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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT of 1934
For the quarterly period ended September 30, 2002
Commission file number 0-24061
US LEC Corp.
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(Exact name of registrant as specified in its charter)
Delaware 56-2065535
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Morrocroft III, 6801 Morrison Boulevard
Charlotte, North Carolina 28211
(Address of principal executive offices)(Zip Code)
(704) 319-1000
(Registrant's telephone number, including area code)
Not Applicable
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(Former name, former address and former fiscal year, if changed since
last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes ( X ) No (_)
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As of November 14, 2002, there were 26,698,221 shares of Class A Common Stock
outstanding.
1
US LEC Corp.
Table of Contents
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Page
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Statements of Operations - Three and nine months ended
September 30, 2002 and 2001 3
Condensed Consolidated Balance Sheets - September 30, 2002 and
December 31, 2001 4
Condensed Consolidated Statements of Cash Flows - Nine months ended
September 30, 2002 and 2001 5
Condensed Consolidated Statement of Stockholders' Deficiency - Nine months ended
September 30, 2002 6
Notes to Condensed Consolidated Financial Statements 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 20
ITEM 4. CONTROLS AND PROCEDURES 20
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 20
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 20
SIGNATURES 21
2
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
US LEC Corp. and Subsidiaries
Condensed Consolidated Statements of Operations
(In Thousands, Except Per Share Data)
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
2002 2001 2002 2001
---------- --------- --------- ---------
Revenue, Net $ 63,892 $ 45,982 $ 176,630 $ 127,089
Cost of Services (exclusive of depreciation shown
separately below) 30,404 23,276 86,537 64,358
--------- --------- --------- ---------
Gross Margin 33,488 22,706 90,093 62,731
Selling, General and Administrative Expenses (Note 8) 29,538 31,045 92,861 81,291
Depreciation and Amortization 11,291 8,752 32,913 24,520
--------- --------- --------- ---------
Loss from Operations (7,341) (17,091) (35,681) (43,080)
Other (Income) Expense
Interest Income (174) (654) (748) (2,614)
Interest Expense 2,117 2,985 6,538 9,113
--------- --------- --------- ---------
Loss Before Income Taxes (9,284) (19,422) (41,471) (49,579)
Income Tax Benefit - - - -
--------- --------- --------- ---------
Net Loss (9,284) (19,422) (41,471) (49,579)
Preferred Stock Dividends 3,424 3,226 10,121 9,536
Preferred Stock Accretion of Issuance Costs 131 124 387 365
--------- --------- --------- ---------
Net Loss Attributable to Common Stockholders $ (12,839) $ (22,772) $ (51,979) $ (59,480)
========= ========= ========= =========
Net Loss Per Common Share:
Basic and Diluted $ (0.48) $ (0.85) $ (1.96) $ (2.17)
========= ========= ========= =========
Weighted Average Number of Shares Outstanding:
Basic and Diluted 26,698 26,846 26,494 27,458
========= ========= ========= =========
See notes to condensed consolidated financial statements
3
US LEC Corp. and Subsidiaries
Condensed Consolidated Balance Sheets
(In Thousands, Except Per Share Data)
(Unaudited)
September 30, December 31,
2002 2001
------------- ------------
Assets
Current Assets
Cash and cash equivalents $ 32,349 $ 80,502
Restricted cash 1,279 1,300
Accounts receivable (net of allowance of $22,509 and $12,263
at September 30, 2002 and December 31, 2001, respectively) 56,363 42,972
Deferred income taxes 3,081 1,840
Prepaid expenses and other assets 9,396 9,030
--------- --------
Total current assets 102,468 135,644
Property and Equipment, Net 181,644 188,436
Other Assets 9,301 9,233
--------- --------
Total Assets $ 293,413 $333,313
========= ========
Liabilities and Stockholders' Deficiency
Current Liabilities
Accounts payable $ 10,333 $ 10,747
Accrued network costs 25,184 17,877
Commissions payable 7,273 6,679
Accrued expenses - other 14,527 14,928
Deferred revenue 7,552 6,691
Current portion of long-term debt 23,438 18,750
--------- --------
Total current liabilities 88,307 75,672
--------- --------
Long-Term Debt 117,188 131,250
Deferred income taxes 3,081 1,840
Other Liabilities - Noncurrent 6,512 5,721
Series A Redeemable Convertible Preferred Stock (Note 7) 226,663 216,155
Stockholders' Deficiency
Common stock-Class A, $.01 par value (122,925 authorized
shares, 26,698 and 26,388 outstanding at September 30, 2002
and December 31, 2001, respectively) 267 264
Additional paid-in capital 77,043 76,421
Accumulated Deficit (224,756) (172,777)
Unearned compensation - stock options (892) (1,233)
--------- --------
Total stockholders' deficiency (148,338) (97,325)
--------- --------
Total Liabilities and Stockholders' Deficiency $ 293,413 $333,313
========= ========
See notes to condensed consolidated financial statements
4
US LEC Corp. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(In Thousands)
(Unaudited)
Nine Months Ended
September 30,
2002 2001
---------- ----------
Operating Activities
Net Loss $ (41,471) $ (49,579)
--------- ---------
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 32,913 24,520
Provision for doubtful accounts 12,980 (36,445)
Deferred compensation 339 130
Changes in operating assets and liabilities:
Accounts receivable (26,372) 24,562
Prepaid expenses and other assets (1,723) (6,371)
Other assets (275) (2,981)
Accounts payable 1,258 940
Deferred revenue 860 3,517
Accrued network costs 7,307 12,890
Commissions payable 594 (3,432)
Accrued expenses - other 769 10,145
--------- ---------
Total adjustments 28,650 27,475
--------- ---------
Net cash used in operating activities (12,821) (22,104)
--------- ---------
Investing Activities
Purchase of property and equipment (26,095) (34,253)
Redemption of certificate of deposits and restricted cash 21
--------- ---------
Net cash used in investing activities (26,074) (34,253)
--------- ---------
Financing Activities
Proceeds from long-term debt - 20,000
Payments on long-term debt (9,375) -
Payment of loan fees (510) (56)
Cost of recapitalization - (269)
Issuance of common shares 627 677
--------- ---------
Net cash (used)/provided by financing activities (9,258) 20,352
--------- ---------
Net Decrease in Cash and Cash Equivalents (48,153) (36,005)
Cash and Cash Equivalents, Beginning of Period 80,502 105,821
--------- ---------
Cash and Cash Equivalents, End of Period $ 32,349 $ 69,816
========= =========
Supplemental Cash Flow Disclosures
Cash Paid for Interest $ 7,028 $ 7,449
========= =========
See notes to condensed consolidated financial statements
5
US LEC Corp. and Subsidiaries
Condensed Consolidated Statement of Stockholders' Deficiency
For the Nine Months Ended September 30, 2002
(In Thousands)
(Unaudited)
Class A Additional Accumulated Unearned
Common Stock Paid-in Capital Deficit Compensation Total
-------------- ----------------- ------------- -------------- -----------
Balance, December 31, 2001 $ 264 $ 76,421 $(172,777) $ (1,233) $ (97,325)
Exercise of stock options and warrants - 2 - - 2
Issuance of ESPP Stock 3 622 - 625
Unearned Compensation - Stock Options - (2) - 341 339
Preferred Stock Dividends - - (10,121) - (10,121)
Accretion of Preferred Stock Issuance Fees (387) - (387)
Net Loss - - (41,471) - (41,471)
--------- --------- --------- --------- ---------
Balance, September 30, 2002 $ 267 $ 77,043 $(224,756) $ (892) $(148,338)
========= ========= ========= ========= =========
See notes to condensed consolidated financial statements
6
US LEC Corp. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(In Thousands, Except Per Share Data)
(Unaudited)
1. Basis of Presentation and Continuity of Operations
The accompanying unaudited condensed consolidated financial statements of
US LEC Corp. and its subsidiaries ("US LEC" or the "Company") have been prepared
in accordance with accounting principles generally accepted in the United States
of America for interim financial information and the instructions to Form 10-Q
and Article 10 of Regulation S-X promulgated by the United States Securities and
Exchange Commission (the "SEC"). Accordingly, they do not include all of the
information and notes required by accounting principles generally accepted in
the United States of America for complete financial statements. In the opinion
of management, all adjustments considered necessary for a fair presentation for
the periods indicated have been included. Operating results for the three and
nine months ended September 30, 2002 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2002. The balance
sheet at December 31, 2001 has been derived from the audited balance sheet at
that date, but does not include all of the information and notes required by
accounting principles generally accepted in the United States of America for
complete financial statements. The accompanying condensed consolidated financial
statements should be read in conjunction with the audited consolidated financial
statements and related notes thereto included in the Company's Annual Report on
Form 10-K for the year ended December 31, 2001, which is on file with the SEC.
Although the Company has experienced recent operating losses, quarterly
losses have been decreasing and earnings from operations before depreciation and
amortization were positive in the 3rd quarter of 2002. Recent quarterly results
have also evidenced increasing revenue, particularly in end-customer revenue,
growth in the number of customers and in other operating metrics. Management has
focused the Company's operating strategy on continuing to grow end-customers,
improving the efficiency of its network operations and in controlling
administrative costs and capital expenditures. As of September 30, 2002 the
Company had $32 million in cash. Management believes this will fund the
Company's operating, investing and financing activities into the 3rd quarter of
2003. The Company is aggressively pursuing several options to obtain additional
financing and improve liquidity to fund its cash requirements beyond the 3rd
quarter of 2003. These options include, but are not limited to, issuing
additional equity or debt securities, restructuring the existing amortization of
the current credit facility, obtaining vendor financing and working capital
management. Management is forecasting that with the achievement of both its
operating and financing strategies the Company would expect to generate
sufficient cash from operations to meet cash obligations as they come due.
Although management believes it will be successful in achieving this goal, there
can be no assurances. Failure to achieve the Company's operating and financing
strategies would have a material adverse effect on the Company.
2. Significant Accounting Policies
Revenue Recognition - The Company recognizes revenue on
telecommunications, data and enhanced communications services in the period that
the service is provided. Revenue is recognized when earned based upon the
following specific criteria: (1) persuasive evidence of an arrangement exists,
(2) services have been rendered, (3) seller's price to the buyer is fixed or
determinable, and (4) collectibility is reasonably assured. Reciprocal
compensation that is recorded as revenue from other local exchange carriers
represents compensation for local telecommunications traffic terminated on our
network that originates on another carrier's network. To date, a majority of our
reciprocal compensation revenue has been generated from traffic originated by
customers of BellSouth Telecommunications, Inc. ("BellSouth") and Verizon
Communications Inc. ("Verizon"). The billing, payment and other arrangements for
this reciprocal compensation are governed by interconnection agreements the
Company has with BellSouth and Verizon as well as orders of the Federal
Communications Commission (the "FCC") and the public utility commissions (the
"PUCs") of states where we operate. Revenues are recorded net of amounts that
are due to a customer or outside sales agent pursuant to each respective
7
telecommunications service contract. Early termination fees and certain other
charges are recognized when paid and revenue related to billings in advance of
providing services is deferred and recognized when earned.
The Company defers revenue associated with installation costs from
contracts with end customers and with other carriers and amortizes this revenue
over the estimated average life of the related contracts.
Cost of Services - The Company defers installation charges from incumbent
local exchange carriers ("ILECs"), such as BellSouth and Verizon, related to new
customer contracts associated with network and end customer facilities. The
Company is amortizing these costs over the average life of the related
contracts.
The Company's cost of services is comprised primarily of two types of
charges: leased transport charges, including facility installation, which
comprise approximately 80% of the Company's cost of services, and usage
sensitive charges, which comprise approximately 20% of the Company's cost of
services. The Company's leased transport charges are the lease payments incurred
by US LEC for the transmission facilities used to connect the Company's
customers to the Company-owned switch that services that customer and to connect
to the ILEC and other carrier networks. US LEC, as part of its "smart-build"
strategy, does not currently own any fiber or copper transport facilities. These
facilities are leased from various providers including, in many cases, the ILEC.
Usage sensitive charges are primarily comprised of usage charges associated with
the Company's off-net toll, toll-free services, access charges and reciprocal
compensation owed to other carriers.
Cash and Cash Equivalents - Cash equivalents consist of highly liquid
investments with original maturities of three months or less at the time of
purchase.
Property and Equipment - Property and equipment is stated at cost less
accumulated depreciation and amortization. Depreciation and amortization is
computed using the straight-line method over the estimated useful lives of the
assets, except for leasehold improvements as noted below.
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 lease term
The Company capitalizes certain payroll related costs in accordance with
AICPA Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use."
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.
Determination of any impairment would include a comparison of estimated
undiscounted future operating cash flows anticipated to be generated during the
remaining life of the assets with the net carrying value of the associated asset
group. An impairment loss would be recognized as the amount by which the
carrying value of the asset group exceeds their fair value.
Accrued Network Costs - Accrued network costs include management's
estimate of charges for direct access lines, facility charges, outgoing and
incoming minutes, reciprocal compensation and other costs of revenue for the
period for which vendor invoices have not yet been received by the Company as
well as invoices received by the Company for those charges that have not yet
been paid. Management's estimate is developed from the number of lines and
facilities in service, minutes of use and contractual and tarriffed rates
charged by each respective service provider. Subsequent adjustments to this
estimate may result when actual costs are billed by the service provider to the
Company. However, management does not believe such adjustments will be material
to the Company's financial statements.
8
Debt Issuance Cost - The Company capitalizes loan fees associated with
securing long-term debt and amortizes such deferred loan fees over the term of
the debt agreement. The Company has deferred loan fees recorded in other assets
on the accompanying consolidated balance sheets that are being amortized over
the life of the related debt agreement.
Fair Value of Financial Instruments - Management believes the fair value
of the Company's financial instruments, including cash equivalents, restricted
cash, accounts receivables, and accounts payable, approximate their carrying
value. In addition, because the long-term debt consists of variable rate
instruments, its carrying values approximate fair value.
Concentration of Risk - The Company is exposed to concentration of credit
risk principally from trade accounts receivable due from end customers and
carriers. The Company's end customers are located primarily in the southeastern
and mid-Atlantic United States. The Company performs ongoing credit evaluations
of its end customers but does not require collateral deposits from a majority of
its end customers. The Company is exposed to additional credit risk due to the
fact that the Company's most significant trade receivables are from large
telecommunications carriers, see Note 8 for additional discussion of risks and
uncertainties associated with them.
The Company is dependent upon certain suppliers for the provision of
telecommunications services to its customers. The Company has executed
interconnection agreements with these suppliers for all states in which it
operates.
Use of Estimates - The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
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. Significant estimates relate to the allowance for doubtful
accounts receivable, estimated end customer contract life, accrual of network
costs payable to other telecommunications entities, income tax valuation
allowance, and estimated useful lives of fixed assets. Any difference between
the amounts recorded and amounts ultimately realized or paid will be adjusted
prospectively as new facts become known.
Effect of Recent Accounting Pronouncements - Statement of Financial
Accounting Standards ("SFAS") No.144, "Accounting for the Impairment or Disposal
of Long-Lived Assets," which supersedes SFAS No.121, "Accounting for Impairment
or Disposal of Long-Lived Assets and for Long-Lived Assets to be Disposed of,"
but retains many of its fundamental provisions, also expands the scope of
discontinued operations to include more disposal transactions. SFAS No. 144 was
adopted effective January 1, 2002, the adoption did not have a material effect
on the Company's financial statements.
3. Restricted Cash
The restricted cash balance as of September 30, 2002 and December 31,
2001 currently serves as collateral for letters of credit related to certain
office leases. Restricted cash is utilized to secure the Company's performance
of obligations such as letters of credit to support leases or deposits in
restricted use accounts.
4. Net Loss Per Common and Common Equivalent Share
Net loss per common and common equivalent share are based on net loss,
after consideration of preferred stock dividends and the accretion of preferred
stock issuance costs, divided by the weighted average number of common shares
outstanding during the period. Outstanding options and warrants are not included
in the calculation of dilutive earnings per common share because they are
anti-dilutive.
9
5. Income Taxes
Income taxes are provided for temporary differences between the tax and
financial accounting basis of assets and liabilities using the liability method.
The tax effects of such differences, as reflected in the balance sheet, are at
the enacted tax rates expected to be in effect when the differences reverse.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized and are reversed at such time that
realization is believed to be more likely than not.
6. Long-Term Debt
The Company's senior secured loan agreement, as amended, is comprised of
(i) a $125,000 credit facility that converted into a six-year term loan as of
June 30, 2001 and (ii) a $25,000 revolving credit facility that matures in
December 2005. As of September 30, 2002, the outstanding amount under the
Company's senior secured credit facility was $140.6 million and there was no
additional availability under this credit facility. The principal amount of the
term loan is repayable in quarterly installments of $4,687 in 2002 and 2003,
quarterly installments of $6,250 in 2004, quarterly installments of $7,813 in
2005 and 2006. The Company made its third amortization payment under the term
loan on October 1, 2002 in the amount of $4,687. The interest rate for the
facility is a floating rate based, at the Company's option, on a base rate (as
defined in the loan agreement) or the London Interbank Offered Rate ("LIBOR"),
plus a specified margin. The amount outstanding under the credit facility at
September 30, 2002 was $140,626, of which $23,438 is classified as current on
the Company's condensed consolidated balance sheet. Advances under the agreement
as of September 30, 2002 bear interest currently at an average effective annual
rate of 5.84%.
In September 2002, the Company and its lenders amended its senior secured
loan agreement. The amended agreement revised financial covenants, measured
quarterly, the most significant of which relate to the achievement of increasing
levels of revenue and earnings as well as certain levels of capital expenditures
and cash. At June 30, 2002 the Company was not in compliance with its quarterly
minimum EBITDA covenant after establishing an additional provision of $9,500
related to the bankruptcy filing of WorldCom, Inc. and its subsidiaries
("WorldCom") and received a waiver from its lenders. The Company was in
compliance with the amended covenants as of the quarter ended September 30, 2002
and management believes that the Company will be in compliance with all
quarterly financial covenants for a period at least through September 2003 based
upon projected operating results. These projected operating results are
dependent upon the Company meeting quarterly targets for new customers, customer
retention, customer usage, billing rates, gross margins and selling, general and
administrative costs, and as a result involve some degree of uncertainty.
While management believes the $32.3 million in cash at September 30, 2002
will fund the Company's operating, investing and financing activities into the
third quarter of 2003, funding beyond that point will require an amendment of
the senior secured credit facility and/or additional financing. The Company is
aggressively pursuing all options to obtain additional financing and improve
liquidity. These options include, but are not limited to, issuing additional
equity or debt securities, restructuring the existing amortization of the
current credit facility, obtaining vendor financing and continued improvement of
operating results, cost control efforts and working capital management. There
can be no assurance that the Company will be successful in its pursuit of any of
these options.
The credit facility is secured by a pledge of the capital stock of the
Company's principal operating subsidiaries and a security interest in a
substantial portion of the Company's and its operating subsidiaries' equipment,
receivables, leasehold improvements and general intangibles. Proceeds from the
credit facility have been used to fund capital expenditures and working capital
requirements and for other general corporate purposes.
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7. Series A Mandatorily Redeemable Convertible Preferred Stock
On April 11, 2000, the Company issued $200,000 of its Series A
Mandatorily Redeemable Convertible Preferred Stock (the "Series A Preferred
Stock") to affiliates of Bain Capital, Inc. ("Bain") and Thomas H. Lee Partners,
L.P. ("THL"). Proceeds to the Company, net of commissions and other transaction
costs, were approximately $194,000. The Series A Preferred Stock earns dividends
on a cumulative basis at an annual rate of 6%, payable quarterly in shares of
Series A Preferred Stock for three years, and at US LEC's option, in cash or
shares of Series A Preferred Stock over the next seven years. In addition, the
Series A Preferred Stock participates on a pro rata basis in the dividends
payable to common stockholders. As of September 30, 2002, the Company had issued
and accrued $31,689 in shares of Series A Preferred Stock as dividends. In the
event of any liquidation, dissolution or other winding up of the affairs of the
Company, the holders of Series A Preferred Stock are entitled to be paid in
preference to any distribution to holders of junior securities, an amount in
cash equal to $1,000 per share plus all accrued and unpaid dividends on such
shares. The holders of Series A Preferred Stock may convert all or a portion of
their shares into shares of Class A Common Stock at a set conversion price prior
to April 11, 2010 in the event of a change in control or an acquisition event.
Each holder of the Series A Preferred Stock may redeem all or a portion of their
Series A Preferred Stock at a price equal to 101% of $1,000 per share plus all
accrued dividends on such shares after the occurrence of a change in control and
for a period of 60 days following such event. At any time on or after April 11,
2003, the Company may redeem all of the outstanding shares of Series A Preferred
Stock, at a price equal to $1,000 per share plus all accrued and unpaid
dividends on such shares, only if the market price of a share of Class A Common
Stock for 30 consecutive trading days during the 90 day period immediately
preceding the date of the notice of redemption is at least 150% of the then
effective conversion price and the market price of a share of Class A Common
Stock on the redemption date is also at least 150% of the then effective
conversion price. The effective conversion price at September 30, 2002 was
approximately $33 per share of Class A Common Stock. All outstanding shares of
the Series A Preferred Stock are subject to mandatory redemption on April 11,
2010.
The Company incurred $6,240 in expenses related to the issuance of the
Series A Preferred Stock. The cost will be accreted against retained earnings
(deficit) over the life of the agreement. For the nine months ended September
30, 2002, the Company accreted $387 of these costs. As of September 30, 2002,
the Company had $5,026 in issuance costs netted with Series A Preferred Stock on
its condensed consolidated balance sheet.
8. Uncertainties and Contingencies
The deregulation of the telecommunications industry, the implementation
of the Telecom Act on February 8, 1996 and the distress of many carriers in the
wake of the downturn in the telecommunications industry have embroiled numerous
industry participants, including the Company, in lawsuits, proceedings and
arbitrations before state and federal regulatory commissions, private
arbitration organizations such as the American Arbitration Association, and
courts over many issues important to the financial and operational success of
the Company. These issues include the interpretation and enforcement of
interconnection agreements, the terms of interconnection agreements the Company
may adopt, operating performance obligations, reciprocal compensation, access
rates, access rates applicable to different categories of traffic such as
traffic originating from or terminating to cellular or wireless users and the
jurisdiction of traffic for compensation purposes. The Company anticipates that
it will continue to be involved in various lawsuits, arbitrations and
proceedings over these and other material issues. The Company anticipates also
that further legislative and regulatory rulemaking will occur--on the federal
and state level--as the industry deregulates and as the Company enters new
markets or offers new products. Rulings adverse to the Company, adverse
legislation, or changes in governmental policy on issues material to the Company
could have a material adverse effect on the Company's financial condition or
results of its operations. Revenue recognized and amounts recorded as allowances
for doubtful accounts in the accompanying financial statements have been
determined considering the impact, if any, of the items described below.
11
Reciprocal Compensation - On April 27, 2001, the Federal Communications
Commission ("FCC") released an Order on Remand and Report and Order (the "Remand
Order") addressing inter-carrier compensation for traffic terminated to Internet
service providers ("ISPs"). The interpretation and enforcement of the Remand
Order will likely be the most important factor in the Company's efforts to
collect reciprocal compensation for ISP-bound traffic in the future. In the
Remand Order, the FCC addressed a number of important issues, including the
rules under which carriers are to compensate each other for traffic terminated
to ISPs and the rates applicable for ISP-bound traffic as well as traffic bound
to other customers.
While the Remand Order provides greater certainty about the Company's
right to bill for traffic terminated to ISPs, the effect of the Remand Order on
the Company will depend on how it is interpreted and enforced. In particular,
there are uncertainties as to whether the Remand Order has any effect on the
Company's pending arbitral, state regulatory commission and judicial proceedings
seeking to collect compensation for traffic terminated to ISPs; whether certain
provisions of the Remand Order will be applied state-by-state, market-by-market
and/or carrier-by-carrier; whether the limitations on growth of ISP traffic in
the Remand Order will survive legal challenge; and whether the incumbent carrier
will efficiently trigger the rate reductions and other limitations set forth in
the Remand Order.
On May 3, 2002, the U.S. Court of Appeals for the District of Columbia
(the "D.C. Circuit") rejected the FCC's legal analysis in the Remand Order and
remanded the order back to the FCC for further review (the "Second Remand"), but
the D.C. Circuit did not vacate the Remand Order. As such, the ISP compensation
structure established by the FCC in the Remand Order remains in effect. It is
unclear at this time whether, how or when the FCC will respond to the Second
Remand, how the Second Remand affects pending disputes over reciprocal
compensation for ISP traffic, how the Remand Order will be interpreted or
whether affected parties will undertake new challenges to the ISP compensation
structure established by the Remand Order.
If the Remand Order or the Second Remand were to be interpreted in a
manner adverse to the Company on all or any of the issues, or if the Remand
Order is modified as a result of the Second Remand or other pending or new legal
challenges, it could have a material adverse effect on the Company's future
operations. For further discussion of the Remand Order, see
"Business-Regulation" in the Company's Annual Report on Form 10-K for the year
ended December 31, 2001 (the "Form 10-K").
On October 3, 2001 the Company and BellSouth entered into a settlement
agreement (the "Settlement Agreement") by which the Company and BellSouth
resolved outstanding reciprocal compensation receivables in the various states
in which both of us operate and other past payments. BellSouth agreed to pay US
LEC approximately $31,000, in addition to approximately $10,000 it paid in
August 2001, to resolve those issues for periods prior to the effective date of
the Remand Order. The Settlement Agreement imposed on the parties certain
obligations regarding the payment of reciprocal compensation in the future,
which are in the process of being implemented. The Settlement Agreement also
provides that the payments made for periods prior to the effective date of the
Remand Order are not subject to adjustment as a result of subsequent changes in
the Remand Order.
In September 2001, the Company filed a proceeding with the Virginia State
Corporation Commission ("VSCC") and the FCC seeking to collect reciprocal
compensation from Verizon payable for traffic bound for ISPs as well as other
customers. The VSCC declined jurisdiction over the dispute. In January 2002, the
FCC accepted jurisdiction over the dispute. Prior to the Company's filing a
complaint against Verizon at the FCC, and in a separate, but related, case, the
FCC held that the contract with Verizon (that the Company had adopted) did not
obligate the parties to pay reciprocal compensation for traffic bound for ISPs.
That decision is on appeal. In June 2002, Verizon filed a complaint against the
Company in the United States District Court for the Eastern District of Virginia
seeking a declaratory ruling that Verizon is not obligated to pay the Company
reciprocal compensation for traffic bound for ISPs under the agreement adopted
by the Company. The Company has moved to dismiss Verizon's complaint based on,
among other things, that the FCC's reasoning in the prior Virginia case is based
on the Remand Order, which subsequently was the subject of the Second Remand. In
light of these
12
developments, as well as the Second Remand, the Company cannot predict when this
dispute will be resolved or whether the Company will ultimately be successful.
Disputed Access Revenues - A number of inter-exchange carriers ("IXCs")
have refused to pay access charges to competitive local exchange carriers
("CLECs"), including the Company, alleging that the access charges exceed the
rates charged by the ILEC, as well as disputing the rates applicable to
different categories of traffic and the jurisdiction of traffic for compensation
purposes. Currently there are a number of court cases, regulatory proceedings at
the FCC and legislative efforts involving such challenges. The Company cannot
predict the outcome of these cases, regulatory proceedings and legislative
efforts or their impact on access rates.
On April 27, 2001, the FCC released its Seventh Report and Order and
Further Notice of Proposed Rulemaking (the "Access Order") in which it
established a benchmark rate at which a CLEC's interstate access charges will be
presumed to be reasonable and which CLECs may impose on IXCs by tariff. The
Access Order addresses a number of issues important to how CLECs charge IXCs for
originating and terminating interstate toll and toll free traffic.
The Access Order should provide certainty as to the Company's right to
bill IXCs for interstate access at rates above those tariffed by the ILECs.
Notwithstanding the apparent certainty created by the Access Order, its effect
on the Company will depend on how the Access Order is interpreted and enforced
and the outcome of appeals currently pending. If the Access Order is interpreted
or enforced in a manner adverse to the Company as it relates to periods prior to
the effective date, such result could have a material adverse effect on the
Company. For a more complete description of the Access Order, please see
"Business - Regulation" in the Form 10-K.
On May 30, 2001, the FCC issued a decision in AT&T Corp. v. Business
Telecom Inc. (the "BTI Decision"), in which the FCC determined that the
interstate access rates charged by Business Telecom, Inc. ("BTI") were not just
and reasonable. The FCC determined that just and reasonable rates for BTI were
properly based upon the lowest band of rates charged by the National Exchange
Carriers Association ("NECA"). The FCC based this holding on the limited
evidence before it, tending to show that BTI's operations were similar to those
of small, urban ILECs, many of whom charge the lowest band NECA rates. Appeals
of the BTI Decision were subsequently withdrawn. As with the Access Order
described above, the BTI Decision's effect on the Company will depend on how the
order is interpreted. If the BTI Decision is interpreted in a manner adverse to
the Company, such result could have a material adverse effect on the Company.
By settlement dated October 5, 2001, Sprint and the Company resolved
their litigated dispute over access charges. Sprint paid the Company
approximately $8,000, in addition to approximately $1,500 it paid in the four
months preceding the settlement, in payment of past due invoices for periods
through July 2001.
Due to the federal bankruptcy filing by WorldCom, during the quarter
ended June 30, 2002, the Company established an additional provision of $9,500
for doubtful accounts for the remaining outstanding receivables owed to the
Company by WorldCom. The Company is pursuing its claim for the payment of all
outstanding charges in the WorldCom bankruptcy proceeding, but is fully reserved
for the amount due from WorldCom as of July 21, 2002 (the date WorldCom filed
for bankruptcy protection).
On September 18, 2002, US LEC filed a Petition for Declaratory Ruling
with the FCC requesting that the FCC reaffirm its prior positions that access
charges can be collected by local exchange carriers in connection with calls
originating or terminating on the networks of wireless carriers. A number of
different carriers have filed comments in support of, and in opposition to, US
LEC's petition. After US LEC filed its petition with the FCC, ITC/\DeltaCom
Communications, Inc. ("ITC") filed a lawsuit in the United States District Court
for the Northern District of Georgia against US LEC and a number of its
operating subsidiaries. ITC's complaint alleges that in an effort to collect
access charges from ITC for originating wireless traffic destined for ITC's
toll-free customers, US LEC blocked certain signaling data for calls originated
on the networks of US LEC's wireless carrier customers, that would allow the
call to be identified as a wireless call. ITC's lawsuit alleges claims based
13
on a number of different legal theories. US LEC, through counsel, has
investigated ITC's allegations, and has discovered no evidence to support ITC's
claims. US LEC has denied ITC's allegation and asserted a counterclaim against
ITC to recover outstanding access charges owed by ITC. In addition to the
lawsuit filed in federal court, ITC has also filed an Informal Complaint at the
FCC challenging US LEC's right to recover access charges originating for
wireless traffic. If the FCC does not reaffirm its prior guidance, the inability
of US LEC to recover access charges from IXCs for traffic originating on the
networks of wireless carrier customers could have a material negative impact on
US LEC's results of operations.
In light of the general conditions prevailing in the telecommunications
industry, there is a risk of further delinquencies, nonpayment or bankruptcies
by other telecommunications carriers that owe outstanding amounts derived from
access and facility revenues billed by the Company. Such events, in the
aggregate, could have an adverse effect on the Company's performance in future
periods. The Company is unable to predict such events at this time.
Legislation - Periodically, legislation has been introduced in the U.S.
House of Representatives or the U.S. Senate to alter or amend the Telecom Act.
It is the Telecom Act which opened the local telephone markets for competition
and outlines many of the ground rules pursuant to which the ILECs and the CLECs
operate with respect to each other. The Company anticipates that additional
efforts will be made to alter or amend the Telecom Act. The Company cannot
predict whether any particular piece of legislation will become law and how the
Telecom Act might be modified. The passage of legislation amending the Telecom
Act could have a material adverse effect on the Company and its future financial
results.
Interconnection Agreements with ILECs - The Company has agreements for
the interconnection of its networks with the networks of the ILECs covering each
market in which US LEC has installed a switching platform. US LEC may be
required to negotiate new interconnection agreements as it enters new markets in
the future. In addition, as its existing interconnection agreements expire, it
will be required to negotiate extension or replacement agreements. The Company
recently initiated interconnection arbitrations with Verizon in order to obtain
new interconnection agreements on terms acceptable to the Company. There can be
no assurance that the Company will successfully negotiate, successfully
arbitrate or otherwise obtain such additional agreements for interconnection
with the ILECs or renewals of existing interconnection agreements on terms and
conditions acceptable to the Company.
Interconnection with Other Carriers - The Company anticipates that as its
interconnections with various carriers increase, the issue of seeking
compensation for the termination or origination of traffic whether by reciprocal
arrangements, access charges or other charges will become increasingly complex.
The Company does not anticipate that it will be cost effective to negotiate
agreements with every carrier with which the Company exchanges originating
and/or terminating traffic. The Company will make a case-by-case analysis of the
cost effectiveness of committing resources to these interconnection agreements
or otherwise billing and paying such carriers.
Allowance for Doubtful Accounts - The Company has recorded the effects of
the settlements with BellSouth and Sprint in the quarter ended September 30,
2001. Included in the accompanying condensed consolidated statement of
operations for the nine months ended September 30, 2001 is approximately $7.0
million representing a net recovery of amounts previously recorded as reserves
for disputed receivables and certain other accruals related to BellSouth and
Sprint. Additionally, during the nine months ended September 30, 2001, the
Company recorded an additional provision for doubtful account reserves totaling
approximately $13.6 million.
9. Stockholders' Equity
Stock Options - The Company adopted the US LEC Corp. Omnibus Stock Plan
(the "Plan") in January 1998. The number of Class A Common Stock reserved for
issuance under the Plan is 5,000 shares. As of September 30, 2002, the Company
had granted stock options, net of forfeitures, to purchase an aggregate of
14
3,982 shares of Class A Common Stock under the Plan. In addition, in December
2001 the Company granted the Company's new chief executive officer an option to
purchase 550 shares of Class A Common Stock outside the Plan. In connection with
his resignation in October 2002, this option was reduced to 100 shares, which
were previously vested. The Company will record a reversal of approximately $300
of accrued unearned compensation expense in the fourth quarter 2002 related to
the remaining 450 options that were cancelled.
Employee Stock Purchase Plan - The Company established an Employee Stock
Purchase Plan (the "ESPP") in September 2000. Under the ESPP, employees may
elect to invest up to 10% of their compensation in order to purchase shares of
the Company's Class A Common Stock at a price equal to 85% of the market value
at either the beginning or end of the offering period, whichever is less. The
number of Class A Common Stock reserved for issuance under the ESPP is 2,000
shares. As of September 30, 2002, the Company had issued 1,036 shares under the
ESPP.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Except for the historical information contained herein, this report contains
forward-looking statements, subject to uncertainties and risks, including the
demand for US LEC's services, the ability of the Company to introduce additional
products, the ability of the Company to successfully attract and retain
personnel, competition in existing and potential additional markets,
uncertainties as to the stability of other telecommunication carriers,
uncertainties regarding its dealings with ILECs and other telecommunications
carriers and facilities providers, regulatory uncertainties, and the possibility
of adverse decisions related to reciprocal compensation and access charges owed
to the Company by other carriers. These and other applicable risks are
summarized in Notes 1 and 8 to the condensed consolidated financial statements
appearing in this report and in the "Forward-Looking Statements and Risk
Factors" section and elsewhere in the Company's Annual Report on Form 10-K for
the period ended December 31, 2001, and in other reports which are on file with
the Securities and Exchange Commission (the "SEC").
OVERVIEW
US LEC is a rapidly growing switch-based competitive local exchange carrier
("CLEC") that provides integrated telecommunications services to its customers,
including local and long distance voice services, toll free services, frame
relay, high speed Internet, ATM and web hosting. The Company primarily serves
telecommunication-intensive business customers including hotels, universities,
financial institutions, professional service firms, hospitals, and Internet
service providers ("ISPs"). US LEC 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. US LEC initiated service in
North Carolina in March 1997, becoming one of the first CLECs in North Carolina
to provide switched local exchange services. US LEC currently offers service to
customers in selected markets in North Carolina, Florida, Georgia, Tennessee,
Virginia, Alabama, Washington D.C., Pennsylvania, New Jersey, Mississippi,
Maryland, South Carolina, Louisiana and Kentucky. In addition, US LEC is
currently certified to provide local and long distance telecommunication
services in Indiana, Delaware, New York, Ohio, Texas, Connecticut and
Massachusetts and provides selected services in these markets. As of September
30, 2002, US LEC's network was comprised of 26 Lucent 5ESS(R) AnyMedia(TM)
digital switches, 25 Lucent CBX500 ATM data switches and four Juniper M20 (TM)
Internet Gateway routers that are located throughout the Southeast and
mid-Atlantic states, in addition to an Alcatel MegaHub(R) 600ES switch in
Charlotte, North Carolina.
RESULTS OF OPERATIONS
Three and Nine Months Ended September 30, 2002 Compared With The Three and Nine
Months Ended September 30, 2001
Net revenue increased to $63.9 million for the quarter ended September 30,
2002 from $46.0 million for the quarter ended September 30, 2001. Revenue
increased primarily due to net customer additions of 960 to a total of 9,394
customers, an increase in data services sold to customers as evidenced by a 27%
growth in data channels and increased minutes of use on the Company's network
for long distance and access traffic. For the nine months ended September 30,
2002 and 2001, revenue was $176.6 million and $127.1 million, respectively. More
than 90% of the Company's net revenue is currently derived from two sources -
end users and intercarrier compensation. Less than 10% of the Company's net
revenue is derived from other sources, including wholesale customers,
installation revenue, and other miscellaneous sources. Wholesale revenue is
revenue charged to other telecommunications carriers for the termination of
their telecommunications traffic, but does not include reciprocal compensation
or access charges. End customer revenue represented approximately 61% of total
net revenue during the quarter ended September 30, 2002, compared to 60% in the
quarter ended June 30, 2002, and 55% in the quarter ended September 30, 2001.
This increase in the percentage of revenue from end customers is the result of
growth in the number of end customers and a reduction of intercarrier rates for
reciprocal
16
compensation and access revenue billed to other carriers. See Note 8 to the
Company's condensed consolidated financial statements for a further discussion
related to disputed amounts of intercarrier compensation and recent settlements
regarding intercarrier transactions.
Cost of services is comprised primarily of leased transport (including
facility installation) and usage charges. Cost of services increased to $30.4
million, or 48% of revenue, for the quarter ended September 30, 2002, from $23.3
million, or 51% of revenue, for the quarter ended September 30, 2001. For the
nine months ended September 30, 2002, and September 30, 2001, cost of services
increased to $86.5 million, or 49% of revenue, from $64.4 million, or 51% of
revenue. The decrease in cost of services as a percentage of revenue was
primarily a result of cost reduction efforts completed by the Company to reduce
recurring costs for a customer facility as well as a reduction in rates per
minute.
Selling, general and administrative expenses ("SG&A") for the quarter ended
September 30, 2002 decreased to $29.5 million, or 46% of revenue, compared to
$31.0 million, or 68% of revenue, for the quarter ended September 30, 2001.
These expenses increased to $92.9 million, or 53% of revenue, for the first nine
months of 2002, compared to $81.3 million, or 64% of revenue, for the first nine
months of 2001. The increase in SG&A expenses were primarily a result of an
additional provision for doubtful accounts of $9.5 million due to the bankruptcy
filing of WorldCom, Inc. and its subsidiaries ("WorldCom") recorded in the
second quarter of 2002. Additionally, in the quarter ended September 30, 2001,
the Company recorded approximately $7.0 million of a net recovery of amounts
previously recorded as reserves for disputed receivables and other accruals
related to the settlements with BellSouth and Sprint. Additional costs
associated with developing and expanding the Company's customer base such as
personnel, sales and marketing, occupancy, administration and billing, and legal
expenses associated with litigation and regulatory issues remained consistent
quarter over quarter.
Depreciation and amortization for the quarter ended September 30, 2002
increased to $11.3 million from $8.8 million for the comparable 2001 period. For
the first nine months ended September 30, 2002, depreciation and amortization
increased to $32.9 million from $24.5 million for the comparable period of 2001.
The increase in depreciation and amortization is due to the increase in
depreciable assets in service related to US LEC's network. The Company's network
build out was completed in 2001. As a result, future capital expenditures will
decrease as additions will be primarily determined by growth in the number of
customers and services, rather than geographic expansion.
Interest income for the three and nine months ended September 30, 2002 was
$0.2 million and $0.7 million, respectively, compared to $0.7 million and $2.6
million, respectively, for the three and nine months ended September 30, 2001.
This decrease was primarily due to declining interest rates as well as a
decrease in cash and cash equivalent balances. Interest expense for the three
and nine months ended September 30, 2002 was $2.1 million and $6.5 million,
respectively, compared to interest expense of $3.0 million and $9.1 million for
the three and nine months ended September 30, 2001, respectively. This decrease
in interest expense was primarily due to declining interest rates on borrowings
under the Company's credit facility as well as a decreased debt balance
resulting from principal payments of $4.7 million in both April and July 2002.
For the three months and nine months ended September 30, 2002 and 2001, the
Company did not record an income tax expense or benefit. For these periods, the
deferred tax asset, primarily created from operating losses, was offset by
increases in the tax valuation allowance.
Net loss for the three and nine months ended September 30, 2002 amounted to
$9.3 million and $41.5 million, respectively. Dividends accrued on Series A
Preferred Stock for the three and nine months ended September 30, 2002 amounted
to $3.4 million and $10.1 million, respectively (See Note 7 to the Company's
condensed consolidated financial statements for additional information). The
accretion of preferred stock issuance cost for the three and nine months ended
September 30, 2002 amounted to $131 thousand and $387 thousand, respectively.
17
As a result of the foregoing, net loss attributable to common stockholders
for the three months ended September 30, 2002 amounted to $12.8 million, or
($0.48) per share (diluted) compared to net loss of $22.8 million, or ($0.85)
per share (diluted) for the three months ended September 30, 2001. For the nine
months ended September 30, 2002, net loss attributable to common stockholders
was $52.0 million, or ($1.96) per share (diluted), compared to a net loss
attributable to common stockholders for the nine months ended September 30,
2001, of $59.5 million, or ($2.17) per share (diluted).
LIQUIDITY AND CAPITAL RESOURCES
Although the Company has experienced recent operating losses, quarterly
losses have been decreasing and earnings from operations before depreciation and
amortization were positive in the 3rd quarter of 2002. Recent quarterly results
have also evidenced increasing revenue, particularly in end-customer revenue,
growth in the number of customers and in other operating metrics. Management has
focused the Company's operating strategy on continuing to grow end-customers,
improving the efficiency of its network operations and in controlling
administrative costs and capital expenditures. As of September 30, 2002 the
Company had $32 million in cash. Management believes this will fund the
Company's operating, investing and financing activities into the 3rd quarter of
2003. The Company is aggressively pursuing several options to obtain additional
financing and improve liquidity to fund its cash requirements beyond the 3rd
quarter of 2003. These options include, but are not limited to, issuing
additional equity or debt securities, restructuring the existing amortization of
the current credit facility, obtaining vendor financing and working capital
management. Management is forecasting that with the achievement of both its
operating and financing strategies the Company would expect to generate
sufficient cash from operations to meet cash obligations as they come due.
Although management believes it will be successful in achieving this goal, there
can be no assurances. Failure to achieve the Company's operating and financing
strategies would have a material adverse effect on the Company.
In September 2002, the Company amended its senior secured loan agreement.
The amended agreement revised financial covenants, measured quarterly, the most
significant of which relate to the achievement of increasing levels of revenue
and earnings as well as certain levels of capital expenditures and cash. At
June 30, 2002 the Company was not in compliance with its quarterly minimum
EBITDA covenant after establishing an additional provision of $9.5 million
related to the bankruptcy filing of WorldCom and received a waiver from its
lenders. The Company was in compliance with the amended covenants as of the
quarter ended September 30, 2002 and management believes that the Company will
be in compliance with all quarterly financial covenants for a period at least
through September 2003 based upon projected operating results. These projected
operating results are dependent upon the Company meeting quarterly targets for
new customers, customer retention, customer usage, billing rates, gross margins
and selling, general and administrative costs, and as a result involve some
degree of uncertainty. Should any of these assumptions not be achieved for a
particular quarter, it is possible that a financial covenant will not be met for
the period through September 2003. Although there can be no assurances,
management believes if this were to occur, it would be able to obtain the
necessary waivers or amendments from its lenders. Should such waivers or
amendments not be obtained, the lenders would have the right under the credit
facility to certain remedies including acceleration of debt repayment.
The following table provides a summary of the Company's contractual obligations
and commercial commitments as of September 30, 2002 (in thousands).
Payments Due by Period
---------------------------------------------------
Less than 1-3 4-5 After 5
Contractual Obligations Total 1 year years years years
------------ ----------- ------------ ----------- -----------
Long-term debt $ 140,626 $ 23,438 $ 109,375 $ 7,813 $ -
Operating leases 49,283 7,401 18,657 10,573 12,652
------------ ----------- ------------ ----------- -----------
Total contractual cash obligations $ 189,909 $ 30,839 $ 128,032 $ 18,386 $ 12,652
============ =========== ============ =========== ===========
As of September 30, 2002, the outstanding amount under the Company's senior
secured credit facility was $140.6 million and there was no additional
availability under this credit facility.
18
Cash used in operating activities decreased to $12.8 million for the nine
months ended September 30, 2002 from $22.1 million during the comparable period
in 2001. The decrease in cash used in operating activities was primarily due to
lower operating losses net of non-cash charges and decreases in cash used for
working capital.
Cash used in investing activities decreased to $26.1 million for the nine
months ended September 30, 2002 from $34.3 million during the nine months ended
September 30, 2001. The investing activities are primarily related to purchases
of switching and related telecommunications equipment, office equipment, back
office and leasehold improvements. The decrease in cash used was the result of
the completion of our network expansion in 2001 and current capital expenditures
being primarily customer growth based.
Cash used by financing activities increased to $9.3 million for the nine
months ended September 30, 2002 from $20.4 million of cash provided during the
first nine months of 2001. The increase in cash used by financing activities was
primarily due to payments of $4.7 million of borrowings during both the second
and third quarters of 2002, whereas cash provided during the first nine months
of 2001 was primarily due to proceeds from borrowings. The Company made the
September 2002 scheduled amortization debt payment of $4.7 million on October 1,
2002.
Uncertainties and Contingencies
The Company's receivables are subject to certain uncertainties and
contingencies related to regulatory, judicial and legislative policies and
actions as well as resolutions of disputes with carriers over reciprocal
compensation and access revenue. For further discussion, See Note 8 to the
Company's condensed consolidated financial statements.
19
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
US LEC is exposed to various types of market risk in the normal course of
business, including the impact of interest rate changes on its investments and
debt. As of September 30, 2002, investments consisted primarily of institutional
money market funds. All of the Company's long-term debt consists of variable
rate instruments with interest rates that are based on a floating rate which, at
the Company's option, is determined by either a base rate or the London
Interbank Offered Rate ("LIBOR"), plus, in each case, a specified margin.
Although it is difficult to predict the impact of interest rate changes on the
Company's financial statements, the Company has total bank debt of approximately
$141 million as of September 30, 2002. Currently, quarterly interest expense,
net of interest income, is approximately $2 million. At this level, each one
percent increase or decrease in interest rates will have approximately a $1.4
million annual impact on the financial statements of the Company, depending
somewhat on timing of the borrowing, its maturity and other factors.
Although US LEC does not currently utilize any interest rate management
tools, it continues to evaluate the use of derivatives such as, but not limited
to, interest rate swap agreements to manage its interest rate risk. As the
Company's investments are all short-term in nature and its long-term debt is at
variable short-term rates, management believes the carrying values of the
Company's financial instruments approximate fair values.
ITEM 4. CONTROLS AND PROCEDURES
Our management, under the supervision and with the participation of our
principal executive officer and principal financial officer, evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures within 90 days of the filing date of this Quarterly Report on Form
10-Q. Based on this evaluation, our principal executive officer and principal
financial officer have concluded that the design and operation of our disclosure
controls and procedures are effective. There were no significant changes in our
internal controls or in other factors that could significantly affect these
controls subsequent to the date the evaluation was completed.
PART II OTHER INFORMATION
Item 1. Legal Proceedings
US LEC is not currently a party to any material legal proceeding, other than
proceedings, arbitrations, and any appeals thereof, related to reciprocal
compensation, intercarrier access and other amounts due from other carriers. For
a description of these proceedings and developments that have occurred during
the quarter ended September 30, 2002, see Note 8 to the condensed consolidated
financial statements appearing elsewhere in this report.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit No. Description
11.1 Statement Regarding Computation of
Earnings per Share/(1)/
99.1 Section 906 of Sarbanes-Oxley Act Certification by
Chief Executive Officer
99.2 Section 906 of Sarbanes-Oxley Act Certification by
Chief Financial Officer
/(1)/ Incorporated by reference to the Company's condensed
consolidated statements of operations appearing in Part
I of this report.
(b) No Current Reports on Form 8-K were filed during the period covered by
this report.
20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
US LEC Corp.
By: /s/Michael K. Robinson
----------------------
Michael K. Robinson
Executive Vice President and
Chief Financial Officer
November 14, 2002
21
CERTIFICATION
I, Aaron D. Cowell, Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of US LEC Corp.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function);
(a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls: and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002
By: /s/ Aaron D. Cowell, Jr.
Chief Executive Officer
22
CERTIFICATION
I, Michael K. Robinson , certify that:
1. I have reviewed this quarterly report on Form 10-Q of US LEC Corp.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function);
(a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls: and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002
By: /s/ Michael K. Robinson
Executive Vice President and Chief Financial Officer
23