US LEC CORP, 10-Q, 2000-11-14

US LEC CORP
10-Q, 2000-11-14
TELEPHONE COMMUNICATIONS (NO RADIOTELEPHONE)

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<PAGE>

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2000

Commission file number 0-24061

US LEC Corp.
------------
(Exact name of registrant as specified in its charter)

Delaware
--------
(State or other jurisdiction of incorporation or organization)

56-2065535
----------
(I.R.S. Employer Identification No.)

Morrocroft III, 6801 Morrison Boulevard Charlotte, North Carolina 28211
------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)

(704) 319-1000
--------------
(Registrant's telephone number, including area code)

(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 November 13, 2000, there were 10,825,666 shares of Class A Common Stock
and 16,834,270 shares of Class B Common Stock outstanding.

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US LEC Corp.

Table of Contents
-----------------

<TABLE>
<S> <C>
PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Condensed Consolidated Statements of Operations -
Three and nine months ended September 30, 2000 and 1999

Condensed Consolidated Balance Sheets -
September 30, 2000 and December 31, 1999

Condensed Consolidated Statements of Cash Flows -
Nine months ended September 30, 2000 and 1999

Condensed Consolidated Statement of Stockholders'
Equity - Nine months ended September 30, 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
</TABLE>

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US LEC Corp. and Subsidiaries
Condensed Consolidated Statements of Operations
(In Thousands, Except Per Share Data)

(Unaudited)

<TABLE>
<CAPTION>
Three months Nine months
ended September 30, ended September 30,
2000 1999 2000 1999
---------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Revenue, Net $ 29,860 $ 47,348 $ 81,371 $127,113
Cost of Services 14,359 19,524 37,124 53,987
---------- --------- ---------- ----------
Gross Margin 15,501 27,824 44,247 73,126

Selling, General and Administrative Expenses 22,049 13,707 56,826 35,180
Loss on Resolution of Disputed Revenue - - 55,345 -
Depreciation and Amortization 6,201 3,124 16,268 8,121
---------- --------- ---------- ----------
Earnings (Loss) from Operations (12,749) 10,993 (84,192) 29,825

Other (Income) Expense
Interest Income (1,604) (164) (3,152) (938)
Interest Expense 1,882 785 4,996 1,952
---------- --------- ---------- ----------
Earnings (Loss) Before Income Taxes (13,027) 10,372 (86,036) 28,811

Income Tax Provision - 4,170 (23,727) 11,619
---------- --------- ---------- ----------
Net Earnings (Loss) (13,027) 6,202 (62,309) 17,192
========== ========= ========== ==========
Less: Preferred Stock Dividends 3,040 - 5,673 -

Net Earnings (Loss) Attributable to Common Stockholders $(16,067) $ 6,202 $ (67,982) $ 17,192
========== ========= ========== ==========

Net Earnings (Loss) Per Common Share:
Basic $ (0.58) $ 0.23 $ (2.46) $ 0.63
========== ========= ========== ==========
Diluted $ (0.58) $ 0.22 $ (2.46) $ 0.61
========== ========= ========== ==========
Weighted Average Number of Shares Outstanding:
Basic 27,660 27,428 27,603 27,426
========== ========= ========== ==========
Diluted 27,660 28,520 27,603 28,367
========== ========= ========== ==========
</TABLE>

See notes to condensed consolidated financial statements

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US LEC Corp. and Subsidiaries
Condensed Consolidated Balance Sheets

(In Thousands)

<TABLE>
<CAPTION>
(Unaudited)
September 30, December 31,
2000 1999
-------------- -------------
<S> <C> <C>
Assets

Current Assets
Cash and cash equivalents $ 108,985 $ 15,174
Restricted cash 1,906 1,173
Accounts receivable (net of allowance of $929 at September 30,
2000 and $40,074 at December 31, 1999) 104,925 193,943
Prepaid expenses and other assets 7,987 2,979
-------------- --------------
Total current assets 223,803 213,269

Property and Equipment, Net 177,244 102,002
Deferred Income Taxes 9,452 -
Other Assets 6,617 4,829
-------------- --------------
Total Assets $ 417,116 $ 320,100
============== ==============
Liabilities and Stockholders' Equity

Current Liabilities
Accounts payable $ 15,939 $ 13,050
Deferred revenue 2,801 1,702
Accrued network costs 10,685 12,911
Accrued commissions, net - related party - 22,809
Deferred income taxes 9,452 15,160
Commissions payable 28,446 23,702
Accrued expenses - other 10,878 10,826
-------------- --------------
Total current liabilities 78,201 100,160
-------------- --------------

Long-Term Debt 100,000 72,000
Deferred Income Taxes - 8,796
Other Liabilities - Noncurrent 3,682 274

Series A Redeemable Convertible Preferred Stock (see Note 6) 199,435 -

Stockholders' Equity
Common stock-Class A, $.01 par value (122,925 and 72,925 authorized
shares, 10,826 and 10,426 outstanding at September 30, 2000 and
December 31, 1999, respectively) 108 104
Common stock-Class B, $.01 par value (17,075 authorized shares, 16,834 and 17,075
outstanding at September 30, 2000 and December 31, 1999, respectively) 168 171

Additional paid-in capital (see Note 8) 73,405 108,665
Retained earnings (deficit) (37,883) 29,930
-------------- --------------
Total stockholders' equity 35,798 138,870
-------------- --------------
Total Liabilities and Stockholders' Equity $ 417,116 $ 320,100
============== ==============
</TABLE>

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)

<TABLE>
<CAPTION>
Nine Months Ended
September 30,
2000 1999
---------- ----------
<S> <C> <C>
Operating Activities
Net earnings (loss) $ (62,309) $ 17,192
---------- ----------
Adjustments to reconcile net earnings (loss) to net cash used in operating activities:
Depreciation and amortization 16,268 8,121
Loss on resolution of disputed revenue 55,345 -
Accounts receivable allowance (145) 21,401
Disposal of property and equipment 8 120
Deferred compensation 137 153
Deferred income taxes (23,727) 10,869

Changes in assets and liabilities which provided (used) cash:
Accounts receivable (25,149) (113,864)
Prepaid expenses and other assets (4,599) 933
Other assets (2,391) -
Accounts payable 217 11,787
Deferred revenue 1,100 661
Accrued network costs (3,077) 18,654
Customer commissions payable 4,744 -
Accrued expenses - other 5,251 5,308
---------- ----------
Total adjustments 23,982 (35,857)
---------- ----------
Net cash used in operating activities (38,327) (18,665)
---------- ----------

Investing Activities
Purchase of property and equipment (89,350) (34,356)
Restricted cash (733) (5)
---------- ----------
Net cash used in investing activities (90,083) (34,361)
---------- ----------
Financing Activities
Net proceeds from issuance of Series A Preferred Stock 193,762 -
Proceeds from exercise of stock options and warrants 662 85
Proceeds from long-term debt 120,000 20,000
Payments on long-term debt (92,000) (968)
Payment of loan fees (203) -
---------- ----------
Net cash provided by financing activities 222,221 19,117
---------- ----------
Net (Decrease) Increase in Cash and Cash Equivalents 93,811 (33,909)

Cash and Cash Equivalents, Beginning of Period 15,174 41,965
---------- ----------
Cash and Cash Equivalents, End of Period $ 108,985 $ 8,056
========== ==========
Supplemental Cash Flow Disclosures
Cash Paid for Interest $ 4,873 $ 1,816
========== ==========
</TABLE>

See notes to condensed consolidated financial statements

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US LEC Corp. and Subsidiaries
Condensed Consolidated Statement of Stockholders' Equity
For the Nine Months Ended September 30, 2000
(In Thousands)
(Unaudited)

<TABLE>
<CAPTION>
Class A Class B Additional Retained
Common Stock Common Stock Paid-in Capital Earnings (Deficit) 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 1 - 658 - 659
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 - - (31) 169 138
Distribution to stockholder (see Notes 7 and 8) - - (36,115) - (36,115)
Preferred stock dividends - - - (5,673) (5,673)
Net loss - - - (62,309) (62,309)
--------- --------- ----------- ----------- ---------
Balance, September 30, 2000 $ 108 $ 168 $ 73,405 $ (37,883) $ 35,798
========== ========== =========== =========== =========
</TABLE>

See notes to condensed consolidated financial statements

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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 and nine month periods ended September 30, 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.

Effect of Recent Accounting Pronouncements

Accounting for Derivative Instruments and Hedging Activities -
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities", as amended, is effective for
fiscal years beginning after June 15, 2000. SFAS No. 133 establishes accounting
and reporting standards for derivative instruments and hedging activities by
requiring that entities recognize all derivatives as either assets or
liabilities at fair market value on the balance sheet. The Company does not
expect the impact of the adoption of SFAS No. 133 to be material to its results
of operations as it does not currently hold any derivative instruments or engage
in hedging activities.

Revenue Recognition - The effective date for Staff Accounting Bulletin
("SAB") No. 101, "Revenue Recognition" has been delayed and must be adopted no
later than the fourth quarter of 2000. SAB No. 101 provides guidance on the
recognition, presentation and disclosure of revenue in financial statements.
Management believes this does not have a material effect on results of
operations and financial position of the Company.

2. Restricted Cash

The restricted cash balance as of September 30, 2000 and December 31,
1999 serves as collateral for letters of credit related to certain facility
leases. The September 30, 2000 balance also includes funds held in escrow
related to certain facility lease termination agreements.

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Notes to Condensed Consolidated Financial Statements --- (Continued)

3. Earnings (Loss) Per Common and Common Equivalent Share

Earnings (loss) per common and common equivalent share are based on net
income (loss), after consideration of preferred stock dividends, divided by the
weighted average number of 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 outstanding (in thousands of
shares) for the three and nine month periods ended September 30, 2000 and 1999
were as follows:

<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
2000 1999 2000 1999
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Basic Weighted Average Number of Shares Outstanding 27,660 27,428 27,603 27,426
Dilutive Stock Options - 831 - 689
Dilutive Stock Warrants - 261 - 252
---------- ---------- ---------- ---------
Diluted Weighted Average Number of Shares Outstanding 27,660 28,520 27,603 28,367
========== ========== ========== =========
</TABLE>

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.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized and are reversed at such time that
realization is believed to be more likely than not.

5. Long-Term Debt

In December 1999, the Company amended its senior secured loan agreement
to increase 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
which converts to a six-year term loan on June 30, 2001 and (ii) a $25.0 million
reducing revolving credit facility which expires in December, 2005. 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. As of September 30, 2000, the amount
outstanding under the credit facility was $100 million. Advances under the
agreement as of September 30, 2000 bear interest at an annual rate of
approximately 10.6%. 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 Company is in compliance with the
financial covenants under its amended loan agreement. 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.

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6. Series A Redeemable Convertible Preferred Stock

On April 11, 2000, the Company issued $200 million of its Series A
Redeemable Convertible Preferred Stock (the "Preferred Stock") to affiliates of
Bain Capital, Inc. (Bain) and Thomas H. Lee Partners, L.P. (THL). The Preferred
Stock earns dividends on a cumulative basis at an annual rate of 6%, payable
quarterly in shares of Preferred Stock for three years and at US LEC's option,
in cash or shares of Preferred Stock over the next seven years. Shares of the
Preferred Stock are convertible into shares of Class A Common Stock at an
initial conversion price of $35 per share. All outstanding shares of the
Preferred Stock are subject to mandatory redemption on April 10, 2010. Proceeds
to the Company, net of commissions and other transaction costs, were
approximately $194 million. 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. For the three and nine months ended September 30, 2000, the
Company has accrued $3.0 million and $5.7 million in Preferred Stock Dividends.
For further information refer to Form 8-K filed with the SEC on May 12, 2000 and
Item 2(c) of Part II of this Report.

7. 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 (the "March 31
Order") 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 as such
networks are identified in 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 network in North Carolina (the only state in which Metacomm
operated). The Company did not appeal the March 31 Order, although Metacomm is
prosecuting an appeal.

As a result of the March 31 Order, the Company recorded a pre-tax, non-
recurring, non-cash charge of approximately $55 million in the first quarter of
2000. The charge was 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.

On March 21, 2000, the NCUC issued an interim order (the "March 21 Order")
to BellSouth to pay to the Company all reciprocal compensation owing to the
Company for traffic terminated in North Carolina, other than traffic related to
Metacomm and like networks. 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's action before the NCUC to recover reciprocal compensation and other
charges for non-Metacomm/non-ISP traffic has been stayed by the NCUC while the
Company and BellSouth conduct NCUC-ordered negotiations to resolve the matter.
The amount due to the Company as a result of this proceeding will be determined
by the negotiations or subsequent ruling by the NCUC regarding the non-
Metacomm/non-ISP charges BellSouth is obligated to pay. The Company is
currently working with BellSouth to determine the

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<PAGE>

amount BellSouth will pay under the March 21, 2000 Order. Once this is
determined by negotiation or NCUC ruling, the Company will adjust the non-
recurring 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 have been treated
for financial reporting purposes as a distribution to stockholder and reduced
additional paid-in capital on the Company's balance sheet. The amount owed was
reduced by approximately $1 million in the quarter ended June 30, 2000 for
refunds due on sales and excise tax amounts previously charged on services
provided to Metacomm. The Company has filed for a refund of the sales and
excise tax from the North Carolina Department of Revenue and Internal Revenue
Service. A large portion of this refund was received early in the Fourth
Quarter of 2000. The remainder is expected to be received during the Fourth
Quarter of 2000. Richard T. Aab, Chairman of US LEC and its largest
stockholder, indirectly controlled Metacomm, and has stated that the remaining
balance will be paid no later than March 31, 2001. The Company's audit
committee and Mr. Aab are working to determine the terms of such payment. The
payments will be credited to additional paid-in capital.

Other Disputed Reciprocal Compensation Revenue - The Company is also a
party to the following material proceedings in which it seeks collection of
outstanding amounts owed by incumbent local telephone companies, primarily
BellSouth, for non-Metacomm related 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-NC") 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-NC dismissed BellSouth's petition without prejudice and remanded it back
to the NCUC for further review. Following the U.S District Court-NC's remand,
on June 22, 1999, the NCUC denied BellSouth's request for a further stay of the
NCUC ISP Order.

In addition to denying BellSouth's request for a further stay, the NCUC has
filed an appeal with the U.S. Fourth Circuit Court of Appeals (the "4th
Circuit") of the U.S. District Court-NC'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 a 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
and a similar matter involving different parties consolidated with this appeal
by the 4th Circuit occurred in May 2000. The Company cannot predict when the
4th Circuit will render its decision on this appeal.

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 non-Metacomm
related amounts the Company claims are due from BellSouth in North Carolina. 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 BellSouth has not paid the entire amount due. The total amount
BellSouth has paid to US LEC for traffic

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terminated to ISPs in North Carolina through September 30, 2000 is approximately
$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") concerning the
Company's first and second interconnection agreements with BellSouth in Georgia.
These interconnection agreements cover the period through June 1999. On May 17,
2000, the hearing officer reviewing the Company's first and second
interconnection agreements with BellSouth issued a recommended decision to the
GAPSC stating that BellSouth should be ordered to pay US LEC the disputed
reciprocal compensation at the end office rate, pending submission of evidence
by the Company showing that it is entitled to be compensated at the higher
tandem rate. On June 15, 2000, the GAPSC affirmed this recommended decision, and
issued an order requiring BellSouth to pay US LEC reciprocal compensation for
traffic to ISPs and other customers in Georgia at the end office rate (the
"GAPSC Order"). On July 12, 2000, US LEC filed evidence with the GAPSC regarding
its right to be compensated at the tandem rate. On July 14, 2000, BellSouth
filed an appeal of the GAPSC Order with the U.S. District Court for the Northern
District of Georgia ("U.S. District Court-GA") and with the Georgia Superior
Court in and for Fulton County, Georgia. BellSouth asked the Georgia state court
to cede the appeal to the U.S. District Court - GA and asked the latter court
for permission to pay amounts due into court to avoid paying US LEC pending
appeal. On July 18, 2000, the U.S. District Court- GA granted BellSouth's motion
to pay amounts due into court prior to receipt by the Company of any papers
related to that appeal. On October 2, 2000, the U.S. District Court - GA denied
the Company's request for reconsideration of the order allowing BellSouth to pay
amounts due into court. The Georgia State and Federal Courts are setting a
briefing schedule for the proceeding, and the Company and expects a decision
sometime in 2001. The GAPSC has not yet ruled on the tandem/end office rate
issue. The Company's complaint did not address the third interconnection
agreement in Georgia, which covers the period from June 1999 to December 1999.

Florida -- On July 2, 1999, the Company filed a complaint against BellSouth
before the Florida Public Service Commission ("FLPSC") seeking recovery of
reciprocal compensation for ISP and other traffic in that state. The FLPSC
will also be called upon to decide issues in dispute between the Company and
BellSouth regarding the rate at which reciprocal compensation should be paid for
some of the traffic at issue. The hearing is scheduled to take place on
February 21, 2001.

Tennessee -- On August 6, 1999, the Company filed a complaint against
BellSouth before the Tennessee Regulatory Authority ("TRA") seeking recovery of
reciprocal compensation for ISP and other traffic in that state. The TRA will
also be called upon to decide issues in dispute between the Company and
BellSouth regarding the rate at which reciprocal compensation should be paid for
some of the traffic at issue. 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 FLPSC and the TRA
and in the pending appeal of the NCUC ISP Order and the GAPSC Order with respect
to the eligibility of ISP traffic for reciprocal compensation. 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 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. In September 2000, the FLPSC issued a ruling
regarding one of these rate issues favorable to BellSouth

11
<PAGE>

in a proceeding bought by Intermedia Communications, Inc. The impact of this
ruling has not yet been determined, and the Company has been informed that
Intermedia intends to appeal the decision.

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.

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 D.C. Circuit ruled that the
FCC did not give adequate consideration to a number of facts when it found that
ISP calls were jurisdictionally interstate, including the FCC's own past
analyses of how to determine whether calls dialed to telephone numbers within
the local exchange are interstate or intrastate. The D.C. Circuit also
concluded that the FCC had failed to explain why its jurisdictional analysis had
any relevance to the issue of whether calls to ISPs should be eligible for
reciprocal compensation. The D.C. Circuit sent the case back to the FCC to give
the FCC opportunity to reconsider those questions in light of the D.C. Circuit's
ruling. On June 23, 2000, the FCC requested comments on the issues raised by
the D.C. Circuit in its remand of the ISP Ruling to the FCC. Initial comments
were filed on July 21, 2000. Reply comments were filed on August 4, 2000. The
Company cannot predict when the FCC will issue its decision on remand.

To date, state regulatory bodies in at least thirty 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 significant reciprocal
compensation disputes at September 30, 2000. In this regard, the Alabama Public
Service Commission (the "APSC") 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 APSC decision was affirmed by the United States
District Court for the Middle District of Alabama, and the GAPSC decision was
affirmed by the United States District Court of the Northern District of
Georgia. The FLPSC 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 does not have material amounts of reciprocal compensation
recorded to date for traffic in South Carolina.)

State and federal courts considering the issue on appeal have also
universally 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 is due for traffic
terminated to ISPs.

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If a decision adverse to the Company is issued in any of these proceedings
by any of the state commissions or 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 or if Congress or
any state legislature enacted legislation that ended reciprocal compensation for
ISP traffic or all local traffic, 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 September 30, 2000
included approximately $51 million of earned but uncollected disputed reciprocal
compensation related to non-Metacomm related ISP traffic.

Legislation - Recently, legislation was introduced in the United States
House of Representatives and the United States Senate that would have the effect
of eliminating all reciprocal compensation for calls to ISPs and, under some
proposals, for all local calls. A House subcommittee approved a version of this
legislation. No action has been taken in the Senate. If this or similar
legislation were to become law, it would have a material adverse effect on the
Company.

GTE Reciprocal Compensation Dispute in North Carolina - 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 thousand). GTE has challenged the decision of
the arbitrator in the U.S. District Court for the Eastern District of North
Carolina. Management believes that GTE will not be successful in this
challenge, but cannot predict when the court will issue its decision.

In addition, the Company has filed arbitration to resolve its reciprocal
compensation dispute with GTE in North Carolina for periods after September
1999. That arbitration is in the discovery phase at this time. A hearing in
this arbitration has been set for February 26th and 27th of 2001. Although
the Company cannot predict when this dispute will be resolved, management knows
of no reason why the second arbitration should have an outcome different from
the first, favorable arbitration ruling.

Existing BellSouth Interconnection Agreements -- The Company's
interconnection agreements with BellSouth in all states except North Carolina
have expired, but continue in force until new interconnection agreements are
reached. The Company is vigorously pursuing these agreements, and expects no
interruption in interconnection service as a result. In October 2000, the
Company agreed to adopt existing local interconnection agreements with BellSouth
in South Carolina, Kentucky, Louisiana and Mississippi. The Agreements are for
a term of two years and relate back to the expiration date of the prior
agreements in each state, and therefore will expire at varying dates in 2002.
The Agreements provide for reciprocal compensation at rates significantly lower
than in the Company's prior interconnection agreements. These agreements do not
provide for any reciprocal compensation payments for ISP traffic; rather, the
agreements include a true up provision whereby the parties will track that
traffic pending an order from the FCC on the issue. The Company does not have
significant amounts of reciprocal compensation in these states. The Company
continues to seek interconnection agreements with BellSouth in Florida, Georgia
and Tennessee. BellSouth filed petitions for arbitration in these states
seeking to obtain state-ordered interconnection agreements, but the Company
anticipates that it will be able to avoid or shorten the arbitration process in
these states by adopting interconnection agreements that will result from
recently concluded arbitrations involving other competitive local exchange
carriers ("CLECs"). These new agreements will be effective as of the expiration
date of the prior agreements. The Company anticipates that new interconnection
agreements in these states will also provide for significantly lower rates, but,
unlike the agreements in South Carolina, Kentucky, Louisiana and Mississippi,
the Company does not anticipate that payment of reciprocal compensation for ISP
traffic would be affected by a true up provision.

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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 September 30, 2000, Sprint owed the
Company approximately $9.3 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. Sprint claims it is not
obligated to pay more than an undefined incumbent local exchange carrier
("ILEC") rate. 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 interstate access charges on the basis
that it believes the charges to be too high while also continuing to accept the
benefits of interconnection with the local carrier without taking formal action
to challenge the rates. The FCC has ruled that AT&T was obligated to pay such
access charges due to its failure to commence a proceeding or terminate
interconnection. (MGC Communications, Inc. v. AT&T Corp., FCC Release 99-408).
This decision is now final, as AT&T did not appeal the FCC's ruling. In
addition, the FCC ruled recently in an action brought by Sprint against MGC
Communications, Inc. ("MGC") that the fact that a CLEC's filed interstate rates
exceeded those of the competing ILECs was insufficient to establish that the
CLEC's rates were excessive. The FCC dismissed Sprint's challenge to MGC's
rates. Sprint has appealed the FCC's decision to the United States Court of
Appeals for the District of Columbia Circuit, and oral argument is scheduled for
April 20, 2001. As a result of these rulings, management anticipates a
favorable resolution of the Company's dispute with Sprint.

8. 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 3.5 million shares. As of September 30, 2000, the
Company had granted stock options, net of forfeitures, to purchase an aggregate
of 2.3 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 indirectly
controlled by Richard T. Aab, a majority stockholder of the Company. The
amount due was reduced in the quarter ended June 30, 2000 by approximately $1
million for refunds due on sales and excise tax amounts previously charged on
services provided to Metacomm. The Company has filed for a refund of the sales
and excise tax from the North Carolina Department of Revenue and Internal
Revenue Service. A large portion of this refund was received early in the Fourth
Quarter of 2000, and the remainder expects to be received in the Fourth Quarter
of 2000. The Company has been assured by Mr. Aab that the remaining balance
will be paid, by either Metacomm or by Mr. Aab, and anticipates payment of the
entire amount 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 deemed distribution to the stockholder. At the time such amounts
are paid to the Company, the payment will increase additional paid-in capital as
a capital contribution to the Company.

Employee Stock Purchase Plan - The Company established an Employee Stock
Purchase Plan (ESPP) in September 2000. Under the ESPP, employees may elect to
invest up to 10% of their compensation in order to purchase shares of the
Company's Class A Common Stock at a price equal to 85% of the market value at
either the beginning or end of the offering period, whichever is less. The
number of Class A Common Stock reserved for issuance under the ESPP is 1.0
million shares.

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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 in existing and potential additional
markets, uncertainties regarding its dealings with ILECs and other
telecommunications carriers and facilities providers, regulatory uncertainties,
the possibility of adverse decisions related to reciprocal compensation and
access charges owing to the Company by BellSouth and other carriers, 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 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, Louisiana and Massachusetts. US LEC's current network is comprised
of twenty-one Lucent 5ESS(R) AnyMedia digital switches in Charlotte,
Raleigh/Durham, Greensboro/Winston-Salem, Orlando, Miami, Tampa/St. Petersburg,
Jacksonville, West Palm Beach, Atlanta, Memphis, Nashville, Knoxville,
Chattanooga, Norfolk/Virginia Beach, Richmond, Birmingham, Philadelphia,
Northern Virginia/Washington D.C., Baltimore, Charleston/Myrtle Beach and
Louisville, in addition to its 15 Lucent CBX500 ATM switches, and its Alcatel
MegaHub(R) 600ES switch in Charlotte.

RESULTS OF OPERATIONS

Three and Nine Months Ended September 30, 2000 Compared With The Three and Nine
Months Ended September 30, 1999

Net revenue decreased to $29.9 million for the quarter ended September 30,
2000 from $47.3 million for the quarter ended September 30, 1999. For the nine
months ended September 30, 2000 and 1999, revenue was $81.4 million and $127.1
million, respectively. 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 and related facility revenue,
increased to $26.3 million for the quarter ended September 30, 2000 from $15.0
million for the quarter ended September 30, 1999. For the nine months ended
September 30, 2000, core business revenue increased to $71.4 million from $36.7
million in the comparable period of 1999. Reciprocal compensation revenue
decreased to $3.5 million for the quarter ended September 30, 2000 from $30.1
million for the quarter ended September 30, 1999, net of an $7.3 million
allowance in 1999. For the nine months ended September 30, 2000 and 1999,

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reciprocal compensation revenue was $9.8 million and $83.4 million,
respectively, net of a $21.3 million allowance in 1999. Given uncertainties
associated with the judicial and regulatory proceedings related to reciprocal
compensation issues, the Company recorded a $7.3 million and $21.3 million
allowance against reciprocal compensation revenue and related receivables during
the quarter and nine months ended September 30, 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
Company's most significant reciprocal compensation issue, the Company believes
no allowance is required as of September 30, 2000. See Disputed Revenue
appearing below for a further discussion related to reciprocal compensation and
other disputed amounts.

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 September 30, 2000, and September 30, 1999, were as
follows: business trunks increased to 74,678 from 37,304, ISP/ESP trunks
decreased to 24,030 from 31,895, and business lines increased to 22,560 from
10,833. The decrease in ISP/ESP trunks was primarily due to the elimination of
Metacomm as a customer. 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
$19.5 million, or 41% of revenue, for the quarter ended September 30, 1999, to
$14.4 million, or 48% of revenue, for the quarter ended September 30, 2000. For
the nine month periods ended September 30, 2000, and September 30, 1999, cost of
services decreased from $54.0 million, or 42% of revenue, to $37.1 million, or
46% of revenue. The decrease in cost of services was primarily a result of the
decrease in local interconnect rates and the elimination of commissions payable
to Metacomm 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 third quarter 2000
increased to $22.0 million, or 74% of revenue, compared to $13.7 million, or 29%
of revenue for the third quarter 1999. These expenses increased to $56.8 million
for the first nine months of 2000, or 70% of revenue, compared to $35.2 million,
or 28% of revenue for the comparable period in 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 and adds products,
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. The Company is currently working with BellSouth to
determine the definitive amounts.

Depreciation and amortization for the three months ended September 30, 2000
increased to $6.2 million from $3.1 million over the comparable 1999 period.
For the nine months ended September 30, 2000 depreciation and amortization
increased to $16.3 million from $8.1 million over the comparable 1999 period.
The increase in depreciation and amortization is 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.

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<PAGE>

Interest income for the three and nine months ended September 30, 2000 was
$1.6 million and $3.2 million, respectively, compared to interest income of $0.2
and $0.9 million, respectively, for the three and nine months ended September
30, 1999. The increase in interest income in the quarter ended September 30,
2000 was primarily due to the investing of the proceeds from the issuance of
Series A Redeemable Convertible Preferred Stock on April 11, 2000.

Interest expense for the three and nine months ended September 30, 2000
was $1.9 million and $5.0 million, respectively, compared to interest expense of
$0.8 million and $2.0 million, respectively, for the three and nine months ended
September 30, 1999. This increase in interest expense was primarily due to
borrowings under the Company's credit facility.

Income taxes for the three and nine months ended September 30, 2000 were a
$0.0 and a $23.7 million benefit, respectively, compared to $4.2 million expense
and a $11.6 million expense for the three and nine months ended September 30,
1999. The $23.7 million benefit for the nine months ended September 30, 2000 is
a net amount which includes a $12.3 million valuation allowance against deferred
tax assets relating to the anticipated use of federal and state net operating
losses.

Net loss for the three and nine months ended September 30, 2000 amounted to
$13.0 million and $62.3 million, respectively. Dividends accrued on Series A
Redeemable Convertible Preferred Stock for the three months and nine months
ended September 30, 2000 amounted to $3.0 million and $5.7 million, respectively
(See Note 6).

As a result of the foregoing, net loss attributable to common shareholders
for the three and nine months ended September 30, 2000 amounted to $16.1
million, or ($0.58) per share (diluted) and $68.0 million, or ($2.46) per share
(diluted), respectively, compared to net income of $6.2 million, or $0.22 per
share (diluted), and $17.2 million, or $0.61 per share (diluted) for the three
and nine months ended September 30, 1999.

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 $89.3 million and $34.3 million for the nine months
ended September 30, 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 September 30, 2000, the amount outstanding under the loan
agreement was $100.0 million. As a result, $50.0 million is currently available
to borrow under the loan agreement.

On April 11, 2000, the Company issued $200 million of its Series A
Redeemable Convertible Preferred Stock to affiliates of Bain Capital, Inc.
("Bain") and Thomas H. Lee Partners, L.P. ("THL"). See Note 6 to the condensed
consolidated financial statements that appear elsewhere in this report for a
detailed description of this transaction and the terms of the Preferred Stock.
Proceeds to the Company, net of commissions and other transaction cost, were
approximately $194 million. These proceeds, together with availability under
the Company's $150 million credit facility, will provide funding for the
Company's planned network expansion for the foreseeable future.

Cash used in operating activities increased to $38.3 million for the nine
months ended September 30, 2000 from $18.6 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 September 30, 2000 continue to be amounts due
from BellSouth for reciprocal

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<PAGE>

compensation, facility charges, and other charges. Although the Company has
received payment of over $13 million from BellSouth representing a portion of
the amounts due the Company for ISP 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 $90.1 million for the nine
months ended September 30, 2000 from $34.4 million during the nine months ended
September 30, 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 $222.2 million for the
nine months ended September 30, 2000 from $19.1 million during the first nine
months of 1999. The increase was primarily due the issuance of $200 million in
Series A Redeemable Convertible Preferred Stock (see 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 ("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 (the "March 31 Order") 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 as such networks are
identified in 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 network in North Carolina (the only state in which Metacomm
operated). The Company did not appeal the March 31 Order, although Metacomm is
prosecuting an appeal.

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<PAGE>

amounts have been treated for financial reporting purposes as a distribution to
stockholder and reduced additional paid-in capital on the Company's balance
sheet. The amount owed was reduced by approximately $1 million in the quarter
ended June 30, 2000 for refunds due on sales and excise tax amounts previously
charged on services provided to Metacomm. The Company has filed for a refund of
the sales and excise tax from the North Carolina Department of Revenue and
Internal Revenue Service. A large portion of this refund was received early in
the Fourth Quarter of 2000. The remainder is expected to be received during the
Fourth Quarter of 2000. Richard T. Aab, Chairman of US LEC and its largest
stockholder, indirectly controlled Metacomm, and has stated that the remaining
balance will be paid no later than March 31, 2001. The Company's audit committee
and Mr. Aab are working to determine the terms of such payment. The payments
will be credited to additional paid-in capital.

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<PAGE>

entitled to be compensated at the higher tandem rate. On June 15, 2000, the
GAPSC affirmed this recommended decision, and issued an order requiring
BellSouth to pay US LEC reciprocal compensation for traffic to ISPs and other
customers in Georgia at the end office rate (the "GAPSC Order"). On July 12,
2000, US LEC filed evidence with the GAPSC regarding its right to be compensated
at the tandem rate. On July 14, 2000, BellSouth filed an appeal of the GAPSC
Order with the U.S. District Court for the Northern District of Georgia ("U.S.
District Court-GA") and with the Georgia Superior Court in and for Fulton
County, Georgia. BellSouth asked the Georgia state court to cede the appeal to
the U.S. District Court - GA and asked the latter court for permission to pay
amounts due into court to avoid paying US LEC pending appeal. On July 18, 2000,
the U.S. District Court- GA granted BellSouth's motion to pay amounts due into
court prior to receipt by the Company of any papers related to that appeal. On
October 2, 2000, the U.S. District Court - GA denied the Company's request for
reconsideration of the order allowing BellSouth to pay amounts due into court.
The Georgia State and Federal Courts are setting a briefing schedule for the
proceeding, and the Company and expects a decision sometime in 2001. The GAPSC
has not yet ruled on the tandem/end office rate issue. The Company's complaint
did not address the third interconnection agreement in Georgia, which covers the
period from June 1999 to December 1999.

20
<PAGE>

21
<PAGE>

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 September 30, 2000, Sprint owed the Company
approximately $9.3 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. Sprint claims it is not obligated to pay
more than an undefined incumbent local exchange carrier ("ILEC") rate. 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 interstate access charges on the basis that it believes the
charges to be too high while also continuing to accept the benefits of
interconnection with the local carrier without taking formal action to challenge
the rates. The FCC has ruled that AT&T was obligated to pay such access charges
due to its failure to commence a proceeding or terminate interconnection. (MGC
Communications, Inc. v. AT&T Corp., FCC Release 99-408). This decision is now
final, as AT&T did not appeal the FCC's ruling. In addition, the FCC ruled
recently in an action brought by Sprint against MGC Communications, Inc. ("MGC")
that the fact that a CLEC's filed interstate rates exceeded those of the
competing ILECs was insufficient to establish that the CLEC's rates were
excessive. The FCC dismissed Sprint's challenge to MGC's rates. Sprint has
appealed the FCC's decision to the United States Court of Appeals for the
District

22
<PAGE>

of Columbia Circuit, and oral argument is scheduled for April 20, 2001. As a
result of these rulings, management anticipates a favorable resolution of the
Company's dispute with Sprint.

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<PAGE>

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 September 30, 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 and the arbitration with GTE related to
reciprocal compensation. Note 7 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

None.

Item 3. Defaults upon Senior Securities

None.

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/(1)/

27 Financial Data Schedule (For SEC use
only)

/(1)/ Incorporated by reference to the Company's Condensed
Consolidated Statements of Operations appearing in
Part I of this report.

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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:_______________________
November 14, 2000

Michael K. Robinson
Executive Vice President and Chief Financial
Officer