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, 2000
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.)
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)
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 May 12, 2000, there were 10,812,266 shares of Class A Common Stock and
16,834,270 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
Condensed Consolidated Statements of Operations - Three months
ended March 31, 2000 and 1999
Condensed Consolidated Balance Sheets - March 31, 2000 and
December 31, 1999
Condensed Consolidated Statements of Cash Flows - Three months
ended March 31, 2000 and 1999
Condensed Consolidated Statement of Stockholders' Equity - Three
months ended March 31, 2000
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 SECURITY HOLDERS
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES
2
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US LEC CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS
ENDED MARCH 31,
--------------------
2000 1999
-------- --------
Revenue, Net $ 25,363 $ 36,212
Cost of Services 11,051 15,762
-------- --------
Gross Margin 14,312 20,450
Selling, General and Administrative Expenses 16,013 9,666
Loss on Resolution of Disputed Revenue 55,345 -
Depreciation and Amortization 4,393 2,320
-------- --------
Earnings (Loss) from Operations (61,439) 8,464
Other (Income) Expense
Interest Income (114) (456)
Interest Expense 2,004 491
-------- --------
Earnings (Loss) Before Income Taxes (63,329) 8,429
Income Tax Provision (23,727) 3,414
-------- --------
Net Earnings (Loss) $(39,602) $ 5,015
======== ========
Net Earnings (Loss) Per Common Share:
Basic $ (1.44) $ 0.18
======== ========
Diluted $ (1.44) $ 0.18
======== ========
Weighted Average Number of Shares Outstanding:
Basic 27,513 27,422
======== ========
Diluted 27,513 28,206
======== ========
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
3
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US LEC CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
(UNAUDITED)
MARCH 31, DECEMBER 31,
2000 1999
--------- ---------
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents $ 6,016 $ 15,174
Restricted cash 1,593 1,173
Accounts receivable (net of allowance of $242 at
March 31, 2000 and $40,074 at December 31, 1999) 84,770 193,943
Prepaid expenses and other assets 4,388 2,979
--------- ---------
Total current assets 96,767 213,269
Property and Equipment, Net 131,935 102,002
Deferred Income Taxes 10,248 -
Other Assets 5,232 4,829
--------- ---------
Total Assets $ 244,182 $ 320,100
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 34,395 $ 13,050
Deferred revenue 1,637 1,702
Accrued network costs 11,451 12,911
Accrued commissions, net - related party - 22,809
Deferred income taxes 10,248 15,160
Commissions payable 24,655 23,702
Accrued expenses - other 6,775 10,826
--------- ---------
Total current liabilities 89,161 100,160
--------- ---------
Long-Term Debt 92,000 72,000
Deferred Income Taxes - 8,796
Other Liabilities - Noncurrent 304 274
Stockholders' Equity
Common stock-Class A, $.01 par value (72,925 authorized
shares, 10,693 outstanding at March 31, 2000) 107 104
Common stock-Class B, $.01 par value (17,075 authorized
shares, 16,834 outstanding at March 31, 2000) 168 171
Additional paid-in capital (see Note 7) 72,065 108,665
Retained earnings (deficit) (9,623) 29,930
--------- ---------
Total stockholders' equity 62,717 138,870
--------- ---------
Total Liabilities and Stockholders' Equity $ 244,182 $ 320,100
========= =========
</TABLE>
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
4
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US LEC CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS) (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
2000 1999
-------- --------
<S> <C> <C>
OPERATING ACTIVITIES
Net earnings (loss) $(39,602) $ 5,015
-------- --------
Adjustments to reconcile net earnings (loss) to net cash used in operating activities:
Depreciation and amortization 4,393 2,320
Accounts receivable allowance (833) 6,019
Loss on resolution of disputed revenue 55,345 -
Disposal of property & equipment 3 -
Deferred compensation 49 51
Deferred income taxes (23,727) 3,414
Changes in assets and liabilities which provided (used) cash:
Accounts receivable (4,307) (33,920)
Prepaid expenses and other assets (1,979) 933
Other assets (565) (37)
Accounts payable (270) (2,673)
Deferred revenue (65) 100
Accrued network costs (2,311) 5,254
Customer commissions payable 953 3,415
Accrued expenses - other (1,375) 141
-------- --------
Total adjustments 25,311 (14,983)
-------- --------
Net cash used in operating activities (14,291) (9,968)
-------- --------
INVESTING ACTIVITIES
Purchase of property and equipment (14,426) (10,562)
Restricted cash (420) -
-------- --------
Net cash used in investing activities (14,846) (10,562)
-------- --------
FINANCING ACTIVITIES
Proceeds from exercise of stock options and warrants 158 31
Proceeds from long-term debt 20,000 10,000
Payment of loan fees (179) -
-------- --------
Net cash provided by financing activities 19,979 10,031
-------- --------
DECREASE IN CASH AND CASH EQUIVALENTS (9,158) (10,499)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 15,174 41,965
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 6,016 $ 31,466
======== ========
SUPPLEMENTAL CASH FLOW DISCLOSURES
Cash Paid for Interest $ 2,072 $ 327
======== ========
</TABLE>
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
5
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US LEC CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2000
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
CLASS A CLASS B ADDITIONAL RETAINED
COMMON STOCK COMMON STOCK PAID-IN CAPITAL EARNINGS TOTAL
------------ ------------ --------------- -------- ---------
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1999 $ 104 $ 171 $ 108,665 $ 29,930 $ 138,870
Exercise of stock options and warrants - - 181 - 181
Conversion of Class B common stock
to Class A common stock 3 (3)
Tax effect related to warrants and options - - 228 - 228
Unearned Compensation - Stock Options - - - 49 49
Distribution to Shareholder (see Notes 6 and 7) - - (37,009) - (37,009)
Net loss - - - (39,602) (39,602)
--------- --------- ---------- --------- ----------
BALANCE, MARCH 31, 2000 $ 107 $ 168 $ 72,065 $ (9,623) $ 62,717
========= ========= ========= ========= =========
</TABLE>
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
6
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US LEC CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(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, 2000 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2000. The balance sheet at December 31, 1999 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, as
amended, for the year ended December 31, 1999, which is on file with the U.S.
Securities and Exchange Commission (the "SEC"). Certain amounts in the 1999
financial statements have been reclassified to conform to the 2000 presentation.
2. RESTRICTED CASH
The restricted cash balance as of March 31, 2000 and December 31, 1999
serves as collateral for letters of credit related to certain facility leases.
The March 31, 2000 balance also includes funds held in escrow related to certain
facility lease termination agreements.
3. EARNINGS (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE
Earnings (loss) per common and common equivalent share are based on net
income (loss) 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 period ended March 31, 2000 and 1999 were as
follows:
THREE MONTHS
ENDED MARCH 31,
2000 1999
------ ------
Basic Weighted Average Number of Shares Outstanding 27,513 27,422
Dilutive Stock Options - 536
Dilutive Stock Warrants - 248
------ ------
Diluted Weighted Average Number of Shares Outstanding 27,513 28,206
====== ======
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS --- (CONTINUED)
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.
5. LONG-TERM DEBT
In December 1999, the Company amended its existing senior secured loan
agreement increasing the amount available from $75.0 million to $150.0 million.
The credit facility is comprised of (i) a $125.0 million revolving credit
facility with a term of 18 months with an option that permits the Company to
convert it to a six-year term loan at the end of the 18 month period and (ii) a
$25.0 million reducing revolving credit facility with a six-year term. The
interest rate for the facility is a floating rate based, at the Company's
option, on a base rate (as defined in the loan agreement) or the London
Interbank Offered Rate (LIBOR), plus a specified margin. The amount outstanding
under the credit facility at March 31, 2000 was $92.0 million. Advances under
the agreement as of March 31, 2000 bear interest at an annual rate of
approximately 10%. The credit facility is subject to certain financial
covenants, the most significant of which relate to the maintenance of levels of
revenue, earnings and debt ratios. The credit facility is secured by a pledge of
the capital stock of the Company's principal operating subsidiaries and a
security interest in a substantial portion of the Company's and its operating
subsidiaries' equipment, receivables, leasehold improvements and general
intangibles. Proceeds from the credit facility have been and will be used to
fund capital expenditures and working capital requirements and for other general
corporate purposes.
6. COMMITMENTS AND CONTINGENCIES
THE METACOMM DECISION - As the Company has previously reported,
BellSouth Telecommunications, Inc. ("BellSouth") began a proceeding in September
1998 before the North Carolina Utilities Commission ("NCUC") seeking to be
relieved of any obligation under its interconnection agreements with the Company
to pay reciprocal compensation for traffic related to the network operated by
Metacomm, LLC ("Metacomm"), a customer of both the Company and BellSouth. On
March 31, 2000, the NCUC issued an order in this proceeding that relieves
BellSouth from paying reciprocal compensation to the Company for any minutes of
use attributable to Metacomm network traffic and requires the Company to cease
billing BellSouth reciprocal compensation for minutes of use attributable to the
Metacomm or any similar network (the "March 31 Order"). The March 31 Order does
not affect in any way the NCUC's order of February 1998 requiring BellSouth to
pay reciprocal compensation to the Company for Internet service provider ("ISP")
traffic in North Carolina (the "NCUC ISP Order"). It relates solely to traffic
on Metacomm's and a long-inactive network in North Carolina (the only state in
which Metacomm operates). The March 31 Order also has no legal effect on the
Company's operations in any other state or its pending claims against BellSouth
for reciprocal compensation for ISP and other traffic in Florida, Georgia and
Tennessee. Although the company intends to comply with the March 31 order, it
has not yet made a decision to seek an appeal.
As a result of the March 31 Order, the Company has recorded a pre-tax,
non-recurring, non-cash charge of approximately $55 million. The charge is
composed of the write-off of approximately $153 million in receivables related
to reciprocal compensation revenue offset by previously established reserves of
$39 million and a reduction of $59 million in commissions payable to Metacomm.
The amounts are estimated based on a methodology that must be agreed to by the
NCUC. Final figures are expected in the second quarter of 2000 when the Company
expects to true-up this charge.
8
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS --- (CONTINUED)
The Company had previously recorded $21 million of advances to Metacomm
for commissions payable on reciprocal compensation revenue and a $16 million
receivable for services provided to Metacomm. These amounts are being treated
for financial reporting purposes as a distribution to stockholder and are a
reduction in additional paid-in capital on the accompanying balance sheet.
Richard T. Aab, Chairman of US LEC and its largest shareholder, indirectly
controls Metacomm, and has assured the Company that these amounts will be paid
no later than March 31, 2001. The Company's audit committee and Mr. Aab are
finalizing the terms of such payment. The payments will be credited to
additional paid in capital.
OTHER DISPUTED RECIPROCAL COMPENSATION REVENUE - In addition to the
NCUC proceeding involving Metacomm, the Company is a party to the following
material proceedings in which it seeks collection of outstanding amounts owed by
incumbent local telephone companies, primarily BellSouth, for reciprocal
compensation, including reciprocal compensation related to traffic terminating
to ISPs and other customers:
NORTH CAROLINA -- On February 26, 1998, following a petition by the
Company, the NCUC ordered BellSouth to bill and pay for all ISP-related traffic
(defined above, the "NCUC ISP Order"). 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 ISP 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. In June 1999, the U.S. District Court
dismissed BellSouth's petition without prejudice and remanded back to the NCUC
for further review. Following the U.S District Court's remand, on June 22, 1999,
the NCUC denied BellSouth's request for a further stay of the NCUC ISP Order.
Other than denying BellSouth's request for a further stay, the only
action taken by the NCUC with respect to the remand from the U.S. District Court
is that the NCUC filed with the U.S. Fourth Circuit Court of Appeals (the "4th
Circuit") a notice of appeal of the U.S. District Court's order that rejected
the NCUC's defenses, including its defense that the 11th Amendment to the United
States Constitution bars BellSouth from making the NCUC a party to our
proceeding in the federal courts. The Company has also appealed and the United
States Justice Department has intervened in the appeal. The appellate hearing on
this matter occurred in early May, 2000, and the parties are currently preparing
post-hearing briefs. The Company cannot predict when the 4th Circuit will render
its decision on this appeal.
On March 21, 2000, the NCUC ordered BellSouth to pay to the Company all
reciprocal compensation owing to the Company for traffic terminated in North
Carolina (including traffic terminated to ISPs), other than traffic related to
Metacomm. This order was issued in connection with the on-going proceeding
before the NCUC filed in September 1998 by the Company in which it seeks payment
of reciprocal compensation not related to Metacomm or to traffic terminated to
ISPs, and of other amounts owing to the Company. The Company is currently
working with BellSouth to determine the amount due under the March 21, 2000
order.
On July 16, 1999, the Company received a payment of $11.2 million from
BellSouth representing a portion of the amounts due the Company for ISP
reciprocal compensation in North Carolina. In making the payment, BellSouth
stated that it was for ISP traffic the NCUC had ordered it to pay for in the
NCUC ISP Order, including late fees, and that it was reserving all of its appeal
rights with respect to the payment. BellSouth also stated that this payment did
not include any amounts at issue in its September 1998 NCUC proceeding regarding
Metacomm. This partial payment did not cover all outstanding amounts the Company
claims are due from BellSouth in North Carolina and other states the Company
serves. In addition, BellSouth has from time to time made payments to US LEC for
reciprocal compensation related to traffic terminated in North Carolina, but the
Company believes that the total amount BellSouth has paid to US LEC for traffic
terminated to ISPs in North
9
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS --- (CONTINUED)
Carolina through March 31, 2000 is less than $13 million (including the $11.2
million payment referenced above).
GEORGIA -- On June 30, 1999, the Company filed a complaint against
BellSouth before the Georgia Public Service Commission ("GAPSC"). The hearing
with relation to this complaint concluded January 21, 2000. The Company
anticipates receiving the GAPSC's ruling by the end of June, however there is no
deadline for the decision.
FLORIDA -- On July 2, 1999, the Company filed a complaint against
BellSouth before the Florida Public Service Commission ("FLPSC"). There is no
hearing scheduled for this matter at this time.
TENNESSEE -- On August 6, 1999, the Company filed a complaint against
BellSouth before the Tennessee Regulatory Authority ("TRA"). There is no hearing
scheduled for this matter at this time.
Management believes that the Company will ultimately obtain favorable
results in the state proceedings described above before the GAPSC, FLPSC and the
TRA and in the pending appeal of the NCUC ISP Order. Management's belief is
supported by the determinations of state regulatory bodies and by courts hearing
appeals of the state regulatory decisions, which are discussed below,
notwithstanding the jurisdictional position on ISP traffic taken by the FCC in
February 1999, which has now been vacated, also discussed below. However,
BellSouth may elect to initiate additional proceedings (by way of appeal or
otherwise) challenging amounts owed to the Company. In this regard, BellSouth
recently has asserted a variety of other objections to paying portions of the
reciprocal compensation billed by the Company. They include assertions that US
LEC has miscalculated late payment fees due from BellSouth and that the Company
has billed reciprocal compensation using the wrong rates. The Company believes
BellSouth has asserted these issues and will attempt to raise further issues in
order to avoid or delay payment, and that the Company will obtain favorable
outcomes to these disputes.
FCC'S ISP RULING AND RELATED PROCEEDINGS -- In February, 1999, the FCC
issued a declaratory ruling (the "ISP Ruling") which concluded that for
jurisdictional purposes most calls delivered to ISPs should be deemed to
continue to Internet web sites, which are often located in other states. Thus,
the FCC ruled that such calls are jurisdictionally "interstate" in nature.
However, the FCC further declared that where parties have previously agreed in
interconnection agreements that reciprocal compensation must be paid for traffic
bound for ISPs, the parties should be bound by those agreements, as interpreted
and enforced by state regulatory bodies. The FCC also recognized that some
commissions might reconsider their decisions in light of its ruling.
Significantly, on March 24, 2000, the U.S. Circuit Court for the District of
Columbia (the "D.C. Circuit") vacated the FCC's ISP Ruling. The FCC currently
has before it comments filed in a rule-making proceeding in which the FCC seeks
to determine the method and the rate for inter-carrier compensation.
To date, state regulatory bodies in at least twenty-eight states have
considered the effect of the FCC's ISP Ruling and have overwhelmingly reaffirmed
their earlier decisions requiring payment of reciprocal compensation for this
type of traffic or for the first time determined that such compensation is due.
Included among these states are Alabama, Florida, Georgia and Tennessee, which
together with North Carolina (see discussion above) represent the only states in
BellSouth's operating territory where the Company has meaningful operations at
March 31, 2000. In this regard, the Alabama Public Service Commission concluded
that the treatment of ISP traffic as local was so prevalent in the industry at
the time BellSouth entered into interconnection agreements with CLECs that, if
it was so intended, BellSouth had an obligation to negate such local treatment
in the agreements by specifically delineating that ISP traffic was not local
traffic subject to the payment of reciprocal compensation. The FLPSC reached a
similar conclusion. The GAPSC and the TRA have also reaffirmed decisions that
reciprocal compensation is owed for calls to ISPs. Two BellSouth states - South
Carolina and Louisiana - have ruled that reciprocal compensation is not due for
traffic to ISPs. These decisions which came before the FCC's ISP Ruling was
vacated by the D.C. Circuit, represent a view adopted by very few other states,
10
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS --- (CONTINUED)
and have been appealed. (The Company does not currently provide local service in
Louisiana and has no reciprocal compensation recorded to date for traffic in
South Carolina or Louisiana.)
State and federal courts considering the issue on appeal have also
overwhelmingly supported the position that reciprocal compensation is due for
traffic terminated to ISPs. Included among these are decisions of the U.S.
Circuit Courts of Appeal for the Fifth, Seventh and Ninth Circuits, all of which
considered the issue in light of the FCC's ISP Ruling and affirmed the decision
of the state regulatory body that reciprocal compensation was owing for traffic
terminated to ISPs. Most recently, on May 3, 2000, the U.S. District Court for
the Northern District of Georgia affirmed four decisions of the GAPSC in which
the GAPSC determined that reciprocal compensation is due for traffic terminated
to ISPs.
If a decision adverse to the Company is issued in any of these
proceedings by any of the state commissions or by the 4th Circuit, or in any
appeal or review of a favorable decision, or if either the FCC or any of the
applicable state commissions was 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. Management estimates the Company's gross trade
accounts receivable as of March 31, 2000 included approximately $35 million of
earned but uncollected disputed reciprocal compensation related to ISP traffic.
EXISTING BELLSOUTH INTERCONNECTION AGREEMENTS -- In June 1999, the
Company adopted an existing agreement to extend local interconnection with
BellSouth replacing the previous interconnection agreement, which expired on
June 15, 1999. The adopted interconnection agreement with BellSouth expired on
December 31, 1999 but continues in force until new interconnection agreements
are reached. The new agreements, once they are entered into, will be effective
as of January 1, 2000. BellSouth filed petitions for arbitration in all nine
states in BellSouth operating territory seeking to obtain state-ordered
interconnection agreements, but the Company anticipates that it will be able to
avoid the arbitration process by adopting interconnection agreements that are
either currently in effect or which will result from pending arbitrations
involving other CLECs. The Company's ability to obtain favorable terms for
interconnection following December 31, 1999 in its principal states of operation
will depend on a number of factors, including decisions of the FCC and state
regulatory authorities. However, the Company intends to pursue such agreements
vigorously and does not anticipate any interruption in interconnection service.
The Company does anticipate that any such new interconnection agreements will
provide for reciprocal compensation at rates significantly lower than in the
Company's current interconnection agreement. Management has estimated likely
reciprocal compensation rates based upon currently effective interconnection
agreements of other CLECS.
GTE RECIPROCAL COMPENSATION DISPUTE - In addition to the proceedings
involving BellSouth which are discussed above, in February 2000, the Company
received payment from GTE South Incorporated ("GTE") for reciprocal compensation
for traffic in North Carolina, including ISP traffic. This payment was pursuant
to a commercial arbitration award rendered January 4, 2000 resulting from a
proceeding before the American Arbitration Association. GTE was ordered to pay
US LEC for all reciprocal compensation for the period ending September 1999
(approximately $650,000). GTE has appealed the decision of the arbitrator to the
U.S. District Court for the Eastern District of North Carolina. Management
believes that GTE will not be successful in this appeal, but cannot predict when
the court will issue its decision. In addition, the Company has filed for
arbitration to resolve its reciprocal compensation dispute with GTE for periods
after September 1999. Although the Company cannot predict when this dispute will
be resolved, management anticipates a favorable arbitration ruling.
DISPUTED ACCESS REVENUES - In February 2000, the Company filed suit in
U.S. District Court for the Western District of North Carolina against Sprint
Communications Company L.P. ("Sprint"). This action seeks to collect amounts
owed to the Company for access charges for intrastate and interstate traffic
which was either
11
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS --- (CONTINUED)
handed off to Sprint by the Company or terminated to the Company by Sprint. As
of March 31, 2000, Sprint owed the Company $4.3 million in access charges.
Sprint has refused to pay the amounts invoiced by the Company on the basis that
the rates are higher than the amounts that Sprint is willing to pay. On May 5,
2000 Sprint requested referral of the interstate access charge to the FCC and
dismissal of intrastate for lack of jurisdiction. Sprint also claims it has an
implied contract to pay no more than the rate charged by ILECS in the same
state. The Company's invoices to Sprint are at the rates specified in the
Company's state and federal tariffs. The FCC recently determined that a long
distance company may not withhold access charges on the basis that it believes
the charges to be too high (MGC Communications, Inc. v. AT&T Corp., FCC Release
99-408). As such, management anticipates a favorable resolution of this matter.
7. STOCKHOLDERS' EQUITY
STOCK OPTIONS -- The Company adopted the US LEC Corp. Omnibus Stock
Plan (the "Plan") in January 1998. The number of Class A Common Stock reserved
for issuance under the Plan is 2.0 million shares. As of March 31, 2000, the
Company had granted stock options, net of forfeitures, to purchase an aggregate
of 1.9 million shares of Class A Common Stock.
ADDITIONAL PAID-IN-CAPITAL - Additional Paid-in Capital has been
reduced by $37 million representing amounts due from Metacomm, which is owned by
Richard T. Aab, a majority shareholder of the Company. The Company has been
assured by Mr. Aab that the amounts will be paid in full, by either Metacomm or
by Mr. Aab and anticipates payment of the entire $37 million by March 31, 2001.
Due to Mr. Aab's controlling position in both Metacomm and the Company, this
amount is being treated for financial reporting purposes as a distribution to
the shareholder until such amounts are paid, at which time the payment will
increase additional paid in capital as a capital contribution to the Company.
12
<PAGE>
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,
INCLUDING THE DEMAND FOR US LEC'S SERVICES, THE ABILITY OF THE COMPANY TO
INTRODUCE ADDITIONAL PRODUCTS, THE ABILITY OF THE COMPANY TO SUCCESSFULLY
ATTRACT AND RETAIN PERSONNEL, COMPETITION, UNCERTAINTIES REGARDING ITS DEALINGS
WITH ILECS, AND OTHER TELECOMMUNICATIONS CARRIERS AND FACILITIES PROVIDERS, AND
REGULATORY UNCERTAINTIES, AND 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 "FORWARD-LOOKING STATEMENTS AND RISK
FACTORS" SECTION AND ELSEWHERE IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K, AS
AMENDED, FOR THE YEAR ENDED DECEMBER 31, 1999, AND IN OTHER REPORTS WHICH ARE ON
FILE WITH THE SECURITIES AND EXCHANGE COMMISSION ("SEC").
OVERVIEW
US LEC is a rapidly growing switch-based competitive local exchange
carrier ("CLEC") that provides integrated telecommunications services to its
customers. The Company primarily serves telecommunication-intensive customers
including businesses, universities, financial institutions, professional service
firms, hospitals, enhanced service providers ("ESPs"), Internet service
providers ("ISPs"), hotels 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
currently offers local, long-distance, data/Internet and enhanced services to
customers in selected markets in North Carolina, Florida, Georgia, Tennessee,
Virginia, Alabama, Washington D.C., Pennsylvania, Mississippi, Maryland, South
Carolina and Kentucky. In addition, US LEC is currently certified to provide
telecommunications services in Delaware, New Jersey, New York, Ohio, Texas,
Connecticut and Massachusetts. US LEC's current network is comprised of eighteen
Lucent 5ESS(R) AnyMedia digital switches in Charlotte, Raleigh/Durham,
Greensboro/Winston-Salem, Orlando, Miami, Tampa/St. Petersburg, Jacksonville,
Atlanta, Memphis, Nashville, Knoxville, Chattanooga, Norfolk/Virginia Beach,
Richmond, Birmingham, Philadelphia, Northern Virginia/Washington D.C. and
Baltimore, in addition to its Alcatel MegaHub(R) 600ES switch in Charlotte.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2000 COMPARED WITH THE THREE MONTHS ENDED MARCH 31,
1999
Net revenue decreased to $25.4 million for the quarter ended March 31,
2000 from $36.2 million for the quarter ended March 31, 1999. The significant
decrease in revenue resulted from the elimination of reciprocal compensation
revenue related to Metacomm and a reduction of local interconnect rates,
partially offset by 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. Core business revenue, or revenue other than reciprocal
compensation, increased to $22.4 million for the quarter ended March 31, 2000
from $11.6 million for the quarter ended March 31, 1999. Reciprocal compensation
revenue decreased to $3.0 million for the quarter ended March 31, 2000 from
$24.6 million for the quarter ended March 31, 1999, net of an $0.0 million and
$6.0 million allowance, respectively. Given uncertainties associated with the
judicial and regulatory proceedings related to reciprocal compensation issues,
the Company recorded a $6.0 million allowance against reciprocal compensation
revenue and related receivables during the quarter ended March 31, 1999. Unless
otherwise specified, the results of operations reflected in this report are net
of these and other normal operating adjustments As a result of the resolution of
the most significant reciprocal compensation issue, the Company believes no
allowance is required as of March 31, 2000. See DISPUTED REVENUE appearing below
for a further discussion related to reciprocal compensation and other disputed
amounts.
13
<PAGE>
To quantify the size of its network, the Company uses the number of
Customer Connections for business trunks, ISP/ESP trunks and business lines.
Customer Connections at March 31, 2000, and March 31, 1999, were as follows:
business trunks increased to 54,528 from 20,096, ISP/ESP trunks decreased to
22,087 from 28,080, and business lines increased to 16,076 from 5,560. Prior to
December 1999, the Company quantified the size of its network by reporting its
number of Equivalent Access Lines in service. For a detailed explanation, please
visit the network description section of the Company's web site at
www.uslec.com.
Cost of services is comprised primarily of leased transport, facility
installation, commissions and usage charges. Cost of services decreased from
$15.8 million, or 43.5% of revenue, for the quarter ended March 31, 1999, to
$11.1 million, or 43.6% of revenue, for the quarter ended March 31, 2000. The
decrease in cost of services was primarily a result of the decrease in local
interconnect rates and the elimination of commissions paid on reciprocal
compensation revenue, partially offset by the increase in the size of US LEC's
network, and increased usage by its customers other than Metacomm.
Selling, general and administrative expenses for the first quarter 2000
increased to $16.0 million, or 63.1% of revenue, compared to $9.7 million, or
26.7% of revenue for the first quarter 1999. 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 litigation.
The loss on the resolution of disputed revenue was a result of the
March 31 NCUC Order that relieves BellSouth from paying reciprocal compensation
to US LEC for any minutes of use attributable to the network operated by
Metacomm, a customer of BellSouth and US LEC, or any similar network. As a
result of this order, the Company recorded a pre-tax non-recurring non-cash
charge of $55 million in the first quarter of 2000. This charge is composed of
the write-off of approximately $153 million in receivables related to reciprocal
compensation revenue offset by a previously established allowance of $39
million, and a reduction of approximately $59 million in reciprocal compensation
commissions payable to Metacomm. The amounts are estimated based on a
methodology that must be agreed to by the NCUC. Final figures are expected in
the second quarter of 2000 when the Company expects to true up the loss on the
resolution of disputed revenue.
Depreciation and amortization for the three months ended March 31, 2000
increased to $4.4 million from $2.3 million over the comparable 1999 period 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 three months ended March 31, 2000 was $0.1
million compared to interest income of $0.5 million for the three months ended
March 31, 1999.
Interest expense for the three months ended March 31, 2000 was $2.0
million compared to interest expense of $0.5 million for the three months ended
March 31, 1999. This increase in interest expense was primarily due to
borrowings under the Company's credit facility.
Income taxes for the three months ended March 31, 2000 were a $23.7
million benefit compared to $3.4 million expense for the three months ended
March 31, 1999. Income taxes were based on an effective tax rate of
approximately 38%. The $23.7 million benefit in the first quarter was partially
offset by a $1.4 million valuation allowance against deferred taxes relating to
the anticipated use of federal and state net operating losses.
As a result of the foregoing, net loss for the three months ended March
31, 2000 amounted to $39.6 million, or ($1.44) per share (basic) compared to net
income of $5.0 million, or $.18 per share (diluted) for the three months ended
March 31, 1999.
14
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
US LEC's business is capital intensive and its operations require
substantial capital expenditures for the purchase and installation of network
switches, related electronic equipment and facilities. The Company's cash
capital expenditures were $14.4 million and $10.6 million for the three months
ended March 31, 2000 and 1999, respectively. The Company anticipates that it
will have substantial capital requirements in connection with its planned
expansion into additional locations during the balance of 2000 and beyond. In
December 1999, the Company amended its existing senior secured loan agreement to
increase the amount available under the loan agreement from $75.0 million to
$150.0 million. As of March 31, 2000, the outstanding amount under the loan
agreement was $92.0 million. During the second quarter of 2000, the Company
repaid all amounts owed under the existing loan agreements. As a result, $150.0
million is currently available to borrow under the loan agreement.
On February 25, 2000, the Company announced it had executed a letter of
intent with affiliates of Bain Capital, Inc. (Bain) and Thomas H. Lee Partners,
L.P. (THL) to invest up to $300 million in US LEC. Under the letter of intent,
Bain and THL each agreed to invest up to $150 million in convertible preferred
stock in US LEC, subject to definitive documentation and other standard closing
conditions and approvals. Bain and THL will each receive a seat on US LEC's
board of directors. The investment will be made in two tranches yielding a 6%
dividend and at a weighted average conversion price of approximately $39. The
first tranche of $200 million will carry a conversion price of $35. During the
first year after closing, the investors, at their option, may invest up to an
additional $100 million with a conversion price of $46.50. The first tranche of
this investment for $200 million was funded early in the second quarter of 2000.
After repayment of amounts owed under the existing loan agreements, the balance
of this investment, together with the above $150 million bank facility, fully
funds the Company's planned network expansion for the foreseeable future. For
further information refer to Form 8-K filed with the SEC on May 12, 2000.
Cash used in operating activities increased to $14.3 million for the
three months ended March 31, 2000 from $9.9 million during the comparable 1999
period. The increase was primarily due to the increase in operational activities
associated with the growth of the Company. Additionally, the majority of the
Company's accounts receivable at March 31, 2000 continue to be amounts due from
BellSouth for reciprocal compensation, facility charges, toll and other charges.
Although in July 1999, the Company received a payment of $11.2 million from
BellSouth representing a portion of the amounts due the Company for reciprocal
compensation in North Carolina, management expects receivables due from
BellSouth to continue to increase until the judicial and regulatory proceedings
with BellSouth are resolved. The Company has the same expectations regarding
receivables from Sprint until those judicial proceedings are also resolved (See
DISPUTED REVENUE appearing below for a further discussion related to reciprocal
compensation and other disputed amounts due from BellSouth).
Cash used in investing activities increased to $14.8 million for the
three months ended March 31, 2000 from $10.6 million during the three months
ended March 31, 1999. The investing activities are primarily 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.
Cash provided by financing activities increased to $20.0 million for
the three months ended March 31, 2000 from $10.0 million during the first three
months of 1999. The increase was primarily due to borrowings under the Company's
credit facility as discussed above.
DISPUTED REVENUE
THE METACOMM DECISION - As the Company has previously reported,
BellSouth Telecommunications, Inc. ("BellSouth") began a proceeding in September
1998 before the North Carolina Utilities Commission
15
<PAGE>
("NCUC") seeking to be relieved of any obligation under its
interconnection agreements with the Company to pay reciprocal compensation for
traffic related to the network operated by Metacomm, LLC ("Metacomm"), a
customer of both the Company and BellSouth. On March 31, 2000, the NCUC issued
an order in this proceeding that relieves BellSouth from paying reciprocal
compensation to the Company for any minutes of use attributable to Metacomm
network traffic and requires the Company to cease billing BellSouth reciprocal
compensation for minutes of use attributable to the Metacomm or any similar
network (the "March 31 Order"). The March 31 Order does not affect in any way
the NCUC's order of February 1998 requiring BellSouth to pay reciprocal
compensation to the Company for Internet service provider ("ISP") traffic in
North Carolina (the "NCUC ISP Order"). It relates solely to traffic on
Metacomm's and a long-inactive network in North Carolina (the only state in
which Metacomm operates). The March 31 Order also has no legal effect on the
Company's operations in any other state or its pending claims against BellSouth
for reciprocal compensation for ISP and other traffic in Florida, Georgia and
Tennessee. Although the Company intends to comply with the March 31 order, it
has not yet made a decision to seek an appeal.
As a result of the March 31 Order, the Company has recorded a pre-tax,
non-recurring, non-cash charge of approximately $55 million. The charge is
composed of the write-off of approximately $153 million in receivables related
to reciprocal compensation revenue offset by previously established reserves of
$39 million and a reduction of $59 million in commissions payable to Metacomm.
The amounts are estimated based on a methodology that must be agreed to by the
NCUC. Final figures are expected in the second quarter of 2000 when the Company
expects to true-up this charge.
The Company had previously recorded $21 million of advances to Metacomm
for commissions payable on reciprocal compensation revenue and a $16 million
receivable for services provided to Metacomm. These amounts are being treated
for financial reporting purposes as a distribution to stockholder and are a
reduction in additional paid-in capital on the accompanying balance sheet.
Richard T. Aab, Chairman of US LEC and its largest stockholder, indirectly
controls Metacomm, and has assured the Company that these amounts will be paid
no later than March 31, 2001. The Company's audit committee and Mr. Aab are
finalizing the terms of such payment. The payments will be credited to
additional paid-in capital.
OTHER DISPUTED RECIPROCAL COMPENSATION REVENUE - In addition to the
NCUC proceeding involving Metacomm, the Company is a party to the following
material proceedings in which it seeks collection of outstanding amounts owed by
incumbent local telephone companies, primarily BellSouth, for reciprocal
compensation, including reciprocal compensation related to traffic terminating
to ISPs and other customers:
NORTH CAROLINA -- On February 26, 1998, following a petition by the
Company, the NCUC ordered BellSouth to bill and pay for all ISP-related traffic
(defined above, the "NCUC ISP Order"). 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 ISP 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. In June 1999, the U.S. District Court
dismissed BellSouth's petition without prejudice and remanded back to the NCUC
for further review. Following the U.S District Court's remand, on June 22, 1999,
the NCUC denied BellSouth's request for a further stay of the NCUC ISP Order.
Other than denying BellSouth's request for a further stay, the only
action taken by the NCUC with respect to the remand from the U.S. District Court
is that the NCUC filed with the U.S. Fourth Circuit Court of Appeals (the "4th
Circuit") a notice of appeal of the U.S. District Court's order that rejected
the NCUC's defenses, including its defense that the 11th Amendment to the United
States Constitution bars BellSouth from making the NCUC a party to our
proceeding in the federal courts. The Company has also appealed and the United
States Justice Department has intervened in the appeal. The appellate hearing on
this matter occurred in early May, 2000, and the parties are currently preparing
post-hearing briefs. The Company cannot predict when the 4th Circuit will render
its decision on this appeal.
16
<PAGE>
On March 21, 2000, the NCUC ordered BellSouth to pay to the Company all
reciprocal compensation owing to the Company for traffic terminated in North
Carolina (including traffic terminated to ISPs), other than traffic related to
Metacomm. This order was issued in connection with the on-going proceeding
before the NCUC filed in September 1998 by the Company in which it seeks payment
of reciprocal compensation not related to Metacomm or to traffic terminated to
ISPs, and of other amounts owing to the Company. The Company is currently
working with BellSouth to determine the amount due under the March 21, 2000
order.
On July 16, 1999, the Company received a payment of $11.2 million from
BellSouth representing a portion of the amounts due the Company for ISP
reciprocal compensation in North Carolina. In making the payment, BellSouth
stated that it was for ISP traffic the NCUC had ordered it to pay for in the
NCUC ISP Order, including late fees, and that it was reserving all of its appeal
rights with respect to the payment. BellSouth also stated that this payment did
not include any amounts at issue in its September 1998 NCUC proceeding regarding
Metacomm. This partial payment did not cover all outstanding amounts the Company
claims are due from BellSouth in North Carolina and other states the Company
serves. In addition, BellSouth has from time to time made payments to US LEC for
reciprocal compensation related to traffic terminated in North Carolina, but the
Company believes that the total amount BellSouth has paid to US LEC for traffic
terminated to ISPs in North Carolina through March 31, 2000 is less than $13
million (including the $11.2 million payment referenced above).
GEORGIA -- On June 30, 1999, the Company filed a complaint against
BellSouth before the Georgia Public Service Commission ("GAPSC"). The hearing
with relation to this complaint concluded January 21, 2000. The Company
anticipates receiving the GAPSC's ruling by the end of June, however there is no
deadline for the decision.
FLORIDA -- On July 2, 1999, the Company filed a complaint against
BellSouth before the Florida Public Service Commission ("FLPSC"). There is no
hearing scheduled for this matter at this time.
TENNESSEE -- On August 6, 1999, the Company filed a complaint against
BellSouth before the Tennessee Regulatory Authority ("TRA"). There is no hearing
scheduled for this matter at this time.
Management believes that the Company will ultimately obtain favorable
results in the state proceedings described above before the GAPSC, FLPSC and the
TRA and in the pending appeal of the NCUC ISP Order. Management's belief is
supported by the determinations of state regulatory bodies and by courts hearing
appeals of the state regulatory decisions, which are discussed below,
notwithstanding the jurisdictional position on ISP traffic taken by the FCC in
February 1999, which has now been vacated, also discussed below. However,
BellSouth may elect to initiate additional proceedings (by way of appeal or
otherwise) challenging amounts owed to the Company. In this regard, BellSouth
recently has asserted a variety of other objections to paying portions of the
reciprocal compensation billed by the Company. They include assertions that US
LEC has miscalculated late payment fees due from BellSouth and that the Company
has billed reciprocal compensation using the wrong rates. The Company believes
BellSouth has asserted these issues and will attempt to raise further issues in
order to avoid or delay payment, and that the Company will obtain favorable
outcomes to these disputes.
FCC'S ISP RULING AND RELATED PROCEEDINGS -- In February, 1999, the FCC
issued a declaratory ruling (the "ISP Ruling") which concluded that for
jurisdictional purposes most calls delivered to ISPs should be deemed to
continue to Internet web sites, which are often located in other states. Thus,
the FCC ruled that such calls are jurisdictionally "interstate" in nature.
However, the FCC further declared that where parties have previously agreed in
interconnection agreements that reciprocal compensation must be paid for traffic
bound for ISPs, the parties should be bound by those agreements, as interpreted
and enforced by state regulatory bodies.
17
<PAGE>
The FCC also recognized that some commissions might reconsider their decisions
in light of its ruling. Significantly, on March 24, 2000, the U.S. Circuit Court
for the District of Columbia (the "D.C. Circuit") vacated the FCC's ISP Ruling.
The FCC currently has before it comments filed in a rule-making proceeding in
which the FCC seeks to determine the method and the rate for inter-carrier
compensation.
To date, state regulatory bodies in at least twenty-eight states have
considered the effect of the FCC's ISP Ruling and have overwhelmingly reaffirmed
their earlier decisions requiring payment of reciprocal compensation for this
type of traffic or for the first time determined that such compensation is due.
Included among these states are Alabama, Florida, Georgia and Tennessee, which
together with North Carolina (see discussion above) represent the only states in
BellSouth's operating territory where the Company has meaningful operations at
March 31, 2000. In this regard, the Alabama Public Service Commission concluded
that the treatment of ISP traffic as local was so prevalent in the industry at
the time BellSouth entered into interconnection agreements with CLECs that, if
it was so intended, BellSouth had an obligation to negate such local treatment
in the agreements by specifically delineating that ISP traffic was not local
traffic subject to the payment of reciprocal compensation. The FLPSC reached a
similar conclusion. The GAPSC and the TRA have also reaffirmed decisions that
reciprocal compensation is owed for calls to ISPs. Two BellSouth states - South
Carolina and Louisiana - have ruled that reciprocal compensation is not due for
traffic to ISPs. These decisions which came before the FCC's ISP Ruling was
vacated by the D.C. Circuit, represent a view adopted by very few other states,
and have been appealed. (The Company does not currently provide local service in
Louisiana and has no reciprocal compensation recorded to date for traffic in
South Carolina or Louisiana.)
State and federal courts considering the issue on appeal have also
overwhelmingly supported the position that reciprocal compensation is due for
traffic terminated to ISPs. Included among these are decisions of the U.S.
Circuit Courts of Appeal for the Fifth, Seventh and Ninth Circuits, all of which
considered the issue in light of the FCC's ISP Ruling and affirmed the decision
of the state regulatory body that reciprocal compensation was owing for traffic
terminated to ISPs. Most recently, on May 3, 2000, the U.S. District Court for
the Northern District of Georgia affirmed four decisions of the GAPSC in which
the GAPSC determined that reciprocal compensation is due for traffic terminated
to ISPs.
If a decision adverse to the Company is issued in any of these
proceedings by any of the state commissions or by the 4th Circuit, or in any
appeal or review of a favorable decision, or if either the FCC or any of the
applicable state commissions was 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. Management estimates the Company's gross trade
accounts receivable as of March 31, 2000 included approximately $35 million of
earned but uncollected disputed reciprocal compensation related to ISP traffic.
EXISTING BELLSOUTH INTERCONNECTION AGREEMENTS -- In June 1999, the
Company adopted an existing agreement to extend local interconnection with
BellSouth replacing the previous interconnection agreement, which expired on
June 15, 1999. The adopted interconnection agreement with BellSouth expired on
December 31, 1999 but continues in force until new interconnection agreements
are reached. The new agreements, once they are entered into, will be effective
as of January 1, 2000. BellSouth filed petitions for arbitration in all nine
states in BellSouth operating territory seeking to obtain state-ordered
interconnection agreements, but the Company anticipates that it will be able to
avoid the arbitration process by adopting interconnection agreements that are
either currently in effect or which will result from pending arbitrations
involving other CLECs. The Company's ability to obtain favorable terms for
interconnection following December 31, 1999 in its principal states of operation
will depend on a number of factors, including decisions of the FCC and state
regulatory authorities. However, the Company intends to pursue such agreements
vigorously and does not anticipate any interruption in interconnection service.
The Company does anticipate that any such new interconnection agreements will
provide for reciprocal compensation at rates significantly lower than in the
Company's current interconnection agreement.
GTE RECIPROCAL COMPENSATION DISPUTE - In addition to the proceedings
involving BellSouth which are discussed above, in February 2000, the Company
received payment from GTE South Incorporated ("GTE") for
18
<PAGE>
reciprocal compensation for traffic in North Carolina, including ISP traffic.
This payment was pursuant to a commercial arbitration award rendered January 4,
2000 resulting from a proceeding before the American Arbitration Association.
GTE was ordered to pay US LEC for all reciprocal compensation for the period
ending September 1999 (approximately $650,000). GTE has appealed the decision of
the arbitrator to the U.S. District Court for the Eastern District of North
Carolina. Management believes that GTE will not be successful in this appeal,
but cannot predict when the court will issue its decision. In addition, the
Company has filed for arbitration to resolve its reciprocal compensation dispute
with GTE for periods after September 1999. Although the Company cannot predict
when this dispute will be resolved, management anticipates a favorable
arbitration ruling.
DISPUTED ACCESS REVENUES - In February 2000, the Company filed suit in
U.S. District Court for the Western District of North Carolina against Sprint
Communications Company L.P. ("Sprint"). This action seeks to collect amounts
owed to the Company for access charges for intrastate and interstate traffic
which was either handed off to Sprint by the Company or terminated to the
Company by Sprint. As of March 31, 2000, Sprint owed the Company $4.3 million in
access charges. Sprint has refused to pay the amounts invoiced by the Company on
the basis that the rates are higher than the amounts that Sprint is willing to
pay. The Company's invoices to Sprint are at the rates specified in the
Company's state and federal tariffs. The FCC recently determined that a long
distance company may not withhold access charges on the basis that it believes
the charges to be too high (MGC Communications, Inc. v. AT&T Corp., FCC Release
99-408). As such, management anticipates a favorable resolution of this matter.
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, 2000, investments consisted primarily of institutional
money market funds. All of the Company's long-term debt consists 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 is evaluating 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, GAPSC, FLPSC, and TRA proceedings related to reciprocal
compensation and other amounts due from BellSouth as well as the proceeding with
Sprint related to access revenues. 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.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
19
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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:
None during the quarter ended March 31, 2000.
20
<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:___________________________
May 15, 2000
Michael K. Robinson
Executive Vice President and
Chief Financial Officer
21
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