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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT

PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

FOR THE YEAR ENDED DECEMBER 31, 2003

Commission File Number: 0-24061

US LEC CORP.

(Exact name of registrant as specified in its charter)

Morrocroft III, 6801 Morrison Boulevard

CHARLOTTE, NORTH CAROLINA 28211

(Address of principal executive offices)     (Zip Code)

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

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

Securities registered pursuant to Section 12(g) of Act:    Class A Common Stock, par value $.01 per share.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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

Indicate by check mark whether the registrant is an accelerated filer as defined in Exchange Rule 12b-2. Yes  ¨    No  x

The aggregate market value of voting stock of the registrant held by non-affiliates of the registrant was $49,954,945 as of June 30, 2003 based on the closing sales price on The Nasdaq National Market as of that date. For purposes of this calculation only, affiliates are deemed to be directors and executive officers of the registrant.

As of March 19, 2004 there were 29,853,869 shares of Class A common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Proxy Statement for its Annual Meeting of Stockholders to be held on May 18, 2004 are incorporated by reference into Part III of this report.

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US LEC CORP.

2003 ANNUAL REPORT ON FORM 10-K

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CAUTION REGARDING FORWARD-LOOKING STATEMENTS

This report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements regarding, among other items, our expected financial position, business, risk factors and financing plans. 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. These forward-looking statements are based on a number of assumptions concerning future events, including the outcome of judicial and regulatory proceedings, the adoption of balanced and effective rules and regulations by the Federal Communications Commission (“FCC”) and state public utility commissions (“PUCs”), and US LEC’s ability to successfully execute its business plan. These forward looking statements are also subject to a number of uncertainties and risks, many of which are outside of US LEC’s control, that could cause actual results to differ materially from such statements. Important factors that could cause actual results to differ materially from the expectations described in this report are set forth in Exhibit 99.1 “Risk Factors” and elsewhere in this report. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date they are made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as of a result of new information, future events or otherwise.

As used in the report, the words “we,” “our,” “US LEC,” and the “Company” refer to US LEC Corp. and its subsidiaries.

PART I

ITEM 1.    BUSINESS

OVERVIEW

Based in Charlotte, North Carolina, US LEC is a super-regional telecommunications carrier providing integrated voice, data and Internet services to approximately 17,000 mid-to-large-sized business customers throughout the eastern United States. The Company also provides shared Web hosting and dial-up Internet services to more than 18,000 additional residential and small business customers.

US LEC was founded in 1996 and first initiated service in North Carolina in March 1997, becoming one of the first competitive local exchange carriers in North Carolina to provide switched local exchange services. Since 1997, US LEC’s business has changed substantially as our product offerings have grown to include a full suite of voice, data and Internet services and our geographic area of service has expanded significantly to encompass nearly all of the major business centers in the eastern United States.

US LEC’s principal offices are located at 6801 Morrison Boulevard, Charlotte, North Carolina 28211, and the telephone number is (704) 319-1000. The Company’s Internet address is http://www.uslec.com. We are not including the information contained on our website as a part of, or incorporating it by reference into, this Annual Report on Form 10-K. We make available free of charge (other than an investor’s own Internet access charges) through our website our Annual Report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the Securities and Exchange Commission. In addition, we intend to disclose on our website any amendments to or waivers from our code of ethics that are required to be publicly disclosed pursuant to rules of the Securities and Exchange Commission.

The US LEC product line includes local calling services, long distance, long distance plans featuring toll free, calling card and conferencing services, dedicated and dial-up Internet services, frame relay, multi-link frame relay, Asynchronous Transfer Mode (“ATM”), Digital Private Line (“DPL”) services, managed data solutions,

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data center services, co-location and Web hosting. The US LEC network is currently supported with 27 digital voice and data switching centers and over twenty data points of presence (“POPs”) operating on Lucent 5ESS^® AnyMedia^™, Lucent CBX500 ATM and Tekelec SanteraOne^™ digital switches, as well as Juniper and Cisco^® Internet routers.

US LEC provides its full suite of voice, data and Internet services in 15 states plus the District of Columbia, including Alabama, Delaware, Florida, Georgia, Kentucky, Louisiana, Maryland, Mississippi, New Jersey, New York, North Carolina, Pennsylvania, South Carolina, Tennessee, and Virginia. US LEC also offers nationwide data services, as well as selected voice services, such as long distance calling, calling card, conferencing and toll free service, in 25 additional states including Arkansas, California, Colorado, Connecticut, Delaware, Illinois, Indiana, Iowa, Kansas, Massachusetts, Michigan, Minnesota, Missouri, Montana, Nevada, New Hampshire, North Dakota, Ohio, Oregon, South Dakota, Texas, Washington, West Virginia, Wisconsin and Wyoming.

In December 2003, as part of the Company’s strategy of expanding its range of services, US LEC acquired substantially all of the assets and products of Fastnet^® Corporation (“Fastnet”) related to or used by Fastnet in connection with the operation of its commercial Internet access, co-location, dedicated hosting (including two data centers located in eastern Pennsylvania), shared hosting and dial-up business segments. In addition, US LEC also acquired contracts of approximately 1,500 business customers and over 18,000 residential and small business dial-up Internet and shared hosting customers as a result of the transaction. Fastnet’s product set included dedicated Internet access, virtual private network (“VPN”) solutions, Total Managed Security^™, web hosting, co-location, application hosting, backup and recovery services, and unified messaging. Management believes that the assets acquired will speed the introduction of new data products, enhance US LEC’s ability to attract new customers demanding these products, sell the new product offerings to its current customer base and cross sell its current voice offerings to the customers acquired from Fastnet.

BUSINESS STRATEGY

US LEC’s mission is to be the premier communications partner for businesses by delivering quality voice, data and Internet services and exceeding expectations for customer care.

The principal elements of US LEC’s business strategy include:

Provide Outstanding Customer Service.    Management believes that a key element of the success of a competitive carrier is the ability to satisfy the service needs of its customers. The Company must be able to provide a quality activation, resolve service issues, quickly implement change requests, produce accurate bills, resolve billing issues, provide reliable services, and promptly add additional service and capacity required by our customers. Management believes that providing customers with outstanding customer care enhances the ability of the Company to retain its customers, as well as attract new customers. Customer service is provided locally by our market-based sales, sales support and operations team and centrally by US LEC’s three Network Operations Centers (“NOC”) and two customer service centers. The Company also provides a Web-enabled customer self-care portal that allows customers to manage selected US LEC services.

Offer a Broad Range of Services.    US LEC offers customers a broad range of voice, data and Internet services that can be bundled on a single customer network connection. US LEC offers its customers local calling services, long distance, long distance plans featuring toll free and conferencing services, dedicated and dial-up Internet services, frame relay, multi-link frame relay, ATM, DPL services, managed data solutions, data center services, co-location and Web hosting. Management believes a broad range of services, competitive pricing and an opportunity to bundle services gives US LEC customers an exceptional value, and enables the Company to build a stream of quality recurring revenue.

Target Telecommunications-Intensive Customers.    The Company focuses its sales efforts on telecommunications-intensive business customers that include the automotive, construction, education, financial,

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government, healthcare, hospitality, Internet service providers, professional/legal, real estate, retail, transportation sectors and other telecommunication providers. By focusing on such customers, the Company is able to more efficiently concentrate their telecommunications traffic. In addition, the Company frequently is able to bundle its voice, data and Internet services. This further enhances network utilization and thereby improves margins, as fixed network costs are spread over a larger base of services.

Deploy a Capital-Efficient Network.    US LEC utilizes a “smart-build” strategy of owning and deploying switching and routing equipment and leasing the required fiber optic transmission capacity from competitive access providers (“CAPs”), CLECs, inter-exchange carriers (“IXCs”) or incumbent local exchange carrier (“ILECs”). Management believes the Company’s switch-based, leased-transport strategy enables it to continually take advantage of changes in the transport market. By employing the smart-build strategy, US LEC reduces the up-front capital expenditures required to build a network and enter new markets and avoids the risk of “stranded” investment in under-utilized networks. Unlike some other competitive carriers, the Company does not resell ILEC dial tone services or provide service via Unbundled Network Element Platforms (“UNE-P”) through which a carrier offers local exchange services by purchasing all of the elements of the switching platform from the ILEC.

Maintain a Robust Technology Platform.    US LEC operates 26 Lucent voice switches, 26 Lucent ATM data switches and one Tekelec SanteraOne^™ digital switch active throughout its network. The Company also employs a redundant and diverse advanced intelligent network (“AIN”) platform and SS7 signaling network, which includes Telcordia integrated services control points (“ISCPs”) and Tekelec Eagle signal transfer points (“STPs”). In addition, the Company has also deployed Juniper and Cisco^® routers to provide reliable, scalable and high-speed network elements that enhance the performance of US LEC’s Internet access service. The Company’s data centers are equipped with Intel ISP platforms as well as a variety of other server platforms, based on customer needs.

Focus of Operations.    The Company focuses its network and marketing presence in target markets composed of certain Tier I cities (defined as major metropolitan areas such as Atlanta, Miami, New York, Philadelphia and Washington D.C.) and certain Tier II cities (defined as mid-size metropolitan areas such as Charlotte, Nashville and Tampa) located in the eastern United States. Management believes that the Company’s strategically designed network will enable it to take advantage of customer relationships, calling patterns, capture an increasing portion of customer traffic on its network and improve brand identification.

THE US LEC NETWORK

The US LEC network is currently supported with 27 digital switching centers operating on 26 Lucent 5ESS^® AnyMedia^™ digital switches, 27 Lucent CBX500 ATM data switches and one Tekelec SanteraOne^™ digital switch. The network also includes five Juniper M20^™ Internet routers and over 20 data POPs equipped with Cisco^® routers. The digital switching centers are connected to each other across the network on SONET OC-12, SONET OC-3 and DS-3 lines leased from various other carriers. The Company connects its customers to its digital switching centers through leased lines, including SONET OC-48, SONET OC-12, SONET OC-3, DS-3 and T-1. The SONET lines are generally deployed in a ring configuration.

In order to interconnect its switches to the network of the local incumbent phone company and to exchange traffic with it, the Company maintains interconnection agreements with the incumbent carriers. The Telecommunications Act of 1996 (the “Telecom Act”), decisions of state and federal regulatory bodies and negotiation affect the terms and conditions of the interconnection agreements with the carriers involved. The Company may voluntarily enter into such an agreement, petition a state regulatory commission to arbitrate issues that cannot be resolved by negotiation or opt into agreements executed by the incumbent and other competitive carriers. The Company has signed interconnection agreements with all of the incumbent local carriers where it offers services requiring such agreements, including BellSouth Telecommunications, Inc. (“BellSouth”), Verizon Communications Inc. (“Verizon”) and Sprint Communications Company L.P. (“Sprint”).

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Voice 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 routed to a long distance carrier, an ILEC or another CLEC, depending on the location of the call recipient. Similarly, voice 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.

Data transmissions from a US LEC customer are transported over leased lines to the US LEC switch and then transmitted directly on the Company’s network or transmitted to another carrier for termination. Data transmissions to a US LEC customer work in reverse.

Internet access for US LEC customers is provided by transport over leased lines to the US LEC switch, transmitted over leased lines to one of US LEC’s Internet Gateways, and then, if necessary, to the Internet via Internet transit leased from other carriers.

SERVICES

The Company provides voice services, most significantly local dial-tone services, to customers in major metropolitan areas of 15 states plus the District of Columbia. Local access is available in many different forms including Primary Rate Interface (“PRI”), T-1 and channels. The Company’s network is designed to allow a customer to easily increase or decrease capacity and utilize enhanced services as the telecommunications requirements of the customer change. The Company also offers directory assistance and operator services, long distance services for completing intrastate, interstate and international calls. The Company also provides toll-free services, calling cards, audio conferencing and certain enhanced services such as voice mail.

The Company provides data services including frame relay, multi-link frame relay, ATM and DPL (digital private line) services for the efficient and cost-effective transfer of data communications. US LEC also provides managed router services, offering customers a turnkey solution for comprehensive network management options, as well as Data Network Reports, a convenient on-line reporting tool that provides updated trend reports on a customer’s entire US LEC data network and on their most heavily used individual circuits.

US LEC’s Internet services include dedicated and dial-up Internet access, managed data solutions, data center services, co-location, managed firewalls and IP-VPN, Web hosting, e-mail, news feeds and other services.

The Company’s ability to bundle voice, data and Internet services on the same transport facility allows it to offer customers more efficient use of such facilities, and allows it to aggregate customers’ charges on a single consolidated invoice.

During 2003, the Company continued to expand its voice, data and Internet product offerings, while minimizing the capital requirements associated with product expansions. The goal of these product expansions was two-fold. The first was to add incremental revenue opportunities by complimenting an already strong product set to provide comprehensive customer communications solutions. The second was to more deeply penetrate the US LEC customer base with additional services, with the goal of increasing customer satisfaction, customer loyalty and retention. As examples, in 2003 US LEC added Data Network Reports and enhanced Web hosting packages. Data Network Reports allow customers to see individual and whole network trends in utilization, congestion, discards, and other similar network dispositions. The upgrades in the Web hosting packages enable customers to manage their services with on-line self-management tools and enhanced security. Management also believes the resources provided by the acquisition of Fastnet will enable it to more rapidly introduce new data services, enhance US LEC’s ability to attract new customers as well as selling the new product offerings to existing customers.

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SALES AND MARKETING

Sales.    US LEC employs a well trained and experienced direct sales force to attract new customers and dedicate its efforts to retaining customers. The Company recruits salespeople with strong sales backgrounds in its markets, many of whom have had experience with other telecommunications carriers, including long distance companies, CLECs, ILECs, Internet service providers (“ISPs”), telecommunications equipment manufacturers and network systems integrators. The Company plans to continue to attract and retain highly qualified salespeople by offering them an opportunity to participate in the potential economic rewards made available through a results-oriented compensation program. The Company also leverages its sales force by employing highly skilled data and solutions engineers, who are specialists in designing customer networks. The Company also utilizes independent sales agents to identify and service customers. During 2003, the Company continued to augment its sales force by hiring additional quota-bearing and sales support staff, providing continuing education regarding the Company’s voice, data and Internet services and forming an overlay group to focus on large target customers and data sales.

Marketing and Branding.    US LEC seeks to be the premier communications partner for businesses by delivering quality voice, data and Internet services and exceeding expectations for customer care. The Company builds its reputation and brand identity by working closely with its customers to develop services customized to their particular needs and by implementing targeted product offerings and promotional efforts. With marketing focus and expertise in a number of industries, US LEC is able to distinctly define its competitive advantages, value propositions and service provider differentiators to its customers. In addition, the integration of the Fastnet product line allows the Company to increase the speed-to-market for the enhanced data and Internet services.

The Company primarily uses two trademarks and service marks: US LEC, and a logo that includes US LEC and VOICE/DATA/INTERNET. The US LEC mark has been registered on the Supplemental Register of the United States Patent and Trademark Office for uses related to telecommunications services. Both the US LEC mark and the logo mark have been preliminarily approved for registration on the Principal Register for use with the same or related services.

The Company has recently acquired from Fastnet Corporation a number of federal trademark or service mark registrations (including FASTNET) and one pending federal application for use with related telecommunications services. The Company’s use of these marks will be evaluated as the Fastnet services are integrated into the Company’s existing suite of telecommunications services.

Billing.    The Company operates its billing function in-house, allowing the Company to realize cost savings and provide additional services to customers. Customer bills are available in a variety of formats to meet a customer’s specific needs. US LEC offers customers simplicity and convenience by sending one invoice for all services. The Company offers electronic bill presentment and tools that allow customers web access to bills and supporting information such as call detail information. The Company believes this is an important aspect of customer acquisition and retention.

EMPLOYEES

As of December 31, 2003, the Company employed 1,016 people, including 80 former Fastnet employees. The Company does not expect significant changes in its staffing level in 2004. The Company considers its employee relations to be very good.

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 and

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legislation, legislative hearings and administrative proposals which could change, in varying degrees, the manner in which this industry operates. Neither the outcome of these proceedings and legislation, nor their impact upon the telecommunications industry or the Company, can be predicted at this time. This section also includes 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 PUCs 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 established a regulatory framework for the introduction of local competition throughout the United States and was 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.

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 implemented by FCC regulations. The Telecom Act contemplates that state PUCs will apply the federal regulations and oversee the implementation of all aspects of interconnection not subject to FCC jurisdiction as they oversee interconnection negotiations and, to the extent necessary, enforcement actions between ILECs and their new competitors.

The FCC has significant responsibility for the manner in which the Telecom Act will be implemented, especially in the areas of pricing, universal service, interstate 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 PUCs also have significant responsibility for implementing the Telecom Act. Specifically, the states have authority to establish interconnection pricing, including unbundled loop charges, reciprocal compensation, intrastate access charges and wholesale pricing consistent with FCC regulations. The PUCs are also charged under the Telecom Act with overseeing the arbitration process for resolving interconnection negotiation disputes between CLECs and the ILECs, must approve negotiated, arbitrated or adopted interconnection agreements, and may resolve contract compliance disputes arising from interconnection agreements. The U.S. Supreme Court appears to have assumed, without actually deciding, that the PUCs have the ability to enforce interconnection agreements and that United States District Courts have jurisdiction over appeals from PUC decisions.

The obligations imposed on ILECs by the Telecom Act to promote competition, such as local number portability, dialing parity, reciprocal compensation arrangements and 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 has increased, and likely will continue to increase, the level of competition the Company faces.

Federal Regulation and Related Proceedings.    The Telecom Act and the FCC’s efforts to initiate reform have resulted in numerous legal challenges. As a result, the regulatory framework in which the Company operates is subject to a great deal of uncertainty. Any changes that result from this uncertainty could have a

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material adverse effect on the Company. The FCC has adopted orders prohibiting the use of tariffs for non-dominant carriers providing international and domestic interstate long distance services. Accordingly, non-dominant interstate service providers and international service providers will no longer be able to rely on the filing of end user tariffs with the FCC as a means of providing notice to customers of prices, terms, and conditions under which they offer their international and domestic interstate inter-exchange services. The FCCs orders do not apply to the switched and special access services of the regional bell operating companies (“RBOCs”) and other local exchange service providers. The FCC allows permissive detariffing of these services.

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 afforded significant new pricing flexibility to ILECs subject to price cap regulation. On August 5, 1999, the FCC adopted an order granting price cap ILECs additional pricing flexibility. The order provides certain immediate regulatory relief regarding price cap ILECs and sets forth a framework of “triggers” to provide those companies with greater flexibility to set rates for interstate access services. On February 2, 2001, the D.C. Circuit upheld the FCC’s rules regarding pricing flexibility. To the extent such increased pricing flexibility is utilized for ILECs or such additional regulation is implemented, the Company’s ability to compete with ILECs for certain service could be adversely affected. The FCC has granted pricing flexibility applications for various interstate access services provided by RBOCs in a number of cities, including cities where US LEC competes against BellSouth.

In December 2001, the FCC initiated a comprehensive evaluation of its rules governing the unbundling of network elements (“UNEs”). On May 24, 2002, the United States Court of Appeals for the D.C. Circuit overturned two decisions of the FCC. First the court remanded to the FCC for further consideration its decision on UNEs, which required ILECs to lease numerous UNEs to CLECs. Second, the court vacated and remanded the FCC decision requiring ILECs to unbundle a portion of the spectrum of local copper loops so that data local exchange carriers can offer competitive advanced services such as DSL. The FCC consolidated the issues on UNEs remanded by the D.C. Circuit with its separate Triennial Review UNE proceeding. On August 21, 2003, the FCC released its Triennial Review Order (“TRO”) addressing the remand on UNEs and its statutorily mandated comprehensive evaluation of UNEs. The TRO set the ground rules for the availability of UNEs going forward. In a portion of the TRO, the FCC held that CLECs could order new combinations of UNEs, including enhanced extended links (“EELs”) (loop transport UNE combinations), which are the same elements that comprise special access facilities purchased by long distance carriers. The TRO also held that CLECs could commingle UNEs and UNE combinations with other wholesale services, including special access services, and resold services. Also, with respect to broadband applications, the FCC eliminated the line sharing obligation subject to a three year phase out for new customers with gradually increasing prices; limited ILEC’s unbundling obligations for fiber to the home; and declined to require ILECs to unbundle the next generation network, i.e. packetized capabilities of hybrid loops to permit CLECs to provide broadband services to the mass market. Several parties impacted by the TRO—ILECs as well as CLECs—filed motions for reconsideration with the FCC and appeals from various aspects of the TRO. The appeals were consolidated before the Court of Appeals for the D.C. Circuit, which stayed the effectiveness of portions of the TRO pending appeal. On March 2, 2004, the Court of Appeals issued a decision reversing a substantial portion of the TRO. The Court vacated the FCC’s decision to order unbundling of mass market switches and DS3, DS1 and dark fiber dedicated transport. The Court affirmed the FCC’s decision not to require unbundling of hybrid loops, fiber-to-the-home loops, and line sharing. The Court found reasonable the specific EEL eligibility standards pursuant to which CLECs may obtain high capacity EELs. Given the availability of special access, however, the Court expressed skepticism that carriers providing long distance services or otherwise using special access circuits to provide competitive local exchange services were impaired without access to EELs, and remanded the conversion requirement to the FCC for further consideration. The Court stayed the effectiveness of its decision for sixty (60) days to give the parties the opportunity to seek reconsideration or to seek a writ of certiorari from the Supreme Court. In light of the decision

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and likely requests for reconsideration or further review it is unclear whether the Company will continue to be able to convert special access circuits to UNE circuits and it is also unclear whether the Company will continue to be able to commingle UNEs and special access circuits. Similarly, the Company cannot predict the effect the TRO will have on the Company in the near future.

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 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 is 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 is based on its share of the total interstate telecommunications service and certain defined telecommunications end user revenues. Although the Company has made its required contributions to the fund, the amount of the Company’s contribution changes each quarter. As a result, the Company cannot predict the effect these regulations will have on the Company in the future.

The FCC has initiated rulemaking proceedings to consider whether advanced services offered by ILECs should be regulated as services offered by a dominant or nondominant carrier, as defined. If the service offerings are deemed nondominant, the ILEC will be subject to lessened regulation. In a related proceeding, the FCC is seeking to determine whether advanced services are information services and what regulations should apply, if that is the case. A finding that advanced services are information services, and not telephone services, could result in significantly lower levels of regulation. The Company cannot predict the outcome of these proceedings.

The FCC made and is continuing to consider various reforms to the existing rate structure for charges assessed on long distance carriers for allowing them to connect to local networks. These reforms are designed to move these “access charges” over time to lower, cost-based, rate levels and structures. These changes will reduce charges to long distance carriers while increasing charges to end-users. Although certain of these reforms do not apply directly to CLECs, ILEC reductions in switched access charges will likely place pressure on CLECs, including the Company, to reduce their own switched access charges. Moreover, in April 2001 the FCC for the first time established rates for CLEC switched access charges. Those rates declined substantially over a three-year period. CLECs can charge higher rates if agreed to by the long distance carrier, but cannot tariff a rate higher than the FCC’s benchmark rate.

In October 2002, AT&T Corporation (“AT&T”) filed a petition for declaratory ruling with the FCC with respect to phone-to-phone Internet Protocol telephony. The petition requested that the FCC affirm that such services are exempt from the access charges applicable to circuit switched inter-exchange calls and that it is lawful to provide such service through local end user services. Comments were filed with the FCC in support of and in opposition to the AT&T petition, and it is unclear when the FCC might rule on the question presented. Similarly, in February 2003, Pulver.com filed a petition for declaratory ruling that asked the FCC to determine whether computer-to-computer calls over the Internet constituted a “telecommunications service” and, thus, were subject to access charges. On February 12, 2004, the FCC held that Pulver.com’s service is not telecommunications or a telecommunications service. The FCC determined that because Pulver.com’s peer-to-peer IP communications service does not offer or provide a transmission service, it is not offering “telecommunications” as defined under the Communications Act. The FCC ruled that the service could not be classified as a “telecommunications service” under the Act because it is a free service not offered to the public for a fee. The FCC also decided to classify Pulver.com’s service as an information service and intends to preempt state regulation of that service. The FCC also adopted a Notice of Proposed Rulemaking seeking comment on the various regulatory issues surrounding “IP-enabled” services. The FCC will seek comment on how it might categorize particular types of IP-based services, such as by distinguishing IP services that interconnect with the Public Switched Telephone Network or are being utilized as a substitute for traditional telephone services. The

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Company cannot predict the outcome of these proceedings or other FCC or state proceedings that may affect the Company’s operations or impose additional requirements, regulations or charges upon the Company’s provision of Internet access and related Internet Protocol-based telephony services or the Company’s announced plans to add a voice over IP product.

State Regulation.    The Company has all of the state certifications necessary to offer its current services.

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 generally does 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 intensity. The majority of states mandate that companies seeking to provide local exchange and other intrastate services apply for and obtain the requisite authorization from the 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.

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. Some states where the Company operates have adopted detariffing rules.

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 nondiscriminatory requirements designed to promote universal service, protect the public safety and welfare, maintain the quality of service and safeguard the rights of consumers. 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. Depending on how such charges are ultimately determined, such charges could become a material expense to the Company.

COMPETITION

ILECs.    In each market served by its networks, the Company faces, and expects to continue facing, significant competition from the ILECs, which currently dominate their local telecommunications markets as a result of their historic monopoly position. The ILECs have also recently entered the long distance markets in virtually all of their service areas. They also offer data and Internet services.

The Company competes with the ILECs in its markets for local exchange services on the basis of product offerings, bundling, reliability, state-of-the-art technology, price, network design, 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, a number of which the Company 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. Because US LEC leases fiber optic transmission capacity to link its customers with its networks and uses state-of-the-art technology in its switching platforms, the Company has demonstrated bundling, cost and service quality advantages over some ILEC networks currently available.

IXCs.    Inter-exchange carriers that provide long distance services and other telecommunications services offer or have the capability to offer switched local, long distance, data and Internet services. Some of these carriers have a much larger service footprint than the Company.

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Other CLECs.    In the markets where US LEC has a digital switching center, one or more CLECs are also operating. In some cases, the Company competes head-to-head with other CLECs and in some cases the other CLECs seek to serve a different customer base. The Company competes with other CLECs in its markets on the basis of product offerings, bundling, reliability, state-of-the-art technology, price, network design, ease of ordering and customer service. Some of these carriers have competitive advantages over us, including substantially greater financial, personnel and other resources, including brand name recognition and long-standing relationships with customers. In addition, some have entered and subsequently emerged from bankruptcy with dramatically altered business plans and financial structures that could give those entities the ability to offer more competitive rates than the Company can offer.

Internet Service Providers (ISPs).    Throughout the Company’s service area, various Internet service providers also operate. In some cases, the Company competes head-to-head with other ISPs and in some cases, the other ISPs seek to serve a different customer base. The Company competes with other ISPs in its markets on the basis of product offerings, bundling, reliability, state-of-the-art technology, price, network design, ease of ordering and customer service. Some of these carriers have entered and subsequently emerged from bankruptcy which may give those entities the ability to offer more competitive pricing arrangements than the Company can offer.

Other Competitors.    The Company also faces, and expects to continue facing, competition from other potential competitors in certain markets in which the Company offers services. In addition to the ILECs, IXCs and other CLECs, 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, brand name recognition and vast financial resources. A continuing trend toward business combinations and alliances in the telecommunications industry may create significant new competitors to the Company.

The Company also competes with long distance carriers in the provisioning of long distance services. Although a few major competitors dominate the long distance and data market, hundreds of other companies also compete in the long distance and data marketplace.

Executive Officers of the Registrant

The following table sets forth certain information regarding the executive officers of US LEC Corp:

Richard T. Aab, Chairman of the Board, co-founded US LEC in June 1996 and has served as chairman of the board of directors since that time. He also served as chief executive officer from June 1996 until July 1999. Between 1982 and 1997, Mr. Aab co-founded ACC Corp., an international telecommunications company in Rochester, NY, and held various positions including chairman and chief executive officer, and served as a director.

Aaron D. Cowell, Jr., President, Chief Executive Officer and Director, joined US LEC in June 1998 as executive vice president and general counsel. Later that year, he assumed responsibility for US LEC’s sales and field sales support functions. In 1999, his executive management duties were expanded to include US LEC’s engineering, operations, regulatory, customer care services and marketing departments. He was appointed president and chief operating officer of US LEC in 2000. In October 2002, Mr. Cowell was named chief executive officer and elected to the board of directors. He also holds a position on the executive committee for

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The Association for Local Telecommunications Services, through which he helps promote regulations and decisions that will facilitate fair competition in the telecommunications industry. Before joining US LEC in 1998, Mr. Cowell spent 11 years with Moore & Van Allen PLLC, a large Southeastern law firm, where he represented, among others, US LEC and Alcatel, primarily in corporate finance and merger and acquisition matters. Mr. Cowell is a graduate of Harvard Law School and Duke University.

Michael K. Robinson, Executive Vice President and CFO, joined US LEC in July 1998 as Chief Financial Officer, responsible for finance and investor relations, and has over 20 years of experience in the telecom industry. Since joining US LEC, Mr. Robinson has assumed additional responsibilities including information systems and information technology, human resources, facilities and real estate, and billing system development. Prior to joining US LEC, Mr. Robinson was with Alcatel, an international, multi-billion dollar developer and manufacturer of telecom equipment, where he served as EVP and CFO of the US based transmission systems division, the worldwide enterprise and data division, as well as corporate committees including pension investments and purchasing. Prior to Alcatel, Mr. Robinson was at Windward International and Siecor (now Corning). He holds a bachelor’s degree from Emory & Henry and an MBA from Wake Forest University.

ITEM 2.    PROPERTIES

The Company’s corporate headquarters are located at its principal office at Morrocroft III, 6801 Morrison Blvd., Charlotte, NC 28211. The Company leases all of its administrative and sales offices and its switch sites. The leases expire during various years through 2011 with one lease expiring in 2016. Most of these leases have renewal options. Additional office space and switch sites will be leased or otherwise acquired as the Company’s operations and networks expand and as new networks are constructed.

ITEM 3.    LEGAL PROCEEDINGS

US LEC is not currently a party to any material legal proceedings, other than proceedings, arbitrations, and any appeals thereof, related to reciprocal compensation, inter-carrier access, wireless traffic and other amounts due from other carriers. For a description of these proceedings and developments that have occurred during the year ended December 31, 2003, see Note 8 to the consolidated financial statements appearing elsewhere in this report and Exhibit 99.1—“Risk Factors”.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the quarter ended December 31, 2003.

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PART II

The Company’s Class A common stock trades on The Nasdaq National Market under the symbol CLEC. To date, the Company has not paid cash dividends on its common stock. The Company currently intends to retain any earnings that the Company might generate to support operations, service debt and finance expansion and therefore does not anticipate paying cash dividends in the foreseeable future. In addition, the Company’s senior credit facility, subordinated notes and the preferred stock agreements contain certain limitations on the payment of dividends.

As of March 11, 2004, there were 201 holders of record of the Class A common stock. The following table sets forth the high and low closing price information for the Class A common stock as reported by Nasdaq during the periods indicated.

On January 15, 2003, the Company acquired certain assets, primarily the Internet service provider customer contracts of Eagle Communications, Inc. in North Carolina, Georgia, Florida and Tennessee, and assumed certain operating liabilities. The price of $3.0 million consisted of $1.25 million in cash and a $1.75 million subordinated note with warrants to purchase 921,058 shares of the Company’s Class A common stock at an exercise price of $1.90 per share.

On November 7, 2003, the Company offered and sold 2,000,000 shares of Class A common stock to institutional investors. The gross proceeds of the offering were $10.0 million.

On December 15, 2003, the Company acquired the broadband and dial-up internet access, co-location, and managed hosting business units of Fastnet, as well as two data centers in eastern Pennsylvania that included $5.9 million in cash, Class A common stock with a fair market value of $1.0 million, and a $1.3 million promissory note. The note payable amount is subject to adjustment pending post closing items as allowed for in the purchase agreement which could result in a final purchase price of $8.5 million. Along with the assumption of certain liabilities, cure payments to third party creditors and acquisition related costs, total consideration was $9.8 million.

The shares of Class A common stock issued in these transactions were not registered under the Securities Act of 1933, as amended (the “Securities Act”). These securities were offered and sold in reliance upon the exemption from registration provided by Section 4(2) of the Securities Act for transactions not involving any public offering. The Company’s reliance upon this exemption was based upon the accredited status of the purchasers and the lack of any general solicitation in the offerings.

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ITEM 6.    SELECTED FINANCIAL DATA

The selected financial data have been derived from our audited consolidated financial statements. The selected consolidated financial data should be read in conjunction with Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and related notes, appearing elsewhere in this report.

The following table sets forth our selected consolidated financial data as of and for the years ended December 31, 1999, 2000, 2001, 2002 and 2003.

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

This report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements regarding, among other items, our expected financial position, business, risk factors and financing plans. 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. These forward-looking statements are based on a number of assumptions concerning future events, including the outcome of judicial and regulatory proceedings, the adoption of balanced and effective rules and regulations by the Federal Communications Commission and state public utility commissions, and US LEC’s ability to successfully execute its business plan. These forward-looking statements are also subject to a number of uncertainties and risks, many of which are outside of US LEC’s control, that could cause actual results to differ materially from such statements. Important factors that could cause actual results to differ materially from the expectations described in this report are set forth in Exhibit 99.1 “Risk Factors” and elsewhere in this report. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date they are made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as of a result of new information, future events or otherwise.

Overview

General.    US LEC is a Charlotte, North Carolina-based telecommunications carrier providing voice, data and Internet services to over 17,000 mid-to-large-sized business customers throughout the eastern United States. We primarily serve telecommunications-intensive business customers in a wide variety of industries. In December 2003, we acquired substantially all of the assets of Fastnet Corporation, increasing our end customer base by over 1,500 mid-to-large-sized business customers and adding over 18,000 residential and small business dial-up and shared hosting customers.

In evaluating US LEC’s operating performance, we consider the following measures to be the most important:

During the year ended December 31, 2003, US LEC achieved positive results in each of these measures. We believe this demonstrates the validity of our business plan and our ability to execute it.

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Total and End Customer Revenue.    We derive revenue from two sources: end customers and other telecommunications carriers. End customer revenue is comprised of installation, recurring and usage-sensitive charges (primarily long distance services) paid by businesses and other end customers for voice, data and Internet services. Revenue from other carriers is comprised of access charges and reciprocal compensation paid by IXCs and ILECs for the origination and termination of inter-exchange and local calls. Because end customer revenue represents a stable and recurring revenue stream, our focus has been, and will continue to be, on the growth and retention of end customers and product penetration to these customers. The following table provides a breakdown of the components of our revenue over the past three years:

As illustrated by the table above, the increase in total revenue has resulted primarily from growth in end customer revenue. The growth in end customer revenue is primarily attributed to an increase in the number of customers, achieved through a combination of geographic expansion, increased penetration of established markets and continued development and acceptance of new services. In addition, high rates of customer retention facilitate end customer revenue growth through increased opportunity for additional services. During 2003, excluding the effect of the Fastnet acquisition, our end customer base increased from 10,290 to 15,295, our best year ever in terms of new customer additions. During 2003, our average monthly customer turnover remained constant at approximately 0.66%.

A key source of growth in end customer revenue has been the increase in data services and we anticipate this growth to continue in future periods. During 2003, excluding the effect of the Fastnet acquisition, we added approximately 3,600 customers that purchased data products and increased end customer revenue from data services from approximately 10% of total revenue in 2002 to 15% of total revenue in 2003. The Fastnet acquisition was a strategic step in our effort to accelerate the growth of our data business. Through this acquisition, we obtained two data centers and added new and improved data and Internet services to our product set, which we plan to aggressively market to our existing customers. Fastnet added approximately 1,500 mid-to-large-sized business customers with dedicated Internet or data center services and over 18,000 residential and small business shared web hosting and dial-up Internet data customers. The table above includes approximately $1.0 million of revenue for Fastnet from the closing date of December 15, 2003. We expect the Fastnet acquisition to contribute approximately $24.0 million in annual end customer revenue.

Uncertainties That Could Adversely Affect Revenue.    We expect end customer revenue to continue to increase and carrier revenue to continue to decrease as percentages of total revenue in future periods. We expect this continuing change in revenue mix to occur due to our emphasis on expanding our end customer base and to

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rate reductions in new interconnection agreements with ILECs and IXCs, as well as legislative and regulatory actions that had a negative impact on carrier charges during the second half of 2003.

The deregulation of the telecommunications industry, the implementation of the Telecom Act, and the financial 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 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, the applicability of access rates to wireless traffic, rates applicable to different categories of traffic, and the characterization 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 services. Rulings adverse to the Company, adverse legislation, new regulations or changes in governmental policy on issues material to the Company could have a material adverse effect on the Company’s revenue and cash flow. For a detailed description of the regulatory and judicial proceedings in which the Company is currently involved, see Note 8 to the consolidated financial statements appearing elsewhere in this report and related discussion in Exhibit 99.1 “Risk Factors”.

Customer Retention.    One of the measures that we use to gauge our success in providing quality services to our customers and also to gauge our success in competing against the incumbent and other carriers in our markets is customer retention. As we add more customers to our base, it is important that we keep as many of our current customers as possible as the cost of attaining a new customer is greater than keeping an existing one. We include every category of customer loss when we calculate the customer retention rate for US LEC, including customers that are deactivated due to non-payment of their bills. We believe that US LEC has one of the highest retention rates among any of the carriers in our footprint. In 2003, we kept over 92.6% of our customer base compared to 92.1% in 2002. In addition, as our customer base has grown, we have had a larger percentage of customers’ contracts come up for renewal. US LEC renewed the contracts of over 90% of the customers whose contracts came up for renewal during 2003. Most of our customers are on three-year contracts.

Network Expense.    During 2003, we continued to execute a controlled growth strategy that included an extensive re-configuring and streamlining of our network, strict purchasing controls, network design changes, improved purchasing terms and the addition of lower cost circuits to our network as we began to provision some UNE loops. The results of these efforts are reflected in the reduced cost of our local network and customer loops, which decreased greater than 10% from the fourth quarter of 2002 to the fourth quarter of 2003. Overall, network expense as a percentage of total revenue remained stable at approximately 48% for 2002 and 2003 despite the change in revenue mix from carrier charges toward end customer revenue, which carries higher network costs.

Working Capital Management.    During 2003, we continued to focus on working capital management that included management of customer receivables and days sales outstanding (“DSOs”), accounts payable and vendor relationships and strict purchasing controls of SG&A expenses. As a result of increased revenue and management of our working capital, the first quarter of 2003 was the first quarter since the fourth quarter of 2001 that resulted in positive cash flow from operations and a net increase in cash and cash equivalents. This continued each quarter through the year, resulting in cash flow from operations of $56.0 million and a net increase in cash and cash equivalents of $17.4 million. Cash flow from operations, combined with the proceeds from the sale of Class A common stock and our improved cash position, enabled us to fund capital expenditures of approximately $36.0 million and make two strategic acquisitions during the year and pay over $6.0 million of debt during the fourth quarter.

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Results of Operations

Comparison of Year Ended December 31, 2003 to Year Ended December 31, 2002

Revenue.    Approximately 97% of the Company’s revenue is currently derived from two sources—end users and carrier charges. Less than 3% of the Company’s revenue is derived from other sources, including wholesale customers, installation revenue, and other miscellaneous sources. End customer revenue consists of fees paid by businesses and other end customers for local, long distance, data and Internet services. The components of end customer revenue include monthly recurring charges, usage charges, and initial non-recurring charges. Monthly recurring charges are fees paid by customers for facilities in service and additional features on those facilities. Usage charges are usage-sensitive fees paid for calls made, primarily long distance, by the customer. Initial non-recurring charges consist primarily of the amortization of deferred installation charges. Carrier charges are derived from billings to other carriers, primarily for network access charges and reciprocal compensation. Access charges are comprised of fees paid primarily by IXCs for the origination and termination of inter-exchange toll and toll-free calls. Reciprocal compensation arises when a local exchange carrier completes a call that originated on another local exchange carrier’s network. Reciprocal compensation rates are fixed by an interconnection agreement executed between those carriers or mandated by the FCC.

Revenue increased to $310.8 million for the year ended December 31, 2003, from $250.4 million in 2002. The increase in total revenue in 2003 was due entirely to an increase in end customer revenue, as carrier charges actually decreased slightly in 2003 from 2002. In 2003, the Company’s end customer revenue increased to $211.3 million, or 68% of total revenue from $148.9 million, or 59% of total revenue in 2002. The growth in end customer revenue is due to an increase in the number of end customers and in the services utilized by each customer. During 2003, excluding the effect of the Fastnet acquisition, our end customer base increased 49%, from 10,290 to 15,295. This increase in customers is primarily attributed to increased geographic expansion and penetration of existing markets. Of particular note is that the majority of the increase in end customers was due to an increase of approximately 3,600 data customers, resulting in a $23.0 million increase in data revenue from 2002 to 2003. Our product take rate—the number of services utilized by each customer—increased from 4.03 in 2002 to 4.36 in 2003.

Revenue from carrier charges decreased to $89.3 million in 2003 from $91.9 million in 2002. We expect total revenue to increase at a slower rate in future periods due to decreasing carrier charges. Revenue from inter-carrier access declined from $80.4 million during 2002 to $78.9 million in 2003. On a quarterly basis, revenue from inter-carrier access dropped from $21.5 million during the second quarter of 2003 to $19.2 million during the third quarter of 2003 and $16.6 million during the fourth quarter of 2003 primarily due to the reduction of rates as mandated by the FCC. Future decreases are expected as reductions in access rates as a result of these mandates are expected to offset anticipated increases in usage. Reciprocal compensation and wholesale revenue continue to represent a very minor portion of our total revenue. Reciprocal compensation and wholesale revenue accounted for only 4% of total revenue in 2003 due to a decline of approximately $1.0 million from 2002.

Network Expenses.    Network expenses are comprised primarily of leased transport, facility installation, and usage charges. Network expenses increased to $148.7 million for 2003 from $121.1 million for 2002, but remained constant as a percentage of revenue at 48% despite the shift in revenue mix toward end customer revenue. This increase in network expenses was primarily a result of the increase in the size of US LEC’s network, an increase in customers and usage by its customers, as well as a shift to higher network expense for end customer revenue. Although the total dollar amount of network expense increased, the percent of network expense to revenue remained flat as a result of our continued efforts to keep our network efficient.

Depreciation and Amortization.    Depreciation and amortization for 2003 increased to $48.4 million from $45.1 million in 2002 primarily due to the increase in depreciable assets in service related to US LEC’s network expansion.

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Selling, General and Administrative Expenses.    Selling, general and administrative (“SG&A”) expenses for the year ended December 31, 2003 increased to $126.3 million, or 41% of revenue, compared to $112.9 million, or 45% of revenue, for the year ended December 31, 2002, exclusive of the $9.5 million provision for doubtful accounts related to WorldCom in 2002 and the $5.8 million recovery for doubtful accounts also related to WorldCom in 2003. Salary and related costs continue to account for approximately two-thirds of the Company’s total SG&A. Total headcount increased 12% to 1,016 (including 80 employees of Fastnet) as of December 31, 2003 from 911 as of December 31, 2002 while the Company was able to increase its customer base by 63%. We believe that this reflects the scalability of our team and our business model.

Other SG&A expenses are primarily comprised of costs associated with developing and expanding the infrastructure of the Company as it expands into new markets and adds new products. Such expenses are associated with marketing, occupancy, bad debt, administration and billing. Other SG&A expenses also include legal fees associated with litigation and loss on disposal of fixed assets. The decrease in SG&A expenses as a percentage of revenue in 2003 was primarily due to expense control, an improvement in back office efficiencies and growth in revenue. The progress we have made in increasing the productivity of our employees is best illustrated by the change in our customer-to-employee ratio. In 1999, this ratio was 4:1. At the end of 2003, this ratio had improved dramatically to 17:1. Another illustration of our productivity improvement is the amount of end customer revenue per employee, which increased from $31,300 in the fourth quarter of 2001 to $60,900 in the fourth quarter of 2003, excluding revenue and employees related to Fastnet. We expect continued improvements in both of these measures as we continue to focus on efficiency in our back office.

Other Income.    Other income of $0.3 million for 2003 consisted of an insurance recovery related to damage experienced in one of the Company’s telecommunications switch facilities during the quarter ended March 31, 2003.

Interest Income and Expense.    Interest income for 2003 decreased to $0.4 million from $0.9 million in 2002. The decrease in interest income in 2003 was primarily due to declining rates of return on invested funds. Interest expense for 2003 remained constant at $8.6 million resulting from a combination of a decrease in borrowings under the Company’s credit facility and declining interest rates, offset by the accrued interest related to the deferred principal payments on the Company’s credit facility term loan and interest expense related to the subordinated notes.

Income Taxes.    For the years ended December 31, 2003 and 2002 the Company did not record an income tax benefit. The Company has provided a full valuation allowance against deferred assets resulting from net operating losses, as management cannot predict, based on the weight of available evidence, that it is more likely than not that such assets will be ultimately realized.

Net Loss.    Net loss for 2003 amounted to $14.5 million, compared to a net loss of $45.9 million for 2002. Dividends paid in kind and accrued on preferred stock for the year ended December 31, 2003 and 2002 amounted to $14.4 million and $13.6 million, respectively. The accretion of preferred stock issuance cost was $0.6 million and $0.5 million for each of the years ended December 31, 2003 and 2002, respectively. As a result of the foregoing, net loss attributable to common stockholders for the year ended December 31, 2003 amounted to $29.5 million, or $1.08 per diluted share, as compared to $60.0 million, or $2.26 per diluted share for 2002. The decrease in net loss and net loss per share is attributed to the factors discussed above.

Comparison of Year Ended December 31, 2002 to Year Ended December 31, 2001

Revenue.    Revenue increased to $250.4 million for the year ended December 31, 2002, from $178.6 million in 2001. The significant increase in revenue resulted from an increase in the total number of customers in existing markets and an increase in telecommunications traffic on the Company’s network. In 2002, the Company’s end customer revenue increased to $148.9 million, or 59% of total revenue from $93.8 million, or 53% of total revenue in 2001.

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The Company recorded a significant charge relating to disputed receivables in the fourth quarter of 2000. The $52.0 million provision is netted on the Company’s consolidated statement of operations against a $12.0 million reduction in commissions payable on those receivables, resulting in the $40.0 million provision on the Company’s 2000 consolidated statement of operations. Management believed that this charge was necessary due to the uncertainty surrounding current regulatory proceedings related to reciprocal compensation and other access charges and the continued refusal by ILECs, principally BellSouth, to pay amounts believed by the Company to be owed to it under applicable interconnection agreements and Sprint’s failure to pay US LEC’s access charges. The Company resolved its disputes with both BellSouth and Sprint during 2001. Included in the 2001 consolidated statement of operations is an amount approximating $7.0 million, representing a net recovery of amounts previously recorded as reserves for disputed receivables and certain other related accruals.

Network Expenses.    Network expenses increased to $121.1 million, or 48% of revenue for 2002 from $90.3 million, or 50% of revenue, for 2001. This increase in network expenses was primarily a result of the increase in the size of US LEC’s network, an increase in customers and usage by its customers, as well as a shift to higher network expense for end customer revenue.

SG&A Expense.    SG&A expenses for the year ended December 31, 2002 decreased to $112.9 million, or 45% of revenue, compared to $114.9 million, or 64% of revenue, for the year ended December 31, 2001, exclusive of the $9.5 million provision for doubtful accounts related to WorldCom and the $7.0 million recovery for disputed receivables in 2002 and 2001, respectively. The decrease in selling, general and administrative expenses as a percentage of revenue in 2002 was primarily due to expense control, an improvement in back office efficiencies and growth in revenue.

Depreciation and Amortization.    Depreciation and amortization for 2002 increased to $45.1 million from $35.1 million in 2001 primarily due to the increase in depreciable assets in service related to US LEC’s network expansion.

Interest Income and Expense.    Interest income for 2002 decreased to $0.9 million from $3.2 million in 2001. The decrease in interest income in 2002 was primarily due to a decline in cash available for investing and declining rates of return on invested funds. Interest expense for 2002 decreased to $8.6 million from $11.9 million in 2001. This decrease in interest expense was primarily due to a decrease in the amounts borrowed resulting from over $22.0 million in principal payments made under the Company’s senior credit facility in addition to declining interest rates.

Income Taxes.    For the years ended December 31, 2002 and 2001 the Company did not record an income tax benefit. The Company has provided a full valuation allowance against deferred assets resulting from net operating losses, as management cannot predict, based on the weight of available evidence, that it is more likely than not that such assets will be ultimately realized.

Net Loss.    Net loss for 2002 amounted to $45.9 million, compared to a net loss of $63.4 million for 2001. Dividends paid in kind and accrued on preferred stock for the year ended December 31, 2002 and 2001 amounted to $13.6 million and $12.8 million, respectively (See Note 7 of the Company’s consolidated financial statements). The accretion of preferred stock issuance cost was $0.5 million for each of the years ended December 31, 2002 and 2001. As a result of the foregoing, net loss attributable to common stockholders for the year ended December 31, 2002 amounted to $60.0 million or $2.26 per diluted share as compared to $76.7 million, or $2.83 per diluted share for 2001. The decrease in net loss and net loss per share is attributed to the factors discussed above.

Liquidity and Capital Resources

Since our public offering of approximately $87.1 million of Class A common stock in April 1998, we have funded our operations and capital needs through borrowings under our secured credit facility and private

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placements of equity and debt securities, including the private placement of $200.0 million of Series A convertible preferred stock with affiliates of Bain Capital and Thomas H. Lee Partners L.P. in April 2000, the private sale of $5.0 million of 11% senior subordinated notes in December 2002 and the private placement of $10.0 million of Class A common stock in November 2003. The first quarter of 2003 marked the first quarter since the fourth quarter of 2001 that the Company generated cash flow from operations and had a net increase in cash and cash equivalents. This continued through each quarter of 2003, resulting in cash flow from operations of $56.0 million and a net increase in cash and cash equivalents of $17.4 million during 2003.

On December 31, 2002, we completed an amendment to our senior credit facility. The amended facility was comprised of a $102.9 million term loan and a $25.0 million revolving credit facility. In amending the senior credit facility, the Company deferred $30.0 million of term loan principal payments from 2003 and 2004 to 2005 and 2006; deferred repayment of the $25.0 million outstanding under the revolving facility from December 2005 to December 2006; agreed to pay additional interest on the deferred portion of the term loan amounts at an annual rate of 10%, payable upon the maturity of the loan in December 2006; and agreed to revised financial covenants.

The interest rate under the facility for all outstanding amounts (except the deferred term loan amounts) is a floating rate based, at the Company’s option, on a base rate (as defined in the credit agreement) or the London Interbank Offered Rate, plus a specified margin. As of December 31, 2003, advances under the credit agreement (other than the deferred term loan amounts) bore interest at an annual rate of approximately 5.1% payable monthly. As of the same date, approximately $121.6 million was outstanding under the facility following approximately $5.8 million of payments made in the fourth quarter of 2003. The facility is secured by substantially all of the assets of the Company and its subsidiaries, including the stock of the subsidiaries.

In addition to scheduled principal payments beginning in March 2004, the Company is required to make certain mandatory prepayments of principal equal to a portion of the interest paid to the Company’s subordinated note holders. These mandatory prepayments are scheduled to be $0.3 million in each of 2004, 2005 and 2006. Scheduled principal payments are $0.5 million in March and June 2004; $3.2 million in September 2004; $6.2 million in December 2004; $11.4 million in each quarter of 2005 and the first three quarters of 2006, and a final principal payment of $30.0 million when the term loan and revolving facility mature in December 2006.

The senior credit facility contains certain events of default, including, subject to certain exceptions, events relating to non-payment of principal and interest under the facility or defaults relating to certain other indebtedness and a change of control, as defined in the credit agreement.

Management believes that the Company will be in compliance with all financial covenants for a period at least through December 2004 based on projected operating results. Meeting these projected requirements is dependent on the Company meeting 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 period, it is possible that a financial covenant will not be met for the period through December 2004. 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 agreement to certain remedies including acceleration of debt repayment.

On January 15, 2003, the Company acquired certain assets of Eagle Communications, Inc., including Eagle’s ISP customers. The purchase price of this acquisition included $1.75 million of subordinated notes with terms identical to the subordinated notes we issued in December 2002. All subordinated notes bear interest at an annual rate of 11%, payable monthly, and have a five-year term.

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The following table provides a summary of the Company’s contractual obligations and commercial commitments.

Cash provided by operating activities was approximately $55.3 million in 2003, compared to cash used in operating activities in 2002 of $5.6 million. The increase in cash provided by operating activities of $61.0 million was primarily due to an increase in cash provided by operating activities prior to changes in working capital of $26.0 million, and an increase in cash provided of $35.0 million relating to changes in working capital accounts. Cash provided by accounts receivable increased by $35.2 million due to improved collections resulting from a concerted focus on reducing days sales outstanding (“DSOs”), collection of $11.4 million related to the finalization of a contract with an inter-exchange carrier (“IXC”) for switched access services and the sale of WorldCom pre-petition receivables for $3.6 million. There was also an increase from the prior year in cash provided by customer commissions payable of $9.5 million due to a reduction in the access revenue paid to external parties, commensurate with the decrease in rates used to determine shared amounts.

Cash used in investing activities increased to $42.8 million in 2003 from $31.8 million in 2002. Purchases of property and equipment of $36.3 million in 2003 and $32.0 million in 2002 consist of purchases of switching and related telecommunications equipment, office equipment and leasehold improvements. Future annual capital expenditures for the purchase of property and equipment are expected to be less than those in 2003. Use of cash for assets acquired increased to $8.7 million over the prior year and relates to the acquisitions of assets of Eagle and Fastnet. These uses of cash were offset by proceeds from an insurance claim related to damage experienced in one of the Company’s telecommunications switch facilities during the quarter ended March 31, 2003.

Cash provided by financing activities was $4.3 million in 2003 compared to cash used by financing activities of $17.3 million for 2002. This change was primarily due to the decrease in repayments under the Company’s amended senior credit facility in 2003 offset by the proceeds of the private placement of Class A common stock that raised $10 million in November 2003, and by a reduction in proceeds from the issuance of subordinated notes and warrants.

The restricted cash balance of $0.1 million and $1.1 million as of December 31, 2003 and 2002, respectively, serves as collateral for letters of credit related to certain office leases. In addition, the non-current portion of restricted cash of $0.9 million is included in other assets in the consolidated balance sheet as of December 31, 2003. 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.

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Capital expenditures were approximately $36.3 million in 2003, most of which were incurred to support new customer growth. We expect to spend less in 2004 than in 2003. We estimate that our debt service requirements in 2004 will be approximately $19.0 million, which includes approximately $10.8 million of scheduled principal payments and $8.0 million estimated for interest assuming no significant increases in interest rates during the year. Provided our operating results conform to our business plan, we believe our existing cash on hand of approximately $ 43.1 million and cash flow from operations will be sufficient to fund our operating, investing and debt service requirements in 2004.

We have larger payment obligations in 2005 and 2006, including repayments under our amended senior credit facility of $46.1 million in 2005 and $64.7 million in 2006. We may seek additional financing to pay these obligations. We may also seek additional financing to undertake other initiatives not contemplated by our business plan. Future financings may include a range of different sizes or types of financing, including the sale of additional debt or equity securities. However, we may not be able to raise additional funds on favorable terms or at all. Our ability to obtain additional financing depends on several factors, including future market conditions, our success in executing our business plan, our future creditworthiness, and restrictions contained in agreements with our equity investors and our senior lenders. These financings could increase our level of indebtedness or result in dilution to our equity holders.

Critical Accounting Policies and Estimates

Revenue Recognition—The Company recognizes revenue on telecommunications 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 arrangement exists (2) services have been rendered (3) seller’s price to the buyer is fixed or determinable and (4) collectibility is reasonably assured.

US LEC’s revenue is comprised of two primary components: (1) fees paid by end customers for voice, data and Internet services, and (2) carrier charges including access and reciprocal compensation. End customer revenue includes voice, data and Internet services and is comprised of monthly recurring charges, usage charges, and initial non-recurring charges. Monthly recurring charges include the fees paid by customers for facilities in service and additional features on those facilities. Usage charges consist of usage-sensitive fees paid for calls made. Initial non-recurring charges consist primarily of installation charges. Access charges are comprised of charges paid primarily by IXCs to the Company for the origination and termination of inter-exchange toll and toll-free calls. Reciprocal compensation arises when a local exchange carrier completes a call that originated on another local exchange carrier’s network. Reciprocal compensation that is earned as revenue from other local exchange carriers represents compensation for local telecommunications traffic terminated on our network that originates on another carrier’s network. Amounts billed to carriers and IXCs are recorded based on the company’s determination of usage, category of traffic and the associated rate. These items are subject to some degree of estimation and subsequent adjustments may occur. However, management does not believe such adjustments will be material to the consolidated financial statements.

The Company defers non-recurring installation revenue from contracts with end customers and other carriers. This deferred revenue is being amortized over the average initial term of the related contract.

Carrier revenues are recorded net of amounts due to customers under each respective telecommunications service contract.

Early termination fees and late payment charges received from customers are recognized when paid and revenue related to billings in advance of providing service is deferred and recognized when earned.

Network Expenses—Network expenses are comprised primarily of two types of charges: leased transport charges which comprise approximately 75% of the Company’s network expenses and usage sensitive charges

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which comprise approximately 25% of the Company’s network expenses. The Company’s leased transport charges are the lease payments incurred by the Company 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. The Company, 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. Network expenses include management’s estimate of charges for direct access lines, facility charges, outgoing and incoming minutes, reciprocal compensation and other costs of revenue for a given period for which bills have not yet been received by the Company. Management’s estimate is developed from the number of lines and facilities in service, minutes of use and contractual rates charged by each respective service provider as well as estimated amounts accrued for pending disputes with other carriers. 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. The Company has to date been successful in negotiating lease agreements which generally match in the aggregate the duration of its customer contracts, thereby allowing the Company to mitigate the risk of incurring charges associated with transmission facilities that are not being utilized by customers. Usage sensitive charges are primarily comprised of usage charges associated with the Company’s long distance, access charges and reciprocal compensation owed to other carriers.

Also included in network expense are the amortization of deferred customer and network installation costs, which are discussed in more detail below.

Provisions for Doubtful Accounts—The Company maintains an allowance for doubtful accounts for estimated losses resulting from customers’ or carriers’ failure to make payments on amounts due to the Company. These estimates are based on a number of factors including 1) historical experience, 2) aging of trade accounts receivable, 3) disputes, 4) bankruptcy, 5) general economic, industry or business information and 6) specific information obtained by the Company on the financial condition and current credit worthiness of customers or carriers.

Deferred Customer and Network Installation Costs—The Company incurs and capitalizes certain costs in connection with the required expansion of its telecommunications network infrastructure to provide service to new customers. These costs are comprised of payments for equipment and services provided by external parties in connecting the telecommunication systems of new customers to the Company’s telecommunication platform as well as expenditures for expanding the network when customer growth requires capacity enhancements. These two types of costs are referred to as customer installation costs and network installation costs. Customer installation costs represent incremental direct costs to enhance the Company’s telecommunications network to allow the Company to provide services to new customers under contract. These costs result directly from entering into a new customer contract and would not have been incurred by the Company had a new contract not been entered into. These costs are amortized over the average initial term of open contracts, which is currently 30 months.

Network installation costs are paid to local exchange carriers and IXCs for installing circuits and trunks to insure adequate capacity on the Company’s network to serve existing and new customers. Network installation costs are amortized over 60 months, the expected useful life of the circuits and trunks that are installed.

Impairment of 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 undiscounted 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.

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ITEM 7A.    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 December 31, 2003, investments consisted primarily of institutional money market funds. A majority 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 variable rate bank debt of $121.6 million as of December 31, 2003. Currently, quarterly variable interest expense is approximately $1.6 million. At this level, each one percent increase or decrease in interest rates will have approximately a $1.2 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 a majority of its long-term debt is at variable short-term rates, management believes the carrying values of the Company’s financial instruments approximate fair values.

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ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEPENDENT AUDITORS’ REPORT

Board of Directors and Stockholders of

US LEC Corp.

Charlotte, North Carolina

We have audited the accompanying consolidated balance sheets of US LEC Corp. and subsidiaries (the “Company”) as of December 31, 2003 and 2002, and the related consolidated statements of operations, stockholders’ equity (deficiency) and cash flows for each of the three years in the period ended December 31, 2003. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

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

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of US LEC Corp. and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

/s/ Deloitte & Touche LLP

Charlotte, North Carolina

March 22, 2004

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US LEC CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In Thousands)

See notes to consolidated financial statements

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US LEC CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

For the Years Ended December 31, 2003, 2002, and 2001

(In Thousands, Except Per Share Data)

See notes to consolidated financial statements

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US LEC CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)