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 March 31, 1999
Commission file number 0-24061
US LEC Corp.
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(Exact name of registrant as specified in its charter)
Delaware
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(State or other jurisdiction of incorporation or organization)
56-2065535
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(I.R.S. Employer Identification No.)
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Transamerica Square, 401 North Tryon Street, Suite 1000 Charlotte, North Carolina 28202
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(Address of principal executive offices) (Zip Code)
(704) 319-1000
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(Registrant's telephone number, including area code)
N/A
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(Former name, former address and former fiscal year, if changed since last report)
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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 ( )
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As of May 6, 1999, there were 10,351,625 shares of Class A Common Stock and
17,075,270 shares of Class B Common Stock outstanding.
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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 month periods ended
March 31, 1999 and 1998
Condensed Consolidated Balance Sheets - March 31, 1999 and December 31, 1998
Condensed Consolidated Statements of Cash Flows - Three month periods ended
March 31, 1999 and 1998
Condensed Consolidated Statement of Stockholders' Equity - Three months
ended March 31, 1999
Notes to Condensed Consolidated Financial Statements
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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
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US LEC CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
1999 1998
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Revenue, Net $ 36,212 $ 13,630
Cost of Services 15,762 6,473
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Gross Margin 20,450 7,157
Selling, General and Administrative Expenses 9,666 4,426
Depreciation and Amortization 2,320 442
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Earnings from Operations 8,464 2,289
Other (Income) Expense
Interest income (456) (50)
Interest expense 491 140
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Earnings Before Income Taxes 8,429 2,199
Provision for Income Taxes 3,414 880
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Net Earnings $ 5,015 $ 1,319
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Net Earnings Per Common Share:
Basic $ 0.18 $ 0.06
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Diluted $ 0.18 $ 0.06
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Weighted Average Number of Shares
Outstanding (In Thousands):
Basic 27,422 20,695
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Diluted 28,206 21,321
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EBITDA * $ 10,784 $ 2,731
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SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
* EBITDA consists of earnings before interest income and expense, income taxes,
depreciation and amortization. See related discussion in Results of Operations
appearing elsewhere in this report.
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US LEC CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
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MARCH 31, DECEMBER 31,
1999 1998
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ASSETS
Current Assets
Cash and cash equivalents $ 31,466 $ 41,965
Restricted cash 1,171 1,167
Accounts receivable (net of allowance of $18,043 at
March 31,1999 and $12,024 at December 31, 1998) 94,115 66,214
Prepaid expenses and other assets 1,905 2,838
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Total current assets 128,657 112,184
Property and Equipment, Net 64,137 56,219
Other Assets 1,788 1,800
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Total Assets $194,582 $ 170,203
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 13,881 $ 13,509
Deferred revenue 929 829
Accrued network costs 15,120 9,866
Deferred income taxes 8,844 7,108
Accrued expenses - other 4,798 4,657
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Total current liabilities 43,572 35,969
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Deferred Income Taxes 2,936 1,259
Long-Term Debt 30,000 20,000
Stockholders Equity
Common stock-Class A, $.01 par value (72,925 authorized
shares, 10,352 outstanding at March 31, 1999) 103 103
Common stock-Class B, $.01 par value (17,075 authorized
shares, 17,075 outstanding at March 31, 1999) 171 171
Additional paid-in capital 106,833 106,800
Retained earnings 10,967 5,901
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Total stockholders' equity 118,074 112,975
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Total Liabilities and Stockholders' Equity $194,582 $ 170,203
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SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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US LEC CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
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THREE MONTHS ENDED
MARCH 30,
1999 1998
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OPERATING ACTIVITIES
Net earnings $ 5,015 $ 1,319
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Adjustments to reconcile net earnings to net cash used in operating
activities:
Depreciation and amortization 2,320 441
Accounts receivable allowance 6,019 -
Stock compensation - 75
Deferred compensation 51 23
Deferred income taxes 3,414 -
Changes in assets and liabilities which provided (used) cash:
Accounts receivable (33,920) (8,438)
Prepaid expenses and other assets 933 (225)
Other assets (37) 55
Accounts payable 742 826
Deferred revenue 100 (960)
Accrued network costs 5,254 4,108
Accrued expenses - other 141 2,414
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Total adjustments (14,983) (1,681)
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Net cash used in operating activities (9,968) (362)
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INVESTING ACTIVITIES
Purchase of property and equipment (10,562) (3,879)
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Net cash used in investing activities (10,562) (3,879)
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FINANCING ACTIVITIES
Proceeds from exercise of stock options and warrants 31 -
Proceeds from long-term debt 10,000 -
Proceeds of notes payable-stockholders - 3,289
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Net cash provided by financing activities 10,031 3,289
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NET DECREASE IN CASH AND CASH EQUIVALENTS (10,499) (952)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 41,965 3,189
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CASH AND CASH EQUIVALENTS, END OF PERIOD 31,466 $ 2,237
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SUPPLEMENTAL CASH FLOW DISCLOSURES
Cash Paid for Interest $ 327 $ -
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SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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US LEC CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 1999
(IN THOUSANDS)
(UNAUDITED)
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CLASS A CLASS B ADDITIONAL RETAINED
COMMON STOCK COMMON STOCK PAID-IN CAPITAL EARNINGS TOTAL
-------------- -------------- -------------- ----------- ------------
-------------- -------------- -------------- ----------- ------------
BALANCE, DECEMBER 31, 1998 $ 103 $ 171 $ 106,800 $ 5,901 $ 112,975
Exercise of stock options and warrants - - 31 - 31
Tax effect related to warrants and options - - 2 - 2
Unearned Compensation - Stock Options - - 51 51
Net earnings - - - 5,015 5,015
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BALANCE, MARCH 31, 1999 $ 103 $ 171 $ 106,833 $ 10,967 $ 118,074
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SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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US LEC CORP. AND SUBSIDIARIES
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 period ended March 31, 1999 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 1999. The balance sheet at December 31, 1998 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 consolidated financial statements and
related notes thereto included in the Company's Annual Report on Form 10-K for
the year ended December 31, 1998, which is on file with the U.S. Securities and
Exchange Commission (the "SEC"). Certain amounts in the 1998 financial
statements have been reclassified to conform to the 1999 presentation.
2. RESTRICTED CASH
The restricted cash balance as of March 31, 1999 and December 31, 1998
serves as collateral for letters of credit related to certain office leases.
3. EARNINGS PER COMMON AND COMMON EQUIVALENT SHARE
Earnings per common and common equivalent share is based on net income
divided by the weighted average common shares outstanding during the period.
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 month periods ended March 31, 1999 and 1998 were as follows:
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Three Months Ended March 31
1999 1998
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Basic Weighted Average Number of Shares Outstanding 27,422 20,695
Dilutive Stock Options 536 274
Dilutive Stock Warrants 248 352
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Diluted Weighted Average Number of Shares Outstanding 28,206 21,321
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4. INCOME TAXES
Income taxes are provided for temporary differences between the tax and
financial accounting basis of assets and liabilities using the liability method.
The tax effects of such differences, as reflected in the balance sheet, are at
the enacted tax rates expected to be in effect when the differences reverse.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS --- (CONTINUED)
5. LONG-TERM DEBT
In December 1998, the Company entered into a $50.0 million senior
secured loan agreement with General Electric Capital Corporation and First Union
National Bank. The amount outstanding under the loan agreement at March 31, 1999
was $30.0 million. Advances under the agreement as of March 31, 1999 bear
interest at an annual rate of approximately 8.5%.
6. COMMITMENTS AND CONTINGENCIES
DISPUTED REVENUES - 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"), a
majority of which is being disputed (approximately $27 million for the three
months ended March 31, 1999 before a $6 million allowance). Management believes
that such revenue has been earned by the Company and payments are due from
BellSouth pursuant to the interconnection agreements that BellSouth has with the
Company. However, in August 1997, BellSouth notified the Company and other
competitive local exchange carriers ("CLECs") that it considered traffic
terminated to enhanced service providers, including Internet Service Providers
("ISPs") and information service providers, to be interstate traffic, and
therefore not subject to reciprocal compensation, and that BellSouth would not
pay (or bill) reciprocal compensation under interconnection agreements for such
traffic. On February 26, 1998, following a petition by the Company, the North
Carolina Utilities Commission (the "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
judgment and other relief (including a request for an additional stay) with the
United States District Court for the Western District of North Carolina ("U.S.
District Court") pending determination of certain related issues by the Federal
Communications Commission ("FCC"). This action was filed against the Company and
the NCUC. This matter is currently pending before the U.S. District Court.
On February 26, 1999, the FCC ruled that Internet traffic represents
interstate traffic. However, they further ruled that carriers are bound by their
existing interconnection agreements, as interpreted by state utility
commissions, and thus are subject to reciprocal compensation obligations to the
extent provided by such agreements or as determined by state utility
commissions. As noted, the NCUC had ruled on February 26, 1998 in favor of the
Company with respect to the Company's existing interconnection agreement with
BellSouth.
On September 14, 1998, BellSouth filed a complaint with the NCUC seeking
to be relieved from an unspecified portion of obligations under its
interconnection agreement with the Company to pay reciprocal compensation for
traffic related to Metacomm, LLC ("Metacomm"), a customer of BellSouth and the
Company and, as of June 1998, a related party of the Company. In addition to
disputing the traffic due to its ISP nature, BellSouth has also alleged that
traffic related to Metacomm would not qualify for reciprocal compensation,
alleging that such traffic does not constitute "telecommunications" subject to
reciprocal compensation under the Telecommunications Act of 1996 and the
existing interconnection agreement. On September 14, 1998, the Company filed a
complaint with the NCUC seeking payment of facilities charges, non-ISP based
reciprocal compensation and intraLATA toll termination charges. These matters
,are currently pending before the NCUC with a hearing currently scheduled in
August 1999 and a decision expected prior to the end of 1999.
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 the Company. If a decision adverse to the Company is issued in any of these
proceedings by the U.S. District Court, the
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NCUC or the FCC, or in any appeal or review of a favorable decision by the U.S.
District Court, the NCUC, or the FCC, or in any other proceeding affecting these
issues in another forum, or if either the FCC or the NCUC were to alter its view
of reciprocal compensation, such an event could have a material adverse effect
on the Company's operating results and financial condition. The Company's net
trade accounts receivable as of March 31, 1999 included approximately $81
million (before an $18 million allowance) of earned but unpaid reciprocal
compensation, the majority of which was generated as a result of traffic related
to Metacomm.
The Company's interconnection agreements with BellSouth are scheduled to
terminate in June 1999 and the Company does not anticipate that BellSouth will
agree to renew the agreements in a manner consistent with the Company's existing
agreements as they relate to reciprocal compensation. However, the Company
intends to pursue such agreements vigorously and does not anticipate any
interruption in interconnection service. The Company's ultimate ability to
obtain such terms will depend on a number of factors, including the decision of
the FCC and state regulatory authorities.
7. STOCKHOLDERS' EQUITY
INITIAL PUBLIC OFFERING - In the second quarter of 1998, US LEC
completed an offering of 6.3 million shares of Class A Common Stock. The total
offering resulted in net proceeds of approximately $87.1 million, after
deducting underwriting discounts, commissions and offering expenses.
STOCK OPTIONS -- US LEC adopted the US LEC Corp. Omnibus Stock Plan (the
"Plan") in January 1998. At the Annual Meeting of the Stockholders held on
April 20, 1999, the Company's stockholders voted to amend the Plan to increase
the number of Class A Common Stock reserved for issuance from 1.3 million to
2.0 million shares. As of March 31, 1999, the Company had granted stock
options, net of forfeitures, to purchase an aggregate of 1.1 million shares of
Class A Common Stock.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Except for historical information, this report contains forward-looking
statements subject to uncertainties and risks, and as a result, US LEC's 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 that capacity, the need to finance operations and
future capital expenditures, the possibility of an adverse decision related to
reciprocal compensation owed to the Company by BellSouth, as well as the
Company's ability to successfully initiate operations in additional markets.
These and other applicable risks are described in the Company's Annual Report on
Form 10-K for the year ended December 31, 1998 and other filings with the SEC.
OVERVIEW
US LEC is a rapidly growing competitive local exchange carrier ("CLEC")
that provides switched local, long distance and enhanced telecommunications
services to its customers. The Company primarily serves
telecommunication-intensive customers including businesses, universities,
financial institutions, hospitals, hotels, ISPs and government agencies. US LEC
was founded in June 1996 after passage of the Telecommunications Act of 1996
("Telecom Act"), which enhanced the competitive environment for local exchange
services. US LEC initiated service in North Carolina in March 1997, becoming one
of the first CLECs in North Carolina to provide switched local exchange
services. US LEC's network is currently comprised of twelve Lucent 5ESS(R) Any
Media(TM) switches located in Charlotte, Raleigh, Greensboro, Atlanta, Memphis,
Nashville, Knoxville, Orlando, Miami, Tampa, Jacksonville, and Norfolk/Virginia
Beach, in addition to its recently installed Alcatel MegaHub(R) 600ES switch in
Charlotte. US LEC currently plans to establish switch sites in additional
markets during 1999, including Richmond, Birmingham, Philadelphia and Northern
Virginia. As of March 31, 1999 the Company had 246,440 Equivalent Access Lines
in service. See below for a detailed explanation of how the Company calculates
Equivalent Access Lines.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999 COMPARED WITH THE THREE MONTHS ENDED
MARCH 31, 1998
Net revenue increased to $36.2 million for the quarter ended March 31,
1999 from $13.6 million for the quarter ended March 31, 1998. The significant
increase in revenue of $22.6 million resulted from the Company's expansion into
new markets, an increase in the total number of customers in existing markets
and an increase in telecommunications traffic on its network. The Company's core
business revenue continued to grow, as well as the revenue related to reciprocal
compensation. (See Note 6 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 near term resolution of the
reciprocal compensation issue is expected, the Company recorded an additional
$6.0 million allowance against reciprocal compensation revenue and related
receivables during the quarter ended March 31, 1999. The results of operations
reflected in this report are net of these and other normal operating
adjustments. This allowance was made for the uncertainty associated with the
current judicial and regulatory proceedings related to this revenue, and does
not reflect a change in the Company's commitment to pursue the matter to a
successful conclusion.
Billable minutes of use were approximately 5.8 billion in the first
quarter of 1999 compared to approximately 1.4 billion in the first quarter of
1998. Billable trunks increased by 35,777 to 48,176 at March 31, 1999 compared
to 12,399 billable trunks at March 31, 1998. Equivalent Access Lines ("EALs")
increased from 75,536 at March 31, 1998 to 246,440 at March 31, 1999. Equivalent
Access Lines is a term used by US LEC to quantify the size of its network.
During 1998, the Company modified the ratio of lines per trunk used in
calculating EALs, which 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 EALs 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 of what multiplier to use is based on management's
experience, which now indicates that the typical business
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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 of 1998, management changed the multiplier that it uses in the
calculation of EALs 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
$6.5 million, or 47.5% of revenue, for the quarter ended March 31, 1998, to
$15.8 million, or 43.5% of revenue, for the quarter ended March 31, 1999. The
increase in cost of services was primarily a result of the increase in the size
of US LEC's network, increased usage by its customers and increased commissions
due to reciprocal compensation.
Selling, general and administrative expenses for the first quarter 1999
increased to $9.7 million, or 26.7% of revenue, compared to $4.4 million, or
32.5% of revenue for the first quarter 1998. 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 as well as
legal expenses associated with the BellSouth litigation.
Depreciation and amortization for the first quarter of 1999 increased to
$2.3 million from $0.4 million over the first quarter of 1998 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.
Interest income for the quarter ended March 31, 1999 increased to $0.5
million from $0.1 million over the first quarter of 1998, primarily as a result
of investing the proceeds from the Company's initial public offering.
Interest expense for the quarter ended March 31, 1999 increased to $0.5
million from $.0.1 million over the quarter ended March 31, 1998. This increase
was due to borrowings under the Company's credit facility partially offset by
the full repayment of $3.3 million in notes payable to stockholders in June of
1998.
Provision for income taxes for the quarter ended March 31, 1999 was $3.4
million, based on an effective tax rate of 40.5% and $0.9 for the quarter ended
March 31, 1998, based on an effective tax rate of 40.0%.
As a result of the foregoing, net income for the three months ended
March 31, 1999 amounted to $5.0 million, or $.18 per share (diluted) compared to
net income of $1.3 million, or $.06 per share (diluted), for the three months
ended March 31, 1998.
Earnings before interest, taxes, depreciation and amortization
("EBITDA") for the quarter ended March 31, 1999 increased to $10.8 million from
$2.7 million for the quarter ended March 31, 1998. EBITDA 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. 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 the 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 cash
capital expenditures were $10.6 million and $3.9 million for the three months
ended March 31, 1999 and 1998, respectively. The Company anticipates that it
will have substantial capital requirements in connection with its planned
expansion into additional locations 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
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outstanding receivable due from BellSouth, the Company believes no additional
financing will be necessary to fulfill the Company's existing expansion plans.
Cash used in operating activities was approximately $9.9 million for the
three months ended March 31, 1999 compared to $0.4 million during the comparable
1998 period. The increase in cash used in operating activities was primarily due
to a $19.5 million increase related to accounts receivable (net of a $6.0
million receivable allowance) offset by an increase in net income of $3.7
million, an increase in depreciation of $1.9 million and an increase in deferred
taxes of $3.4 million. The majority of the Company's accounts receivable at
March 31, 1999 represented amounts due from BellSouth for reciprocal
compensation, facility charges, toll and other charges. Management expects
receivables due from BellSouth to continue to increase until the judicial and
regulatory proceedings with BellSouth are resolved. The increase in depreciation
was due to the increase in depreciable assets in service related to US LEC's
network expansion. The increase in deferred taxes was due to timing differences
between book and tax income as of March 31, 1999.
Cash used in investing activities increased to $10.6 million for the
quarter ended March 31, 1999 from $3.9 million during the first quarter of 1998.
The increase was related to purchases of switching and related
telecommunications equipment, office equipment and leasehold improvements
associated with the Company's expansion into additional locations and markets
during 1999.
Cash provided by financing activities increased to $10.0 million for the
quarter ended March 31, 1999 from $3.3 million during the first quarter of 1998.
The increase was due to a $10.0 million advance under the Company's credit
facility which is discussed above.
YEAR 2000 READINESS DISCLOSURE
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 1997 and, because the Company's systems are
relatively new and there were no legacy systems to integrate, management
believes the Company's internal software and hardware systems will function
properly with respect to dates in the Year 2000 and thereafter. In addition,
Year 2000 issues are also addressed as the Company's network and internal
systems are upgraded in the normal course of business. As of March 31, 1999, the
Company's costs expended towards Year 2000 compliance has been minimal and it
does not expect its additional expenditures directly related to Year 2000
compliance cost to exceed $100 thousand. Management continually reassesses the
estimated costs and status of the Company's Year 2000 compliance efforts.
The Company began conducting verification testing of all its internal
information technology and information systems in 1998. The testing is a
multi-phased process which includes, but is not 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 are being tested and validated using this process. The final
phase of testing is scheduled to be completed by October 1999.
While management 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. The Company is monitoring all
key vendors and suppliers for Year 2000 compliance by various methods including,
but not limited to, gathering information from a detailed survey sent by the
Company, public domain websites, public service commission filings, and SEC
filings. 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 other local exchange carriers, long distance
carriers, service providers, competitive access providers, or others on whose
services the Company depends are not Year 2000 compliant, a material adverse
effect on the Company's financial condition and results of operations could
result. The Company is not aware of any significant vendor who may be unable to
provide services to the Company as a result of Year 2000 non-compliance. The
Company currently has a disaster recovery plan in place which will serve as a
foundation for its contingency plan in the event its suppliers and vendors are
not Year 2000 compliant. The full contingency plan is currently being developed
and will be completed in the third quarter of 1999.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
US LEC is exposed to various types of market risk in the normal course
of business, including the impact of interest rate changes on its investments
and debt. As of March 31, 1999, investments consisted primarily of institutional
money market funds. All of the Company's long-term debt consist of variable rate
instruments with interest rates that are based on a floating rate which, at the
Company's option, is determined by either a base rate or the London Interbank
Offered Rate, plus, in each case, a specified margin.
Although US LEC does not currently utilize any interest rate management
tools, it will evaluate the use of derivatives such as, but not limited to,
interest rate swap agreements to manage its interest rate risk. As the Company's
investments are all short-term in nature and its long-term debt is at variable
short-term rates, management believes the carrying values of the Company's
financial instruments approximate fair values.
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 6 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 quarter ended March 31, 1999.
USE OF PROCEEDS FROM REGISTERED SECURITIES
On February 13, 1998, US LEC filed a registration statement with the
SEC 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 has used
approximately $85 million of such net proceeds together with proceeds from prior
capital contributions as follows: (i) $54.0 million for the purchase of property
and equipment, (ii) $3.8 million to repay indebtedness to two stockholders,
including accrued interest (iii) $1.2 million for payment of debt issuance fees
and (iv) the balance for general corporate purposes necessitated by the
inability of the Company to collect earned but unpaid amounts due from BellSouth
for reciprocal compensation (see note 6 to the Company's condensed consolidated
statements included elsewhere in this report).
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
None in the quarter ended March 31, 1999.
13
<PAGE>
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
EXHIBIT NO. DESCRIPTION
11.1 Statement Regarding Computation
of Earnings per Share*
27 Financial Data Schedule (For SEC
use only)
* Incorporated by reference to the Company's
Condensed Consolidated Statements of Operations
appearing in Part I of this report.
(b) Form 8-K:
The Company filed a Current Report on Form 8-K on January 7, 1999
related to the execution of a $50 million Loan and Security Agreement,
dated as of December 30, 1998, among US LEC Corp., certain operating
subsidiaries of US LEC Corp., General Electric Capital Corporation and
First Union National Bank.
14
<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 and Chief Financial Officer
15
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