address: 212 South Tryon Street, Suite 1540, Charlotte, North
Carolina 28281, Attention: Chairman, or such other address as the Company shall
designate in a written notice to the Holder. In addition, the Holder shall
deliver to the Company this Warrant (or any replacement warrant issued by the
Company pursuant to Paragraph 3 below), an executed copy of the signature page
of the Operating Agreement of the Company (but only with respect to the first
exercise of the Warrant), and a certified check representing payment to the
Company of the aggregate Exercise Price of the Non-Voting Units to be purchased.
The exercise by the Holder of any rights granted hereunder shall be
conditioned on the continued employment of the Holder by the Company at the time
of any such exercise. In addition, the exercise of this Warrant shall be
conditioned on compliance with all applicable laws and regulations, including,
without limitation, obtaining all requisite approvals, if any, which may then be
required under applicable law.
This Warrant, and all rights of the Holder to purchase or acquire
Non-Voting Units hereunder, shall expire automatically and without any further
action by the Company at 5:00 p.m. E.S.T., on August 4, 2000, or upon
termination of the Holder's employment with the Company, whichever is sooner.
3. Effect of Exercise. The exercise of this Warrant (or any replacement
warrant issued by the Company as provided herein), shall become effective on the
first day of the month
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immediately following the month in which notice of exercise is given to the
Company. Upon the exercise of this Warrant or any replacement warrant the
Company shall, as promptly as practicable, deliver to the Holder a certificate
or certificates representing the number of Non-Voting Units purchased by the
Holder. If this Warrant shall be exercised with respect to less than all of the
Non-Voting Units to which the Holder is entitled to purchase hereunder, the
Holder shall be entitled to receive a replacement warrant covering the number of
Non-Voting Units in respect of which this Warrant shall not have been exercised,
which new warrant shall in all other respects be identical to this Warrant.
4. Exercise Price. The exercise price (the "Exercise Price") per each Unit
purchased pursuant to the terms of this Warrant shall be FOUR THOUSAND TWO
HUNDRED EIGHTY-FIVE DOLLARS ($4,285.00).
5. No Transfer Rights. Neither this Warrant nor the Non-Voting Units have
been registered under the Securities Act of 1933, as amended ("Securities Act"
or any state securities laws "Blue Sky Laws"). This Warrant has been acquired
for investment purposes and not with a view to distribution or resale and may
not be pledged, hypothecated, sold, made subject to a security interest, or
otherwise transferred (voluntarily or involuntarily) without (a) the prior
written consent of the Company and (b) (i) an effective registration statement
for such Warrant under the Securities Act and such applicable Blue Sky Laws, or
(ii) an opinion of counsel, which opinion and counsel shall be reasonably
satisfactory to the Company and its counsel, that registration is not required
under the Securities Act or under any applicable Blue Sky Laws. Any attempted
transfer of this Warrant in violation of this Paragraph 5. shall render this
Warrant null and void and of no further force and effect. In addition, any
Non-Voting Units issued upon the exercise of this Warrant shall be subject to
the restrictions on transfer set forth in the Operating Agreement of the
Company, and shall bear substantially the following legend:
THE UNITS REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933, AS
AMENDED, OR UNDER THE SECURITIES LAWS OF ANY STATE. THE
UNITS HAVE BEEN ACQUIRED FOR INVESTMENT AND MAY NOT BE
SOLD OR OFFERED FOR SALE IN THE ABSENCE OF AN EFFECTIVE
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF
1933, AS AMENDED, OR AN OPINION OF COUNSEL SATISFACTORY
TO THE COMPANY AND ITS COUNSEL TO THE EFFECT THAT THE
PROPOSED TRANSACTION DOES NOT INVOLVE A VIOLATION OF
THE SECURITIES ACT OF 1933, AS AMENDED.
THE UNITS REPRESENTED BY THIS CERTIFICATE, AND THE
TRANSFER HEREOF, ARE SUBJECT TO THE TERMS AND
CONDITIONS OF THAT CERTAIN OPERATING AGREEMENT DATED
JANUARY 1, 1997, AS AMENDED FROM TIME TO TIME, A COPY
OF WHICH IS ON FILE IN THE PRINCIPAL OFFICE OF THE
COMPANY.
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6. Additional Actions. The Holder and the Company agree to execute such
other documents and instruments as counsel for the Company reasonably deems
necessary to effect the compliance of the issuance of this Warrant and any
Non-Voting Units issued upon exercise hereof with applicable federal and state
securities laws.
7. Governing Law. This Warrant shall be governed by the laws of the State
of North Carolina applicable to agreements made entirely within the State of
North Carolina.
IN WITNESS WHEREOF, the parties hereto have set their hands as of the date
first above written.
COMPANY:
US LEC L.L.C.,
a Delaware limited liability company
By: ______________________________
Richard T. Aab, Chairman
HOLDER:
__________________________________
Craig Simpson
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US LEC CORP. SUBSIDIARIES
Name Jurisdiction of Organization/Incorporation
- ---- ------------------------------------------
US LEC of North Carolina L.L.C. North Carolina
US LEC of Florida Inc. North Carolina
US LEC of Georgia L.L.C. Delaware
US LEC of Georgia Inc. Delaware
US LEC of South Carolina Inc. Delaware
US LEC of Tennessee L.L.C. Delaware
US LEC of Tennessee Inc. Delaware
US LEC of Virginia L.L.C. Delaware
<PAGE>
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Registration Statement of US LEC Corp. on
Form S-1 of our report dated February 4, 1998, appearing in the Prospectus,
which is part of this Registration Statement.
We also consent to the reference to us under the headings "Summary
Historical Consolidated Financial and Operating Data," "Selected Historical
Consolidated Financial and Operating Data" and "Experts" in such Prospectus.
DELOITTE & TOUCHE LLP
Charlotte, North Carolina
February 12, 1998
