SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
Commission file number 0-24061
US LEC Corp.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
56-2065535
(I.R.S. Employer Identification No.)
<TABLE>
<CAPTION>
<S> <C>
Transamerica Square, 401 North Tryon Street, Suite 1000 Charlotte, North Carolina 28202
- --------------------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(704) 319-1000
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
</TABLE>
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes ( X ) No ( )
- --------------------------------------------------------------------------------
As of October 30, 1998, there were 10,345,000 shares of Class A Common Stock and
17,075,270 shares of Class B Common Stock outstanding.
1
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US LEC Corp.
Table of Contents
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED):
Condensed Consolidated Statements of Operations - Three and nine month periods
ended September 30, 1998 and 1997
Condensed Consolidated Balance Sheets - September 30, 1998 and December 31, 1997
Condensed Consolidated Statements of Cash Flows - Nine month periods ended
September 30, 1998 and 1997
Condensed Consolidated Statement of Stockholders' Equity - Nine months ended
September 30, 1998
Notes to Condensed Consolidated Financial Statements
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES
2
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US LEC Corp.
Condensed Consolidated Statements of Operations
(Dollars in thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three months Nine months
Ended September 30, Ended September 30,
1998 1997 1998 1997
------------ --------- ----------- ---------
<S> <C> <C> <C> <C>
Revenue $ 22,291 $1,530 $ 54,269 $1,760
Cost of Services 7,296 1,075 21,306 1,813
------------ --------- ----------- ---------
Gross Margin 14,995 455 32,963 (53)
Selling, General and Administrative Expenses 6,690 1,294 16,863 3,391
Depreciation and Amortization 1,547 125 2,914 228
------------ --------- ----------- ---------
Operating Income (Loss) 6,758 (964) 13,186 (3,672)
Interest Income (705) (18) (1,434) (31)
Interest Expense 1 120 224 307
------------ --------- ----------- ---------
Income (Loss) Before Income Taxes 7,462 (1,066) 14,396 (3,948)
Provision for Income Taxes 2,999 - 5,784 -
------------ --------- ----------- ---------
Net Income (Loss) $ 4,463 $(1,066) $ 8,612 $(3,948)
============ ========= =========== =========
Earnings (Loss) Per Common Share:
Basic $ 0.16 $(0.06) $ 0.35 $(0.22)
============ ========= =========== =========
Diluted $ 0.16 $(0.06) $ 0.34 $(0.22)
============ ========= =========== =========
Weighted average number of shares
outstanding (in thousands):
Basic 27,420 19,076 24,579 18,114
Diluted 27,905 19,076 25,032 18,114
EBITDA * $ 8,305 $ (839) $ 16,100 $(3,444)
======================= =========== =========
</TABLE>
See notes to condensed consolidated financial statements
* EBITDA consists of earnings (loss) before interest income and expense, income
taxes, depreciation and amortization. See related discussion in Results of
Operations appearing elsewhere in this report.
3
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US LEC Corp.
Condensed Consolidated Balance Sheets
(Dollars in thousands, except per share information)
(Unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 36,840 $ 3,189
Certificates of deposit and restricted cash 1,177 349
Accounts Receivable (net of allowance of $6,007 at
September 30, 1998 and $0 at December 31, 1997) 45,179 6,006
Prepaid expenses and other assets 752 111
------------ ------------
Total current assets 83,948 9,655
PROPERTY AND EQUIPMENT, NET 49,905 12,890
OTHER ASSETS 467 136
------------ ------------
TOTAL ASSETS $ 134,320 $ 22,681
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 10,797 $ 8,201
Deferred revenue 511 1,142
Accrued expenses 14,436 2,581
------------ ------------
Total current liabilities 25,744 11,924
------------ ------------
NOTES PAYABLE-STOCKHOLDERS - 5,000
------------ ------------
STOCKHOLDERS' EQUITY
Common stock-Class A, $.01 par value (72,924,728 authorized
shares, 10,345,000 outstanding at September 30, 1998) 103 38
Common stock-Class B, $.01 par value (17,075,272 authorized
shares, 17,075,270 outstanding at September 30, 1998) 171 166
Additional paid-in capital 106,561 11,174
Retained earnings (Accumulated deficit) 1,741 (5,621)
------------ ------------
Total stockholders' equity 108,576 5,757
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 134,320 $ 22,681
============ ============
</TABLE>
See notes to condensed consolidated financial statements
4
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US LEC Corp.
Condensed Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1998 1997
--------- ---------
OPERATING ACTIVITIES:
<S> <C> <C>
Net income (loss) 8,612 $(3,948)
------- -------
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization 2,914 227
Allowance for accounts receivable 6,007 --
Stock compensation 75 24
Loss on sale of assets 32 --
Deferred compensation expense 91 --
Changes in assets and liabilities which provided (used) cash:
Accounts receivable (45,180) (1,253)
Prepaid expenses and other assets (516) (56)
Accounts payable 2,003 661
Deferred revenue (630) --
Accrued expenses 11,947 878
------- -------
Total adjustments (23,257) 481
------- -------
Net cash used in operating activities (14,645) (3,467)
------- -------
INVESTING ACTIVITIES:
Purchase of property and equipment (38,505) (3,261)
Sale of property and equipment 15 --
Certificates of deposit and restricted cash (828) (150)
Advance to stockholder -- (135)
------- -------
Net cash used in investing activities (39,318) (3,546)
------- -------
FINANCING ACTIVITIES:
Issuance of common shares and limited liability company units 87,614 6,044
Proceeds of notes payable-stockholders (Net of repayments) -- 2,540
------- -------
Net cash provided by financing activities 87,614 8,584
------- -------
NET INCREASE IN CASH AND CASH EQUIVALENTS 33,651 1,571
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 3,189 726
------- -------
CASH AND CASH EQUIVALENTS, END OF PERIOD 36,840 $ 2,297
======= =======
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Cash Paid for Interest 505 $ 1
======= =======
Cash Paid for Taxes 1,860 $ --
======= =======
</TABLE>
See notes to condensed consolidated financial statements
5
<PAGE>
US LEC Corp.
Condensed Consolidated Statement of Stockholders' Equity
For the Nine Months ended September 30, 1998
(Dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Class A Class B Additional Retained Earnings
Common Stock Common Stock Paid-in Capital (Accumulated Deficit) Total
------------ ------------ --------------- --------------------- ----------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1997 $ 38 $ 166 $ 11,174 $ (5,621) $ 5,757
Public stock offering 63 - 87,079 - 87,142
Conversion of $5,000 stockholder
loans for 480,770 shares of
Class B Common Stock - 5 4,995 - 5,000
Dividend - - 1,250 (1,250) -
Issuance of stock warrants - - 75 - 75
Issuance of employee stock options - - 548 - 548
Exercise of warrants (net of tax benefit) 2 - 1,440 - 1,442
Net income - - - 8,612 8,612
------- ------ -------- ----------- -------
Balance at September 30, 1998 $ 103 $ 171 $106,561 $ 1,741 $ 108,576
====== ====== ======== ========== =========
</TABLE>
See notes to condensed consolidated financial statements
6
<PAGE>
US LEC Corp.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share data)
(Unaudited)
1. Basis of Presentation and Significant Accounting Policies
The accompanying unaudited condensed consolidated financial statements of US LEC
Corp. and its subsidiaries ("US LEC" or the "Company") have been prepared in
accordance with generally accepted accounting principles for interim financial
information and the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and notes required by
generally accepted accounting principles for complete financial statements. In
the opinion of management, all adjustments considered necessary for a fair
presentation for the periods indicated have been included. Operating results for
the three month and nine month periods ended September 30, 1998 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1998. The balance sheet at December 31, 1997 has been derived from
the audited balance sheet at that date, but does not include all of the
information and notes required by generally accepted accounting principles for
complete financial statements. The accompanying financial statements should be
read in conjunction with the audited financial statements (including the notes
thereto) for the year ended December 31, 1997 included in the Company's
prospectus dated April 23, 1998, and the first and second quarterly reports for
1998 on Form 10-Q, which are on file with the U.S. Securities and Exchange
Commission (the "Commission"). Certain amounts in the 1997 financial statements
have been reclassified to conform to the 1998 presentation.
2. Certificates of Deposit and Restricted cash
Certificates of deposit and restricted cash are carried at cost and serve as
collateral for letters of credit related to certain office leases.
3. Earnings (Loss) Per Common and Common Equivalent Share
Earnings (loss) per common and common equivalent share has been calculated in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 128,
Earnings Per Share, and is based on net income (loss) divided by the weighted
average common shares outstanding during the period. The weighted average shares
outstanding used in the calculation for 1997 has been determined by giving
retroactive effect to the merger of the predecessor limited liability company
into the Company, which occurred on December 31, 1997 (based on the share
conversion ratios utilized in the merger). Outstanding options and warrants are
included in the calculation of dilutive earnings per common share to the extent
they are dilutive. The Company's basic and diluted weighted average number of
shares (in thousands of shares) for the three and nine month periods ended
September 30, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
Three months Nine months
ended September 30, ended September 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Basic Weighted Average Number of
Shares Outstanding 27,420 19,076 24,579 18,114
Dilutive Stock Options 237 - 133 -
Dilutive Stock Warrants 248 - 320 -
------ ------ ------ ------
Diluted Weighted Average Number of
Shares Outstanding 27,905 19,076 25,032 18,114
====== ====== ====== ======
</TABLE>
7
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4. Income Taxes
US LEC 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 effectively converted
to C Corporation status. Effective January 1, 1998, US LEC began recognizing
income tax expense associated with its taxable income. Accordingly, US LEC
recognized income tax expense in the amount of $5,784 applicable to taxable
income for the nine months ended September 30, 1998. If the Company had operated
as a C Corporation during 1997 there would have been no material change in
reported net loss or loss per share.
5. Commitments and Contingencies
A majority of the Company's revenue is derived from reciprocal compensation
amounts due from incumbent local exchange carriers ("ILECs"), principally
BellSouth Telecommunications, Inc. ("BellSouth"). Management believes that such
amounts are due pursuant to its interconnection agreements with ILECs. However,
in August 1997, BellSouth notified US LEC and other CLECs that it would not pay
or collect reciprocal compensation under interconnection agreements for traffic
terminated to enhanced service providers ("ESPs"), including information service
providers such as internet service providers ("ISPs"). On February 26, 1998,
following a petition by US LEC, the North Carolina Utilities Commission ("NCUC")
ordered BellSouth to bill and pay for all such traffic. Following motions filed
by BellSouth, the NCUC stayed enforcement of its order until June 1, 1998. On
April 27, 1998, BellSouth filed a petition for judicial review of the NCUC's
order and an action for declaratory judgement and other relief (including a
request for an additional stay) with the United States District Court for the
Western District of North Carolina. This action was filed against US LEC and the
NCUC. The parties are currently awaiting the decision of the U.S. District Court
on certain motions, including BellSouth's motion requesting referral from the
Federal Communications Commission ("FCC").
On September 14, 1998, US LEC filed a complaint with the NCUC in which it is
asking the NCUC to order BellSouth to pay all sums due related to facilities,
non-ISP based reciprocal compensation and intraLATA toll termination charges. In
addition, on September 14, 1998, BellSouth filed a complaint with the NCUC
seeking to be relieved from an unspecified portion of obligations under the
interconnection agreement to pay reciprocal compensation related to traffic
related to Metacomm, LLC, a BellSouth and US LEC customer.
Management believes that the Company will ultimately obtain favorable results in
these proceedings. However, BellSouth may elect to initiate additional
proceedings (by way of appeal or otherwise) challenging amounts owed to US LEC.
If a decision adverse to US LEC is issued in any of these proceedings by the
U.S. District Court or the NCUC or on any appeal or review of a favorable
decision by the U.S. District Court, the NCUC, or in any other proceeding
related to these issues, or if the FCC were to alter its view of reciprocal
compensation, such an event would have a material adverse effect on US LEC's
operating results and financial condition.
6. Stockholders' Equity
Initial Public Offering -- On April 29, 1998, US LEC completed the sale of
5,500,000 shares of Class A Common Stock through an initial public offering.
Additionally, on May 12, 1998, US LEC issued 825,000 shares of Class A Common
Stock in connection with the underwriters' exercise of their option to cover
over-allotments. The total offering resulted in net proceeds of approximately
$87,142, after deducting underwriting discounts, commissions and offering
expenses. US LEC intends to use substantially all of the net proceeds of the
initial public offering to further expand and develop its telecommunications
network.
8
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Stock Options -- US LEC adopted the US LEC Corp. Omnibus Stock Plan (the
"Plan") in January 1998. As of September 30, 1998, the Company had granted stock
options, net of forfeitures, to purchase an aggregate of 936,300 shares of Class
A Common Stock.
Form S-8 Registration Statement -- On August 17, 1998 the Company filed a
registration statement on Form S-8 to register (i) 1,300,000 shares of Class A
Common Stock reserved for issuance under the Company's 1998 Omnibus Stock Plan
and (ii) 180,000 shares of Class A Common Stock reserved for issuance upon the
exercise on nontransferable warrants granted by the Company to employees.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Except for the historical information contained herein, this report contains
forward-looking statements, subject to uncertainties and risks, and as a result,
our actual results may differ materially from those discussed here. These
uncertainties and risks include among others, the demand for US LEC's services,
the ability of the Company to successfully attract and retain personnel,
competition, uncertainties regarding its dealings with ILECs, other
telecommunications carriers and facility providers, regulatory uncertainties,
reliance on leased transmission capacity and the cost of the capacity, the need
to finance operations and future capital expenditures, the possibility of an
adverse decision related to reciprocal compensation owing to the Company by
BellSouth, as well as the Company's ability to begin operations in additional
markets. These and other applicable risks are summarized in the "risk factors"
sections and elsewhere in the Company's prospectus dated April 23,1998, which is
on file with the Securities and Exchange Commission.
OVERVIEW
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. US LEC was founded in June 1996 after passage of
the Telecommunications Act of 1996, which enhanced the competitive environment
for local exchange services. US LEC 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, Atlanta, Georgia and Memphis, Nashville,
and Knoxville, Tennessee, Orlando, and Miami, Florida. US LEC currently plans to
enter additional markets during 1998 and 1999.
RESULTS OF OPERATIONS
Three and Nine Months Ended September 30, 1998 Compared With The Three and Nine
Months Ended September 30, 1997
Revenue for the quarter ended September 30, 1998 and 1997 was $22.3 million and
$1.5 million respectively. For the nine months ended September 30, 1998 and
1997, revenue was $54.3 million and $1.8 million, respectively. The significant
increase in revenue was due the Company's expansion into new markets, an
increase in the total number of customers in existing markets and an increase in
usage by customers. The Company's core business revenue continued to grow, as
well as the revenue related to reciprocal compensation. (See Note 5 to the
condensed consolidated financial statements appearing elsewhere in this report
for a discussion related to reciprocal compensation and other disputed amounts
owed from BellSouth). A majority of the Company's revenue was comprised of
reciprocal compensation derived from traffic terminated by US LEC that was
originated by customers of ILECs (principally BellSouth) in the Company's
markets. Given that no
9
<PAGE>
near term resolution of the reciprocal compensation issue is expected, the
Company elected to accrue a $6.0 million reserve against reciprocal compensation
revenue and receivables during the quarter ending September 30, 1998. The
results reported in this report are net of these and other normal operating
adjustments. This reserve was made based on management's' estimates, and does
not reflect a change in the Company's commitment to pursue the matter to a
successful conclusion.
Billable minutes of use (MOUs) were approximately 69.7 million in the third
quarter of 1997 compared to approximately 3.1 billion in the third quarter of
1998. Year-to-date MOUs were 78.4 million in the nine-month period ended
September 30, 1997 compared to 6.4 billion in the nine-month period ended
September 30, 1998. Billable trunks at September 30, 1998 were 29,981, which
represents an increase of more than 27,000 over the number of trunks at
September 30, 1997. Equivalent access lines increased from 15,504 at September
30, 1997 to 152,018 at September 30, 1998. Equivalent Access Lines is a term
used by US LEC to quantify the size of its network. During the quarter ending
September 30, 1998, the Company modified the ratio of lines per trunk used in
calculating Equivalent Access Lines. (See note below)
Note: Equivalent Access Lines are 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 five and adding to the result the number of
its separate access lines in service. The decision to use five as the multiplier
is based on management's experience, which now 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 2,000 seconds during the busy hour
(or approximately 55.6% of capacity during the busy hour) or approximately five
times use during the busy hour of a typical business line. Beginning in the
third quarter, management changed the multiplier that it uses in the calculation
of EAL from six to five in order to reflect changes in the usage of its network.
Cost of services is comprised primarily of leased transport, facility
installation, commissions and usage charges. Cost of services increased from
$1.1 million, or 70.3% of revenue, for the quarter ended September 30, 1997, to
$7.3 million, or 32.7% of revenue, for the quarter ended September 30, 1998, and
from $1.8 million, or 103.0% of revenue, to $21.3 million, or 39.2% of revenue,
for the comparable year-to-date periods. This increase was primarily a result of
the increase in the size of US LEC's network and increased usage by its
customers. During the third quarter, the Company continued to evaluate its
network cost accruals and an adjustment was made reducing network cost by $2.6
million. This adjustment represents the difference between the remaining
invoices expected to be paid for certain prior periods compared to the accrual
remaining for the same periods. Reported results are net of these and other
normal operating adjustments.
Selling, general and administrative expenses for the third quarter 1998
increased to $6.7 million, or 30% of revenue, compared to $1.3 million, or 85%
of revenue for the third quarter 1997. These expenses increased to $16.9 million
for the first nine months of 1998, or 31% of revenue, compared to $3.4 million,
or 193% of revenue for the comparable period in 1997. These increases were
primarily a result of costs associated with developing and expanding the
infrastructure of the Company as it expands into new markets, such as expenses
associated with personnel, sales and marketing, occupancy, administration and
billing and also legal expenses associated with the BellSouth litigation.
Depreciation and amortization for the quarter and year-to-date for 1998
increased to $1.5 million from $0.1 million and to $2.9 million from $0.2
million, respectively, over the comparable 1997 periods due to the increase in
depreciable assets in service related to US LEC's network expansion.
Depreciation and amortization will continue to increase in conjunction with
spending on capital asset deployment related to US LEC's network expansion.
10
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Interest income for the quarter and year-to-date periods in 1998 increased over
1997 by $0.7 million and $1.4 million, respectively, as a result of investing
the proceeds from the Company's initial public offering.
Interest expense for the quarter and year-to-date periods in 1998 decreased from
comparable 1997 periods by $119,000 and $83,000, respectively. These decreases
were primarily due to the full repayment of $3.3 million in notes payable in
June of 1998.
Provision for income taxes for the quarter and year-to-date periods in 1998 is
$3.0 million and $5.8 million, respectively, and is based on a 40% effective tax
rate.
As a result of the foregoing, net income for the three months and nine months
ended September 30, 1998 amounted to $4.5 million, or $.16 per share (diluted),
and $8.6 million, or $.34 per share (diluted), respectively, compared to a net
loss of ($1.1 million), or ($.06) per share (diluted), and ($3.9 million), or
($.22) per share (diluted), for the comparable periods in 1997, respectively.
Earnings before interest, taxes, depreciation and amortization ("EBITDA") for
the quarter and year-to-date for 1998 increased to $8.3 million from a loss of
($0.8) million and to $16.1 million from a loss of ($3.4) million, respectively,
over the comparable 1997 periods. 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. However, EBITDA is not necessarily comparable with
similarly titled measures for other companies.
LIQUIDITY AND CAPITAL RESOURCES
US LEC's business is capital intensive and its operations will require
substantial capital expenditures for the purchase and installation of network
switches, related electronic equipment and facilities. The Company's capital
expenditures were $38.5 million and $3.3 million for the nine months ended
September 30, 1998 and 1997, respectively. The Company anticipates that it will
have substantial capital requirements in connection with its planned expansion
into additional locations during 1998, 1999 and beyond. Funding for expansion
beyond the Company's initial network deployment may require additional
financing. There can be no assurance that the Company will be able to secure
additional financing in amounts or under terms acceptable to the Company. Should
the Company receive payment of a significant portion of the outstanding
receivable due from BellSouth, the Company believes no additional financing will
be necessary to fulfill the Company's initial expansion.
Cash used in operating activities was approximately $14.6 million for the nine
months ended September 30, 1998 compared to $3.5 million during the comparable
1997 period. The increase in cash used in operating activities was primarily due
to a $37.9 million increase in accounts receivable (net of receivable
allowance), offset by an increase in net income of $12.6 million, an increase in
depreciation of $2.7 million and an $11.1 million increase in accrued expenses.
Substantially all of the Company's accounts receivable at September 30, 1998
represented amounts due from BellSouth for reciprocal compensation, facility
charges, intraLATA toll and other charges. Management expects receivables due
from BellSouth to continue to increase until the pending issues with BellSouth
are resolved. (See Note 5 to the condensed consolidated financial statements
appearing elsewhere in this report for a discussion of certain contingencies
associated with reciprocal compensation and other amounts due from Bell South).
The increase in depreciation is due to the increase in depreciable assets in
service related to US LEC's network expansion. The increase in accrued expenses
was primarily the result of an increase in accrued network costs, accrued
compensation and other accrued expenses related to the Company's expansion.
11
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YEAR 2000
Many computer systems will experience difficulty processing dates beyond the
year 1999 and will need to be modified prior to the year 2000. Failure to make
such modifications could result in system failures or miscalculations causing a
disruption of operations. Most of the Company's information technology purchases
were made after March of 1997 and, since the Company's systems are relatively
new and there were no legacy systems to integrate, the Company believes its
internal software and hardware systems will function properly with respect to
dates in the year 2000 and thereafter. The Company, therefore, does not expect
it's year 2000 compliance cost to exceed $100 thousand.
The Company will begin conducting verification testing of all its internal
information technology and information systems beginning in 1998. The testing
will be a multi-phased process which will include, but not be limited to,
setting the system clocks to simulate several key dates and times in the year
2000, then performing daily activities. The infrastructure, servers and
workstations, as well as software systems will be tested and validated using
this process.
While the Company believes that its hardware and software applications are year
2000 compliant, there can be no assurance until the year 2000 occurs that all
systems will then function adequately. Further, while most of the Company's
significant suppliers and vendors have advised the Company that they are or
anticipate being year 2000 compliant, if the software applications of local
exchange carriers, long distance carriers, service providers or others on whose
services the Company depends on are not year 2000 compliant, a material adverse
effect on the Company's financial condition and results of operations could
result. The Company has not yet established a contingency plan in the event its
suppliers and vendors are not year 2000 compliant.
PART II OTHER INFORMATION
Item 1. Legal Proceedings
US LEC is not currently a party to any material legal proceedings, other than
the NCUC and U.S. District Court proceedings related to reciprocal compensation
and other amounts due from BellSouth. Note 5 to the Company's condensed
consolidated statements included elsewhere in this report is incorporated by
reference into the Company's response to this item.
Item 2. Changes in Securities and Use of Proceeds
Recent Sales of Unregistered Securities
None in the third quarter ending September 30, 1998.
Use of Proceeds from Registered Securities
On February 13, 1998, US LEC filed a Registration Statement to register up to
6,325,000 shares of its Class A Common Stock (the "Common Stock") for sale by
the Company. In April and May 1998, the Company completed an offering of these
6,325,000 shares (the "Equity Offering"). The net proceeds to the Company from
the Equity Offering were approximately $87.1 million, after deducting
underwriting discounts and commissions of $6.6 million and offering expenses of
$1.1 million. Since receiving these proceeds, the Company had used approximately
$48 million of such net proceeds together with proceeds from prior capital
contributions as follows: (i) $34.2 million for the purchase of property and
equipment, (ii) $3.8 million to repay indebtedness to two stockholders,
including accrued interest and (iii) the balance for general corporate purposes.
12
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Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Securities Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit No. Description
----------- -----------
3.1 Restated Certificate of Incorporation*
3.2 By-laws*
3.3 Amendment No. 1 to By-laws*
11.1 Statement Regarding Computation of
Earnings per Share**
27 Financial Data Schedule
* Incorporated by reference to the corresponding exhibit
to the Company's Registration Statement on Form S-1
(File No. 333-46341).
** Incorporated by reference to the Company's Condensed
Consolidated Statements of Operations appearing in
Part I of this report.
(b) Form 8-K: None
13
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
US LEC Corp.
By:_______________________
Michael K. Robinson
Executive Vice President-Finance and Chief
Financial Officer
14
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0001054290
<NAME> US LEC
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 38,017
<SECURITIES> 0
<RECEIVABLES> 53,186
<ALLOWANCES> 6,007
<INVENTORY> 0
<CURRENT-ASSETS> 83,948
<PP&E> 52,936
<DEPRECIATION> 3,031
<TOTAL-ASSETS> 134,320
<CURRENT-LIABILITIES> 25,744
<BONDS> 0
0
0
<COMMON> 274
<OTHER-SE> 108,302
<TOTAL-LIABILITY-AND-EQUITY> 134,320
<SALES> 0
<TOTAL-REVENUES> 54,269
<CGS> 0
<TOTAL-COSTS> 21,306
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 224
<INCOME-PRETAX> 14,396
<INCOME-TAX> 5,784
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,612
<EPS-PRIMARY> 0.35
<EPS-DILUTED> 0.34
</TABLE>
