US WATS INC, 10-K, 1998-03-31

US WATS INC
10-K, 1998-03-31
TELEPHONE COMMUNICATIONS (NO RADIOTELEPHONE)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-K
_____________________________________

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 1997

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

For the transition period from _________ to ___________

Commission File Number: 0-22944

US WATS, INC.
-------------
(Exact name of Registrant as specified in its charter)

New York 22-3055962
- ------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)

111 Presidential Boulevard, Suite 114
Bala Cynwyd, Pennsylvania 19004
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)

(Registrant's telephone number, including area code): (610) 660-0100

Securities registered pursuant to Section 12 (b) of the Act: None

Securities registered pursuant to Section 12 (g) of the Act:

Common Stock ($0.001 par value)
--------------------------------
(Title of Class)

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
---------

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form10-K.

As of February 27, 1998 the aggregate market value of the Company's Common
Stock held by non-affiliates of the Registrant, based on the average closing
sale price, was approximately $12,900,000.

As of February 27, 1998 the Registrant has 17,727,000 shares of Common Stock
outstanding.
1-2
<PAGE>

TABLE OF CONTENTS

PART I

Item 1. Business ................................................... 4
Item 2. Properties ................................................. 10
Item 3. Legal Proceedings .......................................... 10
Item 4. Submission of Matters to a Vote of Security Holders ........ 10

PART II

Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters ...................................... 11
Item 6. Selected Financial Data .................................... 12
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations ................................ 13
Item 8. Financial Statements and Supplementary Data ................ 18
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure ................................. 19

PART III

Item 10. Directors and Executive Officers of the Registrant ......... 20
Item 11. Executive Compensation and Options Outstanding ............. 21
Item 12. Security Ownership of Certain Beneficial Owners
and Management ........................................... 26
Item 13. Certain Relationships and Related Transactions ............. 28

PART IV

Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K ...................................... 30

<PAGE>
PART 1

Item 1. Business

DESCRIPTION OF BUSINESS

US WATS, Inc. ("the Company") is a switch-based interexchange carrier
providing long distance telephone communications services primarily to small
and medium-size business customers. The Company also provides inbound-800
long distance services, as well as other telecommunications services such as
travel cards (calling cards), cellular, paging, internet service, dedicated
access, data services, pre-paid calling cards (debit cards), International
Callback and carrier termination services. The Company uses its own switches
and facilities to originate, transport and terminate calls for customers
generally located between Boston, Massachusetts and Norfolk, Virginia and
California (on-net area). Approximately 85% of the calls billed by the
Company each month are processed through the Company's own switches. For calls
originating or terminating outside the Company's own network (off-net area),
the Company utilizes the services provided by other long distance companies.

The Company's revenues are derived primarily from the transport of outgoing
and incoming calls which are billed by the Company to end-users at specified
rates. Transport costs of these calls are billed to the Company from other
carriers at contractual rates. These carriers supply the Company with call
detail information which enables the Company to bill its customers depending
upon the Company's individual rates. The combination of the efficiency of the
Company's network and facilities, and the purchase of long distance services
in bulk from other carriers allow the Company to offer competitive rates to
small and medium-sized businesses.

The Company's principal executive offices are located at 111 Presidential
Boulevard, Suite 114, Bala Cynwyd, Pennsylvania 19004. The Company's
telephone number at that location is (610) 660-0100.

On October 28, 1997, the Company entered into an Agreement and Plan of Merger
with ACC Corp. and a wholly-owned subsidiary of ACC Corp., pursuant to which
ACC Corp. would issue approximately $46 million worth of its Common Stock to
holders of US WATS capital stock, and US WATS would become a wholly-owned
subsidiary of ACC Corp. The merger was subject to the satisfaction of certain
conditions, including that the merger be treated as a pooling of interests.
Costs associated with the merger of $567,000 incurred by the Company prior to
December 31, 1997 are included in selling, general, and administrative
expenses in the Company's Statement of Operations. Subsequent to 1997, the
Company expects to incur costs of approximately $131,000 associated with the
merger. On March 11, 1998, the Company announced an agreement with ACC Corp.
for mutual termination of the Agreement and Plan of Merger, by and among US
WATS, ACC Corp. and a subsidiary of ACC Corp.

CORPORATE STRATEGY

The Company's objective is to provide its customers with a comprehensive range
of telecommunications services with value-added features at competitive
prices. The Company markets through three channels (direct, agent and
reseller) and offers a diversified mix of products and services. The Company
employs a direct sales force, and also markets through independent agents. The
Company offers individual value-added services to resellers depending on each
reseller's requirements. The Company offers competitive wholesale pricing to
its resellers which it expects will lead to significant revenue growth. Net
sales revenue attributable to the Company's agents and resellers accounts for
approximately 50% of the Company's non-wireless revenue. The Company also
utilizes numerous carriers allowing for network redundancy. This allows the
Company to offer both carrier specific and private label services. The
Company is focused on servicing commercial accounts; revenue from commercial
accounts represented greater than 90% of gross revenue during 1997.

4
<PAGE>

SERVICES

The Company provides domestic outbound long distance service to and from
anywhere in the United States, international calling services to 245
countries, inbound 800 services, cellular local and long distance services,
regional and national paging services, internet service, travel/calling cards,
prepaid calling, dedicated access services, private line networks, data
services, international callback, and carrier termination services.

The Company charges its customers based upon minutes of usage, at both flat
and banded rates (price is based on distance of call). In those areas which
provide for equal access (all intra-Local Access Transport Area ("LATA") calls
are normally routed through the local exchange carrier), the Company offers
its customers "dialers" to access the Company's network for intra-LATA calls.
The use of dialers eliminates the need for the customer to dial the Company's
local access number and personal authorization code prior to placing the call.
The Company is a "RESPORG" (Responsible Organization) for the inbound 800
services it provides to its customers. This allows the Company direct access
to the 800 number database allowing for faster 800 number service. This
increases the speed at which the Company can perform such services as blocking
and routing changes for its customers' inbound 800 services.

The Company utilizes Bell Atlantic NYNEX Mobile Systems to carry its cellular,
local calls. The Company provides its cellular customers with competitive
long distance services provided by its own network. The Company's travel cards
provide its customers with an "easy-to-remember" 800 number access to the
Company's network from all locations in the United States and Canada, and
feature personal identification numbers ("PINs") which are selected by the
individual customer. The Company's prepaid calling cards (debit cards) are
marketed wholesale primarily to retail distribution and specialty advertising
outlets.

SWITCH AND NETWORK FACILITIES

The Company maintains a digital network on both the East and West coasts of
the United States. The Company's East Coast network extends from Boston,
Massachusetts south to Norfolk, Virginia and west to Pittsburgh, Pennsylvania.
The Company's switching facilities are located in Philadelphia, Pennsylvania
and Oakland, California. Calls terminating off-net are transported and
terminated for the Company on circuits operated by other carriers. The
Company's network utilizes SS7 common channel signaling. SS7 signaling
increases network efficiency by reducing call set-up time.

The network is supported by a Digital Switch Corporation DEX400 switch in
Philadelphia and a Digital Switch Corporation DEX600 in Oakland which are used
to process customer calls. Intelligent call processing required by the
Company's enhanced services products (calling card and international callback)
is provided by a NACT SCX switching platform. This switching platform
provides customized voice prompts and other enhanced services required by
these products. The ability of the Company to transport calls over its
company owned switches and leased facilities allows the company to maximize
gross margins and control network quality of service.

The Company is continually re-configuring its call processing through the
utilization of least-cost routing software. The Company has contracted with
numerous domestic and international transport carriers which allow for
country-specific least-cost routing and the maintenance of diverse routes.

MARKETING

The Company markets its services utilizing three sales channels focused on
developing a customer base primarily within the New York City to Washington DC
corridor. The Company employs a direct sales force who are paid a salary plus
commission basis. The Company also maintains an independent agent network of
more than 187 agents who receive a commission based on monthly billings. The
Company's reseller channel is comprised of approximately 12 switchless
resellers which contract for services at a fixed price (buy price). These
resellers are permitted to establish their own retail billing rates, and do
not lease or own any switching equipment, transmission facilities, or billing
software. Because of this, they are dependent on switch-based carriers for

5
<PAGE>

products and services. The Company offers these resellers competitive
wholesale rates, a variety of products, customer support services, billing,
credit and collection services, as well as other value-added features such as
on-line electronic access to customer account information, back office
support, automatic electronic order entry and account profitability reporting.
The Company offers its customer's a comprehensive invoice including extensive
management reports to all sales channels. Included in the Company's invoices
are more than 20 management reports covering call distribution studies, time
of day analysis, call duration distribution, as well as individual telephone
number call detail records allowing them to quickly analyze their calling
patterns and costs.

The Company's current average retail customer uses approximately $250 in
monthly long distance revenue, which in not unlike the industry average for
revenue generated through an agent sales force. Typically, agents require
ubiquitous product offerings that can be offered to any prospective customer
nationwide, and they focus on high margin small business and residential
accounts where the retail rates and margins sold to a customer support the
agents residual commission.

Coincident to entering the Competitive Local Exchange business in the Mid-
Atlantic states, the Company plans to develop a direct sales force to solicit
and secure larger middle market accounts, where the combination of local and
long distance revenue justifies dedicated access. The nature of dedicated
access products, requires a more detailed and focused sales approach by
experienced telecommunications sales professionals who are capable of
directing their efforts to specific market segments in clearly defined
geographic territories. As a result of the Company's initiatives in the local
area, the Company believes that its agents and certain smaller business
accounts will benefit from simple resale of Bell Atlantic local services, in
those instances where the bundling approach does not justify dedicated T1
connectivity.

COMPETITION

The Company views the long distance industry as a three-tiered industry which
is dominated by the nation's three largest long distance providers: AT&T, MCI
Telecommunications Corporation ("MCI") and Sprint Communications Company, L.P.
("Sprint"). AT&T, MCI and Sprint, collectively generate, approximately 80%
of the nation's long distance revenue (approximately $87 billion) and comprise
what is known as "Tier 1" International Long Distance Companies. The second
tier consists of several other companies with annual revenues of $250 million
to $1.5 billion each. The third tier, which includes the Company, consists of
more than 300 companies with annual revenues of less than $250 million each,
the majority below $50 million each.

The Company targets small and medium-sized commercial customers. The number of
telecommunications services offered by the Company on a consolidated, one-bill
basis serves, to some extent, to distinguish the Company from some of its
competitors. Competitive distinctions are made based upon the number of
services offered, the pricing plans, the length of contracts, as well as the
billing information provided. The Company currently owns switch capacity,
develops and implements its own products, monitors and deploys its
transmission facilities and prepares and designs its own billing and reporting
systems.

In addition to direct competition from what the Company estimates are several
hundred switchless resellers, the Company competes with the sales
organizations and resellers of large telecommunications companies such as MCI
and Sprint, which at any particular time may offer more desirable services or
prices than those offered by the Company.

On October 29, 1996, the FCC adopted an order in which it eliminated the
requirement that non-dominant interstate carriers such as the Company maintain
tariffs on file with the FCC for domestic interstate interexchange services.
The FCC's order was issued pursuant to authority granted to the FCC in the
Telecommunications Act to "forebear" from regulating any telecommunications
service provider if the FCC determines that the public interest will be
served. Pursuant to the FCC's order, after a transition period, relationships
between carriers and their customers would be set by contract and long
distance companies would no longer be permitted to file with the FCC tariffs
for interstate interexchange services. However, MCI, Sprint and The American

6
<PAGE>

Carriers Telephone Association have separately appealed the FCC's order to the
United States Court of Appeals for the District of Columbia Circuit ("DC
Circuit"). On February 13, 1997, the DC Circuit ruled that the FCC's order
became effective. The Company may benefit from the elimination of FCC tariffs
by gaining more flexibility and speed in dealing with marketplace changes.
However, the absence of tariffs will also require that the Company secure
contractual agreements with its customers regarding many of the terms of its
existing tariffs or face possible claims arising because of the rights of the
parties are no longer clearly defined.

In spite of AT&T's additional flexibility and the pending interexchange
competition from the Regional Bell Operating Companies, the Company believes
that it continues to provision and sell telecommunications service to small to
medium sized businesses at competitive rates. In addition, the Company
believes that the deregulation of the local exchange telecom market represents
a significant opportunity similar to the opportunity provided at the
deregulation of AT&T in 1984.

EMPLOYEES

At the end of 1997, the Company had 69 full-time employees working at two
locations. The Company is not a party to any organized labor contracts. The
Company considers its relationship with its employees to be satisfactory.

REGULATORY MATTERS

Regulatory Requirements. The Company is a regulated entity at the Federal
level with regard to international traffic and interstate traffic. The
Company has received Section 214 authorization to resell international
switched services and has filed an FCC tariff for its domestic interstate
services.

State regulatory requirements vary from state to state. The Company has
obtained certification in all states which require certification in order to
provide long distance services, with the exception of two(2) states in which
certifications are pending (Maine and Arizona). Some states place statutory
restrictions on the operations of "telecommunications service resellers," as
that term is defined in these states. Some states require telecommunications
service resellers to file and operate in accordance with service and rate
"tariffs." Changes in existing regulations or their interpretation in any
state could classify the Company as a "telecommunications service reseller"
and subject it to regulation. Such regulation could result in an increase in
customers' usage charges and, in some cases, could limit or eliminate the
Company's ability to service customers in that jurisdiction. The Company
would incur, among other expenses, certain administrative costs and legal fees
in contesting or complying with such regulatory changes that would increase
the Company's cost of doing business.

The providers of local exchange telecommunications services to the Company are
also heavily regulated at the Federal level and in the states in which they
operate. Changes in existing regulations or their interpretation affecting
these providers could materially adversely affect their business or even
prevent them from offering telecommunications services to their customers,
including the Company, on favorable terms.

In addition, certain services offered by the Company which are not presently
regulated in all states may become regulated. Such regulation could delay the
deployment of products and/or services and would increase certain
administrative costs and legal fees in contesting or complying with such
regulation. The FCC has granted applications by companies seeking to provide
international callback (also known as "call reorigination" services) to those
countries where the practice is legal under local law. The FCC has taken the
view that call reorigination services created incentive to lower foreign
collection rates to the benefit of U.S. ratepayers and serve the FCC's general
policies favoring resale and increased competition in the international
marketplace. Although the FCC has consistently expressed its support for call
reorigination services enacted by foreign countries. In response to the input
of certain foreign countries in rulemaking proceedings, the FCC has
acknowledged that foreign countries face unusual difficulties in implementing
prohibitions on call reorigination but has stated that such countries continue

7
<PAGE>

to bear the principal responsibility for enforcing their domestic laws.
However, the FCC has stated that, as a matter of international comity the FCC
will prohibit U.S. authorized carriers from providing call reorigination in
countries where it is expressly prohibited. The FCC established a variety of
requirements that a foreign country must meet before the FCC will consider
assisting a foreign government in enforcing its domestic ban. To date, the
FCC has taken no action to enforce a foreign country's ban with respect to a
U.S. provider. However, there can be no assurance that the FCC will not
enforce such a ban.

Legislation. On February 8, 1996, President Clinton signed into law the
Telecommunications Act of 1996. The law capped a multi-year effort to amend
the Communications Act of 1934 to take into account the extraordinary changes
in the telecommunications market which have occurred since passage of the
original act. The bill is intended to spur additional competition in
telecommunications services particularly within the local exchange markets
which are now dominated by incumbent local exchange carriers.

The law codifies a new set of interconnection principles which will apply to
interconnection for both interstate and intrastate services. State public
utilities commissions are given a significant role in administering the
interconnection provisions of the new act, and deadlines are imposed for
decisions by both the FCC and state commissions.

The new act also eliminates the existing AT&T antitrust consent decree which
barred the provision of long distance services and manufacturing by the Bell
Operating Companies (BOCs). Under the new act, BOCs may immediately offer
long distance services outside their home regions. The BOCs may offer service
within their regions as soon as they satisfy the following requirements:

i) the BOC has provided interconnection to a competitor under Section
252 of the Act, or,
ii) the BOC has been granted state commission approval of its
interconnection tariff, the BOC has received no interconnection
request after 10 months after enactment, and no carrier has
submitted a request for interconnection within the 3 months prior to
the BOC's application to provide inter-LATA service.

The BOC must also submit and have granted an application to the FCC to provide
the service.

The law provides for the Commission to establish new universal service
principles and a regulatory mechanism to insure that financial support is
available for universal service. This program benefits schools, health care
providers, and libraries and was initiated in January, 1998. The law requires
that all telecommunication service providers contribute financial support for
universal service. The law allows the Company to pass these universal service
fees to the end users. The Company, as well as most competitors, began this
process in January, 1998.

The interconnection provisions of the new law are intended to benefit the
Company by making available local exchange connections which are more
efficient and potentially cheaper than those available today. In August,
1996, the FCC reached a decision in its proceeding implementing the new Act's
interconnection provisions. This ruling is intended to reduce interconnection
costs for competing local carriers connecting with incumbent local exchange
companies. Certain provisions of the ruling have been appealed to various
U.S. Courts of Appeals. These appeals have been consolidated into proceedings
currently pending before the U.S. Court of Appeals for the Eighth Circuit
("Eighth Circuit"). Applications for a stay of the proposed rules were
rejected by the FCC. However, the Eighth Circuit has granted a temporary stay
of certain provisions of the Interconnection Decision, including the pricing
rules and rules that would have permitted new entrants to "pick and choose"
among various provisions of existing interconnection agreements, pending a
decision on the merits. The FCC applied to the U.S. Supreme Court to vacate
the judicial stay, but the U.S. Supreme Court, on November 12, 1996, refused
to vacate the stay. All other provisions of the Interconnection Decision
remain in effect pending resolution of the appeal on the merits.

Additional competition with existing local exchange carriers should provide
price discipline in an area which has been monopolized by incumbent local
exchange carriers. The Company can also expect a substantial increase in the

8
<PAGE>

competition which it faces in interexchange markets as a result of the entry
of the Bell Operating Companies into long distance services. Not only will
there be additional competition providing services which are similar to those
provided by the Company, but they can be expected to bundle those services
with other offerings such as local service, cellular and video services.
These package offerings may be more attractive to consumers than offerings of
stand-alone services.

Equal Access Charges. The FCC has also commenced a proceeding to reform the
rules governing interstate access charges. Access charges are charges imposed
by LECs on 1ong distance providers for access to the local exchange network,
and are designed to pay LECs for investment in the local network. Prior to
December 1993, pricing of those "access services" was on an equal rate per
minute ("equal per unit") basis for "local transport." On September 17, 1992,
the FCC announced it would: (1) maintain the existing "equal per unit" pricing
rules until late 1993; (2) implement an interim rate structure and pricing
plan during the subsequent two years: and (3) implement a further rulemaking
for consideration of a permanent rate structure beginning no earlier than late
1995. (The local access restructuring plan went into effect in December
1993.)

In December 1996, the FCC issued an order which, among other things, requested
comment on a number of access charge reform issues designed to foster
efficient pricing of access, competition for access services, and to reflect
the development of local services prompted by the 1996 Telecommunications Act.
The FCC has also sought comment on whether Internet service providers and
other information service providers should be subject to access charges. As
of January, 1998, these access charges are being incurred by the Company, and
are being passed on to the end users.

As part of the AT&T Divestiture Decree, the divested regional BOCs were
required to charge AT&T and all other carriers (including US WATS) equal per
minute rates for "local transport" service (the transmission of switched long
distance traffic between the BOCs' central offices and the interexchange
carriers' points of presence). BOC and other Local Exchange Carrier ("LEC")
tariffs for local transport service have been based upon these "equal per
unit" rules since 1984, pursuant to the AT&T Divestiture Decree and the FCC's
waiver of its inconsistent local transport pricing rules. Although the
portion of the AT&T Divestiture Decree containing this rule ceased to be
effective by its terms on September 1, 1991, the FCC had extended its effect
until it concluded the rulemaking proceeding in which it is considering
whether to retain or modify the "equal per unit" local transport pricing
structure. In its September 1992 "First Transport Order", the FCC adopted an
interim transport rate structure plan that replaced the FCC's former equal-
charge rules. The interim plan incorporated both flat-rate and usage-
sensitive charges which, together with an interconnection charge, was designed
to enable the LECs to receive approximately the same revenues they would have
received under the former equal-charge plan. In the "First Transport Order",
the FCC provided that the interim rate structure would remain in effect
through October 31, 1995. On December 30, 1993, the LECs' interim transport
rate structure tariffs became effective. In July 1993, January 1994 and
December 1994 the FCC issued orders refining and clarifying its interim rate
structure. On September 22, 1995 the Commission extended the effectiveness of
the interim transport rate structure pending further Commission action. Based
upon the analysis set forth in the FCC's December 22nd Order, the Company does
not anticipate that these decisions will have a material impact.

The FCC has required LECs to provide virtual co-location arrangements to LEC
competitors to enable them to provide alternative transport services to
interexchange carriers, although SBC Corporation has challenged this
requirement in the Court of Appeals for the District of Columbia Circuit. As
a result of these arrangements, the Company may have alternatives to
purchasing all of its local access from LECs.

The Telecommunications Act of 1996 codifies a new set of interconnection
principles which significantly overlap the Commission's expanded
interconnection requirements. Under the law the Commission is required to
conduct a rulemaking, to be completed within six months after passage of the
act, to implement the new interconnection principles. This rulemaking could
alter the existing rules regarding expanded interconnection.

9
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TELECOMMUNICATION FRAUD

The Company is subject to attempts by outsiders to gain access to the
Company's telecommunications network. Such attempts can take the form of the
theft of calling cards, and the cloning of cellular phones. Breaches of
security can also involve improper use of 800 telephone numbers and customer
PBX equipment. The Company monitors the use of its network through certain
fraud detection devices and believes that its procedures are satisfactory.
Due to the highly technical nature of the business, complete assurance that
sufficient controls are in place to prevent a material loss is not possible,
however, the Company does not believe that it has been subject to material
telecommunications fraud.

Item 2. Properties

The Company currently leases approximately 27,000 square feet in four
buildings at a monthly cost of approximately $38,000. Its executive offices
and headquarters at 111 Presidential Boulevard in Bala Cynwyd, Pennsylvania is
leased for a term of five years expiring in 1998. The Company's leased switch
space in Philadelphia, Pennsylvania expires in 2003. The Company's leased
switch space in Oakland, California expires in 2000. The Company considers
its space to be adequate for its current needs.

Item 3. Legal Proceedings

On June 13, 1997, Mark Scully, the former President and Chief Operating
Officer of the Company, filed a complaint against the Company, Kevin O'Hare,
Aaron Brown and Stephen Parker in the United States District Court for the
Eastern District of Pennsylvania. Mr. Scully asserts various claims in
connection with his termination of employment with the Company on December 30,
1996. In particular, he alleges, among other things, breach of contract in
connection with the termination of certain stock options, breach of the
alleged contract for employment, breach of an asserted duty of good faith and
fair dealing, fraudulent and negligent misrepresentation, and civil
conspiracy. Mr. Scully alleges damages of at least $1.6 million, plus
attorneys' fees, costs and other disbursements and the cost of COBRA payments
and interest; $1 million of the alleged damages claimed are punitive. The
Company contests the allegations of the complaint and intends to vigorously
defend against the action.

The Company is party, in the ordinary course of business, to other litigation
involving services rendered, contract claims and other miscellaneous causes of
action arising from its business. The Company has established reserves
relating to its legal claims and believes that potential liabilities in excess
of those recorded will not have a material adverse effect on the Company's
Consolidated Financial Statements, however, there can be no assurances to this
effect.

Item 4. Submission of Matters to a Vote of Security Holders

1) None

10
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PART II

Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters

The following figures represent the high and low closing price as reported by
NASDAQ during each successive quarter beginning in 1996.

QUARTER HIGH LOW
------------------ ----- -----
4th Quarter 1997 $2.31 $1.25
3rd Quarter 1997 $2.00 $1.34
2nd Quarter 1997 $1.63 $ .84
1st Quarter 1997 $1.53 $1.03
4th Quarter 1996 $1.41 $1.00
3rd Quarter 1996 $1.41 $1.00
2nd Quarter 1996 $1.41 $ .56
1st Quarter 1996 $1.09 $ .66

Effective January 21, 1994, the Company's Common Stock was listed on the
National Association of Securities Dealers Automated System (NASDAQ) under the
symbol "USWI".

As of February 20, 1998 there were approximately 159 holders of record of the
Company's Common Stock. Most of the shares of the Common Stock are held in
street name for a larger number of beneficial owners.

The Company has not paid any dividends on its Common Stock, however, the
Company is paying quarterly dividends on its Preferred Stock at a rate of 9%
or approximately $6,750 per quarter. The Company does not currently
anticipate the payment of dividends on its Common Stock.

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<PAGE>

Item 6. Selected Financial Data

The selected financial data presented below is for the years ended December
31, for each of the periods indicated below. The following information should
be read in connection with the consolidated financial statements of the
Company and related notes included elsewhere in this report and with Item 7 of
this report.
<TABLE>
<CAPTION>

Year Ended December 31,
-----------------------
1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Operating Data
- --------------

Net sales $56,466,698 $40,304,442 $27,755,388 $23,633,312 $20,521,332

Net Income (loss)(1) $(3,699,821) $ 88,625 $ (277,723) $(1,246,076) $ 424,401

Net Income (loss)
per common share(2) $ (.23) $ -- $ (.02) $ (.09) $ .03

December 31,
------------
Balance Sheet Data 1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------
Total assets $11,813,475 $11,992,359 $ 9,500,361 $ 9,552,833 $ 8,265,750

Capital
lease obligations $ 653,355 $ 703,696 $ 731,701 $ 1,396,364 $ 1,730,913

Redeemable
preferred stock $ 330,000 $ 300,000 $ 300,000 $ 1,300,000 $ 1,500,000

Cash dividends $ 27,000 $ 27,000 $ 67,255 $ 120,000 $ 33,750
on preferred stock

<FN>
(1) 1994 results include a reduction of network costs of $783,000 in
connection with the reversal of an account payable due to a former vendor.

1995 results reflect favorable resolution of the Company's dispute with
Colonial Penn Group, Inc. and Colonial Penn Insurance, resulting in the
reversal of an account payable in the amount of approximately $2,880,000.
However, this benefit was substantially offset by the cost of
unsuccessfully litigating the resultant AT&T case on the basis of anti-
trust. The costs of litigation with AT&T incurred during 1995
approximated $850,000. These costs do not include the additional expense
of approximately $305,000 of related expenses pertaining to the write-down
of certain AT&T signal conversion equipment and accounts receivable
written off, which were attributable to AT&T services provided by the
Company. In addition, AT&T was awarded a counter claim in the litigation
in the amount of $669,000 pertaining to services utilized in prior years.
As a result of settlement of these matters, the Company recognized a net
favorable impact of approximately $1,056,000 in 1995.

1997 results include an increase in bad debt expense of approximately
$986,000 due to higher than anticipated carrier write-offs. In addition,
the Company incurred approximately $173,000 of severance expense upon the
termination of three members of management during 1997. Finally, costs
associated with the proposed merger with ACC Corp. (see Note 15 to the
financial statements, Proposed Merger Transaction) amounted to
approximately $567,000 in 1997.

(2) The Company has retroactively adopted Statement of Financial Accounting
Standards No. 128, Earnings Per Share ("SFAS 128"). In accordance with
SFAS 128, since the Company has incurred losses from continuing operations
for the years ended December 31, 1994, 1995 and 1997, no potential Common
Shares have been included in the computation of any diluted per share
amount. For the years ended December 31, 1993 and 1996 the difference
between diluted and basic earnings per share is not significant.
Accordingly, only basic earnings per share have been presented.
</TABLE>
12
<PAGE>

Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

Certain information contained herein may include "forward-looking statements"
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended. All statements, other than statements of historical facts included
in this report are forward-looking statements. Such statements are subject to
certain risks and uncertainties, which include these discussed below. Should
one or more of these risks or uncertainties materialize, actual results may
vary materially from those estimated, anticipated or projected. Although the
Company believes that the expectations reflected by such forward-looking
statements are reasonable based on information currently available to the
Company, no assurance can be given that such expectations will prove to have
been correct. Cautionary statements identifying important facts that could
cause actual results to differ materially from the Company's expectations are
set forth in this report. All forward-looking statements included herein are
expressly qualified in their entirety by these cautionary statements.

RESULTS OF OPERATIONS

--1997 COMPARED TO 1996--

OVERVIEW

US WATS, Inc. is a switch-based interexchange carrier providing long distance
telephone communications services primarily to small and medium-size business
customers. The Company also provides inbound-800 long distance services, as
well as other telecommunications services such as travel cards (calling
cards), cellular, paging, internet service, dedicated access, data services,
pre-paid calling cards (debit cards), International Callback and carrier
termination services. The Company uses its own switches and facilities to
originate, transport and terminate calls for customers generally located
between Boston, Massachusetts and Norfolk, Virginia and in California (on-net
area). Approximately 85% of the calls billed by the Company each month are
processed through the Company's own switches. For calls originating or
terminating outside the Company's own network (off-net area), the Company
utilizes the services provided by other long distance companies.

The Company experienced significant changes in its business that negatively
impacted its results of operations for the year ended December 31, 1997. The
Company hired new management late in 1996 and early in 1997 in order to seek
entry into the local telecommunications provider market. Late in 1997,
however, the Company's board of directors determined to replace the management
team and, as a result, experienced operational disruptions and incurred
severance costs during 1997 of approximately $173,000.

In addition, margins on the Company's products and services continued to
decrease in 1997, as competitive pressures continued to affect both the
Company's retail and wholesale (or carrier) price points. The decreased
margins more than offset the gains in the Company's gross revenues in 1997.
In addition, commission expense increased by more than $2,115,000 over
commission expense in 1996 due primarily to an increase in revenues on which
commissions are paid. The Company's bad debt expense also increased
significantly in 1997 by approximately $986,000. Of this increase,
approximately $780,000 is related to the provision for bad debts of three
specific carrier accounts, $137,000 is related to uncollectable international
toll calls, and $56,000 is the result of the bankruptcy of one of the
Company's rebillers.

The Company raised $2,300,000 in a private placement of 1,590,000 shares of
its Common Stock in November 1997. This enabled the Company to temporarily

13
<PAGE>

meet the capital and surplus requirements for the continued listing of its
Common Stock on The Nasdaq Small Cap Market, and provided the necessary cash
to sustain the Company's operations.

REVENUE

Total revenues increased 40.1% or approximately $16,162,000 to approximately
$56,467,000 in 1997, due primarily to an increase in agent revenue of
approximately $11,350,000, an increase in carrier revenue of approximately
$8,792,000, and an increase in switchless revenue of approximately $2,454,000.
The increase in revenues was partially offset by a decrease in reseller
revenue of approximately $5,012,000.

The table below shows the distribution of revenues on a percentage basis by
product line:

DISTRIBUTION OF REVENUES

Service % 1997 % 1996
-----------------------------------------------------------
Domestic 1+ 37% 39%
International 31% 24%
Inbound 15% 16%
Wireless 4% 7%
Domestic Carrier Termination 13% 14%

GROSS PROFIT

Gross profit margin in 1997 decreased 7.0% to 26.5% from 1996. The decrease
in gross profit margin is primarily attributable to the substantial increase
in carrier revenue, which generates a much lower margin than the Company's
retail products, but are a necessary component of fully utilizing network
facilities. In addition, the rate charged to the Company's retail customers
for long distance service decreased by an average of $ .021 per minute as a
result of increased competition in the industry, while the Company's costs to
deliver such services has remained relatively constant. As a percentage of
total revenue, carrier revenue increased to approximately 28% for 1997 versus
17% in 1996.

14
<PAGE>

SELLING, GENERAL AND ADMINISTRATIVE EXPENSE

Selling, General and Administrative ("SG&A") expenses for 1997 were
approximately $4,222,000 higher than the amount incurred during 1996. SG&A
expenses for 1997 were 30.0% of revenue compared with 31.6% in 1996.
Commission expense increased approximately $2,115,000 or 46% from 1996 due
primarily to an increase in revenues on which commissions are paid. Salary
compensation expense increased approximately $466,000 to approximately
$3,615,000 resulting in part from severance costs in the amount of
approximately $173,000 related to the termination of certain executives. In
addition, in 1997, the Company incurred consulting, legal and accounting fees
related to the proposed merger of the Company with ACC Corp. of approximately
$567,000.

PROVISION FOR BAD DEBT

Bad debt expense increased approximately $986,000 (from approximately 1.2% of
net sales in 1996 to approximately 2.6% of net sales in 1997). Of this
increase, approximately $780,000 is related to the provision for bad debts of
three specific carrier accounts, $137,000 is related to uncollectable
international toll calls, and $56,000 is the result of the bankruptcy of one
of the Company's rebillers.

NET LOSS FROM OPERATIONS

The Company recorded a net loss before preferred dividends for 1997 of
approximately $3,700,000 versus a profit of approximately $89,000 for 1996.
The net loss reported in 1997 resulted primarily from lower gross margins and
higher SG&A expenses.

--1996 COMPARED TO 1995--

OVERVIEW

During 1996, the Company made significant additions and changes to its network
to support revenue growth in Carrier Services and its International Call Back
businesses. During 1996 new DS3 Points of Presence were added in New York
City, Chicago, Washington D.C. and Los Angeles. Additionally, the Company has
expanded its network to provide service in all of California, except for the
San Diego metropolitan area.

In an effort to increase the Company's network efficiencies the Company became
the Responsible Organization "RespOrg" for the provisioning of 800 and 888
services. During the year coincident with its becoming its own "RespOrg" the
Company initiated a program of LATA take back to drive down the provisioning
costs of 800 and 888 services.

To enhance the Company's ability to provision International Call Back services
the Company upgraded and installed a new NACT switching platform.
Additionally, in support of both its agent sales and carrier sales the Company
engaged a major carrier for both long haul point-to-point services and off
network origination and termination.

REVENUE

Revenue for the year ended December 31, 1996 increased approximately
$12,549,000 (approximately 45%) over revenues for the year ended December 31,
1995. Revenues for the fourth quarter ending December 31, 1996 increased over
the quarter ended September 30, 1996 by approximately $1,506,000
(approximately 15%). Quarterly revenue levels steadily increased during 1996.
The increases were mainly due to significant growth in international calling
as well as the implementation of the carrier termination revenue channel.

15
<PAGE>

Revenue level from the inbound product remained steady in dollars, although
decreased as a percentage of overall revenue. Revenue from the domestic 1 +
product increased by approximately $2,100,000 in 1996 (approximately 16%), but
decreased as a percentage of overall revenue due to the increases in
international calling and revenue generated through the new carrier sales
channel.

During 1996, the Company focused its efforts on a national agent program and
implementing the carrier sales product. As a result, the Company's revenue by
distribution channel changed during 1996. Direct Sales revenue as a
percentage of total sales, exclusive of Wireless revenue, declined by
approximately 29% in 1996 compared to 1995. The primary reason for the
decline was the growth of agent and reseller channels. Revenue through these
channels increased approximately 33% in 1996.

As part of its plan for growth in 1996 the Company implemented a national
agent sales program and emphasized its efforts on the carrier sales program.
This strategy enabled the Company to maximize network efficiencies by
increasing the volume of traffic on the network.

The national agent sales program included the addition of four agent sales
managers throughout the country. This strategy enabled the Company to
penetrate other local markets and utilize the network on both the east and
west coasts.

The Carrier sales channel was also an important area of focus in 1996. This
distribution channel (domestic carrier termination) generated approximately
14% of overall revenue in 1996 and helped maximize network efficiencies.

DISTRIBUTION OF REVENUES

Service % 1996 % 1995
-----------------------------------------------------------
Domestic 1+ 39% 49%
International 24% 17%
Inbound 16% 25%
Wireless 7% 9%
Domestic Carrier Termination 14% --

GROSS PROFIT

Gross profit in 1996 as a percentage of net sales revenue decreased to 33.5%
from 34.7% in 1995. This decrease is mainly attributed to the increase in
carrier revenue which generates lower gross margins compared to retail and
other revenues.

SELLING, GENERAL, AND ADMINISTRATIVE COSTS

Selling, General, and Administrative ("SG&A") expenses increased in 1996 by
approximately $2,619,000, primarily due to an increase in salary and
commission expense. SG&A as a percentage of net sales decreased from 36.4%
in 1995 to 31.6% in 1996.

Salary expense increased approximately $445,000, due to the addition of four
new agent sales managers and eight new administrative positions which were
created to support the company's revenue growth. Commission expense increased
approximately $1,312,000 due to increased reseller and agent traffic levels.
The Company purchased additional fixed assets (primarily Telecommunications
equipment) which increased depreciation expense approximately $465,000 in
1996.

16
<PAGE>

PROVISION FOR BAD DEBT

Bad debt expense declined in 1996 by approximately $363,000 (from
approximately 3.0% to 1.2% of net sales) despite the write off of a large
receivable in the amount of $350,000. Bad debt expense exclusive of this
write-off would have been approximately .3% in 1996. The decrease in bad debt
expense was attributed to a solid credit policy which is continually enforced
by our internal Collections Department.

NET INCOME FROM OPERATIONS

Net income from operations in 1996 substantially improved over the results
achieved in 1995. Net income for 1996 was $88,625 as compared to a net loss
of $277,723 in 1995. The primary reason for this improvement was a decrease
in Selling, General and Administrative ("SG&A") expense as a percentage of
overall revenue. As indicated above, SG&A expense accounted for 36.4% of
revenue in 1995 and only 31.6% in 1996. The 1995 results were helped by
several non-recurring items. The Company's dispute with Colonial Penn Group,
Inc. and Colonial Penn Insurance Company (collectively "CPG") was favorably
resolved, resulting in the reversal of an accounts payable in the amount of
approximately $2,880,000. However, this benefit was substantially offset by
the cost of unsuccessfully litigating the resultant AT&T case on the basis of
anti-trust. The costs of litigation with AT&T incurred during 1995
approximated $850,000. These costs do not include the additional expense of
approximately $305,000 of related expenses pertaining to the write-down of
certain AT&T signal conversion equipment and accounts receivable written-off,
which were attributable to AT&T services provided by the Company. In
addition, AT&T was awarded a counter claim in the litigation in the amount of
$669,000, pertaining to services utilized in prior years. As a result of
settlement of these matters, the Company recognized a net favorable impact of
approximately $1,056,000 in 1995 which is included in litigation settlements
in other income on the Consolidated Statement of Operations.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 1997, cash and cash equivalents were approximately $1,588,000.
Cash flow used in operations in 1997 was approximately $1,384,000. Net cash
used in investing activities in 1997 was approximately $395,000, which
resulted from the purchase of property and equipment.

Working capital at December 31, 1997 was approximately $(2,664,000) as
compared to approximately $(2,214,000) at December 31, 1996. The decrease in
working capital was primarily due to the net loss as stated above.

The Company has a revolving $2,000,000 credit facility with Century Business
Credit Corporation, which was automatically renewed on March 11, 1997 for two
successive one year periods. Interest on the revolving credit facility is
currently calculated at the prime lending rate plus 3 3/4%, with a minimum
loan value of $750,000. The loan is collateralized by accounts receivable and
fixed and intangible assets of the Company. As of December 31, 1997, the
Company's outstanding balance on its credit facility was approximately
$691,000, leaving approximately $1,309,000 available for future borrowing
under the credit facility. The Company was not in compliance with several of
its covenants at December 31, 1997, however, the Company received a waiver
related to such conditions of non-compliance at December 31, 1997. The
Company's loan contains certain subjective financial performance criteria and
in the event the company fails to meet such criteria during 1998, the lender
has the right to call the loan in full.

In addition, the Company raised $2,300,000 in a private placement of 1,590,000
shares of its Common Stock in November 1997. This enabled the Company to
temporarily meet the capital and surplus requirements for the continued
listing of its Common Stock on The Nasdaq Small Cap Market. Currently, the
Company does not meet the minimum Nasdaq capital requirements. As a result,
The Nasdaq Stock Market may require that the Company raise additional capital
to maintain the listing of its Common Stock on The Nasdaq Small Cap Market.

17
<PAGE>

There can be no assurance that the Company will be able to raise additional
capital to maintain the listing of its Common Stock on The Nasdaq Small Cap
Market.

The Company has capital lease obligations for various equipment pursuant to
leases with terms of three to five years. These leases expire at various
times through the year 2000. The leases carry interest rates ranging from
9.0% to 13.9%, and are collateralized by the equipment purchased. The
aggregate lease balance as of December 31, 1997 was approximately $775,000.
The Company anticipates that its minimum lease payments for 1998 will be
approximately $347,500.

The Company plans to focus on growing its revenue base through the addition of
profitable customers and decreasing its network costs. Management will focus
on obtaining additional financing or possibly raising additional equity
through private placement, in order to ensure adequate funding is available to
support operations, if necessary. The Company's ability to operate beyond the
immediate future is dependent upon its ability to achieve levels of revenues
to support the Company's cost structure, decrease its network costs, maintain
adequate financing, and generate sufficient cash flow from operations to meet
its operating needs. However, no assurance can be given that the Company will
be successful in its efforts to implement its plans and achieve a level of
profitability.

YEAR 2000

The Company is in the preliminary stages of a project to determine the impact
of the Year 2000 issue on the Company's computer systems. The Company is
currently assembling a list of, and analyzing, its internally developed
software, purchased software, hardware, and external data feeds, including
switches used by carriers who terminate the Company's off-net traffic, that
utilize embedded date codes which may experience operational problems when the
Year 2000 is reached. The Company currently plans to complete its analysis by
the end of 1998 and will continue to make required modifications to the
identified problem areas through the early part of 1999.

Preliminary results to date indicate that that the Company will be required to
replace its switch located in Philadelphia. Management has estimated the cost
of replacement at approximately $1.7 million and anticipate such replacement
will occur in the third quarter of 1998. The total remaining cost of making
the Company "Year 2000 Compliant" cannot be accurately determined at this
time. In addition, the Company currently cannot assess the effect of
incomplete or untimely resolution of Year 2000 issues on its operations.

Item 8. Financial Statements and Supplementary Data

See "Index To Consolidated Financial Statements and Notes To Consolidated
Financial Statements" on page F-i herein.

18
<PAGE>

Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure

On March 14, 1997, US WATS, Inc. (the "Company") replaced Rudolph, Palitz LLP
as the principal accountant for the Company and its subsidiaries. The former
principal accountant's reports on the Company's financial statements for the
past year have not contained an adverse opinion or a disclaimer of opinion,
nor have its opinions been qualified or modified as to uncertainty, audit
scope or accounting principles. The Company's decision to replace its
principal accountant was approved by the board of directors. During the
Company's two immediately preceding fiscal years (January 1, 1994 to December
31, 1994 and January 1, 1995 to December 31, 1995) and any subsequent interim
period preceding the Company's replacement of its principal accountant, there
were no disagreements with the former accountant on any matter of accounting
principles or practices, financial statement disclosure or auditing scope or
procedure, which disagreements, if not resolved to the satisfaction of the
former accountant, would have caused it to make reference to the subject
matter of the disagreement in connection with its report.

19
<PAGE>

PART III

Item 10. Directors and Executive Officers of the Registrant.

The following table sets forth information with respect to all of the
incumbent directors of the Company at February 27, 1998.

Name Age Position Director Since
- ------------------------------------------------------------------------------
Stephen J. Parker (59) Director, President and Chief 1989
Executive Officer (1)

Aaron R. Brown (44) Chairman (2) 1997

Murray Goldberg (55) Director (3) 1996

Arthur Regan (34) Director and Secretary (4) 1997

(1) Stephen J. Parker holds a Ph.D. from Ohio University. He was employed
part-time by the Company from October 1989 until March 1990. He joined
the Company full-time in March 1990 as Vice President of Operations.
Prior to his employment with the Company, and in August 1989, Mr. Parker
and Aaron Brown, a former Director, Chief Executive Officer and Treasurer
of the Company, founded Parker Brown, Inc. ("PBI"), a broker-dealer that
became licensed with the NASD in November 1990. PBI did not conduct any
business, and Mr. Parker sold all of his interest in PBI in September
1991. Mr. Parker and Mr. Brown also founded Parker Brown Partners ("PBP")
in August 1989. PBP was organized to operate as a branch office of Morgan
Gladstone, a registered broker-dealer, and to provide investment banking
and consulting services to start-up and development stage businesses. PBP
operated as a branch office of Morgan Gladstone until April 1990. Mr.
Parker is a former stockbroker, and in addition to his association with
PBI and Morgan Gladstone in 1989-1990, he was employed as a stockbroker
with Princeton Financial, and with Profile Investments, both in
Philadelphia, during 1989. Mr. Parker was Executive Vice President of the
Company until May 24, 1995 and Chief Operating Officer and Chairman of the
Board from that date until December 16, 1996. He has been Vice Chairman
since that date.

(2) Aaron R. Brown was named Chairman of the Board of Directors of USW on
November 26, 1997. Mr. Brown served as Chairman of the Board and
President of USW from its inception until May 1995 and as Chief Executive
Officer from inception until December 16, 1996. He served as a Director
from May 1995 through January 1997. Prior to his employment with USW, and
in August 1989, Mr. Brown co-founded PBI. PBI did not conduct any
business, and Mr. Brown sold his interest in PBI in September 1991. Mr.
Brown also co-founded PBP in August 1989. PBP was organized to operate as
a branch office of Morgan Gladstone, a registered broker-dealer, and to
provide investment banking and consulting services to start-up and
development stage businesses. PBP operated as a branch office of Morgan
Gladstone until April 1990. Mr. Brown was Vice President of Finance for
United Environmental Services, an asbestos removal firm in Philadelphia,
in 1988. Mr. Brown is a Certified Public Accountant.

20
<PAGE>

(3) Murray Goldberg, a shareholder of the Company since 1989, and an
independent sales agent of the Company since 1993, is also currently
employed as a sales agent for Goldberg & Associates, a partnership, Mr.
Goldberg also is the owner and a Vice-President of Jamco, Inc., a discount
shoe distributor in Florida and the owner and Director of Doxs, Inc., an
anaesthesia equipment developer and distributor. Prior to January 1993,
Mr. Goldberg worked as an anesthesiologist at Paoli Memorial Hospital.
From June 1994 until May 1996, he was an owner of Strathmore Bagel
Franchise Company. Mr. Goldberg was elected a Director of the Company in
November, 1996.

(4) Arthur Regan has been a director of USW since August 1997. Mr. Regan is
currently President of Regan & Associates, Inc., a proxy
solicitation/shareholder services firm in New York, New York that has been
a vendor of USW since 1993. Mr. Regan also is the Chairman, President and
Chief Executive Officer of RD's Place, Inc., a messenger/courier company
located in Jersey City, New Jersey. Mr. Regan was previously a Director
and President of David Francis & Co., Inc., a proxy
solicitation/shareholder services firm, from 1988 through 1991.

Executive Officers

The Company's executive officers are appointed by the Board of Directors and,
except as described herein, hold office at the pleasure of the Board until
their successors are appointed and have qualified. In addition to Mr. Parker,
who serves as an executive officer, the Company has an additional executive
officer, David B. Hurwitz.. Mr. Hurwitz, the Executive Vice President of
Sales and Marketing of the Company, age 34, served from 1995 to 1996 as the
Vice President of Sales and Marketing of Commonwealth Long Distance, a C-TEC
company. Prior to the position with Commonwealth, he served as Executive Vice
President and Chief Operating Officer of InterNet Communications Services,
Inc. and as General Manager of FiberNet from 1992 to 1995. Both InterNet and
FiberNet are affiliated with one another. From 1985 to 1992 Mr. Hurwitz held
sales and sales management positions with RCI Long Distance, a subsidiary of
Rochester Telephone Corp. (now Frontier Corporation).

Item 11. Executive Compensation.

The following table shows for the years ended December 31, 1995, 1996 and
1997, certain compensation paid or accrued by the Company for services by the
named officers.

21
<PAGE>

<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
- ------------------------------------------------------------------------------------------------------------------------------------
Long Term Compensation
--------------------------------------
Annual Compensation Awards Payouts
- ------------------------------------------------------------------------------------------------------------------------------------
Name Other Restricted Common All
and Annual Stock Stock LTIP Other
Principal Salary Bonus Comp. Awards Underlying Payouts Comp.
Position Year ($) ($) ($) (1) ($) Options (#) ($) ($)
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Stephen J. Parker '97 169,125 -- -- -- -- -- --
President and Chief '96 165,000 -- -- -- -- -- 2,065(2)
Executive Officer (3) '95 160,000 -- -- -- 600,000(5) -- 4,332(2)
- ------------------------------------------------------------------------------------------------------------------------------------
David Hurwitz '97 150,000 69,821 -- -- -- -- --
Executive Vice President '96 6,250 -- -- -- 700,000 -- --
of Sales and Marketing '95 N/A N/A N/A N/A N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------------------
Kevin M. O'Hare '97 150,000 -- -- -- -- -- 66,667(6)
Former President and '96 8,333 -- -- -- 1,100,000(6) -- --
Chief Executive Officer (6) '95 N/A N/A N/A N/A N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------------------
Aaron R. Brown '97 6,875 -- -- -- -- -- 119,792
Former Chief Executive '96 165,000 -- -- -- -- -- 1,116(2)
Officer and Treasurer (4) '95 160,000 -- -- -- 600,000(5) -- 1,932(2)
- ------------------------------------------------------------------------------------------------------------------------------------
Mark Mendes '97 97,615 -- -- -- 350,000(6) -- 54,000(6)
Former Chief Operating '96 N/A N/A N/A N/A N/A N/A N/A
Officer (6) '95 N/A N/A N/A N/A N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------------------
Christopher Shannon '97 95,200 -- -- -- 350,000(6) -- 52,000(6)
Former Chief '96 N/A N/A N/A N/A N/A N/A N/A
Financial Officer (6) '95 N/A N/A N/A N/A N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------------------

<FN>
(1) For 1995, 1996 and 1997 the aggregate amount of such Other Annual
Compensation for each named officer is not reportable under SEC rules
because such amount is the lesser of either $50,000 or 10% of the total
salary for such named officer.

(2) Includes amounts paid for life insurance of the named officer where the
Company is not the beneficiary of the policy.

(3) Mr. Parker became President and Chief Executive Officer on October 1,
1997.

(4) Mr. Brown resigned his positions with the Company as Chief Executive
Officer and Treasurer effective December 16, 1996, but remained a Director
of the Company at the end of fiscal 1996. He became a consultant to the
Company on January 14, 1997 at a fee of $125,000 per annum.

(5) On May 11, 1995, the Company agreed to issue each of Messrs. Brown and
Parker warrants to purchase 600,000 shares of the Company's common stock
in consideration for their limited personal guarantees provided in
connection with the Company's revolving credit facility.

(6) Effective September 30, 1997, Kevin O'Hare, President and Chief Executive
Officer, terminated his employment with the Company. Mr. O'Hare was
immediately replaced by Stephen Parker as President and Chief Executive
Officer. Upon termination Mr. O'Hare received severance pay of
approximately $67,000 and retained 100,000 stock options at $1.03125 per
share. Mr. O'Hare originally had a three year employment agreement
effective December 16, 1996 including an additional 500,000 stock options
at $1.03125 per share and 500,000 stock options at $1.30 per share. These
additional stock options were relinquished as of September 30, 1997.

In October 1997, Mark Mendes, Chief Operating Officer, and Christopher
Shannon, Chief Financial Officer terminated their employment with the
Company. Mr. Mendes and Mr. Shannon each had a three year employment
agreement -- their termination agreements entitled them to receive
severance pay in the amount of $54,000 and $52,000 respectively. Also
upon termination, Mr. Mendes retained 56,667 stock options at $1.25 per
share and Mr. Shannon retained 56,667 stock options at $1.219 per share.
At termination, each relinquished 293,333 stock options at the same price.

22-23
<PAGE>

Option Grants In Last Fiscal Year

The following table summarizes the number of options granted to named officers
during the year ended December 31, 1997. The Company did not grant any stock
appreciation rights in 1997.

</TABLE>
<TABLE>
<CAPTION>

Potential Realizable
Value of Assumed Annual
Number of Shares of Percent of Total Rates of Stock Price
Name Common Stock Options Granted in Exercise Expiration Appreciation for Option
Underlying Options Fiscal Year(1) Price Date Term(2)
Granted
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
5% 10%
- ------------------------------------------------------------------------------------------------------------------------------------
Kevin M. O'Hare(3) 500,000(4)(5) 31.1% $1.30 01/15/02 $179,583 $396,832
- ------------------------------------------------------------------------------------------------------------------------------------
Aaron R. Brown -- -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Stephen J. Parker -- -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
David Hurwitz 300,000(4) 18.6% $1.30 01/15/02 $107,750 $238,099
- ------------------------------------------------------------------------------------------------------------------------------------
Mark Mendes (3) 350,000 21.7% 1.25 03/03/02 $120,873 $267,098
- ------------------------------------------------------------------------------------------------------------------------------------
Christopher Shannon (3) 350,000 21.7% 1.219 01/10/02 $117,875 $260,474
- ------------------------------------------------------------------------------------------------------------------------------------
<FN>
(1) Based upon options to purchase a total of 1,616,000 shares granted to all
officers and employees of the Company in 1997 under its Amended and
Restated Stock Option Plan or its predecessor plans.

(2) These amounts represent hypothetical gains that could be achieved for the
respective stock options if exercised at the end of the option term.
These gains are based on assumed rates of stock appreciation of 5% and 10%
compounded annually from the date the respective options were granted to
their expiration date.

(3) Messrs. O'Hare, Mendes and Shannon terminated their employment during 1997
and relinquished certain options (see Footnote #14 to the financial
statements, Changes in Management).

(4) On January 10, 1997, these options replaced options granted in December
1996 which vested upon the attainment of certain performance criteria.

(5) Mr. O'Hare's options to purchase the foregoing shares terminated upon his
termination of employment which occurred on September 30, 1997.
</TABLE>
25
<PAGE>

Aggregated Option Exercises In Last Fiscal Year and Fiscal Year-End Option
Values

The following table summarizes the number and value of unexercised options
held by the named officers as of December 31, 1997.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
Number of Value Number of Shares of Common Value of Unexercised
Shares Realized Stock In-The-Money Options
Acquired on Underlying Unexercised Options or Warrants
Exercise or Warrants at Fiscal Year-End at Fiscal Year-End(1)
------------------------------------------------------------------
EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
NAME # # $ $
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Kevin M. O'Hare -0- N/A 100,000(2) -- 128,125 none
- ------------------------------------------------------------------------------------------------------------------------
Aaron R. Brown(3) 31,000 5,812 809,000(4) 60,000(5) 936,250 56,250
- ------------------------------------------------------------------------------------------------------------------------
Stephen J. Parker(3) 31,000 5,812 809,000(4) 60,000(5) 936,250 56,250
- ------------------------------------------------------------------------------------------------------------------------
David Hurwitz 50,000 54,688 250,000 400,000 320,313 431,875
- ------------------------------------------------------------------------------------------------------------------------
Mark Mendes -- -- 56,667(2) -- 60,209 none
- ------------------------------------------------------------------------------------------------------------------------
Christopher Shannon -- -- 56,667(2) -- 61,965 none
- ------------------------------------------------------------------------------------------------------------------------
<FN>
(1) Based upon a market price of the Company's common stock on December 31,
1997 of $2.3125 per share (last trading day in December 1997).

(2) Messrs. O'Hare, Mendes and Shannon terminated their employment during
1997. (See Footnote #14 to the financial statements, Changes in
Management.)

(3) Options to purchase 300,000 shares of the Company's common stock issued on
September 1, 1993 to each of Messrs. Brown and Parker that vested upon the
attainment of certain performance goals were terminated on December 16,
1996, the date Messrs. Brown and Parker resigned certain executive
positions with the Company.

(4) Includes options to purchase 240,000 shares of common stock issued on
September 1, 1993 under the Company's 1993 Executive Stock Option Plan
(the "Executive Plan", now consolidated with the Employee Compensation
Stock Option Plan in the Amended and Restated Stock Option Plan) at an
exercise price of $1.375 per share and warrants to purchase 569,000 shares
of the Company's Common Stock issued on May 11, 1995 at $1.0625 per share.

(5) Represents options to purchase 60,000 shares of common stock issued on
September 1, 1993 under the Company's Executive Stock Option Plan at a
price of $1.375 per share.
</TABLE>
25
<PAGE>

Compensation of Directors

Directors who also serve as salaried employees of the Company do not receive
any additional compensation for their services as directors.

During 1996, no compensation was paid to non-employee directors of the Company
for their services as directors. Beginning in 1997, non-employee directors
are entitled to receive $1,000 for each Board meeting attended in person, and
$500 for participation in each Board meeting conducted by telephone conference
call. In addition, the Company granted to each non-employee director options
to purchase 20,000 shares of the Company Common Stock for his services as a
director during 1997. These grants consist of options to purchase 20,000
shares of the Company Common Stock at $1.43 per share granted to Mr. Sugarman,
a former director, and options to purchase 20,000 shares of the Company Common
Stock at $1.69 per share granted to Mr. Regan.

Employment Agreements

Mr. Parker has a seven year Employment Agreement terminating December 31,
2000, which is automatically renewable for an additional five years unless
either party provides written notice of non-renewal no later than thirty (30)
days prior to the expiration of the initial term. The contract provides for
an annual base salary of not less than $165,000 subject to annual cost of
living increases as measured by the growth in the Consumer Price Index--Urban
Consumer, All Items, U.S. Cities' Average. Upon the death of Mr. Parker, the
Company is obligated to pay his beneficiary his annual salary in effect at the
time of his death for the remainder of the term of the agreement. Mr.
Parker's Employment Agreement provides that Mr. Parker may not be terminated
by the Company except for the conviction of a felony. Any costs of legal
counsel engaged by Mr. Parker relating to the Company's failure to comply with
the terms of the Employment Agreement will be paid by the Company.

Mr. Brown had an Employment Agreement that was substantially similar to the
Employment Agreement the Company has with Mr. Parker, described above.
Effective December 16, 1996, Mr. Brown released the Company from its
obligations under the Agreement. On January 14, 1997, Mr. Brown entered into
a Consulting Agreement with the Company. The Consulting Agreement, which is
for a term of six years with an automatic extension of one year unless a party
gives thirty-days written notice of its intent not to renew, provides that Mr.
Brown will be compensated at a rate of $125,000 annually, to be increased each
year in accordance with the Consumer Price Index.

Mr. Hurwitz has a three year Employment Agreement terminating January 5, 2000.
The contract provides for an annual base salary of not less than $150,000
subject to annual cost of living increases as measured by the Consumer Price
Index.

Item 12. Security Ownership of Certain Beneficial Owners and Management.

The following table sets forth, as of February 27, 1998 information concerning
the shares of the Company's Common Stock beneficially owned by: (i) each
person or group known to the Company to be the beneficial owner of more than
5% of the outstanding shares of Common Stock; (ii) each director; (iii) each
Executive Officer; and (iv) all directors and executive officers as a group.
Except as otherwise indicated, each person named or included in a group has
sole voting and investment power with respect to his or its shares of Common
Stock. The Company also has outstanding 30,000 shares of Preferred Stock.
For purposes of this table, it has been assumed that the outstanding shares of
Preferred Stock have been converted into 300,000 shares of Common Stock in
accordance with its terms as of February 27, 1998. No Executive Officer or
Director of the Company owns any shares of the Company's Preferred Stock.

26
<PAGE>

Name and Address of Beneficial Amount and Nature
Owner or Identity of Group of Beneficial Ownership Percent of Class(1)
- ------------------------------------------------------------------------------
Stephen Parker 2,990,000(1) 16.1%
111 Presidential Boulevard
Suite 114
Bala Cynwyd, PA 19004

Aaron R. Brown 2,640,000(2) 14.2%
111 Presidential Boulevard
Suite 114
Bala Cynwyd, PA 19004

Murray Goldberg 2,270,000(3) 12.8%
26 Anthony Drive
Malvern, PA 19355

Arthur Regan 32,000(4) *
15 Park Row
New York, NY 10038

Tel-Save Holdings, Inc. 2,164,225(5) 12.2%
6805 Route 202
New Hope, PA 18938

Gold & Appel Transfer, S.A. 2,957,400(6) 16.7%
Omar Hodge Building
Wickhams Cay
Road Town
Tortula, British Virgin Islands

David B. Hurwitz 400,000(7)
48 Dalton Way
Holland, PA 18966

All Directors and Executive Officers
as a group (5 persons) 8,332,000(8) 42.3%

* Less than 1%

27
<PAGE>

(1) Includes 2,181,000 shares of Common Stock owned by Mr. Parker. Also
includes warrants to purchase 569,000 shares of Common Stock at an
exercise price of $1.0625 per share and options to purchase 240,000 shares
of Common Stock at an exercise price of $1.375 per share.
(2) Includes 1,831,000 shares of Common Stock owned by Mr. Brown. Also
includes warrants to purchase 569,000 shares of Common Stock at an
exercise price of $1.0625 per share and options to purchase 240,000 shares
of Common Stock at an exercise price of $1.375 per share.
(3) Includes 2,270,000 shares of Common Stock owned by Mr. Goldberg.
(4) Includes 12,000 shares of Common Stock and options to purchase 20,000
shares of Common Stock at an exercise price of $1.69 per share.
(5) As reported on Schedule 13D, under the 1934 Act, filed by Tel-Save
Holdings, Inc.
(6) As reported on Schedule 13D, under the 1934 Act, filed by Gold & Appel
Transfer, S.A.
(7) Includes 50,000 shares of Common Stock owned by Mr. Hurwitz. Also includes
options to purchase 250,000 shares of Common Stock at $1.03125 per share
and options to purchase 100,000 shares of Common Stock at $1.30 per share.
(8) Includes shares issuable to Messrs. Parker, Brown, Regan, and Hurwitz
upon the exercise of options and warrants described in notes 1, 2, 4,
and 7.

Item 13. Certain Relationships and Related Transactions.

Loan Guarantees
On May 11, 1995, the Company entered into a Loan and Security Agreement with
Century Business Credit Corporation ("Century") for a revolving credit
facility of $2,000,000. On April 27, 1995, the Company issued 500,000 shares
of restricted Common Stock to each of Aaron R. Brown and Stephen J. Parker in
consideration for their limited personal guarantee given to Century equal to
25% of the indebtedness incurred with Century. In connection with this
transaction Messrs. Brown and Parker also terminated 420,000 stock options.
After review of the transaction by a Special Committee appointed by the Board
of Directors, the issuance of the restricted stock and the cancellation of
options were rescinded. In their place, the Company issued to each of Messrs.
Brown and Parker warrants to purchase 600,000 shares of Common Stock in
consideration for the limited personal guarantees given by each in connection
with the credit facility. Each warrant issued in the transaction entitles the
holder to purchase shares of Common Stock at a price of $1.0625 per share
until May 11, 2000. The warrants are non-transferable by the officers and the
stock issuable upon exercise of the warrants is restricted stock under the
federal securities laws.

Indemnification Arrangements
The Company is a party to indemnification agreements with two of its
directors, Aaron R. Brown and Stephen J. Parker, dated August 1990. In
addition, the Company has entered into an indemnification agreement with Kevin
O'Hare, a former executive officer of the Company, dated July, 1997. In
general, the indemnification agreements obligate the Company to indemnify each
of Messrs. Brown, Parker and O'Hare against the liabilities and expenses
incurred by them in acting as a director or officer of the Company to the
maximum extent allowed by law. The Company, together with Messrs. Parker,
Brown and O'Hare, have been sued by the Company's former president for various
claims asserted by the plaintiff in connection with his termination of
employment with the Company on December 30, 1996. The Company and the
individual defendants have selected counsel to defend the action. The Board
of Directors of the Company has authorized the Company to advance the expenses
of the individual defendants incurred in defending this action upon the
receipt of an undertaking from each of them to repay the amounts so advanced
in the event it is determined that they are not entitled to indemnification
under applicable law.

28
<PAGE>

Sales Agency
Mr. Goldberg acts as a sub-agent for the Company and is the co-owner of
Goldberg & Associates, a company that acts as an agent for the Company in the
sale of the Company's products and services. During 1997, the Company paid
Mr. Goldberg and such company a total of $136,983 in commissions for their
services as the Company's sales agents.

Loans
During the first quarter of 1996, the Company borrowed $100,000 from each of
Aaron R. Brown and Stephen J. Parker, directors of the Company. During 1996,
the Company repaid the entire outstanding balance of the loans to Messrs.
Brown and Parker with interest at a rate of 10% per annum. The loans were
payable upon demand.

29
<PAGE>

PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a) Documents filed as part of this Annual Report on Form 10-K:

(1) Financial Statements

See "Index To Consolidated Financial Statements and Financial
Statement Schedules" on page F-i herein.

(2) Financial Statement Schedules required to be filed by Item 8 on
this form.

See "Index To Consolidated Financial Statements and Financial
Statement Schedules" on page F-i herein.

(b) Reports on Form 8-K:

(1) On November 26, 1997, the Company filed Form 8-K regarding a private
placement of $2.3 million.

(2) On October 10, 1997, the Company filed Form 8-K regarding its
continued inclusion of the Company's shares on The NASDAQ Small Cap
Market for failure to meet the capital and surplus requirements.

(3) On February 25, 1997, the Company filed Form 8-K regarding executive
management changes and changes in the Board of Directors.

(4) On March 19, 1997, the Company filed Form 8-K regarding its decision
to replace its certifying accountant for the year ended
December 31, 1996.

30
<PAGE>

Exhibit No. Description

3.1 Certificate of Incorporation of Registrant*
3.2 Amendment to Certificate of Incorporation*
3.3 By-Laws of Registrant*
4.1 Specimen Common Share Certificate*
10.1 DSC Marketing Services Supply Agreement**
10.2 Key Employees Incentive Stock Option Plan**
10.3 Employee Compensation Stock Option Plan**
10.4 Agreement of Lease for 3 Parkway, Philadelphia, PA**
10.6 Employment Agreement dated December 23, 1993, between US WATS,
Inc. and Stephen J. Parker* * *
10.7 Loan and Security Agreement between US WATS, Inc. and Century
Business Credit Corporation dated May 11, 1995****
10.8 Employment Agreements dated February 25, 1997, between US WATS,
Inc. and David B. Hurwitz, Kevin M. O'Hare and
Mark A. Mendes*****
10.9 Employment Agreement dated March 3, 1997, between US WATS, Inc.
and Christopher J. Shannon.
10.10 Termination Agreement dated September 30, 1997, between US
WATS, Inc. and Kevin M. O'Hare.
10.11 Termination Agreement dated October 15, 1997 between US WATS,
Inc. and Mark A. Mendes
10.12 Termination Agreement dated October 17, 1997, between US WATS,
Inc. and Christopher J. Shannon
* Filed as an exhibit with corresponding Exhibit No. to
Registrant's post effective amendment No. 1 to Registration
Statement on Form S-18, or previous Annual Report Form 10-K.
** Incorporated by reference to the December 31, 1992 Form 10-K
*** Incorporated by reference to the December 31, 1993 Form 10-K
**** Incorporated by reference to the June 30, 1995 Form 10-Q
***** Incorporated by reference to the February 25, 1997 Form 8-K

31
<PAGE>

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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 WATS, INC.
(Registrant)

By: /s/ Stephen Parker
------------------------------
Stephen Parker

Date: [ ]

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

SIGNATURE TITLE DATE

/s/ Stephen Parker
- -----------------------
Stephen Parker President, Chief Executive Officer [ ]
and Director

/s/ Michael P. McAnulty
- ------------------------
Michael P. McAnulty Chief Financial Officer
(Principal Accounting Officer) [ ]

/s/ Aaron R. Brown
- ------------------------
Aaron R. Brown Chairman of the Board [ ]

32
<PAGE>

US WATS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
PAGE (S)

CONSOLIDATED FINANCIAL STATEMENTS:

Independent Auditors' Reports F-1 to F-2

Consolidated Balance Sheets
December 31, 1997 and 1996 F-3 to F-4

Consolidated Statements of Operations
Years ended December 31, 1997, 1996, and 1995 F-5

Consolidated Statements of Common Shareholders'
Equity (Deficiency) Years ended
December 31, 1997, 1996, and 1995 F-6 to F-8

Consolidated Statements of Cash Flows
Years ended December 31, 1997, 1996, and 1995 F-9

Notes to Consolidated Financial Statements F-10 to F-23

Financial Statement Schedule
- - Schedule II - - Valuation and Qualifying Accounts F-24

F-i
<PAGE>

INDEPENDENT AUDITORS' REPORT

Board of Directors and Shareholders
US WATS, Inc.
Bala Cynwyd, Pennsylvania

We have audited the accompanying consolidated balance sheets of US WATS, Inc.
and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of operations, common shareholders' equity
(deficiency), and cash flows for the years then ended. Our audits also
included the financial statement schedule listed in the Index at Item
14(a)(2). These financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements and financial statement schedule
based on our audit.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the 1997 and 1996 consolidated financial statements present
fairly, in all material respects, the financial position of US WATS, Inc. and
subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and cash flows for the years then ended in conformity with
generally accepted accounting principles. Also, in our opinion, such
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.

The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 3 to
the consolidated financial statements, the Company's net loss, negative
working capital and stockholders' deficiency raise substantial doubt about its
ability to continue as a going concern. Management's plans concerning these
matters are also described in Note 3. The consolidated financial statements
do not include any adjustments that might result from the outcome of this
uncertainty.

DELOITTE & TOUCHE LLP
Philadelphia, Pennsylvania

March 11, 1998

F-1
<PAGE>

INDEPENDENT AUDITORS' REPORT

Board of Directors and Shareholders
US WATS, Inc.
Bala Cynwyd, Pennsylvania

We have audited the accompanying consolidated statements of operations, common
shareholders' equity, and cash flows of US WATS, Inc. and subsidiaries for the
year ended December 31, 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.

We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the results of operations and cash
flows of US WATS, Inc. and subsidiaries for the year ended December 31, 1995,
in conformity with generally accepted accounting principles.

RUDOLPH, PALITZ LLP
Plymouth Meeting, Pennsylvania

March 25, 1996

F-2
<PAGE>

US WATS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

December 31,
-------------------
1997 1996
---- ----
ASSETS
- ------

Current Assets
Cash and cash equivalents $ 1,588,267 $ 1,455,186
Accounts receivable, net of allowance for
doubtful accounts of $1,498,749 for 1997 and
$672,058 for 1996 6,899,082 6,513,899
Prepaid expenses and other 108,683 137,325
----------- -----------
Total Current Assets 8,596,032 8,106,410
----------- -----------

Property and Equipment
Telecommunications equipment 3,881,857 3,773,459
Equipment 1,579,435 1,356,609
Software 647,797 610,286
Office furniture and fixtures 155,553 130,003
Leasehold improvements 36,432 35,226
----------- -----------
6,301,074 5,905,583
Less accumulated depreciation and amortization 3,286,435 2,305,565
----------- -----------

Total Property and Equipment 3,014,639 3,600,018
----------- -----------

Other assets, principally deposits 202,804 285,931
----------- -----------
$11,813,475 $11,992,359
=========== ===========

The accompanying notes are an integral part of these financial statements

F-3
<PAGE>

US WATS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

December 31,
1997 1996

LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIENCY)
- -------------------------------------------------
Current Liabilities
Note payable $ 690,826 $ 1,196,860
Capital lease obligations, current portion 273,095 194,472
Accounts payable 6,975,779 6,378,296
Accrued commissions 943,556 918,129
Accrued expenses and other 1,007,980 553,445
State and Federal taxes payable 1,293,417 963,372
Deferred revenue 75,494 116,222
----------- -----------
Total Current Liabilities 11,260,147 10,320,796
----------- -----------

Long-Term Liabilities
Capital lease obligations, net of current portion 380,260 509,224
----------- -----------

Commitments and Contingencies - see note 7

Redeemable preferred stock, $.01 par, authorized
150,000 shares, issued and outstanding:
30,000 shares in 1997 and 1996
Redemption value: $11.00 per share 330,000 300,000
----------- -----------

Common Shareholders' Equity (Deficiency)
Common Stock issuable 166 --
Common stock, $.001 par, authorized
30,000,000 shares; issued:
17,654,100 shares in 1997
15,902,100 shares in 1996 17,654 15,902
Additional paid-in capital 5,328,982 2,623,350
Accumulated Deficit (5,503,484) (1,776,663)
----------- -----------
(156,682) 862,589
Common stock held in treasury
(250,000 shares), at cost (250) (250)
----------- -----------
(156,932) 862,339
----------- -----------
$11,813,475 $11,992,359
=========== ===========

The accompanying notes are an integral part of these financial statements

F-4
<PAGE>

<TABLE>
<CAPTION>
US WATS, INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended December 31,
------------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Revenues $56,466,698 $40,304,442 $27,755,388
Cost of sales 41,511,542 26,802,398 18,129,212
----------- ----------- -----------
Gross profit 14,955,156 13,502,044 9,626,176

Selling, general and administrative expenses 16,939,142 12,716,965 10,098,363
Provision for bad debt 1,465,248 479,208 842,628
----------- ----------- -----------
(Loss) Income from operations (3,449,234) 305,871 (1,314,815)

Other income (expense)
Interest income 71,921 62,732 69,859
Interest expense (322,508) (272,978) (88,767)
Litigation settlements -- -- 1,056,000
----------- ----------- -----------
(Loss) Income before income tax expense (benefit) (3,699,821) 95,625 (277,723)
Income tax expense -- 7,000 --
----------- ----------- -----------
Net (loss) income (3,699,821) 88,625 (277,723)

Preferred dividends and accretion 57,000 27,000 67,255
----------- ----------- -----------
Net (loss) income applicable to
common shareholders $(3,756,821) $ 61,625 $ (344,978)
=========== =========== ===========

Net loss per share
applicable to common shareholders $(.23) $-- $(.02)
=========== =========== ===========
Weighted average number of shares outstanding 16,084,971 15,877,900 15,100,400
=========== =========== ===========

The accompanying notes are an integral part of these financial statements
</TABLE>

F-5
<PAGE>

US WATS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF COMMON SHAREHOLDERS' EQUITY (DEFICIENCY)
YEAR ENDED DECEMBER 31, 1997

COMMON COMMON ADD'L TREASURY TREASURY SHAREHOLDERS'
COMMON STOCK PAR VALUE STOCK PAID-IN STOCK STOCK AT EQUITY
DESCRIPTION SHARES ISSUED $.001 PAYABLE CAPITAL DEFICIT SHARES COST (DEFICIENCY)
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1996 15,902,100 $15,902 -- $2,623,350 $(1,776,663) 250,000 $(250) $ 862,339
Net Loss before Preferred
Dividends for the year ended
December 31, 1996 -- -- -- -- (3,699,821) -- -- (3,699,821)
Private Placement 1,590,000 1,590 -- 2,298,410 -- -- -- 2,300,000
Exercise of Employee Stock
Options 100,000 100 110,575 -- -- -- 110,675
Exercise of Warrants 62,000 62 65,813 65,875
Common Stock to be Issued -- -- $166 209,834 -- -- -- 210,000
Options Issued for Consulting
Services 51,000 51,000
Accretion in Value of
Preferred Stock (30,000) (30,000)
Cash Dividends on Preferred
Stock ($.90 per share) (27,000) (27,000)
---------- ------- ---- ---------- ----------- ------- ----- ---------
Balance, December 31, 1997 17,654,100 $17,654 $166 $5,328,982 $(5,503,484) 250,000 $(250) $(156,932)
========== ======= ==== ========== =========== ======= ===== =========

The accompanying notes are an integral part of these financial statements
</TABLE>

F-6
<PAGE>
<TABLE>
<CAPTION>
US WATS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF COMMON SHAREHOLDERS' EQUITY
YEAR ENDED DECEMBER 31, 1996

TREASURY
COMMON ADD'L TREASURY STOCK
COMMON STOCK PAR VALUE PAID-IN STOCK AT SHAREHOLDERS'
DESCRIPTION SHARES ISSUED $.001 CAPITAL DEFICIT SHARES COST EQUITY
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995 15,852,100 $15,852 $2,573,400 $(1,838,288) 250,000 $(250) $750,714

Net Income (loss) before Preferred
Dividends for the year ended
December 31, 1996 -- -- -- 88,625 -- -- 88,625

Exercise of Employee Stock
Options 50,000 50 49,950 -- -- -- 50,000

Cash Dividends on Preferred
Stock, December 1, 1996
($.90 per share (27,000) (27,000)
---------- ------- ---------- ----------- ------- ----- --------
Balance, December 31, 1996 15,902,100 $15,902 $2,623,350 $(1,776,663) 250,000 $(250) $862,339
========== ======= ========== =========== ======= ===== ========

The accompanying notes are an integral part of these financial statements
</TABLE>

F-7
<PAGE>
<TABLE>
<CAPTION>
US WATS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF COMMON SHAREHOLDERS' EQUITY
YEAR ENDED DECEMBER 31, 1995

TREASURY
COMMON ADD'L TREASURY STOCK
COMMON STOCK PAR VALUE PAID-IN STOCK AT SHAREHOLDERS'
DESCRIPTION SHARES ISSUED $.001 CAPITAL DEFICIT SHARES COST EQUITY
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1994 14,691,100 $14,691 $1,395,691 $(1,493,310) 250,000 $(250) $(83,178)

Net Income (loss) before Preferred
Dividends for the year ended
December 31, 1995 -- -- -- (277,723) -- -- (277,723)

Conversion of 100,000 shares
of Series 9% Preferred Stock 1,000,000 1,000 999,000 -- -- -- 1,000,000

Employee Stock Bonus 50,000 50 24,950 -- -- -- 25,000

Exercise of Employee Stock Options 111,000 111 153,759 -- -- -- 153,870

Cash Dividends on Preferred
Stock, December 1, 1995
($.90 per share) -- -- -- (67,255) -- -- (67,255)
---------- ------- ---------- ----------- ------- ----- --------
Balance, December 31, 1995 15,852,100 $15,852 $2,573,400 $(1,838,288) 250,000 $(250) $750,714
========== ======= ========== =========== ======= ===== ========

The accompanying notes are an integral part of these financial statements
</TABLE>
F-8
<PAGE>
<TABLE>
<CAPTION>

US WATS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW

Years Ended December 31,
------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) before preferred dividends $(3,699,821) $ 88,625 $(277,723)
Adjustment to reconcile net income (loss) to
net cash provided by (used-in) operating activities
Litigation settlement -- -- (2,882,223)
Issuance of stock bonus -- -- 25,000
Stock to be issued for services 201,000 -- --
Depreciation and amortization 1,010,186 930,293 769,685
Provision for bad debts 1,465,248 479,208 842,628
Write-off of fixed assets -- -- 305,008
Changes in assets and liabilities which provided
(used) cash:
Accounts receivable (1,850,431) (2,093,041) (218,822)
Prepaid expenses and other 28,642 (30,134) (20,822)
Other assets 94,554 24,332 (27,501)
Deferred revenue (40,728) (255,569) 79,274
Accounts payable and accrued expenses 1,077,445 2,153,891 1,209,863
State & Federal Taxes payable 330,045 488,360 (72,977)
---------- ---------- ---------
Net cash provided by (used in) operating activities (1,383,860) 1,785,965 (268,610)
---------- ---------- ---------

INVESTING ACTIVITIES:
Purchase of property and equipment (395,491) (864,304) (695,469)
Investment in internet service provider -- (40,000) --
---------- ---------- ---------
Net cash used in investing activities (395,491) (904,304) (695,469)
---------- ---------- ---------

FINANCING ACTIVITIES:
Proceeds from private placement 2,300,000 -- --
Proceeds from stock option and warrant exercises 236,550 50,000 153,870
(Decrease) Increase in notes payable net (506,034) 21,696 1,175,164
Repayment of capital lease obligations (50,341) (152,005) (134,453)
Preferred stock dividend (27,000) (27,000) (67,255)
Payment of loan acquisition costs (40,743) -- (110,986)
---------- ---------- ---------
Net cash (used in) provided by financing activities 1,912,432 (107,309) 1,016,340

Net increase (decrease) in cash and cash equivalents 133,081 774,352 52,261

Beginning cash and cash equivalents 1,455,186 680,834 628,573
---------- ---------- ---------
Ending cash and cash equivalents $1,588,267 $1,455,186 $ 680,834

The accompanying notes are an integral part of these financial statements
</TABLE>

F-9
<PAGE>

US WATS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BACKGROUND

US WATS, Inc. (the "Company" or "USW") is a switch-based interexchange carrier
providing long distance telephone communications services primarily to small
and medium-size business customers. The Company also provides inbound-800 long
distance services, as well as other telecommunications services such as travel
cards (calling cards), cellular, paging, internet service, dedicated access,
data services, pre-paid calling cards (debit cards), international callback,
and carrier termination services. The Company uses its own switches and
facilities to originate, transport and terminate calls for customers generally
located in the Mid-Atlantic region and California (on-net areas). For calls
originating or terminating outside the Company's own network (off-net area),
the Company utilizes the services provided by other long distance companies.
Substantially all of the Company's revenues are earned from its customers
located on the East Coast.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and
its three wholly-owned subsidiaries, USW Corporation, USW Enterprises, Inc.,
and Carriers Group, Inc. after elimination of all inter-company accounts,
transactions and profits. The Company's investment in an internet service
provider is accounted for under the Cost Method.

Revenue Recognition

The Company recognizes revenue based upon the customer's usage of services.
The Company bills its customers for service on a monthly basis.

Cash and Cash Equivalents

The Company considers cash in bank and repurchase agreements with a maturity
of three months or less when purchased as cash and cash equivalents.

Allowance for Doubtful Accounts

Write-offs of accounts receivable for 1997 and 1996 were approximately
$732,000 and $213,000 respectively.

F-10
<PAGE>

Property and Equipment

Property and equipment are recorded at cost. Depreciation is calculated for
financial reporting purposes using the straight line method over the estimated
useful lives of the assets:

Telecommunications equipment ..........................7 years
Furniture fixtures and other...........................5 years

Depreciation and amortization expense of property, plant and equipment for
1997, 1996, and 1995, was $1,010,186, $930,293, and $1,030,462, respectively.
Included in depreciation expense for 1995 was approximately $305,000 resulting
from the recognized obsolescence of telecommunications equipment.

Deferred Revenue

Deferred revenue consists primarily of prepayments of Debit Card and
International Call Back services. Deferred revenue is recognized as income
based on monthly usage.

Deferred Financing Costs

Loan origination costs are amortized by the straight-line method over the term
of the related loan, and are included in other assets.

Accounts Payable

Accounts payable includes the cost of access charges due local telephone
companies and long distance transport purchased from long distance carriers.

Marketing

All costs related to marketing and advertising the Company's products and
services are expensed in the period incurred.

Use of Estimates

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

F-11
<PAGE>

(Loss) Income per Common Share Applicable to Common Shareholders

(Loss) income per common share applicable to common share holders is computed
by dividing net (loss) income, after deduction of preferred stock dividends,
by the weighted average number of common shares outstanding during the period.

In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share," which was adopted by the Company effective for the year ended December
31, 1997, as required by the statement. For the years ended December 31,
1997, 1996, and 1995, the Company's potential common stock equivalents have
either an antidilutive or have no effect on (loss) income per share applicable
to common shareholders and, therefore, diluted (loss) income per common share
applicable to common shareholders has not been presented.

The following table summarizes those securities that could potentially dilute
(loss) income per common share applicable to common stockholders in the future
that were not included in determining the fully diluted (loss) income per
common share applicable to common stockholders as the effect is either
antidilutive or has no effect.

Years Ended December 31,
Potential Common Shares resulting from: 1997 1996 1995
---- ---- ----
Stock Options (see Note 10) 1,206,691 60,799 875,547

Stock Warrants (see Note 10) 624,822 23,801 207,009

Cumulative, Convertible, Redeemable
Preferred Stock (see Note 9) 300,000 300,000 300,000
--------- ------- ---------
2,131,513 384,600 1,382,556
========= ======= =========

Fair Value of Financial Instruments

The fair value of the Company's financial instruments such as accounts
receivable, accounts payable, and note payable approximate their carrying
amounts.

Carrying Value of Long-Term Assets

The Company evaluates the carrying value of long-term assets, including
property, plant and equipment, and other intangibles, based upon current and
anticipated undiscounted cash flows, and recognizes an impairment when such
estimated cash flows are less than the carrying value of the asset.
Measurement of the amount of impairment, if any, is based upon the difference
between carrying value and fair value.

New Accounting Pronouncements

In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income." This statement, which establishes standards for
reporting and disclosure of comprehensive income, is effective for interim and
annual periods beginning after December 15, 1997, although earlier adoption is
permitted. Reclassification of financial information for earlier periods
presented for comparative purposes is required under SFAS No. 130. As this
statement only requires additional disclosures in the Company's consolidated
financial statements, its adoption will not have any impact on the Company's
consolidated financial position or results of operations. The Company will
adopt SFAS No. 130 effective January 1, 1998.

F-12
<PAGE>

In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." This statement, which establishes
standards for the reporting of information about operating segments and
requires the reporting of selected information about operating segments in
interim financial statements, is effective for fiscal years beginning after
December 15, 1997, although earlier application is permitted.
Reclassification of segment information for earlier periods presented for
comparative purposes is required under SFAS No. 131. The Company does not
expect adoption of this statement to result in a material effect on the
consolidated financial position or results of operations. The Company will
adopt SFAS No. 131 effective January 1, 1998.

In February 1998, the FASB issued SFAS No. 132 "Employers' Disclosures about
Pensions and Other Postretirement Benefits." This statement, which improves
disclosure about pensions and other postretirement benefits, is effective for
fiscal year beginning after December 15, 1997, although earlier application is
permitted. Management has not yet determined the impact this statement will
have on its financial statements.

Reclassification of Accounts

Certain reclassifications have been made to conform prior years' balances to
the current year presentation.

3. LIQUIDITY AND CONTINUATION OF BUSINESS

The consolidated financial statements of the Company have been prepared on a
going-concern basis, which contemplates the continuation of operations,
realization of assets and liquidation of liabilities in the ordinary course of
business. The Company incurred a net loss applicable to common shareholders of
$3,756,821 during the year ended December 31, 1997 and had negative cash flow
from operating activities of $1,383,860. At December 31, 1997 the Company had
a net working capital deficit of $2,664,115, an accumulated deficit of
$5,503,484, and total shareholders' deficiency of $156,932. In addition, the
Company was not in compliance with several of its covenants in its Loan and
Security Agreement with Century Business Credit Corporation, however, the
Company received a waiver related to such conditions of non-compliance. The
Company's loan contains certain subjective financial performance criteria and
in the event the company fails to meet such criteria during 1998, the lender
has the right to call the loan in full. Such conditions raise substantial
doubt about the Company's ability to continue as a going concern. The
accompanying financial statements do not include any adjustments that might be
necessary should the Company be unable to continue as a going concern.

The Company plans to focus on growing its revenue base through the addition of
profitable customers and decreasing its network costs. The Company intends to
reduce its network costs by obtaining more favorable pricing from suppliers
and by forming strategic alliances with certain similarly situated companies,
inducing the Company's sales agents to continue higher revenue production at
higher margins. Additionally, the Company is aggressively exploring ways to
provide local access to its current and prospective business customers under
its favorable interconnection agreements currently not being utilized.

Management will focus on obtaining additional financing or possibly raising
additional equity through private placement, in order to ensure adequate
funding is available to support operations, if necessary. The Company's
ability to operate beyond the immediate future is dependent upon its ability
to achieve levels of revenues to support the Company's cost structure,
decrease its network costs, maintain adequate financing, and generate
sufficient cash flow from operations to meet its operating needs. However, no
assurance can be given that the Company will be successful in its efforts to
implement its plans and achieve a level of profitability.

F-13
<PAGE>

4. NOTE PAYABLE

On May 11, 1995, the Company entered into a Loan and Security Agreement with
Century Business Credit Corporation for a revolving credit facility of
$2,000,000. The loan was established for an initial period of two years, and
was automatically renewed for two successive years on March 11, 1997.
Interest on the loan is currently calculated at prime plus 3 3/4% with a
minimum loan value of $750,000. The loan is collateralized by accounts
receivable and fixed and intangible assets of the Company.

The loan agreement contains covenants and restrictions which, among other
things, require maintenance of certain subjective financial performance
criteria and restrict encumbrance of assets, creation of indebtedness and
places limitations on annual capital expenditures. The Company was not in
compliance with several of its covenants in the Loan and Security Agreement,
including covenants pertaining to certain subjective financial performance
criteria, however, the Company received a waiver related to such conditions of
non-compliance at December 31, 1997. In the event the Company fails to meet
the subjective financial performance criteria during 1998, the lender has the
right to call the loan in full.

In exchange for warrants to purchase 600,000 shares of Common Stock each, an
executive officer and a board member both provided limited personal guarantees
in connection with the credit facility. (See Note 10)

5. OBLIGATIONS UNDER CAPITAL LEASES

Property under capital leases is recorded at the lesser of the present value
of the minimum lease payments or its fair value at inception. The Company
leases various equipment under three-to-five-year noncancellable leases which
expire at various dates through 2000.

The leases carry interest rates ranging from approximately 9.0% to
approximately 13.9% and are collateralized by the equipment purchased. The
future minimum lease payments for the next five years and related lease
obligation balances as of December 31, 1997 are as follows:

1998 $347,514
1999 265,156
2000 162,251
--------
TOTAL $774,921

1997 1996
---- ----
Aggregate capital lease obligation
as of the year ended December 31 $774,921 $878,315
Less--amounts representing interest 121,566 174,619
-------- --------
Present value of net minimum payments under
capital leases 653,355 703,696
Less--current portion of capital lease obligations 273,095 194,472
-------- --------
Capital lease obligations, net of current portion $380,260 $509,224
======== ========

F-14
<PAGE>

The following is an analysis of property under capital leases:

1997 1996
---- ----
Telecommunications Equipment $1,405,151 $1,028,660
Office Equipment 57,300 57,300
---------- ----------
TOTAL 1,462,451 1,085,960

Less Accumulated Amortization 434,783 224,340
---------- ----------
Net Assets Under Capital Lease $1,027,668 $ 861,620
========== ==========

Amortization of assets under capital leases charged to operations and included
in depreciation expense was $210,443, $149,523 and $102,574 in 1997, 1996, and
1995 respectively.

6. INCOME TAXES

The net deferred tax asset at December 31 includes the following:

1997 1996
---- ----
Deferred Tax Asset $ 2,295,700 $ 953,000
Deferred Tax Liability (359,200) (322,000)
Valuation Allowance for Deferred Tax Asset (1,936,500) (631,000)
----------- ---------
$ -- $ --
=========== =========

The utilization of the deferred tax asset depends on the Company's ability to
earn taxable income in the future. Although estimates are subject to change,
management was not able to determine that utilization of the deferred tax
asset is likely. Accordingly, a valuation allowance has been provided for the
entire deferred tax asset. The tax effect of major temporary differences that
gave rise to the Company's deferred tax assets and liabilities at December 31
are as follows:

1997 1996
---- ----
Net Operating Loss and Carryforwards $1,441,100 $ 609,000
Allowance for Doubtful Accounts 659,400 344,000
Legal and Commission Reserves 195,200 --
Depreciation (359,200) (322,000)
---------- ---------
Net Deferred Tax Asset 1,936,500 $631,000
---------- ---------
Valuation Allowance (1,936,500) (631,000)
---------- ---------
Total $ -- $ --
========== ========

F-15
<PAGE>

The provision for income tax expense (benefit) for the years ended December
31, consisted of the following amounts:

1997 1996 1995
Current tax expense (benefit)
Federal $ -- $7,000 $ --
State -- -- --
------ ------ ------
-- 7,000

Deferred tax expense
Federal -- -- --
State -- -- --
------ ------ ------
$ -- $7,000 $ --

Total income tax expense amounted to $7,000 in 1996, an effective tax rate
of 8.1%, compared to income tax expense (benefit) of $(1,257,900) in 1997, $
29,500 in 1996 and $(94,000) in 1995 computed by applying the statutory rate
of 34% to income (loss) before income tax (benefit). These differences are
accounted for as follows:

<TABLE>
<CAPTION>
1997 1996 1995
% of % of % of
pretax pretax pretax
Amount income Amount income Amount income
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Computed "expected" income
tax expense (benefit) $(1,257,900) (34.0) $ 29,500 34.0 $(94,000) (34.0)
Valuation allowance 1,250,600 33.8 (30,500) (35.1) 80,000 28.9
Other 7,300 .2 8,000 9.2 14,000 5.1
----------- ----- ------- ----- -------- ----
Actual income tax
expense (benefit) $ -- -- $ 7,000 8.1 $ -- --

</TABLE>

The Company has available approximately $4,214,860 and $1,736,926 net
operating loss carryforwards which may be applied against future Federal
taxable income and alternative taxable income respectively. These
carryforwards begin to expire in 2005.

F-16
<PAGE>

7. COMMITMENTS AND CONTINGENCIES

The Company has a long term contract for the purchase of 1+, 800, and Private
lines services over a 36 month period, expiring in May 1999. The contract
provides for a minimum monthly commitment of $250,000 and an aggregate
commitment of $9,000,000 over the contract life. The Company has met its
monthly commitments through December 1997.

The Company leases certain offices and equipment. Future annual minimum lease
payments under the significant agreements are as follows for the years ended
December 31:

1998 $ 395,370
1999 228,240
2000 208,617
2001 149,748
2002 132,366
thereafter 280,525
----------
TOTAL $1,394,866
==========

Rent expense incurred for operating leases was approximately $488,436, $
422,896 and $351,300 in 1997, 1996, and 1995, respectively.

The Company had entered into employment agreements with certain of its
Executive Officers. At December 31, 1997, the total minimum commitment level
over the next three years is approximately $825,000.

The Company entered into a contract in December 1996 with its Chairman for
consulting services. The total minimum aggregate commitment level over the
remaining five years of the contract as of December 31, 1997 is approximately
$625,000.

The Company entered into an agreement with a long distance carrier effective
August 25, 1995 for that carrier to provide network design, network operation
and network management of the Company's switch in Oakland, CA. The agreement
specified certain incentive bonuses, payable in common stock, for the carrier
based on traffic levels of the Oakland switch. Based on levels reached during
the two year term of the agreement which ended August 25, 1997, the Company
owes the carrier 106,060 shares of common stock. At December 31, 1997, the
Company had not yet issued the stock to the carrier and as such has recorded
the par value of the shares which is $106 in common stock payable. The
difference between the par value and the fair value of the shares of $150,000,
which was determined at two different anniversary dates, has been recorded as
paid in capital with the related charge to Selling, General and Administrative
Expense.

The Company received a request from two of its stockholders requesting the
company investigate possible violations of Section 16(b) of the Securities
Exchange Act of 1934 by Gold & Appel Transfer, S.A., a holder of more than 10%
of the outstanding shares of the Company's common stock. The alleged
violations relate to "short-swing" profits that may have been realized by Gold
& Appel in connection with certain purchase and sale transactions in the
Company's common stock during the period beginning January 1997 through the
present. The stockholders further request that if the company's investigation
confirms such violations occurred, the Company take steps to recoup all
profits obtained by Gold & Appel in violation of Section 16(b). The Company
is currently investigating this matter and is evaluating the possible actions
to be taken by the company, if any. The Company is currently unable to
estimate the potential amount of any such "short-swing" profits that may have
to be paid back to the Company, but believes that such amount could be
material to the Company.

See also Notes 12 and 13.

F-17
<PAGE>

8. PENSION PLANS

The Company sponsors a 401(K) Pension and Profit Sharing Plan for all
employees. The Company had matched up to 25% of the first 6% of the employee
contributions for the period July 1, 1997 through December 31, 1997. Prior to
July 1, 1997, the Company has elected not to match any employee contributions
or make any profit sharing contributions to the plan.

9. PREFERRED STOCK

Redeemable Preferred:

The Company has outstanding cumulative, convertible, redeemable preferred
stock which is convertible at the option of respective shareholders thereof,
into ten (10) common shares at a conversion price of one dollar ($1.00) each.

At any time after September 1, 1996, the Company, at the option of its Board
of Directors, may redeem part or all of the preferred shares outstanding at
$11.00 each plus unpaid and accumulated dividends. At December 31, 1997, the
maximum aggregate redemption value is $330,000 and there were no unpaid
accumulated dividends. The preferred stock is mandatorily redeemable in cash
on January 2, 2049 at $11.00 per share. Dividends on the preferred stock are
payable in cash only at a rate of 9% per annum on December 1, March 1, June 1,
and September 1.

Preferred Stock:

In July 1994, the shareholders approved an amendment to the Company's
Certificate of Incorporation to authorize 850,000 shares of par value $.01 per
share preferred stock. No shares were issued as of December 31, 1997.

10. COMMON STOCK, STOCK OPTIONS AND WARRANTS

Under the Company's stock option plans, options may be granted to officers and
employees of the Company and its subsidiaries. No option may be granted for a
term in excess of ten years from the date of grant. As of December 31, 1997,
1,909,000 of the outstanding stock options were exercisable under the plans.
The exercise prices of the outstanding options represented the fair market
value at dates of grant.

F-18
<PAGE>

A summary of the Company's stock option plans activity for common shares for
the three years ended December 31, 1997 follows:

Weighted
Average
Exercise
Number of Shares Price
---------------- --------
Outstanding 12/31/94 3,108,300 $1.37
Granted 2,282,500 $1.17
Exercised (111,000) $1.48
Terminated (1,028,800) $1.66
---------- -----
Outstanding 12/31/95 4,251,000 $1.19
Granted 2,045,000 $1.52
Exercised (50,000) $1.00
Terminated (1,770,000) $.97
---------- -----
Outstanding 12/31/96 4,476,000 $1.43
Granted 1,610,000 $1.27
Exercised (160,000) $1.07
Terminated (3,483,166) $1.48
---------- -----
Outstanding 12/31/97 2,442,834 $1.28
========== =====

The Company accounts for its stock option plans in accordance with Accounting
Principles Board Opinion No. 25, under which compensation cost is recognized
based on the difference, if any, between the fair value of the Company's stock
at the time of option grant and the amount the employee must pay to acquire
the stock. The Company's options have been issued at fair market value at the
time of grant. Had compensation cost for the incentive and nonqualifed
options been determined consistent with Statement of Financial Accounting
Standards No. 123, Accounting for Stock - Based Compensation (SFAS 123), the
Company's pro forma net loss and net loss per share for the years ended
December 31 are as follows:

1997 1996
---- ----
Reported Net (Loss) Income $(3,726,821) $ 61,625
Proforma Net Loss $(4,454,993) $(288,493)
Reported Net Income (Loss) Per Share $ (0.23) $ --
Proforma Net Loss Per Share $ (0.28) $ (0.02)

In accordance with the requirements of SFAS 123, this method of accounting has
not been applied to options granted prior to the fiscal year beginning January
1, 1995. The resulting pro forma compensation cost may not be representative
of that to be expected in future years.

The weighted fair value of options granted during Fiscal 1997 and 1996 was
$.75 and $.55, respectively. The fair values of each stock option grant is
estimated on the date of grant using the Black-Scholes option pricing model
with the following weighted average assumptions used for grants in 1997 and
1996: risk-free interest rates of 6.5%, expected dividend yields of 0%,
expected lives of three years from the date of grant, and expected price
volatility of 65% for the options granted in 1996 and 1997.

In May 1995, the Company agreed to issue to each of two directors/officers of
the Company 600,000 Warrants to purchase Common Stock, in consideration for
limited personal guarantees to be provided in connection with the revolving
credit facility. Each Warrant entitles the holder to purchase one share of
Common Stock of the Company at a price of $1.0625 per share until May, 2000.
In September 1997, each of the two directors/officers exercised 31,000
warrants resulting in an additional amount of $25 and $24,975 added to Common
Stock and paid in capital, respectively. (See Note 4)

F-19
<PAGE>

In May 1997, the Company agreed to issue to an independent contractor, 50,000
warrants to purchase Common Stock. Each warrant entitles the holder to
purchase one share of Common Stock of the Company at a price of $1.03 per
share until May 2002. The Company recorded the related consulting fees as an
expense in the amount of $51,000 representing the estimated fair value of the
options in accordance with SFAS 123.

The Company was notified in August, 1997 that it had failed to meet the
Capital and Surplus requirement for continued listing of its Common Stock on
the Nasdaq SmallCap Market as of June 30, 1997. The Company was granted a
temporary exemption from the NASD subject to the Company meeting certain
conditions. In order to prevent the Company's stock from being delisted, on
September 19, 1997, certain members of the Company's Board of Directors
exercised outstanding warrants to purchase 62,000 shares of Common Stock for
$65,875 in net proceeds to the Company. In November 1997, the Company sold an
additional 1,590,000 shares of its Common Stock for $1.50 per share, raising
$2,300,000 of net proceeds in a private placement sale to a significant former
shareholder. At December 31, 1997, the Company does not meet the minimum
Nasdaq capital requirements. As a result, The Nasdaq Stock Market may require
that the Company raise additional capital to maintain the listing of its
Common Stock on The Nasdaq Small Cap Market. There can be no assurance that
the Company will be able to raise additional capital to maintain the listing
of its Common Stock on The Nasdaq Small Cap Market.

11. CASH FLOW INFORMATION

Supplemental Disclosure of Cash Flow Information

The Company made cash payments for interest of $322,508, $272,978, and
$87,189, for the years ended December 31, 1997, 1996, and 1995, respectively.
The Company made cash payments for income taxes of $0, $0, and $75,000 for the
years ended December 31, 1997, 1996, and 1995, respectively.

Supplemental Disclosure of Non-Cash Investing and Financing Activities

Redeemable Preferred Stock in the amount of $1,000,000 was converted into
Common Stock in the year ended December 31, 1995. Redeemable Preferred Stock
accreted in value by $30,000 in the year ended December 31, 1997.

During the years ended December 31, 1997, 1996, and 1995, the Company acquired
approximately $176,000, $124,000 and $739,000, respectively of telephone
communications and other equipment with capital leases. The lease agreements
were financed over three and five year periods.

F-20
<PAGE>

12. LITIGATION

During 1995, the Company's dispute with Colonial Penn Group, Inc. and
Colonial Penn Insurance Company (collectively "CPG") was favorably resolved ,
resulting in the reversal of an accounts payable in the amount of
approximately $2,880,000. However, this benefit was substantially offset by
the cost of unsuccessfully litigating the resultant AT&T case on the basis of
anti-trust. The costs of litigation with AT&T incurred during 1995
approximated $850,000. These costs do not include approximately $305,000 of
related expenses pertaining to the write-down of certain AT&T signal
conversion equipment and accounts receivable written-off, which were
attributable to AT&T services provided by the Company. In addition, AT&T was
awarded a counter claim in the litigation in the amount of $669,000,
pertaining to services utilized in prior years. As a result of settlement of
these matters the Company recognized a net favorable impact of approximately
$1,056,000 in 1995 which is included in litigation settlements in other income
on the Consolidated Statement of Operations.

13. RELATED PARTY TRANSACTIONS

Indemnification Arrangements

USW is a party to indemnification agreements with two of its directors, Aaron
R. Brown and Stephen J. Parker, dated August 1990. In addition, USW has
entered into an indemnification agreement with Kevin O'Hare, a former
executive officer of USW, dated July, 1997. In general, the indemnification
agreements obligate USW to indemnify each of Messrs. Brown, Parker and O'Hare
against the liabilities and expenses incurred by them in acting as a director
or officer of USW to the maximum extent allowed by law. USW, together with
Messrs. Parker, Brown and O'Hare, have been sued by USW's former president for
various claims asserted by the plaintiff in connection with his termination of
employment with USW on December 30, 1996. USW and the individual defendants
have selected counsel to defend the action. The Board of Directors of USW has
authorized USW to advance the expenses of the individual defendants incurred
in defending ths action upon the receipt of an undertaking from each of them
to repay the amounts so advanced in the event it is determined that they are
not entitled to indemnification under applicable law. As of December 31,
1997, no amounts had been advanced by USW under such agreements. (See Note 12)

F-21
<PAGE>

Sales Agency

Mr.Goldberg, a director of USW, acts as a sub-agent for USW and is the co-
owner of Goldberg & Associates, a company that acts as an agent for USW in the
sale of USW's products and services. During 1997 USW paid Mr. Goldberg and
such company a total of $136,983 in commissions for their services as USW's
sales agents.

Loans

During the first quarter of 1996, USW borrowed $100,000 from each of Aaron R.
Brown and Stephen J. Parker, directors of USW. During 1996, USW repaid the
entire outstanding balance of the loans to Messrs. Brown and Parker with
interest at a rate of 10% per annum. The loans were payable upon demand.

14. CHANGES IN MANAGEMENT

Effective September 30, 1997, Kevin O'Hare, President and Chief Executive
Officer, terminated his employment with the Company. Mr. O'Hare was
immediately replaced by Stephen Parker as President and Chief Executive
Officer. Upon termination Mr. O'Hare received severance pay of approximately
$67,000 and retained 100,000 stock options at $1.03125 per share. Mr. O'Hare
originally had a three year employment agreement effective December 16, 1996
including an additional 500,000 stock options at $1.03125 per share and
500,000 stock options at $1.30 per share. These additional stock options were
relinquished as of September 30, 1997.

In October 1997, Mark Mendes, Chief Operating Officer, and Christopher
Shannon, Chief Financial Officer terminated their employment with the Company.
Mr. Mendes and Mr. Shannon each had a three year employment agreement -- their
termination agreements entitled them to receive severance pay in the amount of
$54,000 and $52,000 respectively. Also upon termination, Mr. Mendes retained
56,667 stock options at $1.25 per share and Mr. Shannon retained 56,667 stock
options at $1.219 per share. At termination, each relinquished 293,333 stock
options at the same price.

15. PROPOSED MERGER TRANSACTION

F-22
<PAGE>

16. FOURTH QUARTER RESULTS (UNAUDITED)

The Company experienced a fourth quarter net loss of approximately $2,462,000
or $.15 per share. Non-recurring expenses in the fourth quarter accounted for
approximately $1,800,000 of the net loss. Included in the non-recurring
expenses were consulting, legal, and accounting fees of approximately $600,000
which were incurred in the fourth quarter in connection with the now
terminated proposed merger with ACC Corp. Approximately $700,000 of such
expenses were related to higher than anticipated bad debt charge-offs on
individual carrier accounts, which became uncollectible in the fourth quarter.
Reserves for litigation, severance payments to former executives, and stock
compensation paid to consultants accounted for $500,000 of such expenses. The
remaining fourth quarter loss was attributable to operational challenges faced
by the Company in the fourth quarter.

F-23
<PAGE>
<TABLE>
<CAPTION>
US WATS, INC.
Schedule II - Valuation and Qualifying Accounts

- ----------------------------------------------------------------------------------------------------
COL. A COL. B COL. C COL. D COL. E
- ----------------------------------------------------------------------------------------------------
DESCRIPTION BALANCE AT CHARGED TO DEDUCTIONS- BALANCE AT
BEGINNING CHARGED TO OTHER ACCOUNTS END OF
OF PERIOD EXPENSE ACCOUNTS- WRITTEN OFF PERIOD
RECOVERIES
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Period ended 12/31/97

ALLOWANCE FOR DOUBTFUL
ACCOUNTS-
ACCOUNTS RECEIVABLE $ 672,058 $ 1,465,248 $ 93,343 $ (731,900) $1,498,749
- ----------------------------------------------------------------------------------------------------
Period ended 12/31/96

ALLOWANCE FOR DOUBTFUL
ACCOUNTS-
ACCOUNTS RECEIVABLE $ 268,921 $ 479,209 $ 137,532 $ (213,604) $ 672,058
- ----------------------------------------------------------------------------------------------------
Period ended 12/31/95

ALLOWANCE FOR DOUBTFUL
ACCOUNTS-
ACCOUNTS RECEIVABLE $ 537,533 $ 842,628 $ 22,779 $(1,134,019) $ 268,921
- ----------------------------------------------------------------------------------------------------
</TABLE>
F-24
<PAGE>

TERMINATION AGREEMENT

This Termination Agreement, made as of this 30th day of September,
1997 by and between U.S. WATS, INC., a New York corporation with offices at
111 Presidential Boulevard, Suite 114, Bala Cynwyd, Pennsylvania 19004 (the
"Company") and KEVIN M. O'HARE, residing at 48 Steeplechase Drive, Doylestown,
Pennsylvania 18901 (the "Executive").

WITNESSETH:

WHEREAS, the Company and the Executive are parties to an Executive
Employment Agreement made as of the 16th day of December, 1996, amended as of
January 10, 1997 (as so amended, the "Employment Agreement"); and

WHEREAS, the Company and the Executive are desirous of terminating
the Employment Agreement effective immediately;

NOW, THEREFORE, in consideration of the premises and mutual
covenants contained herein, the parties hereto, intending to be legally bound,
agree as follows:

1. Employment. The Company and the Executive agree that the Execu
tive's employment by the Company is terminated as of September 30, 1997 and
that Execu tive's resignation from the Company's board of directors will be
tendered and accepted on the day this Agreement is executed by all parties.
Executive shall sign promptly upon request all documents reasonably required
to transition his duties and responsibilities to other persons designated by
the Company.

2. Severance. Notwithstanding the termination of Executive's
employment with the Company, the Company shall pay the Executive the sum of
$66,666.68 upon execution of this Termination Agreement, in two (2) equal
installments of $33,333.34 due on October 10, 1997 and December 1, 1997.

3. Options. All of the stock options granted by the Company to
Executive, whether or not those stock options have vested, shall terminate as
of the date hereof, except that options to purchase up to 100,000 shares of
the Company's Common Stock at an exercise price of $1.03125 per share, granted
to Executive pursuant to an Amended and Restated Stock Option Agreement dated
as of January 10, 1997, shall continue in effect until March 31, 1998. The
common stock issuable upon exercise of such stock options shall be registered
with the Securities and Exchange Commission in order to permit public sale of
such shares. The options not exercised shall terminate on March 31, 1998.

4. Confidentiality. The provisions of section 8 of the Employment
Agreement shall survive this Termination Agreement.

5. Indemnification. The Company agrees to indemnify fully and
hold harmless Executive from any claim or liability resulting from claims of
third parties arising out of the performance of his duties under the
Employment Agreement, including the litigation pending in the United States
District Court for the Eastern District of Pennsylvania captioned Mark Scully
v. U.S. Wats, Inc., Civil Action No. 97-4051. The Company's obligations
hereunder shall include all expenses of defending Executive in connection with
any such claim or liability, as well as providing Executive with counsel
reasonably acceptable to him and to the Company. Nothing in this paragraph
shall obligate the Company to indemnify or hold harmless Executive for claims
or liability arising out of deliberate wrongdoing by Executive as determined
by a court of competent jurisdiction. The Company shall advance the expenses
of defending Executive until such time as a court of competent jurisdiction
determines that Executive has engaged in deliberate wrongdoing. Executive
shall promptly repay the Company all expenses advanced on his behalf upon a
finding by a court of competent jurisdiction that he has engaged in deliberate
wrongdoing. Nothing in this paragraph shall be deemed to affect any coverage
or obligation under any directors' and officers' liability insurance policy
maintained by the Company for the benefit of officers and directors of the
Company, including Executive.

6. Repayment. Executive shall pay to the Company upon execution
hereof the sum of $1,100. Executive will further return to the Company all
computers, cellular telephones, pagers, safety deposit box keys and other
property of the Company that are in his possession.

7. Release. The Company and the Executive each waive, release and
forever discharge one another of and from any and all past or present causes
of action, suits, agreements or other claims which one may have against the
other upon or by reason of any matter, cause or thing whatsoever arising out
of Executive's employment by the Company and each promises not to file a
lawsuit to assert such claims; provided, however, that this release shall not
apply to the obligations set forth in this Termination Agreement.

8. Business Goodwill. At all times following the date hereof,
Executive shall make no comments or take any other actions, direct or
indirect, that will reflect adversely on the Company or its officers,
directors, employees or agents in such capacity or adversely affect their
respective business reputations or goodwill. At all times following the date
hereof, the Board of Directors, each director and each officer of the Company
and Stephen Parker and Aaron Brown shall make no comments or take any other
actions, direct or indirect, that will reflect adversely on Executive or
adversely affect his business reputation or goodwill.

9. Entire Agreement. This Termination Agreement contains the
entire agreement of the parties.

10. Applicable Law. This Termination Agreement shall be construed
according to the laws of the Commonwealth of Pennsylvania.

IN WITNESS WHEREOF, the parties hereto have executed this
Termination Agreement the day and year aforesaid.

U.S. WATS, INC.

By:_________________________________

____________________________________
Stephen Parker

____________________________________
Aaron R. Brown

____________________________________
Kevin M. O'Hare

TERMINATION AGREEMENT

This Termination Agreement, made as of this 15th day of October,
1997 by and between U.S. WATS, INC., a New York corporation with offices at
111 Presidential Boulevard, Suite 114, Bala Cynwyd, Pennsylvania 19004 (the
"Company") and MARK A. MENDES, residing at 35641 Dunthorpe Lane, Purcellville,
Virginia 20132 (the "Executive").

WITNESSETH:

WHEREAS, the Company and the Executive are parties to an Executive
Employment Agreement made as of the 10th day of January, 1997 (the "Employment
Agreement"); and

WHEREAS, the Company and the Executive are desirous of terminating
the Employment Agreement effective immediately;

NOW, THEREFORE, in consideration of the premises and mutual
covenants contained herein, the parties hereto agree as follows:

1. Employment. The Company and the Executive agree that the Execu
tive's employment by the Company is terminated as of October 15, 1997.
Executive shall sign promptly upon request all documents reasonably required
to transition his duties and responsi bilities to other persons designated by
the Company.

2. Severance. Notwithstanding the termination of Executive's
employment with the Company, the Company shall pay the Executive the sum of
$54,000 upon execution of this Termination Agreement, in two (2) equal
installments of $27,000 due on October 17, 1997 and December 12, 1997.

3. Options. All of the stock options granted by the Company to
Executive, whether or not those stock options have vested, shall terminate as
of the date hereof, except that options to purchase up to 56,667 shares of the
Company's Common Stock at an exercise price of $1.25 per share, granted to
Executive pursuant to a Stock Option Agreement dated as of January 10, 1997,
shall continue in effect until April 15, 1998. The common stock issuable upon
exercise of such stock options shall be registered with the Securities and
Exchange Commission in order to permit public sale of such shares. The
options not exercised shall terminate on April 15, 1998.

4. Confidentiality. The provisions of section 8 of the Employment
Agreement shall survive this Termination Agreement, except for section
8.1(iii). Nothing in this Termination Agreement shall be deemed to prohibit
Executive from engaging in or becoming interested in or associated with any
other person, corporation, firm, partnership or other entity engaged in a
business which is competitive with any business conducted or contemplated by
the Company, provided that Executive shall not disclose or utilize in such
activity any confidential information of the Company.

5. Indemnification. The Company agrees to indemnify fully and
hold harmless Executive from any claim or liability resulting from claims of
third parties arising out of the performance of his duties under the
Employment Agreement. The Company's obliga tions hereunder shall include all
expenses of defending Executive in connection with any such claim or
liability, as well as providing Executive with counsel reasonably acceptable
to him and to the Company. Nothing in this paragraph shall obligate the
Company to indemnify or hold harmless Executive for claims or liability
arising out of deliberate wrongdoing by Executive as determined by a court of
competent jurisdiction. The Company shall advance the expenses of defending
Executive until such time as a court of competent jurisdiction deter mines
that Executive has engaged in deliberate wrongdoing. Executive shall promptly
repay the Company all expenses advanced on his behalf upon a finding by a
court of competent jurisdiction that he has engaged in deliberate wrongdoing.
Nothing in this paragraph shall be deemed to affect any coverage or obligation
under any insurance policy maintained by the Company.

6. Return of Company Property. Executive will return to the
Company all computers, cellular telephones, pagers, safety deposit box keys
and other property of the Company that are in his possession, other than the
automobile described in paragraph 7. Executive shall further return to the
Company all memoranda, notes, records, reports and other information, whether
preserved on paper or on a computer or computer disk (and all copies thereof)
relating to the businesses of the Company, which Executive obtained while
employed by, or otherwise serving or acting on behalf of the Company and which
he may possess or have under his control.

7. Automobile. Executive shall be solely responsible for
terminating the lease for the Mercedes Benz automobile the Company leased for
his benefit. The Company agrees to cooperate with Executive to terminate the
lease. Executive shall provide evidence reasonably satisfactory to the
Company on or before November 15, 1997 that the lease has been terminated
without cost or liability to the Company.

8. Release. The Company and the Executive each waive, release and
forever discharge one another of and from any and all past or present causes
of action, suits, agreements or other claims which one may have against the
other upon or by reason of any matter, cause or thing whatsoever arising out
of Executive's employment by the Company and each promises not to file a
lawsuit to assert such claims; provided, however, that this release shall not
apply to the obligations set forth in this Termination Agreement.

9. Business Goodwill. At all times following the date hereof,
Executive shall make no comments or take any other actions, direct or
indirect, that will reflect adversely on the Company or its officers,
directors, employees or agents in such capacity or adversely affect their
respective business reputations or goodwill. At all times following the date
hereof, the Board of Directors, each director and each officer of the Company
and Stephen Parker and Aaron Brown shall make no comments or take any other
actions, direct or indirect, that will reflect adversely on Executive or
adversely affect his business reputation or goodwill.

10. Entire Agreement. This Termination Agreement contains the
entire agreement of the parties.

11. Applicable Law. This Termination Agreement shall be construed
according to the laws of the Commonwealth of Pennsylvania.

IN WITNESS WHEREOF, the parties hereto have executed this
Termination Agreement the day and year aforesaid.

U.S. WATS, INC.

By:_________________________________

____________________________________
Stephen Parker

____________________________________
Aaron R. Brown

____________________________________
Mark A. Mendes

TERMINATION AGREEMENT

This Termination Agreement, made as of this 17th day of October,
1997 by and between U.S. WATS, INC., a New York corporation with offices at
111 Presidential Boulevard, Suite 114, Bala Cynwyd, Pennsylvania 19004 (the
"Company") and CHRISTOPHER SHANNON, residing at 288 Fox Hound Drive,
Doylestown, Pennsylvania 18901 (the "Executive").

WITNESSETH:

WHEREAS, the Company and the Executive are parties to an Executive
Employment Agreement made as of the 3rd day of March, 1997 (the "Employment
Agree ment"); and

WHEREAS, the Company and the Executive are desirous of terminating
the Employment Agreement effective immediately;

NOW, THEREFORE, in consideration of the premises and mutual
covenants contained herein, intending to be legally bound, the parties hereto
agree as follows:

1. Employment. The Company and the Executive agree that the Execu
tive's employment by the Company is terminated as of October 17, 1997.
Executive shall sign promptly upon request all documents reasonably required
to transition his duties and responsi bilities to other persons designated by
the Company.

2. Severance. Notwithstanding the termination of Executive's
employment with the Company, the Company shall pay the Executive the sum of
$52,000 upon execution of this Termination Agreement, in two (2) equal
installments of $26,000 due on October 20, 1997 and December 12, 1997.

3. Options. All of the stock options granted by the Company to
Executive, whether or not those stock options have vested, shall terminate as
of the date hereof, except that options to purchase up to 56,667 shares of the
Company's Common Stock at an exercise price of $1.219 per share, granted to
Executive pursuant to a Stock Option Agreement dated as of March 3, 1997,
shall continue in effect until April 15, 1998. The common stock issuable upon
exercise of such stock options shall be registered with the Securities and
Exchange Commission in order to permit public sale of such shares. The
options not exercised shall terminate on April 15, 1998.

5. Indemnification. The Company agrees to indemnify fully and
hold harmless Executive from any claim or liability resulting from claims of
third parties arising out of the performance of his duties under the
Employment Agreement. The Company's obliga tions hereunder shall include all
expenses of defending Executive in connection with any such claim or
liability, as well as providing Executive with counsel reasonably acceptable
to him and to the Company. Nothing in this paragraph shall obligate the
Company to indemnify or hold harmless Executive for claims or liability
arising out of deliberate wrongdoing by Executive as determined by a court of
competent jurisdiction. The Company shall advance the expenses of defending
Executive until such time as a court of competent jurisdiction deter mines
that Executive has engaged in deliberate wrongdoing. Executive shall promptly
repay the Company all expenses advanced on his behalf upon a finding by a
court of competent jurisdiction that he has engaged in deliberate wrongdoing.
Nothing in this paragraph shall be deemed to affect any coverage or obligation
under any insurance policy maintained by the Company for the benefit of
Executive.

6. Return of Company Property. Executive shall return to the
Company all computers, cellular telephones, pagers, safety deposit box keys
and other property of the Company that are in his possession. Executive shall
further return to the Company all memoranda, notes, records, reports and other
information, whether preserved on paper or on a computer or computer disk (and
all copies thereof) relating to the businesses of the Company, which Executive
obtained while employed by, or otherwise serving or acting on behalf of the
Company and which he may possess or have under his control.

7. Disability Insurance. Executive shall pay to the Company
$1,200 upon execution of this Termination Agreement. Company shall convey to
Executive all of its right, title and interest in a certain disability
insurance policy on Executive, including the right, if any, to any return
premium on termination thereof.

10. Entire Agreement. This Termination Agreement contains the
entire agreement of the parties.

11. Applicable Law. This Termination Agreement shall be construed
according to the laws of the Commonwealth of Pennsylvania.

IN WITNESS WHEREOF, the parties hereto have executed this
Termination Agreement the day and year aforesaid.

U.S. WATS, INC.

By:_________________________________

____________________________________
Stephen Parker

____________________________________
Aaron R. Brown

____________________________________
Christopher Shannon