US WATS INC, 10-K, 2000-03-30

US WATS INC
10-K, 2000-03-30
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, 1999

[ ] 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)

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

2 Greenwood Square, 3331 Street Road
Bensalem, Pennsylvania 19020
- ------------------------------------ --------------
(Address of principal executive offices) (Zip Code)

(Registrant's telephone number, including area code): (215) 633-9400
--------------

Securities registered pursuant to Section 12 (b) of the Act: None
----
</TABLE>
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.[_]

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As of March 21, 2000 the market value of the Company's Common Stock held by non-
affiliates of the Registrant, based on the average closing sale price, was
approximately $12,600,000.

As of March 21, 2000 the Registrant has 20,728,444 shares of Common Stock
outstanding.

2
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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 the 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....................................... 18

PART III
========

Item 10. Directors and Executive Officers of the Registrant................ 19
Item 11. Executive Compensation and Options Outstanding.................... 21
Item 12. Security Ownership of Certain Beneficial Owners and Management.... 23
Item 13. Certain Relationships and Related Transactions.................... 24

PART IV
=======

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K... 26

3
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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 businesses as well as residential 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 Maine and Norfolk, Virginia and California
(on-net area). Approximately 90% of the calls billed by the Company each month
are processed through the Company's own switches as of December 31, 1999. 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 as well as residential customers.

The Company's principal executive offices are located at 2 Greenwood Square,
3331 Street Road, Suite 275, Bensalem, Pennsylvania 19020. The Company's
telephone number at that location is (215) 633-9400.

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 agents,
which it expects will lead to significant revenue growth. Net sales revenue
attributable to the Company's agents and resellers accounted for approximately
57% of the Company's non-wireless revenue during the period ended December 31,
1999. 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 has recently instituted several private internet
web sites from which its agents are generating new orders electronically. The
Company expects to continue its efforts to expand this strategy in order to
generate new business. The Company is focused on servicing both commercial and
residential accounts.

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SERVICES

The Company provides domestic outbound long distance service to and from
anywhere in the United States, international calling services to approximately
250 countries, inbound 800 services, cellular local and long distance services,
regional and national paging services, internet service, travel/calling cards,
prepaid calling cards (debit cards), 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 predetermined
flat intrastate, interstate and international rates based on the termination of
the call. In those areas which provide for equal access customers have the
ability to choose their long distance carrier for all intra-Local Access
Transport Area ("LATA") calls. The Company is a "RESPORG" (Responsible
Organization) for the inbound 800 services it provides to its customers. This
gives the Company direct access to the 800 number database allowing for
efficient provisioning of 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 Maine to Norfolk,
Virginia and west to Pittsburgh, Pennsylvania. The Company's west coast network
extends from California to Phoenix, Arizona and parts of Nevada. 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 an Alcatel MegaHub 600E switch in Philadelphia and
an Alcatel 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 STX 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 regularly reconfigures its call processing through the utilization
of least-cost routing software. This software assures that the Company routes
calls, which terminate off-net, to the carrier vendor supplying the Company with
the lowest cost to that point. The Company has contracted with numerous
domestic and international transport carriers, which allow for international
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 Boston to Washington, DC
corridor. The Company employs a direct sales force who are paid on a salary
plus commission basis. The Company also maintains an independent agent network
of approximately 350 agents as of December 31, 1999, 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

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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 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 customers 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.

As of December 31, 1999, the Company's average retail customer uses
approximately $156 in monthly long distance revenue, which is similar to the
industry average for revenue generated through an agent sales force.

Coincident to entering the Competitive Local Exchange business, initially as a
Bell Atlantic Reseller 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
WorldCom and Sprint Corporation ("Sprint"). MCI WorldCom has entered into an
agreement to acquire Sprint. Based on industry data, the Company believes that
AT&T, MCI WorldCom and Sprint, collectively generate approximately 80% of the
nation's interexchange long distance revenue (approximately $118 billion during
1999) 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 $5 billion each. The third tier, which includes the
Company, consists of more than 500 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 as well as
residential 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 AT&T, MCI WorldCom
and Sprint, which at any particular time may offer more desirable services or
prices than those offered by the Company. Also, the FCC has recently granted
approval to a Bell Operating Company ("BOC") to provide in-region long distance
service and other BOCs may be approved to enter the long distance market in
additional states in the future.

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

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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 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 stayed the FCC's
detariffing rules. These rules remain subject to pending appeals. 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
addition, to the extent disputes arise over such contracts, carriers without
tariffs may no longer resort to the legal doctrine that the terms of a filed
tariff supersede individual contract language.

In spite of AT&T's additional flexibility and the expected increased
interexchange competition from the BOCs, the Company believes that it continues
to provide and sell telecommunications service to small to medium sized
businesses and individuals 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 breakup of
AT&T in 1984.

EMPLOYEES

At the end of 1999, the Company had 70 full-time employees working at three
locations. The majority of the employees work at the Company's principal
executive offices located at 2 Greenwood Square, 3331 Street Road, Suite 275,
Bensalem, Pennsylvania 19020. 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 resold long distance services, with the exception of Alaska, Colorado
and Hawaii. Additionally, the Company's application for certification in
Arizona is currently pending. The Company is also authorized to provide
competitive local exchange telecommunications services in two (2) states and the
District of Columbia. Some states place statutory restrictions on the
operations of telecommunications service providers, including requiring
telecommunications service providers to file and operate in accordance with
service and rate tariffs. Further, carriers are required to charge just and
reasonable rates and not discriminate among similarly situated customers. Some
states and the FCC also require the filing of periodic reports, the payment of
various regulatory fees and surcharges, and compliance with service standards
and consumer protection rules. Changes in existing regulations or their
interpretation in any state could subject the Company to increased 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

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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 accounting rates to
the benefit of U.S. ratepayers, while serving 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, while the FCC has stated that such countries continue to bear the
principal responsibility for enforcing their domestic laws. However, 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 direct enforcement action against an
individual carrier to enforce a foreign country's ban with respect to a U.S.
provider. However, there can be no assurance that the FCC or foreign governments
will not enforce such a ban.

LEGISLATION. On February 8, 1996, President Clinton signed into law the
- -----------
Telecommunications Act of 1996 (the "1996 Act"). The bill was intended to spur
additional competition in telecommunications services particularly within the
local exchange markets, which are now dominated by incumbent local exchange
carriers.

The 1996 Act codifies a new set of interconnection principles, applicable to
interconnection for both interstate and intrastate services. State public
utilities commissions are given a significant role in administering the
interconnection provisions of the act, and deadlines are imposed for decisions
by both the FCC and state commissions. On August 8, 1996, the FCC released the
Interconnection Decision which established a framework of minimum, national
rules enabling state commissions and the FCC to begin implementing many of the
local competition provisions of the 1996 Act. Among other things, the
Interconnection Decision prescribed certain minimum points of interconnection;
adopted a minimum list of unbundled network elements that ILECs must make
available to competitors; and adopted a methodology for states to use when
setting prices for unbundled elements and for wholesale resale services. On
January 25, 1999, the Supreme Court overturned prior decisions of the United
States Court of Appeals for the Eighth Circuit that had vacated certain portions
of the Interconnection Decision. The Supreme Court's decision confirmed the
FCC's authority to issue regulations implementing the pricing and other
provisions of the 1996 Act and reinstated most of the challenged rules. The
Supreme Court decision, however, vacated a key FCC rule that identified the
network elements that ILECs must unbundle. The FCC has since adopted a new
standard for analyzing unbundled network elements, as required by the Supreme
Court. The FCC concluded that ILECs would no longer be required to provide
directory assistance and operator services as network elements, though they will
continue to be available pursuant to tariffed rates. The FCC declined, however,
except in limited circumstances, to require ILECs to unbundle certain facilities
used to provide high-speed Internet access and other data services. Uncertainty
remains surrounding the effect of the Eighth Circuit decisions, the decision of
the Supreme Court reversing portions of it, and subsequent proceedings.

The 1996 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 act, BOCs may immediately offer long
distance services outside their home regions. The BOCs may offer service within
their regions upon FCC approval based on a showing that facilities-based
competition and interconnection agreements meeting a 14-point checklist both
exist. On December 22, 1999, the FCC granted Bell Atlantic's application to
offer in-region long distance services in New York, marking the first time since
the breakup of AT&T that a BOC is able to provide its customers with both local
and long distance service.

In 1997, the FCC released an order establishing a significantly expanded federal
universal service subsidy regime. Specifically, the FCC established new
universal service funds to support telecommunications and information services
provided to qualifying schools, libraries and rural health

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care providers, and expanded the federal subsidies for local telephone services
provided to low-income consumers. The FCC collects money to fund this expanded
regime from interstate carriers and certain other entities. Contribution factors
vary quarterly and are passed on by the Company to end users. Recently the
United States Court of Appeals for the Fifth Circuit rejected the FCC's effort
to base contributions in part on intrastate revenues. The FCC's universal
service program may be altered as a result of appeals, agency reconsiderations
of its actions, or future Congressional action.

Additional competition with incumbent local exchange carriers ("ILECs") should
provide price discipline in an area which has been monopolized by ILECs. The
Company can also expect a substantial increase in the competition, which it
faces in interexchange markets as a result of the entry of the BOCs 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.

ACCESS CHARGES. The cost of providing long distance and local exchange services
- --------------
will be affected by changes in the access charges imposed by ILECs for
origination and termination of calls over local facilities. The term "access
service" describes the use of local exchange facilities for the origination and
termination of interexchange communications. On May 8, 1997, the FCC released
an order intended to reform the FCC's system of interstate access charges to
make that regime compatible with the pro-competitive deregulatory framework of
the 1996 Act. The FCC's access reform order adopts various changes to federal
policies governing interstate access service pricing designed to move access
charges, over time, to more economically efficient levels and rate structures.
Among other things, the FCC modified rate structures for certain no-traffic
sensitive access rate elements, moving some costs from a per-minute-of-use basis
to flat-rate recovery, changed its structure for interstate transport services,
and affirmed interstate access charges do not apply to Internet service
providers. On August 18, 1998 the Eighth Circuit affirmed the FCC's access
reform order.

In response to claims that existing access charge levels are excessive, the FCC
stated that it would rely on market forces first to drive prices for interstate
access to competitive levels but that a "prescriptive" approach might be
considered if necessary. In the absence of competition, the FCC stated that it
might specify the nature and timing of changes to existing access rate levels.
On August 5, 1999, the FCC adopted an order granted ILECs additional pricing
flexibility, implementing certain access charge reforms, and seeking comments on
others. The order provides a framework of "triggers" to provider those
companies with greater pricing flexibility to set interstate access rates as
competition increases. The order also initiated a rulemaking to determine
whether the FCC should regulate the access charges of CLECs. If this increased
pricing flexibility for price cap ILECs is not effectively monitored, or if the
FCC regulates CLEC access charges, it could have a material adverse impact on
our ability to price our own interstate access services competitively. As of
January 1998, access charges incurred by the Company are being passed on to end
users.

On March 31, 1999, the FCC released its Collocation Order which requires ILECs
incumbent carriers to permit CLECs to collocate any equipment used for
interconnection or access to unbundled network elements even if that equipment
includes switching or enhanced service functions. Among other things, the
Collocation Order also prohibits ILECs from placing any limits on the use of
switching or enhanced features for collocated equipment, and requires ILECs to
make cageless collocation available and permit CLECs to construct their own
cross-connect facilities.

On March 17, 2000, the United States Court of Appeals for the District of
Columbia Circuit vacated limited portions of the Collocation Order, holding
certain definitions contained in FCC rules were impermissibly broad. The court
remanded the Collocation Order in part for further FCC consideration of these
issues. The FCC will be instituting proceedings to comply with the court's
remand.

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Also, as part of Access Reform mandated in the Telecommunications Act of 1996,
beginning in 1998 local phone companies are permitted to assess the Pre-
subscribed Interexchange Carrier Charge, also known as "PICC." The "PICC" is a
monthly per line cost charged by the local telephone company to each long
distance carrier for every customer phone line that is pre-subscribed to that
carrier. These charges are passed on to the end users.

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 total monthly cost of approximately $38,000. Its executive offices and
headquarters at 2 Greenwood Square, 3331 Street Road, Suite 275 in Bensalem,
Pennsylvania is leased for a term of three years expiring in August, 2001. The
Company's leased switch space in Philadelphia, Pennsylvania expires in February,
2003. The Company's second leased switch space in Philadelphia, Pennsylvania
expires in May, 2007. The Company's leased switch space in Oakland, California
expires in September, 2002. The Company considers its space to be adequate for
its current needs.

ITEM 3. LEGAL PROCEEDINGS
- --------------------------

On June 13, 1997, Mark Scully, a former President and Chief Operating Officer of
the Company, filed a complaint against the Company, Kevin O'Hare, Aaron Brown
and Stephen Parker, all former Company executives, in the United States District
Court for the Eastern District of Pennsylvania. Mr. Scully asserted various
claims in connection with his termination of employment with the Company on
December 30, 1996. In particular, he alleged, 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 alleged 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 contested the allegations of the complaint and intends to vigorously
defend against the action. On June 9, 1999, the court issued its decision and
judgment was entered in favor of Mr. Scully and against the Company and two
former officers for the sum of $626,442.20. The Court denied Mr. Scully's claim
for attorneys' fees and liquidated damages. An additional amount of $376,000
was accrued during the quarter ended June 30, 1999 to increase the reserve to
the full judgment amount and was recorded in SG&A expenses. The Company has
appealed the decision and maintains that the Court made a number of errors of
law and that the Court applied the wrong measure of damages. Mr. Scully has
advised that he intends to appeal as well.

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
- ------------------------------------------------------------

Reference is made to the information contained in Item 5 of the Company's
Current Report on Form 8-K filed with the Securities and Exchange Commission on
December 8, 1999 regarding the Company's 1999 Annual Meeting of Shareholders
held on November 24, 1999.

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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 1998.

QUARTER HIGH LOW
------- ---- ---

4th Quarter 1999 $ 2.63 $ 1.53
3rd Quarter 1999 $ 2.06 $ 1.31
2nd Quarter 1999 $ 1.91 $ 1.19
1st Quarter 1999 $ 2.69 $ 1.63
4th Quarter 1998 $ 1.91 $ 1.38
3rd Quarter 1998 $ 2.19 $ 1.50
2nd Quarter 1998 $ 2.25 $ 1.91
1st Quarter 1998 $ 2.38 $ 1.16

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 March 7, 2000 there were approximately 129 holders of record of the
Company's Common Stock.

The Company has not paid any dividends on its Common Stock. However, the
Company paid quarterly dividends on its Preferred Stock at a rate of 9%
annually, or approximately $6,750 per quarter for the first two quarters of
1999. On July 1, 1999 the only preferred shareholder converted 30,000 Preferred
Shares to 300,000 Common Shares. The Company does not currently anticipate the
payment of dividends on its Common Stock.

On March 23, 1999, the Company issued 900,000 shares of common stock to Gold &
Appel Transfer, S.A., a majority shareholder of the Company, for an aggregate
purchase price of $1,530,000 or $1.70 per share. The proceeds of the issuance
were used for general working capital. The terms of such transaction were
negotiated between the Company and Gold & Appel Transfer, S.A. on an arms length
basis, with Mr. Anderson abstaining from all negotiations on the Company's
behalf.

On August 31, 1999, the Company issued 150,000 shares of Common Stock to
purchase certain assets of JMR Marketing Corporation, a company owned by James
M. Rossi, a director of the Company. The purchased assets included a customer
base, property and equipment and sales contracts. The terms of the acquisition
of JMR were negotiated between the Company and Mr. Rossi on an arms-length
basis, with Mr. Rossi abstaining from negotiations on the Company's behalf.

The shares issued on March 23, 1999 and August 31, 1999 were issued directly by
the Company to the holders without an underwriter or placement agent and were
issued without registration under the Securities Act of 1933 pursuant to the
private placement exemption contained in Section 4(2) of such Act.

11
<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.

Year Ended December 31,
--------------------------------------
Operating Data 1999 1998 1997 1996 1995
- ----------------------- ------------- ------------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Net sales $39,777,331 $44,679,060 $56,466,698 $40,304,442 $27,755,388

Net Income (loss)/(1)/ $(2,950,899) $(1,828,369) $(3,699,821) $ 88,625 $ (277,723)

Net Income (loss)
per common share/(2)/ $ (.15) $ (.10) $ (.23) $ -- $ (.02)

December 31,
-----------
Balance Sheet Data 1999 1998 1997 1996 1995
- ----------------------- ------------- ------------- ------------- ------------ ------------

Total assets $10,906,213 $11,021,464 $11,813,475 $11,992,359 $ 9,500,361

Capital
lease obligations $ 153,289 $ 376,760 $ 653,355 $ 703,696 $ 731,701

Redeemable
preferred stock $ 0 $ 330,000 $ 330,000 $ 300,000 $ 300,000

Cash dividends $ 13,500 $ 27,000 $ 27,000 $ 27,000 $ 67,255
on preferred stock
</TABLE>

(1) 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 a proposed merger with ACC Corp. amounted to approximately
$567,000 in 1997.

1998 results include approximately $393,000 in additional depreciation
expense due to the acceleration of depreciation of assets associated with
the Philadelphia Switch, which was replaced in 1999. In addition, the
Company incurred approximately $300,000 of salary expense for severance
paid to a former President. Finally, approximately $102,000 in
miscellaneous expenses were incurred in connection with the relocation of
the corporate office in 1998.

12
<PAGE>

1999 results include an increase in bad debt expense of approximately
$861,000 due to the write-off of a carrier account in the third quarter.
Also, an additional legal accrual of approximately $376,000 was incurred
for a lawsuit judgment (see footnote 12 of the financial statements).
Finally, approximately $105,000 in additional depreciation expense was due
to the acceleration of depreciation of assets associated with the old
Philadelphia switch.

(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, 1995, 1997, 1998 and 1999 no potential
Common Shares have been included in the computation of any diluted per
share amount. For the year ended December 31, 1996 the difference between
diluted and basic earnings per share is not significant. Accordingly, only
basic earnings per share have been presented.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------

This annual report on Form 10-K includes "forward-looking statements" within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended and
Section 27A of the Securities Exchange Act of 1933, as amended. Such statements
are subject to certain risks and uncertainties, including but not limited to:
changes in general economic conditions, increasing levels of competition in the
telecommunications industry, changes in telecommunications technologies, changes
in FCC regulations, the Company's reliance on transmission facilities based
carriers, risks involved in conducting international operations, the inability
to generate sufficient revenues to meet debt service obligations and operating
expenses, unanticipated costs associated with the Company's recent and future
acquisitions and the failure of the Company to manage its growth effectively.
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. All forward-looking statements included herein are expressly
qualified in their entirety by these cautionary statements.

RESULTS OF OPERATIONS
- ---------------------

-1999 COMPARED TO 1998-

OVERVIEW

US WATS, Inc. is a switch-based interexchange carrier providing long distance
telephone communications services primarily to small and medium-size business
customers as well as residential 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 Maine and Norfolk, Virginia and in California (on-net area).
Approximately 90% of the calls billed by the Company each month are processed
through the Company's own switches as of December 31, 1999. 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.

13
<PAGE>

Total revenues decreased in 1999 by approximately $4,902,000 primarily due to
the decline in the average retail rate per minute and the Company's exit from
the International Callback business.

In addition, approximately $2,527,000 of the decrease in revenue was due to a
decline in retail sales through the agent and reseller channels, mostly
attributed to decreasing selling rates because of strong competition in the
marketplace. Also, revenue through the carrier sales channel decreased by
approximately $1,338,000 for the year ended December 31, 1999. In 1998, revenue
through the carrier channel consisted of a large amount of high credit risk
international traffic. In 1999, the Company limited the amount of this traffic
in order to reduce bad debt exposure.

REVENUE

Revenues decreased 11% or approximately $4,902,000 to approximately $39,777,000
in 1999. This was primarily due to a decrease in revenue through the carrier
sales channel of approximately $1,338,000. In 1999, the Company limited the
amount of high-risk international traffic in order to reduce bad debt exposure.
Also, there was a decline in International Callback revenue of approximately
$1,037,000. As deregulation occurs in European and Asian countries, the
International Callback business continues to diminish. In addition, there was a
decrease in retail revenue of approximately $2,527,000. As a result of strong
competition in the long distance marketplace, the Company's average retail rate
per minute decreased $.0194 from January, 1999 to December, 1999. This accounted
for approximately $2,360,000 of the decrease in retail revenue.

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

DISTRIBUTION OF REVENUES

Service % 1999 % 1998
------------------------------------------------
Domestic 1+ 48% 45%
International 22% 23%
Inbound 17% 15%
Wireless 3% 4%
Domestic Carrier Termination 10% 13%

GROSS PROFIT

Gross profit margin increased marginally from 28.8% in 1998 to 29.1% in 1999.
Gross profit decreased approximately $1,308,000 in 1999. This was primarily due
to the decrease in revenues.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSE

Selling, General and Administrative ("SG&A") expenses for 1999 were
approximately $813,000 lower than the amount incurred during 1998. However,
SG&A expenses as a percentage of revenue increased from 31.0% in 1998 to 32.8%
in 1999. Depreciation expense decreased approximately $385,000 in 1999 due to
accelerating the depreciation of assets associated with one of the Company's
switches in 1998 (See footnote 2 of the financial statements). Commission
expense decreased approximately $354,000 or 6.7% from 1998 due primarily to a
decrease in revenues on which commissions are paid. Salary compensation expense
decreased approximately $188,000 to approximately $2,857,000 primarily due to a
severance payment to a former president in 1998 of approximately $300,000.
Legal and consulting expenses increased approximately $243,000 primarily due to
fees associated with potential

14
<PAGE>

strategic alternatives for the Company and the Company's pending reincorporation
merger into the state of Delaware. Also, other miscellaneous SG&A expenses
decreased approximately $129,000 in 1999.

PROVISION FOR BAD DEBT

Bad debt expense increased approximately $665,000 (from approximately 1.8% of
net sales in 1998 to approximately 3.7% of net sales in 1999). In 1999, the
Company incurred bad debt expense of approximately $861,000 related to a large
carrier account, which contributed to bad debt expense for the year of
approximately $1,453,000.

NET LOSS FROM OPERATIONS

The Company recorded a net loss for 1999 of approximately $2,951,000 compared to
a net loss of approximately $1,828,000 for 1998. This was primarily due to a
decrease in revenues, and an increase in bad debt expense. A portion of the net
loss in 1999 was attributable to the following: bad debt expense of
approximately $861,000 related to the writeoff of a large carrier account,
depreciation expense of approximately $105,000 associated with accelerating
depreciation of certain assets (See footnote 2 of the financial statements), and
a miscellaneous expense of $376,000 associated with a legal judgment (See
footnote 12 of the financial statements).

-1998 Compared to 1997-

Overview

The Company experienced significant changes in its business that negatively
impacted its results of operations for the year ended December 31, 1998. In the
first quarter of 1998, the Company and ACC Corp. mutually terminated an
Agreement and Plan of Merger between the two Companies. During the first quarter
of 1998, prior to the termination of such agreement, the Company's operating and
sales initiatives were not met due to management's focus on integration plans
with ACC Corp. As a result, the Company's revenues in the first quarter of 1998
were negatively impacted.

Also, revenues decreased in 1998 by approximately $3,023,000 due to a decline in
the International Callback revenue channel. This was a result of management's
decision to gradually exit the International Callback business. This decision
was based primarily on the telecommunications deregulation in European and Asian
countries. As pricing for long distance services has decreased in these areas,
the International Callback business as a whole has diminished.

In addition, approximately $3,875,000 of the decrease in revenue was due to a
decline in the retail revenue channel, mostly attributed to decreasing selling
rates because of strong competition in the marketplace. Also, revenue through
the carrier sales channel decreased by approximately $4,200,000 for the year
ended December 31, 1998. In 1997, revenue through the carrier channel consisted
of a large amount of high credit risk international traffic. In 1998, the
Company limited the amount of this traffic in order to reduce bad debt exposure.

REVENUE

Total revenues decreased 20.9% or approximately $11,788,000 to approximately
$44,679,000 in 1998, primarily due to a decrease in carrier revenue of
approximately $4,200,000, a decrease in International Callback revenue of
approximately $3,023,000, and a decrease in retail revenue of approximately
$3,875,000. As a result of strong competition in the long distance market, the
Company's average retail rate per minute decreased $.018 from January, 1998 to
December, 1998. This accounted for approximately $2,009,000 of the $3,875,000
decrease in retail revenue.

15
<PAGE>

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

DISTRIBUTION OF REVENUES

Service % 1998 % 1997
------------------------------------------------
Domestic 1+ 45% 37%
International 23% 31%
Inbound 15% 15%
Wireless 4% 4%
Domestic Carrier Termination 13% 13%

GROSS PROFIT

Gross profit margin in 1998 increased 8.7% to 28.8% from 1997. The increase in
gross profit margin is primarily attributable to the decrease 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. As a
percentage of total revenue, carrier revenue decreased to approximately 26% for
1998 versus 28% in 1997.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSE

Selling, General and Administrative ("SG&A") expenses for 1998 were
approximately $3,088,000 lower than the amount incurred during 1997. However,
SG&A expenses as a percentage of revenue increased marginally from 30.0% in 1997
to 31.0% in 1998. Depreciation expense increased approximately $441,000 in
1998. Of this increase, $393,000 was due to accelerating the depreciation of
assets associated with one of the Company's switches. Commission expense
decreased approximately $1,408,000 or 21.0% from 1997 due primarily to a
decrease in revenues on which commissions are paid. Salary compensation expense
decreased approximately $570,000 to approximately $3,045,000 due to less
headcount throughout 1998. Also, other miscellaneous SG&A expenses decreased
approximately $1,537,000 in 1998.

PROVISION FOR BAD DEBT

Bad debt expense decreased approximately $677,000 (from approximately 2.6% of
net sales in 1997 to approximately 1.8% of net sales in 1998). In 1997, the
Company incurred bad debts related to three large carrier accounts. The
improvement in 1998 is mainly attributed to the Company's ability to more
effectively monitor and control exposure from revenue derived from the carrier
channel.

NET LOSS FROM OPERATIONS

The Company recorded a net loss before preferred dividends for 1998 of
approximately $1,828,000 versus a net loss before preferred dividends of
approximately $3,700,000 for 1997. This improvement is mainly due to an
increase in gross profit margins, a decrease in bad debt expense, a decrease in
commission expense, a decrease in legal and accounting fees and a decrease in
salary expense offset by an increase in depreciation expense. A portion of the
net loss before preferred dividends of approximately $1,828,000 in 1998 was
attributable to the following: a one time salary expense of approximately
$300,000 associated with severance paid to a former President, an increase in
miscellaneous expense of approximately $102,000 associated with moving the
corporate office, an increase in depreciation expense of approximately $393,000
(See footnote 2 under Property and

16
<PAGE>

Equipment), consulting expenses of approximately $100,000 associated with the
engagement of Paine Webber to explore potential strategic alternatives for the
Company and approximately $256,000 for other consulting, legal and accounting
fees associated with potential strategic alternatives for the Company.

LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------

At December 31, 1999, cash and cash equivalents were approximately $1,597,000.
Cash flow used in operations in 1999 was approximately $525,000. Net cash used
in investing activities in 1999 was approximately $1,172,000, which resulted
from the purchase of property and equipment primarily related to the new switch.

Working capital deficiency at December 31, 1999 was approximately $1,549,000 as
compared to a deficiency of approximately $369,000 at December 31, 1998. The
increase in working capital deficiency was primarily due to the increase in net
loss from 1998 to 1999 as stated above.

The Company has a revolving $2,000,000 credit facility with Century Business
Credit Corporation, which was renegotiated and amended on May 11, 1999 and is
automatically renewable for three successive one year periods. Interest on the
revolving credit facility is currently calculated at the prime lending rate plus
2 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, 1999, the Company's outstanding balance on its credit facility was
approximately $1,037,000, leaving approximately $963,000 available for future
borrowing under the credit facility. The Company was not in compliance with
several of its debt covenants at December 31, 1999. However, the Company
received a waiver related to such conditions of non-compliance. The Company
expects to incur approximately $2,000,000 in capital expenditures in 2000 in
order to upgrade its network and switching technology.

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, 1999 was approximately $153,000, which is due within
the next year.

On March 23, 1999, the Company through a private placement transaction, issued
900,000 shares of common stock to Gold & Appel Transfer, S.A., a majority
shareholder of the Company, for an aggregate purchase price of $1,530,000 or
$1.70 per share. The proceeds of the issuance were used for general working
capital. The terms of such transaction were negotiated between the Company and
Gold & Appel Transfer, S.A. on an arms length basis, with Mr. Anderson, the
controlling party of Gold & Appel, abstaining from all negotiations.

On March 22, 2000, the Company entered into a Loan Agreement with Gold & Appel
Transfer, S.A. ("G &A") and the Foundation for the International Non-
Governmental Development of Space, a non-profit organization ("FINDS"), of which
Mr. Anderson is the president and director. The terms of the agreement call for
the Company to borrow up to $1,000,000 from G&A and $500,000 from FINDS at a
rate of 10% per annum and due and payable on March 1, 2001. The agreement
includes that all parties may convert all or any portions of the loan amount to
shares of the Company's Common Stock at $2.50 per share.

17
<PAGE>

Company's plans for growth include both substantial internal growth and the
potential acquisition of other long distance companies. Also, in order to
achieve the Company's plans for growth in the long distance business as well as
its entry into other communications services, the Company may require additional
equity and is currently seeking sources of funding. The Company cannot give
assurance as to the potential success of these efforts.

YEAR 2000
- ---------

The Year 2000 issue involved the fact that many computers and computer
applications define dates by the last two digits of the year, and as such would
possibly not be able to properly calculate, store, use or identify a date after
December 31, 1999. In response to the Year 2000 issue, the Company dedicated
the time and resources it deemed necessary to address and correct any potential
Year 2000 problems. Prior to January 1, 2000, the Company reviewed and
evaluated the possible effects of the Year 2000 issue upon its computer systems,
network elements and software applications and other office systems.

As part of the plan to identify and address the Year 2000 issue, the Company
identified an inventory of all systems, assessed the compliance of all systems,
upgraded or replaced any systems which were non-compliant and developed a
contingency plan to minimize the effects of any Year 2000 noncompliance. The
Company also initiated inquiries from vendors that the Company interacts with
electronically regarding their compliance with the Year 2000 issue.

The Company purchased a new DSC MegaHub 600E switch in order to replace an old
noncompliant switch in Philadelphia. The switch was installed and began
supporting operations in the third quarter of 1999. The total cost of replacing
the switch was approximately $2.0 million. As a result of the Company's focus
on the testing its computer systems, network elements, and software
applications, there were no disruptions from the Year 2000 issue.

The Company believes that its own network systems are Year 2000 compliant due to
the nature and extent of the testing the Company conducted and continues to
implement on such systems.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ----------------------------------------------------

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

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------------------------------------------------------------------------
FINANCIAL DISCLOSURE
- --------------------

1) Not applicable

18
<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 March 3, 2000.

NAME AGE POSITION DIRECTOR SINCE
- ------------------- ---- --------------------------- --------------

James M. Rossi (48) Director (1) 1999

Dominic J. Romano (59) Director (2) 1999

Walt Anderson (46) Director (3) 1998

Murray Goldberg (57) Director (4) 1996

Arthur Regan (36) Director and Secretary (5) 1997

(1) JAMES M. ROSSI has been a Director of the Company since August 1999. Mr.
Rossi is a co-founder of Solar Communications Group, Inc., a productivity
service provider, and has been a Director and Chairman and Chief Executive
Officer of Solar Communications Group, Inc. since October 1994. Mr. Rossi
has also served as a Director and Chairman and Chief Executive Officer of
JMR Corporation, a telecommunication consulting firm, since 1971, as a
Director and Chairman and Chief Executive Officer of Cam-Comm, Inc. a data
fiber optics reseller, since 1997, and as a President and a Director of
Comanco, Inc., a data fiber optics reseller, since 1997.

(2) DOMINIC J. ROMANO has been a Director of the Company since September 1999.
Mr. Romano has served as the managing partner of Romano, Hearing & Testa, a
certified public accounting and consulting firm located in Vineland, New
Jersey, since 1967. His areas of specialization include valuations of
businesses for acquisition purposes and financial, tax and estate planning.
He currently is a board member of Solar Communications Group, Inc. He is a
certified public accountant, registered municipal accountant, and he holds
a Bachelor of Science in Accounting degree from Seton Hall University.

(3) WALT ANDERSON has been a Director of the Company since May 1998. Since
1992, Mr. Anderson has been the financial advisor to Gold & Appel Transfer,
S.A., a venture capital company, which owns substantial positions in
several public and private telecommunications companies, including the
Company. Pursuant to a power of attorney, Mr. Anderson has sole investment
power over the shares of Common Stock owned by Gold & Appel Transfer, S.A.
Mr. Anderson is a pioneer in the telecommunications industry. He founded
Mid Atlantic Telecom, a regional long distance carrier, in 1984 to take
advantage of the breakup of AT&T. He also founded Espirit Telecom in 1991
and was Chairman of that company until 1999. Mr. Anderson is also on the
Board of Directors of several other companies including TotalTel USA
Communications, Net-tel Corp., World Exchange Communications, Teleport UK
Ltd., American Technology Labs, Inc., Galactech Corp., Rotary Rocket Co,
Aquarius Holdings Limited, and Cis Lunar Development.

(4) MURRAY GOLDBERG has been a Director of the Company since November 1996 and
an independent sales agent of the Company since 1993. Mr. Goldberg is also
the owner and a Vise-President of Jamco, Inc., a discount shoe distributor
in Florida, and the owner and Director of Doxs, Inc., an anesthesia
equipment developer and distributor. From June 1994 until May 1996, he was
also an owner of Strathmore Bagel Franchise Company.

19
<PAGE>

(5) ARTHUR REGAN has been a Director of the Company since August 1997. Mr.
Regan has been President of Regan & Associates, Inc., a proxy
solicitation/shareholder services firm in New York, New York that has been
a vendor of the Company since 1993. Since 1988, Mr. Regan has also been
the Chairman, President and Chief Executive Officer of RD's Place, Inc., a
messenger/courier company located in Jersey City, New Jersey.

Executive Officers

The Company's executive officers are appointed by the Board of Directors and,
except as described below, hold office at the pleasure of the Board until their
successors are appointed and have qualified. The Company has three executive
officers, David B. Hurwitz, Michael McAnulty and John Colarossi.

Mr. Hurwitz, age 37, became the Executive Vice President of Sales and Marketing
and General Manager of the Company in December 1996 and was elected President
and Chief Executive Officer of the Company in February 1999. From 1995 to 1996,
he served as the Vice President of Sales and Marketing of Commonwealth Long
Distance, a company engaged in the provision of local and long distance
telephone services. From 1993 to 1995, he served as Executive Vice President and
Chief Operating Officer of InterNet Communications Services, Inc., a company
engaged in the provision of pre-paid calling card services. From 1992 to 1995,
he served as General Manager of FiberNet, a company engaged in the provision of
local and private line telephone services. 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).

Michael McAnulty, age 33, joined the Company in 1996 as Controller and became
the Company's Chief Financial Officer in May 1998. From 1993 to 1996, he was the
Accounting Manager for PageNet, Inc., a company engaged in the provision of
wireless paging services. Before joining PageNet, he was employed by Crown Cork
& Seal Co., Inc., a can manufacturer, from 1990 to 1993 as a Plant Controller.

John R. Colarossi, who has an extensive background in executive and sales
management with privately held companies, has been Vice President of Sales for
the Company since October 1999. Mr. Colarossi came to the Company from DigiHut,
an upstart Internet company, where he served as Chief Operating Officer in 1999.
From 1993 to 1998, Mr. Colarossi held the successive positions of Vice President
of Operations, Senior Vice President of Sales and Operations, Chief Operating
Officer and President of Moran Industries, Inc., a Midlothian, Illinois
franchise management company. From 1984 to 1992, Mr. Colarossi held positions of
increasing responsibility with AAMCO Transmissions, Inc., a national franchisor
of automotive after-market services, culminating with the position of Executive
Vice President of Sales and Operations.

SECTION 16(A) - BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
officers, directors and persons who own more than ten percent (10%) of the
Common Stock to file reports of ownership and changes in ownership with the
Securities and Exchange Commission. Officers, directors and greater than ten
percent (10%) shareholders are required by regulations to furnish the Company
with copies of all Section 16(a) forms they file. Based solely on review of the
copies of such forms furnished to the Company or a written representation that
no Annual Statements of Beneficial Ownership of Securities on Form 5 were
required to be filed, the Company believes that during the year ended December
31, 1999, all Section 16(a) filing requirements applicable to its officers,
directors and greater than ten percent (10%) shareholders were complied with
except as follows: Mr. McAnulty became an executive officer of the Company in
May, 1998 but did not file his initial Form 3 until October, 1999. Mr. Colarossi
became an executive officer of the Company in October 1999 but did not file his
initial Form 3 until February 2000. Mr. Hurwitz did not file a Form 4 reporting
his December 1997 exercise of option to acquire

20
<PAGE>

50,000 shares of Common Stock until October 1999. Each of Mr. Goldberg and Mr.
Regan did not file a Form 4 reporting their 1998 award of options to acquire
25,000 shares of Common Stock until October 1999.

ITEM 11. EXECUTIVE COMPENSATION AND OPTIONS OUTSTANDING
- --------------------------------------------------------

The following table sets forth certain information concerning the compensation
paid for the years ended December 31, 1999, 1998 and 1997: (i) to the Company's
President and Chief Executive Officer, and (ii) to the Company's former
President and Chief Executive Officer. The combined 1999 salary and bonus of
the Company's other executive officers, Michael McAnulty and John Colarossi, was
less than $100,000.

SUMMARY COMPENSATION TABLE

LONG TERM COMPENSATION
ANNUAL COMPENSATION AWARDS
- ------------------------------------------------------------------------------------------------------------------------------
Name Common All
and Stock Other
Principal Salary Bonus Underlying Comp.
Position Year ($) ($) Options (#) ($)
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
David B. Hurwitz '99 217,578 -- 400,000 --
President and Chief '98 215,030 -- 50,000 --
Executive Officer /(1)/ '97 150,000 69,821 -- --
- ------------------------------------------------------------------------------------------------------------------------------
Aaron R. Brown '99 22,547 -- -- 112,109
Former President and '98 64,171 -- -- 82,747
Chief Executive '97 6,875 -- -- 119,792
Officer /(2)/
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>

(1) Mr. Hurwitz became President and Chief Executive Officer on February 17,
1999.

(2) Effective August 21, 1998, Mr. Brown became the interim President and Chief
Executive Officer with a salary of $178,125 per annum. Prior to that he was
a consultant to the Company since January 14, 1997 at a fee of $128,125 per
annum. Effective February 17, 1999, Mr. Brown resigned as interim president
and Chief Executive Officer, at which time he resumed the terms of his
consulting contract.

OPTION GRANTS IN LAST FISCAL YEAR

The following table summarizes the number of options granted to the named
executive officers during the year ended December 31, 1999. The Company did not
grant any stock appreciation rights in 1999.

21
<PAGE>

Potential Realizable
Number of Shares of Percent of Total Value of Assumed Annual
Name Common Stock Options Granted in Exercise Expiration Rates of Stock Price
Underlying Options Fiscal Year/(1)/ Price Date Appreciation for Option
Granted Term/(2)/
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
5% 10%
- --------------------------------------------------------------------------------------------------------------------------
David B. Hurwitz 400,000 38.2% $1.5625 12/13/04 $172,676 $393,059
- --------------------------------------------------------------------------------------------------------------------------
Aaron R. Brown -- -- -- -- -- --
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>

(1) Based upon options to purchase a total of 1,046,000 shares granted to all
officers and employees of the Company in 1999 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.

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, 1999.

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>
David B. Hurwitz -- -- 600,000 500,000 $819,688 $495,000
- ------------------------------------------------------------------------------------------------------------------------------------
Aaron R. Brown -- -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

(1) Based upon a market price of the Company's common stock on December 31, 1999
of $2.50 per share (last trading day in December 1999).

COMPENSATION OF DIRECTORS

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

In 1999, 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

EMPLOYMENT AGREEMENTS

Mr. Hurwitz has renewed a one year Employment Agreement terminating January 3,
2001. The contract provides for an annual base salary of $225,000.

22
<PAGE>

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------------------

The following table sets forth, as of March 14, 2000, information concerning the
shares of the Company's Common Stock beneficially owned by: (a) each person or
group known to the Company to be the beneficial owner of more than 5% of the
outstanding shares of Common Stock; (b) each director and named executive
officer; and (c) all directors and executive officers as a group. Except as
otherwise indicated below, to the Company's knowledge, each person named or
included in a group has sole voting and investment power with respect to his or
its shares of Common Stock.

Name And Address of Beneficial Amount and Nature
Owner or Identity of Group of Beneficial Ownership Percent of Class
- --------------------------------- --------------------------- -----------------
<S> <C> <C>
James M. Rossi 1,162,000/(1)/ 5.6%
21 East Main Street
Suite 201
Millville, NJ 08332

Dominic J. Romano 5,000 *
150 South Main Road
Vineland, NJ 08360

Murray Goldberg 285,183/(2)/ 1.4%
26 Anthony Drive
Malvern, Pa 19355

Arthur Regan 57,000/(3)/ *
15 Park Row
New York, NY 10038

Walter Anderson
c/o Gold & Appel Transfer, S.A. 12,927,034/(4)(5)/ 70.8%
Omar Hodge Building
Wickhams Cay
Road Town
Tortula, British Virgin Islands

Gold & Appel Transfer, S.A. 12,927,034/(5)/ 70.8%
Omar Hodge Building
Wickhams Cay
Road Town
Tortula, British Virgin Islands

David B. Hurwitz 761,000/(6)/ 3.6%
2 Greenwood Square
3331 Street Road
Suite 275
Bensalem, PA 19020

Michael Mcanulty 68,000/(7)/ *
2 Greenwood Square

3331 Street Road
Suite 275
Bensalem, PA 19020

All Directors and Executive Officers 15,265,217 70.8%
as a group (8 persons)

</TABLE>

23
<PAGE>

- ---------------------
* Less than 1%

(1) Based on a Schedule 13D dated August 31, 1999 filed with the Securities and
Exchange Commission. Includes 1,162,000 shares of Common Stock owned by
JMR Marketing Corporation and Solar Investment Group, LLC, entities
controlled by Mr. Rossi.

(2) Consists of 260,183 shares of Common Stock owned by Mr. Goldberg as well as
options to purchase 25,000 shares of Common Stock at $1.1875 per share.

(3) Consists of 12,000 shares of Common Stock owned by Mr. Regan, options to
purchase 25,000 shares of Common Stock at $1.1875 per share and options to
purchase 20,000 shares of Common Stock at $1.69 per share.

(4) All of such shares are held of record by Gold & Appel Transfer, S.A.
Pursuant to a power of attorney, Mr. Anderson has sole investment power
over such shares and as a result may be deemed to be the beneficial owner
of such shares. Mr. Anderson, however, has disclaimed such beneficial
ownership. Excludes 1,744,200 shares of Common Stock held by the
Foundation for the International Non-Governmental Development of Space, a
non-profit organization ("FINDS"), of which Mr. Anderson is the president
and director. Mr. Anderson has no pecuniary interest in the shares held by
FINDS and has no power to control the voting or disposition of the shares
held by FINDS. Mr. Anderson has disclaimed beneficial ownership of such
shares. The information in this note (4) is based on a joint Schedule
13D/A dated September 30, 1999 filed ny Gold & Appel Transfer, S.A. and Mr.
Anderson with the Securities and Exchange Commission.

(5) Based on a joint Schedule 13D/A dated September 30, 1999 filed Gold & Appel
Transfer, S.A. and Mr. Anderson with the Securities and Exchange
Commission.

(6) Consists of 61,000 shares of Common Stock owned by Mr. Hurwitz as well as
options to purchase 350,000 shares of Common Stock at $1.03125 per share,
options to purchase 300,000 shares of Common Stock at $1.30 per share and
options to purchase 50,000 shares of Common Stock at $1.1875 per share.
Does not include options to purchase 400,000 shares of Common Stock at
$1.5625 per share, which options do not first become exercisable until
December 13, 2000.

(7) Consists of 3,000 shares of Common Stock owned by Mr. McAnulty as well as
options to purchase 15,000 shares of Common Stock at $1.40 per share and
options to purchase 50,000 shares of Common Stock at $1.50 per share. Does
not include options to purchase 50,000 shares of Common Stock at $1.5625
per share, which options do not first become exercisable until December 13,
2000.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------

INDEMNIFICATION ARRANGEMENTS

The Company is a party to indemnification agreements with two of its former
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 Board of Directors of the Company has authorized the
Company to advance the expenses of the

24
<PAGE>

individual defendants incurred in defending this action. Reference is made to
Part I of Item 3 of this Annual Report.

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 1999, the Company paid Mr. Goldberg and
such company a total of $89,960 in commissions for their services as the
Company's sales agents. Commissions paid to Mr. Goldberg and such company were
at competitive rates.

PRIVATE PLACEMENT

ACQUISITIONS

On March 17, 2000, the Company purchased certain assets of the business of Cam-
Comm, Inc. The Company acquired the customer base and accounts receivable of
approximately 70 private line customers from Cam-Comm, Inc. in exchange for a
cash payment of $150,000 and an agreement to pay an additional amount not to
exceed an additional $159,000 for an outstanding liability of Cam-Comm, Inc.,
with Mr. Rossi being responsible to reimburse the Company one half of any amount
paid by the Company in excess of a total of $200,000. The Company's Chairman,
James M. Rossi, is also the Chairman of Cam-Comm. The terms of the acquisition
of Cam-Comm, Inc. were negotiated between the Company and Mr. Rossi on an arms-
length basis, with Mr. Rossi abstaining from negotiations on the Company's
behalf.

On August 31, 1999, the Company purchased certain assets of JMR Marketing
Corporation including a customer base, property and equipment and sales
contracts associated with certain Affinity Groups in exchange for 150,000 shares
of common stock. The shares of common stock were issued to James M. Rossi (the
sole shareholder of JMR Marketing Corporation).

Consulting Agreement

As compensation for a two year consulting agreement, during 1999 the Company
issued 100,000 options to purchase Common Stock at fair market value to an
independent director. The options entitle the director to purchase 100,000
shares at $1.5625 per share.

25
<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 December 8, 1999, the Company filed Form 8-K, which reported under
Item 5 as to the annual meeting of shareholders held on November 24,
1999 and the voting results of the elected Board of Directors, an
amendment to the Certificate of Incorporation, the adoption of the 1999
Stock Option Plan, and the reincorporation of the Company.

26
<PAGE>

Exhibit No. Description
- ----------- -----------

2.1 Agreement and Plan of Merger with Capsule Communications, Inc.(1)
2.2 Certificate of Incorporation with Capsule Communications, Inc.(1)
2.3 By-Laws of Capsule Communications, Inc.(1)
3.1 Certificate of Incorporation of Registrant(2)
3.2 Amendment to Certificate of Incorporation(2)
3.3 By-Laws of Registrant(2)
3.4 Amended and Restated By-Laws of the Company********
4.1 Specimen Common Share Certificate(2)
10.1 DSC Marketing Services Supply Agreement(3)
10.2 Key Employees Incentive Stock Option Plan(3)
10.3 Employee Compensation Stock Option Plan(3)
10.4 Agreement of Lease for 3 Parkway, Philadelphia, PA(3)
10.5 Loan and Security Agreement between US Wats, Inc. and Century
Business Credit Corporation dated May 11, 1995(4)
10.6 Severance, General Release, and Cooperation Agreement dated August
21, 1999, between US Wats, Inc. and Stephen Parker(5)
10.7 Stock Repurchase Agreement dated August 21, 1999, between US Wats,
Inc. and Stephen Parker(5)
10.8 Employment Agreement dated December 13, 1999, between US Wats, Inc.
and David B. Hurwitz*
10.9 Employment Agreement dated January 15, 2000, between US Wats, Inc.
and Michael McAnulty*
10.10 Employment Agreement dated January 15, 2000, between US Wats, Inc.
and John Colarossi*
10.11 Stock Option Agreement dated December 13, 1999, between US Wats,
Inc. and David B. Hurwitz*
10.12 Stock Option Agreement dated December 13, 1999, between US Wats,
Inc. and Michael McAnulty*
10.13 Stock Option Agreement dated December 13, 1999, between US Wats,
Inc. and John Colarossi*
10.14 Stock Option and Consulting Agreement dated December 13, 1999,
between US Wats, Inc. and Dominic Romano*
10.15 Amendment and extension of the Loan and Security Agreement between
US Wats, Inc. and Century Business Credit Corporation dated April
9, 1999(6)
10.16 Purchase Agreement dated August 31, 1999, between US Wats, Inc. and
JMR Marketing Corporation
10.17 Purchase Agreement dated March 17, 2000, between US Wats, Inc. and
Cam-Comm, Inc.
10.18 Loan Agreement dated March 22, 2000, between US Wats, Inc. and Gold
Appel Transfer, S.A.
10.19 Loan Agreement dated March 22, 2000 between US Wats, Inc. and
Foundation for the International Non-governmental Development of
Space

(1) Incorporated by reference to the October 25, 1999 Form DEF 14A
(2) 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.
(3) Incorporated by reference to the December 31, 1992 Form 10-K
(4) Incorporated by reference to the June 30, 1995 Form 10-Q
(5) Incorporated by reference to the September 1, 1998 Form 8-K
(6) Incorporated by reference to the September 16, 1999 Form 8-K

* Compensatory arrangement

27
<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/ Michael McAnulty
----------------------
Michael McAnulty
Chief Financial Officer and Treasurer

Date: March 30, 2000

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/ David B. Hurwitz President and Chief Executive Officer March 30, 2000
- ------------------------
David B. Hurwitz

/s/ Michael McAnulty Chief Financial Officer and Treasurer March 30, 2000
- ------------------------
Michael McAnulty

/s/ James M. Rossi Chairman of the Board March 30, 2000
- ------------------------
James M. Rossi

/s/ Walt Anderson Director March 30, 2000
- ------------------------
Walt Anderson

/s/ Dominic J. Romano Director March 30, 2000
- ------------------------
Dominic J. Romano

28
<PAGE>

US WATS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997

Page (s)
--------

CONSOLIDATED FINANCIAL STATEMENTS:

Independent Auditors' Report F-1

Consolidated Balance Sheets
December 31, 1999 and 1998 F-2 to F-3

Consolidated Statements of Operations
Years ended December 31, 1999, 1998, and 1997 F-4

Consolidated Statements of Common Shareholders' Equity (Deficiency)
Years ended December 31, 1999, 1998, and 1997 F-5 to F-7

Consolidated Statements of Cash Flows
Years ended December 31, 1999, 1998, and 1997 F-8

Notes to Consolidated Financial Statements F-9 to F-20

Financial Statement Schedule
- - Schedule II - - Valuation and Qualifying Accounts F-21

F-i
<PAGE>

INDEPENDENT AUDITORS' REPORT

Board of Directors and Shareholders
US Wats, Inc.
Bensalem, Pennsylvania

We have audited the accompanying consolidated balance sheets of US Wats, Inc.
and subsidiaries as of December 31, 1999 and 1998, and the related consolidated
statements of operations, common shareholders' equity (deficiency), and cash
flows for each of the three years in the period ended December 31, 1999. 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 audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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, such consolidated financial statements present fairly, in all
material respects, the financial position of US Wats, Inc. and subsidiaries as
of December 31, 1999 and 1998, and the results of their operations and cash
flows for each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States of
America. 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 negative cash flows from operations 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 27, 2000

F-1
<PAGE>

US WATS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

December 31,
-----------------------
1999 1998
----------- ----------

ASSETS
- ------

Current Assets
Cash and cash equivalents $ 827,048 $1,665,485
Restricted cash 770,363 --
Accounts receivable, net of allowance for
doubtful accounts of $1,711,853 for 1999 and
$934,624 for 1998 5,772,799 6,165,896
Prepaid expenses and other 201,724 166,977
---------- ----------

Total Current Assets 7,571,934 7,998,358
---------- ----------

Property and Equipment
Telecommunications equipment 4,120,775 5,031,047
Equipment 1,863,177 1,690,490
Software 655,422 652,422
Office furniture and fixtures 161,282 157,006
Leasehold improvements 668,820 46,671
---------- ----------
7,469,476 7,577,636
Less accumulated depreciation and amortization 4,459,111 4,708,113
---------- ----------

Total Property and Equipment, net 3,010,365 2,869,523
---------- ----------

Other assets, net 323,914 153,583
---------- ----------

Total $10,906,213 $11,021,464
============ ===========

The accompanying notes are an integral part of these consolidated financial
statements

F-2
<PAGE>

US WATS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

December 31,
----------------------------
1999 1998
------------- -------------
<S> <C> <C>
Liabilities and Shareholders' Equity
- ------------------------------------

Current Liabilities
Note payable $ 1,036,507 $ 1,121,341
Capital lease obligations, current portion 153,289 226,968
Accounts payable and accrued carrier cost 5,085,368 4,372,548
Accrued commissions 643,321 891,318
Accrued expenses and other 1,162,975 790,699
State and Federal taxes payable 1,039,966 961,731
Deferred revenue -- 2,887
------------ -----------

Total Current Liabilities 9,121,426 8,367,492
------------ -----------

Long-Term Liabilities
Capital lease obligations, net of current portion -- 149,792
------------ -----------

Commitments and Contingencies - see note 7

Redeemable preferred stock, $.01 par, authorized
150,000 shares; 0 shares issued and
outstanding in 1999 and 30,000 1998
Redemption value: $11.00 per share -- 330,000
------------ -----------

Common Shareholders' Equity
Common stock, $.001 par, authorized
100,000,000 shares; issued:
20,925,944 shares in 1999 and
20,077,144 shares in 1998 20,926 20,077
Additional paid-in capital 12,087,332 9,514,075
Accumulated deficit (10,323,252) (7,358,853)
------------ -----------
1,785,006 2,175,299
Common stock held in treasury
(219,000 shares in 1999 and 1,119,000 shares
in 1998), at par value (219) (1,119)
------------ -----------

1,784,787 2,174,180
------------ -----------

Total $ 10,906,213 $11,021,464
============ ===========
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements

F-3
<PAGE>

US WATS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Revenues $39,777,331 $44,679,060 $56,466,698

Cost of sales 28,195,547 31,789,200 41,511,542
----------- ----------- -----------

Gross profit 11,581,784 12,889,860 14,955,156

Selling, general and administrative expenses 13,038,455 13,851,001 16,939,142

Provision for bad debts 1,453,496 788,493 1,465,248
----------- ----------- -----------

Loss from operations (2,910,167) (1,749,634) (3,449,234)

Other income (expense)
Interest income 135,646 164,180 71,921
Interest expense (181,197) (232,915) (322,508)
----------- ----------- -----------
Loss before income taxes (2,955,718) (1,818,369) (3,699,821)

Income tax benefits (expense) 4,819 (10,000) --
----------- ----------- -----------

Net loss (2,950,899) (1,828,369) (3,699,821)

Preferred dividends and accretion 13,500 27,000 57,000
----------- ----------- -----------

Net loss attributable to
common shareholders $(2,964,399) $(1,855,369) $(3,756,821)
=========== =========== ===========

Net loss per share
attributable to common shareholders $(.15) $(.10) $(.23)
=========== =========== ===========

Weighted average number of shares outstanding 20,009,728 18,785,656 16,084,971
=========== =========== ===========
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements

F-4
<PAGE>

US WATS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMMON SHAREHOLDERS' EQUITY
YEAR ENDED DECEMBER 31, 1999

<TABLE>

Common Common Additional Treasury Treasury
Common Stock Par Value Stock Paid-In Stock Stock At Shareholders'
Description Shares Issued $ .001 Payable Capital Deficit Shares Par Value Equity
- -------------------------- ------------- ------- ------- ------------ ------------- --------- --------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1998 20,077,144 $20,077 $ 9,514,075 $ (7,358,853) 1,119,000 $(1,119) $ 2,174,180

Net Loss (2,950,899) (2,950,899)

Shares Issued in
Acquisition 150,000 150 262,350 262,500

Exercise of Employee Stock
Options 398,800 399 420,896 421,295

Conversion of Preferred
Stock 300,000 300 329,700 330,000

Private Placement 1,529,100 (900,000) 900 1,530,000

Options Issued to
Employees at
Below Market Value 31,211 31,211
Cash Dividends on
Preferred
Stock ($.90 per share) (13,500) (13,500)
---------- -------- ------- ----------- ------------ --------- ------- -----------
Balance, December 31, 1999 20,925,944 $20,926 $0 $12,087,332 $(10,323,252) 219,000 $ (219) $ 1,784,787
========== ======= ======= =========== ============ ========= ======= ===========

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

F-5
<PAGE>

US WATS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMMON SHAREHOLDERS' EQUITY (DEFICIENCY)
YEAR ENDED DECEMBER 31, 1998

<TABLE>

Common Common Additional Treasury Treasury Shareholders'
Common Stock Par Value Stock Paid-In Stock Stock At Equity
Description Shares Issued $ .001 Payable Capital Deficit Shares Par Value (Deficiency)
- -------------------------- ------------- ------- ------- ----------- ------------ --------- --------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997 17,654,100 $17,654 $ 166 $ 5,328,982 $(5,503,484) 250,000 $ (250) $ (156,932)

Net Loss -- -- -- -- (1,828,369) -- -- (1,828,369)

Short-Swing Profit
Proceeds -- 2,430,979 -- -- -- 2,430,979

Exercise of Employee Stock
Options 1,068,984 1,069 1,403,422 -- -- -- 1,404,491

Exercise of Warrants 1,188,000 1,188 1,259,419 1,260,607

Common Stock Issued 166,060 166 $(166) -- -- --

Options Issued for
Consulting Services 133,204 133,204

Repurchase of Common Stock (1,041,931) 869,000 $ (869) (1,042,800)

Cash Dividends on
Preferred
Stock ($.90 per share) (27,000) (27,000)
---------- -------- ------- ----------- ------------ --------- ------- -----------
Balance, December 31, 1998 20,077,144 $20,077 $ 0 $ 9,514,075 $(7,358,853) 1,119,000 $(1,119) $ 2,174,180
========== ======= ===== =========== =========== ========= ======= ===========

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

F-6
<PAGE>

US WATS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMMON SHAREHOLDERS' EQUITY
YEAR ENDED DECEMBER 31, 1997

<TABLE>

Common Common Additional Treasury Treasury Shareholders'
Common Stock Par Value Stock Paid-In Stock Stock At Equity
Description Shares Issued $ .001 Payable Capital Deficit Shares Par Value (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 -- -- -- -- (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 consolidated financial statements
</TABLE>

F-7
<PAGE>

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

Years Ended December 31,
-------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net loss before preferred dividends $(2,950,899) $(1,828,369) $(3,699,821)
Adjustment to reconcile net loss to
net cash provided by (used-in) operating activities
Stock and stock options issued for services 31,211 133,204 201,000
Depreciation and amortization 1,069,329 1,439,171 1,010,186
Provision for bad debts 1,453,496 788,493 1,465,248
Changes in assets and liabilities which provided
(used) cash:
Accounts receivable (1,060,399) (55,307) (1,850,431)
Prepaid expenses and other (34,747) (58,294) 28,642
Other assets 54,356 (8,272) 94,554
Deferred revenue (2,887) (72,607) (40,728)
Accounts payable and accrued expenses 837,099 (2,872,750) 1,077,445
State & Federal Taxes payable 78,235 (331,686) 330,045
----------- ----------- -----------

Net cash used in operating activities (525,206) (2,866,417) (1,383,860)
----------- ----------- -----------

INVESTING ACTIVITIES:
Purchase of property and equipment (1,172,358) (1,276,562) (395,491)
Investment in internet service provider -- 40,000 --
Increase in restricted cash (770,363) -- --
----------- ----------- -----------

Net cash used in investing activities (1,942,721) (1,236,562) (395,491)
----------- ----------- -----------

FINANCING ACTIVITIES:
Proceeds from private placement 1,530,000 -- 2,300,000
Proceeds from stock option and warrant exercises 421,295 2,665,098 236,550
Short swing profit proceeds -- 2,430,979 --
Buyback of common stock -- (1,042,800) --
(Decrease) increase in notes payable net (84,834) 430,515 (506,034)
Repayment of capital lease obligations (223,471) (276,595) (50,341)
Preferred stock dividends (13,500) (27,000) (27,000)
Payment of loan acquisition costs -- -- (40,743)
----------- ----------- -----------

Net cash provided by financing activities 1,629,490 4,180,197 1,912,432
----------- ----------- -----------

Net increase (decrease) in cash (838,437) 77,218 133,081

Beginning cash and cash equivalents 1,665,485 1,588,267 1,455,186
----------- ----------- -----------

Ending cash and cash equivalents $ 827,048 $ 1,665,485 $ 1,588,267
=========== =========== ===========
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements

F-8
<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 as well as residents. 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.

The Company has formed a new subsidiary in the state of Delaware under the name
of Capsule Communications, Inc. The shareholders have approved to reincorporate
in Delaware by merging the Company into the new subsidiary. Upon approval from
the Public Utility Commissions, the Company will operate as a Delaware
Corporation under the name Capsule Communications, Inc.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- -----------------------------------------------

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company and
its five wholly-owned subsidiaries, USW Corporation, USW Enterprises, Inc.,
Carriers Group, Inc., US Wats of Virginia Inc. and Capsule Communications, Inc.
after elimination of all inter-company accounts, transactions and profits.

BUSINESS SEGMENTS

The Company's operations have been aggregated into a single reportable segment,
based on the similarity of its customers, products and methods of distribution,
as permitted under SFAS NO. 131.

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. However, in some
instances, it bills certain customers on a more frequent 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.

F-9
<PAGE>

At certain times during the year, the Company has balances in its operating
accounts that in the aggregate exceed the $100,000 Federal Deposit Insurance
Corporation insurance limit.

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

The Company acquired a new MegaHub 600E switch to replace its Dex 400 switch in
Philadelphia in 1998. The cost of the replacement switch was approximately
$1,062,000, which is included in telecommunications equipment. The Company
began depreciating the new switch in 1998 and the switch was fully installed in
1999.

Depreciation and amortization expense of property, plant and equipment, loan
origination costs and goodwill for 1999, 1998, and 1997, was $1,069,329,
$1,439,171, and $1,010,186, respectively.

DEFERRED FINANCING COSTS

Loan origination costs are amortized over the term of the related loan, and are
included in other assets.

GOODWILL

The Company records the excess of purchase price over the fair market value of
net assets acquired as goodwill. Goodwill is amortized using the straight line
method over 3 years.

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 the Consolidated 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.

INCOME TAXES

The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." (See Note 6)

F-10
<PAGE>

LOSS PER COMMON SHARE ATTRIBUTABLE TO COMMON SHAREHOLDERS

Loss per common share attributable to common shareholders is computed by
dividing net loss after deduction of preferred stock dividends, by the
weighted average number of common shares outstanding during the period.

For the years ended December 31, 1999, 1998, and 1997, the Company's potential
common stock equivalents have either an antidilutive or have no effect on loss
per share attributable to common shareholders and, therefore, diluted loss per
common share attributable to common shareholders has not been presented.

The following table summarizes those securities that could potentially dilute
loss per common share attributable to common shareholders in the future that
were not included in determining the fully diluted loss per common share
attributable to common shareholders as there is either no effect or the effect
is antidilutive.

<TABLE>
<CAPTION>
Years Ended December 31,
Potential Common Shares resulting from: 1999 1998 1997
------------- ------------- -------------

<S> <C> <C> <C>
Stock Options (see Note 10) 427,620 589,785 1,206,691

Stock Warrants (see Note 10) 0 0 624,822

Cumulative, Convertible, Redeemable Preferred Stock
(see Note 9) 0 300,000 300,000
------- ------- ---------

427,620 889,785 2,131,513
======= ======= =========
</TABLE>

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 1998, the FASB issued Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities. This
statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. The Company adopted this standard in January, 1999, which had no
impact on the Company's financial statements.

F-11
<PAGE>

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
approximately $2,964,000 during the year ended December 31, 1999 and had
negative cash flow from operating activities of $525,000. At December 31, 1999
the Company had a net working capital deficit of $1,549,000 and an accumulated
deficit of $10,323,000. 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 non-compliance. 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, by
forming strategic alliances with certain similarly situated companies and by
upgrading its switching technology to an Asynchronous Transfer Mode (ATM) based
backbone. This ATM packet switching technology transforms circuit switched voice
and data to packet switched voice and data allowing calls to be compressed,
therefore increasing capacity while decreasing the cost per minute to carry the
call. The Company has recently instituted several private internet web sites
from which its agents are generating new orders electronically. The Company
expects to continue its efforts to expand this strategy in order to generate new
business. Additionally, the Company intends to resell local access services
where available to its current and prospective customers in six Bell Atlantic
states under its favorable interconnection agreements. Finally, in an effort to
increase product lines, the Company has recently implemented a marketing plan to
resell Digital Subscriber Line (DSL) services where available to its current and
prospective customers, which provides dedicated internet access at much greater
speeds than existing dial-up service.

On March 23, 1999, the Company through a private placement transaction, issued
900,000 shares of common stock to Gold & Appel Transfer, S.A., a majority
shareholder of the Company, for an aggregate purchase price of $1,530,000 or
$1.70 per share. The proceeds of the issuance are being used for general
working capital. The terms of such transaction were negotiated between the
Company and Gold & Appel Transfer, S.A. on an arms length basis, with Mr.
Anderson abstaining from all negotiations and approvals.

The Company believes that it will require additional funds in the near future to
continue its operations. In addition, the Company must raise additional capital
to meet the capital and surplus requirements for its Common Stock to remain
listed on The Nasdaq SmallCap Market. Management will focus on obtaining
additional financing and raising additional equity through private placement, in
order to support future growth. The Company's plans for growth include both
substantial internal growth and the potential acquisition of other long distance
companies. Also, in order to achieve the Company's plans for growth in the long
distance business as well as its entry into other communications services, the
Company may require

F-12
<PAGE>

additional equity and is currently seeking sources of funding. The Company
cannot give assurance as to the potential success of these efforts.

4. NOTE PAYABLE
- ----------------

The Company has a revolving $2,000,000 credit facility with Century Business
Credit Corporation, which is renewable for three successive one year periods
beginning on May 11, 1999. Interest on the revolving credit facility is
currently calculated at the prime lending rate plus 2 3/4%, on a minimum loan
balance of $750,000. The loan is collateralized by accounts receivable and
fixed and intangible assets of the Company. As of December 31, 1999, the
Company's outstanding balance on its credit facility was approximately
$1,037,000 leaving approximately $963,000 available based on collateral, for
future borrowing under the credit facility.

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, 1999.

During 1999, the Company obtained a letter of credit in the amount of $752,000
for the potential settlement of litigation related to Mr. Scully (See footnote
12).

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
13.5% and are collateralized by the equipment purchased. The balance outstanding
on such leases was approximately $153,000, which is due in full in the next
year.
<TABLE>
<CAPTION>

1999 1998
--------- ---------
<S> <C> <C>

Aggregate capital lease obligation
as of the year ended December 31 $162,251 $427,407
Less--amounts representing interest 8,962 50,647
-------- --------
Present value of net minimum payments under capital leases 153,289 376,760
Less--current portion of capital lease obligations 153,289 226,968
-------- --------
Capital lease obligations, net of current portion $ 0 $149,792
======== ========

</TABLE>

The following is an analysis of property under capital leases:

1999 1998
---------- ----------

Telecommunications Equipment $1,300,951 $1,405,151
Office Equipment 22,512 57,300
---------- ----------
TOTAL 1,323,463 1,462,451

Less Accumulated Amortization 855,669 645,226
---------- ----------
Net Assets Under Capital Lease $ 467,794 $ 817,225
========== ==========

F-13
<PAGE>

Amortization of assets under capital leases charged to operations and included
in depreciation expense was $210,443 per year in 1999, 1998, and 1997.

6. INCOME TAXES
- ----------------

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

1999 1998
---- ----

Deferred Tax Asset $ 3,470,000 $ 3,323,000
Deferred Tax Liability (138,000) (168,000)
Valuation Allowance for Deferred Tax Asset (3,332,000) (3,155,000)
------------- -------------
$ -- $ --
============= =============

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:

1999 1998
---- ----

Net Operating Loss and Carryforwards $ 2,412,000 $ 2,270,000
Allowance for Doubtful Accounts 716,000 893,000
Legal and Commission Reserves 334,000 157,000
Charitable Contributions -- 3,000
Depreciation (138,000) (168,000)
AMT Credit 8,000 --
----------- -----------
Net Deferred Tax Asset 3,332,000 3,155,000
----------- -----------
Valuation Allowance (3,332,000) (3,155,000)
----------- -----------
Total $ -- $ --
----------- -----------

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

1999 1998 1997
---- ---- ----

Current tax expense (benefit)
Federal $ -- $10,000 $ --
State -- -- --
------- ------- -------

Deferred tax expense
Federal -- -- --
State -- -- --
------- ------- -------
$ -- $10,000 $ --
======= ======= =======

F-14
<PAGE>

The differences between the Company's income tax expense (benefit) and income
tax expense (benefit) computed using the U.S. Federal Income Tax rate were as
follows:
<TABLE>
<CAPTION>

1999 1998 1997
% 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) $(989,000) (34.0) $(1,209,000) (34.0) $(1,257,900) (34.0)
Valuation allowance 989,000 34.0 1,219,000 34.5 1,250,600 33.8
Other 0 0 0 0 7,300 .2
--------- ---- ----------- ----- ----------- -----
Actual income tax
expense (benefit) -- -- $ 10,000 .5 $ -- --
========= ==== =========== ===== =========== =====
</TABLE>

The Company has available approximately $5,482,000 of net operating loss carry
forwards which may be applied against future federal taxable income. These carry
forwards begin to expire in 2005.

7. COMMITMENTS AND CONTINGENCIES
- ---------------------------------

The Company has extended a long term contract for the purchase of 1+, 800, and
Private lines services over a 42 month period, expiring in November 2002. 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 1999.

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

<S> <C>
2000 449,511
2001 379,369
2002 197,313
2003 71,301
2004 64,680
thereafter 156,310
----------
TOTAL $1,318,484
==========
</TABLE>

Rent expense incurred for operating leases was approximately $482,771, $492,789,
and $488,436 in 1999, 1998, and 1997, respectively.

The Company entered into employment agreements with certain of its key
management personnel. At December 31, 1999, the total minimum commitment level
over the next year is approximately $640,000.

The Company entered into a contract in December 1996 with its former Chairman
for consulting services. The total minimum aggregate commitment level over the
remaining three years of the contract as of December 31, 1999 is approximately
$400,000.

F-15
<PAGE>

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
issued the carrier 106,060 shares of common stock in 1999. The fair value of
the shares was charged to Selling, General and Administrative Expense in 1997.
The agreement also specified performance incentives payable in the form of stock
option grants. In 1998, 100,000 options were awarded at a purchase price of
$2.375 per share. (See note 10)

8. PENSION PLANS
- ------------------

The Company sponsors a 401(K) Pension and Profit Sharing Plan for all employees.
Effective January 1, 2000, the Company has elected to match 25% of the first 8%
of an employee's contribution to the plan.

9. PREFERRED STOCK
- --------------------

REDEEMABLE PREFERRED:

On July 1, 1999, the only preferred shareholder converted 30,000 shares of
preferred stock to 300,000 shares of common stock. The Company paid $13,500 in
dividends to the preferred shareholder in 1999. The Company has no outstanding
cumulative, convertible, redeemable preferred stock as of December 31, 1999.

PREFERRED STOCK:

In November 1999, the shareholders approved an amendment to the Company's
Certificate of Incorporation to authorize 3,000,000 shares of par value $.01 per
share preferred stock. No shares were issued as of December 31, 1999.

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, 1999,
1,289,500 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. In November 1999, the shareholders approved an amendment to
the Company's Certificate of Incorporation to adopt a new stock option plan by
the Company that would permit the grant of options with respect to 3,000,000
shares of common stock.

F-16
<PAGE>

A summary of the Company's stock option plans activity for common shares for the
three years ended December 31, 1999 follows:
<TABLE>
<CAPTION>

Stock Weighted
Options Average
Price Range Exercise
Number of Shares Per Share Price
---------------- --------- -----
<S> <C> <C> <C>

Outstanding 12/31/96 4,476,000 $1.00 to $2.25 $1.43
Granted 1,610,000 $1.00 to $1.91 $1.27
Exercised (160,000) $1.00 to $1.44 $1.07
Terminated (3,483,166) $1.00 to $2.25 $1.48
---------- -------------- -----
Outstanding 12/31/97 2,442,834 $1.00 to $2.25 $1.28
Granted 516,750 $1.19 to $2.38 $1.20
Exercised (1,068,984) $1.00 to $1.53 $1.31
Terminated (37,300) $1.00 to $2.00 $1.33
---------- -------------- -----
Outstanding 12/31/98 1,853,300 $1.00 to $2.38 $1.28
Granted 1,046,000 $1.38 to $2.22 $1.55
Exercised (398,800) $1.00 to $1.53 $1.05
Terminated (101,250) $1.00 to $2.22 $1.35
---------- -------------- -----
Outstanding 12/31/99 2,399,250 $1.00 to $2.38 $1.43
========== ============== =====

</TABLE>

Options Outstanding Options Exercisable
-------------------------------------------------------- -------------------
Weighted Weighted Average Weighted
Average Remaining Average
Range of Exercise Contractual Exercise
Exercised Prices Outstanding Price Life in Years Exercisable Price
---------------- ----------- ----- ------------- ----------- -----
<S> <C> <C> <C> <C> <C>

$1.00 - $1.03 354,000 $1.03 2.01 354,000 $1.03
$1.19 - $1.30 770,750 $1.24 1.91 670,750 $1.23
$1.38 - $1.75 1,047,500 $1.55 4.21 38,500 $1.58
$2.00 - $2.38 227,000 $2.17 .60 226,250 $2.17
--------- ----- ---- --------- -----
2,399,250 $1.43 2.81 1,289,500 $1.35
========= ===== ==== ========= =====
</TABLE>

EMPLOYEE STOCK OPTIONS

The Company accounts for stock options issued to employees 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

F-17
<PAGE>

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:

1999 1998 1997
------------- ------------- -------------
<S> <C> <C> <C>
Reported Net Loss $(2,964,399) $(1,855,369) $(3,756,821)
Proforma Net Loss $(3,194,796) $(2,040,115) $(4,454,993)
Reported Net Loss Per Share $ (.15) $ (0.10) $ (0.23)
Proforma Net Loss Per Share (.16) $ (0.11) $ (0.28)
</TABLE>

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 1999, 1998 and 1997 was
$.84, $.69 and $.75 respectively. The fair value 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 1999, 1998 and
1997: risk-free interest rates of 5.7%, 4.5% and 6.5% respectfully, expected
dividend yields of 0%, expected lives ranging from two to five years from the
date of grant, and expected price volatility between 60% and 80% for the options
granted in 1999, 1998 and 1997.

During 1999, the Company issued stock options to employees to purchase Common
Stock at below fair market value. The Company recorded $31,000 in selling,
general and administrative expense associated with these options.

THIRD PARTY STOCK OPTIONS

The Company accounts for stock options issued to outside consultants in
accordance with SFAS 123, under which compensation expense is recognized based
on the difference, if any, between the fair value of the award or the goods or
services received, whichever is more reliably measurable. The Company has
measured the options based on the fair value of the award and the amount that
the outside consultant must pay to acquire the stock at the date of grant due to
its inability to reliably measure the fair value of the goods or services. (See
footnote 7).

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. In 1997, 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. In May 1998, the independent contractor exercised all
50,000 warrants resulting in an additional amount of $50 and $51,450 added to
Common Stock and paid in capital, respectively. There are no outstanding
warrants remaining as of December 31, 1998.

During 1998, the Company issued 143,750 options to purchase Common Stock to
three independent contractors. The options entitle one contractor to purchase
100,000 shares at $2.375 per share, another contractor to purchase 25,000 shares
at $1.1875 per share and the last contractor to purchase 18,750 shares at
$1.1875 per share. In 1998, the Company recorded approximately $133,000 in
selling, general and administrative expenses associated with these options.

There are no outstanding warrants remaining as of December 31, 1999.

11. CASH FLOW INFORMATION
- --------------------------

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

The Company made cash payments for interest of $181,197, $232,915 and $322,508,
for the years ended December 31, 1999, 1998, and 1997, respectively. The Company
made cash payments for income taxes of $0, $10,000, and $0, for the years ended
December 31, 1999, 1998, and 1997, respectively.

SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES

Redeemable Preferred Stock accreted in value by $30,000 in the year ended
December 31, 1997.

F-18
<PAGE>

During the years ended December 31, 1999, 1998, and 1997, the Company acquired
approximately $0, $0, and $176,000, respectively of telephone communications and
other equipment with capital leases. The lease agreements were financed over
three and five year periods.

On July 1, 1999, the only preferred shareholder converted 30,000 shares of
preferred stock to 300,000 shares of common stock.

12. LITIGATION
- ---------------

On June 13, 1997, Mark Scully, a 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. On June 9,
1999, the Court issued its decision and judgment was entered in favor of Mr.
Scully and against the Company and two former officers for the sum of
approximately $626,000 and required the Company to establish an escrow account
equal to 120% of the judgment. The Court denied Mr. Scully's claim for
attorneys' fees and liquidated damages. An additional amount of $376,000 was
accrued during the quarter ended June 30, 1999 to increase the reserve to the
full judgment amount and was recorded in SG&A expenses. The balance in the
escrow account at December 31, 1999 was $770,363, and is recorded as Restricted
Cash. The Company has appealed the decision and maintains that the Court made a
number of errors of law and that the Court applied the wrong measure of damages.
Mr. Scully has appealed the judgment as well.

13. RELATED PARTY TRANSACTIONS
- -------------------------------

INDEMNIFICATION ARRANGEMENTS

The Company is 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. As stated above, the Company, together with Messrs. Parker, Brown and
O'Hare, have been sued by a 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 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. As of December 31, 1999,
no amounts had been advanced by the Company under such agreements. (See Note 12)

SALES AGENCY

Mr.Goldberg, a director of the Company, 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 products and services. During 1999, the Company paid
Mr. Goldberg and such company a total of $89,960 in commissions for their
services as sales agents. Commissions paid to Mr. Goldberg and such company
were at competitive rates.

PRIVATE PLACEMENT

On March 23, 1999, the Company through a private placement transaction, issued
900,000 shares of common stock to Gold & Appel Transfer, S.A., a majority
shareholder of the Company, for an aggregate purchase price of $1,530,000 or
$1.70 per share. The proceeds of the issuance are being used for general
working capital. The terms of such transaction were negotiated between the
Company and Gold & Appel Transfer, S.A. on an arms length basis, with Mr.
Anderson abstaining from all negotiations and approvals.

CHANGES IN MANAGEMENT

Effective February 19, 1999, Aaron Brown, Chairman, President and Chief
Executive Officer, terminated his employment with the Company. Mr. Brown was
immediately replaced by David Hurwitz as President and Chief Executive Officer.

ACQUISITION

14. SUBSEQUENT EVENTS
- ----------------------

On March 17, 2000, the Company purchased certain assets of the business of Cam-
Comm, Inc. The Company acquired the customer base and accounts receivable of
approximately 70 private line customers from Cam-Comm, Inc. in exchange for a
cash payment of $150,000 and an agreement to pay an amount not to exceed an
additional $159,000 for an outstanding liability of Cam-Comm, Inc. The Company's
Chairman, James M. Rossi, is also the Chairman of Cam-Comm, Inc. Mr.
Rossi has agreed to reimburse the Company one half of any amount paid by
the Company in excess of a total of $200,000.

On March 22, 2000, the Company entered into a Loan Agreement with two
significant shareholders. The terms of the agreement call for the Company to
borrow up to $1,500,000 at a rate of 10% per annum and due and payable on March
1, 2001. The agreement includes that all parties may convert all or any portions
of the loan amount to shares of the Company's Common Stock at $2.50 per share.

F-19
<PAGE>

15. OTHER SALES INFORMATION
- ---------------------------

Net sales information by the Company's product groups for the years ended
December 31 are summarized as follows:

<TABLE>
<CAPTION>
1999 1998 1997
----------------- ----------------- -----------------
Amount % Amount % Amount %
----------------- ----------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
Domestic 1+ $19,093,119 48 $20,105,578 45 $20,892,678 37
International 8,751,013 22 10,276,183 23 17,504,676 31
Inbound 6,762,146 17 6,701,859 15 8,470,005 15
Wireless 1,193,320 3 1,787,162 4 2,258,668 4
Domestic Carrier Termination 3,977,733 10 5,808,278 13 7,340,671 13
----------- --- ----------- --- ----------- ---
Total $39,777,331 100% $44,679,060 100% $56,466,698 100%
=========== === =========== === =========== ===
</TABLE>
All of the Company's operations are conducted in the United States of America.

F-20
<PAGE>

US WATS, INC.
Schedule II - Valuation and Qualifying Accounts

<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------
COL. A COL. B COL. C COL. D COL. E COL. F
- ----------------------------------------------------------------------------------------------------------------------
DESCRIPTION BALANCE AT CHARGED TO DEDUCTIONS- BALANCE AT
BEGINNING CHARGED TO OTHER ACCOUNTS- ACCOUNTS END OF
OF PERIOD EXPENSE RECOVERIES WRITTEN OFF PERIOD
<S> <C> <C> <C> <C> <C>

Period ended 12/31/99
- ---------------------

ALLOWANCE FOR DOUBTFUL
ACCOUNTS-
ACCOUNTS RECEIVABLE $ 934,624 $1,453,496 $ 67,797 $ (744,064) $1,711,853
------------------------------------------------------------------------------
Period ended 12/31/98
- ---------------------

ALLOWANCE FOR DOUBTFUL
ACCOUNTS-
ACCOUNTS RECEIVABLE $1,498,749 $ 788,493 $(18,763) $(1,333,855) $ 934,624
------------------------------------------------------------------------------
Period ended 12/31/97
- ---------------------

ALLOWANCE FOR DOUBTFUL
ACCOUNTS-
ACCOUNTS RECEIVABLE $ 672,058 $1,465,248 $ 93,343 $ (731,900) $1,498,749
-------------------------------------------------------------------------------
</TABLE>

F-21

<PAGE>

Exhibit 10.8

EXECUTIVE EMPLOYMENT AGREEMENT

THIS EXECUTIVE EMPLOYMENT AGREEMENT is made as of the 13th day of December,
1999, by and between US WATS, INC., a New York corporation, with offices at 331
Street Road, 2 Greenwood Square, Suite 275, Bensalem, Pennsylvania 19020 (the
"Company"), and DAVID B. HURWITZ, residing at 48 Dalton Way, Holland,
Pennsylvania 18966 (the "Executive").

W I T N E S S E T H:

WHEREAS, the Company desires to continue to employ the Executive, and the
Executive is willing to continue to be employed by the Company, upon the terms
and subject to the conditions hereinafter set forth:

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

1. EMPLOYMENT. The Company agrees to continue to employ the Executive,
and the Executive agrees to continue in employment with the Company, subject to
the terms and conditions herein set forth.

2. TERM. The term of the Executive's employment under this Agreement
shall commence on January 3, 2000 (the "Effective Date") and shall terminate on
the first (1st) anniversary of the Effective Date, subject to the provisions of
this Agreement (such period is hereinafter referred to as the "Term").

3. DUTIES.

3.1 During the Term, the Executive shall be employed as President and
Chief Executive Officer of the Company and any successors thereto or to its
business, and shall be in charge of and responsible for the general and
supervisory duties normally and customarily attendant to such office and shall
render such other lawful services, and exercise such powers, which are from time
to time requested of him, assigned to him or vested in him by the Board of
Directors of the Company (the "Board") and which are commensurate with his
position as President and Chief Executive Officer.

3.2 The Executive agrees that, during the Term, unless the Board shall
otherwise consent, he will devote such amount of his time, energies, labor and
skills to the business of the Company and to the duties and responsibilities
specified in Section 3.1 as shall be reasonably necessary.

4. BASE COMPENSATION. In consideration for services to be performed
hereunder by Executive, the Company shall pay to the Executive an annual base
salary of $225,000 in installments payable in accordance with the Company's
customary payroll practices, but in no event less than one time per month. On
each anniversary of the Effective Date of this Agreement, the Executive's base
salary shall be increased at a minimum by an amount equal to the base salary
then in effect multiplied by the greater of (i) the percentage increase in the
consumer price index from the preceding year, or (ii) five percent. In addition,
the Company shall reimburse the Executive for all expenses reasonably incurred
by him in the performance of his duties hereunder and the business of the
Company upon the submission to the Company of appropriate receipts therefor.

5. BENEFITS AND CASH BONUS.

5.1 During the Term, the Executive shall be eligible to participate in
any pension, profit-sharing, stock option or similar plan or program of the
Company now existing or established hereafter for the benefit of its employees
generally, to the extent that he is eligible under the general provisions
thereof. The Executive shall also be entitled to participate in any group
insurance, hospitalization, medical, health and accident, disability or other
plan or program of the Company now existing or established hereafter for the
<PAGE>

benefit of its employees or executives generally, to the extent that he is
eligible under the general provisions thereof.

5.2 During the Term, the Company shall provide the Executive with a
policy of term life insurance in an amount equal to not less than two (2) times
his yearly salary hereunder, payable to such beneficiary or such beneficiaries
as shall be designated in writing by the Executive.

5.3 During the Term, the Executive shall be entitled to receive an
annual bonus, payable within sixty (60) days following the end of each calendar
year during the Term, based on the achievement by the Company or the Executive
of such targets as the Board may from time to time prescribe; provided that the
minimum annual bonus shall be an amount equal to thirty percent (30%) of the
Executive's annual base salary for the preceding calendar year; and provided
further that upon the termination of Executive's employment hereunder during the
middle of any calendar year for any reason other than a discharge of Executive
by the Company for Cause (as defined below), Executive's death or Disability (as
defined below) or Executive's resignation without Good Reason (as defined
below), the final bonus shall be prorated based on that portion of the calendar
year that Executive was employed with the Company.

5.4 During the Term, the Company shall provide Executive an automobile
allowance of $700 per month to cover Executive's use of his vehicle for business
purposes.

6. STOCK OPTION GRANT. As provided in the stock option agreement attached
hereto as Exhibit A, the Executive will be granted options to purchase shares of
---------
the Company's common stock under the 1999 US WATS, Inc. Stock Option Plan (the
"Option Plan").

7. TERMINATION OF EXECUTIVE'S EMPLOYMENT.

7.1 The Executive's employment hereunder may be terminated by the
Company or by the Executive at any time. Upon termination, the Executive shall
be entitled to only the compensation and benefits described in this Section 7.
Any amount payable under this Section 7 will be subject to tax withholding in
accordance with applicable law and subject to the Company's normal payroll
practices.

7.2 In the event that the Executive's employment hereunder is
terminated as a result of (i) his death, (ii) his Disability (as defined below),
(iii) his discharge by the Company for Cause (as defined below), or (iv) his
resignation without Good Reason (as defined below), then the Company's
obligation to Executive will be limited solely to the payment of accrued and
unpaid salary and benefits through the date of such termination. All salary and
benefits shall cease at the time of such termination, subject to the terms of
any benefit or compensation plans then in force and applicable to Executive, and
the Company shall have no further obligations or liabilities to the Executive
hereunder.

7.3 In the event that the Executive's employment hereunder is
terminated (i) without Cause by the Company or (ii) by the Executive for Good
Reason, then the Company shall be obligated to make monthly severance payments
to Executive in an amount equal to his monthly base salary, at the rate in
effect immediately preceding such termination, (or if such termination is by the
Executive for Good Reason as described in Section 7.6.3(i), the rate in effect
immediately preceding the reduction in the Executive's base salary), for a
period equal to the remainder of the Term, plus three months. In addition, the
Executive shall be entitled to a final bonus payment as provided in Section 5.3.

7.4 Notwithstanding anything contained in this Agreement to the
contrary, if the Executive's employment hereunder is terminated without Cause by
the Company or by Executive for Good Reason following a Change in Control (as
defined in the Option Plan), then, within sixty (60) days of the termination,
the Company will make a single sum severance payment to Executive in an amount
equal to the greater of: (i) the total amount of base salary Executive would
have received during the remainder of the Term, but for such termination, or
(ii) one and one-half (1.50) times his annual base salary. In either case, for
purposes of this

2of 6
<PAGE>

Section 7.4, Executive's base salary shall be determined with reference to his
rate of base salary as in effect immediately preceding the termination of his
employment hereunder (or, if such termination is by Executive for Good Reason as
described in Section 7.6.3(i), the rate of base salary in effect immediately
preceding the reduction in Executive's base salary). Any amount paid under this
Section 7.4 will be in lieu of, and not in addition to, any amount otherwise
payable under Section 7.3.

7.5 Payments under this Section 7 shall be made without regard to
whether the deductibility of such payments (or any other payments) would be
limited or precluded by Section 280G of the Internal Revenue Code of 1986 (the
"Code") and without regard to whether such payments would subject the Executive
to the federal excise tax levied on certain "excess parachute payments" under
Section 4999 of the Code; provided, however, that if the Total After-Tax
Payments (as defined below) would be increased by the limitation or elimination
of any amount payable under this Section 7, then the amount payable under
Section 7 will be reduced to the extent necessary to maximize the Total After-
Tax Payments. The determination of whether and to what extent payments under
this Section 7 are required to be reduced in accordance with the preceding
sentence will be made at the Company's expense by an independent, certified
public accounting firm selected by the Board or by such other qualified person
or firm as the Board may select. In the event of any underpayment or overpayment
under this Section 7 (as determined after the application of this Section 7.5),
the amount of such underpayment or overpayment will be immediately paid by the
Company to the Executive or refunded by the Executive to the Company, as the
case may be, with interest at the applicable federal rate provided for in
Section 7872(f)(2) of the Code.

7.6 For purposes of this Agreement, the following definitions will
apply

7.6.1 "Cause" shall mean: (i) Executive's conviction of a
felony; (ii) gross misconduct relating to the Company and
not cured within ten (10) days of the delivery of written
notice thereof; (iii) intentional misappropriation of
Company funds; or (iv) deliberate and premeditated acts
against the interest of the Company not cured within ten
(10) of the delivery of written notice days notice.

7.6.2 "Disability" shall mean the Executive is mentally or
physically disabled from properly and fully performing
his duties and responsibilities hereunder for a period of
120 consecutive days or for 180 days, even though not
consecutive, within a 360-day period, all as evidenced by
the written certification of a qualified medical doctor
selected by the Company.

7.6.3 "Good Reason" shall mean: (i) a reduction in Executive's
base salary, (ii) a reduction in Executive's bonus or
fringe benefits other than in proportion to reductions
applicable to other senior executive officers of the
Company, (iii) a significant adverse alteration in the
nature or status of Executive's title, duties or
authority not cured within thirty (30) days of the
delivery of written notice thereof, (iv) any other
material breach of this Agreement by the Company not
cured within thirty (30) days of the delivery of written
notice thereof, or (v) relocation of the principal place
where Executive performs his day-to-day responsibilities
by more than 100 miles.

7.6.4 "Total After-Tax Payments" means the total of all
"parachute payments" (as that term is defined in Section
280G(b)(2) of the Code) made to or for the benefit of
Executive (whether made hereunder or otherwise), after
reduction for all applicable federal taxes (including,
without limitation, the tax described in Section 4999 of
the Code).

3of 6
<PAGE>

8. COVENANTS OF THE EXECUTIVE.

8.1 CONFIDENTIALITY. The Executive acknowledges that his employment
by the Company will, throughout his employment, bring him into close contact
with the confidential affairs of the Company, including information about costs,
profits, markets, sales, key personnel, pricing policies, operational methods,
and other business affairs, methods and information, including plans for future
developments, not readily available to the public. The Executive further
acknowledges that the services to be performed by him under this Agreement are
of a special, unique, unusual, extraordinary and intellectual character, and
that the Company currently competes or intends to compete with other
organizations that are located in all of the states of the United States. In
recognition of the foregoing, the Executive covenants and agrees that: (i) he
will not knowingly divulge any material confidential matters of the Company
which are not otherwise in the public domain and will not intentionally disclose
them to anyone outside of the Company during his employment by the Company
hereunder or following the expiration or termination of his employment with the
Company for any reason; (ii) he will deliver promptly to the Company at the end
of Term, or at any other time as the Company may so request, at the Company's
expense, all memoranda, notes, records, reports and other documents (and all
copies thereof) relating to the businesses of the Company which he obtained
while employed by, or otherwise serving or acting on behalf of, the Company, or
any of its subsidiaries or affiliates, and which he may then possess or have
under his control; and (iii) during the Term and any additional period during
which the Executive may be employed by the Company (whether or not such
employment shall be pursuant to written agreement) the Executive will not,
unless the Board shall otherwise consent, along or together with any other
person, firm, partnership, corporation, or other entity whatsoever (except any
subsidiaries or affiliates of the Company), directly or indirectly, whether as
an officer, director, stockholder, partner, proprietor, associate, employee,
representative, public relations or advertising representative, management
consultant or otherwise, engage in or become or be interested in or associated
with any other person, corporation, firm, partnership or other entity engaged in
any business which is competitive with any business conducted or contemplated by
the Company.

8.2 ANTI-RAIDING. Executive agrees that during the Term and
thereafter for a period of six (6) months, he will not, as a principal, agent,
employee, employer, consultant, director or partner of any person, firm,
corporation or business entity, or in any individual or representative capacity
whatsoever, directly or indirectly, without the prior express written consent of
the Company, attempt to induce any person who is then in the employ of the
Company to leave the employ of the Company or employ, or attempt to employ, any
such person or persons who at any time during the six months period preceding
termination of Executive's employment with the Company was in the employ of the
Company.

8.3 Notwithstanding the provisions of Section 8.1(iii), the Executive
may own, as a passive investor, securities of a corporation engaged in a
competitive line of business whose equity securities are registered under
Section 12(b) or 12(g) of the Securities Exchange Act of 1934, so long as his
beneficial ownership in any one such corporation shall not in the aggregate
constitute more than five percent (5%) of any class of equity securities of such
corporation.

8.4 The parties agree that the remedy at law for any breach or
threatened breach of any covenant contained in this Section 8 will be inadequate
and that either party, in addition to such other remedies as may be available to
it, and/or them, at law or in equity, shall be entitled to injunctive relief
without bond or other security.

9. GOVERNING LAW. This Agreement shall be construed in accordance with
and governed by the laws of the State of Delaware applicable to contracts
executed in and to be performed solely within such state.

10. NOTICES. All notices required or permitted to be given by either party
hereunder, including notice of change of address, shall be in writing and
delivered by hand, or by telecopier or mailed, postage prepaid, certified or
registered mail, return receipt requested, to the other party as follows:

4of 6
<PAGE>

If to the Company: US WATS, Inc.
331 Street Road
2 Greenwood Square, Suite 275
Bensalem, PA 19020
Attention: Chairman of the Board

With a copy to: Pepper Hamilton, LLP
3000 Two Logan Square
18th & Arch Streets
Philadelphia, PA 19103
Attention: Michael H. Friedman, Esq.

If to the Executive: David B. Hurwitz
48 Dalton Way
Holland, PA 18966

11. MISCELLANEOUS.

11.1 ENTIRE AGREEMENT. This Agreement constitutes the entire
agreement among the parties with respect to the subject matter hereof and
supersedes any and all prior oral or written agreements and understandings;
however, this Agreement shall not supersede, diminish or modify any rights of
the Executive under any employee benefit plans of the Company. There are no oral
promises, conditions, representations, understandings, interpretations or terms
of any kind as conditions or inducements to the execution hereof or in effect
among the parties. This Agreement may not be amended, and no provision hereof
shall be waived, except by a writing signed by the Company and the Executive, or
in the case of a waiver, by the party waiving compliance therewith, which states
that it is intended to amend or waive a provision of this Agreement. Any waiver
of any rights or failure to act in any one instance shall not be regarded as an
agreement to waive any rights or failure to act in any other instance, whether
or not similar.

11.2 FURTHER ACTS. The parties hereto agree that, after the execution
of this Agreement, they will make, do, execute or cause to be made, done or
executed all such further and other lawful acts, deeds, things, devices,
conveyances and assurances in law whatsoever as may be required to carry out the
true intention and to give full force and effect to this Agreement.

11.3 SURVIVABILITY. Should any provision of this Agreement be held by
a court of competent jurisdiction to be unenforceable or prohibited by an
applicable law, this Agreement shall be considered divisible as to such
provision, which shall be inoperative, and the remainder of this Agreement shall
be valid and binding as though such provision were not included herein.

11.4 SUCCESSORS AND ASSIGNS. This Agreement shall insure to the
benefit of, and be binding upon, the Company and any corporation with which the
Company merges or consolidates (including Capsule Communications, Inc.) or to
which the Company sells all or substantially all of its assets, and upon the
Executive and his executors, administrators, heirs and legal representatives.

11.5 HEADINGS. All headings in this Agreement are for convenience
only and are not intended to affect the meaning of any provision hereof.

11.6 COUNTERPARTS. This Agreement may be executed in two or more
counterparts with the same effect as if the signatures to all such counterparts
were upon the same instrument, and all such counterparts shall constitute one
instrument.

5of 6
<PAGE>

IN WITNESS WHEREOF, the Executive has executed this Agreement and the
Company has caused this Agreement to be executed by its duly authorized
representative as of the day and year first above written.

ATTEST US WATS, INC.

By: By: James M. Rossi
----------------------- ----------------------
Chairman
(corporate seal)
David B. Hurwitz
----------------------
David B. Hurwitz

6of 6

<PAGE>

Exhibit 10.9

EXECUTIVE EMPLOYMENT AGREEMENT

THIS EXECUTIVE EMPLOYMENT AGREEMENT is made as of the 15TH day of JANUARY,
---- -------
2000, by and between US WATS, INC., a New York corporation, with offices at 331
Street Road, 2 Greenwood Square, Suite 275, Bensalem, Pennsylvania 19020 (the
"Company"), and Michael McAnulty, residing at 313 Rolling Brook Way, Sewell, New
---------------- ----------------------------------
Jersey 08080 (the "Executive").
- ------------

W I T N E S S E T H:

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

1. EMPLOYMENT. The Company agrees to continue to employ the Executive,
and the Executive agrees to continue in employment with the Company, subject to
the terms and conditions herein set forth.

2. TERM. The term of the Executive's employment under this Agreement
shall commence on January 15, 2000 (the "Effective Date") and shall terminate on
the first (1st) anniversary of the Effective Date, subject to the provisions of
this Agreement (such period is hereinafter referred to as the "Term").

3. DUTIES.

3.1 During the Term, the Executive shall be employed as CHIEF
-----
FINANCIAL OFFICER, AND/OR CONTROLLER of the Company and any successors thereto
- ------------------------------------
or to its business, and shall be in charge of and responsible for the general
and supervisory duties normally and customarily attendant to such office and
shall render such other lawful services, and exercise such powers, which are
from time to time requested of him, assigned to him or vested in him by the
President & CEO of the Company (the "Board") and which are commensurate with
such position.

3.2 The Executive agrees that, during the Term, unless the President &
CEO shall otherwise consent, he will devote such amount of his time, energies,
labor and skills to the business of the Company and to the duties and
responsibilities specified in Section 3.1 as shall be reasonably necessary.

4. BASE COMPENSATION. In consideration for services to be performed
hereunder by Executive, the Company shall pay to the Executive an annual base
salary of $86,670.00 in installments payable in accordance with the Company's
----------
customary payroll practices, but in no event less than one time per month. On
each anniversary of the Effective Date of this Agreement, the Executive's base
salary shall be increased at a minimum by an amount equal to the base salary
then in effect multiplied by the greater of (i) the percentage increase in the
consumer price index from the preceding year, or (ii) five percent. In addition,
the Company shall reimburse the Executive for all expenses reasonably incurred
by him in the performance of his duties hereunder and the business of the
Company upon the submission to the Company of appropriate receipts therefor.

5. BENEFITS AND CASH BONUS.

1of 4
<PAGE>

benefit of its employees or executives generally, to the extent that he is
eligible under the general provisions thereof.

5.2 During the Term, the Executive may be entitled to receive an
annual bonus, payable within sixty (60) days following the end of each calendar
year during the Term, based on the achievement by the Company or the Executive
of such targets as the President & CEO and/or Board may, or may not, prescribe.

5.3 The Company shall provide the Executive with a policy of term life
insurance in an amount equal to not less than (2) times his yearly salary
hereunder, payable to such beneficiary or such beneficiaries as shall be
designated in writing by the Executive.

6. TERMINATION OF EXECUTIVE'S EMPLOYMENT.

6.1 Notwithstanding any provisions contained herein to the contrary,
the Executive's employment may be terminated by the Company upon the Executive's
death or disability (as defined below); or for Cause (as defined below); or upon
a Change in Control (as defined below).

6.2 For purposes of this Agreement, "disability" shall mean the
Executive is mentally or physically disabled from properly and fully performing
his duties and responsibilities hereunder for a period of 120 consecutive days
or for 180 days, even though not consecutive, within a 360- day period, all as
evidenced by the written certification of a qualified medical doctor agreed to
by the Company and the Executive or, in the absence of such agreement, by a
doctor selected by the agreement of a qualified medical doctor selected by each
of the Company and the Executive.

6.3 For purposes of this Agreement, "Cause" shall mean: (i) the
conviction of the Executive of a felony by a federal or state court of competent
jurisdiction; (ii) gross misconduct relating to the Company; (iii) intentional
misappropriation of funds; (iv) deliberate and premeditated acts against the
interest of the Company; (v.) dishonesty on the part of the Executive as
determined in the good faith judgement of the Company; (vi.) Fraud,
misappropriation or embezzlement by Executive in connection with the Company's
business, as determined in the good faith judgement of the Company; or (vii.)
Gross deficiency in the performance of Executives duties, as determined in the
good faith judgement of the Company. In the case of any of the foregoing, the
Company shall have the right, following notice and a reasonable opportunity to
cure of not less than thirty (30) days (except in the case of clauses (i), (iii)
and (vi) hereunder), to terminate this Agreement without further obligation to
the executive.

6.4 In the event that the Executive's employment hereunder is
terminated as a result of death, disability or for Cause by the Company, then
the Company shall have no further obligations or liabilities to the Executive
hereunder, such that all benefits and salary provided for within this Agreement
shall terminate simultaneously with the termination of the Executive's
employment.

6.5 In the event that the Executive's employment hereunder is
terminated for reasons other than Cause, the Company shall be obligated to pay
the Executive an amount equal to the balance of the Executive's base salary
which would have been earned for the remainder of the Term.

7. COVENANTS OF THE EXECUTIVE.

2of 4
<PAGE>

United States. In recognition of the foregoing, the Executive covenants and
agrees that: (i) he will not knowingly divulge any material confidential matters
of the Company which are not otherwise in the public domain and will not
intentionally disclose them to anyone outside of the Company during his
employment by the Company hereunder or following the expiration or termination
of his employment with the Company for any reason; (ii) he will deliver promptly
to the Company at the end of Term, or at any other time as the Company may so
request, at the Company's expense, all memoranda, notes, records, reports and
other documents (and all copies thereof) relating to the businesses of the
Company which he obtained while employed by, or otherwise serving or acting on
behalf of, the Company, or any of its subsidiaries or affiliates, and which he
may then possess or have under his control; and (iii) during the Term and any
additional period during which the Executive may be employed by the Company
(whether or not such employment shall be pursuant to written agreement) the
Executive will not, unless the Board shall otherwise consent, along or together
with any other person, firm, partnership, corporation, or other entity
whatsoever (except any subsidiaries or affiliates of the Company), directly or
indirectly, whether as an officer, director, stockholder, partner, proprietor,
associate, employee, representative, public relations or advertising
representative, management consultant or otherwise, engage in or become or be
interested in or associated with any other person, corporation, firm,
partnership or other entity engaged in any business which is competitive with
any business conducted or contemplated by the Company.

7.2 ANTI-RAIDING. Executive agrees that during the Term and
thereafter for a period of six (6) months, he will not, as a principal, agent,
employee, employer, consultant, director or partner of any person, firm,
corporation or business entity, or in any individual or representative capacity
whatsoever, directly or indirectly, without the prior express written consent of
the Company, attempt to induce any person who is then in the employ of the
Company to leave the employ of the Company or employ, or attempt to employ, any
such person or persons who at any time during the six months period preceding
termination of Executive's employment with the Company was in the employ of the
Company.

7.3 Notwithstanding the provisions of Section 8.1(iii), the Executive
may own, as a passive investor, securities of a corporation engaged in a
competitive line of business whose equity securities are registered under
Section 12(b) or 12(g) of the Securities Exchange Act of 1934, so long as his
beneficial ownership in any one such corporation shall not in the aggregate
constitute more than five percent (5%) of any class of equity securities of such
corporation.

7.4 The parties agree that the remedy at law for any breach or
threatened breach of any covenant contained in this Section 8 will be inadequate
and that either party, in addition to such other remedies as may be available to
it, and/or them, at law or in equity, shall be entitled to injunctive relief
without bond or other security.

8. GOVERNING LAW. This Agreement shall be construed in accordance with
and governed by the laws of the State of Delaware applicable to contracts
executed in and to be performed solely within such state.

9. NOTICES. All notices required or permitted to be given by either party
hereunder, including notice of change of address, shall be in writing and
delivered by hand, or by telecopier or mailed, postage prepaid, certified or
registered mail, return receipt requested, to the other party as follows:

If to the Company: US WATS, Inc. If to Employee: Mike McAnulty
331 Street Road 313 Rolling Brook Way
2 Greenwood Square, Sewell, New Jeresey 08080
Suite 275
Bensalem, PA 19020
Attention: President & CEO

10. MISCELLANEOUS.

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<PAGE>

10.1 ENTIRE AGREEMENT. This Agreement constitutes the entire
agreement among the parties with respect to the subject matter hereof and
supersedes any and all prior oral or written agreements and understandings;
however, this Agreement shall not supersede, diminish or modify any rights of
the Executive under any employee benefit plans of the Company. There are no oral
promises, conditions, representations, understandings, interpretations or terms
of any kind as conditions or inducements to the execution hereof or in effect
among the parties. This Agreement may not be amended, and no provision hereof
shall be waived, except by a writing signed by the Company and the Executive, or
in the case of a waiver, by the party waiving compliance therewith, which states
that it is intended to amend or waive a provision of this Agreement. Any waiver
of any rights or failure to act in any one instance shall not be regarded as an
agreement to waive any rights or failure to act in any other instance, whether
or not similar.

10.2 FURTHER ACTS. The parties hereto agree that, after the execution
of this Agreement, they will make, do, execute or cause to be made, done or
executed all such further and other lawful acts, deeds, things, devices,
conveyances and assurances in law whatsoever as may be required to carry out the
true intention and to give full force and effect to this Agreement.

10.3 SURVIVABILITY. Should any provision of this Agreement be held by
a court of competent jurisdiction to be unenforceable or prohibited by an
applicable law, this Agreement shall be considered divisible as to such
provision, which shall be inoperative, and the remainder of this Agreement shall
be valid and binding as though such provision were not included herein.

10.4 SUCCESSORS AND ASSIGNS. This Agreement shall insure to the
benefit of, and be binding upon, the Company and any corporation with which the
Company merges or consolidates (including Capsule Communications, Inc.) or to
which the Company sells all or substantially all of its assets, and upon the
Executive and his executors, administrators, heirs and legal representatives.

10.5 HEADINGS. All headings in this Agreement are for convenience
only and are not intended to affect the meaning of any provision hereof.

10.6 COUNTERPARTS. This Agreement may be executed in two or more
counterparts with the same effect as if the signatures to all such counterparts
were upon the same instrument, and all such counterparts shall constitute one
instrument.

ATTEST US WATS, INC.

By: By: David B. Hurwitz
---------------------- ----------------------
David B. Hurwitz
(corporate seal)

By: Michael McAnulty
----------------------
Michael McAnulty

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<PAGE>

Exhibit 10.10
EXECUTIVE EMPLOYMENT AGREEMENT

THIS EXECUTIVE EMPLOYMENT AGREEMENT is made as of the 15TH day of JANUARY,
---- -------
2000, by and between US WATS, INC., a New York corporation, with offices at 3331
Street Road, 2 Greenwood Square, Suite 275, Bensalem, Pennsylvania 19020 (the
"Company"), and John Colarossi, residing 1372 Jasper Drive, Ambler, PA 19002
--------------
(the "Executive").

W I T N E S S E T H:

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

1. EMPLOYMENT. The Company agrees to continue to employ the Executive,
and the Executive agrees to continue in employment with the Company, subject to
the terms and conditions herein set forth.

3. DUTIES.

3.1 During the Term, the Executive shall be employed as VICE PRESIDENT
--------------
SALES of the Company and any successors thereto or to its business, and shall be
- -----
in charge of and responsible for the general and supervisory duties normally and
customarily attendant to such office and shall render such other lawful
services, and exercise such powers, which are from time to time requested of
him, assigned to him or vested in him by the President & CEO of the Company (the
"Board") and which are commensurate with such position.

4. BASE COMPENSATION. In consideration for services to be performed
hereunder by Executive, the Company shall pay to the Executive an annual base
salary of $120,000.00 in installments payable in accordance with the Company's
-----------
customary payroll practices, but in no event less than one time per month. On
each anniversary of the Effective Date of this Agreement, the Executive's base
salary shall be increased at a minimum by an amount equal to the base salary
then in effect multiplied by the greater of (i) the percentage increase in the
consumer price index from the preceding year, or (ii) five percent. In addition,
the Company shall reimburse the Executive for all expenses reasonably incurred
by him in the performance of his duties hereunder and the business of the
Company upon the submission to the Company of appropriate receipts therefor.

5. BENEFITS AND CASH BONUS.

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<PAGE>

benefit of its employees or executives generally, to the extent that he is
eligible under the general provisions thereof.

5.2 The Company shall provide performance criteria in accordance with
its annual business plan, which, depending upon the level of attainment by the
Executive of such criteria, shall entitle the Executive to reasonably earn an
annual cash bonus, payable quarterly, in arrears, in an amount in the vicinity
Executive's annualized base salary.

5.3 Until such time as the Company shall have implemented the bonus
plan under Section 5.2 hereof, but in no event for less than the first six
months of the Term, the Company shall pay the Executive a monthly cash bonus,
payable in arrears, in an amount equal to 2.5% of the Executive's annualized
base salary payable under this Agreement.

5.4 The Company shall provide the Executive with a policy of term life
insurance in an amount equal to not less than (2) times his yearly salary
hereunder, payable to such beneficiary or such beneficiaries as shall be
designated in writing by the Executive.

6. TERMINATION OF EXECUTIVE'S EMPLOYMENT.

7. COVENANTS OF THE EXECUTIVE.

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<PAGE>

7.1 CONFIDENTIALITY. The Executive acknowledges that his employment
by the Company will, throughout his employment, bring him into close contact
with the confidential affairs of the Company, including information about costs,
profits, markets, sales, key personnel, pricing policies, operational methods,
and other business affairs, methods and information, including plans for future
developments, not readily available to the public. The Executive further
acknowledges that the services to be performed by him under this Agreement are
of a special, unique, unusual, extraordinary and intellectual character, and
that the Company currently competes or intends to compete with other
organizations that are located in all of the states of the United States. In
recognition of the foregoing, the Executive covenants and agrees that: (i) he
will not knowingly divulge any material confidential matters of the Company
which are not otherwise in the public domain and will not intentionally disclose
them to anyone outside of the Company during his employment by the Company
hereunder or following the expiration or termination of his employment with the
Company for any reason; (ii) he will deliver promptly to the Company at the end
of Term, or at any other time as the Company may so request, at the Company's
expense, all memoranda, notes, records, reports and other documents (and all
copies thereof) relating to the businesses of the Company which he obtained
while employed by, or otherwise serving or acting on behalf of, the Company, or
any of its subsidiaries or affiliates, and which he may then possess or have
under his control; and (iii) during the Term and any additional period during
which the Executive may be employed by the Company (whether or not such
employment shall be pursuant to written agreement) the Executive will not,
unless the Board shall otherwise consent, along or together with any other
person, firm, partnership, corporation, or other entity whatsoever (except any
subsidiaries or affiliates of the Company), directly or indirectly, whether as
an officer, director, stockholder, partner, proprietor, associate, employee,
representative, public relations or advertising representative, management
consultant or otherwise, engage in or become or be interested in or associated
with any other person, corporation, firm, partnership or other entity engaged in
any business which is competitive with any business conducted or contemplated by
the Company.

If to the Company: US WATS, Inc. If to Employee: John Colarossi
331 Street Road 1372 Jasper Drive

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<PAGE>

2 Greenwood Square, Ambler, PA 19020
Suite 275
Bensalem, PA 19020
Attention: President & CEO

10. MISCELLANEOUS.

10.5 HEADINGS. All headings in this Agreement are for convenience
only and are not intended to affect the meaning of any provision hereof.

ATTEST US WATS, INC.

By: By: David B. Hurwitz
---------------------- ----------------------
David B. Hurwitz
(corporate seal)
By: John Colarossi
----------------------
John Colarossi

4of 4

<PAGE>

Exhibit 10.11

US WATS, INC.

NONQUALIFIED STOCK OPTION AGREEMENT

THIS NONQUALIFIED STOCK OPTION AGREEMENT ("Agreement"), is made as of the
13th day of December, 1999 by and between US WATS, INC., (a New York
corporation), having offices at 331 Street Road, 2 Greenwood Square, Suite 275,
Bensalem, PA 19020 (the "Company"), and David B. Hurwitz (the "Optionee").
Capitalized terms not defined herein shall have the meanings ascribed thereto in
the Plan.

WHEREAS, the Company maintains the 1999 US WATS, Inc. Stock Option (the
"Plan") for the benefit of its eligible employees, consultants and directors;
and

WHEREAS, effective as of December 13, 1999, (the "Date of Grant") and
subject to the terms and conditions of the Plan, the Board of Directors of the
Company (the "Board") authorized the grant to the Optionee of an Option (the
"Option") to purchase an aggregate of Four Hundred Thousand (400,000) shares of
the authorized but unissued Common Stock (the "Option Shares"), conditioned upon
the Optionee's acceptance thereof upon the terms and conditions set forth in
this Agreement; and

WHEREAS, the Company and the Optionee desire to reflect their agreement as
to the Option and related matters.

NOW, THEREFORE, the parties hereto, intending to be legally bound, hereby
agree that the Option granted to the Optionee pursuant to the Agreement shall be
subject to the following terms and conditions:

1. DATE OF GRANT. The effective date of grant of this Option is December
13, 1999.

2. NATURE OF THE OPTION. This Option is a Nonqualified Stock Option
subject to the terms and conditions of the Plan.

3. EXERCISE PRICE. The exercise price is $1.5625, the Fair Market Value
Per Share on the Date of Grant, for each share of the Common Stock subject to
purchase hereunder, subject to adjustment in accordance with the Plan.

4. EXERCISABILITY OF OPTION. This Option shall be exercisable during its
term as follows:

4.1 400,000 shares underlying this Option shall be exercisable (become
vested) on the first anniversary of the Date of Grant.

4.2 This Option may not be exercised for a fraction of a share.

4.3 After a portion of the Option becomes exercisable it shall remain
exercisable except as otherwise provided herein, until the close of business on
the fifth (5th) anniversary of the Date of Grant.

5. METHOD OF EXERCISE.

5.1 NOTICE TO THE COMPANY. The Option shall be exercised in whole or
in part by written notice in substantially the form attached hereto as Exhibit A
directed to the Company at its principal place of business accompanied by full
payment of the exercise price as hereinafter provided for the number of Option
Shares specified in the notice.
<PAGE>

5.2 DELIVERY OF OPTION SHARES. The Company shall issue a certificate
or certificates evidencing the Option Shares as soon as practicable after the
notice and payment is received. The certificate or certificates evidencing the
Option Shares shall be registered in the name of the person or persons so
exercising the Option.

5.3 PAYMENT OF PURCHASE PRICE.

5.3.1 CASH PAYMENT. The Optionee shall make cash payments by
wire transfer, certified or bank check or personal check, in each case payable
to the order of the Company; the Company shall not be required to deliver
certificates for Option Shares until the Company has confirmed the receipt of
good and available funds in payment of the purchase price thereof.

5.3.2 CASHLESS PAYMENT. At the election of the Optionee, the
purchase price for any of all of the Option Shares to be acquired may be paid
by: (i) surrender of shares of Common Stock of the Company held by or for the
account of the Optionee with a Fair Market Value Per Share equal to the purchase
price multiplied by the number of Option Shares to be purchased, or (ii) the
surrender of any exercisable but unexercised portion of the Option having an
Option Spread (as defined below) equal to the purchase price multiplied by the
number of Option Shares to be purchased. The "Option Spread" of a surrendered
portion of the Option means, as of the exercise date, an amount equal to the
excess of the total fair market value of the shares of Common Stock underlying
the surrendered portion of the Option over the total purchase price of such
shares of Common Stock underlying the surrendered portion of the Option.

5.4 PAYMENT PRICE OF WITHHOLDING TAX. Any required withholding tax
may be paid in cash or with Common Stock in accordance with Section 5.3.1 and
5.3.2.

5.5 EXCHANGE ACT COMPLIANCE. Notwithstanding the foregoing, the
Company shall have the right to reject the payment in the form of Common Stock
if in the reasonable opinion of counsel for the Company (i) it could result in
an event of "recapture" under Section 16(b) of the Securities Exchange Act of
1934; and (ii) such shares of Common Stock may not be sold or transferred to the
Company.

5.6 RESTRICTIONS ON EXERCISE. This Option may not be exercised if the
issuance of such Shares upon such exercise or the method of payment of
consideration for such shares would constitute a violation of any applicable
federal or state securities or other law of regulation, including any rule under
Part 207 of Title 12 of the Code of Federal Regulations ("Regulation G") as
promulgated by the Federal Reserve Board. As a condition to the exercise of this
Option, the Company may require the Optionee to make any representation and
warranty to the Company as may be required by any applicable law or regulation.

6. OPTIONEE'S REPRESENTATIONS AND ACKNOWLEDGEMENTS. The Optionee hereby
represents and warrants to the Company that:

6.1 INVESTMENT INTENT. The Optionee is acquiring the Option and shall
acquire the Option Shares for his own account and not with a view towards the
distribution thereof.

6.2 EXCHANGE ACT DOCUMENTS. The Optionee has received a copy of all
reports and documents required to be filed by the Company with the Commission
pursuant to the Exchange Act within the last 24 months and all reports issued by
the Company to its stockholders.

6.3 ACCESS TO INFORMATION. The Optionee has had both the opportunity
to ask questions and receive answers from the officers and directors of the
Company and all persons acting on its behalf concerning the terms and conditions
of the offer made hereunder and to obtain any additional information to the

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<PAGE>

extent the Company possesses or may possess such information or can acquire it
without unreasonable effort or expense.

6.4 PLAN DOCUMENTATION. The Optionee acknowledges receipt of a copy
of the Plan, a copy of which is annexed hereto, and represents that the Optionee
is familiar with the terms and provisions thereof, and hereby accepts this
Option subject to all of the terms and provisions set forth in this Agreement.
The Optionee hereby agrees to accept as binding, conclusive and final all
decisions or interpretations of the Board upon any questions arising under the
Plan.

7. WITHHOLDING TAX. Not later than the date as of which an amount first
becomes includable in the gross income of the Optionee for federal income tax
purposes with respect to the Option, the Optionee shall pay to the Company, or
make arrangements satisfactory to the Committee regarding the payment of, any
federal, state and local taxes of any kind required by law to be withheld or
paid with respect to such amount, The obligations of the Company under the Plan
and pursuant to this Agreement shall be conditioned on such payment or
arrangements with the Company, and the Company shall, to the extent permitted by
law, have the right to deduct any such taxes from any payment of any kind
otherwise due to the Optionee from the Company.

8. TERMINATION OF STATUS AS AN EMPLOYEE.

8.1 If the Optionee's employment by the Company terminates for any
reason other than death, Disability, or termination by the Company for Cause (as
defined in the Employment Agreement between the Company and the Optionee dated
_______ (the "Employment Agreement"), the Optionee may exercise this Option to
the extent that the Optionee was entitled to exercise this Option at the date of
such termination for a period equal to the lesser of: (i) one hundred eighty
(180) days, or (ii) the remaining term of the Option, as specified in Section
11. 8.2 If the Optionee employment's by the Company terminates because of his
death, Disability, or termination by the Company for Cause, then the subsequent
exercisiability of the Option will be governed by the terms of the Plan;
provided, however, that "Cause" will have the meaning defined in the Employment
Agreement rather than the meaning defined in the Plan.

8.3 Notwithstanding any other provision of this Agreement, if the
Optionee's employment is terminated by the Company without Cause (as defined in
the Employment Agreement) or by Executive for Good Reason (as defined in the
Employment Agreement) following a Change in Control, then any shares underlying
this Option that are not already exercisable (i.e., vested) will become
exercisable as of the date of such termination.

8.4 If the Optionee does not exercise this Option within the time
specified herein, the Option shall terminate.

9. NON-TRANSFERABILITY OF OPTION. This Option may not be transferred in
any manner otherwise than by will or by the laws of descent or distribution and
may be exercised during the lifetime of the Optionee only by the Optionee. The
terms of this Option shall be binding upon the executors, administrators, heirs,
successors and assigns of the Optionee. No transfer of the Option by the
Optionee by will or by the laws of descent and distribution shall be effective
to bind the Company unless the Company shall have been furnished with written
notice thereof and a copy of the will and such other evidence as the Company may
deem necessary to establish the validity of the transfer and the acceptance by
the transferee or transferees of the terms and conditions of the Option.

10. EARLY DISPOSITION OF SHARES. (intentionally omitted)

11. TERM OF OPTION. This Option may not be exercised more than five years
from the Date of Grant, and may be exercised during such term only in accordance
with the Plan and the terms of this Agreement.

-3-
<PAGE>

12. RESTRICTION ON TRANSFER OF OPTION SHARES. Anything in this Agreement
to the contrary notwithstanding, the Optionee hereby agrees that he or she shall
not sell, transfer by any means or otherwise dispose of the Option Shares
acquired by him or her without registration under the 1933 Act or, in the event
that they are not so registered, unless (i) an exemption from the 1933 Act
registration requirements is available thereunder, and (ii) the Optionee has
furnished the Company with notice of such proposed transfer and the Company's
legal counsel, in its reasonable opinion, shall deem such proposed transfer to
be so exempt.

13. MISCELLANEOUS.

13.1 NOTICES. All notices, requests, deliveries, payments, demands
and other communications which are required or permitted to be given under this
Agreement shall be in writing and shall be either delivered personally or sent
by registered or certified mail, or by private courier, return receipt
requested, postage prepaid, to the Company at its principal executive office and
to the Optionee at his or her address set forth above, or to such other address
as either party shall have specified by notice in writing to the other. Notice
shall be deemed duly given hereunder when delivered or mailed as provided
herein.

13.2 PLAN PARAMOUNT; CONFLICTS WITH PLAN. Except to the extent
described in Section 2 hereof, this Agreement and the Option shall, in all
respects, be subject to the terms and conditions of the Plan, whether or not
stated herein. In the event of a conflict between the provisions of the Plan and
the provisions of this Agreement, the provisions of the Plan shall in all
respects be controlling.

13.3 STOCKHOLDER RIGHTS. The Optionee shall not have any of the
rights of a stockholder with respect to the Option Shares until such shares have
been issued after the due exercise of the Option.

13.4 WAIVER. The waiver by any party hereto of a breach of any
provision of this Agreement shall not operate or be construed as a waiver of any
other or subsequent breach.

13.5 ENTIRE AGREEMENT. This Agreement constitutes the entire
agreement between the parties with respect to the subject matter hereof and
supersedes any and all prior oral or written agreement and understandings. This
Agreement may not be amended except by writing executed by the Optionee and the
Company.

13.6 BINDING EFFECT; SUCCESSORS. This Agreement shall inure to the
benefit of and be binding upon the parties hereto and, to the extent not
prohibited herein, their respective heirs, successors, assigns and
representatives.

13.7 GOVERNING LAW. This Agreement shall be governed by and construed
in accordance with the laws of the Commonwealth of Pennsylvania (without regard
to choice-of-law provisions).

13.8 HEADINGS. The headings contained herein are for the sole purpose
of convenience of reference and shall no in any way limit or affect the meaning
or interpretation of any of the terms or provisions of this Agreement.

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<PAGE>

IN WITNESS WHEREOF, the parties hereto have signed this Agreement as of
the day and year first above written.

US WATS, INC.
(a New York corporation)

By: James M. Rossi
-----------------------------
Title: Chairman
--------------------------
Date:
---------------------------

ATTESTED BY:

By:
---------------------------
Title:
------------------------

(Corporate Seal)
David B. Hurwitz
-----------------------------
David B. Hurwitz, Optionee

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<PAGE>

Exhibit 10.12

US WATS, INC.

NONQUALIFIED STOCK OPTION AGREEMENT

THIS NONQUALIFIED STOCK OPTION AGREEMENT ("Agreement"), is made as of the
13th day of December, 1999 by and between US WATS, INC., (a New York
corporation), having offices at 3331 Street Road, 2 Greenwood Square, Suite 275,
Bensalem, PA 19020 (the "Company"), Michael McAnulty (the "Optionee").
----------------
Capitalized terms not defined herein shall have the meanings ascribed thereto in
the Plan.

WHEREAS, the Company maintains the 1999 US WATS, Inc. Stock Option (the
"Plan") for the benefit of its eligible employees, consultants and directors;
and

WHEREAS, effective as of December 13, 1999, (the "Date of Grant") and
subject to the terms and conditions of the Plan, the Board of Directors of the
Company (the "Board") authorized the grant to the Optionee of an Option (the
"Option") to purchase an aggregate of Fifty Thousand (50,000) shares of the
authorized but unissued Common Stock (the "Option Shares"), conditioned upon the
Optionee's acceptance thereof upon the terms and conditions set forth in this
Agreement; and

WHEREAS, the Company and the Optionee desire to reflect their agreement as
to the Option and related matters.

1. DATE OF GRANT. The effective date of grant of this Option is December
13, 1999.

2. NATURE OF THE OPTION. This Option is a Nonqualified Stock Option
subject to the terms and conditions of the Plan.

4. EXERCISABILITY OF OPTION. This Option shall be exercisable during its
term as follows:

4.1 50,000 shares underlying this Option shall be exercisable (become
vested) on the 30th day of the month following the first anniversary of the Date
of Grant.

4.2 This Option may not be exercised for a fraction of a share.

4.3 After a portion of the Option becomes exercisable it shall remain
exercisable except as otherwise provided herein, until the close of business on
the fifth (5th) anniversary of the Date of Grant.

5. METHOD OF EXERCISE.

5.3 PAYMENT OF PURCHASE PRICE.

5.4 PAYMENT PRICE OF WITHHOLDING TAX. Any required withholding tax
may be paid in cash or with Common Stock in accordance with Section 5.3.1 and
5.3.2.

6. OPTIONEE'S REPRESENTATIONS AND ACKNOWLEDGEMENTS. The Optionee hereby
represents and warrants to the Company that:

6.1 INVESTMENT INTENT. The Optionee is acquiring the Option and shall
acquire the Option Shares for his own account and not with a view towards the
distribution thereof.

8. TERMINATION OF STATUS AS AN EMPLOYEE.

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<PAGE>

Optionee dated January 15, 2000 (the "Employment Agreement"), the Optionee may
exercise this Option to the extent that the Optionee was entitled to exercise
this Option at the date of such termination for a period equal to the lesser of:
(i) thirty (30) days, or (ii) the remaining term of the Option, as specified in
Section 11.

8.2 If the Optionee employment's by the Company terminates because of
his death, Disability, or termination by the Company for Cause, then the
subsequent exercisiability of the Option will be governed by the terms of the
Plan; provided, however, that "Cause" will have the meaning defined in the
Employment Agreement rather than the meaning defined in the Plan.

8.3 Notwithstanding any other provision of this Agreement, if the
Optionee's employment is terminated by the Company without Cause (as defined in
the Employment Agreement) following a Change in Control, then any shares
underlying this Option that are not already exercisable (i.e., vested) will
become exercisable as of the date of such termination.

8.4 If the Optionee does not exercise this Option within the time
specified herein, the Option shall terminate.

10. EARLY DISPOSITION OF SHARES. (intentionally omitted)

13. MISCELLANEOUS.

13.3 STOCKHOLDER RIGHTS. The Optionee shall not have any of the
rights of a stockholder with respect to the Option Shares until such shares have
been issued after the due exercise of the Option.

13.4 WAIVER. The waiver by any party hereto of a breach of any
provision of this Agreement shall not operate or be construed as a waiver of any
other or subsequent breach.

-3-
<PAGE>

13.7 GOVERNING LAW. This Agreement shall be governed by and construed
in accordance with the laws of the Commonwealth of Pennsylvania (without regard
to choice-of-law provisions).

IN WITNESS WHEREOF, the parties hereto have signed this Agreement as of the
day and year first above written.

US WATS, INC.
(a New York corporation)

By: David B. Hurwitz
----------------------------
Title: President & CEO
-------------------------
Date:
----------------------------

ATTESTED BY:

By:
----------------------------
Title:
-------------------------
(Corporate Seal)
Michael McAnulty
----------------------------
Michael McAnulty, Optionee

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<PAGE>

Exhibit 10.13
US WATS, INC.

NONQUALIFIED STOCK OPTION AGREEMENT

THIS NONQUALIFIED STOCK OPTION AGREEMENT ("Agreement"), is made as of the
13th day of December, 1999 by and between US WATS, INC., (a New York
corporation), having offices at 3331 Street Road, 2 Greenwood Square, Suite 275,
Bensalem, PA 19020 (the "Company"), John Colarossi (the "Optionee").
--------------
Capitalized terms not defined herein shall have the meanings ascribed thereto in
the Plan.