-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LzIKBy9GL6rLYM1eYaV/FYsrICdK3n83G77h7F9NuoxKw9FtHhyorQwn/nta5t2M bTH2WLE8Qb33PHNt0VSXZg== 0000950168-98-001103.txt : 19980407 0000950168-98-001103.hdr.sgml : 19980407 ACCESSION NUMBER: 0000950168-98-001103 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 16 FILED AS OF DATE: 19980406 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: US LEC CORP CENTRAL INDEX KEY: 0001054290 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 562065535 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1/A SEC ACT: SEC FILE NUMBER: 333-46341 FILM NUMBER: 98588402 BUSINESS ADDRESS: STREET 1: 212 S TRYON ST STREET 2: STE 1540 CITY: CHARLOTTE STATE: NC ZIP: 28251 MAIL ADDRESS: STREET 1: 212 S TRYON ST STREET 2: SUITE 1540 CITY: CHARLOTTE STATE: NC ZIP: 28281 S-1/A 1 US LEC CORP. S-1/A #2 As filed with the Securities and Exchange Commission on April 6, 1998 Registration No. 333-46341 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 --------------- AMENDMENT NO. 2 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 --------------- US LEC Corp. (Exact Name of Registrant as Specified in Its Charter)
Delaware 4813 56-2065535 (State or Other Jurisdiction (Primary Standard Industrial (IRS Employer of Incorporation or Organization) Classification Code Number) Identification No.)
212 South Tryon Street, Suite 1540 Charlotte, North Carolina 28281 (704) 319-1000 (Address, Including Zip Code, and Telephone Number Including Area Code, of Registrant's Principal Executive Offices) Tansukh V. Ganatra President and Chief Operating Officer US LEC Corp. 212 South Tryon Street, Suite 1540 Charlotte, North Carolina 28281 (704) 319-1000 (Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent for Service) Copies to: Barney Stewart III, Esq. Barry A. Brooks, Esq. Aaron D. Cowell, Jr., Esq. Paul, Hastings, Janofsky & Walker LLP Moore & Van Allen, PLLC 399 Park Avenue 100 North Tryon Street, Floor 47 New York, New York 10022-4697 Charlotte, North Carolina 28202-4003
Approximate date of proposed sale to the public: To commence as soon as practicable after this Registration Statement becomes effective. If any of the securities registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [ ] If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] --------------- The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Information contained herein is subject to completion or amendment. A registration statement relating to securities has been filed with the Securities and Exchange Commission. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. This prospectus shall not constitute an offer to sell or the soliciation of an offer to buy nor shall there be any sale of these securities in any state in which such offer, solicitation or sale would be unlawful prior to qualification under the securities laws of any such state. SUBJECT TO COMPLETION DATED APRIL 6, 1998 PROSPECTUS (US LEC logo appears here) 5,500,000 Shares US LEC Corp. Class A Common Stock ------------ The 5,500,000 shares of Class A Common Stock offered hereby are being sold by US LEC Corp. (the "Company" or "US LEC"). Prior to this offering (the "Offering"), there has not been a public market for the Class A Common Stock of the Company. It is currently estimated that the initial public offering price of the Class A Common Stock will be between $13.00 and $15.00 per share. See "Underwriting" for information relating to factors to be considered in determining the initial public offering price. The Class A Common Stock has been conditionally approved for listing on the Nasdaq National Market under the symbol "CLEC." The Company has two classes of common stock, the Class A Common Stock and the Class B Common Stock (collectively, the "Common Stock"). The rights of the holders of the Class A Common Stock and the Class B Common Stock are substantially identical, except that (i) holders of the Class A Common Stock are entitled to one vote per share and holders of the Class B Common Stock are entitled to 10 votes per share and, except as provided in clause (ii), holders of both classes vote together as one class on all matters submitted to a vote of stockholders, including the election of directors; (ii) holders of the Class B Common Stock vote as a separate class to elect two members of the Company's Board of Directors; and (iii) the Class B Common Stock, subject to the terms of an agreement among the holders of Class B Common Stock, is fully convertible at any time into Class A Common Stock, at the option of the holder, or automatically upon transfer to a person other than an existing holder of Class B Common Stock or his, her or its Permitted Transferee (as defined), on a one-for-one basis. See "Description of Capital Stock." After the Offering, Richard T. Aab, the Chairman, Chief Executive Officer and a founder of US LEC, will own or otherwise control the vote of 100% of the outstanding Class B Common Stock, representing approximately 94.8% of the total voting power of the outstanding Common Stock. See "Risk Factors -- Control by Single Stockholder," "Security Ownership of Management" and "Description of Capital Stock." See "Risk Factors" beginning on page 7 for a discussion of certain factors which should be considered by potential investors. ------------ THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
Price to Underwriting Discounts Proceeds to Public and Commissions (1) Company (2) Per Share $ $ $ Total (3) $ $ $
- -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- (1) For information regarding indemnification of the Underwriters, see "Underwriting." (2) Before deducting expenses, estimated at $650,000, which are payable by the Company. (3) The Company has granted the Underwriters a 30-day option to purchase up to 825,000 additional shares of Class A Common Stock solely to cover over-allotments, if any. If such option is exercised in full, the total Price to Public, Underwriting Discounts and Commissions and Proceeds to Company will be $ , $ and $ , respectively. See "Underwriting." ------------ The shares of Class A Common Stock are being offered by the several Underwriters named herein, subject to prior sale, when, as and if accepted by them and subject to certain conditions. It is expected that certificates for the shares of Class A Common Stock offered hereby will be available for delivery on or about , 1998, at the office of Smith Barney Inc., 333 West 34th Street, New York, New York 10001 or through the facilities of The Depository Trust Company. ------------ Salomon Smith Barney Bear, Stearns & Co. Inc. Wheat First Union , 1998. (Map appears here with the following cities pictured: US LEC's Network Roanoke Richmond Greensboro Raleigh Charlotte Asheville Wilmington Knoxville Greenville/Spartanburg Charleston/Myrtle Beach Nashville Columbia Atlanta Memphis Jacksonville Orlando Tampa Ft. Lauderdale Miami Switch Activation Schedule (bullet) Markets currently served (bullet) Service to be initiated during the remainder of 1998 (bullet) Service to be initiated in 1999 CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE CLASS A COMMON STOCK, INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING TRANSACTIONS IN SUCH SECURITIES, AND THE IMPOSITION OF A PENALTY BID, IN CONNECTION WITH THE OFFERING. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING." PROSPECTUS SUMMARY The following is a summary of certain information contained elsewhere in this Prospectus. Reference is made to, and this Prospectus Summary is qualified in its entirety by, the more detailed information, including the consolidated financial statements and notes thereto contained herein. The Company is the successor to US LEC L.L.C., a Delaware limited liability company, that merged into the Company on December 31, 1997. Unless the context otherwise requires, the terms "US LEC" and the "Company" refer to US LEC Corp., a Delaware corporation and its consolidated subsidiaries and the Company's predecessor, US LEC L.L.C. Capitalized terms used in this Prospectus which are not otherwise defined herein, have the meaning ascribed to them in the Glossary included in this Prospectus. References herein to "EBITDA" refer to net earnings (loss) before interest expense, income taxes, depreciation and amortization. Information in this Prospectus, unless otherwise indicated, assumes that the over-allotment option that has been granted to the Underwriters in the Offering will not be exercised. The Company US LEC is a rapidly growing competitive local exchange carrier ("CLEC") that provides switched local, long distance and enhanced telecommunications services primarily to medium and large-sized organizations located in selected markets in the southeastern United States. The Company was founded in June 1996 after passage of the Telecommunications Act of 1996 (the "Telecom Act"), which enhanced the competitive environment for local exchange services. The Company initiated service in Charlotte, North Carolina in March 1997, becoming one of the first CLECs in North Carolina to provide switched local exchange services, and subsequently initiated service in Raleigh and Greensboro, North Carolina and in Atlanta, Georgia. As of February 28, 1998, the Company had 62,545 Equivalent Access Lines (as defined in the Glossary) in service. US LEC plans to enter 15 new markets in Tennessee, Florida, South Carolina, Virginia and North Carolina by the end of 1999. US LEC's objective is to become the primary provider of switched local telecommunications services to its existing and target customers. Network Strategy US LEC purchases and deploys switching equipment and leases fiber optic transmission capacity from competitive access providers ("CAPs"), other CLECs and incumbent local exchange carriers ("ILECs"). Management believes that this switch-based, leased-transport strategy provides the Company with significant competitive advantages. By owning its switches, the Company is able to better configure its network to provide cost-effective and customized solutions for its customers' telecommunications needs. By leasing transmission capacity, the Company is able to (i) reduce the up-front capital expenditures required to enter new markets, (ii) avoid the risk of "stranded" investment in under-utilized fiber networks and (iii) enter markets and generate revenue and positive cash flow more rapidly than if the Company first constructed its own transmission facilities. Management believes that the availability of several suppliers of fiber optic transmission facilities in each of the Company's markets provides US LEC with negotiating leverage, vendor diversity and the ability to offer customers enhanced reliability at a competitive price. Market Opportunity The Company focuses its primary sales efforts on telecommunications-intensive organizations with at least 100 access lines, including businesses, government agencies, other telecommunications companies and value-added resellers ("VARs"). After completing its planned expansion, US LEC will operate in 19 markets located in six contiguous states in the southeastern United States -- one of the fastest growing regional markets for business telecommunications services in the country. Within the Southeast, the Company has selected its target markets based on a number of considerations, including the number of potential customers and other competitors in such markets and the presence of multiple transmission facility suppliers. Based on the Company's study of state regulatory filings (the "Market Study"), in the four markets presently served by the Company there were approximately 1.4 million business lines that generated approximately $2.1 billion in local exchange and long distance revenues in 1996. The Market Study indicates that the 19 markets in which management expects the 1 Company to be operating by the end of 1999 had a total of approximately 4.1 million business lines that generated approximately $5.7 billion in local exchange and long distance revenues in 1996. The local and long distance revenue figures reported in the Market Study do not include revenue associated with enhanced services and carrier access fees, which US LEC is pursuing as part of its business plan. Since commencing network operations, US LEC has achieved significant growth in its Equivalent Access Lines in service and in the number of switched minutes of use ("MOUs") carried over the Company's network. As indicated in the following table, from March 1997 through February 1998, the Company increased its number of Equivalent Access Lines in service at month-end from 288 to 62,545 and increased its monthly number of MOUs during the same period from approximately 40,000 to approximately 450 million.
1997 ------------------------------------------------------------------------------------- Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec. ------ ------ ------- ------- -------- -------- --------- -------- -------- --------- Cumulative Equivalent Access Lines in Service (1): Charlotte ....................... 288 757 2,204 2,881 4,571 5,157 9,789 10,863 12,824 16,724 Raleigh ......................... -- 168 624 1,206 1,948 3,012 5,715 9,590 13,935 19,017 Greensboro ...................... -- -- -- -- -- -- -- -- 3,168 13,488 Atlanta ......................... -- -- -- -- -- -- -- -- -- -- --- --- ----- ----- ----- ----- ----- ------ ------ ------ Totals ......................... 288 925 2,828 4,087 6,519 8,169 15,504 20,453 29,927 49,229 === === ===== ===== ===== ===== ====== ====== ====== ====== MOUs (in thousands) (2) ......... 40 500 3,118 5,000 16,323 20,024 33,383 54,273 95,542 243,637 === === ===== ===== ====== ====== ====== ====== ====== ======= 1998 ------------------- Jan. Feb. --------- --------- Cumulative Equivalent Access Lines in Service (1): Charlotte ....................... 24,943 27,027 Raleigh ......................... 19,800 20,685 Greensboro ...................... 14,203 14,689 Atlanta ......................... -- 144 ------ ------ Totals ......................... 58,946 62,545 ====== ====== MOUs (in thousands) (2) ......... 446,386 450,000 ======= =======
- ---------- (1) As of the end of the month indicated. "Equivalent Access Lines" is a term used by management to quantify the size of the Company's network. For a detailed definition, see Glossary. (2) MOUs indicate the number of local and long distance switched minutes of use carried over the Company's network during the month indicated. The Company's existing North Carolina operations generated positive EBITDA of $200,264 during the month of December 1997, ten months after the Company first initiated service in Charlotte. While EBITDA does not represent cash flow or results of operations in accordance with generally accepted accounting principles, it is a measure of financial performance commonly used in the telecommunications industry. Management expects the Company to achieve similar operating results in each of its new markets within a comparable time frame. Management attributes US LEC's ability to achieve this performance primarily to two factors. First, the Company's capital-efficient network strategy eliminates the lengthy "build-out" period usually required to construct a fiber optic transmission network, permitting the Company to quickly enter new markets and rapidly generate revenue and positive cash flow. Second, US LEC's telecommunications-intensive customers typically transmit a large amount of switched traffic over the Company's network, resulting in efficient network utilization and attractive operating margins. Management US LEC believes that the quality of its management team has been a critical factor in the Company's successful entry into existing markets and will be a key to the implementation of its strategy in entering additional markets. The Company has assembled a proven management team with extensive telecommunications experience in the deployment of local exchange, long distance, cellular and international gateway services in emerging competitive environments. The Company's seven executive officers have an average of over 15 years of experience in the telecommunication services industry. In 1982, Richard T. Aab, US LEC's Chairman and Chief Executive Officer, co-founded ACC Corp., a publicly traded international telecommunications company, and served that company in various capacities, including Chairman and Chief Executive Officer, through mid-1997. Tansukh V. Ganatra, US LEC's President and Chief Operating Officer, served as ACC Corp.'s President, Chief Operating Officer, and Vice President of Engineering and Operations over a ten-year period ending in 1997. Prior to joining ACC Corp., Mr. Ganatra spent 19 years at Rochester Telephone Corp. (now part of Frontier Corp.), most recently serving as Director of Network Engineering. Other key US LEC executives have extensive experience in telecommunications engineering, marketing, sales, operations and regulation. 2 Business Strategy US LEC's objective is to become the primary provider of switched local telecommunications services to its existing and target customers. The principal elements of US LEC's strategy include: o Deploy a Capital-Efficient Network. Management believes that US LEC is one of the first CLECs to utilize a strategy of purchasing and deploying switching equipment in each target market and leasing the required fiber optic transmission capacity from CAPs, other CLECs and ILECs. Management believes the Company's switch-based, leased-transport strategy enables it to enter markets and generate revenue and positive cash flow more rapidly than if the Company first constructed its own transmission facilities. This strategy also reduces the up-front capital expenditures required to enter new markets and avoids the risk of "stranded" investment in under-utilized fiber networks. Management also believes that the Company's ability to align its leased transmission costs with customer orders permits a higher return on invested capital. o Focus on a Southeastern Cluster of Operations. After completing its planned expansion, the Company will operate in 19 markets located in six contiguous states in the southeastern United States -- one of the fastest growing regional markets for business telecommunications services in the country. Within the Southeast, the Company has selected its target markets based on a number of considerations, including the number of potential customers and other competitors in such markets and the presence of multiple transmission facility suppliers. Management believes that the Company's clustered network will enable it to take advantage of regional calling patterns and capture an increasing portion of customer traffic on its network. Management also believes that by originating and terminating calls on its network, the Company can achieve significant cost savings and potential pricing advantages over its competition. o Target Telecommunications-Intensive Customers. The Company focuses its primary sales efforts on telecommunications-intensive organizations with at least 100 access lines, including businesses, government agencies, other telecommunications companies and VARs. The volume of usage generated by the Company's target customers allows the Company to efficiently concentrate the telecommunications traffic of its customers on one or more leased T-1 lines. In addition, the Company frequently is able to sell enhanced and long distance services to complement its core local services. This further enhances network utilization and improves margins, as fixed network costs are spread over a larger base of MOUs. o Install a Robust, Uniform Technology Platform. The Company has chosen the 5ESS(R)-2000 digital switch manufactured by Lucent Technologies, Inc. ("Lucent") to provide a consistent technology platform throughout its network. The Lucent switch enables the Company to provide both local and long distance services from a single platform. This uniform and advanced switching platform enables the Company to (i) deploy features and functions quickly throughout its entire network, (ii) expand switch capacity in a cost effective manner, (iii) lower maintenance costs through reduced training and spare part requirements and (iv) achieve direct connectivity to cellular and personal communication system applications in the future. o Employ a Direct Sales Force with Extensive Local Market Experience. Management believes that the Company's success in a particular market is enhanced by employing a direct sales force with extensive local market and telecommunications sales experience. The Company employed this strategy in building its existing sales forces in North Carolina and Georgia and intends to continue implementing this strategy in other markets. Salespeople with experience in a particular market provide the Company with extensive knowledge of the Company's target customer base and in many cases already have existing relationships with target customers. The experience and relationships of these salespeople enable them to pre-sell the Company's products and services prior to initiating network operations in a particular market. o Implement Efficient Provisioning Processes. Management believes that a critical aspect of the success of a CLEC is timely and effective provisioning systems, which includes the process of transitioning ILEC customers to the Company's network. The Company focuses on implementing effective and timely provisioning practices in each of its markets to rapidly and efficiently transition customers from the ILEC to the Company without disruption of the customer's operations. Management believes that these practices provide the Company with a long-term competitive advantage and enable it to implement services in its markets rapidly and to shorten the time between receipt of the customer order and the generation of revenue. 3 The Offering Class A Common Stock offered by the Company....................... 5,500,000 shares Common Stock to be outstanding after the Offering: Class A Common Stock............. 9,355,000 shares (1) Class B Common Stock............. 17,075,270 shares Total.......................... 26,430,270 shares (1) Use of Proceeds.................... The Company intends to use substantially all of the net proceeds from the Offering for capital expenditures relating to its expansion into new markets. See "Use of Proceeds." Nasdaq National Market Symbol...... CLEC - ---------- (1) Excludes 469,000 shares of Class A Common Stock issuable upon exercise of outstanding warrants having exercise prices ranging from $2.86 to $10.00 per share, 182,800 shares issuable upon exercise of outstanding options granted under the US LEC Corp. 1998 Omnibus Stock Plan (the "Stock Plan") with an exercise price of $10.00 per share and 10,000 shares issuable upon exercise of options to be granted at the completion of the Offering having an exercise price equal to the initial public offering price. Risk Factors See "Risk Factors" for a discussion of certain factors which should be considered by prospective purchasers of the Class A Common Stock. Address The principal executive offices of the Company are located at 212 South Tryon Street, Suite 1540, Charlotte, North Carolina 28281. The Company's telephone number is (704) 319-1000. 4 SUMMARY HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA The summary historical consolidated financial data presented below as of December 31, 1996 and 1997, for the period from June 6, 1996 (inception) to December 31, 1996 and for the year ended December 31, 1997 are derived from and qualified by reference to the audited consolidated financial statements and notes thereto of US LEC contained elsewhere in this Prospectus. The Company's consolidated financial statements as of December 31, 1996 and 1997, for the period from June 6, 1996 (inception) to December 31, 1996 and for the year ended December 31, 1997, have been audited by Deloitte & Touche LLP, independent public accountants. The summary historical financial data for each quarter of 1997 have been derived from the unaudited interim consolidated financial statements of the Company. In the opinion of management, the unaudited interim consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments, which consist only of normal recurring adjustments, necessary for a fair presentation of the financial position and the results of operations for these periods. All of the data should be read in conjunction with and are qualified by reference to "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the audited consolidated financial statements and notes thereto of the Company contained elsewhere in this Prospectus.
Period from Quarter Ended June 6, 1996 --------------------------------------------------------------- (Inception) to December 31, March 31, June 30, September 30, December 31, 1996 1997 1997 1997 1997 ---------------- --------------- --------------- --------------- --------------- Statement of Operations Data: Revenue ..................................... $ -- $ 1,141 $ 228,620 $ 1,529,745 $ 4,698,155 Cost of services ............................ -- 423,093 314,828 1,075,183 2,387,897 ------------- ------------ ----------- ------------ ------------- Gross margin ................................ -- (421,952) (86,208) 454,562 2,310,258 Selling, general and administrative ......... 941,743 1,049,130 1,047,940 1,294,115 2,726,152 Depreciation and amortization ............... 4,059 14,046 88,406 124,994 215,468 ------------- ------------ ----------- ------------ ------------- Loss from operations ........................ (945,802) (1,485,128) (1,222,554) (964,547) (631,362) Interest expense, net ....................... 16,861 66,556 108,021 101,326 78,953 ------------- ------------ ----------- ------------ ------------- Net loss .................................... $ (962,663) $ (1,551,684) ($ 1,330,575) $ (1,065,873) $ (710,315) ============= ============ =========== ============ ============= Net loss per share .......................... $ (.06) $ (.09) $ (.07) $ (.06) $ (.04) ============= ============ =========== ============ ============= Weighted average shares outstanding ......... 17,310,000 17,310,000 17,832,750 19,075,500 20,239,500 ============= ============ =========== ============ ============= Other Financial Data: Capital expenditures ........................ $ 279,634 $ 1,798,152 $ 634,122 $ 828,903 $ 9,793,930 EBITDA (1) .................................. (941,743) (1,471,082) (1,134,148) (839,553) (415,894) Net cash flow used in operating activities ................................. (1,079,069) (1,043,972) (1,253,840) (1,168,631) (2,127,650) Net cash flow provided by (used in) investing activities ....................... (465,792) (1,598,152) (3,251,162) 1,303,141 (2,405,058) Net cash flow provided by financing activities ................................. 2,271,000 2,400,000 4,848,244 1,335,280 5,424,871 Operating Data: Cumulative Equivalent Access Lines in service (2) ................................ -- 288 4,087 15,504 49,229 MOUs (3) .................................... -- 40,000 8,618,000 69,730,000 393,452,000 Year Ended December 31, 1997 --------------- Statement of Operations Data: Revenue ..................................... $ 6,457,661 Cost of services ............................ 4,201,001 ------------ Gross margin ................................ 2,256,660 Selling, general and administrative ......... 6,117,337 Depreciation and amortization ............... 442,914 ------------ Loss from operations ........................ (4,303,591) Interest expense, net ....................... 354,856 ------------ Net loss .................................... $ (4,658,447) ============ Net loss per share .......................... $ (.25) ============ Weighted average shares outstanding ......... 18,653,308 ============ Other Financial Data: Capital expenditures ........................ $ 13,055,107 EBITDA (1) .................................. (3,860,677) Net cash flow used in operating activities ................................. (5,594,093) Net cash flow provided by (used in) investing activities ....................... (5,951,231) Net cash flow provided by financing activities ................................. 14,008,395 Operating Data: Cumulative Equivalent Access Lines in service (2) ................................ 49,229 MOUs (3) .................................... 471,840,000
As of December 31, 1997 -------------------------------------------------------- As of December 31, Pro Forma 1996 Actual Pro Forma (4) As Adjusted (4) (5) ------------- --------------- --------------- -------------------- Balance Sheet Data: Current assets .................................. $1,067,662 $ 9,654,993 $ 9,654,993 $80,614,993 Working capital (deficiency) .................... 936,884 (2,268,883) (2,268,883) 68,691,117 Property and equipment, net ..................... 276,097 12,889,335 12,889,335 12,889,335 Total assets .................................... 1,466,835 22,680,681 22,680,681 93,640,681 Notes payable -- stockholders ................... 1,671,000 5,000,000 -- -- Total stockholders' equity (deficiency) ......... (334,943) 5,756,805 10,756,805 81,716,805
5 - ---------- (1) EBITDA consists of net earnings (loss) before interest expense, income taxes, depreciation and amortization. It is a measure commonly used by analysts, investors and other interested parties in the telecommunications industry and is presented to assist in understanding the Company's operating results. However, EBITDA is not a measurement of financial performance under generally accepted accounting principles and should not be considered an alternative to net income or (loss) as a measure of performance or to cash flow as a measure of liquidity. EBITDA is not necessarily comparable with similarly titled measures for other companies. (2) As of the end of the period indicated. "Equivalent Access Lines" is a term used by management to quantify the size of the Company's network. For a detailed definition, see Glossary. (3) MOUs indicate the number of local and long distance switched minutes of use carried over the Company's network during the period indicated. (4) Reflects the exchange of a note payable to a stockholder in the amount of $5.0 million for 480,770 shares of Class B Common Stock on February 14, 1998. See "Certain Relationships and Related Transactions" and Note 9 to the Company's consolidated financial statements for the year ended December 31, 1997. (5) Adjusted to reflect the sale of Class A Common Stock offered hereby (based on an assumed initial public offering price of $14.00 per share) assuming no exercise of the Underwriters' over-allotment option, and after deducting the Underwriters' Discounts and Commissions and estimated expenses of the Offering. See "Use of Proceeds." 6 RISK FACTORS Prospective investors should consider carefully the following factors together with the other information contained in this Prospectus: Limited Operating History US LEC was formed in June 1996, began generating revenue in March 1997 and has a relatively small number of customers. Accordingly, prospective investors have very limited historical operating and financial information upon which to base an evaluation of the Company's performance and an investment in the Class A Common Stock. Given the Company's limited operating history, there can be no assurance that it will be able to compete successfully in the telecommunications business, achieve or sustain profitability or generate sufficient positive cash flow in the future to meet debt service, working capital or other cash requirements. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Risks Associated with Implementation of Growth Strategy The expansion and development of US LEC's operations will depend on, among other things, the Company's ability to (i) accurately assess potential new markets, (ii) identify, hire and retain qualified personnel, (iii) lease access to suitable fiber optic networks, (iv) purchase, install and operate switches and (v) obtain any required government authorizations, all in a timely manner, at reasonable costs and on satisfactory terms and conditions. In addition, US LEC has experienced rapid growth since its inception, and management believes that sustained growth will place a strain on operational, human and financial resources. The Company's ability to manage its expansion effectively will also depend on the continued development of plans, systems and controls for its operational, financial and management needs. Given the Company's limited operating history, there can be no assurance that the Company will be able to satisfy these requirements or otherwise manage its growth effectively. The failure of US LEC to satisfy these requirements could have a material adverse effect on the Company's financial condition and its ability to fully implement its expansion plans. The Company's growth strategy also involves the following risks: Qualified Personnel. A critical component for US LEC's success will be hiring and retaining additional qualified managerial, sales and technical personnel. Since its inception, the Company has experienced significant competition in hiring and retaining personnel possessing necessary skills and telecommunications experience. Although management believes the Company has been successful in hiring and retaining qualified personnel, there can be no assurance that US LEC will be able to do so in the future. Switch and Equipment Installation. An essential element of the Company's current strategy is the provision of switched local service. There can be no assurance that installation of the switches and associated electronics necessary to implement the Company's business plan will continue to be completed on a timely basis or that, during the testing of this equipment, the Company will not experience technological problems that cannot be resolved. The failure of the Company to install and operate successfully additional switches and other network equipment could have a material adverse effect on the Company's financial condition and its ability to enter additional markets. Interconnection Agreements. The Company has agreements for the interconnection of its networks with the networks of the ILECs covering each market in which US LEC either has or is currently installing a switching platform. US LEC may be required to negotiate new, or renegotiate existing, interconnection agreements as it enters new markets in the future, such as in Virginia and Florida. In addition, as its existing interconnection agreements expire, it will be required to negotiate extension or replacement agreements. There can be no assurance that the Company will successfully negotiate such other agreements for interconnection with the ILECs or renewals of existing interconnection agreements on terms and conditions acceptable to the Company. A decision by the United States Court of Appeals for the Eighth Circuit vacating several of the FCC's rules creates uncertainty about the rules governing pricing, terms and conditions of interconnection agreements. As a result of this decision, which has been appealed to the U.S. Supreme Court, and a pending review of this issue by the FCC, negotiating and enforcing such agreements could become more difficult and protracted, and renegotiation of 7 existing agreements could be required. See "Business -- Regulation -- Eighth Circuit Court of Appeals Decision." The failure to negotiate and obtain required interconnection agreements on terms and conditions acceptable to the Company could have a material adverse effect on the Company's ability to rapidly enter a particular market and on its operations in its existing markets. Ordering, Provisioning and Billing. The Company has developed processes and procedures and is working with external vendors, including the ILECs, in the implementation of customer orders for services, the provisioning, installation and delivery of such services and monthly billing for those services. The failure to manage effectively processes and systems for these service elements or the failure of the Company's current vendors or the ILECs to deliver ordering, provisioning and billing services on a timely and accurate basis could have a material adverse effect upon the Company's ability to achieve its growth strategy. Products and Services. The Company currently focuses its efforts on providing local and long distance telecommunications services. In order to address the needs of its target customers, the Company will be required to emphasize and develop additional products and services. No assurance can be given that the Company will be able to provide the range of telecommunication services that its target customers need or desire. Acquisitions. US LEC may acquire other businesses as a means of expanding into new markets or developing new services. The Company is unable to predict whether or when any prospective acquisitions will occur or the likelihood of a material transaction being completed on favorable terms and conditions. Such transactions involve certain risks including, but not limited to, (i) difficulties assimilating acquired operations and personnel; (ii) potential disruptions of the Company's ongoing business; (iii) the diversion of resources and management time; (iv) the possibility that uniform standards, controls, procedures and policies may not be maintained; (v) risks associated with entering new markets in which the Company has little or no experience; and (vi) the potential impairment of relationships with employees or customers as a result of changes in management. If an acquisition were to be made, there can be no assurance that the Company would be able to obtain the financing to consummate any such acquisition on terms satisfactory to it or that the acquired business would perform as expected. Uncertainties Related to Reciprocal Compensation The Telecom Act requires ILECs to provide reciprocal compensation to a CLEC for local traffic terminated on such CLEC's network. Notwithstanding this requirement, a number of Regional Bell Operating Companies ("RBOCs") have taken the position that traffic terminated to enhanced service providers ("ESPs"), including information service providers such as internet service providers ("ISPs"), is not local traffic. CLECs have been generally successful in challenging the RBOCs in public utility commission ("PUC") proceedings in several states, including North Carolina (a proceeding that the Company initiated) and Virginia. The PUCs in Florida, Georgia and Tennessee are currently reviewing this issue. Although the Company is not a party to these proceedings, it is considering joining them as an intervening party. The Company is not aware of any current proceedings involving this issue before the South Carolina PUC, the only other state in the Company's current and proposed operating territory. In addition to the various state PUC proceedings, this issue is under general review by the FCC. In August 1997, BellSouth Telecommunications, Inc. ("BellSouth") notified the Company and other CLECs that it would not pay or collect reciprocal compensation under interconnection agreements for traffic terminated to an ESP or an ISP. The Company petitioned the North Carolina PUC to resolve this issue. On February 26, 1998, the North Carolina PUC ruled that the reciprocal compensation provision contained in the interconnection agreement between BellSouth and the Company is fully applicable to traffic terminated to ESP and ISP customers when the originating caller and the called number are associated with the same calling area, and directed BellSouth to bill and pay reciprocal compensation for all such calls. On March 27, 1998, BellSouth filed a motion requesting (i) a stay of the order issued by the NC PUC, (ii) an extension of the period during which BellSouth must file an appeal of the NC PUC order with an intermediate state appeallate court and (iii) permission to deposit the disputed amounts into an interest bearing escrow account under the control of an agent acceptable to both parties. In an order dated March 31, 1998, the NC PUC granted BellSouth's motion, thereby extending the appeal period to April 27, 1998. In addition, under the Telecom Act, BellSouth may be entitled to seek review of the decision of the North Carolina PUC by the United States District Court for the Eastern District of North Carolina. 8 A significant portion of the Company's estimated total revenue for 1998 and 1999 is expected to be derived from reciprocal compensation from BellSouth for traffic terminated on US LEC's network to ESPs and ISPs in North Carolina. If a decision adverse to the Company is issued on any appeal or review of the order of the North Carolina PUC, by the FCC or by one or more PUCs in other southeastern states in which the Company currently operates or plans to operate in the future, the ability of the Company to serve existing and future ESP and ISP customers profitably would be limited, which could have a material adverse affect on US LEC's operating results, financial condition and current strategy. Dependence on Key Personnel The Company's business is managed by a small number of key executive officers, most notably Richard T. Aab, Chairman and Chief Executive Officer, and Tansukh V. Ganatra, President and Chief Operating Officer. The loss of the services of one or more of these key people, particularly Mr. Aab or Mr. Ganatra, could materially and adversely affect US LEC's business and its prospects. None of the Company's executive officers have employment agreements or are subject to noncompetition agreements, and the Company does not maintain key man life insurance on any of its officers. The competition for qualified managers in the telecommunications industry is intense. Accordingly, there can be no assurance that US LEC will be able to hire and retain necessary personnel in the future to replace any of its key executive officers, if any of them were to leave US LEC or be otherwise unable to provide services to US LEC. Reliance on Leased Capacity A key element of US LEC's business and growth strategy is leasing fiber optic transmission capacity instead of constructing its own transport facilities. In implementing this strategy, the Company relies upon its ability to lease capacity from CAPs, other CLECs and ILECs operating in its markets. In order for this strategy to be successful, the Company must be able to negotiate and renew satisfactory agreements with its fiber optic network providers, and the providers must process provisioning requests on a timely basis, maintain their networks in good working order and provide adequate capacity. Although US LEC enters into agreements with its network providers that are intended to ensure access to adequate capacity and timely processing of provisioning requests, (and although US LEC's interconnection agreements with ILECs generally provide that the Company's connection and maintenance orders will receive attention at parity with the ILECs and other CLECs and that adequate capacity will be provided), there can be no assurance that the ILECs and other network providers will comply with their contractual (and, in the case of the ILECs, legally required) network provisioning obligations, or that the provisioning process will be completed for the Company's customers on a timely and otherwise satisfactory basis. Furthermore, there can be no assurance that the rates to be charged to US LEC under future interconnection agreements or lease agreements with other providers will allow the Company to offer usage rates low enough to attract a sufficient number of customers and operate its networks at satisfactory margins. Competition The telecommunications industry is highly competitive. In each of the Company's existing and target markets, the Company competes and will continue to compete principally with the ILECs serving that area. ILECs are established providers of local telephone services to all or virtually all telephone subscribers within their respective service areas. ILECs also have greater financial and personnel resources, brand name recognition and long-standing relationships with regulatory authorities at the federal and state levels. The Company also faces, and expects to continue to face, competition from other current and potential market entrants, including long distance carriers seeking to enter, reenter or expand entry into the local exchange marketplace, and from other CLECs, CAPs, cable television companies, electric utilities, microwave carriers, wireless telephone system operators and private networks built by large end-users. In addition, a continuing trend toward combinations and strategic alliances in the telecommunications industry could give rise to significant new competitors. Many of these current and potential competitors have financial, personnel and other resources, including brand name recognition, substantially greater than those of the Company, as well as other competitive advantages over the Company. The Company also competes with long distance carriers in the provisioning of long distance services. Although the long distance market is dominated by four major competitors, hundreds of other companies also compete in the long distance marketplace. 9 In addition, the regulatory environment in which the Company operates is undergoing significant change. As this regulatory environment evolves, changes may occur which could create greater or unique competitive advantages for all or some of the Company's current or potential competitors, or could make it easier for additional parties to provide services. See "Business -- Competition." Regulation Although passage of the Telecom Act has resulted in increased opportunities for companies that are competing with the ILECs, no assurance can be given that changes in current or future regulations adopted by the FCC or state regulators or other legislative or judicial initiatives relating to the telecommunications industry would not have a material adverse effect on the Company. In addition, although the Telecom Act, as passed, conditions RBOCs' provisioning of in-region long distance service on a showing that the local market has been opened to competition, a United States District Court in Texas has held these portions of the Telecom Act invalid. That decision has been stayed pending appeal, and has been appealed to the United States Court of Appeals for the Fifth Circuit. If the decision is upheld, it could (i) remove the incentive RBOC's presently have to cooperate with companies like US LEC to foster competitition within their service areas so that they can qualify to offer in-region long distance by allowing RBOC's to offer such services immediately and (ii) give the RBOC's the ability to offer "one-stop shopping" for both long distance and local service. The Company cannot yet determine when or how the Court will rule on this appeal. If the decision is reversed, there can be no assurance that these ILECs will negotiate quickly with competitors such as the Company for the required interconnection of the competitor's networks with those of the ILEC or provisioning of services on a timely basis, or that such interconnection agreements will be on terms acceptable to the Company. On May 8, 1997, the FCC released an order establishing a significantly expanded federal telecommunications universal service program which both increased the size of existing subsidies and created new subsidy funds to which the Company may be required to contribute. These funds relate to subsidies for certain services offered in high-cost areas or to low income subscribers, schools, libraries and rural healthcare providers. As of December 31, 1997, the Company was unable to quantify the payments, if any, that it will be required to make for the year. Based upon preliminary guidance provided by the FCC regarding the calculation of these payments, management believes that the amount of any such payments will not be material for 1997. In the May 8 order, the FCC also announced that it will soon revise its rules for subsidizing service provided to consumers in high cost areas. The Company also may be required to contribute to state-established funds. The Telecom Act also governs interconnection, resale of ILEC services by CLECs, lease of unbundled network elements and termination of traffic. On July 18, 1997, the United States Court of Appeals for the Eighth Circuit overturned many of the rules the FCC had established pursuant to the Telecom Act. The Eighth Circuit decision substantially limits the FCC's jurisdiction and expands the state regulators' jurisdiction to set and enforce rules governing the development of local competition. As a result, it is more likely that the rules governing local competition will vary substantially from state to state. Most states, however, have already begun to establish rules for local competition that are consistent with the FCC rules overturned by the Eighth Circuit. If a patchwork of state regulations were to develop, it could increase the Company's costs of regulatory compliance and could make entry into, and conducting business, in some markets more difficult and expensive than in others. The U.S. Supreme Court has decided to review the Eighth Circuit's decision. There can be no assurance as to how or when the U.S. Supreme Court will act on the appeals or that the outcome of the appeals will not have a material adverse effect on the Company. See "Business -- Regulation." Negative Cash Flow and Operating Losses The Company intends to satisfy most of its working capital needs through cash generated from operations. To date, the Company has not generated positive cash flow from its operations on a consolidated basis. Moreover, US LEC's operations have resulted in net losses of $962,663 for the period from inception (June 6, 1996) through December 31, 1996 and approximately $4.7 million for the year ended December 31, 1997. There can be no assurance that the Company will achieve or sustain profitability or generate positive cash flow in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." 10 Future Capital Requirements Implementation of the Company's expansion plans will require significant capital expenditures. The Company's principal capital expenditures relate to the purchase and installation of its switching platform. The Company estimates that the capital expenditures required to fund its expansion plans will approximate $40 million in 1998 and $30 million in 1999. Management expects to satisfy these capital requirements primarily with the net proceeds of this Offering, although there can be no assurance that the actual capital expenditures required to complete the Company's proposed expansion will not exceed such estimated amounts. In addition, the actual amount and timing of the Company's future capital expenditures may differ materially from the Company's estimates as a result of, among other things, the ability of the Company to meet its planned expansion schedule, the number of its customers and the services for which they subscribe and regulatory, technological and competitive developments in the Company's industry. Due to the uncertainty of these factors, actual revenues and costs may vary from expected amounts, possibly to a material degree, and such variations are likely to affect the Company's planned capital expenditures. The Company also will continue to evaluate revenue opportunities in other southeastern markets as well as potential acquisitions and, as and when attractive opportunities develop, the Company may elect to pursue such opportunities. The Company expects to obtain the capital required to pursue such opportunities from credit facilities and other borrowings, the sale of additional equity or debt securities or cash generated from operations. There can be no assurance, however, that the Company would be successful in raising sufficient additional capital on acceptable terms or that the Company's operations would produce sufficient positive cash flow to pursue such opportunities should they arise. Failure to raise and generate sufficient funds or unanticipated increases in capital requirements may require the Company to delay or curtail its expansion plans, which could have a material adverse effect on the Company's growth and its ability to compete in the telecommunications services industry. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." Variability of Quarterly Operating Results As a result of the significant expenses associated with the Company's expansion into new markets, the Company anticipates that its operating results will vary significantly from period to period. Control by Single Stockholder As of the date of this Prospectus, Richard T. Aab beneficially owns or otherwise controls 100% of the outstanding shares of Class B Common Stock representing approximately 97.8% of the Company's total voting power, without giving effect to the Offering, and approximately 94.8% of the Company's total voting power after giving effect to the Offering. In addition, holders of Class B Common Stock are entitled to vote as a separate class to elect two members of the Board of Directors and to vote with the holders of Class A Common Stock for the election of other members of the Board of Directors. As a result, Mr. Aab will be able to control the board and all stockholder decisions and, in general, to determine (without the consent of the Company's other stockholders) the outcome of any corporate transaction or other matter submitted to the stockholders for approval, including mergers, consolidations and the sale of all or substantially all of the Company's assets. Mr. Aab also has the power to prevent or cause a change in control of the Company. See "Security Ownership of Management" and "Description of Capital Stock." Absence of Prior Public Market; Possible Volatility of Stock Price Prior to the Offering, there has been no public market for the Class A Common Stock, and there can be no assurance that an active trading market for the Class A Common Stock will develop or be sustained after the Offering. The initial public offering price of the Class A Common Stock will be determined through negotiations with the representatives of the Underwriters. There can be no assurance that future market prices for the Class A Common Stock will equal or exceed the initial public offering price set forth on the cover page of this Prospectus. The market prices of securities of early stage telecommunications companies similar to the Company have historically been highly volatile. See "Underwriting." Future announcements concerning the Company or its competitors, including quarterly results, technological innovations, services, government legislation or regulation, and general market, economic and political conditions, may have a significant effect on the market price of the Class A Common Stock. 11 Substantial Dilution Purchasers of the Class A Common Stock in the Offering will incur immediate and substantial dilution in net tangible book value per share. As of December 31, 1997, on a pro forma basis, the Company's existing stockholders have paid an average price of $0.78 per share for their shares of Common Stock compared to an assumed initial public offering price of $14.00 per share for shares of Class A Common Stock purchased by investors in the Offering. See "Dilution." Potential Effect on Market Price of Future Sales of Shares Upon completion of the Offering, 26,430,270 shares of Common Stock will be outstanding. Of these shares, the 5,500,000 shares of Class A Common Stock expected to be sold in the Offering will be freely tradable without restriction under the Securities Act of 1933, as amended (the "Securities Act"), except for any such shares which may be acquired by an "affiliate" of the Company as that term is defined in Rule 144 ("Rule 144") under the Securities Act. The remainder of the outstanding shares of Class A Common Stock, and all of the shares of Class B Common Stock outstanding after the Offering, will be "restricted securities" as that term is defined in Rule 144. These shares of Class A Common Stock (and shares of Class A Common Stock acquired upon the conversion of Class B Common Stock by the current holders thereof) will begin to become eligible for sale in the public market after December 31, 1998, subject to the volume, manner of sale and other limitations of Rule 144. The Company, its directors and executive officers, who, as of March 31, 1998, beneficially owned a total of 19,343,270 shares of Common Stock, have agreed not to offer, sell or contract to sell, or otherwise dispose of, directly or indirectly, or announce an offering of, any shares of Class A Common Stock or any securities convertible into, or exchangeable for, shares of Class A Common Stock for a period of 180 days from the date of this Prospectus, without the prior written consent of Smith Barney Inc., except under limited circumstances. See "Underwriting." Promptly after completion of the Offering, the Company intends to file a Registration Statement on Form S-8 with the Commission to register 650,000 shares of Class A Common Stock reserved for issuance or sale under the Stock Plan. No prediction can be made as to the effect, if any, that future sales of shares, or the availability of shares for future sale, will have on the market price of the Class A Common Stock prevailing from time to time. Sales of substantial amounts of Class A Common Stock (including shares issued upon the exercise of outstanding stock options and warrants and conversion of shares of Class B Common Stock), or the perception that such sales could occur, could adversely affect the prevailing market prices of the Class A Common Stock. See "Shares Eligible for Future Sale." Risks Regarding Forward Looking Statements The statements contained in this Prospectus and in associated filings by the Company with the Securities and Exchange Commission (the "Commission") which are not historical facts are "forward-looking statements" (as such term is defined in the Private Securities Litigation Reform Act of 1995). These statements are identified by the use of forward-looking terminology such as "believes," "expects," "may," "will," "should," "estimates" or "anticipates" or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy that involve risks and uncertainties. Management wishes to caution the reader that these forward-looking statements, such as those relating to the Company's plans to enter new markets, its anticipation of revenues from new markets, and statements regarding the development of the Company's businesses, the markets for the Company's services and products, the Company's anticipated capital expenditures, regulatory reform and other statements contained herein regarding matters that are not historical facts, are only predictions. No assurance can be given that the future results covered by the forward-looking statements will be achieved. Such statements are subject to risks, uncertainties and other factors which could cause actual events or results to differ materially from future results indicated, expressed or implied by such forward-looking statements. The most significant of such risks, uncertainties and other factors are discussed under the heading "Risk Factors" beginning on page 7 of this Prospectus, and prospective investors are urged to carefully consider such factors as a result of risks facing the Company. 12 USE OF PROCEEDS The net proceeds to the Company from the sale of the Class A Common Stock in this Offering are estimated to be approximately $70,960,000 ($81,701,500 if the Underwriters' over-allotment option is exercised in full) based on an assumed initial public offering price of $14.00 per share and after deduction of the Underwriters' Discounts and Commissions and estimated expenses payable by the Company. The Company intends to use substantially all of the net proceeds from the Offering for capital expenditures relating to its expansion into new markets. In addition, the Company may use a portion of the proceeds of the Offering for acquisitions, although the Company is not currently involved in any acquisition negotiations. Pending such uses, the net proceeds to the Company will be invested in short-term, investment grade securities. See "Management's Discussion and Analysis of Financial Condition and Results of Operation -- Liquidity and Capital Resources." DIVIDEND POLICY The Company has not paid any cash dividends on its Common Stock. The Company intends to retain future earnings, if any, to finance the operation and expansion of its businesses and, therefore, does not anticipate paying any dividends on the Common Stock in the foreseeable future. DILUTION As of December 31, 1997, the pro forma net tangible book value of the Company was $10,756,805 or $0.51 per share of Common Stock. Pro forma net tangible book value per share represents the Company's net worth divided by 20,930,270 shares of Common Stock outstanding as of December 31, 1997, and reflects the exchange of a $5.0 million note payable to a stockholder for 480,770 shares of Class B Common Stock in February 1998. See "Capitalization." After giving effect to the sale by the Company of 5,500,000 shares of Class A Common Stock pursuant to the Offering (at an assumed initial public offering price of $14.00 per share) and after deducting the Underwriters' Discounts and Commissions and estimated expenses of the Offering, the pro forma as adjusted net tangible book value of the Company at December 31, 1997, was $81,716,805, or $3.09 per share of Common Stock. Such amount represents an immediate increase in pro forma net tangible book value of $2.58 per share of Common Stock to the existing stockholders and an immediate dilution to new investors of $10.91 per share of Common Stock. The following table illustrates the dilution in pro forma net tangible book value per share to new investors: Assumed initial public offering price ........................................... $ 14.00 Pro forma net tangible book value before the Offering .......................... $ 0.51 Increase in pro forma net tangible book value attributable to net proceeds of the Offering ................................................................. 2.58 ------- Pro forma net tangible book value as adjusted for the Offering .................. 3.09 -------- Dilution to new investors ....................................................... $ 10.91 ========
The following table sets forth as of December 31, 1997, on a pro forma as adjusted basis, the difference between the existing holders of Common Stock and the purchasers of shares of Class A Common Stock in the Offering, with respect to the number of shares of Common Stock purchased, the total consideration paid and the average price per share of Common Stock paid (assuming an initial public offering price of $14.00 per share):
Total Shares Purchased Consideration Average ------------------------ -------------------------- Price Number Percent Amount Percent Per Share ------------ --------- -------------- --------- ---------- Existing stockholders ......... 20,930,270 79.2% $16,330,815 17.5% $ 0.78 New investors ................. 5,500,000 20.8 77,000,000 82.5 14.00 ---------- ----- ----------- ----- Total ...................... 26,430,270 100.0% $93,330,815 100.0% ========== ===== =========== =====
The foregoing tables and discussions exclude shares of Class A Common Stock issuable upon the exercise of outstanding warrants and options. See "Management -- Omnibus Stock Plan," "Security Ownership of Management" and "Notes to Consolidated Financial Statements." To the extent that outstanding warrants or options are exercised in the future, there will be further dilution to new investors. 13 CAPITALIZATION The following table sets forth certain information with respect to the cash and cash equivalents and capitalization of the Company as of December 31, 1997. This table should be read in conjunction with the Selected Historical Consolidated Financial and Operating Data and the audited consolidated financial statements and notes thereto of US LEC included elsewhere in this Prospectus. See "Use of Proceeds," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Description of Capital Stock."
As of December 31, 1997 ------------------------------------------------------- Pro Forma Actual Pro Forma (1) As Adjusted (1)(2) --------------- --------------- ------------------- Cash and cash equivalents .......................... $ 3,189,210 $ 3,189,210 $ 74,149,210 ============ ============ ============ Long-term debt (3) ................................. $ 5,000,000 $ -- $ -- ------------ ------------ ------------ Stockholders' equity: Class A Common Stock, $.01 par value, 72,924,728 shares authorized; 3,855,000 shares issued and outstanding, actual; and 9,355,000 shares, as adjusted for the Offering (4)(5) ................ 38,550 38,550 93,550 Class B Common Stock, $.01 par value, 17,075,272 shares authorized; 16,594,500 shares issued and outstanding, actual; and 17,075,270 shares issued and outstanding, pro forma (4) .................. 165,945 170,753 170,753 Additional paid-in capital ....................... 11,173,420 16,168,612 87,073,612 Accumulated deficit .............................. (5,621,110) (5,621,110) (5,621,110) ------------ ------------ ------------ Total stockholders' equity ......................... 5,756,805 10,756,805 81,716,805 ------------ ------------ ------------ Total capitalization ............................... $ 10,756,805 $ 10,756,805 $ 81,716,805 ============ ============ ============
- ---------- (1) Reflects the exchange of a note payable to a stockholder in the amount of $5.0 million for 480,770 shares of Class B Common Stock on February 14, 1998. See "Certain Relationships and Related Transactions" and Note 9 to the Company's consolidated financial statements for the year ended December 31, 1997. (2) Adjusted to reflect the sale of Class A Common Stock offered hereby assuming no exercise of the Underwriters' over-allotment option and after deducting the Underwriters' Discounts and Commissions and estimated expenses of the Offering. (3) Consists of indebtedness to stockholder. See Note 4 to the audited consolidated financial statements. (4) The authorized shares of Class A Common Stock and Class B Common Stock as of December 31, 1997 have been adjusted to reflect an amendment to the Company's Certificate of Incorporation that decreased the authorized Class A Common Stock and increased the authorized Class B Common Stock by 480,770 shares. (5) Issued and outstanding Class A Common Stock excludes (i) 182,800 shares issuable upon the exercise of outstanding options, none of which are vested, (ii) 10,000 shares issuable upon exercise of options to be granted upon completion of the Offering, (iii) 469,000 shares issuable upon the exercise of outstanding and presently exercisable warrants and (iv) 16,594,500 (actual) and 17,075,270 (pro forma) shares issuable upon conversion of outstanding shares of Class B Common Stock. See "Description of Capital Stock." 14 SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA The selected historical consolidated financial data presented below as of December 31, 1996 and 1997, for the period from June 6, 1996 (inception) to December 31, 1996 and for the year ended December 31, 1997 are derived from and qualified by reference to the audited consolidated financial statements and notes thereto of US LEC contained elsewhere in this Prospectus. The Company's consolidated financial statements as of December 31, 1996 and 1997, for the period from June 6, 1996 (inception) to December 31, 1996 and for the year ended December 31, 1997, have been audited by Deloitte & Touche LLP, independent public accountants. The selected historical financial data for each quarter of 1997 have been derived from the unaudited interim consolidated financial statements of the Company. In the opinion of management, the unaudited interim consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments, which consist only of normal recurring adjustments, necessary for a fair presentation of the financial position and the results of operations for these periods. All of the data should be read in conjunction with and are qualified by reference to "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the audited consolidated financial statements and notes thereto of the Company contained elsewhere in this Prospectus.
Period from Quarter Ended June 6, 1996 --------------------------------------------------------------- (Inception) to December 31, March 31, June 30, September 30, December 31, 1996 1997 1997 1997 1997 ---------------- --------------- --------------- --------------- --------------- Statement of Operations Data: Revenue ..................................... $ -- $ 1,141 $ 228,620 $ 1,529,745 $ 4,698,155 Cost of services ............................ -- 423,093 314,828 1,075,183 2,387,897 ------------- ------------ ------------ ------------ ------------- Gross margin ................................ -- (421,952) (86,208) 454,562 2,310,258 Selling, general and administrative ......... 941,743 1,049,130 1,047,940 1,294,115 2,726,152 Depreciation and amortization ............... 4,059 14,046 88,406 124,994 215,468 ------------- ------------ ------------ ------------ ------------- Loss from operations ........................ (945,802) (1,485,128) (1,222,554) (964,547) (631,362) Interest expense, net ....................... 16,861 66,556 108,021 101,326 78,953 ------------- ------------ ------------ ------------ ------------- Net loss .................................... $ (962,663) $ (1,551,684) $ (1,330,575) $ (1,065,873) $ (710,315) ============= ============ ============ ============ ============= Net loss per share .......................... $ (.06) $ (.09) $ (.07) $ (.06) $ (.04) ============= ============ ============ ============ ============= Weighted average shares outstanding ......... 17,310,000 17,310,000 17,832,750 19,075,500 20,239,500 ============= ============ ============ ============ ============= Other Financial Data: Capital expenditures ........................ $ 279,634 $ 1,798,152 $ 634,122 $ 828,903 $ 9,793,930 EBITDA (1) .................................. (941,743) (1,471,082) (1,134,148) (839,553) (415,894) Net cash flow used in operating activities ................................. (1,079,069) (1,043,972) (1,253,840) (1,168,631) (2,127,650) Net cash flow provided by (used in) investing activities ....................... (465,792) (1,598,152) (3,251,162) 1,303,141 (2,405,058) Net cash flow provided by financing activities ................................. 2,271,000 2,400,000 4,848,244 1,335,280 5,424,871 Operating Data: Cumulative Equivalent Access Lines in service (2) ............................. -- 288 4,087 15,504 49,229 MOUs (3) .................................... -- 40,000 8,618,000 69,730,000 393,452,000 Year Ended December 31, 1997 --------------- Statement of Operations Data: Revenue ..................................... $ 6,457,661 Cost of services ............................ 4,201,001 ------------ Gross margin ................................ 2,256,660 Selling, general and administrative ......... 6,117,337 Depreciation and amortization ............... 442,914 ------------ Loss from operations ........................ (4,303,591) Interest expense, net ....................... 354,856 ------------ Net loss .................................... $ (4,658,447) ============ Net loss per share .......................... $ (.25) ============ Weighted average shares outstanding ......... 18,653,308 ============ Other Financial Data: Capital expenditures ........................ $ 13,055,107 EBITDA (1) .................................. (3,860,677) Net cash flow used in operating activities ................................. (5,594,093) Net cash flow provided by (used in) investing activities ....................... (5,951,231) Net cash flow provided by financing activities ................................. 14,008,395 Operating Data: Cumulative Equivalent Access Lines in service (2) ............................. 49,229 MOUs (3) .................................... 471,840,000
As of As of December 31, 1997 December 31, ------------------------------------------------------- 1996 Actual Pro Forma (4) As Adjusted (4)(5) ------------- --------------- --------------- ------------------- Balance Sheet Data: Current assets .................................. $1,067,662 $ 9,654,993 $ 9,654,993 $80,614,993 Working capital (deficiency) .................... 936,884 (2,268,883) (2,268,883) 68,691,117 Property and equipment, net ..................... 276,097 12,889,335 12,889,335 12,889,335 Total assets .................................... 1,466,835 22,680,681 22,680,681 93,640,681 Notes payable--stockholders ..................... 1,671,000 5,000,000 -- -- Total stockholders' equity (deficiency) ......... (334,943) 5,756,805 10,756,805 81,716,805
- ---------- (1) EBITDA consists of net earnings (loss) before interest expense, income taxes, depreciation and amortization. It is a measure commonly used by analysts, investors, and other interested parties in the telecommunications industry and is presented to assist in understanding the Company's operating results. However, 15 EBITDA is not a measurement of financial performance under generally accepted accounting principles and should not be considered an alternative to net income or loss as a measure of performance or to cash flow as a measure of liquidity. EBITDA is not necessarily comparable with similarly titled measures for other companies. (2) As of the end of the period indicated. "Equivalent Access Lines" is a term used by management to quantify the size of the Company's network. For a detailed definition, see Glossary. (3) MOUs indicate the number of local and long distance switched minutes of use carried over the Company's network during the period indicated. (4) Reflects the exchange of a note payable to a stockholder in the amount of $5.0 million for 480,770 shares of Class B Common Stock on February 14, 1998. See "Certain Relationships and Related Transactions" and Note 9 to the Company's consolidated financial statements for the year ended December 31, 1997. (5) Adjusted to reflect the sale of Class A Common Stock offered hereby (based on an assumed initial public offering price of $14.00 per share) assuming no exercise of the Underwriters' over-allotment option and after deducting the Underwriters' Discounts and Commissions and estimated expenses of the Offering. See "Use of Proceeds." 16 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview US LEC is a rapidly growing CLEC that provides switched local, long distance and enhanced telecommunications services primarily to medium and large-sized organizations located in selected markets in the southeastern United States. The Company was founded in June 1996 after passage of the Telecom Act, which enhanced the competitive environment for local exchange services. The Company initiated service in Charlotte, North Carolina in March 1997, becoming one of the first CLECs in North Carolina to provide switched local exchange services, and subsequently initiated service in Raleigh and Greensboro, North Carolina and in Atlanta, Georgia. As of February 28, 1998, the Company had 62,545 Equivalent Access Lines in service. US LEC plans to enter 15 new markets in Tennessee, Florida, South Carolina, Virginia and North Carolina by the end of 1999. Since commencing network operations, US LEC has achieved significant growth in its Equivalent Access Lines in service and in the number of MOUs carried over the Company's network. As indicated in the following table, from March 1997 through February 1998, the Company increased its number of Equivalent Access Lines in service at month-end from 288 to 62,545 and increased its monthly number of MOUs during the same period from approximately 40,000 to approximately 450 million:
1997 ------------------------------------------------------------------------------------- Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec. ------ ------ ------- ------- -------- -------- --------- -------- -------- --------- Cumulative Equivalent Access Lines in Service (1): Charlotte ....................... 288 757 2,204 2,881 4,571 5,157 9,789 10,863 12,824 16,724 Raleigh ......................... -- 168 624 1,206 1,948 3,012 5,715 9,590 13,935 19,017 Greensboro ...................... -- -- -- -- -- -- -- -- 3,168 13,488 Atlanta ......................... -- -- -- -- -- -- -- -- -- -- --- --- ----- ----- ----- ----- ----- ------ ------ ------ Totals ........................ 288 925 2,828 4,087 6,519 8,169 15,504 20,453 29,927 49,229 === === ===== ===== ===== ===== ====== ====== ====== ====== MOUs (in thousands) (2) ......... 40 500 3,118 5,000 16,323 20,024 33,383 54,273 95,542 243,637 === === ===== ===== ====== ====== ====== ====== ====== ======= 1998 ------------------- Jan. Feb. --------- --------- Cumulative Equivalent Access Lines in Service (1): Charlotte ....................... 24,943 27,027 Raleigh ......................... 19,800 20,685 Greensboro ...................... 14,203 14,689 Atlanta ......................... -- 144 ------ ------ Totals ........................ 58,946 62,545 ====== ====== MOUs (in thousands) (2) ......... 446,386 450,000 ======= =======
- ---------- (1) As of the end of the month indicated. "Equivalent Access Lines" is a term used by management to quantify the size of the Company's network. For a detailed description of the manner in which the Company determines its Equivalent Access Lines, see the definition of this term in the Glossary included as an Annex hereto. (2) MOUs indicate the number of local and long distance switched minutes of use carried over the Company's network during the month indicated. The Company's existing North Carolina operations generated positive EBITDA of $200,264 during the month of December 1997, ten months after the Company first initiated service in Charlotte. While EBITDA does not represent cash flow or results of operations in accordance with generally accepted accounting principles, it is a measure of financial performance commonly used in the telecommunications industry. Management expects the Company to achieve similar operating results in each of its new markets within a comparable time frame. Management attributes US LEC's ability to achieve this performance primarily to two factors. First, the Company's capital-efficient network strategy eliminates the lengthly "build-out" period usually required to construct a fiber optic transmission network, permitting the Company to quickly enter new markets and rapidly generate revenue and positive cash flow. Second, US LEC's telecommunications-intensive customers typically transmit a large amount of switched traffic over the Company's network, resulting in efficient network utilization and attractive operating margins. See "Risk Factors -- Limited Operating History," " -- Risks Associated With Implementation of Growth Strategy" and " -- Negative Cash Flow and Operating Losses." Factors Affecting Future Operations Revenue. The Company's revenue is comprised of monthly recurring charges, usage charges, and initial, non-recurring charges. Monthly recurring charges include the fees paid by customers for lines in service and additional features on those lines. Monthly recurring charges are derived only from end user customers. Usage charges consist of fees paid by end users for each call made, fees paid by the ILEC as reciprocal compensation (which results from US LEC terminating calls made by ILEC customers), and access charges paid by carriers 17 for long distance traffic originated and terminated by US LEC. Usage charges are derived from both end user customers and from other carriers. Initial non-recurring charges are paid by end users, if applicable, for the installation of service by the Company. See "Risk Factors -- Regulation." A majority of the Company's revenue currently consists of reciprocal compensation. This is the result of an imbalance of inbound and outbound traffic due to the preponderance of inbound applications utilized by the Company's customers. Specifically, the Company's customers have been generating an increasing number of inbound MOUs as the demand for Internet services continues to grow. Reciprocal compensation and carrier access invoices are sent monthly to the appropriate ILECs and long distance carriers according to standard industry practices and in standard industry formats. During 1997, BellSouth disputed that portion of the reciprocal compensation charges billed to it which it believed was related to Internet access services. Due to uncertainty regarding the outcome of this dispute, the Company has deferred $1,141,386 of revenue as of December 31, 1997. See "Risk Factors -- Uncertainties Related to Reciprocal Compensation" and "Business -- Regulation." Cost of Services. Cost of services is currently comprised primarily of leased transport charges and, to a lesser extent, reciprocal compensation related to calls that originate with a US LEC customer and terminate on the network of the ILEC or another CLEC. The Company's leased transport charges are the lease payments incurred by US LEC for the fiber optic transmission facilities used to connect the Company's customers to its switch and to connect to the ILEC and other CLEC networks. The Company's strategy of leasing rather than building its own fiber transport facilities results in the Company's cost of services being a significant component of total costs. In addition, the Company has to date been successful in negotiating lease agreements which generally match the duration of its customer contracts, thereby allowing the Company to avoid the risk of continuing expenses associated with transmission facilities that are not being used by revenue generating customers. While the majority of the Company's cost of services is comprised of leased transport charges, management expects that over time outbound traffic and other usage sensitive charges will become the major component of cost of services as the Company begins to carry more of its customers' outbound calls. Selling, General and Administrative Expenses. The Company's selling, general and administrative expenses include selling and marketing costs, customer service, billing, corporate administration, personnel and network maintenance. Management expects the Company to incur significant selling and marketing costs as it continues to expand its operations, a significant amount of which will be incurred in a particular market before the switch becomes operational and begins to generate revenue. Consequently, selling and marketing expenses are expected to increase as a percentage of revenue until implementation of the Company's expansion plan is substantially complete. US LEC will incur other costs and expenses, including the costs associated with the maintenance of its networks, administrative overhead, office leases and bad debts. Management expects that these costs will grow significantly as the Company expands its operations and that administrative overhead will be a large portion of these expenses during the start-up phase in each of the Company's new markets. However, management expects these expenses to become smaller as a percentage of the Company's revenue as the Company increases its customer base. Results of Operations Although US LEC began operations on June 6, 1996, it did not generate revenue in 1996, and, accordingly, any comparison of operating results between 1996 and 1997 would not be meaningful. Year Ended December 31, 1997. During the year ended December 31, 1997, the Company generated $6,457,661 of revenue. Cost of services totaled $4,201,001 and selling, general and administrative expenses during the period were $6,117,337. Cost of services consisted primarily of leased transport and usage based charges. Selling, general and administrative expenses were largely comprised of payroll, selling and marketing costs, rents and professional fees. Depreciation and amortization expense during the period was $442,914, resulting primarily from network assets placed in service in the Company's operational markets. Net interest expense for the year ended December 31, 1997 was $354,856, as interest incurred on the Company's borrowings exceeded interest earned on 18 investments. The Company's net loss for the year ended December 31, 1997 totaled $4,658,447. This was primarily due to the incurrence of operating expenses prior to realizing any significant revenue, since the Company was developing its markets during the year. Period from June 6, 1996 (Inception) to December 31, 1996. During the period ended December 31, 1996, the Company did not generate operating revenue. Selling, general and administrative expenses were $941,743 resulting primarily from payroll costs. The Company's net loss for the period ended December 31, 1996 was $962,663, resulting from operating expenses incurred for the initial development of the Company's business. Liquidity and Capital Resources The competitive telecommunications services business is capital intensive. The Company's existing operations have required and will continue to require substantial capital expenditures for the purchase and installation of network switches and related electronic equipment in order to provide switch-based local exchange and long distance services in its markets, and will continue to require cash to fund operating losses during the start-up phase of each market. Specifically, the Company estimates that the cash required to fund capital expenditures for its expansion plans will approximate $40 million and $30 million in 1998 and 1999, respectively. When the Company enters a new market, the majority of its capital expenditures are related to acquiring and installing the Lucent 5ESS(R)-2000 switch and paying the associated site preparation costs (including air conditioning, power supply, backup generators and fire suppression). Once the Company begins selling services on a particular switch, there are incremental capital expenditures associated with expanding the switch, primarily in the form of additional cards. These expenditures are "success-based" in that they are incurred only in response to customer orders, thereby ensuring a high level of utilization of the Company's network infrastructure. The Company's capital expenditure requirements over the next two years could change materially if the Company places in service significantly more or significantly fewer access lines than it currently anticipates. In each fiscal quarter since its inception, the Company has generated negative EBITDA and incurred net losses, although the Company's North Carolina operations generated positive EBITDA of $200,264 during the month of December 1997. Management attributes the rapid generation of positive EBITDA in these markets primarily to the Company's switch-based, leased transport network strategy. Management expects that the Company will generate positive EBITDA on a consolidated basis in the first quarter of 1998 and that positive cash flow from existing markets will be greater than the operating losses incurred from initiating service in new markets thereafter. However, there can be no assurance that the Company will realize positive consolidated EBITDA or cash flow in this or future periods. Until sufficient cash flow is generated, the Company will continue to rely on financing activities for its cash requirements. Management expects its available cash, including the net proceeds from the Offering and operating cash flow, will be sufficient to fund its capital expenditures and working capital requirements through 1999, although there can be no assurance that the amount of funds required to complete the Company's expansion plans through the end of 1999 will not exceed its currently estimated expenditures. See "Risk Factors -- Negative Cash Flow and Operating Losses" and " -- Future Capital Requirements." To date, the Company has funded its capital and liquidity requirements with approximately $11.3 million in cash equity investments by Messrs. Aab and Ganatra, certain other executive officers and private investors. In addition, Mr. Aab, Melrich Associates, L.P. (an entity of which Mr. Aab is a general partner) and Mr. Ganatra have loaned the Company $8.3 million, of which approximately $5.0 million was advanced in 1996 and 1997 and approximately $3.3 million was advanced in January 1998. These loans are secured by substantially all of the assets of the Company's operating subsidiaries in North Carolina and Georgia which, as of December 31, 1997, represented substantially all of the Company's assets. On February 14, 1998, Mr. Aab exchanged $5.0 million of these loans for 480,770 shares of Class B Common Stock. The balance of the loans mature on January 16, 2003, subject to possible acceleration in the event of a change in control of the Company, and bear interest, payable quarterly, at an annual rate of 12%. As of December 31, 1997, the Company had cash and cash equivalents of approximately $3.2 million and $74.1 million on a pro forma basis after giving effect to the Offering. The Company will continue to evaluate revenue opportunities in other southeastern markets as well as potential acquisitions, and as attractive opportunities emerge, the Company may elect to pursue such opportunities. The Company expects to obtain the capital required to pursue such opportunities from credit facilities and other borrowings, the sale of additional equity or debt securities or cash generated from operations. There can be no assurance, however, that the Company would be successful in raising sufficient additional capital on acceptable terms or that the Company's operations would 19 produce sufficient positive cash flow to pursue such opportunities should they arise. Failure to raise and generate sufficient funds or unanticipated increases in capital requirements may require the Company to delay or curtail its expansion plans, which could have a material adverse effect on the Company's growth and its ability to compete in the telecommunications services industry. BUSINESS General US LEC is a rapidly growing CLEC that provides switched local, long distance and enhanced telecommunications services primarily to medium and large-sized organizations located in selected markets in the southeastern United States. The Company was founded in June 1996 after passage of the Telecom Act, which enhanced the competitive environment for local exchange services. The Company initiated service in Charlotte, North Carolina in March 1997, becoming one of the first CLECs in North Carolina to provide switched local exchange services, and subsequently initiated service in Raleigh and Greensboro, North Carolina and in Atlanta, Georgia. As of February 28, 1998, the Company had 62,545 Equivalent Access Lines in service. US LEC plans to enter 15 new markets in Tennessee, Florida, South Carolina, Virginia and North Carolina by the end of 1999. Market Opportunity According to FCC statistics, total revenue from local exchange services in the United States was approximately $101 billion in 1996. Two years after the Telecom Act established a competitive framework for local competition, more than 100 CLECs have raised approximately $14 billion in capital and have signed 2,400 interconnection agreements. Although CLECs as a whole tripled their customer lines in service in 1997 to 1.5 million, CLECs currently account for only 2.6% of all local telephone revenues. After completing its planned expansion, US LEC will operate in 19 markets located in six contiguous states in the southeastern United States -- one of the fastest growing regional markets for business telecommunications services in the country. Based on the Company's Market Study, in the four markets presently served by the Company there were approximately 1.4 million business lines in the four markets presently served by the Company that generated approximately $2.1 billion in local exchange and long distance revenues in 1996. The Market Study indicates that the 19 markets in which management expects the Company to be operating by the end of 1999 had a total of approximately 4.1 million business lines that generated approximately $5.7 billion in local exchange and long distance revenues in 1996. These local and long distance revenue figures do not include revenues associated with enhanced services and carrier access fees, which US LEC is pursuing as part of its business plan. The table below sets forth certain information from the Market Study regarding the markets in which US LEC currently operates and the markets it plans to enter by the end of 1999. 20
1996 Market Data ------------------------------------------------------- Revenue ($) (millions) Number of --------------------------------------- Launch Period Business Lines Local Long Distance Total ------------------ ---------------- ------- --------------- -------- (thousands) Current Markets: Charlotte, NC ................... March 1997 203 119 186 305 Raleigh, NC ..................... April 1997 196 115 180 295 Greensboro, NC .................. October 1997 138 81 127 208 Atlanta, GA ..................... February 1998 847 497 777 1,274 --- --- --- ----- Subtotal ....................... 1,384 812 1,270 2,082 Planned Markets: Tennessee Memphis ......................... 2nd Quarter 1998 192 102 160 262 Knoxville ....................... 2nd Quarter 1998 72 39 60 99 Nashville ....................... 2nd Quarter 1998 155 83 129 212 Florida Orlando ......................... 3rd Quarter 1998 355 170 266 436 Miami ........................... 3rd Quarter 1998 482 219 343 562 Tampa ........................... 4th Quarter 1998 421 208 325 533 Ft. Lauderdale .................. 4th Quarter 1998 329 150 234 384 Jacksonville .................... 1st Quarter 1999 187 85 133 218 South Carolina Charleston/Myrtle Beach ......... 1st Quarter 1999 90 59 93 152 Greenville/Spartanburg .......... 1st Quarter 1999 96 62 97 159 Columbia ........................ 3rd Quarter 1999 95 62 96 158 Virginia Richmond ........................ 2nd Quarter 1999 154 91 142 233 Roanoke ......................... 2nd Quarter 1999 46 27 42 69 North Carolina Wilmington ...................... 3rd Quarter 1999 35 21 32 53 Asheville ....................... 4th Quarter 1999 29 17 27 44 ----- --- ----- ----- Subtotal ....................... 2,738 1,395 2,179 3,574 ----- ----- ----- ----- Total ........................ 4,122 2,207 3,449 5,656 ===== ===== ===== =====
Business Strategy US LEC's objective is to become the primary provider of switched local telecommunications services to its existing and target customers. The principal elements of US LEC's strategy include: o Deploy a Capital-Efficient Network. Management believes that US LEC is one of the first CLECs to utilize a strategy of purchasing and deploying switching equipment in each target market and leasing the required fiber optic transmission capacity from CAPs, other CLECs and ILECs. Management believes the Company's switch-based, leased-transport strategy enables it to enter markets and generate revenue and positive cash flow more rapidly than if the Company first constructed its own transmission facilities. This strategy also reduces the up-front capital expenditures required to enter new markets and avoids the risk of "stranded" investment in under-utilized fiber networks. Management also believes that the Company's ability to align its leased transmission costs with customer orders permits a higher return on invested capital. o Focus on a Southeastern Cluster of Operations. After completing its planned expansion, the Company will operate in 19 markets located in six contiguous states in the southeastern United States -- one of the fastest growing regional markets for business telecommunications services in the country. Within the Southeast, the Company has selected its target markets based on a number of considerations, including the number of potential customers and other competitors in such markets and the presence of multiple transmission facility suppliers. Management believes that the Company's clustered network will enable it to take advantage of regional 21 calling patterns and capture an increasing portion of customer traffic on its network. Management also believes that by originating and terminating calls on its network, the Company can achieve significant cost savings and potential pricing advantages over its competition. o Target Telecommunications-Intensive Customers. The Company focuses its primary sales efforts on telecommunications-intensive organizations with at least 100 access lines, including businesses, government agencies, other telecommunications companies and VARs. The volume of usage generated by the Company's target customers allows the Company to efficiently concentrate the telecommunications traffic of its customers on one or more leased T-1 lines. In addition, the Company frequently is able to sell enhanced and long distance services to complement its core local services. This further enhances network utilization and thereby improves margins, as fixed network costs are spread over a larger base of MOUs. o Install a Robust, Uniform Technology Platform. The Company has chosen the 5ESS(R)-2000 digital switch manufactured by Lucent to provide a consistent technology platform throughout its network. The Lucent switch enables the Company to provide both local and long distance services from a single platform. This uniform and advanced switching platform will enable the Company to (i) deploy features and functions quickly throughout its entire network, (ii) expand switch capacity in a cost effective manner, (iii) lower maintenance costs through reduced training and spare part requirements and (iv) achieve direct connectivity to cellular and personal communication system applications in the future. o Employ a Direct Sales Force with Extensive Local Market Experience. Management believes that the Company's success in a particular market is enhanced by employing a direct sales force with extensive local market and telecommunications sales experience. The Company employed this strategy in building its existing sales forces in North Carolina and Georgia and intends to continue implementing this strategy in other markets. Salespeople with experience in a particular market provide the Company with extensive knowledge of the Company's target customer base and in many cases already have existing relationships with target customers. The experience and relationships of these salespeople enable them to pre-sell the Company's products and services prior to initiating network operations in a particular market. o Implement Efficient Provisioning Processes. Management believes that a critical aspect of the success of a CLEC is timely and effective provisioning systems, which includes the process of transitioning ILEC customers to the Company's network. The Company focuses on implementing effective and timely provisioning practices in each of its markets to rapidly and efficiently transition customers from the ILEC to the Company without disruption of the customer's operations. Management believes that these practices provide the Company with a long-term competitive advantage and enable it to implement services in its markets rapidly and to shorten the time between receipt of the customer order and the generation of revenue. US LEC's Network After completing its planned expansion, the Company will operate in 19 markets located in six contiguous states in the southeastern United States -- one of the fastest growing regional markets for business telecommunications services in the country. Within the Southeast, the Company has selected its target markets based on a number of considerations, including the number of potential customers and other competitors in such markets and the presence of multiple transmission facility suppliers. Management believes that the Company's clustered network will enable it to take advantage of regional calling patterns and capture an increasing portion of customer traffic on its network. Management also believes that by originating and terminating calls on its network, the Company can achieve significant cost savings and potential pricing advantages over its competition. US LEC purchases and deploys switching equipment and leases fiber optic transmission capacity from CAPS, other CLECs and ILECs. Management believes that this switch-based, leased-transport strategy provides the Company with significant competitive advantages. By owning its switches, the Company is able to better configure its network to provide cost-effective and customized solutions for its customers' telecommunications needs. By leasing transmission capacity, the Company is able to (i) reduce the up-front capital expenditures required to enter new markets, (ii) avoid the risk of "stranded" investment in under-utilized fiber networks and (iii) enter markets and generate revenue and positive cash flow more rapidly than if the Company constructed its own transmission facilities. Management believes that the availability of several suppliers of fiber optic transmission facilities in each of the Company's markets provides US LEC with negotiating leverage, vendor diversity and the ability to offer customers enhanced reliability at a competitive price. 22 US LEC provides its customers with inbound and outbound telecommunications services over its switch-based, leased-transport network. Calls originating with a US LEC customer are transported over leased lines to the US LEC switch and can either be terminated directly on the Company's network or they can be routed to a long distance carrier, the ILEC or another CLEC, depending on the location of the call recipient. Similarly, calls originating from the public switched telephone network and destined for a US LEC customer are routed through the US LEC switch and delivered to call recipients via leased transmission facilities. A diagram of the Company's typical network layout is presented in the following figure: (Graphic appears here with the following information: Off-Net Customer Lead Transport From ILEC On-Net Customer SONET Ring Fiber Transport Leased From CAP US LEC logo ILEC Central Office ILEC Access Tandem IXC Public Switched Telephone Network 23 Uniform Technology Platform. The Company is implementing a consistent technology platform based on the Lucent 5ESS(R)-2000 digital switch throughout its network. Unlike traditional long distance or local switches deployed by many of the Company's competitors, the Lucent switch enables the Company to provide local and long distance services from a single platform. This uniform and advanced switch platform enables the Company to (i) deploy features and functions quickly in all of its networks, (ii) expand switch capacity in a cost effective manner and (iii) lower maintenance costs through reduced training and spare parts requirements. In addition, the scalability and capacity of the Lucent switches enable the Company to accommodate the increased volume of on-net traffic that is anticipated to result from the Company's clustered network strategy and will facilitate direct connectivity to cellular and personal communication system applications in the future. Leasing of Transmission Capacity. As part of its capital efficient network structure, the Company's transmission facilities are leased from CAPs, other CLECs and ILECs. In general, US LEC seeks to lease fiber optic transmission facilities from multiple sources in each of its current and target markets. Management believes that this type of broad coverage of the markets in which it operates results in the following advantages: o an increased number of buildings that can be directly connected to the Company's switching network, which should maximize the number of customers to which the Company can offer its services; o a higher volume of telecommunications traffic both originating and terminating on the Company's network, which should result in improved operating margins; o enhanced reliability at competitive prices; o the ability to leverage its investment in high capacity switching equipment and electronics; and o the opportunity for the Company's network to provide backhaul carriage for other telecommunications service providers, such as long distance and wireless carriers. Interconnection. The Company has executed interconnection agreements for all of its current operating networks: in North Carolina, with BellSouth (which expires in November 1998), GTE (which expires in March 1999) and Sprint (which expires in October 1999), and in Georgia, with BellSouth (which expires in November 1998). The agreement with BellSouth covers all states within BellSouth's operating territory. The Company is currently negotiating interconnection agreements with GTE and Sprint for Florida. Furthermore, the Company is currently negotiating a new interconnection agreement with BellSouth, which will have a term of three years. In addition, the Company believes that interconnection arrangements between the ILECs and other CLECs or the Company will be in place in other markets that the Company may enter. Interconnection agreements between the Company (or other CLECs) and ILECs are subject to approval of the relevant PUC, and under the terms of the Telecom Act, each ILEC which is subject to the Telecom Act is required to negotiate an interconnection agreement with the Company (and with other CLECs). See "Business -- Regulation." Where an interconnection agreement cannot be reached on terms and conditions satisfactory to the Company, the Company may pursue binding arbitration of any disputes before the state utility commissions as provided under the Telecom Act. There can be no assurance, however, that the Company will be able to negotiate interconnection agreements on terms and conditions satisfactory to the Company or to renew existing interconnection agreements as they expire. However, a decision by the United States Court of Appeals for the Eighth Circuit vacating several of the FCC's rules creates uncertainty about the rules governing pricing, terms and conditions of interconnection agreements. As a result of this decision, which has been appealed to the Supreme Court, and a pending review of this issue by the FCC, negotiation and enforcement of such agreements could become more difficult and protracted, and renegotiation of existing agreements could be required. Products and Services The Company's products and services are designed to appeal to the sophisticated telecommunications needs of its target customers. Local Services. The Company provides local dial-tone services to customers, which allows them to complete calls in a free calling area and to access a long distance calling area. Local services and long distance services can be bundled together using the same transport facility. The Company's network is designed to allow a 24 customer to easily increase or decrease capacity and alter enhanced services as the telecommunications requirements of the business change. In addition to its core local services, the Company also provides access to third party directory assistance and operator services. Long Distance Services. US LEC provides domestic and international long distance services for completing intrastate, interstate and international calls. Long distance service is offered as an additional service to the Company's local exchange customers. Long distance calls which do not terminate on the Company's network are passed to long distance carriers which route the remaining portion of the call. The Company's ability to integrate local and long distance services allows it to aggregate customers' monthly recurring, local usage and long distance charges on a single, consolidated invoice. Enhanced Services. In addition to providing typical enhanced services such as voicemail, call transfer and conference calling, US LEC offers additional value-added enhanced services to complement its core local and long distance services. These enhanced service offerings include: o Access to Internet Services -- Enables customers to use their available capacity for access to ISPs. o Data Networking Services -- The Company can provide high-speed, broadband services to use for data and internet access such as Integrated Services Digital Network (ISDN) and Primary Rate Interface (PRI). o Specialized Application Services -- The Company can create products and services that are tailored for target industries with special telecommunications needs such as the hospitality industry. These services typically include non-measured rate local calling, expanded local calling area, discounted long distance rates and tailored trunking configurations. Sales and Marketing Sales. US LEC is building a highly motivated and experienced direct sales force. The Company recruits salespeople with strong sales backgrounds in its existing and target markets, including salespeople from long distance companies, telecommunications equipment manufacturers, network systems integrators and ILECs. The Company expanded its sales force from four salespeople at December 31, 1996 to 23 salespeople at December 31, 1997, and management expects to further increase the Company's sales force to over 100 salespeople by the end of 1998. The Company plans to continue to attract and retain highly qualified salespeople by offering them an opportunity to work with an experienced management team in an entreprenurial environment and to participate in the potential economic rewards made available through a results-oriented compensation program that emphasizes sales commissions. During the months prior to initiating service in a new market, the Company's salespeople begin pre-selling the Company's services to target customers. This pre-selling effort is designed to shorten the period between the availability of service and the receipt of a customer order and to generate customers in each market who may enter into service agreements before the local US LEC network becomes operational. The Company also retains an independent sales agent to identify ISPs and other potential users of the Company's services. If one of these potential users becomes a US LEC customer, the Company pays the sales agent a commission based on the reciprocal compensation that US LEC receives from traffic terminated to that customer. Marketing. In its existing markets, US LEC seeks to position itself as a high quality alternative to ILECs for local telecommunication services by offering network reliability and superior customer support at competitive prices. The Company intends to build its reputation and brand identity by working closely with its customers to develop services tailored to their particular needs and by implementing targeted advertising and promotional efforts, which will be gradually expanding to mass media. Customer Service. Management believes that the Company's ability to provide superior customer service is a key factor in acquiring new customers and reducing churn of existing customers. The Company has developed a customer service strategy that is designed to effectively meet the service requirements of its target customers. The principal salesperson for each customer provides the first line of customer service by identifying and resolving any customer concerns. An account development representative is assigned to each customer to supervise all 25 aspects of customer relations, including account collections and complaint resolution, and to provide a single point of contact for all customer service issues. The Company also employs a staff of locally-based customer service representatives who efficiently provide real time problem identification and resolution and superior customer service. Billing. US LEC outsources the preparation of customer bills, which are available in a variety of formats that can be tailored to a customer's specific needs. For example, the Company can provide account codes that enable a customer to track expenses by employee, department or division. Codes also can be used to restrict calling by individuals to help the customer manage costs. The Company plans to implement an internal computerized billing system during the second quarter of 1998 that is expected to enhance flexibility and reduce costs associated with the billing function. Regulation The following summary of regulatory developments and legislation does not purport to describe all present and proposed federal, state and local regulations and legislation affecting the telecommunications industry. Other existing federal and state legislation and regulations are currently the subject of judicial proceedings, legislative hearings and administrative proposals which could change, in varying degrees, the manner in which this industry operates. Neither the outcome of these proceedings, nor their impact upon the telecommunications industry or the Company, can be predicted at this time. This section also sets forth a brief description of regulatory and tariff issues pertaining to the operation of the Company. Overview. The Company's services are subject to varying degrees of federal, state and local regulation. The FCC generally exercises jurisdiction over the facilities of, and services offered by, telecommunications common carriers that provide interstate or international communications. The state regulatory commissions retain jurisdiction over the same facilities and services to the extent they are used to provide intrastate communications. Federal Legislation. The Company must comply with the requirements of common carriage under the Communications Act of 1934, as amended (the "Communications Act"). The Telecom Act, enacted on February 8, 1996, substantially revised the Communications Act. The Telecom Act establishes a regulatory framework for the introduction of local competition throughout the United States and is intended to reduce unnecessary regulation to the greatest extent possible. Among other things, the Telecom Act preempts, after notice and an opportunity for comment, any state or local government from prohibiting any entity from providing telecommunications service. This provision invalidated prohibitions on entry found in almost half of the states in the country at the time the Telecom Act was passed. The Telecom Act also establishes a dual federal-state regulatory scheme for eliminating other barriers to competition faced by competitors to the ILECs and other new entrants into the local telephone market. Specifically, the Telecom Act imposes on ILECs certain interconnection obligations, some of which are to be implemented by FCC regulations. The Telecom Act contemplates that states will apply the federal regulations and oversee the implementation of all aspects of interconnection not subject to FCC jurisdiction as they oversee interconnection negotiations between ILECs and their new competitors. The FCC has significant responsibility in the manner in which the Telecom Act will be implemented especially in the areas of universal service, access charges and price caps. The details of the rules adopted by the FCC will have a significant effect in determining the extent to which barriers to competition in local services are removed, as well as the time frame within which such barriers are eliminated. The state PUCs have an even more significant responsibility in implementing the Telecom Act. Specifically, the states have authority to establish interconnection pricing, including unbundled loop charges, reciprocal compensation and wholesale pricing. The states are also charged under the Telecom Act with overseeing the arbitration process for resolving interconnection negotiation disputes between CLECs and the ILECs and must approve interconnection agreements. See " -- BellSouth North Carolina PUC Proceeding" for a discussion of the Company's action before the North Carolina PUC related to its interconnection agreement with BellSouth. The Telecom Act imposes on ILECs certain interconnection obligations that, taken together, grant competitive entrants such as the Company what is commonly referred to as "co-carrier status." It is anticipated that co-carrier status and the preemption of state and local prohibitions on entry could permit the Company to become a full service provider of switched telecommunications services anywhere in the United States. The following 26 table summarizes the interconnection rights granted by the Telecom Act that are most important to the achievement of the Company's goals and the Company's belief as to the anticipated effect of the new requirements, if implemented in the manner in which the Company believes Congress intended. There can be no assurance that these statutory provisions will be implemented in this fashion due to the currently-pending appeals of the FCC's implementing rules and court decisions regarding those rules.
Issue Definition Anticipated Effect - -------------------- ----------------------------------------------- --------------------------------------------- Interconnection Efficient network interconnection, through Allows a CLEC to service and terminate calls physical or virtual co-location or purchase to and from customers connected to other of network elements to transfer calls back networks and forth between ILECs and competitive networks (including 911, 0 +, directory assis- tance, etc.) Local Loop Allows competitors to selectively gain access Reduces the capital and operating costs of a Unbundling to ILEC wires which connect ILEC central CLEC to serve customers not directly con- offices with customer premises or CLEC's nected to its networks central office (if applicable) Reciprocal Mandates payment for local traffic exchanges Enables CLECs to recover cost of terminat- Compensation between ILECs and competitors ing ILEC-originated traffic Number Portability Allows customers to change local carriers Allows customers to switch to a CLEC's local without changing numbers; true portability service without changing phone numbers allows incoming calls to be routed directly to a competitor. Interim portability allows incoming calls to be routed through the ILEC to a competitor at the economic equivalent of true portability Dialing Parity Allows customers to access CLEC without Allows customers to access CLEC on same dialing access codes basis as ILEC Access to Phone Mandates assignment of new telephone num- Allows CLECs to provide telephone num- Numbers bers to competitive telecommunications pro- bers to new customers on the same basis as vider's customers on non-discriminatory terms the ILEC Resale ILECs must establish wholesale rates for the Promotes resale activities by CLECs services they offer at retail
The Company expects to receive a significant portion of its initial revenue in a given market from the ILEC in the form of reciprocal compensation payments due to the Company's ESP and ISP customers receiving more calls than they make. Several ILECs have challenged the applicability of the reciprocal compensation scheme to ISP traffic. For a discussion see " -- State Regulation" and " -- BellSouth North Carolina PUC Proceeding." Certain of the obligations in the table above, including the obligations to establish number portability, dialing parity and reciprocal compensation arrangements, and to provide non-discriminatory access to telephone poles, ducts, conduits and rights-of-way also apply to CLECs, including the Company. As a result of the Telecom Act's applicability to other telecommunications carriers, it may provide the Company with the ability to reduce its own interconnection costs by interconnecting directly with non-ILECs, but may also cause the Company to incur additional administrative and regulatory expenses in responding to interconnection requests. At the same time, the Telecom Act also makes competitive entry into other service or geographic markets more attractive to RBOCs, other ILECs, long distance carriers and other companies and likely will increase the level of competition the Company faces. In addition, the Telecom Act, as passed, provided that ILECs that are subsidiaries of RBOCs could not offer in-region, long distance services across LATAs until they had demonstrated that (i) they have entered into an 27 approved interconnection agreement with a facilities-based CLEC or that no such CLEC has requested interconnection as of a statutorily determined deadline, (ii) they have satisfied a 14-element checklist designed to ensure that the ILEC is offering access and interconnection to all local exchange carriers on competitive terms and (iii) the FCC has determined that in-region, inter-LATA approval is consistent with the public interest, convenience and necessity. Recently, a U.S. District Court ruled that these RBOC-specific provisions were unconstitutional. See " -- U.S. District Court Decision." Federal Regulation and Related Proceedings. The Telecom Act gives the FCC the authority to forebear from regulating companies if it finds such regulation does not serve the public interest, and directs the FCC to review its regulations for continued relevance on a regular basis. As a result of this directive, a number of the regulations that historically applied to CLECs have been and may continue to be eliminated in the future. While it is therefore expected that a number of regulations that were developed prior to the Telecom Act will be eliminated in time, those which apply to the Company at present are discussed below. Pursuant to its authority to forebear, the FCC has adopted orders eliminating tariff filing requirements for non-dominant carriers providing interstate access and domestic interstate long distance services. However, on February 13, 1997, the United States Court of Appeals for the District of Columbia granted motions for stay of the FCC order detariffing domestic interstate long distance service pending judicial review of that order. The result of this stay is that carriers must continue to file tariffs for interstate long distance services. Tariff filing requirements remain in place for international traffic. US LEC has filed federal interstate long distance, interstate access and international tariffs. In addition to its forbearance activities, the FCC also has proposed reducing the level of regulation that applies to the ILECs, and increasing their ability to respond quickly to competition from the Company and others. For example, in accordance with the Telecom Act, the FCC has applied "streamlined" tariff regulation to the ILECs, which greatly accelerates the time prior to which changes to tariffed service rates may take effect, and has eliminated the requirement that ILECs obtain FCC authorization before constructing new domestic facilities. These actions will allow ILECs to change service rates more quickly in response to competition. Similarly, the FCC has proposed affording significant new pricing flexibility to ILECs subject to price cap regulation. To the extent such increased pricing flexibility is provided, the Company's ability to compete with ILECs for certain service may be adversely affected. In addition, a U.S. District Court in Texas recently invalidated certain provisions of the Telecom Act which prohibited the RBOCs from engaging in certain manufacturing and marketing activities and conditioned RBOC provision of in-region long distance service upon a demonstration that the local market had been opened to competition. This decision has been stayed, and has been appealed to the United States Court of Appeals for the Fifth Circuit. See " -- U.S. District Court Decision." The FCC has taken several actions related to the assignment of telephone numbers, first in July 1995 mandating the responsibility for administering and assigning local telephone numbers be transferred from the RBOCs and a few other ILECs to a neutral entity, and second in July 1996 adopting a regulatory structure under which a wide range of number portability issues would be resolved. In March 1997, the FCC affirmed its number portability rules, but it extended slightly certain deadlines for the implementation of true number portability. The FCC plans to establish cost recovery rules for long-term number portability. On August 8, 1996, the FCC issued an order containing rules providing guidance to the ILECs, CLECs, long distance companies and state PUCs regarding several provisions of the Telecom Act. The rules include, among other things, FCC guidance on: (i) discounts for end-to-end resale of ILEC retail local exchange services (which the FCC has suggested should be in the range of 17%-25%); (ii) availability of unbundled local loops and other unbundled ILEC network elements; (iii) the use of Total Element Long Run Incremental Costs in the pricing of these unbundled network elements; (iv) average default proxy prices for unbundled local loops in each state; (v) mutual compensation proxy rates for termination of ILEC/CLEC local calls; and (vi) the ability of CLECs and other interconnectors to opt into portions of previously-approved interconnection agreements negotiated by the ILECs with other parties on a most favored nation (or a "pick and choose") basis. See " -- Eighth Circuit Court of Appeals Decision" for a discussion of the Eighth Circuit Court of Appeals decision invalidating several pertinent aspects of this August 8 order. On May 8, 1997, the FCC released an order establishing a significantly expanded federal universal service program which subsidized certain eligible services. For example, the FCC established new subsidies for services provided to qualifying schools and libraries with an annual cap of $2.25 billion and for services provided to rural 28 health care providers with an annual cap of $400 million. The FCC also expanded the federal subsidies to low-income consumers and consumers in high-cost areas. Providers of interstate telecommunications service, such as the Company, as well as certain other entities, must pay for these programs. The Company's share of the schools, libraries and rural health care funds will be based on its share of the total industry telecommunications service and certain defined telecommunications end user revenues. The Company's share of all other federal subsidy funds will be based on its share of the total interstate telecommunications service and certain defined telecommunications end user revenues. As of December 31, 1997, the Company was unable to quantify the payments, if any, that it will be required to make for the year. Based upon preliminary guidance provided by the FCC regarding the calculation of these payments, management believes that the amount of any such payments will not be material for 1997. In the May 8 order, the FCC also announced that it will soon revise its rules for subsidizing service provided to consumers in high cost areas. Several parties have appealed the May 8 order. Such appeals have been consolidated and transferred to the United States Court of Appeals for the Fifth Circuit where they are currently pending. In addition, on July 3, 1997, several ILECs filed a petition for stay of the May 8 order with the FCC. That petition is also pending. In a combined Report and Order and Notice of Proposed Rulemaking released on December 24, 1996, the FCC made changes and proposed further changes in the interstate access charge structure. In the Report and Order, the FCC removed restrictions on an ILEC's ability to lower access prices and relaxed the regulation of new switched access services in those markets where there are other providers of access services. If this increased pricing flexibility is not effectively monitored by federal regulators, it could have a material adverse effect on the Company's ability to compete in providing interstate access services. On May 16, 1997, the FCC released an order revising its access charge rate structure. The new rules substantially increase the costs that ILECs subject to the FCC's price cap rules ("price cap LECs") recover through monthly, non-traffic sensitive access charges and substantially decrease the costs that price cap LECs recover through traffic sensitive access charges. In the May 16 order, the FCC also announced its plan to bring interstate access rate levels more in line with cost. The plan will include rules to be established sometime this year that grant price cap LECs increased pricing flexibility upon demonstrations of increased competition (or potential competition) in relevant markets. The manner in which the FCC implements this approach to lowering access charge levels will have a material effect on the Company's ability to compete in providing interstate access services. Several parties have appealed the May 16 order. Those appeals have been consolidated and transferred to the United States Court of Appeals for the Eighth Circuit where they are currently pending. As part of its overall plan to lower interstate access rates, the FCC also released an order on May 21, 1997, in which the FCC revised its price cap rules. In the May 21 order, the FCC increased the so-called X-Factor (the percentage by which price cap LECs must lower their interstate access charges every year, net of inflation and exogenous cost increases) and made it uniform for all price cap LECs. The results of these rule changes will be both a one-time overall reduction in price cap ILEC interstate access charges and an increase in the rate at which those charges will be reduced in the future. Several parties have appealed the May 21 order. Those appeals were consolidated and transferred to the United States Court of Appeals for the Tenth Circuit. They have been subsequently transferred to the United States Court of Appeals for the District of Columbia where they are currently pending. The Company anticipates that the FCC will initiate a number of additional proceedings, of its own volition and as a result of requests from CLECs and others, as a result of the Telecom Act. While the Eighth Circuit's decision in the appeal of the August 8, 1996 order limits the FCC's jurisdiction over the local competition provisions of the Telecom Act and while the decision of the U.S. District Court for the Northern District of Texas has held that the RBOC-specific provisions of the Telecom Act are unconstitutional and this issue has been raised in other proceedings (see above and below), such proceedings may nonetheless further define and construe the Telecom Act's terms. The FCC also requires carriers to file periodic reports concerning carriers interstate circuits and deployment of network facilities. The FCC generally does not exercise direct oversight over cost justification and the level of charges for services of non-dominant carriers, although it has the power to do so. The FCC also imposes prior approval requirements on transfers of control and assignments of operating authorizations. The FCC has the authority to generally condition, modify, cancel, terminate, or revoke operating authority for failure to comply with federal laws or rules, regulations and policies of the FCC. Fines or other penalties also may be imposed for 29 such violations. There can be no assurance that the FCC or third parties will not raise issues with regard to the Company's compliance with applicable laws and regulations. Eighth Circuit Court of Appeals Decision. Various parties, including ILECs and state PUCs, requested that the FCC reconsider its own rules and/or filed appeals of the FCC's August 8, 1996 order in various U.S. Courts of Appeal. Also, several parties petitioned the FCC and the courts to stay the effectiveness of the FCC's rules included in the FCC's order, pending a ruling on the appeals. The appeals were consolidated and transferred to the U.S. Court of Appeals for the Eighth Circuit. On July 18, 1997, the Eighth Circuit overturned the pricing rules established in the August 8, 1996 order, except those applicable to commercial mobile radio service providers. The Eighth Circuit held that, in general, the FCC does not have jurisdiction over prices for interconnection, resale, leased unbundled network elements and traffic termination. The Eighth Circuit also overturned the FCC's "pick and choose" rules as well as certain other FCC rules implementing the Telecom Act's local competition provisions. In addition, the Eighth Circuit decision substantially limits the FCC's authority to enforce the local competition provisions of the Telecom Act. The FCC and others have appealed the Eight Circuit decision to the U.S. Supreme Court, and the U.S. Supreme Court granted certiorari on January 26, 1998. In the short term, management believes that the Eighth Circuit decision will not have a material adverse effect on the Company, because it already has interconnection agreements in place, or expects to have such agreements in place, under the provisions of the FCC's order and the Telecom Act which were not invalidated by the Court. The decision does not delay the implementation of the Telecom Act by the parties and by the state PUCs, but rather eliminates the guidance on pricing and most favored nation procedures as well as other issues that the FCC sought to provide to the parties and the state PUCs. However, since the Eighth Circuit decision creates uncertainty about the rules governing pricing, terms and conditions of interconnection agreements, it could make negotiation and enforcement of such agreements more difficult and protracted, and may require renegotiation of existing agreements. In the long term, the Eighth Circuit's decision makes it more likely that the rules governing local competition will vary from state to state. Most states have already begun to establish rules for local competition that are consistent with the FCC rules overturned by the Eighth Circuit. If a patchwork of state regulations were to develop, it could increase the Company's costs of regulatory compliance and could make competitive entry in some markets more difficult and expensive than in others. U.S. District Court Decision. On July 2, 1997, SBC and its local exchange carrier subsidiaries filed a lawsuit in the United States District Court for the Northern District of Texas challenging on U.S. Constitutional grounds the Telecom Act restrictions applicable to the RBOCs only. The plaintiffs in the case sought both a declaratory judgment and an injunction against the enforcement of the challenged provisions. On December 31, 1997, this U.S. District Court ruled that Sections 271-275 of the Telecom Act were unconstitutional on the grounds that these sections constituted a "bill of attainder." Based on this U.S. District Court ruling, the RBOCs that are parties to this proceeding could technically re-enter the inter-LATA long distance market immediately. The FCC and long distance carriers requested a stay of the decision, which has been granted. The decision of the U.S. District Court has been appealed to the U.S. Court of Appeals for the Fifth Circuit, and the resulting decision could be appealed to the U.S. Supreme Court. In addition, BellSouth has appealed to the U.S. Court of Appeals for the D.C. Circuit the FCC's prior decisions denying BellSouth's applications to provide in-region long distance service in South Carolina and Louisiana. BellSouth challenged the decisions on the same grounds on which SBC challenged Sections 271-275 of the Telecom Act. On January 14, 1998, the North Carolina PUC gave BellSouth approval to file with the FCC to provide long distance services in North Carolina, provided it first improves its operating support systems and performance measures. 30 State Regulation. The Company is certified by the appropriate state PUCs as follows:
State Order Dated Telecommunication Services - ----------------- -------------------- -------------------------------------------------------------------- North Carolina September 27, 1996 local exchange, exchange access, and intrastate interexchange long distance Georgia August 5, 1997/ local exchange (interim) and long distance (interim) and intrastate February 3, 1998 interexchange alternate operator services (interim) Virginia September 8, 1997 intrastate local exchange and exchange access, no certification required for long distance Tennessee September 18, 1997 local exchange, exchange access and interexchange South Carolina November 10, 1997 resale and facilities-based local exchange, exchange access and intrastate interexchange Florida December 22, 1997 local exchange and long distance
These are all of the states in which the Company operates or currently intends to begin operations in 1998 or 1999. To the extent that an area within a state in which the Company operates is served by a small (in line counts) or rural ILEC not currently subject to competition, the Company may not have authority to service those areas at this time. Most states regulate entry into local exchange and other intrastate service markets, and states' regulation of CLECs vary in their regulatory intensity. The majority of these states mandate that companies seeking to provide local exchange and other intrastate services apply for and obtain the requisite authorization from a PUC. This authorization process generally requires the carrier to demonstrate that it has sufficient financial, technical, and managerial capabilities and that granting the authorization will serve the public interest. As a CLEC, the Company is subject to the regulatory directives of each state in which the Company is certified. In addition to tariff filing requirements (described in greater detail below), most states require that CLECs charge just and reasonable rates and not discriminate among similarly situated customers. Some states also require the filing of periodic reports, the payment of various regulatory fees and surcharges, and compliance with service standards and consumer protection rules. States also often require prior approvals or notifications for certain transfers of assets, customers, or ownership of a CLEC. States generally retain the right to sanction a carrier or to revoke certifications if a carrier violates relevant laws and/or regulations. In all of the states where US LEC is certified, the Company is required to file tariffs or price lists setting forth the terms, conditions and/or prices for services which are classified as intrastate. In some states, the Company's tariff may list a range of prices or a ceiling price for particular services, and in others, such prices can be set on an individual customer basis, although the Company may be required to file tariff addenda of the contract terms. The Company is not subject to price cap or to rate of return regulation in any state in which it currently provides services. As noted above, the states have the primary regulatory role over intrastate services under the Telecom Act. The Telecom Act allows state regulatory authorities to continue to impose competitively neutral and nondiscriminitory requirements designed to promote universal service, protect the public safety and welfare, maintain the quality of service and safeguard the rights of consumers. State PUCs will implement and enforce most of the Telecom Act's local competition provisions, including those governing the specific charges for local network interconnection. In some states, those charges are being determined by generic cost proceedings and in other states they are being established through arbitration proceedings. BellSouth North Carolina PUC Proceeding. The Company has petitioned the North Carolina Utilities Commission ("NC PUC") to resolve a dispute between the Company and BellSouth related to their interconnection agreement, dated November 29, 1996 and approved in North Carolina by the NC PUC by an order dated January 29, 1997 (effective November 20, 1996). In August 1997, BellSouth issued a memorandum to the Company in which BellSouth announced its unilateral decision to neither bill nor pay reciprocal charges for traffic terminated by a CLEC or BellSouth to ESPs including ISPs. The Company believes this memorandum was sent to all CLECs who have an interconnection agreement with BellSouth. BellSouth based its announcement on the theory that such traffic is not "local," and therefore not subject to reciprocal compensation. On October 24, 1997, the Company filed a petition with the NC PUC seeking an order which, among other things, would direct BellSouth to pay reciprocal compensation for all local traffic terminated on the Company's network, including traffic terminated by US LEC to its customers which are ESPs or ISPs. The petition, among other things, also 31 noted that similar positions recently had been taken by other RBOCs in other states; that disputes between those RBOCs and the CLECs regarding ESP and ISP traffic had been the subject of arbitration and/or complaint proceedings in at least eight states; and that, as of the date of the petition, the respective PUCs in all eight states had ordered the payment of reciprocal compensation for traffic terminated by the CLEC to ESPs and ISPs. As of February 13, 1998, twelve states (including Virginia) have ordered the payment by an RBOC of reciprocal compensation for traffic terminated by a CLEC to an ESP or ISP. The FCC is also generally considering the issue of reciprocal compensation to ISPs/ESPs, and the Eighth Circuit is considering an appeal of the FCC's decision not to impose access charges on ISPs. There can be no assurance that the payment of reciprocal compensation for ISP traffic will be maintained. A determination that such traffic is not subject to reciprocal compensation would have a material adverse effect on the Company. On February 26, 1998, the North Carolina PUC ruled that the reciprocal compensation provision contained in the interconnection agreement between BellSouth and the Company is fully applicable to traffic terminated to ESP and ISP customers when the originating caller and the called number are associated with the same calling area, and directed BellSouth to bill and pay reciprocal compensation for all such calls. On March 27, 1998, BellSouth filed a motion requesting (i) a stay of the order issued by the NC PUC, (ii) an extension of the period during which BellSouth must file an appeal of the NC PUC order with an intermediate state appeallate court and (iii) permission to deposit the disputed amounts into an interest bearing escrow account under the control of an agent acceptable to both parties. In an order dated March 31, 1998, the NC PUC granted BellSouth's motion, thereby extending the appeal period to April 27, 1998. In addition, under the Telecom Act, BellSouth may be entitled to seek review of the decision of the North Carolina PUC by the United States District Court for the Eastern District of North Carolina. While the Company believes that it will ultimately be successful on any appeal or review of this proceeding, there can be no assurances in this regard, and it is possible that an adverse result could occur if an appeal or other review is sought. A final determination that such traffic is not eligible for reciprocal compensation would have a material adverse effect on the Company. In addition to this proceeding, PUCs in Tennessee, Georgia and Florida are currently reviewing this issue. See "Risk Factors -- Uncertainties Related to Reciprocal Compensation." Competition As noted above, the regulatory environment in which the Company operates is changing rapidly. The passage of the Telecom Act combined with other actions by the FCC and state regulatory authorities continues to promote competition in the provision of telecommunications services. ILECs. In each market served by its networks, the Company faces, and expects to continue to face, significant competition from the ILECs, which currently dominate their local telecommunications markets. The Company competes with the ILECs in its markets for local exchange services on the basis of product offerings, reliability, state-of-the-art technology, price, route diversity, ease of ordering and customer service. However, the ILECs have long-standing relationships with their customers and provide those customers with various transmission and switching services that the Company, in a few cases, does not currently offer. In addition, ILECs enjoy a competitive advantage due to their vast financial resources. The Company has sought, and will continue to seek, to achieve parity with the ILECs in order to become able to provide a full range of local telecommunications services. See "Business -- Regulation" for additional information concerning the regulatory environment in which the Company operates. Because US LEC leases fiber optic transmission capacity to link its customers with its networks, and uses state-of-the-art technology in its switch platforms, the Company may have cost and service quality advantages over some currently available ILEC networks. Other Competitors. The Company also faces, and expects to continue to face, competition from other potential competitors in certain of the markets in which the Company offers its services. In addition to the ILECs and CAPs, potential competitors capable of offering switched local and long distance services include long distance carriers, cable television companies, electric utilities, microwave carriers, wireless telephone system operators and private networks built by large end-users. Many of these potential competitors enjoy competitive advantages based upon existing relationships with subscribers and vast financial resources. The Company believes that the Telecom Act as well as a recent series of completed and proposed transactions between ILECs and long distance companies and cable companies increase the likelihood that barriers to 32 local exchange competition will be removed. The Telecom Act, as passed, conditioned the provision of in-region, inter-LATA services by RBOCs upon a demonstration that the market in which an RBOC seeks to provide such services has been opened to competition. When ILECs that are RBOC subsidiaries are permitted to provide such services, they will be in a position to offer single source service. ILECs that are not RBOC subsidiaries may offer single source service presently. As a result of a U.S. District Court's invalidation of Sections 271-275 of the Telcom Act, RBOCs that were parties to that proceeding also may have this ability presently. In addition, BellSouth has appealed the FCC's prior decision denying BellSouth's application to provide in-region long distance service in South Carolina. BellSouth challenged the decision on the same basis used by SBC to invalidate Sections 271-275 of the Telecom Act. See "Business -- Regulation -- U.S. District Court Decision." A continuing trend toward business combinations and alliances in the telecommunications industry may create significant new competitors to the Company. In addition, many of the Company's existing and potential competitors have financial, personnel and other resources, including brand name recognition, significantly greater than those of the Company. The Company also competes with long distance carriers in the provision of long distance services. Although the long distance market is dominated by four major competitors, hundreds of other companies also compete in the long distance marketplace. Properties The Company leases all of its administrative and sales offices and its switch sites. The various leases expire in years ranging from 2000 to 2003. All have renewal options. Additional office space and switch sites will be leased or otherwise acquired as the Company's operations and networks are expanded and as new networks are constructed. Employees As of December 31, 1997, the Company employed 78 people. The Company expects to employ approximately 270 people by the end of 1998. The Company considers its employee relations to be good. None of the employees of the Company is covered by a collective bargaining agreement. Servicemarks, Trademarks and Trade Names The Company uses "US LEC" as its primary servicemark and has developed a proprietary logo. In October 1996, the Company filed for federal servicemark and trademark protection of US LEC and its logo. The application for the servicemark "US LEC" has matured to federal registration on the supplemental register. The servicemark application for the logo has matured to registration on the principal register. Legal Proceedings The Company is not currently a party to any legal proceedings, other than the NC PUC proceeding relating to reciprocal compensation from BellSouth for ISP and ESP traffic. See "Business -- Regulation -- BellSouth North Carolina PUC Proceeding." 33 MANAGEMENT Directors and Executive Officers The following table sets forth certain information regarding the executive officers and directors of US LEC. Directors of the Company are elected annually at the annual meeting of stockholders. The backgrounds and business experience of the Company's executive officers and directors are described following the table.
Name Age Position - ---------------------------- ----- --------------------------------------------------------- Richard T. Aab 48 Chairman, Chief Executive Officer and Director (Class B Director) Tansukh V. Ganatra 54 President, Chief Operating Officer and Director (Class B Director) David N. Vail 41 Executive Vice President -- Finance and Chief Financial Officer David C. Conner 40 Executive Vice President -- Engineering and Operations Gary D. Grefrath 56 Executive Vice President -- Administration Michael K. Simmons 39 Executive Vice President -- Sales Craig K. Simpson 34 Senior Vice President -- Corporate Development David M. Flaum * 45 Director (Class A Director) Steven L. Schoonover * 52 Director (Class A Director)
- ---------- * Indicates a member of the Audit Committee. Richard T. Aab co-founded US LEC in June 1996 and has served as its Chairman and Chief Executive Officer and as a Director since that time. In 1982, he co-founded ACC Corp., which is a publicly-traded international telecommunications company currently under agreement to be acquired by Teleport Communications Group, Inc. for approximately $1.1 billion. Between 1982 and 1997, Mr. Aab held various positions with ACC Corp. including Chairman, Chief Executive Officer and Director. Under Mr. Aab's leadership, ACC Corp. participated in the introduction of competition into local and long distance telecommunications markets in the United States, Canada and the United Kingdom. Tansukh V. Ganatra co-founded US LEC in June 1996 and has served as its President and Chief Operating Officer and as a Director since that time. Mr. Ganatra is a specialist in the field of intelligent switching technology and transport network systems. From 1987 to 1997, Mr. Ganatra held various positions with ACC Corp., including serving as its President and Chief Operating Officer. Prior to joining ACC Corp., Mr. Ganatra held various positions during a 19-year career with Rochester Telephone Corp. (now Frontier Corp.), culminating with the position of Director of Network Engineering. David N. Vail has been US LEC's Executive Vice President -- Finance and Chief Financial Officer since August 1997. Prior to joining US LEC, Mr. Vail served as the controller for Harris Beach & Wilcox LLP, a multi-state law firm based in Rochester, New York, from 1986 to May 1997. From 1984 to 1986, Mr. Vail served as Controller for Voit Corporation, a publicly-traded sporting goods manufacturer. Prior to his tenure with Voit Corporation, Mr. Vail spent six years in public accounting with Naramore, Niles and Company, CPAs and Deloitte & Touche LLP. Mr. Vail is a Certified Public Accountant. David C. Conner has been US LEC's Executive Vice President -- Engineering and Operations since November 1996. From 1990 until he joined US LEC, Mr. Conner served in various positions with ACC Corp. including Vice President of Engineering and Operations for one of its cellular operations and Operations Director for its long distance operations in the United Kingdom. From May 1985 until October 1990, Mr. Conner served in various positions with Rochester Telephone Corp. (now Frontier Corp.), including several positions in operations and management information systems. At Rochester Telephone Corp., Mr. Conner had significant responsibility in the development of operational support systems, the development and operation of its network control center and the coordination of installation and repair of facilities. Gary D. Grefrath has been US LEC's Executive Vice President -- Administration since August 1996. Prior to joining US LEC, Mr. Grefrath was employed by Rochester Telephone Corp. (now Frontier Corp.) since 1969, 34 where he held various positions and most recently was responsible for management of major areas of administration for that company. He was also responsible for the preparation of tariff filings with the State of New York and the FCC and for all service and contractual relations with interexchange carriers. Michael K. Simmons has been US LEC's Executive Vice President -- Sales since October 1996. Prior to joining US LEC, Mr. Simmons was employed by Time Warner Communications from December 1993 to October 1996 as its Vice President and General Manager of western North Carolina operations. From August 1983 to December 1993, Mr. Simmons was branch manager for MCI Communications Corp's. ("MCI") western North Carolina region and also held various sales, marketing and management positions in four states. Craig K. Simpson joined US LEC in February 1997 as its Vice President -- Marketing, was promoted to Senior Vice President -- Corporate Development in August 1997 and has since served in this capacity. Prior to joining US LEC, Mr. Simpson was employed by MCI from 1989 to February 1997, where he most recently served as carrier manager for its North Carolina operations. In that capacity, Mr. Simpson was responsible for sales to interexchange carriers, CLECs and independent telephone companies. From 1985 to 1988, Mr. Simpson was employed by Unisys Corporation in its computer mainframe sales and marketing division. Steven L. Schoonover was elected to US LEC's Board of Directors in January 1998. Mr. Schoonover is President and Chief Executive Officer of CellXion, Inc., which specializes in construction, installation and management of cellular telephone and personal communications systems. From 1990 until its sale in November 1997 to Telephone Data Systems, Inc., Mr. Schoonover served as President of Blue Ridge Cellular, Inc., a full-service cellular telephone company. From 1983 to 1996, he served in various positions, including President and Chief Executive Officer, with Fibrebond Corporation, a firm involved in site development, shelter and tower construction for the cellular telecommunications industry. David M. Flaum was elected to US LEC's Board of Directors in January 1998. Mr. Flaum has served as President of Flaum Management Company, Inc. ("Flaum Management"), a real estate development firm based in Rochester, New York, since 1985, and President of The Hague Corporation, a commercial real estate management firm, since 1993. Flaum Management is active in the development of retail centers, office buildings and high technology facilities in the eastern United States. Election of Directors The Company's Bylaws provide that the Board of Directors shall consist of at least three members and no more than eleven members. Pursuant to the Company's Certificate of Incorporation, so long as there are any shares of Class B Common Stock outstanding, holders of Class B Common Stock will have the right to elect two members to the Company's Board of Directors. In addition, the holders of Class A Common Stock and Class B Common Stock vote together as one class for the election of the other members of the Company's Board of Directors. 35 Executive Compensation The following table sets forth, for the year ended December 31, 1997, individual compensation information for the Chairman and Chief Executive Officer, the President and Chief Operating Officer and each of the other executive officers of US LEC who received compensation in excess of $100,000 during the year (the "Named Executive Officers"). SUMMARY COMPENSATION TABLE
Annual Compensation ----------------------------------------------- Other Annual All Other Name and Principal Position Year Salary ($) Bonus ($) Compensation ($) Compensation ($) (1) - -------------------------------------- ------ ------------ ----------- ------------------ --------------------- Richard T. Aab Chairman and Chief Executive Officer .................. 1997 -- -- -- -- Tansukh V. Ganatra President and Chief Operating Officer .................. 1997 6,750 -- 7,968 (2) 423 Michael K. Simmons Executive Vice President -- Sales .............................. 1997 129,459 37,500 -- 423 Gary D. Grefrath Executive Vice President -- Administration ..................... 1997 81,012 25,000 -- 264 David C. Conner Executive Vice President -- Engineering and Operations ......... 1997 79,785 25,000 -- 260
- ---------- (1) Consists of premiums paid by the Company for term life insurance for the Named Executive Officer. (2) Consists of automobile lease payments. The Board of Directors has determined that base salaries for the Company's executive officers for 1998 will be as follows: Mr. Aab -- $160,000; Mr. Ganatra -- $150,000; Mr. Simmons -- $125,000; Mr. Grefrath -- $95,000; Mr. Conner -- $95,000; Mr. Vail -- $95,000; and Mr. Simpson -- $90,000. See "Certain Relationships and Related Transactions." Compensation of Directors Following completion of the Offering, US LEC intends to pay its directors who are not officers or employees ("Outside Directors") an annual retainer of $5,000 and a fee of $1,000 for each meeting of the Board of Directors and $500 for each meeting of any committee thereof attended. The Company also will reimburse each director for reasonable out-of-pocket expenses incurred in attending meetings of the Board of Directors and any of its committees. Immediately upon completion of the Offering, each of the Company's two Outside Directors will be granted nonqualified stock options under the Stock Plan covering 5,000 shares of Class A Common Stock with an exercise price equal to the initial public offering price of the Class A Common Stock. Omnibus Stock Plan The Company adopted the US LEC Corp. 1998 Omnibus Stock Plan in January 1998 (the "Stock Plan"). The Stock Plan is intended to enable the Company to recruit, reward, retain and motivate employees and to attract and retain outside directors, agents and consultants on a basis competitive with industry practices. The Company has reserved 650,000 shares of Class A Common Stock for issuance under the Stock Plan. The Stock Plan will be administered by the Board of Directors or the Compensation Committee of the Board of Directors (such committee or the Board of Directors itself, as applicable, is hereinafter referred to as the "Committee"). Awards under the Stock Plan may include, but are not limited to, stock options, stock appreciation rights, restricted stock, performance awards, or other stock-based awards, such as stock units, securities convertible into stock, phantom securities and dividend equivalents. The Committee has sole authority and discretion under the Stock Plan to (i) designate eligible participants and (ii) determine the types of awards to be 36 granted and the conditions and limitations applicable to such awards, if any, including the acceleration of vesting or exercise rights upon a Change in Control of the Company (as defined in the Stock Plan). The awards may be granted singly or together with other awards, or as replacement of, in combination with, or as alternatives to, grants or rights under the Stock Plan or other employee benefit plans of US LEC. Awards under the Stock Plan may be issued based on past performance, as an incentive for future efforts or contingent upon the future performance of the Company. Options granted under the Stock Plan must be exercised within the period fixed by the Committee, which may not exceed 10 years from the date of the option grant, or in the case of incentive stock options granted to any 10% stockholder, five years from the date of the option grant. Options may be made exercisable in whole or in installments, as determined by the Committee. Except as authorized by the Committee, options will not be transferable other than by will or the laws of descent and distribution and, during the lifetime of an optionee, may be exercised only by the optionee. The option price will be determined by the Committee. However, the option price for incentive stock options may not be less than the market value of the Class A Common Stock on the date of grant of the option and the option price for incentive stock options granted to any 10% stockholder may not be less than 110% of the market value of the Class A Common Stock on the date of grant. Unless otherwise designated by the Committee as "incentive stock options" intended to qualify under Section 422 of the Internal Revenue Code of 1986, as amended, options granted under the Stock Plan are intended to be "nonqualified stock options." The Committee has granted incentive stock options covering 182,800 shares of Class A Common Stock to substantially all employees of the Company who are not executive officers. These options vest annually in four equal installments beginning in the first quarter of 1999 and the exercise price is $10.00 per share. Immediately upon completion of the Offering, the Committee intends to grant nonqualified stock options covering 5,000 shares of Class A Common Stock to each of the Company's two Outside Directors at an exercise price equal to the initial public offering price of the Class A Common Stock. Promptly after completion of the Offering, the Company intends to register the shares of Class A Common Stock reserved for issuance under the Stock Plan under the Securities Act. See "Shares Eligible for Future Sale." CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS At January 31, 1998, the Company's indebtedness to Messrs. Aab and Ganatra, and Melrich Associates, L.P. ("Melrich"), an entity of which Mr. Aab is a general partner, was $8,289,150. The borrowings were allocated as follows: Mr. Aab ($5,000,000), Mr. Ganatra ($1,000,000) and Melrich ($2,289,150). On February 14, 1998, the entire principal amount of the loan payable to Mr. Aab was exchanged for 480,770 shares of Class B Common Stock. The terms of the loans outstanding to Mr. Ganatra and Melrich currently provide for interest at an annual rate of 12% per annum, payable quarterly and a due date of January 16, 2003. The Company's operating subsidiaries in North Carolina and Georgia have guaranteed the payment of the loans and granted to Mr. Ganatra and Melrich a security interest in substantially all of such subsidiaries' assets. Management believes that the terms of these loan transactions were no less favorable to the Company than could be arranged with unrelated lenders. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." Under a consulting agreement between US LEC and a limited liability company owned in its entirety by Mr. Aab, the limited liability company provided strategic, financial planning and other consulting services to US LEC in 1997 for a fee $125,000. Under a consulting agreement with a limited partnership controlled by Mr. Ganatra, the limited partnership provided general business and operations advice to the Company in exchange for a fee of $50,000. These agreements were terminated on December 31, 1997. Management believes that the terms of these consulting agreements were no less favorable to the Company than could have been arranged with unrelated third parties. In January 1998, the Company agreed to purchase a Carrier Access Billing System and related software and support systems from Global Vista Communications, LLC ("Global") for $397,500. Mr. Aab owns a 44% equity interest in Global, but does not control the company and is not active in its management. Management believes that the quality and pricing of these systems were comparable to systems available from unrelated vendors. 37 SECURITY OWNERSHIP OF MANAGEMENT As of March 31, 1998, there were 53 holders of record of the Common Stock. The following table sets forth certain information with respect to the beneficial ownership of shares of Common Stock as of March 31, 1998 and as adjusted to reflect the sale of shares of Class A Common Stock in the Offering, by (i) each director of the Company, (ii) each of the Named Executive Officers, (iii) each person known by the Company to beneficially own 5% or more of the outstanding shares of any class of Common Stock and (iv) all directors and executive officers of US LEC as a group.
Prior to the Offering (1) ---------------------------------------- Amount and Percent of Percent of Name and Address Title of Nature of Percent Total Shares Total Voting of Beneficial Owner Class Ownership (2) of Class Outstanding Power - ----------------------------------------- ---------- ------------------- ---------- -------------- -------------- Richard T. Aab .......................... Class B 17,075,270(3) 100.0% 81.6% 97.8% Joyce M. Aab ............................ Class B 4,309,500(3) 25.2% 20.6% 24.7% Tansukh V. Ganatra ...................... Class B 4,044,000(4) 23.7% 19.3% 23.2% David C. Conner ......................... Class A 660,000(5) 17.1% 3.2% * Gary D. Grefrath ........................ Class A 504,000 13.1% 2.4% * Michael K. Simmons ...................... Class A 567,000(6) 14.7% 2.7% * David N. Vail ........................... Class A 183,000(7) 4.6% * * David M. Flaum .......................... Class A 180,000 4.7% * * Steven L. Schoonover .................... Class A -- -- -- -- Craig K. Simpson ........................ Class A 174,000(8) 4.3% * * All directors and executive officers as a group (9 persons) ...................... Class A 2,268,000 54.2% 10.7% 1.3% Class B 17,075,270 100.0% 81.6% 97.8% After the Offering (1) --------------------------------------- Percent of Percent of Name and Address Percent Total Shares Total Voting of Beneficial Owner of Class Outstanding Power - ----------------------------------------- ---------- -------------- ------------- Richard T. Aab .......................... 100.0% 64.6% 94.8% Joyce M. Aab ............................ 25.2% 16.3% 23.9% Tansukh V. Ganatra ...................... 23.7% 15.3% 22.5% David C. Conner ......................... 7.1% 2.5% * Gary D. Grefrath ........................ 5.4% 1.9% * Michael K. Simmons ...................... 6.1% 2.1% * David N. Vail ........................... 1.9% * * David M. Flaum .......................... 1.9% * * Steven L. Schoonover .................... -- -- -- Craig K. Simpson ........................ 1.8% * * All directors and executive officers as a group (9 persons) ...................... 23.4% 8.5% 1.3% 100.0% 64.6% 94.8%
- ---------- (1) An "*" indicates less than one percent. (2) In accordance with Commission rules, each beneficial owner's holdings have been calculated assuming full exercise of outstanding warrants and options exercisable by such holder within 60 days after March 31, 1998, but no exercise of outstanding warrants and options held by any other person. The table set forth above assumes that the over-allotment option is not exercised by the Underwriters. Except as otherwise indicated, each person named in this table has sole voting and dispositive power with respect to the shares of Common Stock beneficially owned by such person. (3) Includes 4,309,500 shares held by Melrich. Mr. Aab and his wife, Joyce M. Aab, are the sole general partners of Melrich and share voting and dispositive power with respect to these shares. Also includes 4,044,000 shares held by Mr. Ganatra and Super STAR Limited Partnership as to which Mr. Aab holds voting power. Mr. and Mrs. Aab's address is 212 South Tryon Street, Suite 1540, Charlotte, NC 28281. (4) Includes 3,750,000 shares held by Super STAR Associates Limited Partnership. Mr. Ganatra, the majority general partner, has dispositive power with respect to these shares. Mr. Ganatra's address is 212 South Tryon Street, Suite 1540, Charlotte, NC 28281. (5) Includes 165,000 shares owned by Mr. Conner's wife, as to which he is deemed to share voting and dispositive power. (6) Includes 247,500 shares held by Michael K. Simmons Family Limited Partnership as to which Mr. Simmons, the sole general partner, has voting and dispositive power. (7) Includes 165,000 shares subject to a presently exercisable warrant held by Mr. Vail. (8) Includes 165,000 shares subject to a presently exercisable warrant held by Mr. Simpson. 38 DESCRIPTION OF CAPITAL STOCK General The authorized capital stock of the Company consists of: (i) 90,000,000 shares of common stock, $.01 par value per share (the "Common Stock"), which is divided into two classes consisting of 72,924,728 shares of Class A Common Stock (3,855,000 shares of which were outstanding as of the date of this Prospectus) and 17,075,272 shares of Class B Common Stock (17,075,270 shares of which were outstanding as of the date of this Prospectus); and (ii) 10,000,000 shares of preferred stock, $.01 par value per share (the "Preferred Stock"), none of which are issued and outstanding. Effective upon completion of the Offering, 9,355,000 shares of Class A Common Stock will be issued and outstanding, 17,075,270 shares of Class B Common Stock will be issued and outstanding and no shares of Preferred Stock will be issued and outstanding. In addition, 650,000 shares of Class A Common Stock are reserved for issuance under the Stock Plan, 469,000 shares of Class A Common Stock are reserved for issuance under presently exercisable warrants and 17,075,270 shares of Class A Common Stock are reserved for issuance upon conversion of the Class B Common Stock. The following summary of certain provisions of the Company's Certificate of Incorporation ("Certificate") and Bylaws does not purport to be complete and is subject to, and qualified in its entirety by, reference to the Certificate and Bylaws of the Company, copies of which have been filed as exhibits to the registration statement of which this Prospectus is a part. Common Stock The shares of Class A Common Stock and Class B Common Stock are identical in all respects, except for voting rights and certain conversion rights with respect to the shares of Class B Common Stock which are described herein. Shares of Class B Common Stock may be owned only by the holders of Class B Common Stock as of the date of this Prospectus and their Permitted Transferees (as defined in the Certificate). Any shares of Class B Common Stock transferred to any other person automatically convert into shares of Class A Common Stock on a one-for-one basis. Each share of Class B Common Stock may be converted, at any time at the option of the holder thereof, into one share of Class A Common Stock, subject to the rights of other holders of Class B Common Stock under the Class B Stockholders Agreement. The Class A Common Stock and the Class B Common Stock are entitled to vote on all matters which come before the stockholders, voting together as a single class on all matters, except as described below and as otherwise required by law. Each share of Class A Common Stock has one vote and each share of Class B Common Stock has 10 votes on all matters on which holders of Common Stock are entitled to vote. Holders of the Class B Common Stock are also entitled by the Certificate and Bylaws to approve certain amendments to the Certificate or the Bylaws. The Certificate provides that the Board of Directors shall have two classes of directors: (i) "Class B Directors," of which there shall be two at all times during which shares of Class B Common Stock are issued and outstanding, and (ii) "Class A Directors," who are all directors other than the Class B Directors. The Class B Directors are elected solely by majority vote of the holders of Class B Common Stock voting as a separate class. The Class A Directors are elected by holders of all shares of the Company's capital stock entitled to vote thereon, voting as a single class, including both shares of Class A Common Stock and shares of Class B Common Stock. Any Class A Director may be removed, with or without cause (except as otherwise provided by law), by the vote of a majority of all votes entitled to be cast in the election of Class A Directors. However, Class B Directors may be removed only by the holders of a majority of the shares of Class B Common Stock, and may be removed with or without cause. Holders of Common Stock are entitled to receive ratably such dividends, if any, as may be declared by the Board of Directors out of funds legally available therefor, subject to the preferential dividend rights of any outstanding shares of Preferred Stock. Any dividends declared which are payable on the Common Stock shall be payable at the same rate on both classes of Common Stock. Upon the liquidation, dissolution or winding-up of the Company, the holders of Common Stock are entitled to receive ratably the net assets of the Company available after the payment of all debts and other liabilities and subject to the prior rights of any outstanding shares of Preferred Stock. Holders of Common Stock have no preemptive, subscription or redemption rights. All the outstanding shares of Common Stock are fully paid and nonassessable. The rights, preferences and privileges of holders of Common Stock are subject to, and may be adversely affected by, the rights of the holders of shares of any series of Preferred Stock that the Company may designate and issue in the future. 39 Agreement Among Class B Stockholders The holders of the Class B Common Stock entered into an agreement on January 1, 1998 (the "Class B Stockholders Agreement") pursuant to which, among other things, they agreed to grant to Mr. Aab an irrevocable proxy to vote all of their shares of Class B Common Stock, and Mr. Aab has agreed to vote the shares of Class B Common Stock covered by the proxy to elect Mr. Ganatra as a director. In addition, the Class B Stockholders Agreement provides that if a party to the agreement proposes to sell or otherwise transfer shares of Class B Common Stock to anyone other than a Permitted Transferee (such as lineal descendants of the Class B Stockholders, trusts for the benefit of such holders and descendants, and corporations, partnerships and other entities and business organizations controlled by the Class B Stockholders), the other holders of Class B Common Stock who are parties to the Class B Stockholders Agreement would have a right to acquire the shares of Class B Common Stock that are proposed to be sold or transferred. The Class B Stockholders Agreement also provides that if a party to the agreement proposes to convert his, her or its shares of Class B Common Stock into shares of Class A Common Stock, the other parties to the Class B Stockholders Agreement have the right to purchase the shares of Class B Common Stock proposed to be converted or to exchange shares of Class A Common Stock for such shares. The Class B Stockholders Agreement has an initial term of ten years. Preferred Stock Under the terms of the Certificate, the Board of Directors of the Company is authorized to issue shares of Preferred Stock in one or more series without stockholder approval, subject to any limitations prescribed by law. Each series of Preferred Stock shall have such rights, preferences, privileges and restrictions, including voting rights, dividend rights, conversion rights, redemption privileges and liquidation privileges, as shall be determined by the Board of Directors. The purpose of authorizing the Board of Directors to issue Preferred Stock and determine its rights and preferences is to eliminate delays associated with a stockholder vote on specific issuances. The issuance of Preferred Stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from acquiring, a majority of the outstanding voting stock of the Company. No shares of Preferred Stock have been issued or authorized for issuance, and there are no agreements or undertakings relating to the issuance of shares of Preferred Stock. Board of Directors Under the terms of the Certificate and the Bylaws, the Board of Directors consists of at least three directors and no more than eleven directors. As noted above, at all times when shares of Class B Common Stock are outstanding, the two directors who are designated as "Class B Directors" are elected by the holders of a majority of the shares of the Class B Common Stock voting as a separate class, and Class B Directors may only be removed by the affirmative vote of a majority of the holders of the Class B Common Stock. The Bylaws provide that if at any time the number of directors is seven or more, the terms of the Class A Directors shall be staggered and the Class A Directors shall be grouped into three classes of nearly equal size. If the Class A Directors are staggered, the first staggered class shall be elected for an initial three year term, the second staggered class shall be elected for an initial two year term and the third staggered class shall be elected for an initial one year term. Thereafter, at each annual meeting of stockholders, directors shall be elected to fill the seats of the staggered class of Class A Directors whose term then expires shall be elected for three year terms. If the terms of office of the Class A Directors are staggered, then the Class A Directors may be removed only for cause during the term for which they have been elected. Warrants The Company has issued warrants to three of its employees which entitle them to acquire an aggregate of 345,000 shares of Class A Common Stock at an exercise price of $2.86 per share. These warrants may be exercised, in whole or in part, at any time prior to August 4, 2000 (with respect to 330,000 shares) or prior to November 10, 2000 (with respect to 15,000 shares). The Company has also issued a warrant to a sales agent which entitles him to acquire 99,000 shares of Class A Common Stock at an exercise price of $2.86 per share with an expiration date of August 1, 2000 and a warrant to a consultant which entitles him to acquire 25,000 shares of Class A Common Stock at an exercise price of $10.00 per share with an expiration date of January 1, 2001. These warrants may be exercised, in whole or in part, at any time prior to their expiration dates. 40 Certain Charter and Statutory Provisions Article VIII of the Certificate provides that the Company shall indemnify all directors and officers to the full extent permitted by the General Corporation Law of the State of Delaware (the "Delaware Law"), or any other applicable laws as now or hereafter in effect. In addition, the Certificate authorizes the Company to enter into one or more agreements with any person which provide for indemnification greater or different than that provided in its Certificate. Section 145 of the Delaware Law permits a corporation to indemnify its directors and officers against expenses (including attorney's fees), judgments, fines and amounts paid in settlements actually and reasonably incurred by them in connection with any action, suit or proceeding, whether criminal or civil, brought by a third party if such directors or officers acted in good faith and in a manner they reasonably believed to be in or not opposed to the best interests of the corporation and, with respect to any criminal action or proceeding, had no reason to believe their conduct was unlawful. In addition, Section 102 of the Delaware Law provides that a corporation may include in its certificate of incorporation a provision eliminating or limiting the personal liability of directors for monetary damages for breach of fiduciary duty, provided that such provision shall not eliminate or limit the liability of a director: (i) for any breach of the director's duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith that involve intentional misconduct or a knowing violation of the law; (iii) for conduct leading to unlawful distributions by the corporation; or (iv) for any transaction from which the director derived an improper personal benefit. The Certificate includes such a provision. The effect of this provision is to eliminate the rights of the Company and its stockholders (through stockholder's derivative suits on behalf of the Company) to recover monetary damages against a director for breach of fiduciary duty of care as a directory (including breaches resulting from negligent or grossly negligent behavior) except in situations described in clauses (i) through (iv) above. This provision does not limit or eliminate the rights of the Company or any stockholder to seek nonmonetary relief (such as an injunction or rescission) in the event of a breach of a director's duty of care. Following the Offering, the Company will also be subject to the provisions of Section 203 of the Delaware Law. In general, the statute prohibits a publicly-held Delaware corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless (i) prior to such date the board of directors of the corporation approved either the business combination or the transaction that resulted in the stockholder becoming an interested stockholder, (ii) upon consummation of the transaction that resulted in such person becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced (excluding, for purposes of determining the number of shares outstanding, shares owned by certain directors or certain employee stock plans), or (iii) on or after the date the stockholder became an interested stockholder, the business combination is approved by the board of directors and authorized by the affirmative vote (and not by written consent) of at least two-thirds of the outstanding voting stock excluding that stock owned by the interested stockholder. For the purposes of Section 203, a "business combination" includes a merger, asset sale or other transaction resulting in a financial benefit to the interested stockholder, as well as any transaction that has the effect of increasing the interested stockholder's proportionate share ownership in the corporation. An "interested stockholder" is a person who (other than the corporation and any direct or indirect majority-owned subsidiary of the corporation) together with affiliates and associates owns (or, as an affiliate or associate, within three years prior, did own) 15% or more of the corporation's outstanding voting stock. Section 203, however, expressly exempts from the requirements described above any business combination by a corporation with an interested stockholder who became an interested stockholder at a time when the section did not apply to the corporation. It further provides that its provisions shall not apply if the corporation does not have a class of voting stock that (i) is listed on a national securities exchange, (ii) authorized for quotation on the Nasdaq National Market or (iii) held of record by more than 2,000 stockholders (unless any of the foregoing results from a transaction in which a person becomes an interested stockholder). Mr. Aab, Melrich, Mr. Ganatra and Super STAR Associates Limited Partnership became interested stockholders prior to the Offering at a time when such exemption from the provisions of Section 203 applied to the Company. Accordingly, future transactions between the Company and such persons and entities will not be subject to the requirements of Section 203. 41 Listing The Class A Common Stock has been conditionally approved for listing on the Nasdaq National Market under the symbol "CLEC." Transfer Agent and Registrar First Union National Bank, Charlotte, North Carolina will be the transfer agent and registrar for the Class A Common Stock (the "Transfer Agent"). SHARES ELIGIBLE FOR FUTURE SALE Upon completion of the Offering, 9,355,000 shares of Class A Common Stock will be outstanding, excluding (i) 182,800 shares reserved for issuance upon exercise of options that have been granted under the Stock Plan, none of which are currently vested, (ii) 10,000 shares issuable upon exercise of options to be granted at the completion of the Offering under the Stock Plan, (iii) 469,000 shares reserved for issuance upon exercise of presently exercisable warrants and (iv) 17,075,270 shares reserved for issuance upon conversion of Class B Common Stock. Of these shares, the 5,500,000 shares of Class A Common sold in the Offering will be freely tradable without restriction or further registration under the Securities Act, except for any shares purchased by an "affiliate" (as defined in the Securities Act) of the Company, which will be subject to the resale limitations of Rule 144 ("Rule 144") under the Securities Act. The remaining shares of Class A Common Stock outstanding and all of the shares of Class B Common Stock outstanding will be "restricted securities" as that term is defined in Rule 144, and may in the future be sold without restriction under the Securities Act to the extent permitted by Rule 144 or any applicable exemption under the Securities Act. In general, under Rule 144 as currently in effect, beginning 90 days after the date of this Prospectus a person (or persons whose shares are aggregated) who has beneficially owned its, his or her restricted securities (as that term is defined in Rule 144) for at least one year from the date such securities were acquired from the Company or an affiliate of the Company would be entitled to sell within any three-month period a number of shares that does not exceed the greater of (i) one percent of the then outstanding shares of the Class A Common Stock and (ii) the average weekly trading volume of the Class A Common Stock during the four calendar weeks preceding a sale by such person. Sales under Rule 144 are also subject to certain manner-of-sale provisions, notice requirements and the availability of current public information about the Company. Under Rule 144, however, a person who has held restricted securities for a minimum of two years from the later of the date such securities were acquired from the Company or an affiliate of the Company and who is not, and for the three months prior to the sale of such restricted securities has not been, an affiliate of the Company, is free to sell such shares of Class A Common Stock without regard to the volume, manner-of-sale and the other limitations contained in Rule 144. The foregoing summary of Rule 144 is not intended to be a complete discussion thereof. Of the outstanding shares of Class A Common Stock that will be "restricted securities," all of such shares will be eligible for sale in the public market subject to the volume, manner of sale and other limitations of Rule 144 described below after December 31, 1998. The 17,075,270 shares of Class B Common Stock outstanding upon completion of the Offering will also be restricted securities. Each share of Class B Common Stock may be converted at any time by the holder thereof into one share of Class A Common Stock, subject to the rights of other holders of Class B Common Stock under the Class B Stockholders Agreement. If any shares of Class B Common Stock are converted by the current holders into shares of Class A Common Stock, the holding period of the shares of Class A Common Stock could, under the provisions of Rule 144, be tacked with the holding period of the Class B Common Stock such that 16,594,500 of such shares will be eligible for sale in the public market after December 31, 1998 and the remainder will be eligible for sale in the public market after February 14, 1999 subject to the volume, manner of sale and other limitations of Rule 144. The Company, its directors and executive officers, who will beneficially own, as of the completion of this Offering, an aggregate of 2,268,000 shares of Class A Common Stock (or presently exercisable warrants to purchase Class A Common Stock) and 17,075,270 shares of Class B Common Stock (which, subject to the terms of the Class B Stockholders Agreement, may be converted at any time into shares of Class A Common Stock and, pursuant to the Certificate, automatically convert into shares of Class A Common Stock as a result of certain transfers), have each agreed not to offer, sell or contract to sell, or otherwise dispose of, directly or indirectly, or announce an offering of, any shares of Class A Common Stock or any securities convertible into, or 42 exchangeable for, shares of Class A Common Stock for a period of 180 days from the date of this Prospectus, without the prior written consent of Smith Barney Inc. except under limited circumstances. Promptly upon completion of the Offering, the Company intends to file a Registration Statement on Form S-8 with the Commission to register 650,000 shares of Class A Common Stock reserved for issuance or sale under the Stock Plan. As of March 31, 1998, there were outstanding options to purchase a total of 182,800 shares of Class A Common Stock, none of which were vested, and outstanding and presently exercisable warrants to purchase a total of 469,000 shares of Class A Common Stock. Following such registration, all shares of Class A Common Stock issuable upon the exercise of options granted under the Stock Plan will be freely tradable without restriction under the Securities Act, unless such shares are held by an affiliate of the Company. Prior to the Offering, there has been no established market for the Class A Common Stock, and no predictions can be made about the effect, if any, that market sales of shares of Class A Common Stock or the availability of such shares for sale will have on the market price prevailing from time to time. Nevertheless, the actual sale of, or the perceived potential for the sale of, Class A Common Stock in the public market may have an adverse effect on the market price for the Class A Common Stock. UNDERWRITING Subject to the terms and conditions set forth in an underwriting agreement among the Company and the Underwriters (the "Underwriting Agreement"), the Company has agreed to sell to each of the Underwriters named below (the "Underwriters"), for whom Smith Barney Inc., Bear, Stearns & Co. Inc. and Wheat First Union, a division of Wheat First Securities, Inc., are acting as representatives (the "Representatives"), and each of the Underwriters has severally agreed to purchase from the Company the aggregate number of shares of Class A Common Stock set forth opposite its name below:
Number of Underwriters Shares - ---------------------------------------------- ---------- Smith Barney Inc. .................... Bear, Stearns & Co. Inc. ............. Wheat First Securities, Inc. ......... Total ............................ 5,500,000 =========
The Company has been advised by the Representatives that the several Underwriters propose initially to offer the shares of Class A Common Stock to the public at the Price to Public set forth on the cover page of this Prospectus, and to certain dealers at such price less a discount not in excess of $ per share. The Underwriters may allow, and such dealers may reallow, a discount not in excess of $ per share on sales to certain other dealers. After the initial public offering, the public offering price and such concessions may be changed. The Company has granted the Underwriters an option, exercisable within 30 days of the date of this Prospectus, to purchase up to 825,000 additional shares of Class A Common Stock to cover over-allotments, if any, at the Price to the Public set forth on the cover page of this Prospectus less the Underwriting Discount. To the extent that the Underwriters exercise such option, in whole or in part, each Underwriter will have a firm commitment, subject to certain conditions, to purchase a number of option shares proportionate to such Underwriter's initial commitment. The Underwriting Agreement provides that the obligations of the Underwriters to purchase the Class A Common Stock listed above are subject to certain conditions set forth therein. The Underwriters are committed 43 to purchase all of the Class A Common Stock offered by this Prospectus (other than those covered by the Underwriters' overallotment option described in the immediately preceding paragraph), if any are purchased. In the event of default by any Underwriter, the Underwriting Agreement provides that, in certain circumstances, the purchase commitments of the non-defaulting Underwriters may be increased or the Underwriting Agreement may be terminated. The obligations of the Underwriters under the Underwriting Agreement are several and may be terminated in their discretion upon the occurrence of certain stated events including if certain events have occurred the effect of which on financial markets is such as to make it, in the judgment of the Underwriters, impracticable or inadvisable to proceed with the Offering. The Underwriting Agreement provides that the Company will indemnify the several Underwriters against certain liabilities, including liabilities under the Securities Act, or contribute to payments the Underwriters may be required to make in respect thereof. The Company and its directors and executive officers have each agreed with the Underwriters that they will not offer, sell or contract to sell, or otherwise dispose of, directly or indirectly, or announce an offering of, any shares of Class A Common Stock or any securities convertible into, or exchangeable for, shares of Class A Common Stock for a period of 180 days from the date of this Prospectus, without the prior written consent of Smith Barney Inc., except (a) in the case of the Company, (i) grants of options and issuances and sales of Class A Common Stock issued pursuant to the Stock Plan, (ii) issuances of Class A Common Stock upon the conversion of shares of Class B Common Stock or the exercise of warrants outstanding on the date of the Underwriting Agreement or (iii) issuance of Common Stock or securities convertible into Common Stock in connection with acquisitions; provided that the recipients of such shares of Common Stock agree in writing with Smith Barney Inc. to be bound by the unexpired term of such agreement not to sell; and (b) in the case of directors and executive officers, shares of Class A Common Stock disposed of as bona fide gifts or pledges where the recipients of such gifts or the pledgees, as the case may be, agree in writing with Smith Barney Inc. to be bound by the terms of such agreement. At the request of the Company, the Underwriters have reserved up to 385,000 shares of Class A Common Stock for sale at the Price to Public set forth on the cover page of this Prospectus to certain officers, directors, employees and other persons designated by the Company. The number of shares of Class A Common Stock available for sale to the general public will be reduced to the extent such persons purchase such reserved shares. Any reserved shares not so purchased will be offered by the Underwriters to the general public on the same basis as the other shares offered hereby. The Representatives have informed the Company that they do not expect sales to accounts over which they exercise discretionary authority to exceed five percent of the total number of shares of Class A Common Stock sold in the Offering. Prior to the Offering, there has been no public market for the Class A Common Stock. Accordingly, the initial public offering price for the Class A Common Stock will be determined by negotiation among the Company and the Representatives. Among the factors considered in determining the initial public offering price of the Class A Common Stock, in addition to prevailing market conditions, will be the Company's historical performance, estimates of the business potential and earnings prospects of the Company, an assessment of the Company's management and the consideration of the above factors in relation to market valuation of companies in related businesses. There can be no assurance that the price at which shares of Class A Common Stock will sell in the public market after the Offering will not be lower than the price at which they are sold in the Offering by the Underwriters. The Class A Common Stock has been conditionally approved for listing on the Nasdaq National Market under the symbol "CLEC." In connection with the Offering, the Underwriters may purchase and sell the Class A Common Stock in the open market in accordance with Regulation M under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These transactions may include over-allotment and stabilizing transactions and purchases to cover syndicate short positions created in connection with the Offering. Stabilizing transactions consist of certain bids or purchases for the purpose of preventing or retarding a decline in the market price of the Class A Common Stock; and syndicate short positions involve the sale by the Underwriters of a greater number of shares 44 of Class A Common Stock than they are required to purchase from the Company in the Offering. The Underwriters also may impose a penalty bid, whereby selling discounts allowed to syndicate members or other broker-dealers in respect of the securities sold in the Offering for their account may be reclaimed by the syndicate if such securities are repurchased by the syndicate in stabilizing or covering transactions. These activities may stabilize, maintain or otherwise affect the market price of the Class A Common Stock, which may be higher than the price that might otherwise prevail in the open market; and these activities, if commenced, may be discontinued at any time. These transactions may be effected on the Nasdaq National Market in the over-the-counter market or otherwise. LEGAL MATTERS The validity of the Class A Common Stock will be passed upon for the Company by Moore & Van Allen, PLLC, Charlotte, North Carolina and for the Underwriters by Paul, Hastings, Janofsky & Walker LLP, New York, New York. EXPERTS The financial statements included in this Prospectus have been audited by Deloitte & Touche LLP, independent public accountants, as stated in their report appearing herein; and are included in reliance upon the report of said firm given upon their authority as experts in accounting and auditing. AVAILABLE INFORMATION The Company has filed a Registration Statement on Form S-1, Commission File No. 333-46341, under the Securities Act with the Commission with respect to the shares of Class A Common Stock offered by the Offering. This Prospectus, which is part of the Registration Statement, does not contain all of the information set forth in the Registration Statement and the exhibits and schedules thereto. For further information with respect to the Company and the Class A Common Stock, reference is made to the Registration Statement and the exhibits and schedules filed therewith. Statements contained in this Prospectus as to the contents of any contract or any other document to which reference is made are necessarily summaries thereof, and in each instance reference is made to the copy of such contract or other document filed as an exhibit to the Registration Statement, each such statement being qualified in all respects by such reference. The Company has not previously been subject to the reporting requirements of the Exchange Act. Upon completion of the Offering, the Company will be subject to the informational requirements of the Exchange Act and in accordance therewith will be required to file periodic reports and other information with the Commission. Copies of the Registration Statement, periodic reports and other information filed by the Company with the Commission may be inspected without charge. Copies of such material may also be obtained at prescribed rates at the Public Reference Section of the Commission at 450 Fifth Street, N.W., Washington, DC 20549, or at its regional offices located at Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and Seven World Trade Center, Suite 1300, New York, New York 10048. In addition, the Commission maintains a website that contains periodic reports and other information filed by the Company via the Commission's Electronic Data Gathering and Retrieval System. This website can be accessed at www.sec.gov. Copies of such material can be also be obtained from the Company upon request by contacting the Company at its principal executive office. The Company intends to furnish its stockholders with annual reports containing financial statements audited by an independent public accounting firm and quarterly reports for the first three quarters of each fiscal year containing unaudited interim financial information. 45 GLOSSARY CAP -- Competitive access provider. CLEC -- Competitive local exchange carrier. Communications Act -- Communications Act of 1934, as amended. DS-0, DS-1, DS-3, T-1, T-3 -- These are the standard circuit capacity classifications which are distinguishable by bit rate. Each of these transmission services can be provided using the same type of fiber optic cable or other transmission medium, but offer different bandwidth (that is, capacity), depending upon the individual needs of the end-user. A DS-0 is a dedicated circuit that is considered to meet the requirements of usual business communications, with transmission capacity of up to 64 kilobits of bandwidth per second (that is, a voice grade equivalent circuit). This service offers a basic low capacity dedicated digital line for connecting telephones, fax machines, personal computers and other telecommunications equipment. A DS-1 is a high speed digital circuit typically linking high volume customer locations to long distance carriers or other customer locations. Typically utilized for voice transmissions as well as the interconnection of local area networks, DS-1 service accommodates transmission speeds of up to 1.544 megabits per second, which is equivalent to 24 DS-0 circuits or 24 voice grade equivalent circuits. DS-3 service provides a very high capacity digital circuit with transmission capacity of 45 megabits per second, which is equivalent to 28 DS-1 circuits or 672 voice grade equivalent circuits. This is a digital service used by long distance carriers for central office connections and by some large commercial users to link multiple sites. T-1 is synonymous with DS-1 and T-3 is synonymous with DS-3. EBITDA -- Net earnings (loss) before interest expense, income taxes, depreciation and amortization. ESP -- Enhanced service provider. Equivalent Access Lines -- This term is used by management to quantify the size of the Company's network. It is based on the number of customer lines and Trunks and the utilization of those lines and Trunks during the "busy hour." The "busy hour" refers to the hour of the day when line usage is at its highest level. The Company calculates its Equivalent Access Lines by multiplying the number of its Trunks in service by six and adding to the result to the number of its separate access lines in service. The decision to use six as the multiplier is based on management's experience, which indicates that the typical business access line is in use for approximately 400 seconds during the busy hour (or approximately 11.1% of capacity during the busy hour) and a typical business Trunk is in use for approximately 2,400 seconds during the busy hour (or approximately 66.7% of capacity during the busy hour), or approximately six times use during the busy hour of a typical business line. FCC -- The United States Federal Communications Commission. ILEC -- Incumbent local exchange carrier. ISP -- Internet service provider. Interconnect -- Connection of a telecommunications device or service to the public switched telephone network. Inter-LATA -- Telecommunications services originating in a LATA and terminating outside of that LATA. LATA (Local Access and Transport Area) -- one of approximately 200 local geographic areas in the United States within which a local telephone company may offer telecommunications services. Local Exchange -- A geographic area determined by the appropriate state regulatory authority in which calls generally are transmitted without toll charges to the calling or called party. Long Distance Carriers (Interexchange Carriers) -- Long distance carriers provide services between local exchanges on an interstate or intrastate basis. A long distance carrier may offer services over its own or another carrier's facilities. MOU -- Minutes of use. NC PUC -- North Carolina Public Utilities Commission. PUC -- Public Utilities Commission. 46 RBOC -- Regional bell operating company. Reciprocal Compensation -- The compensation paid to and from a CLEC and the ILEC for termination of a local call on each other's networks. Switch -- A device that opens or closes circuits or selects the paths or circuits to be used for transmission of information. Switching is the process of interconnecting circuits to form a transmission path between users. It also captures information for billing purposes. Switched Services -- Transmission of switched calls through the local switched network. Telecom Act -- Telecommunications Act of 1996. Trunk -- A DS-0 which concentrates subscriber lines. A trunked system combines multiple channels with unrestricted access in such a manner that user demands for channels are automatically "queued" and then allocated to the first available channel. VAR -- Value added reseller. 47 (THIS PAGE INTENTIONALLY LEFT BLANK) INDEX TO FINANCIAL STATEMENTS US LEC CORP. AND SUBSIDIARIES
Page ----- INDEPENDENT AUDITORS' REPORT ............................................................ F-2 FINANCIAL STATEMENTS: Consolidated Balance Sheets as of December 31, 1996 and 1997 ........................... F-3 Consolidated Statements of Operations for the Period From June 6, 1996 (Inception) to December 31, 1996 and the Year Ended December 31, 1997 ................................ F-4 Consolidated Statements of Stockholders' Equity (Deficiency) for the Period From June 6, 1996 (Inception) to December 31, 1996 and the Year Ended December 31, 1997 ................. F-5 Consolidated Statements of Cash Flows for the Period From June 6, 1996 (Inception) to December 31, 1996 and the Year Ended December 31, 1997 ................................ F-6 Notes to Consolidated Financial Statements ............................................. F-7
F-1 INDEPENDENT AUDITORS' REPORT Board of Directors US LEC Corp. Charlotte, North Carolina We have audited the accompanying consolidated balance sheets of US LEC Corp. (the "Company") and subsidiaries as of December 31, 1996 and 1997, and the related consolidated statements of operations, stockholders' equity (deficiency), and cash flows for the period from June 6, 1996 (inception) to December 31, 1996 and the year ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform our audits 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 financial statements present fairly, in all material respects, the financial position of US LEC Corp. and subsidiaries as of December 31, 1996 and 1997, and the results of their operations and their cash flows for the period from June 6, 1996 (inception) to December 31, 1996 and the year ended December 31, 1997 in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP February 4, 1998 Charlotte, North Carolina F-2 US LEC CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1996 and 1997 (Note 1)
1996 1997 ------------- --------------- ASSETS (Note 4) CURRENT ASSETS: Cash and cash equivalents (Note 2) ............................ $ 726,139 $ 3,189,210 Certificates of deposit (Note 2) .............................. -- 349,473 Accounts receivable (Note 2) .................................. -- 6,005,742 Due from stockholder (Note 6) ................................. 200,000 -- Prepaid expenses and other assets ............................. 141,523 110,568 ---------- ------------ Total current assets ...................................... .. 1,067,662 9,654,993 PROPERTY AND EQUIPMENT, NET (Notes 2 and 3) ..................... 276,097 12,889,335 OTHER ASSETS .................................................... 123,076 136,353 ---------- ------------ TOTAL ASSETS .................................................... $1,466,835 $ 22,680,681 ========== ============ LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY) CURRENT LIABILITIES: Accounts payable .............................................. $ 48,125 $ 8,200,926 Deferred revenue .............................................. -- 1,141,386 Accrued network costs ......................................... -- 1,864,659 Accrued interest payable -- related party ..................... 16,861 282,311 Accrued expenses -- other ..................................... 65,792 434,594 ---------- ------------ Total current liabilities ................................. .. 130,778 11,923,876 ---------- ------------ NOTES PAYABLE -- STOCKHOLDERS (Notes 4 and 9) ................... 1,671,000 5,000,000 ---------- ------------ COMMITMENTS AND CONTINGENCIES (Note 5) STOCKHOLDERS' EQUITY (DEFICIENCY) (Notes 8 and 9): Common stock -- Class A, $.01 par value (73,405,498 authorized shares, 3,855,000 outstanding at December 31, 1997) .......... -- 38,550 Common stock -- Class B, $.01 par value (16,594,502 authorized shares, 16,594,500 outstanding at December 31, 1997) ......... -- 165,945 Members' units -- voting (10,000 units outstanding as of December 31, 1996) ........................................... 600,000 -- Members' units -- nonvoting (1,540 units outstanding as of December 31, 1996) ........................................... 27,720 -- Additional paid-in capital .................................... -- 11,173,420 Accumulated deficit ........................................... (962,663) (5,621,110) ---------- ------------ Total stockholders' equity (deficiency) ................... .. (334,943) 5,756,805 ---------- ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY) .................................................. $1,466,835 $ 22,680,681 ========== ============
See notes to consolidated financial statements. F-3 US LEC CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS The Period from June 6, 1996 (Inception) to December 31, 1996 and the Year Ended December 31, 1997 (Note 1)
1996 1997 ------------- --------------- Revenue (Note 2) .......................................... $ -- $ 6,457,661 Cost of Services .......................................... -- 4,201,001 ---------- ------------ Gross Margin .............................................. -- 2,256,660 Selling, General and Administrative ....................... 941,743 6,117,337 Depreciation and Amortization ............................. 4,059 442,914 ---------- ------------ Loss from Operations ...................................... (945,802) (4,303,591) Interest Income ........................................... -- (65,660) Interest Expense (Note 4) ................................. 16,861 420,516 ---------- ------------ Net Loss .................................................. $ (962,663) $ (4,658,447) ========== ============ Net Loss Per Share -- Basic and diluted (Note 2) .......... $ (.06) $ (.25) ========== ============ Weighted Average Shares Outstanding ....................... 17,310,000 18,653,308 ========== ============
See notes to consolidated financial statements. F-4 US LEC CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY) The Period from June 6, 1996 (Inception) to December 31, 1996 and the Year Ended December 31, 1997 (Notes 1 and 8)
Common Stock Common Stock Common Stock/ Class A Class B Voting Units(1) ----------------------- ------------------------ ---------------------------- Shares Amount Shares Amount Shares Amount ------------ ---------- ------------- ---------- ------------ --------------- BALANCE, JUNE 6, 1996 (INCEPTION) ........................... -- $ -- -- $ -- -- $ -- Issuance of voting shares/units ....... -- -- -- -- 10,000 600,000 Shares/units granted to employees ..... -- -- -- -- -- -- Net loss .............................. -- -- -- -- -- -- ---------- ------- ---------- -------- ------ ------------- BALANCE (DEFICIENCY), DECEMBER 31, 1996 ..................... -- -- -- -- 10,000 600,000 Issuance of nonvoting units ........... -- -- -- -- -- -- Issuance of voting units .............. -- -- -- -- 1,063 4,554,995 Issuance of warrants .................. -- -- -- -- -- -- Contribution to capital ............... -- -- -- -- -- -- Exchange of limited liability company units for C Corporation shares ............................... 3,855,000 38,550 16,594,500 165,945 (11,063) (5,154,995) Net loss .............................. -- -- -- -- -- -- --------- ------- ---------- -------- ------- ------------- BALANCE, DECEMBER 31, 1997 ............ 3,855,000 $38,550 16,594,500 $165,945 -- $ -- ========= ======= ========== ======== ======= ============= Common Stock/ Nonvoting Units(1) Additional --------------------------- Paid-in Accumulated Shares Amount Capital Deficit Total ----------- --------------- -------------- --------------- --------------- BALANCE, JUNE 6, 1996 (INCEPTION) ........................... -- $ -- $ -- $ -- $ -- Issuance of voting shares/units ....... -- -- -- -- 600,000 Shares/units granted to employees ..... 1,540 27,720 -- -- 27,720 Net loss .............................. -- -- -- (962,663) (962,663) ----- ------------- ----------- ------------ ---------- BALANCE (DEFICIENCY), DECEMBER 31, 1996 ..................... 1,540 27,720 -- (962,663) (334,943) Issuance of nonvoting units ........... 1,030 4,413,550 -- -- 4,413,550 Issuance of voting units .............. -- -- -- -- 4,554,995 Issuance of warrants .................. -- -- 70,800 -- 70,800 Contribution to capital ............... -- -- 1,710,850 -- 1,710,850 Exchange of limited liability company units for C Corporation shares ............................... (2,570) (4,441,270) 9,391,770 -- -- Net loss .............................. -- -- -- (4,658,447) (4,658,447) ------ ------------- ----------- ------------ ---------- BALANCE, DECEMBER 31, 1997 ............ -- $ -- $11,173,420 $ (5,621,110) $5,756,805 ====== ============= =========== ============ ==========
- ------- (1) On December 31, 1996, all S Corporation common shares were converted into limited liability company units based on a one-for-one conversion ratio of units for each share. On December 31, 1997, all limited liability units were converted into C Corporation common shares based upon a conversion ratio of 1,500 shares for each unit. See notes to consolidated financial statements. F-5 US LEC CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS The Period from June 6, 1996 (Inception) to December 31, 1996 and the Year Ended December 31, 1997 (Note 1)
1996 1997 -------------- ---------------- OPERATING ACTIVITIES: Net loss ..................................................................... $ (962,663) $ (4,658,447) ------------ ------------ Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization .............................................. 4,059 442,914 Stock compensation ......................................................... 27,720 70,800 Changes in assets and liabilities which provided (used) cash: Accounts receivable ....................................................... -- (6,005,742) Prepaid expenses and other assets ......................................... (141,523) 30,955 Other assets .............................................................. (123,598) (14,322) Accounts payable .......................................................... 34,283 899,452 Deferred revenue .......................................................... -- 1,141,386 Accrued expenses -- other ................................................. 65,792 368,802 Accrued network costs ..................................................... -- 1,864,659 Accrued interest payable -- related party ................................. 16,861 265,450 ------------ ------------ Total adjustments ........................................................ (116,406) (935,646) ------------ ------------ Net cash used in operating activities .................................... (1,079,069) (5,594,093) ------------ ------------ INVESTING ACTIVITIES: Purchase of property and equipment ........................................... (265,792) (5,801,758) Certificates of deposit ...................................................... -- (349,473) (Advances to) repayments from stockholder .................................... (200,000) 200,000 ------------ ------------ Net cash used in investing activities .................................... (465,792) (5,951,231) ------------ ------------ FINANCING ACTIVITIES: Issuance of common shares and limited liability company units ................ 600,000 8,968,545 Contribution to capital ...................................................... -- 1,710,850 Proceeds from notes payable -- stockholders .................................. 1,671,000 4,289,150 Repayment of notes payable -- stockholders ................................... -- (960,150) ------------ ------------ Net cash provided by financing activities ................................ 2,271,000 14,008,395 ------------ ------------ NET INCREASE IN CASH AND CASH EQUIVALENTS ..................................... 726,139 2,463,071 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ................................ -- 726,139 ------------ ------------ CASH AND CASH EQUIVALENTS, END OF PERIOD ...................................... $ 726,139 $ 3,189,210 ============ ============ SUPPLEMENTAL CASH FLOW DISCLOSURES -- Cash paid for interest .................. $ -- $ 672 ============ ============ SUPPLEMENTAL NON CASH INVESTING AND FINANCING ACTIVITIES -- During 1997, accrued interest of $54,544 due to stockholders was converted into voting equity. At December 31, 1996 and 1997, $13,842 and $7,267,191, respectively, of property and equipment additions are included in outstanding accounts payable.
See notes to consolidated financial statements. F-6 US LEC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Period From June 6, 1996 (Inception) to December 31, 1996 and Year Ended December 31, 1997 1. ORGANIZATION AND NATURE OF BUSINESS The consolidated financial statements include the accounts of US LEC Corp. (the "Company") and its six subsidiaries, of which two are wholly owned and four are 99% owned. All significant intercompany transactions and balances have been eliminated. The Company was incorporated in 1996 as an S Corporation. Effective December 31, 1996, US LEC Corp. was converted to a limited liability company ("US LEC L.L.C.") through an exchange of the S Corporation common stock for voting and nonvoting units of US LEC L.L.C. On December 31, 1997, in anticipation of a planned initial public offering of common stock, the Company became a C Corporation through a merger of US LEC L.L.C. into the Company and the exchange of all of the limited liability company units into shares of Class A and Class B Common Stock. The Company, through its subsidiaries, provides switched local, long distance and enhanced telecommunications services primarily to medium and large-sized organizations in selected markets in the southeastern United States. The Company was a development stage enterprise from inception until March 1997, when it began generating telecommunications revenues. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Revenue Recognition -- The Company recognizes revenue on telecommunications and enhanced communications services in the period that the service is provided. Revenue is presented net of amounts which are rebated to end user customers and outside sales agents pursuant to telecommunications service contracts. Revenue on billings to customers in advance of providing services is deferred and recognized when earned. At December 31, 1997, deferred revenue primarily represents billings which are subject to review by a state public utilities commission (see Note 5). Cash and Cash Equivalents -- Cash equivalents consist of highly liquid investments with original maturities of three months or less at the time of purchase. Certificates of Deposit -- Certificates of deposit are carried at cost. These certificates mature during 1998, and serve as collateral for letters of credit related to certain office leases. Property and Equipment -- Property and equipment is stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. The estimated useful lives of the Company's principal classes of property and equipment are as follows: Telecommunications switching and other equipment ................................... 5 - 9 years Office equipment, furniture and other ......... 5 years Leasehold improvements ........................ The lesser of the estimated useful lives or the term of the lease
Long-Lived Assets -- The Company reviews the carrying value of its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable. Measurement of any impairment would include a comparison of estimated future operating cash flows anticipated to be generated during the remaining life of the assets with their net carrying value. An impairment loss would be recognized as the amount by which the carrying value of the assets exceeds their fair value. Fair Value of Financial Instruments -- As of December 31, 1996 and 1997, the fair values of the Company's financial instruments, including cash equivalents, certificates of deposit, receivables, accounts payable and notes payable to stockholders approximate their carrying values. Income Taxes -- The Company was organized as an S Corporation for the period from inception to December 31, 1996, and as a limited liability company for the period from January 1, 1997 to December 31, 1997, on which date it was converted to C Corporation status. Accordingly, no provision (benefit) for income taxes is F-7 US LEC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued necessary for 1996 and 1997 since income taxes were the responsibility of the individual S Corporation stockholders or limited liability company members. On a pro forma basis, had the Company been structured as a C Corporation since inception, there would have been no change in the net loss or net loss per share for each period presented. At December 31, 1997, deferred tax assets and liabilities related to the conversion to a C Corporation are not significant. Concentration of Risk -- The Company is exposed to concentration of credit risk principally from trade accounts receivable. At December 31, 1997, the Company's trade customers are located in North Carolina. The Company performs ongoing credit evaluations of its customers but does not require collateral to support customer receivables. Credit risk is reduced by the fact that the Company's most significant trade receivables are from large, well-established telecommunications entities. At December 31, 1997, no allowance for doubtful receivables is considered necessary. The Company is dependent upon certain suppliers for the provision of telecommunications services to its customers. The Company has executed interconnection agreements for all of its current operating networks, and these agreements expire at various dates in 1998 and 1999. Management believes that suitable interconnection agreements can be negotiated in the future and, accordingly, does not expect any disruption of services. Use of Estimates -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates. A significant estimate relates to the accrual of network costs payable to other telecommunications entities. Any difference between the ultimate payments made and the accrual would be recorded at the time of payment. Advertising -- The Company expenses advertising costs in the period incurred. Advertising expense amounted to $22,311 and $136,935 for 1996 and 1997, respectively. Net Loss Per Share -- Net loss per share has been calculated in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings Per Share. The weighted average shares outstanding used in the calculation have been determined by giving retroactive effect to the conversion to C Corporation status which occurred on December 31, 1997 (based on the share conversion ratios utilized in the conversion from a limited liability company). The effect on diluted loss per share of outstanding stock warrants to purchase 444,000 common shares is antidilutive for the year ended December 31, 1997. Securities and Exchange Commission Staff Accounting Bulletin No. 98 requires that equity instruments granted at nominal amounts for periods prior to the filing of the registration statement be included in the calculation of per share data as if outstanding for all periods presented. Accordingly, the weighted average shares used in the calculation of basic and diluted loss per share in 1996 includes 2,310,000 shares (1,540 limited liability company units) granted in 1996 to employees, as if such shares were outstanding for the entire period. 3. PROPERTY AND EQUIPMENT
December 31, ---------------------------- 1996 1997 ----------- -------------- Telecommunications switching and other equipment ......... $212,259 $11,790,370 Office equipment, furniture and other .................... 67,375 774,536 Leasehold improvements ................................... -- 769,835 -------- ----------- 279,634 13,334,741 Less accumulated depreciation and amortization ........... (3,537) (445,406) -------- ----------- Total .................................................... $276,097 $12,889,335 ======== ===========
F-8 US LEC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued 4. NOTES PAYABLE -- STOCKHOLDERS The Company's majority stockholder has loaned an aggregate of $5,000,000 to the Company as of December 31, 1997 ($710,850 as of December 31, 1996). Interest charged through 1997 was at prime plus 2% (10.5% per annum at December 31, 1997). In January 1998, an entity controlled by this stockholder loaned an additional $2,289,150 to the Company. Interest on both loans will be at 12% per annum, payable on a quarterly basis, with principal due in January 2003. (See Note 9) Another stockholder loaned the Company an aggregate of $960,150 in 1996, with interest at prime plus 2%. These loans were repaid in 1997. In January 1998, this stockholder loaned $1,000,000 to the Company, with interest at 12% per annum, payable on a quarterly basis, with principal due in January 2003. Substantially all of the Company's assets are pledged as collateral on such stockholder loans. Interest expense to related parties was $16,861 in 1996 and $419,814 in 1997. 5. COMMITMENTS AND CONTINGENCIES Leases -- The Company leases office premises in various locations under operating lease arrangements. Most of these leases have renewal options. Total rent expense amounted to $12,331 and $180,414 in 1996 and 1997, respectively. Future minimum rental payments under operating leases having initial or remaining noncancelable lease terms in excess of one year (including leases entered into in 1998) are as follows: 1998 ................. $ 795,000 1999 ................. 901,000 2000 ................. 813,000 2001 ................. 700,000 2002 ................. 609,000 Thereafter ........... 578,000 ---------- Total ................ $4,396,000 ==========
Purchase Commitments -- At December 31, 1997, the Company has outstanding commitments to purchase network equipment with an aggregate cost of $8,844,880. FCC Subsidy -- On May 8, 1997, the FCC released an order establishing a significantly expanded federal telecommunications universal service program which both increased the size of existing subsidies and created new subsidy funds with respect to certain services offered in high-cost areas or to low income subscribers, schools, libraries, and rural healthcare providers. In the May 8 order, the FCC also announced that it will soon revise its rules for subsidizing service provided to consumers in high cost areas. The Company also may be required to contribute to state-established funds. As of December 31, 1997, the Company was unable to quantify the subsidy payments it may be required to make for the year. However, management believes that any such subsidy payments relating to periods through 1997 will not have a material effect on the Company's financial position or results of operations. BellSouth Proceeding -- A portion of the Company's revenue is derived from reciprocal compensation payments from incumbent local exchange carriers ("ILEC's") such as BellSouth Telecommunications, Inc. ("BellSouth"). Management believes that such payments are due pursuant to its ILEC interconnection agreements when, in the aggregate, the Company's customers receive more calls from the ILEC's customers than they make to the ILEC's customers. However, in August 1997 BellSouth indicated that it was not obligated to make such payments to the Company with respect to calls made to certain customers, principally internet service providers. In October 1997, the Company filed a petition with the public utilities commission ("PUC") in North Carolina seeking an order to compel BellSouth to make the reciprocal compensation payments. It is expected that the PUC will issue a F-9 US LEC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued 5. COMMITMENTS AND CONTINGENCIES -- Continued ruling in the first quarter of 1998, but such ruling may be subject to appeal. Management believes that the Company will ultimately be successful in this proceeding, but a final determination that the Company is not eligible for reciprocal compensation with respect to such calls could have a material adverse effect on the Company's financial condition and future results of operations. Since reciprocal compensation earned during 1997 is subject to the ruling to be issued by the PUC in North Carolina, the Company has deferred recognition of a significant portion ($1,141,386) of such revenue at December 31, 1997. 6. RELATED PARTIES During the year ended December 31, 1997, the Company received services under consulting agreements with two entities each controlled by Company stockholders. Payments under these agreements totaled $175,000, comprised of $125,000 and $50,000, respectively. Company management believes that these transactions were under terms no less favorable to the Company than could be arranged with unrelated parties. In 1996 the Company advanced $200,000 to its majority stockholder. The amount was repaid in January 1997. 7. EMPLOYEE BENEFIT PLAN The Company has a 401(k) profit-sharing plan under which employees can contribute up to 15% of their annual salary. Employees are eligible for participation after completing 1,000 hours of service within a 12-month period. The Company may make a discretionary contribution. However, no such contributions have been made for the period from inception to December 31, 1997. 8. STOCKHOLDERS' EQUITY Common Stock -- The Company has authorized two classes of common stock, Class A and Class B. The rights of holders of the Class A Common Stock and the Class B Common Stock are substantially identical, except that (i) holders of the Class A Common Stock are entitled to one vote per share and holders of the Class B Common Stock are entitled to 10 votes per share; (ii) holders of the Class B Common Stock vote as a separate class to elect two members of the Company's Board of Directors in addition to voting with the holders of Class A Common Stock in the election of the other members of the Board of Directors; and (iii) the Class B Common Stock is fully convertible at any time into Class A Common Stock, at the option of the holder, or automatically upon transfer to certain third persons, on a one-for-one basis. Pursuant to an agreement among the Class B stockholders, if a Class B stockholder proposes to sell or transfer Class B Common Stock to anyone other than a permitted transferee (as defined in the agreement), the other Class B stockholders who are parties to the agreement would have a right to acquire the Class B Common Stock that is proposed to be sold or transferred. Preferred Stock -- The Company is authorized to issue 10,000,000 shares of preferred stock ($.01 par value) in one or more series without stockholder approval, subject to any limitations prescribed by law. Each series of preferred stock shall have such rights and preferences as shall be determined by the Company's Board of Directors. No shares of preferred stock have been issued. Capital Contribution -- During 1997, the Company's majority stockholder contributed an aggregate of $1,710,850 to additional paid-in capital. Employee Stock Grants -- In 1996, as part of the Company's organizational activities, an aggregate of 1,540 non-voting limited liability company units were issued to induce certain employees to join the Company. The Company recorded compensation expense of $27,720 in 1996 for these units, based on the estimated fair value at the time the units were issued. F-10 US LEC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued 8. STOCKHOLDERS' EQUITY -- Continued Warrants -- During 1997, the Company issued warrants to three employees to purchase an aggregate of 345,000 shares of Class A Common Stock and a warrant to an outside sales agent to purchase 99,000 shares of Class A Common Stock. All of these warrants are fully vested and are exercisable at $2.86 per share for a three-year period from the date of issuance. None of these warrants have been exercised at December 31, 1997. Management believes that the employee warrants issued through October 1997 are noncompensatory based upon an internal valuation of their fair value. The exercise price of those warrants is the same as the issuance price in 1997 of shares to numerous outside investors. In November 1997, the Company granted to an employee, warrants to purchase 15,000 shares of Class A Common Stock at an exercise price of $2.86 per share. Management estimated the fair value of these warrants granted in November to be $6.00 per share. As a result, compensation of $47,100 has been charged to expense relating to the difference between the fair value and the exercise price of the warrants on the date of grant. In addition, in January 1998 the Company issued a warrant to a consultant to purchase 25,000 shares of Class A Common Stock at $10 per share, exercisable at any time through January 1, 2001. The Company will record compensation expense of $75,000 in the first quarter of 1998 associated with the warrant issued in January 1998. Had compensation cost for the employee warrants issued in 1997 been determined based on the fair value at the grant date in accordance with SFAS No. 123, Accounting for Stock-Based Compensation, the Company's 1997 net loss and net loss per share would have been $4,737,436 and $.25, respectively. The Company estimated the fair value of the warrants using the Black-Scholes model assuming no dividend yield or volatility, a risk-free interest rate of 6.0% and an expected life of 18 months for each of the warrants. For the warrant issued in 1997 to the outside sales agent, the fair value charged to expense was $23,700. The weighted average remaining contractual life of warrants outstanding at December 31, 1997 is 32 months. Stock Option Plan -- In January 1998, the Company adopted the US LEC Corp. 1998 Omnibus Stock Plan (the "Stock Plan"). Under this plan, 650,000 shares of Class A Common Stock have been reserved for issuance of stock options, stock appreciation rights, restricted stock, performance awards or other stock-based awards. Options granted under the Stock Plan are to be at exercise prices as determined by the Compensation Committee of the Board of Directors. For incentive stock options the option price may not be less than the market value of the Class A Common Stock on the date of grant (110% of market value for greater than 10% stockholders). In January 1998, the Company granted incentive stock options to substantially all employees to purchase an aggregate of 182,800 shares of Class A Common Stock at $10 per share, which options vest annually in four equal installments beginning in January 1999. The Company will record deferred compensation of $548,400 in the first quarter of 1998 associated with these options which will be amortized, beginning in the first quarter of 1998, to compensation expense over the four-year vesting period. Also, upon completion of a planned initial public offering of the Class A Common Stock, the Company intends to grant nonqualified options to purchase 5,000 shares of Class A Common Stock at the initial public offering price to each of the Company's two outside directors. 9. SUBSEQUENT EVENT (UNAUDITED) On February 14, 1998, the Company's majority stockholder exchanged $5,000,000 of loans to the Company for 480,770 shares of Class B Common Stock. The fair value of the Class B Common Stock issued in the exchange was $1,250,000 in excess of the carrying value of the debt. Accordingly, the difference between the carrying value of the debt and the fair value of the Class B Common Stock issued in the exchange will be recorded as a dividend to the majority shareholder in the first quarter of 1998. ******** F-11 (THIS PAGE INTENTIONALLY LEFT BLANK) - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- No dealer, salesperson or any other person has been authorized to give any information or to make any representations other than those contained in this Prospectus in connection with the offer contained herein, and, if given or made, such information or representations must not be relied upon as having been authorized by the Company or by any of the Underwriters. This Prospectus does not constitute an offer of any securities other than those to which it relates or an offer to sell, or a solicitation of an offer to buy, those to which it relates in any state to any person to whom it is not lawful to make such offer in such state. The delivery of this Prospectus at any time does not imply that the information herein is correct as of any time subsequent to its date. -------------------------- TABLE OF CONTENTS
Page --------- Prospectus Summary ........................................ 1 Risk Factors .............................................. 7 Use of Proceeds ........................................... 13 Dividend Policy ........................................... 13 Dilution .................................................. 13 Capitalization ............................................ 14 Selected Historical Consolidated Financial and Operating Data ......................................... 15 Management's Discussion and Analysis of Financial Condition and Results of Operations .......... 17 Business .................................................. 20 Management ................................................ 34 Certain Relationships and Related Transactions ............ 37 Security Ownership of Management .......................... 38 Description of Capital Stock .............................. 39 Shares Eligible for Future Sale ........................... 42 Underwriting .............................................. 43 Legal Matters ............................................. 45 Experts ................................................... 45 Available Information ..................................... 45 Glossary .................................................. 46 Index to Financial Statements ............................. F-1
Until , 1998 (25 days after the commencement of the Offering), all dealers effecting transactions in the Class A Common Stock, whether or not participating in this distribution, may be required to deliver a Prospectus. This is in addition to the obligation of dealers to deliver a Prospectus when acting as Underwriters and with respect to their unsold allotments or subscriptions. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 5,500,000 Shares US LEC Corp. Class A Common Stock (US LEC LOGO) ----------------- PROSPECTUS Dated , 1998 ----------------- Salomon Smith Barney Bear, Stearns & Co. Inc. Wheat First Union PART II. INFORMATION NOT REQUIRED IN PROSPECTUS Item 13. Other Expenses of Issuance And Distribution. The following is a list of the estimated expenses to be incurred by US LEC Corp. (the "Company" or the "Registrant") in connection with the distribution of the Class A Common Stock being registered hereby. Except for the Securities and Exchange Commission Registration Fee, the NASD Filing Fee and the Nasdaq National Market Listing Fee, all amounts are estimates. Securities and Exchange Commission Registration Fee ......... $ 27,989 NASD Filing Fee ............................................. 9,988 Nasdaq National Market Listing Fee .......................... 75,625 Printing and Engraving Costs ................................ 90,000 Accounting Fees and Expenses ................................ 200,000 Legal Fees and Expenses (excluding Blue Sky) ................ 225,000 Transfer Agent and Registrar Fees ........................... 10,000 Miscellaneous ............................................... 11,398 -------- Total ....................................................... $650,000 ========
Item 14. Indemnification of Directors and Officers. Certain provisions of the Company's Certificate of Incorporation (the "Certificate") and Bylaws provide that the Company shall indemnify all of its directors and officers to the fullest extent permitted by the General Corporation Law of the State of Delaware (the "Delaware Law"). In addition, the Certificate authorizes the Registrant to enter into one or more agreements with any person which provide for indemnification greater or different than that provided in its Certificate. Section 145 of the Delaware Law permits a corporation to indemnify its directors and officers against expenses (including attorney's fees), judgments, fines and amounts paid in settlements actually and reasonably incurred by them in connection with any action, suit or proceeding, whether criminal or civil, brought by a third party if such directors or officers acted in good faith and in a manner they reasonably believed to be in or not opposed to the best interests of the corporation and, with respect to any criminal action or proceeding, had no reason to believe their conduct was unlawful. In a derivative action, indemnification may be made only for expenses actually and reasonably incurred by directors and officers in connection with the defense or settlement of an action or suit and only with respect to a matter as to which they shall have acted in good faith and in a manner they reasonably believed to be in or not opposed to the best interest of the corporation, except that no indemnification shall be made if such person shall have been adjudged liable to the corporation, unless and only to the extent that the court in which the action or suit was brought shall determine upon application that the defendant officers or directors are reasonably entitled to indemnity for such expenses despite such adjudication of liability. In addition, Section 102 of the Delaware Law provides that a corporation may include in its certificate of incorporation a provision eliminating or limiting the personal liability of directors for monetary damages for breach of fiduciary duty, provided that such provision shall not eliminate or limit the liability of a director: (i) for any breach of the director's duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith that involve intentional misconduct or a knowing violation of the law; (iii) conduct in violation of Section 174 of the Delaware Law (which section relates to unlawful distributions); or (iv) for any transaction from which the director derived an improper personal benefit. The Certificate currently includes such provisions. Reference is also hereby made to Section 8 of the Underwriting Agreement, a copy of which is filed as Exhibit 1 to this Registration Statement, for information concerning indemnification arrangements among the Company and the Underwriters. Item 15. Recent Sales of Unregistered Securities. On December 31, 1997, US LEC L.L.C., a Delaware limited liability company, was merged into the Company (the "Merger"). As a result of the Merger, the Company issued (i) 3,855,000 shares of Class A Common II-1 Stock to the holders of all outstanding nonvoting units of membership interest in US LEC L.L.C (the "Nonvoting Units"), (ii) 16,594,500 shares of Class B Common Stock to the holders of all outstanding voting units of membership interest in US LEC L.L.C. (the "Voting Units") and (iii) warrants to purchase 444,000 shares of Class A Common Stock to the holders of all outstanding warrants to purchase Nonvoting Units (the "Warrants"). Immediately prior to the Merger, the 2,570 outstanding Nonvoting Units were beneficially owned by a total of 53 persons, including employees of US LEC L.L.C. and private investors, the 11,063 outstanding Voting Units were beneficially owned by Messrs. Aab and Ganatra and the Warrants were held by three employees and a sales agent of US LEC L.L.C. The transaction was not registered under the Securities Act pursuant to the exemption provided by Section 4(2) thereof for transactions not involving any public offering. In January 1998, the Company granted incentive stock options to 96 employees covering 182,800 shares of Class A Common Stock. These transactions were not registered under the Securities Act pursuant to the exemption provided by Rule 701 promulgated thereunder for sales of securities pursuant to compensatory benefit plans. In February, 1998, Mr. Aab exchanged a note payable by Company to him in the amount of $5,000,000 for 480,770 shares of Class B Common Stock. The transaction was not registered under the Securities Act pursuant to the exemption provided by Section 4(2) thereof for transactions not involving any public offering. Item 16. Exhibits and Financial Statement Schedules. (a) Exhibits:
Exhibit No. Description - ------------- ---------------------------------------------------------------------------------------- 1 Form of Underwriting Agreement** 3.1 Form of Restated Certificate of Incorporation of the Company 3.2 Bylaws of the Company* 3.3 Amendment No. 1 to By-laws of the Company 4 Form of Class A Common Stock Certificate 5 Opinion of Moore & Van Allen, PLLC 10.1 US LEC Corp. 1998 Omnibus Stock Plan* 10.2 Promissory Note, dated January 16, 1998, made by the Company to Melrich Associates, L.P. 10.3 Security Agreement, dated January 16, 1998, by and between the Company and Melrich Associates, L.P. 10.4 Promissory Note, dated January 16, 1998, made by the Company to Tansukh V. Ganatra 10.5 Security Agreement, dated January 16, 1998, by and between the Company and Tansukh V. Ganatra 10.6 Guaranty and Suretyship Agreement, dated January 16, 1998, by and among the Company and Richard T. Aab, Melrich Associates, L.P. and Tansukh V. Ganatra 10.7 Contribution Agreement, dated February 14, 1998, by and between US LEC Corp. and Richard T. Aab 10.8 Non-transferable Warrant, dated August 4, 1997, issued to David N. Vail* 10.9 Non-transferable Warrant, dated August 4, 1997, issued to Craig K. Simpson* 10.10 Form of Amended and Restated Class B Stockholders Agreement, dated as of January 1, 1998 10.11 Consulting Agreement, dated December 18, 1997 by and between the Company and RTA Associates, LLC and related termination letter, dated January 1, 1998 10.12 Consulting Agreement, dated December 18, 1997 by and between the Company and Super STAR Associates Limited Partnership and related termination letter, dated January 1, 1998 21 Subsidiaries of the Registrant 23.1 Consent of Deloitte & Touche LLP 23.2 Consent of Moore & Van Allen, PLLC (included in its opinion filed as Exhibit 5) 24 Power of Attorney*
- ---------- * Previously filed. ** To be filed by amendment. II-2 Item 17. Undertakings. The undersigned Registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of Prospectus filed as part of this Registration Statement in reliance upon Rule 430A and contained in a form of Prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective; (2) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of Prospectus shall be deemed to be a new Registration Statement relating to the securities offered therein, and the offering of such securities at that item shall be deemed to be the initial bona fide public offering thereof; and (3) The undersigned Registrant hereby undertakes to provide to the Underwriters at the closing specified in the Underwriting Agreement, certificates in such denominations and registered in such names as required by the Underwriters to permit prompt delivery to each purchaser. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act of 1933 and will be governed by the final adjudication of such issue. II-3 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Charlotte, State of North Carolina, on April 4, 1998. US LEC Corp. By: /s/ DAVID N. VAIL -------------------------------- David N. Vail, Executive Vice President -- Finance and Chief Financial Officer In accordance with the requirements of the Securities Act of 1933, this Registration Statement was signed by the following persons in the capacities and on the dates stated:
Signature Title Date - ------------------------------------ ----------------------------------------- -------------- /s/ RICHARD T. AAB* Chairman of the Board of Directors, April 4, 1998 ------------------------------- Richard T. Aab Chief Executive Officer and Director /s/ TANSUKH V. GANATRA* President, Chief Operating Officer and April 4, 1998 ------------------------------- Tansukh V. Ganatra Director /s/ DAVID N. VAIL Executive Vice President -- Finance and April 4, 1998 ------------------------------- David N. Vail Chief Financial Officer (Principal Accounting Officer) /s/ DAVID M. FLAUM* Director April 4, 1998 ------------------------------- David M. Flaum /s/ STEVEN L. SCHOONOVER* Director April 4, 1998 ------------------------------- Steven L. Schoonover *By: /s/ DAVID N. VAIL --------------------------- David N. Vail Attorney-in-Fact
II-4 EX-3 2 EXHIBIT 3.1 RESTATED CERTIFICATE OF INCORPORATION OF US LEC CORP. US LEC Corp., a corporation organized and existing under the laws of the State of Delaware, hereby certifies as follows: I. 1. The name of the Corporation is US LEC Corp. The Corporation was originally incorporated under the same name, and the original Certificate of Incorporation of the Corporation was filed with the Secretary of State of the State of Delaware on December 29, 1997. 2. Pursuant to Sections 242 and 245 of the General Corporation Law of the State of Delaware, this Restated Certificate of Incorporation restates and integrates and further amends the provisions of the Certificate of Incorporation of the Corporation. 3. The text of the Restated Certificate of Incorporation as heretofore amended or supplemented is hereby restated and further amended to read in its entirety as follows. II. The address of the Corporation's registered office in the State of Delaware is The Corporation Trust Center, 1209 Orange Street, in the City of Wilmington, County of New Castle. The name of the Corporation's registered agent at such address is The Corporation Trust Company. III. The nature of the business or purposes to be conducted or promoted by the Corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of the State of Delaware. IV. 1. The total number of shares of all stock which the Corporation shall have the authority to issue is One Hundred Million shares (100,000,000), consisting of Ten Million (10,000,000) shares of Preferred Stock, $.01 par value per share, and Ninety Million (90,000,000) shares of Common Stock. The Common Stock shall be divided into two (2) classes as follows: (a) Seventy-Two Million Nine Hundred Twenty-Four Thousand Seven Hundred Twenty-Eight (72,924,728) shares of Class A Common Stock, $.01 par value per share ("Class A Common"); and (b) Seventeen Million Seventy-Five Thousand Two Hundred Seventy-Two (17,075,272) shares of Class B Common Stock, $.01 par value per share ("Class B Common"). 2. Common Stock. (a) Rights Generally. Except as provided herein, all shares of Class A Common and Class B Common (together, the "Common Stock") shall be identical and entitle the holders thereof to the same rights and privileges. (b) Dividends and Stock Splits. Whenever dividends upon Preferred Stock at the time outstanding, to the extent of any preference to which such stock is entitled, shall have been paid in full, or declared and set apart for payment, for all current and, if such Preferred Stock shall have cumulative rights, all past dividend periods, and after the provisions for any sinking or purchase fund or funds for any series of Preferred Stock shall have been complied with, the Board of Directors may declare and pay dividends on the Common Stock, payable in cash or otherwise, and the holders of shares of Preferred Stock shall not be entitled to share therein, subject to the certificate of designation for any outstanding series of Preferred Stock, provided that, if dividends are declared on the Common Stock which are payable in shares of Common Stock, dividends shall be declared which are payable at the same rate on both classes of Common Stock with dividends payable in shares of Class A Common payable to holders of shares of Class A Common and dividends payable in shares of Class B Common shall be payable to holders of shares of Class B Common; and provided further, that no dividends payable in shares of Class A Common or Class B Common shall be declared unless an adequate number of authorized but unissued shares of Class A Common or Class B Common, as applicable, is available as of the date of such declaration. No split of the Class A Common may occur unless the Class B Common are split in the same manner and no split of the Class B Common may occur unless the Class A Common are split in the same manner. (c) Liquidation. In the event of any liquidation, dissolution or winding up of the Corporation or upon the distribution of assets of the Corporation, all assets and funds of the Corporation remaining, after the payment to the holders of Preferred Stock of the full preferential amounts to which they shall be entitled pursuant to the certificate of designation for such series of Preferred Stock, shall be divided and distributed among the holders of the Common Stock ratably. (d) Voting. Except as otherwise required by law, the holders of Class A Common shall be entitled to one (1) vote per share on all matters to be voted on by the stockholders of the Corporation and the holders of Class B Common shall be entitled to ten (10) votes per share on all matters to be voted on by the stockholders of the Corporation. Except as otherwise provided by law and as otherwise provided in Article VI.2 below with respect to the election of the Class B Directors (as defined below), the holders of Class A 2 Common and the holders of Class B Common shall vote as a single class on all matters that are submitted to the stockholders for a vote. (e) Conversion. (i) Mandatory Conversion. Upon the sale, distribution or disposition of any or all of the shares of Class B Common held by Richard T. Aab ("Aab"), Melrich Associates, L.P., ("Melrich"), Tansukh V. Ganatra ("Ganatra"), Super STAR Associates Limited Partnership ("STAR") or any Permitted Transferee (as defined clause (f) below) to any party other than to, between or among Aab, Melrich, Ganatra, STAR (collectively, the "Initial Holders") or a Permitted Transferee, each share so sold, distributed or disposed of shall immediately be converted into one fully paid and nonassessable share of Class A Common (a "Mandatory Conversion"). Each such Mandatory Conversion shall be carried out as follows: Concurrently with the occurrence of a transfer giving rise to a Mandatory Conversion, the transferor shall surrender for conversion into Class A Common the certificate or certificates representing the Class B Common shares transferred at the principal office of the Corporation at any time during normal business hours, together with a written notice stating that such transferor has transferred the shares, or a stated number of the shares, of Class B Common represented by such certificate or certificates to a transferee other than an Initial Holder or a Permitted Transferee. Such notice shall also state the name or names (with addresses) of the transferee of such shares, which shall also be the name in which the shares of Class A Common will be issued. Regardless of when the surrender of certificates representing the transferred shares of Class B Common and the accompanying notice are received by the Corporation, the Mandatory Conversion shall be deemed to have been effected on and as of the date of such transfer of the shares of Class B Common, and at such time the rights of the transferor of the converted shares of Class B Common as a holder of such shares shall cease and the person or persons in whose name or names the certificate or certificates for such shares of Class A Common are to be issued shall be deemed to have become the holder or holders of record of the shares of Class A Common represented thereby. (ii) Elective Conversion. At the election of any Initial Holder, or a Permitted Transferee then holding shares of Class B Common, each share of Class B Common shall be convertible at any time into one fully paid and nonassessable share of Class A Common (an "Elective Conversion"). Each such Elective Conversion of shares of Class B Common into shares of Class A Common shall be effected by the surrender of the certificate or certificates representing the shares to be converted at the principal office of the Corporation at any time during normal business hours, together with a written notice stating that such holder desires to convert the shares, or a stated number of the shares, of Class 3 B Common represented by such certificate or certificates into shares of Class A Common. Such notice shall also state the name or names (with addresses) and denominations in which the certificate or certificates for such Class A Common are to be issued. Such conversion shall be deemed to have been effected as of the close of business on the date on which such certificate or certificates have been surrendered and such notice has been received, and at such time the rights of the holder of the converted shares of Class B Common as such holder shall cease and the person or persons in whose name or names the certificate or certificates for such shares of Class A Common are to be issued upon such conversion shall be deemed to have become the holder or holders of record of the shares of Class A Common represented thereby. (iii) New Certificates. Pursuant to either a Mandatory Conversion or an Elective Conversion, the Corporation shall issue and deliver each of the following upon surrender of the certificates of Class B Common for conversion and the receipt of the required written notice: (A) The certificate or certificates representing the shares of Class A Common issuable upon such conversion; and (B) a certificate representing any shares of Class B Common which were represented by the certificate or certificates delivered to the Corporation in connection with such conversion but which were not converted into shares of Class A Common. The issuance of certificates representing shares of Class A Common received upon conversion of shares of Class B Common shall be made without charge to the holders of such shares for any issuance tax in respect thereof or other cost incurred by the Corporation in connection with such conversion and the related issuance of Class A Common. (iv) The Corporation will not close its books against the transfer of shares of Class A Common in any manner which would interfere with the timely conversion of any shares of Class B Common. (v) The Corporation shall at all times reserve from its authorized Class A Common a sufficient number of shares to provide for conversion of all Class B Common from time to time outstanding. (vi) Following its conversion to Class A Common, a share of Class B Common may not be reissued by the Corporation. (vii) The Corporation shall note on the certificates for shares of Class B Common that there are restrictions on transfer imposed by Article IV, Section (e) hereof. 4 (f) As used herein, "Permitted Transferee" means any of the following: (i) In the case of any Initial Holder who is a natural person or any Permitted Transferee who is a natural person: (A) Any spouse or lineal descendant of such stockholder (the stockholder and such spouse and lineal descendants are herein collectively referred to as "Class B Holder's Family Members"); (B) The trustee of a trust (including a voting trust) principally for the benefit of such stockholder and/or one or more of his, her or its Permitted Transferees, provided that such trust may also grant a general or special power of appointment to one or more of such Class B Holder's Family Members and may permit trust assets to be used to pay taxes, legacies and other obligations of the trust or of the estates of one or more of such Class B Holder's Family Members payable by reason of the death of any of such Class B Holder's Family Members; (C) A corporation if a majority of all of the outstanding capital stock of such corporation which is entitled to vote for the election of directors is owned by the holder of the Class B Common in question or his, her or its Permitted Transferees, provided that if by reason of any change in the ownership of such stock, such corporation would no longer qualify as a Permitted Transferee, all shares of Class B Common then held by such corporation shall, at the moment of such change, be subject to a Mandatory Conversion; (D) A partnership if a majority of the interests in the partnership are owned by the holder of the Class B Common in question or his, her or its Permitted Transferees determined under this clause (f)(i), provided that if by reason of any change in the ownership of such partnership interests, such partnership would no longer qualify as a Permitted Transferee, all shares of Class B Common then held by such partnership shall, at the moment of such change, be subject to a Mandatory Conversion; (E) A limited liability company if a majority of all of the member interests in the company are owned by the holder of the Class B Common in question or his, her or its Permitted Transferees determined under this clause (f)(i), provided that if by reason of any change in the ownership of such member interests, such company would no longer qualify as a Permitted Transferee, all shares of Class B Common then held by such company shall, at the moment of such change, be subject to a Mandatory Conversion; and 5 (F) The estate of such stockholder. (ii) In the case of a holder of shares of Class B Common holding such shares as trustee pursuant to a trust, Permitted Transferee means (A) any person transferring shares of Class B Common to such trust and (B) any Permitted Transferee of any such person determined pursuant to clause (f)(i) above. (iii) In the case of a holder of Class B Common which is a limited partnership that acquired record and beneficial ownership of the shares of Class B Common in question upon its initial issuance by the Corporation, Permitted Transferee means (A) any limited or general partner of such partnership as of the date of the initial issuance of the shares of Class B Common, and (B) any Permitted Transferee of any such person determined under clause (f)(i) above. (iv) In the case of a holder of Class B Common which is a corporation, partnership or limited liability company (other than a limited partnership described in clause (f)(iii) above) holding record and beneficial ownership of the shares of Class B Common in question, Permitted Transferee means (A) any person transferring such shares of Class B Common to such corporation, partnership or company and (B) any Permitted Transferee of any such person determined under clause (f)(i) above. (v) In the case of a holder of Class B Common which is the estate of a deceased stockholder, or which is the estate of a bankrupt or insolvent stockholder, which holds record and beneficial ownership of the shares of Class B Common in question, Permitted Transferee means a Permitted Transferee of such deceased, bankrupt or insolvent stockholder as determined pursuant to clause (f)(i), (f)(ii), (f)(iii) or (f)(iv) above, as the case may be. (g) For purposes of Article IV.2(f) above: (i) The relationship of any person that is derived by or through legal adoption shall be considered a natural one. (ii) Each joint owner of a share of Class B Common shall be considered a stockholder. (iii) Unless otherwise specified, the term "person" means both natural persons and legal entities. (h) Without derogating from the effect of a change in ownership described in Article IV.2(f) above, each reference to a corporation shall include any successor corporation or other entity resulting from a merger, consolidation or other corporate 6 reorganization or similar event, each reference to a partnership shall include any successor partnership or other entity resulting from the death or withdrawal of a partner or a merger, consolidation or similar event, and each reference to a limited liability company shall include any successor limited liability company or other entity resulting from the death or withdrawal of a member or a merger, consolidation or similar event. (i) No restatement or amendment may be made to this Restated Certificate of Incorporation that adversely affects the specified rights of the holders of Class B Common (including, but not limited to, the conversion rights, voting rights, and rights with respect to the election of directors and classification of directors) or to authorize any additional shares of capital stock other than the capital stock authorized herein, without the affirmative vote of a majority of the holders of the Class B Common. 3. Preferred Stock. The Board of Directors is authorized, subject to limitations prescribed by law, to provide for the issuance of the shares of Preferred Stock in classes, and by filing a certificate setting forth the designations of such shares pursuant to the applicable law of the State of Delaware, to establish from time to time the number of shares to be included in each such class, and to fix the designations, powers, preferences and rights of the shares of each such class and the qualifications, limitations or restrictions thereof. The authority of the Board of Directors with respect to each class shall include, but not be limited to, determination of the following: (a) The number of shares constituting that class and the distinctive designation of that class; (b) The dividend rate, if any, on the shares of that class, the dividend preference, if any, of that class, whether dividends shall be cumulative, and, if so, from which date or dates, and the relative rights of priority, if any, of payment of dividends on shares of that class; (c) Whether that class shall have voting rights, in addition to the voting rights provided by law, and if so, the terms of such voting rights; (d) Whether that class shall have conversion privileges, and, if so, the terms and conditions of such conversion, including provision for adjustment of the conversion rate in such events as the Board of Directors shall determine; (e) Whether or not the shares of that class shall be redeemable, and, if so, the terms and conditions of such redemption, including the date or date upon or after which the class shall be redeemable, and the amount per share payable in case of redemption, which amount may vary under different conditions and at different redemption dates; (f) Whether that class shall have a sinking fund for the redemption or purchase of shares of that class, and, if so, the terms and amount of such sinking fund; 7 (g) The rights of the shares of that class in the event of voluntary or involuntary liquidation, dissolution or winding up of the Corporation, and the relative rights of priority, if any, of payment of shares of that class; and (h) Any other relative rights, preferences and limitations of that class. If, upon any voluntary or involuntary liquidation, dissolution or winding up of the Corporation, the assets available for the distribution to holders of shares of Preferred Stock of all classes shall be insufficient to pay such holders the full preferential amount to which they are entitled, then such assets shall be distributed ratably among the shares of all classes of Preferred Stock in accordance with the respective preferential amounts (including unpaid cumulative dividends, if any) payable with respect thereto. V. The Board of Directors is expressly authorized and empowered to adopt, amend, modify and repeal the By-Laws of the Corporation, subject to (a) the limitations on such power set forth in Article VIII of the By-Laws and (b) the power of the stockholders of the Corporation, subject to the limitation on such power set forth in Article VIII of the By-Laws, to amend, modify or repeal any By-Laws adopted by the Board of Directors. VI. 1. The business of the Corporation shall be managed by a Board of Directors, and, subject to the requirement that the number of directors comprising the Board of Directors may not be less than three (3), the number of directors comprising the Board of Directors shall be fixed by the By-Laws and such number may from time to time be increased or decreased (but not below three) in such manner as is provided by the By-Laws of the Corporation. The number of directors comprising the Board of Directors on the date hereof shall be four (4). 2. The Board of Directors shall consist of two classes of directors: (a) "Class B Directors" of which there shall be two (2) directors at all times during which shares of Class B Common are issued and outstanding. The Class B Directors shall be elected solely by majority vote of the holders of the Class B Common voting as a separate class from all other shares of capital stock of the Corporation, and (b) "Class A Directors", who shall be all directors of the Corporation who are not Class B Directors. Class A Directors shall be elected by holders of all shares of capital stock of the Corporation entitled to vote in the election of directors (including, but not limited to, the Class A Common and the Class B Common). Class B Directors may be removed at any time, and the vacancy(ies) thereby created filled, by a majority vote of the holders of the Class B Common voting as a separate class from all other shares of capital stock of the Corporation. If at any time after the date hereof no shares of Class B Common are issued and outstanding, this subsection VI.2 shall be void and of no further force or effect. 8 VII. Each person who is or was or had agreed to become a director or officer of the Corporation, or each such person who is or was serving or had agreed to serve at the request of the Board of Directors or an officer of the Corporation as an employee or agent of the Corporation or as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise (including the heirs, executors, administrators or estate of such person), shall be indemnified by the Corporation to the fullest extent permitted by the General Corporation Law of the State of Delaware or any other applicable laws as now or hereafter in effect. Without limiting the generality or effect of the foregoing, the Corporation may enter into one or more agreements with any person which provide for indemnification greater or different that that provided in this Article VII. No amendment to or repeal of this Article VII shall apply to or have any effect on the right to indemnity permitted or authorized hereunder for or with respect to claims asserted before or after such amendment or repeal arising from acts or omissions occurring in the whole or in part before the effective date of such amendment or repeal. VIII. To the fullest extent permitted by the Delaware General Corporation Law as the same exists or may hereafter be amended, a director of the Corporation shall not be liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director. No amendment to or repeal of this Article VIII shall apply to or have any effect on the liability or alleged liability of any director of the Corporation for or with respect to any acts or omissions of such director occurring prior to such amendment or repeal. IX. Subject to Article IV.2(i) hereof, the Corporation reserves the right to amend, modify or repeal any provision contained in this Restated Certificate of Incorporation, in the manner now or hereafter prescribed by statute or by this Restated Certificate of Incorporation of the Corporation, and all rights conferred upon stockholders herein are granted subject to this reservation. IN WITNESS WHEREOF, this Restated Certificate of Incorporation has been signed by Tansukh V. Ganatra, its authorized officer this _______ day of _____________, 1998. US LEC CORP. By: Tansukh V. Ganatra President and Chief Operating Officer 9 EX-3 3 EXHIBIT 3.3 AMENDMENT NO. 1 TO BY-LAWS OF US LEC CORP. RESOLVED, that Article VII of the Bylaws of the Corporation be, and it hereby is, amended by adding the following Section 4: Section 4. Advancement of Expenses. Expenses (including attorneys' fees) incurred by an officer or director in defending any civil, criminal, administrative or investigative action, suit or proceeding with respect to which such person may be entitled to indemnification shall be paid by the Corporation in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of such director or officer to repay such amount if it shall ultimately be determined that such person is not entitled to be indemnified by the Corporation as authorized under Delaware General Corporation Law and under the Corporation's Certificate of Incorporation. FURTHER RESOLVED, that except as amended hereby, all provisions of the Bylaws shall continue and remain in full force and effect. Adopted as of February 1, 1998 EX-4 4 EXHIBIT 4 Exhibit 4 [US LEC Corp. Logo] CLASS A COMMON STOCK NUMBER SHARES US LEC CORP. INCORPORATED UNDER THE LAWS OF THE STATE OF DELAWARE CUSIP 90331S 10 9 THIS CERTIFIES THAT: IS THE REGISTERED HOLDER OF FULLY PAID AND NONASSESSABLE SHARES OF CLASS A COMMON STOCK, PAR VALUE $0.01 PER SHARE, OF US LEC Corp. (the "Corporation"), a Delaware corporation. The shares represented by this certificate are transferable only on the stock transfer books of the Corporation by the holder of record hereof, or by his duly authorized attorney or legal representative, upon the surrender of this certificate properly endorsed. This certificate is not valid until countersigned and registered by the Corporation's transfer agent and registrar. IN WITNESS WHEREOF, the Corporation has caused this certificate to be executed by the facsimile signatures of its duly authorized officers and has caused a facsimile of its corporate seal to be hereunto affixed. Dated Countersigned and Registered: /s/ Richard T. Aab Chairman and Chief Executive Officer First Union National Bank (Charlotte, North Carolina) Transfer Agent and /s/ Tansukh V. Ganatra Registrar Assistant Secretary By Authorized Officer SEAL OF US LEC CORP. US LEC CORP. The shares represented by this certificate are issued subject to all the provisions of the certificate of incorporation and bylaws of US LEC Corp. (the "Corporation") as from time to time amended (copies of which are on file at the principal executive offices of the Corporation). The Corporation will furnish to any stockholder upon request and without charge a full statement of the powers, designations, preferences and relative participating, optional or other special rights of each authorized class of stock or series thereof and the qualifications, limitations or restrictions of such preferences and/or rights, to the extent that the same have been fixed, and of the authority of the board of directors to designate the same with respect to other series. Such request may be made to the Corporation or to its transfer agent and registrar. The following abbreviations, when used on the face of this certificate, shall be construed as though they were written out in full according to applicable laws or regulations:
TEN COM -- as tenants in common UNIF GIFT MIN ACT-- ............Custodian.......... TEN ENT -- as tenants joined by the entireties (Cust) (Minor) JT TEN -- as joint tenants with right of Under Uniform Gifts to Minors survivorship and not as Act ........................... tenants in common (State) UNIF TRANS MIN ACT -- ............Custodian.......... (Cust) (Minor) Under Uniform Transfers to Minors Act ..................... (State)
Additional abbreviations may also be used though not in the above list. For value received, hereby sell, assign and transfer unto ---------------------- PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER OF ASSIGNEE ------------------------------------------------ ------------------------------------------------ - ----------------------------------------------------------------------------- (PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS, INCLUDING ZIP CODE) - ----------------------------------------------------------------------------- - ----------------------------------------------------------------------------- Shares - ------------------------------------------------------------------------- of the Common Stock represented by the within certificate, do and hereby irrevocably constitute and appoint Attorney - -------------------------------------------------------------------- 2 to transfer the said shares on the books of the within named Corporation with full power of substitution in the premises. Dated --------------------------- NOTICE: -------------------------------------------- THE SIGNATURE TO THIS ASSIGNMENT MUST CORRESPOND WITH THE NAME AS WRITTEN UPON THE FACE OF THE CERTIFICATE IN EVERY PARTICULAR, WITHOUT ALTERATION OR ENLARGEMENT OR ANY CHANGE WHATEVER. SIGNATURE(S) GUARANTEED: ------------------------------------------------ THE SIGNATURE(S) SHOULD BE GUARANTEED BY AN ELIGIBLE GUARANTOR INSTITUTION (BANKS, STOCKBROKERS, SAVINGS AND LOAN ASSOCIATIONS AND CREDIT UNIONS WITH MEMBERSHIP IN AN APPROVED SIGNATURE GUARANTEE MEDALLION PROGRAM), PURSUANT TO S.E.C. RULE 17ad-15. 3 EX-5 5 EXHIBIT 5 MOORE & VAN ALLEN, PLLC NATIONSBANK CORPORATE CENTER 100 NORTH TRYON STREET, FLOOR 47 CHARLOTTE, NORTH CAROLINA 28202-4003 April __, 1998 US LEC Corp. 212 South Tryon Street, Suite 1540 Charlotte, North Carolina 28281 Re: Registration Statement on Form S-1 Ladies and Gentlemen: We have acted as counsel to US LEC Corp., a Delaware corporation (the "Company"), in connection with the registration by the Company under the Securities Act of 1933, as amended, on Form S-1 of 5,500,000 shares (the "Initial Shares") of the Company's Class A Common Stock, par value $0.01 per share (the "Common Stock"), and up to 825,000 shares (the "Option Shares") of Common Stock upon the exercise of the over-allotment option granted to the several underwriters named in the registration statement relating to the Shares (as defined below) (the "Registration Statement"). The Initial Shares and the Option Shares (to the extent the aforementioned option is exercised) are herein collectively referred to as the "Shares." The Shares will be sold pursuant to an Underwriting Agreement by and among the Company, Smith Barney Inc., Bear Stearns & Co., Inc. and Wheat First Securities, Inc. as representatives of the several underwriters named in the Registration Statement (the "Underwriting Agreement"). We have reviewed such documents and considered such matters of law and fact as we, in our professional judgment, have deemed appropriate to render the opinions contained herein. Where we have considered it appropriate, as to certain facts we have relied, without investigation or analysis of any underlying data contained therein, upon certificates or other comparable documents of public officials and officers or other appropriate representatives of the Company. Based upon such examination, and relying upon statements of fact contained in the documents which we have examined, we are of the opinion that the Shares to be sold pursuant to the Underwriting Agreement have been duly authorized and will be validly issued, fully paid and nonassessable when issued, delivered and paid for as contemplated by the Underwriting Agreement. We hereby consent to the filing of this opinion as Exhibit 5 to the Registration Statement and to the reference to this firm under the caption "Legal Matters" in the Prospectus included therein. Very truly yours, MOORE & VAN ALLEN, PLLC EX-10.2 6 PROMISSORY NOTE US LEC CORP. PROMISSORY NOTE January 16, 1998 $2,289,150 US LEC Corp., a Delaware corporation (the "Company"), hereby promises to pay to the order of Melrich Associates, L.P. the principal amount of Two Million Two Hundred Eighty-Nine Thousand One Hundred Fifty Dollars ($2,289,150) together with interest thereon calculated from the date hereof in accordance with the provisions of this Note. 1. Payment of Interest. Interest shall accrue at the rate of twelve percent (12%) per annum on the unpaid principal amount of this Note outstanding from time to time, or (if less) at the highest rate then permitted under applicable law. The Company shall pay to the holder of this Note all accrued interest on the last day of each March, June, September and December, beginning March 30, 1998. Unless prohibited under applicable law, any accrued interest which is not paid on the date on which it is due and payable shall bear interest at the same rate at which interest is then accruing on the principal amount of this Note until such interest is paid. Any accrued interest which for any reason has not theretofore been paid shall be paid in full on the date on which the final principal payment on this Note is made. Interest shall accrue on any principal payment due under this Note and, to the extent permitted by applicable law, on any interest which has not been paid on the date on which it is due and payable until such time as payment therefor is actually delivered to the holder of this Note. 2. Payment of Principal on Note. (a) Prepayments. The Company may, at any time and from time to time without premium or penalty, prepay all or any portion of the outstanding principal amount of the Notes, provided that (i) the Company has paid all interest on the Notes accrued through the immediately preceding scheduled interest payment date and (ii) the minimum principal amount so prepaid shall be the lesser of $100,000 or the amount of principal outstanding on the Notes. In connection with each prepayment of principal hereunder, the Company shall also pay all accrued and unpaid interest on the principal amount of the Notes being repaid. (b) Principal Repayment. On January 16, 2003 (the "Scheduled Repayment Date"), the Company shall pay all outstanding principal and interest on the Notes. (c) Special Principal Repayments. (i) If a Change in Control has occurred or the Company obtains knowledge that a Change in Control is proposed to occur, the Company shall give prompt written notice of such Change in Control describing in reasonable detail the material terms and date of consummation thereof to the holder of this Note, but in any event such notice shall not be given later than five days after the occurrence of such Change in Control, and the Company shall give the holder of this Note prompt written notice of any material change in the terms or timing of such transaction. The holder of this Note may require the Company to pay all or any portion of the principal amount remaining on this Note plus all unpaid accrued interest with respect to such principal amount. (ii) The Company shall be obligated to pay the amount set forth in subparagraph (i) above with respect to the Change in Control. If any proposed Change in Control does not occur, all requests for payment in connection therewith shall be automatically rescinded, or if there has been a material change in the terms or the timing of the transaction, the holder of the Note may rescind its request for payment by giving written notice of such rescission to the Company. (iii) The term "Change in Control" means (a) any sale, transfer or issuance or series of sales, transfers and/or issuances of Common Stock by the Company or any holders thereof which results in any Person or group of Persons (as the term "group" is used under the Securities Exchange Act of 1934, as amended), owning shares of Common Stock entitling the owners thereof to more than 40% of the combined voting power of all shares of Common Stock outstanding immediately after such sale, transfer or issuance or series of sales, transfers and/or issuances or (b) any change of 50% or more of the members of the Company's Board of Directors during any 12 month period if the election of the new members is not approved or recommended by the Company's Board of Directors in office prior to such change. (iv) If a Fundamental Change is proposed to occur, the Company shall give written notice of such Fundamental Change describing in reasonable detail the material terms and date of consummation thereof to the holder of this Note not more than 45 days nor less than 20 days prior to the consummation of such Fundamental Change, and the Company shall give the holder of this Note prompt written notice of any material change in the terms or timing 2 of such transaction. The holder of this Note may require the Company to pay all or any portion of the principal amount remaining on this Note plus all unpaid accrued interest with respect to such principal amount. (v) The Company shall be obligated to pay the amount set forth in subparagraph (iv) above upon the consummation of such Fundamental Change. If any proposed Fundamental Change does not occur, all requests for payment in connection therewith shall be automatically rescinded, or if there has been a material change in the terms or the timing of the transaction, the holder of this Note may rescind its request for payment by delivering written notice thereof to the Company prior to the consummation of the transaction. (vi) The term "Fundamental Change" means (a) any sale or transfer of more than 50% of the assets of the Company and its Subsidiaries on a consolidated basis (measured either by book value in accordance with generally accepted accounting principles consistently applied or by fair market value determined in the reasonable good faith judgment of the Company's board of directors) in any transaction or series of transactions (other than sales in the ordinary course of business) and (b) any merger or consolidation to which the Company is a party, except for a merger in which the Company is the surviving corporation, and after giving effect to such merger, no Person or group of Persons (as the term "group" is used under the Securities Act of 1934, as amended) owns more than 40% of the combined voting power of all shares of Common Stock outstanding immediately after such merger who did not own 40% or more of such voting power of the Company prior to such merger. 3. Events of Default. (a) Definition. For purposes of this Note, an Event of Default shall be deemed to have occurred if any of the following exist or occur: (i) the Company fails to pay when due and payable (whether at maturity or otherwise) the full amount of interest then accrued on any Note or the full amount of any principal due on any Note, and such failure to pay is not cured within five days after the occurrence thereof; or (ii) the Company fails to perform or observe any other material covenant or agreement in this Note and such failure is not cured 3 within 30 days after the earlier of (A) the receipt of notice thereof by the holder of this Note or (B) the discovery thereof by the Company; (iii) US LEC of Georgia L.L.C. and US LEC of North Carolina L.L.C. fail to perform or observe any other material covenant or agreement in that Certain Guaranty and Suretyship Agreement dated as of the date hereof (the "Payment Default") and such failure is not cured within 30 days after the earlier of (A) the receipt of notice thereof by the holder of this Note or (B) the discovery thereof by the Company; (iv) any representation, warranty or information required to be furnished to the holder is misleading in any material respect on the date made or furnished and such false or misleading representation, warranty or information relates to a material adverse effect on the Company and its Subsidiaries, taken as a whole, or fails to disclose a material adverse change on the Company and its Subsidiaries, taken as a whole; (v) the Company or any Subsidiary makes an assignment for the benefit of creditors or admits in writing its inability to pay its debts generally as they become due; or an order, judgment or decree is entered adjudicating the Company or any Subsidiary bankrupt or insolvent; or any order for relief with respect to the Company or any Subsidiary is entered under the Federal Bankruptcy Code; or the Company or any Subsidiary petitions or applies to any tribunal for the appointment of a custodian, trustee, receiver or liquidator of the Company or any Subsidiary, or of any substantial part of the assets of the Company or any Subsidiary, or commences any proceeding (other than a proceeding for the voluntary liquidation and dissolution of any Subsidiary) relating to the Company or any Subsidiary under any bankruptcy reorganization, arrangement, insolvency, readjustment of debt, dissolution or liquidation under the law of any jurisdiction; or any such petition or application is filed, or any such proceeding is commenced, against the Company or any Subsidiary and either (A) the Company or any such Subsidiary by any act indicates its approval thereof, consent thereto or acquiescence therein or (B) such petition, application or proceeding is not dismissed within 60 days; (vi) a judgment in excess of $500,000 is rendered against the Company or any Subsidiary and, within 60 days after entry thereof, such judgment is not discharged in full or execution thereof stayed 4 pending appeal, or within 60 days after the expiration of any such stay, such judgment is not discharged in full; or (vii) the Company or any Subsidiary defaults in the performance of any obligation if the effect of such default is to cause an amount exceeding $500,000 to become due prior to its stated maturity or to permit the holder or holders of such obligation to cause an amount exceeding $500,000 to become due prior to its stated maturity. The foregoing shall constitute Events of Default whatever the reason or cause for any such Event of Default and whether it is voluntary or involuntary or is effected by operation of law or pursuant to any judgment, decree or order of any court or any order, rule or regulation of any administrative or governmental body. (b) Consequences of Events of Default. (i) If any Event of Default of the type described in subparagraph 5(a)(i), 5(a)(ii) or 5(a)(iii) has occurred and is continuing, the interest rate on this Note shall increase immediately to 15% or (if less) to the highest rate permitted by law and any increase of the interest rate resulting from the operation of this subparagraph shall terminate as of the close of business on the date on which no Event of Default of the type described in subparagraph 5(a)(i) or 5(a)(ii) exists (subject to subsequent increases pursuant to this subparagraph). (ii) If an Event of Default of the type described in subparagraph 5(a)(iv) has occurred, the aggregate principal amount of this Note (together with all accrued interest thereon and all other amounts due and payable with respect thereto) shall become immediately due and payable without any action on the part of the holder of this Note, and the Company shall immediately pay to the holder of this Note all amounts due and payable with respect to this Note. (iii) If any Event of Default has occurred and is continuing, the holder of this Note may declare all or any portion of the outstanding principal amount of this Note (together with all accrued interest thereon and all other amounts due and payable with respect thereto) to be immediately due and payable and may demand immediate payment of all or any portion of the outstanding principal amount of this Note (together with all such other amounts then due and payable). 5 (iv) The holder of this Note shall also have any other rights which he may have been afforded under any contract or agreement at any time and any other rights which he may have pursuant to applicable law. (v) The Company hereby waives diligence, presentment, protest and demand and notice of protest and demand, dishonor and nonpayment of this Note and expressly agrees that this Note, or any payment hereunder, may be extended from time to time and that the holder hereof may accept security for this Note or release security for this Note, all without in any way affecting the liability of the Company hereunder. 4. Amendment and Waiver. Except as otherwise expressly provided herein, the provisions of this Note may be amended and the Company may take any action herein prohibited, or omit to perform any act herein required to be performed by it, only if the Company has obtained the written consent of the holder of this Note. 5. Definitions. For purposes of this Note, the following capitalized terms have the following meaning: "Common Stock" means the Company's Common Stock, par value $.01 per share, including all classes and series of such Common Stock. "Convertible Securities" means any stock or securities (other than options) directly or indirectly convertible into or exchangeable for Common Stock. "Person" means an individual, a partnership, a corporation, a limited liability company, an association, a joint stock company, a trust, a joint venture, an unincorporated organization and a governmental entity or any department, agency or political subdivision thereof. "Subsidiary" means, with respect to any Person, any Person of which (i) if a corporation or a limited liability company which is taxed as a corporation for federal purposes, a majority of the total voting power of shares of stock or units of membership entitled (without regard to the occurrence of any contingency) to vote in the election of directors, managers or trustees thereof is at the time owned or controlled, directly or indirectly, by the first Person or one or more of the other Subsidiaries of that first Person or a combination thereof, or (ii) if a limited liability company (which is taxed as a partnership for federal tax purposes), partnership, association or other business entity, a majority of the partnership or other similar ownership interest thereof is at the time owned or controlled, directly or indirectly, by such first Person or one or more Subsidiaries of that first Person or a combination thereof. For purposes hereof, a Person or Persons shall be deemed to have a majority ownership interest in a limited liability company 6 (which is taxed as a partnership for federal tax purposes), partnership, association or other business entity if such Person or Persons shall be allocated a majority of limited liability company, partnership, association or other business entity gains or losses or shall be or control any managing director or general partner of such limited liability company, partnership, association or other business entity. 6. Cancellation. After all principal and accrued interest at any time owed on this Note has been paid in full, this Note shall surrendered to the Company for cancellation and shall not be reissued. 7. Payments. Unless otherwise expressly provided herein, all payments to be made to the holders of this Note shall be made in the lawful money of the United States of America in immediately available funds. 8. Place of Payment. Payments of principal and interest shall be delivered to Melrich Associates, L.P. at the following address: Melrich Associates, L.P. 29 Woodstone Rise ------------------------- Pittsford, N.Y. 14534 ------------------------- or to such other address or to the attention of such other person as specified by prior written notice to the Company. 9. Business Days. If any payment is due, or any time period for giving notice or taking action expires, on a day which is a Saturday, Sunday or legal holiday in the State of New York or the State of North Carolina, the payment shall be due and payable on, and the time period shall automatically be extended to, the next business day immediately following such Saturday, Sunday or legal holiday, and interest shall continue to accrue at the required rate hereunder until any such payment is made. 10. Usury Laws. It is the intention of the Company and the holder of this Note to conform strictly to all applicable usury laws now or hereafter in force, and any interest payable under this Note shall be subject to reduction to the amount not in excess of the maximum legal amount allowed under the applicable usury laws as now or hereafter construed by the courts having jurisdiction over such matters. If the maturity of this Note is accelerated by reason of an election by the holder hereof resulting from an Event of Default, voluntary prepayment by the Company or otherwise, then earned interest may never include more that the maximum amount permitted by law shall be canceled automatically and, if theretofore paid, shall at the option of the holder hereof either be rebated to the Company or credited on the principal amount of this Note, or if this Note has been paid, then the excess shall be rebated to the Company. The aggregate of all interest (whether 7 designated as interest, service charges, points or otherwise) contracted for, chargeable or receivable under this Note shall under no circumstances exceed the maximum legal rate upon the unpaid principal balance of this Note remaining unpaid from time to time. If such interest does exceed the maximum legal rate, it shall be deemed a mistake and such excess shall be canceled automatically and, if theretofore paid, rebated to the Company or credited on the principal amount of this Note, or if this Note has been repaid, then such excess shall be rebated to the Company. 11. Notices. All notices, requests and other communications hereunder shall be in writing and will be deemed to have been duly given (a) when personally delivered, (b) when sent by telefax to a party at the number listed below for such party provided the sender has machine-produced evidence of successful transmission, (c) two (2) Business Days after the day on which the same has been delivered prepaid to a national overnight courier service providing evidence of delivery or (d) three (3) Business Days after the day on which the same was deposited in the United States mail, registered or certified, return receipt requested, postage prepaid, in each case addressed to the party to whom such notice is to be given at the following address for such party: US LEC Corp. 212 South Tryon Street, Suite 1540 Charlotte, North Carolina 28281 Telefax: (704) 319-1345 Attn: Chief Financial Officer Melrich Associates, L.P. 29 Woodstone Rise Pittsford, New York 14534 Telefax:(716) 387-0187 IN WITNESS WHEREOF, the Company has executed and delivered this Note on the date set forth above. US LEC Corp., a Delaware corporation By: /s/ David N. Vail ----------------------------------------- David N. Vail, Executive Vice President Finance and Chief Financial Officer 8 ATTEST: [SEAL] By: /s/ Richard T. Aab ------------------------------------- Richard T. Aab, Secretary 9 EX-10.3 7 SECURITY AGREEMENT SECURITY AGREEMENT THIS SECURITY AGREEMENT, dated as of the 16th day of January, 1998 (the "Security Agreement"), is made by and between US LEC OF GEORGIA L.L.C., a Delaware limited liability company and US LEC OF NORTH CAROLINA, L.L.C., a North Carolina limited liability company (the "Debtors"), and MELRICH ASSOCIATES, L.P., a New York limited partnership ("Melrich" or "Secured Party"). The Company has borrowed an aggregate of $2,289,150 from Secured Party, evidenced by promissory note dated January 16, 1998 (the "Note"). Accordingly, in consideration of the premises and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, Debtors and the Secured Party hereby agrees as follows: ARTICLE I Definitions 1.01 The term "Accounts Receivable" means all present and/or future accounts, accounts receivable, receivables, contracts, contract rights, book debts, checks, notes, drafts, instruments, chattel paper, documents, acceptances, choses in action, any and all amounts due to Debtors from a factor or other purchaser of accounts receivable of Debtors, and other forms of obligations and receivables, together with all proceeds thereof, all monies due and to become due thereon and all returned or repossessed goods, now or hereafter owned or held by or payable to Debtors. 1.02 The term "Debtors' Liabilities" wherever used in this Security Agreement shall mean the indebtedness owing, due or payable from Debtors to the Secured Party under the Notes. 1.03 The term "Machinery, Equipment, and Fixtures" means all machinery, equipment, furniture, rolling stock, vehicles and fixtures owned by Debtors of every kind and description including, without limitation, switching equipment, fixtures, accessories, office equipment, office furnishing, together with all other machinery, equipment, and fixtures wherever located, now owned by the Debtors, or whenever from time to time hereafter acquired by Debtors. 1.04 All of the other terms in this Security Agreement shall have the meanings provided by the Uniform Commercial Code of North Carolina to the extent the same are used or defined therein. ARTICLE II Creation of Security Interest 2.01 To secure the repayment to Secured Party of Debtors' Liabilities, Debtors hereby grant to Secured Party a security interest in Debtors' presently owned or hereafter acquired Accounts Receivable, Machinery, Equipment, and Fixtures (including but not limited to telecommunications switches manufactured by Lucent Technologies, Inc.), and all proceeds, including without limitation, insurance proceeds, of the foregoing collateral. The property and interest in property described in this paragraph 2.01 are sometimes hereinafter collectively referred to as the "Collateral." Page 1 of 5 2.02 Debtors shall execute and deliver to Secured Party concurrently with the execution of this Security Agreement, and at any time or times hereafter at the request of the Secured Party, all assignments, certificates of title, conveyances, assignment statements, financing statements, renewal financing statements, security agreements, affidavits, notices and all other agreements, instruments and documents that the Secured Party may reasonably request, in form satisfactory to the Secured Party and agrees to take any and all other steps reasonably requested by the Secured Party, in order to perfect and maintain the security interests and liens granted herein by Debtors to Secured Party. A carbon, photographic or other reproduction of this Security Agreement or a financing statement is sufficient and may be used as a financing statement under this Security Agreement. 2.03 Debtors do hereby irrevocably make, constitute and appoint Melrich as the true and lawful attorney of Debtors with power to sign the name of Debtors on any financing statement, renewal financing statement, notice or any similar document which, in Melrich's reasonable opinion, must be filed in order to perfect or continue the perfection of the security interests granted in this Security Agreement. This power, being coupled with an interest, is irrevocable so long as any of the Debtors' Liabilities remain unpaid. ARTICLE III Priority of Security Interests 3.01 Debtors warrant and represent that (a) the security interest granted to Secured Party hereunder, when properly perfected by filing, shall constitute at all times a valid and perfected security interest in the Collateral, vested in Secured Party in and upon all of the Collateral and (b) if such security interests are perfected on a timely basis, said security interests in said Collateral shall not become subordinate or junior to the security interests, liens or claims of any other person, firm or corporation, including the United States or any department, agency or instrumentality thereof, or any state, county or local governmental agency. Debtors shall not grant (without the prior written approval of Secured Party) a security interest in or permit a lien or encumbrance upon any of the Collateral to anyone as long as any of Debtors' Liabilities remain unpaid (other than purchase money security interests or liens and encumbrances related to seller financing and other than the security interests granted in the Security Agreements and UCC-1 financing statements dated the date hereof between Debtors, on the one hand, and Richard T. Aab and Tansukh V. Ganatra, on the other hand). Page 2 of 5 3.02 Debtors represent and warrant that it is now and at all times hereafter shall be the sole owner of its Machinery, Equipment, and Fixtures, free and clear of all liens, encumbrances and security interests, except the security interests and rights of Secured Party herein and purchase money security interests or liens and encumbrances related to seller financing. Except for all unused or obsolete Machinery, Equipment, and Fixtures, Debtors will keep the Machinery, Equipment, and Fixtures in good repair and maintained in a reasonable state of proper operating efficiency, and will make all necessary repairs to and replacements of Machinery, Equipment, and Fixtures so that the proper operating efficiency thereof shall at all times be maintained consistent with prudent business practices. Debtors may only sell or otherwise dispose of Machinery, Equipment and Fixtures (a) in the ordinary course of business or (b) when the aggregate book value of the Machinery, Equipment and Fixtures to be sold by Debtors in any one sale (or series of related sales or disposals occurring during any three (3) calendar month period) does not exceed $50,000. 3.03 Debtors represent and warrant that it is now and at all times hereafter shall be the absolute owner, free and clear of all liens, encumbrances and security interests of indefeasible title to its Accounts Receivable (except the security interest and rights of Secured Party granted herein, purchase money security interests and liens and encumbrances related to seller financing and except as consent may be granted by Secured Party). ARTICLE IV Insurance The Debtors shall maintain insurance on all of the Machinery, Equipment and Fixtures in accordance with the requirements of Exhibit A hereto, at its expense. Certified copies of all such insurance policies shall be delivered to the Secured Party promptly upon request. If requested by the Secured Party, such notice shall name the Secured Party as loss payee and require thirty (30) days notice to Secured Party prior to their termination or expiration. If the Debtors shall at any time or times hereafter fail to obtain and maintain any of the policies of insurance required above, or fail to pay any premium in whole or in part relating to any such policies, then the Secured Party may, but he shall have no obligation to do so, obtain and cause to be maintained any or all of such policies, and pay any part or all of the premiums due thereunder, without thereby waiving any default by the Debtors and any sum so disbursed by the Secured Party shall become a part of the Debtors' Liabilities secured by the Collateral, payable on demand. ARTICLE V Default 5.01 Any one of the following events will constitute an Event of Default hereunder: (a) An acceleration of the Note pursuant to its terms; and (b) failure by the Debtors to comply with the terms and conditions of this Security Agreement. 5.02 Upon the occurrence of an Event of Default hereunder and at any time thereafter the Secured Party (a) may, at his election, declare all of the Debtors' Liabilities immediately due and payable; and (b) shall have all rights and remedies of a secured party under the Uniform Page 3 of 5 Commercial Code in addition to all other rights and remedies available at law or in equity, all such rights and remedies being cumulative, not exclusive and enforceable alternatively, successively or concurrently. 5.03 If at any time or times hereafter the Secured Party employs counsel to enforce any rights of the Secured Party or liabilities of the Debtors, account debtors, or any person, firm or corporation which may be obligated to the Secured Party by virtue of this Security Agreement, then in any of such events, all of the reasonable attorneys' fees arising from such services, and any expenses, costs and charges relating thereto, shall become a part of the Debtors' Liabilities and shall be secured by the Collateral, payable on demand. ARTICLE VI Miscellaneous 6.01 This Security Agreement shall be binding upon and inure to the benefit of the successors and assigns of the parties hereto. 6.02 The internal laws and decisions of the State of North Carolina shall govern and control the construction, enforceability, validity and interpretation of this Security Agreement. 6.03 This Security Agreement contains the final, complete and exclusive statement of the agreement between the parties with respect to the transactions contemplated herein and all prior written agreements and all prior and contemporaneous oral agreements with respect to the subject matter hereof are merged herein. This Security Agreement may not be amended, supplemented or modified (or any right or power granted hereunder waived) except by a written instrument signed by the parties hereto (or in the case of a waiver, signed by the party to be bound thereby). This Security Agreement shall inure to the benefit of and be binding upon the parties hereto and their respective successors and permitted assignees. 6.04 Any provision of this Security Agreement which is invalid, prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such invalidity, prohibition or unenforceability without invalidating the remaining provisions hereof, and any such invalidity, prohibition or unenforceability in any such jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. Such invalid, prohibited or unenforceable provision shall be replaced by another provision coming nearest to the commercial intent of such replaced provision, however, being not invalid, prohibited or unenforceable itself. 6.05 The remedies specified herein shall be cumulative and in addition to any other remedies available at law or in equity. No failure of either party to enforce any provision hereof or to resort to any remedy or to exercise any one or more alternate remedies and no delay in enforcing, resorting to or exercising any remedy shall constitute a waiver by that party of its right subsequently to enforce the same or any other provision hereof or to resort to any one or more of such rights or remedies on account of any such ground then existing or which may subsequently occur. Page 4 of 5 IN WITNESS WHEREOF, this Security Agreement has been executed under seal on the day and year first above written by the parties hereto. US LEC OF NORTH CAROLINA L.L.C. By: /s/ David N. Vail ------------------------------------ Name: David N. Vail Title: EVP-Finance and CFO US LEC OF GEORGIA L.L.C. By: /s/ David N. Vail Name: David N. Vail Title: EVP-Finance and CFO MELRICH ASSOCIATES, L.P. By: /s/ Richard T. Aab ----------------------------------- Richard T. Aab, General Partner Page 5 of 5 EX-10.4 8 PROMISSORY NOTE US LEC CORP. PROMISSORY NOTE January 16, 1998 $1,000,000.00 US LEC Corp., a Delaware corporation (the "Company"), hereby promises to pay to the order of Tansukh V. Ganatra the principal amount of One Million Dollars ($1,000,000) together with interest thereon calculated from the date hereof in accordance with the provisions of this Note. 1. Payment of Interest. Interest shall accrue at the rate of twelve percent (12%) per annum on the unpaid principal amount of this Note outstanding from time to time, or (if less) at the highest rate then permitted under applicable law. The Company shall pay to the holder of this Note all accrued interest on the last day of each March, June, September and December, beginning March 30, 1998. Unless prohibited under applicable law, any accrued interest which is not paid on the date on which it is due and payable shall bear interest at the same rate at which interest is then accruing on the principal amount of this Note until such interest is paid. Any accrued interest which for any reason has not theretofore been paid shall be paid in full on the date on which the final principal payment on this Note is made. Interest shall accrue on any principal payment due under this Note and, to the extent permitted by applicable law, on any interest which has not been paid on the date on which it is due and payable until such time as payment therefor is actually delivered to the holder of this Note. 2. Payment of Principal on Note. (a) Prepayments. The Company may, at any time and from time to time without premium or penalty, prepay all or any portion of the outstanding principal amount of the Notes, provided that (i) the Company has paid all interest on the Notes accrued through the immediately preceding scheduled interest payment date and (ii) the minimum principal amount so prepaid shall be the lesser of $100,000 or the amount of principal outstanding on the Notes. In connection with each prepayment of principal hereunder, the Company shall also pay all accrued and unpaid interest on the principal amount of the Notes being repaid. (b) Principal Repayment. On January 16, 2003 (the "Scheduled Repayment Date"), the Company shall pay all outstanding principal and interest on the Notes. (c) Special Principal Repayments. (i) If a Change in Control has occurred or the Company obtains knowledge that a Change in Control is proposed to occur, the Company shall give prompt written notice of such Change in Control describing in reasonable detail the material terms and date of consummation thereof to the holder of this Note, but in any event such notice shall not be given later than five days after the occurrence of such Change in Control, and the Company shall give the holder of this Note prompt written notice of any material change in the terms or timing of such transaction. The holder of this Note may require the Company to pay all or any portion of the principal amount remaining on this Note plus all unpaid accrued interest with respect to such principal amount. (ii) The Company shall be obligated to pay the amount set forth in subparagraph (i) above with respect to the Change in Control. If any proposed Change in Control does not occur, all requests for payment in connection therewith shall be automatically rescinded, or if there has been a material change in the terms or the timing of the transaction, the holder of the Note may rescind its request for payment by giving written notice of such rescission to the Company. (iii) The term "Change in Control" means (a) any sale, transfer or issuance or series of sales, transfers and/or issuances of Common Stock by the Company or any holders thereof which results in any Person or group of Persons (as the term "group" is used under the Securities Exchange Act of 1934, as amended), owning shares of Common Stock entitling the owners thereof to more than 40% of the combined voting power of all shares of Common Stock outstanding immediately after such sale, transfer or issuance or series of sales, transfers and/or issuances or (b) any change of 50% or more of the members of the Company's Board of Directors during any 12 month period if the election of the new members is not approved or recommended by the Company's Board of Directors in office prior to such change. (iv) If a Fundamental Change is proposed to occur, the Company shall give written notice of such Fundamental Change describing in reasonable detail the material terms and date of consummation thereof to the holder of this Note not more than 45 days nor less than 20 days prior to the consummation of such Fundamental Change, and the Company shall give the holder of this Note prompt written notice of any material change in the terms or timing 2 of such transaction. The holder of this Note may require the Company to pay all or any portion of the principal amount remaining on this Note plus all unpaid accrued interest with respect to such principal amount. (v) The Company shall be obligated to pay the amount set forth in subparagraph (iv) above upon the consummation of such Fundamental Change. If any proposed Fundamental Change does not occur, all requests for payment in connection therewith shall be automatically rescinded, or if there has been a material change in the terms or the timing of the transaction, the holder of this Note may rescind its request for payment by delivering written notice thereof to the Company prior to the consummation of the transaction. (vi) The term "Fundamental Change" means (a) any sale or transfer of more than 50% of the assets of the Company and its Subsidiaries on a consolidated basis (measured either by book value in accordance with generally accepted accounting principles consistently applied or by fair market value determined in the reasonable good faith judgment of the Company's board of directors) in any transaction or series of transactions (other than sales in the ordinary course of business) and (b) any merger or consolidation to which the Company is a party, except for a merger in which the Company is the surviving corporation, and after giving effect to such merger, no Person or group of Persons (as the term "group" is used under the Securities Act of 1934, as amended) owns more than 40% of the combined voting power of all shares of Common Stock outstanding immediately after such merger who did not own 40% or more of such voting power of the Company prior to such merger. 3. Events of Default. (a) Definition. For purposes of this Note, an Event of Default shall be deemed to have occurred if any of the following exist or occur: (i) the Company fails to pay when due and payable (whether at maturity or otherwise) the full amount of interest then accrued on any Note or the full amount of any principal due on any Note, and such failure to pay is not cured within five days after the occurrence thereof; or (ii) the Company fails to perform or observe any other material covenant or agreement in this Note and such failure is not cured 3 within 30 days after the earlier of (A) the receipt of notice thereof by the holder of this Note or (B) the discovery thereof by the Company; (iii) US LEC of Georgia L.L.C. and US LEC of North Carolina L.L.C. fail to perform or observe any other material covenant or agreement in that Certain Guaranty and Suretyship Agreement dated as of the date hereof (the "Payment Default") and such failure is not cured within 30 days after the earlier of (A) the receipt of notice thereof by the holder of this Note or (B) the discovery thereof by the Company; (iv) any representation, warranty or information required to be furnished to the holder is misleading in any material respect on the date made or furnished and such false or misleading representation, warranty or information relates to a material adverse effect on the Company and its Subsidiaries, taken as a whole, or fails to disclose a material adverse change on the Company and its Subsidiaries, taken as a whole; (v) the Company or any Subsidiary makes an assignment for the benefit of creditors or admits in writing its inability to pay its debts generally as they become due; or an order, judgment or decree is entered adjudicating the Company or any Subsidiary bankrupt or insolvent; or any order for relief with respect to the Company or any Subsidiary is entered under the Federal Bankruptcy Code; or the Company or any Subsidiary petitions or applies to any tribunal for the appointment of a custodian, trustee, receiver or liquidator of the Company or any Subsidiary, or of any substantial part of the assets of the Company or any Subsidiary, or commences any proceeding (other than a proceeding for the voluntary liquidation and dissolution of any Subsidiary) relating to the Company or any Subsidiary under any bankruptcy reorganization, arrangement, insolvency, readjustment of debt, dissolution or liquidation under the law of any jurisdiction; or any such petition or application is filed, or any such proceeding is commenced, against the Company or any Subsidiary and either (A) the Company or any such Subsidiary by any act indicates its approval thereof, consent thereto or acquiescence therein or (B) such petition, application or proceeding is not dismissed within 60 days; (vi) a judgment in excess of $500,000 is rendered against the Company or any Subsidiary and, within 60 days after entry thereof, such judgment is not discharged in full or execution thereof stayed 4 pending appeal, or within 60 days after the expiration of any such stay, such judgment is not discharged in full; or (vii) the Company or any Subsidiary defaults in the performance of any obligation if the effect of such default is to cause an amount exceeding $500,000 to become due prior to its stated maturity or to permit the holder or holders of such obligation to cause an amount exceeding $500,000 to become due prior to its stated maturity. The foregoing shall constitute Events of Default whatever the reason or cause for any such Event of Default and whether it is voluntary or involuntary or is effected by operation of law or pursuant to any judgment, decree or order of any court or any order, rule or regulation of any administrative or governmental body. (b) Consequences of Events of Default. (i) If any Event of Default of the type described in subparagraph 5(a)(i), 5(a)(ii) or 5(a)(iii) has occurred and is continuing, the interest rate on this Note shall increase immediately to 15% or (if less) to the highest rate permitted by law and any increase of the interest rate resulting from the operation of this subparagraph shall terminate as of the close of business on the date on which no Event of Default of the type described in subparagraph 5(a)(i) or 5(a)(ii) exists (subject to subsequent increases pursuant to this subparagraph). (ii) If an Event of Default of the type described in subparagraph 5(a)(iv) has occurred, the aggregate principal amount of this Note (together with all accrued interest thereon and all other amounts due and payable with respect thereto) shall become immediately due and payable without any action on the part of the holder of this Note, and the Company shall immediately pay to the holder of this Note all amounts due and payable with respect to this Note. (iii) If any Event of Default has occurred and is continuing, the holder of this Note may declare all or any portion of the outstanding principal amount of this Note (together with all accrued interest thereon and all other amounts due and payable with respect thereto) to be immediately due and payable and may demand immediate payment of all or any portion of the outstanding principal amount of this Note (together with all such other amounts then due and payable). 5 (iv) The holder of this Note shall also have any other rights which he may have been afforded under any contract or agreement at any time and any other rights which he may have pursuant to applicable law. (v) The Company hereby waives diligence, presentment, protest and demand and notice of protest and demand, dishonor and nonpayment of this Note and expressly agrees that this Note, or any payment hereunder, may be extended from time to time and that the holder hereof may accept security for this Note or release security for this Note, all without in any way affecting the liability of the Company hereunder. 4. Amendment and Waiver. Except as otherwise expressly provided herein, the provisions of this Note may be amended and the Company may take any action herein prohibited, or omit to perform any act herein required to be performed by it, only if the Company has obtained the written consent of the holder of this Note. 5. Definitions. For purposes of this Note, the following capitalized terms have the following meaning: "Common Stock" means the Company's Common Stock, par value $.01 per share, including all classes and series of such Common Stock. "Convertible Securities" means any stock or securities (other than options) directly or indirectly convertible into or exchangeable for Common Stock. "Person" means an individual, a partnership, a corporation, a limited liability company, an association, a joint stock company, a trust, a joint venture, an unincorporated organization and a governmental entity or any department, agency or political subdivision thereof. "Subsidiary" means, with respect to any Person, any Person of which (i) if a corporation or a limited liability company which is taxed as a corporation for federal purposes, a majority of the total voting power of shares of stock entitled (without regard to the occurrence of any contingency) to vote in the election of directors, managers or trustees thereof is at the time owned or controlled, directly or indirectly, by the first Person or one or more of the other Subsidiaries of the first Person or a combination thereof, or (ii) if a limited liability company (which is taxed as a partnership for federal tax purposes), partnership, association or other business entity, a majority of the partnership or other similar ownership interest thereof is at the time owned or controlled, directly or indirectly, by any Person or one or more Subsidiaries of that first Person or a combination thereof. For purposes hereof, a Person or Persons shall be deemed to have a majority ownership interest in a limited liability company (which is taxed as a partnership 6 for federal tax purposes), partnership, association or other business entity if such Person or Persons shall be allocated a majority of limited liability company, partnership, association or other business entity gains or losses or shall be or control any managing director or general partner of such limited liability company, partnership, association or other business entity. 6. Cancellation. After all principal and accrued interest at any time owed on this Note has been paid in full, this Note shall surrendered to the Company for cancellation and shall not be reissued. 7. Payments. Unless otherwise expressly provided herein, all payments to be made to the holders of this Note shall be made in the lawful money of the United States of America in immediately available funds. 8. Place of Payment. Payments of principal and interest shall be delivered to Tansukh V. Ganatra at the following address: Tansukh V. Ganatra 6523 Ashdale Place Charlotte, North Carolina 28215 or to such other address or to the attention of such other person as specified by prior written notice to the Company. 9. Business Days. If any payment is due, or any time period for giving notice or taking action expires, on a day which is a Saturday, Sunday or legal holiday in the State of New York or the State of North Carolina, the payment shall be due and payable on, and the time period shall automatically be extended to, the next business day immediately following such Saturday, Sunday or legal holiday, and interest shall continue to accrue at the required rate hereunder until any such payment is made. 10. Usury Laws. It is the intention of the Company and the holder of this Note to conform strictly to all applicable usury laws now or hereafter in force, and any interest payable under this Note shall be subject to reduction to the amount not in excess of the maximum legal amount allowed under the applicable usury laws as now or hereafter construed by the courts having jurisdiction over such matters. If the maturity of this Note is accelerated by reason of an election by the holder hereof resulting from an Event of Default, voluntary prepayment by the Company or otherwise, then earned interest may never include more that the maximum amount permitted by law shall be canceled automatically and, if theretofore paid, shall at the option of the holder hereof either be rebated to the Company or credited on the principal amount of this Note, or if this Note has been paid, then the excess shall be rebated to the Company. The aggregate of all interest (whether designated as interest, service charges, points or otherwise) contracted for, 7 chargeable or receivable under this Note shall under no circumstances exceed the maximum legal rate upon the unpaid principal balance of this Note remaining unpaid from time to time. If such interest does exceed the maximum legal rate, it shall be deemed a mistake and such excess shall be canceled automatically and, if theretofore paid, rebated to the Company or credited on the principal amount of this Note, or if this Note has been repaid, then such excess shall be rebated to the Company. 11. Notices. All notices, requests and other communications hereunder shall be in writing and will be deemed to have been duly given (a) when personally delivered, (b) when sent by telefax to a party at the number listed below for such party provided the sender has machine-produced evidence of successful transmission, (c) two (2) Business Days after the day on which the same has been delivered prepaid to a national overnight courier service providing evidence of delivery or (d) three (3) Business Days after the day on which the same was deposited in the United States mail, registered or certified, return receipt requested, postage prepaid, in each case addressed to the party to whom such notice is to be given at the following address for such party: US LEC Corp. 212 South Tryon Street, Suite 1540 Charlotte, North Carolina 28281 Telefax: (704) 319-1345 Attn: Chief Financial Officer Tansukh V. Ganatra 6523 Ashdale Place Charlotte, North Carolina 28215 Telefax: ________________________ IN WITNESS WHEREOF, the Company has executed and delivered this Note on the date set forth above. US LEC Corp., a Delaware corporation By: /s/ David N. Vail ------------------------------------------ David N. Vail, Executive Vice President Finance and Chief Financial Officer ATTEST: [SEAL] 8 By: /s/ Richard T. Aab ------------------------------- Richard T. Aab, Secretary 9 EX-10.5 9 SECURITY AGREEMENT SECURITY AGREEMENT THIS SECURITY AGREEMENT, dated as of the 16th day of January, 1998 (the "Security Agreement"), is made by and between US LEC OF GEORGIA L.L.C., a Delaware limited liability company and US LEC OF NORTH CAROLINA, L.L.C., a North Carolina limited liability company (the "Debtors"), on the one hand and TANSUKH V. GANATRA, a resident of Charlotte, North Carolina ("Ganatra" or "Secured Party") on the other hand. The Company has borrowed an aggregate of $1,000,000 from Secured Party, evidenced by promissory note dated January 16, 1998 (the "Note"). Accordingly, in consideration of the premises and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, Debtors and the Secured Party hereby agree as follows: ARTICLE I Definitions 1.01 The term "Accounts Receivable" means all present and/or future accounts, accounts receivable, receivables, contracts, contract rights, book debts, checks, notes, drafts, instruments, chattel paper, documents, acceptances, choses in action, any and all amounts due to Debtors from a factor or other purchaser of accounts receivable of Debtors, and other forms of obligations and receivables, together with all proceeds thereof, all monies due and to become due thereon and all returned or repossessed goods, now or hereafter owned or held by or payable to Debtors. 1.02 The term "Debtors' Liabilities" wherever used in this Security Agreement shall mean the indebtedness owing, due or payable from Debtors to the Secured Party under the Notes. 1.03 The term "Machinery, Equipment, and Fixtures" means all machinery, equipment, furniture, rolling stock, vehicles and fixtures owned by Debtors of every kind and description including, without limitation, switching equipment, fixtures, accessories, office equipment, office furnishing, together with all other machinery, equipment, and fixtures wherever located, now owned by the Debtors, or whenever from time to time hereafter acquired by Debtors. 1.04 All of the other terms in this Security Agreement shall have the meanings provided by the Uniform Commercial Code of North Carolina to the extent the same are used or defined therein. ARTICLE II Creation of Security Interest 2.01 To secure the repayment to Secured Party of Debtors' Liabilities, Debtors hereby grant to Secured Party a security interest in Debtors' presently owned or hereafter acquired Accounts Receivable, Machinery, Equipment, and Fixtures (including but not limited to telecommunications switches manufactured by Lucent Technologies, Inc.), and all proceeds, including without limitation, insurance proceeds, of the foregoing collateral. The property and interest in property described in this paragraph 2.01 are sometimes hereinafter collectively referred to as the "Collateral." Page 1 of 5 2.02 Debtors shall execute and deliver to Secured Party concurrently with the execution of this Security Agreement, and at any time or times hereafter at the request of the Secured Party, all assignments, certificates of title, conveyances, assignment statements, financing statements, renewal financing statements, security agreements, affidavits, notices and all other agreements, instruments and documents that the Secured Party may reasonably request, in form satisfactory to the Secured Party and agrees to take any and all other steps reasonably requested by the Secured Party, in order to perfect and maintain the security interests and liens granted herein by Debtors to Secured Party. A carbon, photographic or other reproduction of this Security Agreement or a financing statement is sufficient and may be used as a financing statement under this Security Agreement. 2.03 Debtors do hereby irrevocably make, constitute and appoint Ganatra as the true and lawful attorney of Debtors with power to sign the name of Debtors on any financing statement, renewal financing statement, notice or any similar document which, in Ganatra's reasonable opinion, must be filed in order to perfect or continue the perfection of the security interests granted in this Security Agreement. This power, being coupled with an interest, is irrevocable so long as any of the Debtors' Liabilities remain unpaid. ARTICLE III Priority of Security Interests 3.01 Debtors warrant and represent that (a) the security interest granted to Secured Party hereunder, when properly perfected by filing, shall constitute at all times a valid and perfected security interest in the Collateral, vested in Secured Party in and upon all of the Collateral and (b) if such security interests are perfected on a timely basis, said security interests in said Collateral shall not become subordinate or junior to the security interests, liens or claims of any other person, firm or corporation, including the United States or any department, agency or instrumentality thereof, or any state, county or local governmental agency. Debtors shall not grant (without the prior written approval of Secured Party) a security interest in or permit a lien or encumbrance upon any of the Collateral to anyone as long as any of Debtors' Liabilities remain unpaid (other than purchase money security interests or liens and encumbrances related to seller financing and other than the security interests granted in the Security Agreements and UCC-1 financing statements dated the date hereof between Debtors, on the one hand, and Richard T. Aab and Melrich Associates, L.P., on the other hand). Page 2 of 5 3.02 Debtors represent and warrant that it is now and at all times hereafter shall be the sole owner of its Machinery, Equipment, and Fixtures, free and clear of all liens, encumbrances and security interests, except the security interests and rights of Secured Party herein and purchase money security interests or liens and encumbrances related to seller financing. Except for all unused or obsolete Machinery, Equipment, and Fixtures, Debtors will keep the Machinery, Equipment, and Fixtures in good repair and maintained in a reasonable state of proper operating efficiency, and will make all necessary repairs to and replacements of Machinery, Equipment, and Fixtures so that the proper operating efficiency thereof shall at all times be maintained consistent with prudent business practices. Debtors may only sell or otherwise dispose of Machinery, Equipment and Fixtures (a) in the ordinary course of business or (b) when the aggregate book value of the Machinery, Equipment and Fixtures to be sold by Debtors in any one sale (or series of related sales or disposals occurring during any three (3) calendar month period) does not exceed $50,000. 3.03 Debtors represent and warrant that it is now and at all times hereafter shall be the absolute owner, free and clear of all liens, encumbrances and security interests of indefeasible title to its Accounts Receivable (except the security interest and rights of Secured Party granted herein, purchase money security interests and liens and encumbrances related to seller financing and except as consent may be granted by Secured Party). ARTICLE IV Insurance The Debtors shall maintain insurance on all of the Machinery, Equipment and Fixtures in accordance with the requirements of Exhibit A hereto, at its expense. Certified copies of all such insurance policies shall be delivered to the Secured Party promptly upon request. If requested by the Secured Party, such notice shall name the Secured Party as loss payee and require thirty (30) days notice to Secured Party prior to their termination or expiration. If the Debtors shall at any time or times hereafter fail to obtain and maintain any of the policies of insurance required above, or fail to pay any premium in whole or in part relating to any such policies, then the Secured Party may, but he shall have no obligation to do so, obtain and cause to be maintained any or all of such policies, and pay any part or all of the premiums due thereunder, without thereby waiving any default by the Debtors and any sum so disbursed by the Secured Party shall become a part of the Debtors' Liabilities secured by the Collateral, payable on demand. ARTICLE V Default 5.01 Any one of the following events will constitute an Event of Default hereunder: (a) An acceleration of the Note pursuant to its terms; and (b) failure by the Debtors to comply with the terms and conditions of this Security Agreement. 5.02 Upon the occurrence of an Event of Default hereunder and at any time thereafter the Secured Party (a) may, at his election, declare all of the Debtors' Liabilities immediately due and payable; and (b) shall have all rights and remedies of a secured party under the Uniform Page 3 of 5 Commercial Code in addition to all other rights and remedies available at law or in equity, all such rights and remedies being cumulative, not exclusive and enforceable alternatively, successively or concurrently. 5.03 If at any time or times hereafter the Secured Party employs counsel to enforce any rights of the Secured Party or liabilities of the Debtors, account debtors, or any person, firm or corporation which may be obligated to the Secured Party by virtue of this Security Agreement, then in any of such events, all of the reasonable attorneys' fees arising from such services, and any expenses, costs and charges relating thereto, shall become a part of the Debtors' Liabilities and shall be secured by the Collateral, payable on demand. ARTICLE VI Miscellaneous 6.01 This Security Agreement shall be binding upon and inure to the benefit of the successors and assigns of the parties hereto. 6.02 The internal laws and decisions of the State of North Carolina shall govern and control the construction, enforceability, validity and interpretation of this Security Agreement. 6.03 This Security Agreement contains the final, complete and exclusive statement of the agreement between the parties with respect to the transactions contemplated herein and all prior written agreements and all prior and contemporaneous oral agreements with respect to the subject matter hereof are merged herein. This Security Agreement may not be amended, supplemented or modified (or any right or power granted hereunder waived) except by a written instrument signed by the parties hereto (or in the case of a waiver, signed by the party to be bound thereby). This Security Agreement shall inure to the benefit of and be binding upon the parties hereto and their respective successors and permitted assignees. 6.04 Any provision of this Security Agreement which is invalid, prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such invalidity, prohibition or unenforceability without invalidating the remaining provisions hereof, and any such invalidity, prohibition or unenforceability in any such jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. Such invalid, prohibited or unenforceable provision shall be replaced by another provision coming nearest to the commercial intent of such replaced provision, however, being not invalid, prohibited or unenforceable itself. 6.05 The remedies specified herein shall be cumulative and in addition to any other remedies available at law or in equity. No failure of either party to enforce any provision hereof or to resort to any remedy or to exercise any one or more alternate remedies and no delay in enforcing, resorting to or exercising any remedy shall constitute a waiver by that party of its right subsequently to enforce the same or any other provision hereof or to resort to any one or more of such rights or remedies on account of any such ground then existing or which may subsequently occur. Page 4 of 5 IN WITNESS WHEREOF, this Security Agreement has been executed under seal on the day and year first above written by the parties hereto. US LEC OF NORTH CAROLINA L.L.C. By: /s/ Richard T.Aab ----------------------------------- Name: Richard T. Aab ---------------------------------- Title: Chairman & CEO -------------------------------- US LEC OF GEORGIA L.L.C. By: /s/ Richard T. Aab ------------------------------------- Name: Richard T. Aab ---------------------------------- Title: Chairman & CEO --------------------------------- /s/ Tansukh V. Ganatra _______________________________________ Tansukh V. Ganatra Page 5 of 5 EX-10.6 10 GUARANTY AND SURETYSHIP AGREEMENT GUARANTY AND SURETYSHIP AGREEMENT THIS GUARANTY AND SURETYSHIP AGREEMENT (the "Guaranty Agreement" or the "Guaranty"), dated as of January 16, 1998, is made by each of the undersigned (each a "Guarantor" and collectively the "Guarantors") to each of Richard T. Aab, a resident of Rochester, New York, Tansukh V. Ganatra, a resident of Charlotte, North Carolina and Melrich Associates, L.P., a New York limited partnership (each a "Lender" and collectively the "Lenders"). W I T N E S S E T H: WHEREAS, US LEC Corp., a Delaware corporation (the "Borrower"), has executed a separate Promissory Note in favor of each Lender, each dated January 16, 1998 (as from time to time amended, modified or supplemented, the "Notes") pursuant to which the Lenders have loaned to the Borrower, collectively, $8,289,150 (the "Loans"); and WHEREAS, Borrower owns a 99% equity interest in each of the Guarantors; and WHEREAS, the Borrower is required to cause each Guarantor to guarantee to the Lenders payment of the Borrower's Liabilities (as hereinafter defined) in accordance with the terms of this Agreement; and WHEREAS, each Guarantor will materially benefit from the loans made under the Notes, and each Guarantor is willing to enter into this Guaranty to provide an inducement for the Lenders to make the loans under the Notes; NOW, THEREFORE, in order to induce the Lenders to make loans to the Borrower under the Notes, each Guarantor agrees as follows: 1. Definitions. All capitalized terms not otherwise defined herein shall have the meanings ascribed to such terms in the Notes. 2. Guaranty. Each Guarantor hereby jointly and severally, unconditionally, absolutely, continually and irrevocably guarantees to the Lenders the payment and performance in full of the Borrower's Liabilities (as defined below); provided, however, that the liability of each Guarantor with respect to the Guarantors' Obligations (as defined below) shall not exceed at any time the Maximum Amount (as defined below). For all purposes of this Guaranty Agreement, "Borrower's Liabilities" means: (a) the Borrower's prompt payment in full, when due or declared due and at all such times, of all obligations and all other amounts pursuant to the terms of the Notes, now or at any time or times hereafter owing, arising, due or payable from the Borrower to the Lenders, including, but not limited to, principal, interest, premium or fee (including, but not limited to, loan fees and attorneys' fees and expenses); and (b) the Borrower's prompt, full and faithful performance, observance and discharge of each and every agreement, undertaking, covenant and provision to be performed, observed or discharged by the Borrower under the Notes. Each Guarantor's obligations to the Lenders under this Guaranty Agreement are hereinafter collectively referred to as the "Guarantors' Obligations". The "Maximum Amount" means the greater of (X) the aggregate amount of all advances to such Guarantor made directly or indirectly with the proceeds of Loans and not theretofore repaid by such Guarantor or (Y) 95% of (i) the fair salable value of the assets of such Guarantor as of the date hereof minus (ii) the total liabilities of such Guarantor (including contingent liabilities, but excluding liabilities of such Guarantor under this Guaranty and under the Security Agreements dated as of the date hereof executed by such Guarantor in connection with entering into this Guaranty (the "Security Agreements")) as of the date hereof; provided further, however, that, if the calculation of the Maximum Amount in the manner provided above as of the date payment is required of such Guarantor pursuant to this Guaranty would result in a greater positive number, then the Maximum Amount shall be deemed to be such greater positive number. Each Guarantor agrees that it is jointly and severally, directly and primarily liable for the Borrower's liabilities, subject to the limitations and conditions set forth herein. 3. Payment. If the Borrower shall default in payment or performance of any Borrower's Liabilities, whether principal, interest, premium, fee (including, but not limited to, loan fees and attorneys' fees and expenses), or otherwise, when and as the same shall become due, whether according to the terms of the Notes, by acceleration, or otherwise, or upon the occurrence of any other Event of Default under the Notes that has not been cured or waived, then each Guarantor, upon demand thereof by the Lenders or their successors or assigns, will AS OF THE DATE OF THE DEMAND fully pay to the Lenders, subject to any restrictions and limitations set forth in Section 2 hereof, an amount equal to all Guarantor's Obligations then due and owing. 4. Unconditional Obligations. This is a guaranty of payment and not of collection. The Guarantors' Obligations under this Guaranty Agreement shall be joint and several, absolute and unconditional irrespective of the validity, legality or enforceability of the Notes or the Security Agreements or any other guaranty of the Borrower's Liabilities, and shall not be affected by any action taken under the Notes or any other guaranty of the Borrower's Liabilities, or any other agreement between the Lenders and the Borrower or any other Person, in the exercise of any right or power therein conferred, or by any failure or omission to enforce any right conferred thereby, or by any waiver of any covenant or condition therein provided, or by any acceleration of the maturity of any of the Borrower's Liabilities, or by the release or other disposal of any security for or guarantee of any of the Borrower's Liabilities, or by the dissolution of the Borrower or the combination or consolidation of the Borrower into or with another entity or any transfer or disposition of any assets of the Borrower or by any extension or renewal of any of the Notes or the Security Agreements, in whole or in part, or by any modification, alteration, amendment or addition of or to any of the Notes or any of the Security Agreements, any other guaranty of the Borrower's Liabilities, or any other agreement between the Lenders and the Borrower or any other Person, or by any other circumstance whatsoever (with or without notice to or knowledge of any Guarantor) which may or might in any manner or to any extent vary the risks of any Guarantor, or might otherwise constitute a legal or equitable discharge of a surety or guarantor; it being the purpose and intent of the parties hereto that this 2 Guaranty Agreement and the Guarantors' Obligations hereunder shall be absolute and unconditional under any and all circumstances and shall not be discharged except by payment as herein provided or as provided in the Notes or Security Agreements. 5. Currency and Funds of Payment. Each Guarantor hereby guarantees that the Guarantors' Obligations will be paid in lawful currency of the United States of America and in immediately available funds, regardless of any law, regulation or decree now or hereafter in effect that might in any manner affect the Borrower's Liabilities, or the rights of any Lender with respect thereto as against the Borrower, or cause or permit to be invoked any alteration in the time, amount or manner of payment by the Borrower of any or all of the Borrower's Liabilities. 6. Events of Default. In the event that (a) there shall occur an Event of Default under the Notes (b) there shall occur an Event of Default under the Security Agreements; (c) any default shall occur in the payment of amounts due hereunder; or (d) any other default shall occur hereunder which remains uncured or unwaived for a period of thirty (30) days (each of the foregoing an "Event of Default" hereunder); then notwithstanding any collateral available to the Lenders from the Borrower or any Guarantor or any other guarantor of the Borrower's Liabilities, or any other party, at the election of the Lenders and without notice thereof or demand therefor, so long as such Event of Default shall not have been waived, the Guarantors' Obligations shall become immediately due and payable. 7. Suits. Each Guarantor from time to time shall pay to the Lenders, on demand, at the Lenders' principal office or such other address as the Lenders shall give notice of to the Guarantor, the Guarantors' Obligations as they become or are declared due, and in the event such payment is not made forthwith, the Lenders or any of them may proceed to suit against any one or more or all of the Guarantors. At the election of the Lenders, one or more and successive or concurrent suits may be brought hereon by the Lenders against any one or more or all of the Guarantors, whether or not suit has been commenced against the Borrower, any other guarantor of the Borrower's Liabilities, or any other Person and whether or not any Lender has taken or failed to take any other action to collect all or any portion of the Borrower's Liabilities. 8. Set-Off and Waiver. Each Guarantor waives any right to assert against the Lenders as a defense, counterclaim, set-off or cross claim any claim (legal or equitable) which such Guarantor may now or at any time hereafter have against the Borrower without waiving any additional defenses, set-offs, counterclaims or other claims otherwise available to such Guarantor. If at any time hereafter any Lender employs counsel for advice or other representation to enforce the Guarantors' Obligations that arise out of an Event of Default, then, in any of the foregoing events, all of the reasonable attorneys' fees arising from such services and all reasonable expenses, costs and charges in any way or respect arising in connection therewith or relating thereto shall be jointly and severally paid by the Guarantors to the Lenders, on demand. 9. Waiver; Subrogation; Subordination. 3 (a) Each Guarantor hereby waives notice of the following events or occurrences: (i) the Lenders' acceptance of this Guaranty Agreement; (ii) the Lenders' heretofore, now or from time to time hereafter loaning monies or giving or extending credit to or for the benefit of the Borrower, whether pursuant to the Notes, or any amendments, modifications, or supplements thereto, or replacements or extensions thereof; (iii) the Lenders or the Borrower heretofore, now or at any time hereafter, obtaining, amending, substituting for, releasing, waiving or modifying the Notes; (iv) presentment, demand, notices of default, non-payment, partial payment and protest; (v) the Lenders heretofore, now or at any time hereafter granting to the Borrower (or any other party liable to the Lenders on account of the Borrower's Liabilities) any indulgence or extensions of time of payment of or in respect of the Borrower's Liabilities; and (vi) the Lenders heretofore, now or at any time hereafter accepting from the Borrower or any other person, any partial payment or payments on account of the Borrower's Liabilities or any collateral securing the payment thereof or the Lenders settling, subordinating, compromising, discharging or releasing the same in whole or in part. Each Guarantor agrees that each Lender may heretofore, now or at any time hereafter do any or all of the foregoing in such manner, upon such terms and at such times as each Lender, in its sole and absolute discretion, deems advisable, without in any way or respect impairing, affecting, reducing or releasing such Guarantor from the Guarantors' Obligations, (b) each Guarantor hereby consents to each and all of the foregoing events or occurrences and (c) each Guarantor waives, to the extend permitted by law, (1) any right of a surety or guarantor to any defense, discharge, release or diminution of its liabilities hereunder as a result of any of the foregoing events or occurrences, and (2) any right under N.C.G.S. Section 26-7 through 26-9 inclusive or otherwise or require that resort be had to the Borrower or any other guarantor of, or any property securing, all or any part of the Borrower's Liabilities. (b) Each Guarantor hereby agrees that payment or performance by such Guarantor of the Guarantors' Obligations under this Guaranty Agreement may be enforced by the Lenders upon demand by the Lenders to such Guarantor without the Lenders being required, each Guarantor expressly waiving any right it may have to require the Lenders, to (i) prosecute collection or seek to enforce or resort to any remedies against the Borrower or any other Guarantor or any other guarantor of the Borrower's Liabilities, IT BEING EXPRESSLY UNDERSTOOD, ACKNOWLEDGED AND AGREED TO BY EACH GUARANTOR THAT DEMAND UNDER THIS GUARANTY AGREEMENT MAY BE MADE BY THE LENDERS, AND THE PROVISIONS HEREOF ENFORCED BY THE LENDERS, EFFECTIVE AS OF THE FIRST DATE ANY EVENT OF DEFAULT (AS DEFINED IN THE NOTES) OCCURS AND IS CONTINUING UNDER ANY OF THE NOTES, or (ii) seek to enforce or resort to any remedies with respect to any security interests, liens or encumbrances granted to the Lenders by the Borrower or any other Person on account of the Borrower's Liabilities or any guaranty thereof. No Lender shall have any obligation to protect, secure or insure any of the foregoing security interests, liens or encumbrances on the properties or interests in properties subject thereto. The Guarantors' Obligations shall in no way be impaired, affected, reduced, or released by reason of any Lender's failure or delay to do or take any of the acts, actions or things described in this Guaranty Agreement including, without limiting the generality of the foregoing, those acts, actions and things described in this Section 9. 4 (c) Each Guarantor further agrees with respect to this Guaranty Agreement that such Guarantor shall have no right of subrogation, contribution, reimbursement or indemnity, nor any right of recourse to security for the Borrower's Liabilities until the Borrower's Obligations under the Notes have been fully, finally and irrevocably paid and satisfied. (d) Until the Borrower's Obligations under the Notes have been fully, finally and irrevocably paid and satisfied, each Guarantor hereby unconditionally subordinates all present and future debts, liabilities or obligations of the Borrower to such Guarantor to the Borrower's Liabilities, and all amounts due under such debts, liabilities, or obligations shall, upon the occurrence and during the continuance of an Event of Default, be collected and paid over forthwith to the Lenders on account of the Borrower's Liabilities and, pending such payment, shall be held by such Guarantor as agent and bailee of the Lenders separate and apart from all other funds, property and accounts of such Guarantor. Guarantor, at the request of the Lenders, shall execute such further documents in favor of the Lenders to further evidence and support the purpose of this Section 9(d). 10. Effectiveness; Enforceability. This Guaranty Agreement shall be effective as of the date hereof, and shall continue in full force and effect until all of the Borrower's Obligations (other than obligations in the nature of continuing indemnities and liability for expenses which are not yet due and payable, which shall survive as an obligation guarantied by the Guarantors hereunder notwithstanding any termination hereof) are fully, finally and irrevocably paid and satisfied. The Lenders shall give each Guarantor written notice of such termination at each Guarantor's address set forth below such Guarantor's execution hereof on the signature pages of this Guaranty or such other address for the Guarantor as such Guarantor shall give notice to the Lenders in the manner provided for the giving of notices under the Notes (the "Guarantor's Address"). This Guaranty Agreement shall be binding upon and inure to the benefit of each Guarantor, the Lenders and their respective successors and assigns. Notwithstanding the foregoing, no Guarantor may, without the prior written consent of the Lenders, assign any rights, powers, duties or obligations hereunder. Any claim or claims that the Lenders may at any time hereafter have against any Guarantor under this Guaranty Agreement may be asserted by any Lender by written notice directed to any one or more or all of the Guarantors at the applicable Guarantor's Address. 11. Representations and Warranties. Each Guarantor warrants and represents to the Lenders that it is duly authorized to execute, deliver and perform this Guaranty Agreement, that this Guaranty Agreement is legal, valid, binding and enforceable against such Guarantor in accordance with its terms except as enforceability may be limited by bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the enforcement of creditors' rights generally and by general equitable principles; and that such Guarantor's execution, delivery and performance of this Guaranty Agreement do not violate or constitute a breach of any of its charter or governance documents or any agreement to which such Guarantor is a party, or any law, order, rule, regulation, decree or award of any applicable governmental authority or arbitral body. 5 12. Expenses. Each Guarantor agrees to be liable for the payment of all reasonable fees and expenses, including without limitation attorney's fees, incurred by any Lender in connection with the enforcement of this Guaranty Agreement, whether or not suit be brought. 13. Reinstatement. Each Guarantor agrees that this Guaranty Agreement shall continue to be effective or be reinstated, as the case may be, at any time payment received by the Lenders under the Notes or the Security Agreements or this Guaranty Agreement is rescinded or must be restored for any reason. 14. Counterparts. This Guaranty Agreement may be executed in any number of counterparts, each of which shall be deemed to be an original as against any party whose signature appears thereon, and all of which shall constitute one and the same instrument. 15. Reliance. Each Guarantor represents and warrants to the Lenders, that: (a) such Guarantor has adequate means to obtain from Borrower, on a continuing basis, information concerning Borrower and Borrower's financial condition and affairs and has full and complete access to Borrower's books and records; (b) such Guarantor is not relying on any Lender, or its or their employees, agents or other representatives, to provide such information, now or in the future; (c) such Guarantor is executing this Guaranty Agreement freely and deliberately, and understands the obligations and financial risks undertaken by providing this Guaranty; (d) such Guarantor has relied solely on the Guarantor's own independent investigation, appraisal and analysis of Borrower and Borrower's financial condition and affairs in deciding to provide this Guaranty and is fully aware of the same; and (e) such Guarantor has not depended or relied on any Lender, or his or its employees, agents or representatives, for any information whatsoever concerning Borrower or Borrower's financial condition and affairs or other matters material to such Guarantor's decision to provide this Guaranty or for any counseling, guidance, or special consideration or any promise therefor with respect to such decision. Each Guarantor agrees that no Lender has any duty or responsibility whatsoever, now or in the future, to provide to any Guarantor any information concerning Borrower or Borrower's financial condition and affairs, other than as expressly provided herein, and that, if such Guarantor receives any such information from any Lender, its or their employees, agents or other representatives, such Guarantor will independently verify the information and will not rely on any Lender, or its or their employees, agents or other representatives, with respect to such information. 16. Governing Law. (a) THIS AGREEMENT SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF NORTH CAROLINA APPLICABLE TO CONTRACTS EXECUTED, AND TO BE FULLY PERFORMED, IN SUCH STATE. (b) EACH PARTY HEREBY EXPRESSLY AND IRREVOCABLY AGREES AND CONSENTS THAT ANY SUIT, ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT AND THE 6 TRANSACTIONS CONTEMPLATED HEREIN MAY BE INSTITUTED IN ANY STATE OR FEDERAL COURT SITTING IN THE COUNTY OF MECKLENBURG, STATE OF NORTH CAROLINA, UNITED STATES OF AMERICA AND, BY THE EXECUTION AND DELIVERY OF THIS AGREEMENT, EXPRESSLY WAIVES ANY OBJECTION THAT IT MAY HAVE NOW OR HEREAFTER TO THE LAYING OF THE VENUE OR TO THE JURISDICTION OF ANY SUCH SUIT, ACTION OR PROCEEDING, AND IRREVOCABLY SUBMITS GENERALLY AND UNCONDITIONALLY TO THE NONEXCLUSIVE JURISDICTION OF ANY SUCH COURT IN ANY SUCH SUIT, ACTION OR PROCEEDING. (c) EACH PARTY AGREES THAT SERVICE OF PROCESS MAY BE MADE BY PERSONAL SERVICE OF A COPY OF THE SUMMONS AND COMPLAINT OR OTHER LEGAL PROCESS IN ANY SUCH SUIT, ACTION OR PROCEEDING, OR BY REGISTERED OR CERTIFIED MAIL (POSTAGE PREPAID) TO THE GUARANTOR'S ADDRESS (AS HEREIN DEFINED) FOR EACH GUARANTOR AND AT THE ADDRESS OF SUCH OTHER PARTY PROVIDED IN THE NOTES OR SECURITY AGREEMENTS OR BY ANY OTHER METHOD OF SERVICE PROVIDED FOR UNDER THE APPLICABLE LAWS IN EFFECT IN THE STATE OF NORTH CAROLINA. (d) NOTHING CONTAINED IN SUBSECTIONS (b) OR (c) HEREOF SHALL PRECLUDE ANY PARTY FROM BRINGING ANY SUIT, ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE NOTES OR THE SECURITY AGREEMENTS IN THE COURTS OF ANY PLACE WHERE ANY OTHER PARTY OR ANY OF SUCH PARTY'S PROPERTY OR ASSETS MAY BE FOUND OR LOCATED. TO THE EXTENT PERMITTED BY THE APPLICABLE LAWS OF ANY SUCH JURISDICTION, EACH PARTY HEREBY IRREVOCABLY SUBMITS TO THE JURISDICTION OF ANY SUCH COURT AND EXPRESSLY WAIVES, IN RESPECT OF ANY SUCH SUIT, ACTION OR PROCEEDING, THE JURISDICTION OF ANY OTHER COURT OR COURTS WHICH NOW OR HEREAFTER, BY REASON OF ITS PRESENT OR FUTURE DOMICILE, OR OTHERWISE, MAY BE AVAILABLE TO IT. (e) IN ANY ACTION OR PROCEEDING TO ENFORCE OR DEFEND ANY RIGHTS OR REMEDIES UNDER OR RELATED TO THIS AGREEMENT OR ANY AMENDMENT, INSTRUMENT, DOCUMENT OR AGREEMENT DELIVERED OR THAT MAY IN THE FUTURE BE DELIVERED IN CONNECTION WITH THE FOREGOING, EACH PARTY HEREBY AGREES, TO THE EXTENT PERMITTED BY APPLICABLE LAW, THAT ANY SUCH ACTION OR PROCEEDING SHALL BE TRIED BEFORE A COURT AND NOT BEFORE A JURY AND EACH PARTY HEREBY WAIVES, TO THE EXTENT PERMITTED BY APPLICABLE LAW, ANY OBJECTION THAT IT MAY 7 HAVE THAT EACH ACTION OR PROCEEDING HAS BEEN BROUGHT IN AN INCONVENIENT FORUM. 8 IN WITNESS WHEREOF, the parties have duly executed this Guaranty Agreement on the day and year first written above. GUARANTORS: US LEC of North Carolina L.L.C. WITNESS: By: /s/ David N. Vail ------------------------------------ Name: David N. Vail --------------------------------- ______________________ Title: Executive Vice President, Finance Chief Financial Officer ______________________ Address for Notices: US LEC of North Carolina L.L.C. 212 S. Tryon Street, Suite 1540 Charlotte, North Carolina 28281 Telefacsimile: (704) 319-1345 US LEC of Georgia L.L.C. By: /s/ David N. Vail ------------------------------------ Name: David N. Vail --------------------------------- Title: Executive Vice President, Finance WITNESS: Chief Financial Officer ______________________ ______________________ Address for Notices: US LEC of Georgia L.L.C. 212 S. Tryon Street, Suite 1540 Charlotte, North Carolina 28281 Telefacsimile: (704) 319-1345 LENDERS: /s/ Richard T. Aab ---------------------------------- Richard T. Aab /s/ Tansukh V. Ganatra -------------------------------------- Tansukh V. Ganatra Melrich Associates, L.P. By: /s/ Richard T. Aab ---------------------------------- Richard T. Aab, General Partner EX-10 11 EXHIBIT 10.7 CONTRIBUTION AGREEMENT THIS CONTRIBUTION AGREEMENT, is made and effective as of the 14th day of February, 1998, between US LEC Corp., a Delaware corporation (the "Corporation"), and Richard T. Aab, a resident of Pittsford, New York ("Contributor"). BACKGROUND A. The Corporation currently owes Contributor the principal amount of $5,000,000 pursuant to a promissory note dated January 16, 1998 (the "Debt"). B. Contributor desires to convert the Debt to equity by contributing the Debt to the Corporation in exchange for Class B Common Stock of the Corporation at a conversion rate of approximately $10.40 per share, or 480,770 shares of the Class B Common Stock of the Corporation. C. The Corporation desires to accept the contribution to its capital and to issue 480,770 shares of its Class B Common Stock to Contributor in exchange for such contribution. Accordingly, for good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties agree as follows: Section 1. Contribution of Debt. Contributor hereby contributes the entire principal amount of the Debt to the Corporation in exchange for the issuance to him of an additional 480,770 shares of the Corporation's Class B Common Stock. Contributor hereby agrees to deliver to the Corporation the original promissory note representing the Debt marked "converted to equity". Section 2. Issuance of Stock. In consideration of the contribution to the Corporation of the Debt, the Corporation hereby issues to Contributor 480,770 shares of the Corporation's Class B Common Stock and agrees to deliver to Contributor a certificate representing such 480,770 shares as promptly as practicable. The Corporation warrants and represents that such shares are validly issued, fully paid and nonassessable and are free of all liens, encumbrances and claims. Section 3. Effective Date. The contribution of the Debt to equity and the issuance of the 480,770 shares shall be effective as of the date of this Agreement, notwithstanding that the original promissory note and share certificate may not be delivered until a later date. Section 4. Severability. Any provision of this Agreement which is invalid, prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such invalidity, prohibition or unenforceability without invalidating the remaining provisions hereof, and any such invalidity, prohibition or unenforceability in any such jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. Page 1 of 2 Section 5. Counterparts. This Agreement may be executed in any number of counterparts and by the parties hereto on separate counterparts, but all of such counterparts shall together constitute a single instrument. Any party may execute and deliver this Agreement by telefax or other facsimile transmission. Section 6. Additional Actions. Each party hereto agrees to take (or cause others to take) such other action and to execute and deliver (or cause others to execute and deliver) such other agreements, certificates or documents as may be reasonably necessary or desirable to carry out the provisions of this Agreement. Section 7. Entire Agreement. This Agreement shall constitute the entire agreement between the parties hereto with respect to the subject matter hereof and shall not be supplemented, amended or modified except by a written instrument executed on behalf of the parties hereto by such parties or their duly authorized representatives and executed of even date herewith or subsequent hereto. Section 8. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Delaware, as they are applied to contracts made and to be wholly performed in that state, regardless of choice of law principles to the contrary. IN WITNESS WHEREOF, the parties have executed this Contribution Agreement as of the day and year first written above. US LEC CORP. By: /s/ David N. Vail ------------------------------------ Name: David N. Vail Executive Vice President, Finance Chief Financial Officer CONTRIBUTOR /s/ Richard T. Aab -------------------------------- Richard T. Aab Page 2 of 2 EX-10 12 EXHIBIT 10.10 AMENDED AND RESTATED SHAREHOLDERS AGREEMENT THIS SHAREHOLDERS AGREEMENT (the "Agreement"), dated as of the 1st day of January, 1998, is by and among RICHARD T. AAB, a resident of Pittsford, New York ("Aab"), MELRICH ASSOCIATES, L.P., a New York limited partnership ("Melrich"), TANSUKH V. GANATRA, a resident of Charlotte, North Carolina ("Ganatra"), and SUPER STAR ASSOCIATES LIMITED PARTNERSHIP, a North Carolina limited partnership ("Super STAR") (Aab, Melrich, Ganatra and Super STAR are sometimes referred to individual as a "Shareholder", and sometimes referred to collectively as the "Shareholders"). BACKGROUND: A. US LEC Corp., a Delaware corporation (the "Corporation"), has Seventeen Million Seventy-Five Thousand Two Hundred Seventy-Two (17,075,272) shares of authorized Class B Common Stock, par value $.01 per share ("Class B Common"), of which all but two of such shares are currently issued and outstanding (as defined in Section 6, the "Shares"). B. The Shareholders own and hold of record the following shares of Class B Common: SHAREHOLDER NUMBER OF SHARES Richard T. Aab 8,721,770 Melrich Associates, L.P. 4,309,500 Tansukh V. Ganatra 294,000 Super STAR Associates Limited Partnership 3,750,000 C. The Shareholders believe that it is in the best interests of the Shareholders to make specific provisions concerning the disposition and conversion of shares of Class B Common. D. The Shareholders believe it is in the best interests of the Shareholders to make specific provisions concerning the voting of the shares of Class B Common. Accordingly, in consideration of the premises and of the mutual covenants and agreements contained herein, and for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Shareholders do hereby agree as follows: 1. Voting of the Class B Common Shares. Each Shareholder hereby agrees that he, she or it will, for as long as he, she or it holds shares of Class B Common, vote all of his, hers or its shares of Class B Common (whether now owned or hereafter acquired), whether for directors or for any other purpose, in the same manner as Aab. Each Shareholder further agrees to give his, hers or its irrevocable proxy to Aab, contemporaneous with the execution any delivery of this Agreement and hereafter from time to time at the request of Aab, by executing and delivering to Aab an irrevocable proxy in the form of the proxy attached hereto as Exhibit A. Aab agrees to vote the Shares to elect one (1) designee of Ganatra and one (1) designee of Aab as directors of the Corporation. 2. Offer Upon Elective Conversion. If any Shareholder desires to effect an elective conversion of any shares of Class B Common (whether now owned or hereafter acquired) into shares of Class A Common Stock of the Corporation ("Class A Common"), as provided for in the Certificate of Incorporation of the Corporation, the Shareholder shall first submit to all other Shareholders a written notice of the Shareholder's intent to convert his, her or its shares of Class B Common into Class A Common, along with an offer to sell or exchange all or part of the shares of Class B Common proposed to be converted, pursuant to this Section 2 (the "Conversion Notice"). Each Conversion Notice shall constitute dual, binding offers by the offering Shareholder to (A) sell all or part of such shares of Class B Common for cash (the "Cash Offer") or (B) exchange all or part of such shares of Class B Common for an equal number of shares of Class A Common (the "Exchange Offer"). (a) The offered shares of Class B Common shall be allocated among the other Shareholders on the basis of the percentage of shares of Class B Common then owned by them (excluding shares of Class B Common owned by the offering Shareholder). Each offeree Shareholder shall have the right to purchase (by cash or exchange of shares of Class A Common) all or part of his, her or its allocated shares of the offered Shares. (b) Within ten (10) days of delivery of the Conversion Notice, each offeree Shareholder shall provide written notice to the offering Shareholder and all other Shareholders of his, her or its election to consider acceptance of either the Cash Offer or the Exchange Offer and, if he, she or it intends to consider a Cash Offer, the expiration date for the six month period referred to in subsection (c)(ii) below (if applicable). An election by an offeree Shareholder to consider the Cash Offer shall automatically terminate the Exchange Offer to such Shareholder and an election by an offeree Shareholder to consider the Exchange Offer shall automatically terminate the Cash Offer to such Shareholder. (c) For those offeree Shareholders electing to consider the Cash Offer (the "Cash Offerees"), the Cash Offer shall continue to be a binding offer of the offering Shareholder to sell until the later of, (i) the expiration of thirty (30) days after delivery of the Conversion Notice or (ii) 5:00 p.m. on the first business day subsequent to the expiration of the six month period following consummation, by any Cash Offeree, of any transaction treated as a nonexempt sale under Section 16(b) of the Securities Exchange Act of 1934, as amended (the later of such times is referred to herein as the "Cash Offer Expiration Date"). If any Cash Offeree does not purchase all of his, her or its allocated share of the offered shares of Class B Common on or before the Cash Offer Expiration Date, the offering Shareholder shall give written notice to the other Cash Offerees, and such other Cash Offerees shall have an additional ten (10) days from the delivery of such notice to elect to purchase such declined shares of Class B Common at the same price and upon the same terms previously offered to the declining Cash Offeree (and the Cash Offer shall continue to be a binding offer with respect to such declined shares until the expiration of such additional ten (10) day 2 period). Any such shares of Class B Common shall be allocated to the remaining Cash Offeree(s) on the basis of the percentage of shares of Class B Common owned by them (excluding shares of Class B Common owned by the offering Shareholder, the declining Cash Offeree(s), and the Exchange Offeree(s), as defined below). (d) For those offeree Shareholders electing to consider the Exchange Offer (the "Exchange Offerees"), the Exchange Offer shall continue to be a binding offer of the offering Shareholder to exchange shares of Class B Common for an equal number of shares of Class A Common until the expiration of thirty (30) days after delivery of the Conversion Notice (the "Exchange Offer Expiration Date"). If any Exchange Offeree does not exchange all of his, her or its allocated share of the offered shares of Class B Common on or before the Exchange Offer Expiration Date, the offering Shareholder shall give written notice to the other Exchange Offerees, and such other Exchange Offerees shall have an additional ten (10) days from the delivery of such notice to elect to acquire such declined shares of Class B Common upon the same terms previously offered to the declining Exchange Offeree (and the Exchange Offer shall continue to be a binding offer with respect to such declined shares until the expiration of such additional ten (10) day period). Any such shares of Class B Common shall be allocated to the remaining Exchange Offeree(s) on the basis of the percentage of shares of Class B Common owned by them (excluding shares of Class B Common owned by the offering Shareholder, the declining Exchange Offeree(s), and the Cash Offeree(s)). (e) Purchase Price Payable by Cash Offerees. The cash purchase price of each share of Class B Common for purposes of this Section 2 shall be the average of the closing prices of a share of Class A Common for the ten (10) trading days immediately following the date on which Conversion Notice is given by the offering Shareholder, as reported in The Wall Street Journal or other reporting services acceptable to all parties hereto. If at the time the purchase price is to be determined, shares of the Class A Common are not publicly traded, the purchase price shall be determined as follows: (8 x EBITDA) Per Share Purchase Price = .75 x ------------ (Total A&B) Where EBITDA = The Corporation's earnings before interest, taxes, depreciation and amortization as shown on, for periods up to and including December 31, 1999, the forecast for calendar year 1999 in existence at the time this Agreement is signed, and for all periods after January 1, 2000, the most recent consolidated year end financial statements of the Corporation. and Total A&B = Total issued and outstanding shares of the Corporation's Class A Common and Class B Common at the time the purchase price is determined. 3 (f) Terms of Purchase and Payment for Cash Offerees. If any Cash Offeree elects to purchase shares of Class B Common in accordance with this Section 2, the purchase must be consummated at the principal office of the Corporation in the State of North Carolina on the last day the Cash Offer remains binding (or at such other time and place as may otherwise be acceptable to the selling Shareholder and the purchasing Shareholder). Payment of the purchase price of the shares shall be made at closing by wire transfer of immediately available funds to an account designated by the selling Shareholder or by certified check payable to the selling Shareholder. Upon tender of the purchase price, the selling Shareholder shall deliver to the purchasing Shareholder one or more certificates representing all shares of Class B Common being purchased, duly endorsed over to the purchaser or accompanied by duly executed stock powers. The Shareholders shall cause the Corporation to cooperate with selling and purchasing Shareholders in connection with such offers and closing, including, but not limited to, providing appropriately denominated certificates on a timely basis. If, pursuant to this Section 2, the Cash Offer Expiration Date occurs on a date which is subsequent to the thirtieth (30th) day subsequent to delivery of the Conversion Notice, then on the thirtieth day subsequent to delivery of the Conversion Notice, the Cash Offerees (other than those who have, prior to such date either purchased their allocated share of the offered shares of Class B Common or have notified the offering Shareholder of their decision not to purchase their allocated share of the offered shares of Class B Common) shall submit a non-refundable deposit (by wire transfer of immediately available funds to an account designated by the offering Shareholder or by certified check payable to the offering Shareholder) to the offering Shareholder in an amount equal to twenty-five percent (25%) of the purchase price of such Shareholder's share of offered shares of Class B Common (not previously purchased or declined). In the event that a Cash Offeree who has submitted a deposit does not purchase his, her or its allocated shares of the offered shares of Class B Common on or before the Cash Offer Expiration Date, his, her or its deposit shall be forfeited. (g) Terms of Closing for Exchange Offerees. If any Exchange Offeree elects to accept the Exchange Offer in accordance with this Section 2, the exchange must be consummated at the principal office of the Corporation in the State of North Carolina on the last day on which the Exchange Offer remains binding (or at such other time or place as may otherwise be acceptable to the selling Shareholder and the purchasing Shareholder). At the closing, the accepting Exchange Offerees shall deliver to the selling Shareholder one or more certificates representing all shares of Class A Common being exchanged, duly endorsed over to the selling Shareholder or accompanied by duly executed stock powers, and the selling Shareholder shall deliver to the Exchange Offerees one or more certificates representing all shares of Class B Common being exchanged, duly endorsed over to the accepting Exchange Offerees or accompanied by duly executed stock powers. The Shareholders shall cause the Corporation to cooperate with the participating Shareholders in connection with such exchange and closing, including, but not limited to, providing appropriately denominated certificates on a timely basis. 4 3. Transfer of Shares of Class B Common. The Shareholders hereby agree that, unless all of the other Shareholders give their written consent thereto, no Shareholder shall make a voluntary transfer or otherwise dispose of (as defined in Section 6(c) herein) any of his, her or its shares of Class B Common, whether now owned or hereafter acquired, to any party other than another Shareholder, except that such shares of Class B Common may be transferred to a Permitted Transferee (as defined in Article IV of the Restated Certificate of Incorporation of the Corporation), but only if, simultaneous with the transfer of such shares of Class B Common, such Permitted Transferee becomes a signatory to this Agreement as a "Shareholder" (by executing and delivering to all other Shareholders a signature page by which he, she or it agrees without condition to be bound by this Agreement as a "Shareholder," and provides an address for the giving of notices, and executes and delivers to Aab an irrevocable proxy in favor of Aab as required by Section 1 of this Agreement. 4. Divorce or Legal Separation of a Shareholder. (a) Notwithstanding anything herein to the contrary, if a spouse of a Shareholder has received shares of Class B Common as a Permitted Transferee (as defined in Article IV of the Restated Certificate of Incorporation of the Corporation) and such spouse is subsequently no longer legally married to or is legally separated from such Shareholder, then such Shareholder shall have an option to purchase any or all of such Shares (by cash payment or exchange). The option shall constitute a binding offer of the spouse to sell any or all of the Shares to the Shareholder at the same price per share and upon the same terms as is provided in Section 2 hereof, except that the cash purchase price shall be determined based on the closing prices of a share of Class A Common for the ten (10) trading days immediately following the date of the legal separation or divorce of such spouse and Shareholder and the option shall extend from the date of the divorce or legal separation until the applicable expiration date (excluding the additional ten day periods) provided in Section 2 (calculated by using the date of the divorce or legal separation rather than the date of delivery of the Conversion Notice). (b) If such Shareholder does not purchase all such Shares of his or her spouse pursuant to the option described in (a), then (i) such Shareholder shall give written notice (a "Divorce Notice") to all other Shareholders, and (ii) the other Shareholders shall have an option to acquire all or part of the declined Shares. This option shall constitute a binding offer of such spouse to sell all or part of the Shares to the other Shareholders at the same price per share and upon the same terms as provided in Section 2 hereof, except that the cash purchase price shall be determined based on the closing prices of a share of Class A Common for the ten (10) trading days immediately following the date of the legal separation or divorce of such spouse and Shareholder. The option shall confer upon each such other Shareholder the right to purchase (by cash payment or exchange) his, her or its allocated share of the declined Shares (allocated pro rata based on the Shares owned by all Shareholders other than the spouse and the declining Shareholder), and shall extend, with regard to each Shareholder, from the delivery of the Divorce Notice to such other Shareholder until the applicable expiration date (including but not limited to the additional ten day periods) provided in Section 2 (calculated by using the date of the delivery of the Divorce Notice rather than the date of delivery of the Conversion Notice). 5 5. Endorsement on Stock Certificate. The Shareholders shall use their best efforts to cause each certificate representing shares of Class B Common at any time owned by any Shareholder to bear the following legend prominently displayed thereon: "THE SHARES REPRESENTED BY THIS CERTIFICATE, AND THE TRANSFER HEREOF, ARE SUBJECT TO THE TERMS AND PROVISIONS OF THAT CERTAIN SHAREHOLDERS AGREEMENT DATED AS OF JANUARY 1, 1998, AS AMENDED FROM TIME TO TIME, A COPY OF WHICH IS MAY BE OBTAINED FROM ANY SHAREHOLDER OWNING SHARES OF CLASS B COMMON STOCK UPON REQUEST." 6. Certain Interpretations and Definitions. As used in this Agreement: (a) "Shareholder" or "Shareholders" means shareholders of the Corporation who are parties to this Agreement as provided on page 1 hereof, and any successor in interest or transferee of any Shares of such Shareholder who purchased shares in accordance with this Agreement. (b) "Shares" means any outstanding shares of Class B Common Stock of the Corporation now owned (as shown in the Recitals hereto) or hereafter acquired by any Shareholder, any shares distributed with respect to any such shares in a stock split, stock dividend or other recapitalization or reorganization, and any other outstanding shares of the Corporation that otherwise become subject to this Agreement by written agreement of the parties. (c) The terms "transfer", "dispose of" and/or "disposition", when used with respect to shares, mean and include any sale, assignment, transfer, conveyance, gift, encumbrance, pledge, hypothecation, equitable distribution or other disposition of Shares (whether voluntary, involuntary, or otherwise), including permitting a levy or attachment on the Shares. (d) An "involuntary" transfer or disposition of shares means (i) a testamentary or intestate transfer or disposition made incident to the death of a Shareholder, (ii) a transfer made in connection with the divorce or separation of a Shareholder pursuant to a property settlement agreement that is filed for public record, or (iii) a transfer made pursuant to an order issued by a court of competent jurisdiction in connection with the involuntary bankruptcy of, or the appointment of a receiver for, a Shareholder. (e) A "voluntary" transfer or disposition of Shares refers to any transfer or disposition other than an involuntary transfer or disposition. 7. Term. The term of this Agreement shall commence on the date hereof and shall continue in effect for a period of ten (10) years. Thereafter, this Agreement shall automatically renew for successive one (1) year terms all of the Shareholders then holding Shares elect to terminate this Agreement as of the end of the then current term (initial or renewal). 6 Notwithstanding the foregoing, Section 1 hereof shall be of no further force or effect if at any time Aab ceases to own any Shares, and the last sentence of Section 1 shall be of no further force or effect if at any time Ganatra ceases to own any Shares. 8. Notices. Any and all notices, consents, offers, acceptances or other communications made hereunder must be in writing and shall be deemed given and delivered when delivered personally or by courier service, provided evidence of receipt is obtained, or three (3) days after mailing if mailed by registered or certified mail, return receipt requested, postage prepaid, and addressed as follows (or to such other address that the parties may from time to time designate in a writing sent to all other parties of this Agreement in the manner required by this Section 8, except that any such change of address notice shall only be effective upon receipt): (a) if to Richard T. Aab: 29 Woodstone Rise Pittsford, New York 14534 (b) if to Melrich Associates L.P.: 29 Woodstone Rise Pittsford, New York 14534 (c) if to Tansukh V. Ganatra: 6523 Ashdale Place Charlotte, North Carolina 28215 (d) if to Super STAR Associates Limited Partnership: 6523 Ashdale Place Charlotte, North Carolina 28215 (e) A copy of any such correspondence shall also be sent to: Moore & Van Allen, PLLC 100 North Tryon Street, Floor 47 Charlotte, North Carolina 28202-4003 Attention: Aaron D. Cowell, Jr. 9. Severability. If any such provision of this Agreement shall be invalid or unenforceable for any reason, the other provisions shall continue to be effective and binding and this Agreement shall be construed as if the invalid or unenforceable provision were omitted. If any provision of this Agreement is unenforceable after a certain period of years from the date hereof due to the requirements of any state laws, the remainder of the Agreement shall remain enforceable and binding in accordance with its terms. 7 10. Binding Effect. This Agreement shall be binding upon the Shareholders, and their respective heirs, legal representatives, executors, administrators, successors and permitted assigns. Any rights given or duties imposed upon the estate of a deceased Shareholder shall inure to the benefit of and be binding upon the legal representative of such deceased Shareholder's estate in his or her fiduciary capacity. 11. Entire Agreement, Amendment, Waiver. This Agreement contains the entire agreement of the parties hereto with respect to the subject matter hereof, and supersedes any and all other agreements, either written or oral, among the parties hereto regarding the same subject matter. The provisions of this Agreement may be amended, modified or waived only as provided for herein or on unanimous written consent of the Shareholders. A written waiver provided pursuant to this Section 11 shall be effective only in the specific instance and for the specific purpose for which given. No failure or delay on the part of any Shareholder in the exercise of any right, power or privilege hereunder shall operate as a waiver of any such right, power or privilege nor shall any such failure or delay preclude any other or further exercise hereof. 12. Counterparts. This Agreement may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed an original, and it shall not be necessary in making proof of this Agreement to produce or account for more than one such counterpart. 13. Captions. The captions herein are inserted only as a matter of convenience and for reference and in no way define, limit or describe the scope of this Agreement nor any provisions hereof. 14. Governing Law. This Agreement shall be governed by and construed and interpreted in accordance with the laws of the State of Delaware. 15. Arbitration. (a) Any dispute, controversy, difference or claim arising out of, relating to or in connection with this Agreement, any transaction hereunder, or the breach hereof shall be decided by arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association then in effect, except as otherwise agreed by the parties. Any such arbitration shall be conducted on the earliest possible date and conducted in Charlotte, North Carolina. The arbiter's award shall be final and binding on the parties hereto and judgment upon the award may be entered in any court having jurisdiction thereof. Expenses in the arbitration shall be apportioned between the parties by the arbiter. The arbitration award may include reasonable attorneys' fees from the other party. No action, regardless of form, arising out of this Agreement may be brought more than three (3) years after the cause of action for such action has accrued. (b) Notwithstanding subsection (a), either party may, if it believes that it requires or is entitled to injunctive relief, file a civil action in any court having jurisdiction seeking injunctive relief. Any claim or demand for monetary damages shall, however, be governed exclusively by the provisions for arbitration set forth in subsection (a). 8 IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement under seal as of the date first above written. AAB ________________________________ Richard T. Aab MELRICH ASSOCIATES, L.P. By: ______________________________ Richard T. Aab, General Partner GANATRA --------------------------------------- Tansukh V. Ganatra SUPER STAR ASSOCIATES LIMITED PARTNERSHIP By: ------------------------------------- Tansukh V. Ganatra, General Partner 9 EXHIBIT A to AMENDED AND RESTATED SHAREHOLDERS AGREEMENT APPOINTMENT OF IRREVOCABLE PROXY The undersigned shareholder of US LEC CORP., a Delaware corporation (the "Corporation"), does hereby constitute and appoint RICHARD T. AAB ("Aab") as its proxy with full power of substitution, for and on its behalf to attend all meetings of shareholders of such Corporation and to act, vote and execute consents with respect to all of its shares of Class B Common Stock of the Corporation, as fully and to the same extent as the undersigned shareholder might do itself. This proxy is irrevocable and is coupled with an interest, having been executed in connection with that certain Amended and Restated Shareholders Agreement dated as of January 1, 1998 to which Aab and the undersigned are among the parties (the "Shareholders Agreement"). This appointment of proxy shall continue in full force and effect as long as Aab and the undersigned are parties to the Shareholders Agreement. This the ____ day of , 1998. ----------------------- By: ---------------------- Name: -------------------- 10 EX-10.11 13 CONSULTING AGREEMENT RTA ASSOCIATES, LLC 2000 WINTON ROAD SOUTH, BLDG. 4 ROCHESTER, NY 14618 CONSULTING AGREEMENT This Agreement is made by and between RTA Associates, LLC, with an address of 2000 Winton Road South, Rochester, New York 14618 ("Consultant") and US LEC LLC ("USLEC"), a Delaware limited liability company with its principal offices located at 212 South Tryon Street, Suite 1540, Charlotte, North Carolina 28281. 1. Retention as Consultant. USLEC hereby retains Consultant and Consultant hereby accepts such engagement and agrees to perform the services for USLEC as hereinafter set forth. During the Term hereof, Consultant shall act as a general business consultant to USLEC, particularly in the areas of strategic business analysis and planning, financial planning and capital formation, as well as in such other areas as may be assigned from time to time by USLEC's Chairman, President and/or Board of Directors. Consultant shall perform its duties in a diligent, effective, and loyal manner. 2. Compensation. Consultant shall be compensated by USLEC for all services to be rendered by it pursuant to this Agreement by the payment to it of consulting fees in the amount of $125,000.00 per year. In addition, USLEC shall reimburse Consultant for Consultant's reasonable out-of-pocket expenses incurred with respect to the performance of its consulting activities hereunder upon Consultant's presentation, within 30 days after incurring such expenses, of vouchers, receipts, and such other evidence of expenses incurred as shall be reasonably required by USLEC. 3. Term. The term of this Agreement shall be from January 1, 1997 through December 31, 1997, and shall automatically be renewed for successive one-year terms until terminated by one party giving the other at least 30 days' advance notice of its intention to terminate this Agreement at the end of its then-current year. 4. Relationship. Consultant and USLEC are and shall be independent contractors in their relationship with each other and neither is nor shall be considered an agent, employee, or legal representative of the other for federal or state tax purposes or for any other purposes whatsoever. Consultant has no express or implied authority to assume or create any obligation or responsibility on behalf of USLEC or to bind USLEC in any way. Consultant agrees to indemnify, defend, and hold USLEC harmless from and against all claims, damages or liabilities as a result of its breach of this Paragraph. Consultant further acknowledges that as an independent contractor, it shall not be entitled to receive any insurance coverage or other fringe benefits that USLEC customarily provides to its employees, except as may be specifically provided in this Agreement; and that no withholding, FICA or other taxes will be paid or withheld by USLEC on its behalf. 5. General Provisions. (a) Binding Effect. This Agreement shall be binding upon and inure to the benefit of the parties hereto, their personal representatives, successors and assigns. (b) Assignment. This Agreement may not be assigned, in whole or in part, by Consultant without the prior written consent of USLEC. (c) Entire Agreement. This Agreement contains the entire understanding between or among the parties hereto and supersedes any prior understanding, memoranda or other written or oral agreements between or among any of them respecting the within subject matter. (d) Modifications; Waiver. No modification or waiver of this Agreement or any party hereof shall be effective unless in writing and signed by the party or parties sought to be charged therewith. No waiver of any breach or condition of this Agreement shall be deemed to be a waiver of any other or subsequent breach or condition, whether of like or different nature. No waiver of any breach or condition of this Agreement by or with respect to any party hereto shall be deemed to be a waiver of the same breach or condition with respect to any other party hereto. No course of dealing between or among any of the parties hereto will be deemed effective to modify, amend or discharge any part of this Agreement or the rights or obligations of any party hereunder. (e) Partial Invalidity. If any provision of this Agreement shall be held invalid or unenforceable by competent authority, such provision shall be construed so as to be limited or reduced to be enforceable to the maximum extent compatible with the law as it shall then appear. The total invalidity or unenforceability of any particular provision of this Agreement shall not affect the other provisions hereof and this Agreement shall be construed in all respects as if such invalid or unenforceable provision were omitted. (f) Notices. Any notice or other communication required or permitted under this Agreement shall be in writing and shall be deemed to have been duly given (I) upon hand delivery, or (ii) on the third day following delivery to the U.S. Postal Service as certified or registered mail, return receipt requested and postage prepaid, or (iii) on the first day following delivery to a nationally recognized United States overnight courier service, fee prepaid, return receipt or other confirmation of delivery requested, or (iv) when telecopied or sent by facsimile transmission to the following fax numbers: 2 If to USLEC: 704-319-1345 Attention: President If to Consultant: 716-424-5909, Attention: Richard T. Aab Any such notice or communication shall be delivered or directed to a party at its address or fax number set forth above or at such other address or fax number as may be designated by a party in a notice given to all other parties hereto in accordance with the provisions of this paragraph. (g) Governing Law. This Agreement shall be governed by, and construed in accordance with, the laws of the State of New York pertaining to contracts made and to be wholly performed within such state, without taking into account conflicts of laws principles. (h) Jurisdiction and Venue. In the event that any legal proceedings are commenced in any court with respect to any matter arising under this Agreement, the parties hereto specifically consent and agree that the courts of the State of New York and/or the United States Federal Courts located in the State of New York shall have exclusive jurisdiction over each of the parties hereto and over the subject matter of any such proceedings, and the venue of any such action shall be in Monroe County, New York and/or the United States District Court for the Western District of New York. (i) Injunctive Relief. In the event of a breach or threatened breach of any of the terms of this Agreement, USLEC shall be entitled to an injunction restraining Consultant from committing any breach of this Agreement without showing or proving any actual damages and without diminishing any other right or remedy which USLEC may have at law or in equity to enforce the provisions of this Agreement. (j) Expenses of Parties. In the event of a breach of this Agreement, the prevailing party(ies) in any resulting litigation shall be reimbursed its/their reasonable attorneys' fees and expenses incurred in such litigation by the party(ies) against whom judgment is rendered. (k) Headings. The headings contained in this Agreement are inserted for convenience only and do not constitute a part of this Agreement. (l) Fair Meaning. This Agreement shall be construed according its fair meaning, the language used shall be deemed the language chosen by the parties hereto to express their mutual intent, and no presumption or rule of strict construction will be applied against any party hereto. 3 (m) Gender. Whenever the context may require, any pronoun used herein shall include the corresponding masculine, feminine or neuter forms and the singular use of nouns, pronouns and verbs shall include the plural and vice versa. (n) Counterparts. This Agreement may be executed in several counterparts, each of which shall be deemed an original, and all of said counterparts together shall constitute but one of the same instrument. IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the 18th day of December, 1997 CONSULTANT: US LEC,LLC RTA ASSOCIATES, LLC By: /s/ Richard T. Aab By: /s/ T.V. Ganatra ----------------------- -------------------- Richard T. Aab, Member Title: President & COO January 1, 1998 RTA Associates LLC Attn: R.T. Aab 2000 Winton Road South Bldg. 4 Rochester, N.Y. 14618 RE: Consulting Agreement with US LEC Dear Mr. Aab: US LEC hereby notifies you that the consulting agreement between RTA Associates LLC and US LEC dated December 18, 1997 is terminated for future years effective January 1, 1998. Sincerely, /s/ Richard T. Aab - --------------------------- Richard T. Aab Chairman & CEO RTA:alc I hereby agree to the termination of the agreement described above RTA Associates LLC By: /s/ Richard T. Aab 1/4/98 ------------------- -------- Richard T. Aab, Manager Date 4 EX-10.13 14 CONSULTING AGREEMENT Super STAR Associates, L.P. 6523 Ashdale Place Charlotte, NC 28215 CONSULTING AGREEMENT This Agreement is made by and between Super STAR Associates, L.P., with an address of 6523 Ashdale Place, Charlotte, North Carolina 28215 ("Consultant") and US LEC LLC ("USLEC"), a Delaware limited liability company with its principal offices located at 212 South Tryon Street, Suite 1540, Charlotte, North Carolina 28281. 1. Retention as Consultant. USLEC hereby retains Consultant and Consultant hereby accepts such engagement and agrees to perform the services for USLEC as hereinafter set forth. During the Term hereof, Consultant shall act as a general business consultant to USLEC, particularly in the areas of operations expertise, as well as in such other areas as may be assigned from time to time by USLEC's Chairman, President and/or Board of Directors. Consultant shall perform its duties in a diligent, effective, and loyal manner. 2. Compensation. Consultant shall be compensated by USLEC for all services to be rendered by it pursuant to this Agreement by the payment to it of consulting fees in the amount of $50,000.00 per year. In addition, USLEC shall reimburse Consultant for Consultant's reasonable out-of-pocket expenses incurred with respect to the performance of its consulting activities hereunder upon Consultant's presentation, within 30 days after incurring such expenses, of vouchers, receipts, and such other evidence of expenses incurred as shall be reasonably required by USLEC. 3. Term. The term of this Agreement shall be from January 1, 1997 through December 31, 1997, and shall automatically be renewed for successive one-year terms until terminated by one party giving the other at least 30 days' advance notice of its intention to terminate this Agreement at the end of its then-current year. 4. Relationship. Consultant and USLEC are and shall be independent contractors in their relationship with each other and neither is nor shall be considered an agent, employee, or legal representative of the other for federal or state tax purposes or for any other purposes whatsoever. Consultant has no express or implied authority to assume or create any obligation or responsibility on behalf of USLEC or to bind USLEC in any way. Consultant agrees to indemnify, defend, and hold USLEC harmless from and against all claims, damages or liabilities as a result of its breach of this Paragraph. Consultant further acknowledges that as an independent contractor, it shall not be entitled to receive any insurance coverage or other fringe benefits that USLEC customarily provides to its employees, except as may be specifically provided in this Agreement; and that no withholding, FICA or other taxes will be paid or withheld by USLEC on its behalf. 5. General Provisions. (a) Binding Effect. This Agreement shall be binding upon and inure to the benefit of the parties hereto, their personal representatives, successors and assigns. (b) Assignment. This Agreement may not be assigned, in whole or in part, by Consultant without the prior written consent of USLEC. (c) Entire Agreement. This Agreement contains the entire understanding between or among the parties hereto and supersedes any prior understanding, memoranda or other written or oral agreements between or among any of them respecting the within subject matter. (d) Modifications, Waiver. No modification or waiver of this Agreement or any party hereof shall be effective unless in writing and signed by the party or parties sought to be charged therewith. No waiver of any breach or condition of this Agreement shall be deemed to be a waiver of any other or subsequent breach or condition, whether of like or different nature. No waiver of any breach or condition of this Agreement by or with respect to any party hereto shall be deemed to be a waiver of the same breach or condition with respect to any other party hereto. No course of dealing between or among any of the parties hereto will be deemed effective to modify, amend or discharge any part of this Agreement or the rights or obligations of any party hereunder. (e) Partial Invalidity. If any provision of this Agreement shall be held invalid or unenforceable by competent authority, such provision shall be construed so as to be limited or reduced to be enforceable to the maximum extent compatible with the law as it shall then appear. The total invalidity or unenforceability of any particular provision of this Agreement shall not affect the other provisions hereof and this Agreement shall be construed in all respects as if such invalid or unenforceable provision were omitted. (f) Notices. Any notice or other communication required or permitted under this Agreement shall be in writing and shall be deemed to have been duly given (i) upon hand delivery, or (ii) on the third day following delivery to the U.S. Postal Service as certified or registered mail, return receipt requested and postage prepaid, or (iii) on the first day following delivery to a nationally recognized United States overnight courier service, fee prepaid, return receipt or other confirmation of delivery requested, or (iv) when telecopied or sent by facsimile transmission to the following fax numbers: If to USLEC: 704-319-1345 Attention: Chairman If to Consultant: 704-535-7909, Attention: T. V. Ganatra 2 Any such notice or communication shall be delivered or directed to a party at its address or fax number set forth above or at such other address or fax number as may be designated by a party in a notice given to all other parties hereto in accordance with the provisions of this paragraph. (g) Governing Law. This Agreement shall be governed by, and construed in accordance with, the laws of the State of North Carolina pertaining to contracts made and to be wholly performed within such state, without taking into account conflicts of laws principles. (h) Jurisdiction and Venue. In the event that any legal proceedings are commenced in any court with respect to any matter arising under this Agreement, the parties hereto specifically consent and agree that the courts of the State of North Carolina and/or the United States Federal Courts located in the State of North Carolina shall have exclusive jurisdiction over each of the parties hereto and over the subject matter of any such proceedings, and the venue of any such action shall be in Mecklenburg County, North Carolina and/or the United States District Court for the Western District of North Carolina. (i) Injunctive Relief. In the event of a breach or threatened breach of any of the terms of this Agreement, USLEC shall be entitled to an injunction restraining Consultant from committing any breach of this Agreement without showing or proving any actual damages and without diminishing any other right or remedy which USLEC may have at law or in equity to enforce the provisions of this Agreement. (j) Expenses of Parties. In the event of a breach of this Agreement, the prevailing party(ies) in any resulting litigation shall be reimbursed its/their reasonable attorneys' fees and expenses incurred in such litigation by the party(ies) against whom judgment is rendered. (k) Headings. The headings contained in this Agreement are inserted for convenience only and do not constitute a part of this Agreement. (l) Fair Meaning. This Agreement shall be construed according its fair meaning, the language used shall be deemed the language chosen by the parties hereto to express their mutual intent, and no presumption or rule of strict construction will be applied against any party hereto. (m) Gender. Whenever the-context may require, any pronoun used herein shall include the corresponding masculine, feminine or neuter forms and the singular use of nouns, pronouns and verbs shall include the plural and vice versa. 3 (n) Counterparts. This Agreement may be executed in several counterparts, each of which shall be deemed, an original, and all of said counterparts together shall constitute but one of the same instrument. IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the 18th day of December 1997. CONSULTANT: US LEC, LLC Super STAR Associates, L.P. By: /s/ T.V. Ganatra By: /s/ Richard T. Aab ---------------------- ------------------------------ Tansukh V. Ganatra Title: Chairman & CEO January 1, 1998 Super STAR Associates, L.P. Attn: T.V. Ganatra 6523 Ashdale Place Charlotte, N.C. 28215 RE: Consulting Agreement with US LEC Dear Mr. Ganatra: US LEC hereby notifies you that the consulting agreement between Super STAR Associates, L.P. and US LEC dated December 18, 1997 is terminated for future years effective January 1, 1998. Sincerely, /s/ Richard T. Aab - ----------------------- Richard T. Aab Chairman & CEO RTA:alc I hereby agree to the termination of the agreement described above. Super STAR Associates, L.P. by /s/ T.V. Ganatra 1/4/98 ---------------- Date 4 EX-21 15 US LEC CORP. SUBSIDIARIES US LEC CORP. SUBSIDIARIES Name Jurisdiction of Organization/Incorporation - ---- ------------------------------------------ US LEC of North Carolina L.L.C. North Carolina US LEC of Florida Inc. North Carolina US LEC of Georgia Inc. Delaware US LEC of South Carolina Inc. Delaware US LEC of Tennessee L.L.C. Delaware US LEC of Tennessee Inc. Delaware US LEC of Virginia L.L.C. Virginia EX-23 16 EXHIBIT 23.1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the use in this Amendment No. 2 to Registration Statement No. 333-46341 of US LEC Corp. of our report dated February 4, 1998 appearing in the Prospectus, which is part of such Registration Statement and to the reference to us under the headings "Summary Historical Consolidated Financial and Operating Data," "Selected Historical Consolidated Financial and Operating Data" and "Experts" in such Prospectus. DELOITTE & TOUCHE LLP Charlotte, North Carolina April 4, 1998 -----END PRIVACY-ENHANCED MESSAGE-----