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                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549

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

                                   FORM 10-K

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

  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997

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

                       COMMISSION FILE NUMBER 333-16265

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

                           USN COMMUNICATIONS, INC.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

                  DELAWARE                               36-3947804
      (STATE OR OTHER JURISDICTION OF                   (IRS EMPLOYER
       INCORPORATION OR ORGANIZATION)                IDENTIFICATION NO.)


    10 SOUTH RIVERSIDE PLAZA, SUITE 401,                    60606
             CHICAGO, ILLINOIS                           (ZIP CODE)
  (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

      REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (312) 906-3600

          SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:

                                     None

          SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:

                    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 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. [X]

  THE AGGREGATE MARKET VALUE OF THE VOTING STOCK OF THE REGISTRANT HELD BY
NON-AFFILIATES OF THE REGISTRANT WAS APPROXIMATELY $217,519,303 ON MARCH 27,
1998 (BASED ON THE CLOSING SALE PRICE ON THE NASDAQ NATIONAL MARKET ON MARCH
27, 1998). AT MARCH 30, 1998, THE REGISTRANT HAD ISSUED AND OUTSTANDING
22,072,371 SHARES OF COMMON STOCK, PAR VALUE $.01 PER SHARE.

                      DOCUMENTS INCORPORATED BY REFERENCE

               DOCUMENTS                         FORM 10-K REFERENCE

  Proxy Statement for the 1998 Annual
        Meeting of Stockholders
                                                Part III. Items 10-13

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                DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

  This Annual Report on Form 10-K includes "forward-looking statements" within
the meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act") and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), including statements containing the words
"believes," "anticipates," "expects" and words of similar import. All
statements other than statements of historical fact included in this Form 10-K
including, without limitation, certain statements under the headings
"Business" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and located elsewhere herein, regarding the Company
are forward-looking statements. Although the Company believes that the
expectations reflected in such forward-looking statements are reasonable, it
can give no assurance that such expectations will prove to have been correct.
Important factors that could cause actual results to differ materially from
expectations are disclosed in this Form 10-K, including, without limitation,
in conjunction with the forward-looking statements in this Form 10-K. The
Company does not intend to update these forward-looking statements.

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                                    PART I

ITEM 1. BUSINESS

INTRODUCTION

  USN Communications, Inc. ("USN" or the "Company") is a Delaware corporation
formed in April 1994. The Company is one of the fastest growing competitive
local exchange carriers ("CLECs") in the United States. The Company offers a
bundled package of telecommunications products, including local and long
distance telephony, voicemail, paging, teleconferencing, "follow me," Internet
access and other enhanced and value-added telecommunications services,
tailored to meet the needs of its customers. The Company also offers wireless
telephone service on a resale basis. The Company primarily focuses its
marketing efforts on small and medium-sized businesses with telecommunications
usage of less than $5,000 per month. The Company's strategy is to continue to
increase its customer base by being more flexible, innovative and responsive
to the needs of its target customers than the regional Bell operating
companies ("RBOCs") and the first-tier interexchange carriers ("IXCs"), which
have historically concentrated their sales and marketing efforts on
residential and large business customers. The Company primarily differentiates
itself with a value-based marketing strategy by providing an integrated,
customized package of telecommunications services on a single bill and
responsive customer care.

  The Company is presently selling service to customers in certain states in
the Bell Atlantic Corporation ("Bell Atlantic") region (Massachusetts, New
Hampshire, New York and Rhode Island), the entire Ameritech Corporation
("Ameritech") region (Illinois, Indiana, Ohio, Michigan and Wisconsin) and the
State of Connecticut and is currently in negotiations to expand its bundled
services offering throughout the 14-state Bell Atlantic region. Management
anticipates implementing service in at least two additional states by the end
of 1998.

  During 1997, the Company increased aggregate local access lines in service
from 8,364 lines to 171,962 lines, including the provisioning of 55,371 lines
in the fourth quarter. As of December 31, 1997, the Company had sold 191,069
local access lines, including 55,897 lines which were sold in the fourth
quarter. Services are primarily marketed through a direct salesforce in 44
offices located in ten states. As part of its customer-focused product
offering, the Company provides personalized customer service, 24 hours a day,
365 days per year, through its two regional customer care centers.

  On February 20, 1998, the Company completed its previously announced
acquisition (the "Acquisition") of Hatten Communications Holding Company, Inc.
("Hatten Communications"), which conducts its business primarily through its
wholly-owned subsidiary, Connecticut Telephone ("Connecticut Telephone"), for
approximately $68.0 million, which included the repayment of approximately
$14.0 million of indebtedness. Hatten Communications, through its wholly-owned
subsidiaries, including Connecticut Telephone, is primarily a reseller of
cellular and paging services. Connecticut Telephone currently provides
cellular service to more than 65,000 subscribers and paging services to more
than 16,000 subscribers in Connecticut. Connecticut Telephone operates through
nine retail sales and service facilities throughout Connecticut and a direct
sales force of over 40 persons.

SALES AND MARKETING

  The Company's customers include small and medium-sized businesses which
principally have telecommunications usage of less than $5,000 per month. The
Company believes that the RBOCs and large IXCs historically have chosen not to
concentrate their sales and marketing efforts on this business segment, which
the Company believes represents a significant portion of the
telecommunications market. Through radio and newspaper advertising, as well as
various marketing programs, the Company has sought to establish itself as a
recognized brand name for its products and services emphasizing responsive
customer support, competitive product and pricing packages and a targeted
sales and marketing strategy. The Company had in excess of 17,000 customers as
of December 31, 1997.

  The Company's services are currently sold through an approximately 485
member direct salesforce (including an approximately 40 member direct
salesforce of Connecticut Telephone), located in 44 offices in

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Connecticut, Illinois, Indiana, Massachusetts, Michigan, New Hampshire, New
York, Ohio, Rhode Island and Wisconsin. The sales personnel make direct calls
to prospective and existing customers to outline the range of services offered
and discuss the benefits of the Company's integrated service offerings,
enhanced customer care and potential savings. In addition, the Company has
initiated an outbound telemarketing sales channel. The Company intends to
further supplement its sales organization with indirect sales efforts in the
future. The Company believes that its marketing approach will increase market
coverage and reduce marketing and customer acquisition costs.

  The Company has recruited and continues to recruit a direct salesforce in
each of the markets in which it operates. The Company primarily recruits
salespeople with experience in selling competitive telecommunications services
to businesses in the markets where they are based. The Company's salesforce is
trained in-house with a rigorous customer-focused training program that
promotes activity-based selling. The salesforce makes calls to prospective
customers from potential customer modules created by acquiring business
databases sorted by target characteristics (e.g. size of business and number
of telephone lines). Salespeople are given an incentive through a commission
structure, with a target of 50% of a salesperson's compensation based on such
person's performance.

CUSTOMER CARE

  The Company maintains an emphasis on customer care to differentiate itself
from its competitors and reduce churn. By providing each customer with an
account representative, the Company is able to provide ongoing personalized
contact to address the clients' needs. In addition, the Company has
established 24-hour-per-day, 365-day-per-year, customer care centers to
facilitate customer care and customer service requests. At the Company's
customer care centers, customers' calls are answered by experienced customer
care representatives, many of whom are cross-trained in the provisioning
process. The Company believes that the superior customer service, face-to-face
sales process and integrated service offering provide the Company with a
competitive advantage over the existing local service providers.

MANAGEMENT INFORMATION SYSTEMS

  The Company is committed to the continued development and successful
implementation of billing and customer care systems that provide accurate and
timely information to both the Company and its customers. The proprietary
electronic interfaces of the Company's management information systems for the
provisioning of the Company's core local service offering to its customers
have been developed in cooperation with Ameritech and Bell Atlantic.
Provisioning of these services is accomplished through the Company's
proprietary systems, which are designed to interface with the RBOCs' systems
through a variety of delivery mechanisms. Provisioning of other services is
coordinated through the relevant provider. The Company believes this method of
development has been, and will continue to be a critical element to
successfully providing telecommunications services and provides the Company
with a competitive advantage, particularly in the case of local service where
the RBOCs have an economic and strategic incentive to work with resellers that
have sophisticated information systems that can electronically interface with
the RBOCs' systems. The Company's experience in developing these systems
allows it to offer services quickly in new markets. The customer care systems
have been developed and continue to be enhanced in a client/server environment
allowing for flexibility to accommodate an expanding customer base, efficient
entry into new markets and rapid development of additional functionality.

  The Company's billing systems are designed to provide access to a broad
range of information on individual customers, including their call volume,
patterns of usage and billing history. This same information is used by the
Company to identify customer trends and will allow for proactive support of
the Company's marketing efforts.

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  The Company currently outsources the rating, printing and mailing of
customer bills. Since these functions require a high volume of processing in a
limited time frame, the Company has determined that currently the most
economical way to process bills is to outsource this function. The customer
usage information for billing and the tables and procedures used in the rating
of call records are maintained separately by the Company to manage the ongoing
needs of each customer. Standard management reports are generated for every
billing cycle.

VENDOR AGREEMENTS

 Introduction

  The Company has executed comprehensive local exchange resale agreements with
Ameritech for the greater metropolitan Chicago area, Ohio and Michigan, and
with Bell Atlantic for the State of New York. In addition, the Company has
executed month to month resale agreements with Bell Atlantic for the States of
Massachusetts, New Hampshire and Rhode Island and provides local service in
other states on a month to month basis under applicable tariffs. The Company
estimates, based on data compiled by the Federal Communications Commission
("FCC"), that the regions covered by the current comprehensive Ameritech and
Bell Atlantic resale agreements include access to over 10 million business
access lines. Management believes that the entire Bell Atlantic and Ameritech
regions have approximately 20 million business access lines. The Company
continuously evaluates opportunities to enter into agreements with additional
RBOCs, long distance carriers and enhanced and other value-added service
providers in order to aggressively build its customer base as well as to
provide additional services to its existing customers while reducing costs.

  The Company currently has a long distance resale agreement with MCI
Communications Corporation ("MCI"). Such agreement allows the Company to offer
its customers integrated local and long distance telecommunications services.
In addition, such agreement has allowed the Company to enter and establish
itself as a telecommunications provider in strategically targeted markets
prior to establishing a local exchange resale agreement.

 Ameritech Resale Agreements

  Pursuant to the Ameritech resale agreements, the Company purchases local
exchange services at discounted rates based on a ten-year term. These
agreements contain pricing protections designed to maintain the
competitiveness of the Company's discounted rates and position the Company to
purchase capacity at rates at least as favorable as those at which competitors
may eventually negotiate a resale agreement. The level of discounts of the
resold services provided under these agreements vary based on the state and
the nature of services resold (i.e., access lines, local calls, toll calls or
features).

  Services offered for resale include most of the telecommunications products
and services engineered and provided by Ameritech, such as local exchange
calling and attendant features including call waiting, call forwarding, caller
ID and three-way calling. The rates for these services are filed with the
public utilities commission of each respective state. The Company also has an
agreement with Ameritech for the resale of certain non-tariffed services to
its customers, including inside wire maintenance.

  The Ameritech resale agreements include a minimum commitment of resold
access lines per region covered. The minimum commitment in Illinois is 150,000
business access lines and in Ohio and Michigan, 100,000 business access lines
and 10,000 residential lines. The minimum commitment is not a limitation on
the Company's overall ability to sell access lines at discounted rates.
However, if the Company fails to meet its minimum commitment, the Company is
subject to an underutilization charge equal to the number of unutilized lines
multiplied by a fixed average business line rate. The measurement period of
the minimum commitment does not commence, however, until the completion of an
18 month "ramp up" period which gives the Company the ability to build its
customer base. In addition, the Ameritech resale agreements provide a
"carryforward" provision designed to minimize the potential for any liability
resulting from a failure to meet the minimum commitment by carrying forward
underutilization amounts which may arise in the future.


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  If the Company does not meet its minimum commitment by the end of the ten-
year term with the benefit of the carryforward provision, the Company has the
option to either pay a penalty based on the aggregate number of unutilized
lines or subscribe on a monthly basis to an equivalent number of lines during
the next three-year period. In the event the Company terminates any of the
Ameritech resale agreements prior to their expiration, the Company is subject
to a termination charge.

 Bell Atlantic Resale Agreement

  On July 9, 1996, the Company executed a resale agreement with Bell Atlantic
to provide for the resale of local exchange services for the State of New York
at discounted rates based on a ten-year term. The Bell Atlantic resale
agreement contains pricing protections designed to maintain the
competitiveness of discounted rates provided to the Company. Under the Bell
Atlantic resale agreement, the Company receives the lowest rate and/or most
favorable term provided to any reseller; however, if a lower rate is provided
to a reseller committing to both a longer term and a greater volume
commitment, the Company receives the lower rate but must negotiate with Bell
Atlantic a reasonable transition to similar commitments. If the Company cannot
successfully negotiate such a transition with Bell Atlantic, then the Company
may be unable to maintain the lowest rate. The level of discounts of resold
services varies based on the nature of the services. The Bell Atlantic resale
agreement contains a minimum commitment of 100,000 business access lines. In
the event the Company does not satisfy the minimum commitment after a trial
period and ramp-up period, the Company is subject to an underutilization
charge. However, the Bell Atlantic resale agreement also contains a
carryforward provision designed to minimize the potential of an
underutilization charge. The Company has also executed an interim resale
agreement with Bell Atlantic for Massachusetts. This agreement does not
contain a term and volume commitment, but was designed to allow the Company to
begin reselling services in Massachusetts expeditiously in a manner consistent
with state regulatory developments. Although there can be no assurance, it is
expected that the Company and Bell Atlantic will enter into a long-term resale
agreement for Massachusetts similar to the New York Bell Atlantic resale
agreement.

 Long Distance Agreements

  The Company has an agreement with MCI pursuant to which MCI provides a wide
range of long distance telecommunications services to the Company's customers.
Services offered for resale from MCI include a variety of inbound, outbound,
calling card and international services. In addition, the Company also resells
teleconferencing, debit cards, branded operator services and private line
services.

  The Company's long distance carrier agreement with MCI became effective
August 1, 1996 and contains a 33-month term. It requires the Company to
achieve certain monthly dollar targets in order to qualify for discounted
rates on carrier services. The agreement provides for an annual commitment for
each of the final two years of the contract term. If the Company does not meet
its annual commitment during any annual period of the term, an
underutilization charge shall apply in an amount equal to 15% of the
difference between the committed amount and the actual usage. However, the
Company may carry forward up to 10% of the initial annual commitment for a
period of up to three months in the following annual period.

 Wireless, Enhanced and Other Value-Added Telecommunications Services

  The Company has agreements to offer cellular and paging services on a resale
basis as well as other enhanced and value-added services such as Internet
access, "follow me" services and a Windows-based teleconferencing product
which allows the conference host to conduct a conference call using point and
click graphics directly from a personal computer without having to make
teleconference reservations.

COMPETITION

  The Company operates in a highly competitive environment and has no
significant market share in any market in which it operates. The Company
expects that competition will continue to intensify in the future due

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to regulatory changes, including the continued implementation of the
Telecommunications Act of 1996 (the "Telecommunications Act"), and the
increase in the size, resources and number of market participants. In each of
its markets, the Company faces competition for local service from larger,
better capitalized incumbent providers. Additionally, the long distance market
is already significantly more competitive than the local exchange market,
because the incumbent local exchange carriers ("ILECs"), including the RBOCs,
have historically had a monopoly position within the local exchange market.

  In the local exchange market, the Company also faces competition or
prospective competition from one or more CLECs, many of which have
significantly greater financial resources than the Company, and from other
competitive providers, including some non-facilities-based providers like the
Company. For example, AT&T Corp. ("AT&T"), MCI and Sprint Corporation
("Sprint"), among other carriers, have each begun to offer local
telecommunications services in major U.S. markets using their own facilities
or by resale of the ILECs' or other providers' services. In fact, many
competitors, including AT&T, MCI and Sprint, have entered into interconnection
agreements with Ameritech and Bell Atlantic. These competitors either have
begun or in the near future will likely begin offering local exchange service
in those states where the Company conducts business, although the larger IXC
competitors will be subject to the joint marketing restrictions under the
Telecommunications Act. In addition to these long distance service providers,
entities that currently offer or are potentially capable of offering switched
services include CLECs, cable television companies, electric utilities, other
long distance carriers, microwave carriers, wireless telephone system
operators and large customers who build private networks. Many facilities-
based CLECs and long distance carriers, for example, have committed
substantial resources to building their networks or to purchasing CLECs or
IXCs with complementary facilities. By building or purchasing a network or
entering into interconnection agreements or resale agreements with ILECs,
including RBOCs, a facilities-based provider can offer single source local and
long distance services similar to those offered by the Company. Such
additional alternatives may provide such competitors with greater flexibility
and a lower cost structure than the Company. In addition, some of these CLECs
and other facilities-based providers of local exchange service are acquiring
or being acquired by IXCs. While certain of these combined entities, such as
the entity to be formed by the proposed merger of WorldCom, Inc. and MCI, may
continue to be subject to the joint marketing restrictions in the
Telecommunications Act, others will not be subject to such restrictions. These
entities may have resources far greater than those of the Company and may
provide a bundled package of telecommunications products, including local and
long distance telephony, that is in direct competition with the products
offered by the Company.

  With respect to mobile wireless telephone system operators, the FCC has
authorized cellular, personal communications service ("PCS") and other
commercial mobile radio service ("CMRS") providers to offer wireless services
to fixed locations, rather than just to mobile customers, in whatever capacity
such CMRS providers choose. Previously, cellular providers could provide
service to fixed locations only on an ancillary or incidental basis. This
authority to provide fixed as well as mobile services will enable CMRS
providers to offer wireless local loop service and other services to fixed
locations (e.g., office and apartment buildings) in direct competition with
the Company and other providers of traditional wireless telephone service. In
addition, the FCC now classifies CMRS providers as telecommunications
carriers, thus giving them the same rights to interconnection and reciprocal
compensation under the Telecommunications Act as other non-local exchange
carrier ("LEC") telecommunications carriers, including the Company.

  The Company will also face competition from other fixed wireless services,
including Multichannel Multipoint Distribution Service ("MMDS"), 28 GHz Local
Multipoint Distribution Service ("LMDS") and 38 GHz wireless communications
systems, 2.8 GHz Wireless Communications Service ("WCS"), FCC Part 15
unlicensed wireless radio devices, and other services that use existing point-
to-point wireless channels on other frequencies. In March 1998, the FCC
completed an auction for LMDS licenses in all markets for the provision of
high capacity, wide-area fixed wireless point-to-multipoint systems. The MMDS
service, also known as "wireless cable," also currently competes for
metropolitan wireless broadband services. At present, wireless cable licenses
are used primarily for the distribution of video programming and have only a
limited capability to provide two-way communications needed for wireless
broadband telecommunications services, but there can be no assurance

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that this will continue to be the case. The FCC has initiated a proceeding to
determine whether to provide wireless cable operators with greater technical
flexibility to offer two-way services. The FCC also has indicated that it
plans to propose rules for the issuance of licenses in the 24 GHz band for
Digital Electronic Message Service ("DEMS"), which also is designed to offer
high capacity, wide area fixed point-to-multipoint service, and many 24 GHz
DEMS licenses have already been issued nationwide. Finally, the FCC has
allocated a number of spectrum blocks for use by wireless devices that do not
require site or network licensing. A number of vendors have developed such
devices that may provide competition to the Company, in particular for certain
low data-rate transmission services.

  In addition, the FCC has adopted rules to auction geographical area wide
licenses for the operation of fixed wireless point-to-point and point-to-
multipoint communications services in the 38 GHz band. The 38 GHz auction is
expected to occur later in 1998. The Company also faces competition from
entities which already offer, or are licensed to offer, 38 GHz services, such
as Advanced Radio Telecommunications, Inc., WinStar Communications, Inc. and
BizTel, Inc. The Company could also face competition in certain aspects of its
existing and proposed businesses from competitors providing wireless services
in other portions of the radio spectrum, such as CAI Wireless Systems Inc. a
provider of wireless Internet access services, and CellularVision, a provider
of wireless television services which, in the future, also may provide
wireless Internet access and other local telecommunications services. In many
instances, these providers hold licenses for other frequencies (such as 28
GHz) that enable them to provide comparable telecommunications services to
those of the Company in geographic areas which encompass or overlap the
Company's market areas. Additionally, some of these entities include among
their stockholders major telecommunications entities. Due to the relative ease
and speed of deployment of fixed wireless-based technologies, the Company
could face intense price competition from these and other wireless-based
service providers. The Company believes that additional entities having
greater resources than the Company could acquire licenses to provide 38 GHz,
MMDS, LMDS, WCS, DEMS or other fixed wireless services.

  Under the Telecommunications Act and related federal and state regulatory
initiatives, barriers to local exchange competition are being removed. Section
271 of the Telecommunications Act prohibits an RBOC from providing long-
distance service that originates (or in certain cases terminates) in one of
its in-region states until the RBOC has satisfied certain statutory conditions
in that state and has received the approval of the FCC. In particular, the
availability of broad-based local resale and introduction of facilities-based
local competition are required before the RBOCs may provide in-region
interexchange long distance services. Also, the largest long distance carriers
(AT&T, MCI, Sprint and any other carrier with 5% or more of the pre-subscribed
access lines) are prevented under the Telecommunications Act from jointly
marketing local services resold from an RBOC in a particular state with their
long distance services until the earlier of (i) February 8, 1999 or (ii) the
date on which the RBOC whose services are being resold obtains in-region long
distance authority in that state. The RBOCs are currently allowed to offer
certain in-region "incidental" long distance services (such as cellular, audio
and visual programming and certain interactive storage and retrieval
functions) and to offer virtually all out-of-region long distance services.

  The FCC to date has denied each application for Section 271 approval,
including the application of Ameritech for in-region long distance authority
in Michigan. The Company anticipates that a number of RBOCs, including
Ameritech and Bell Atlantic, will file additional applications for in-region
long distance authority in certain states in 1998. The FCC will have 90 days
from the date an application for in-region long distance authority is filed to
decide whether to grant or deny the application. Based on continuing legal
challenges, the Company does not believe that any RBOC will provide in-region
long distance services on a significant basis prior to 1999.

  Once the RBOCs are allowed to offer widespread in-region long distance
services, both they and the largest IXCs will be in a position to offer
single-source local and long distance services similar to those offered by the
Company. On December 31, 1997, a United States District Court judge in Texas
held unconstitutional certain

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sections of the Telecommunications Act, including Section 271. This decision
would permit the three RBOCs that are parties in the case, including Bell
Atlantic, immediately to begin offering widespread in-region long distance
services.The District Court judge subsequently stayed this decision and the
FCC and certain IXCs have filed appeals of the decision with the United States
Court of Appeals for the Fifth Circuit. Unless the stay is continued or the
decision is overturned on appeal, this decision could have a material adverse
effect on the Company. Although there can be no assurance as to the outcome of
this litigation, the Company believes that significant parts of the District
Court decision may be reversed or vacated on appeal.

  While new business opportunities will be made available to the Company
through the continued implementation of the Telecommunications Act and other
federal and state regulatory initiatives, regulators are likely to provide the
ILECs with an increased degree of flexibility with regard to pricing of their
services as competition increases. Although the Ameritech and Bell Atlantic
resale agreements contain certain pricing protections, including adjustments
in the wholesale rates to be consistent with any changes in the Ameritech and
Bell Atlantic retail rates, if the ILECs elect to lower their rates and
sustain lower rates over time, this may adversely affect the revenues of the
Company and place downward pressure on the rates the Company can charge. While
the Ameritech and Bell Atlantic resale agreements ensure that the Company will
receive any lower rate provided to any other reseller, under the Bell Atlantic
resale agreement if such lower rate is provided to a reseller committing to
both a longer term and a greater volume commitment, the Company receives the
lower rate, but must negotiate with Bell Atlantic a reasonable transition to
similar commitments. If the Company cannot successfully negotiate such a
transition with Bell Atlantic, then the Company may be unable to maintain the
lowest rate. The Company believes the effect of lower rates may be offset by
the increased revenues available by offering new products and services to its
target customers, but there can be no assurance that this will occur. In
addition, if future regulatory decisions afford the LECs excessive pricing
flexibility or other regulatory relief, such decisions could have a material
adverse effect on the Company.

  Competition for the Company's products and services is based on price,
quality, network reliability, service features and responsiveness to customer
needs. While the Company believes that it currently has certain advantages
relating to the timing, ubiquity and cost savings resulting from its resale
agreements, there is no assurance that the Company will be able to maintain
these advantages. A continuing trend toward business combinations and
alliances in the telecommunications industry may create significant new
competitors to the Company. Many of the Company's existing and potential
competitors have financial, technical and other resources significantly
greater than those of the Company. In addition, new FCC rules that went into
effect in February 1998 will make it substantially easier for many non-U.S.
telecommunications companies to enter the U.S. market, thus further increasing
the number of competitors. The new rules will also give non-U.S. individuals
and corporations greater ability to invest in U.S. telecommunications
companies, thus increasing the financial and technical resources available to
the Company and its existing and potential competitors.

GOVERNMENT REGULATION

  The Company is subject to varying degrees of federal, state, local and
international regulation. In the United States, the Company's provision of
local exchange services is regulated by the states. The Company must be
separately certified in each state to offer local exchange services. No state,
however, subjects the Company to price cap or rate-of-return regulation. FCC
approval is required for the resale of international facilities and services.
The FCC has determined that nondominant carriers, such as the Company, are
required to file interstate tariffs on an ongoing basis, setting forth the
Company's rates and operating procedures. Such tariffs can currently be
modified on one day's notice. The FCC has issued regulations to eliminate this
tariff filing requirement for all nondominant carriers, such as the Company
and all other nondominant interexchange carriers (except possibly the RBOCs in
certain circumstances). Various carriers have filed suit to overturn the FCC
regulations, and the U.S. Court of Appeals for the D.C. Circuit has stayed the
regulations pending its decision in that appeal, which is expected in the
first half of 1998. The FCC has recently ruled that RBOCs providing out-of-
region long distance service through separate subsidiaries from their local
telephone operations qualify for nondominant treatment. Out-of-region RBOC
services provided through unseparated entities, however, are subject to full

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dominant carrier regulation, including the requirement to submit cost support
with tariffs and to file tariffs on at least 15 to 45 days' notice, depending
on various factors. The FCC has indicated that RBOC in-region service, when
authorized, will be subject to nondominant regulatory status.

  Legislation. On February 8, 1996, President Clinton signed into law the
Telecommunications Act, comprehensive federal legislation affecting all
aspects of the telecommunications industry. The Telecommunications Act
establishes a national policy that promotes local exchange competition. The
Telecommunications Act requires that local and state barriers to entry into
the local exchange market be removed and establishes broad uniform standards
under which the FCC and the state commissions are to implement local
competition and co-carrier arrangements in the local exchange market. Under
certain conditions and subject to reasonable exceptions, ILECs are now
required to make available for resale to new entrants all services offered by
the ILEC on a retail basis. The Telecommunications Act also imposes
significant obligations on the RBOCs and other ILECs, including the obligation
to interconnect their networks with the networks of competitors. Each ILEC is
required not only to open its network but also to "unbundle" the network. The
FCC issued regulations in August 1996 defining a minimum set of elements which
must actually be unbundled, and each state may augment this list if it wishes.
States have begun and, in a number of cases, completed regulatory proceedings
to determine the pricing of these unbundled network elements and services, and
the results of these proceedings will determine whether it is economically
attractive to use these elements.

  The RBOCs have an added incentive to open their local exchange networks to
facilities-based competition because Section 271 of the Telecommunications Act
provides for the removal of the current ban on RBOC provision of in-region
inter-LATA toll service and equipment manufacturing. This ban will be removed
only after the RBOC demonstrates to the FCC, which must consult with the
Department of Justice and the relevant state commissions, that the RBOC has
(1) met the requirements of the Telecommunications Act's 14-point competitive
checklist and (2) entered into an approved interconnection agreement with one
or more unaffiliated, facilities-based competitors in some portion of the
state pursuant to which such competitors provide both business and residential
service (or that by a date certain no such competitors have "requested"
interconnection as defined in the Telecommunications Act). If the FCC
determines that the RBOC's entry into in-region provision of long distance in
that state is in the public interest and that the RBOC has met the 14-point
checklist, it must authorize the RBOC to provide such services. RBOC in-region
services must be provided through a separate subsidiary for three years,
unless extended by the FCC. The FCC to date has denied each such application
filed, including the application of Ameritech, the RBOC in five states where
the Company operates, for in-region long distance authority in Michigan. The
Company anticipates that a number of RBOCs, including Ameritech and Bell
Atlantic, will file additional applications in 1998. Based on continuing legal
challenges, the Company does not believe any RBOC will provide in-region long
distance services on a significant basis prior to 1999.

  Under the 14-point competitive checklist, in order to obtain in-region long
distance authority an RBOC must first demonstrate to the FCC, among other
things, that, within a particular state, it offers competing LECs the
following: interconnection as required under the Telecommunications Act; non-
discriminatory access to unbundled network elements at just and reasonable
rates; non-discriminatory access to its poles, ducts, conduits, and rights-of-
way; unbundled local loop transmission, unbundled local transport and
unbundled local switching; non-discriminatory access to 911 services;
directory assistance, operator call completion services, and white pages
directory listings for competing local carriers' customers; non-discriminatory
access to call routing databases; number portability (i.e., the ability of a
customer to keep the same telephone number when switching local telephone
service providers); dialing parity (i.e., the ability of customers of one
telephone service provider to call customers of other providers without
dialing access codes); reciprocal compensation arrangements for the
termination of calls between competing local networks; and the ability to
resell its telecommunications services.

  SBC Communications Inc. filed a lawsuit in June 1997 challenging the
constitutionality of Section 271 and seeking to have it declared void. On
December 31, 1997, a United States District Court judge in Texas held
unconstitutional certain sections of the Telecommunications Act, including
Section 271. This decision would permit the three RBOCs that are parties in
the case, including Bell Atlantic, immediately to begin offering widespread
in-region long-distance services. The District Court judge has granted the
requests of the FCC and

                                       9
<PAGE>

certain IXCs for a stay and the FCC and certain IXCs have filed appeals of the
decision with the United States Court of Appeals for the Fifth Circuit. Unless
the stay is continued or the decision is overturned on appeal, this decision
could have a material adverse effect on the Company. Although there can be no
assurance as to the outcome of this litigation, the Company believes that
significant parts of the District Court decision may be reversed or vacated on
appeal.

  The Telecommunications Act is intended to preempt state and local statutory
and regulatory barriers to entry, thus accelerating the process of creating a
competitive environment in all markets. This preemption of state laws barring
local competition and the relaxation of regulatory restraints should enhance
the Company's ability to expand its service offerings nationwide. At the same
time, the Telecommunications Act will also substantially increase the
competition the Company will face in its various markets.

  The Telecommunications Act permits the Company, as a telecommunications
carrier with less than 5% of nationwide presubscribed access lines, to offer
unrestricted single-source combined packages of local and long distance
services. In contrast, AT&T, MCI and Sprint may not bundle in an RBOC's
territory their local services resold from an RBOC and in-region long distance
service until the earlier of (i) February 8, 1999 or (ii) the date the RBOC is
authorized under Section 271 to enter the inter-LATA long distance market in
that state.

  Federal Regulation. The Telecommunications Act in some sections is self-
executing, but in most cases the FCC must issue regulations that identify
specific requirements before the Company and its competitors can proceed to
implement the changes the Telecommunications Act prescribes. The Company
actively monitors all pertinent FCC proceedings and has participated in some
of these proceedings. The FCC already has completed most of these rulemaking
proceedings. The outcome of the various ongoing FCC rulemaking proceedings or
judicial appeals of such proceedings could materially affect the Company's
operations.

  In May 1997, the FCC issued new regulations regarding the implementation of
the universal service program and the assessment of access charges on carriers
retaining access to local exchange networks. Both the access charge and
universal service regimes were substantially revised. As a result of these
changes, the costs of business and multiple residential telephone lines are
expected to increase. All telecommunications carriers, including the Company,
that provide interstate or international services are required to contribute,
on an equitable and nondiscriminatory basis, to the preservation and
advancement of universal service pursuant to a universal funding service
mechanism established by the FCC. In addition, the new regulations require a
reseller, such as the Company, to begin contributing to the universal service
programs for low-income consumers and high-cost, rural and insular areas on
the basis of the reseller's interstate and international revenues. Several
parties have appealed various parts of the new FCC rules, including the
revenue basis on which contributions are determined. The FCC issues revised
universal service contribution factors for each quarter. These vary slightly
from quarter to quarter. As an example, in support of high-cost and low-income
universal service programs during the first quarter of 1998, the FCC required
carriers to contribute 3.19% of half of the revenues collected from their
interstate and international services during the first half of 1997. In
support of universal service programs for schools, libraries and rural health
care institutions, the FCC required carriers to contribute 0.72% of half of
the revenues collected from their intrastate, interstate and international
services during the first half of 1997.

  The Telecommunications Act provides that individual state utility
commissions can, consistent with FCC regulations, prohibit resellers from
reselling a particular service to specific categories of customers to whom the
ILEC does not offer that service at retail. In August 1996, the FCC issued
detailed regulations providing that many such limitations are presumptively
unreasonable and that states may enact such prohibitions on resale only in
certain limited circumstances. In particular, the FCC concluded that while it
would be permissible to prohibit the resale of certain residential or other
subsidized services to end users that would be ineligible to receive such
services directly from the LEC, all other "cross-class" selling restrictions,
including those on volume discount and flat-rated offerings to business
customers, would be presumed unreasonable. An ILEC may rebut this presumption,
however, by demonstrating that the class restriction is reasonable and
nondiscriminatory. The FCC also rejected claims by several ILECs to provide
for several exceptions to the general resale obligation. For instance, it
refused to create a general exception for all promotional or discounted
offerings, including contract

                                      10
<PAGE>

and customer-specific offerings. The FCC did, however, conclude that short-
term promotional prices (i.e., those offered for 90 days or less) are not
"retail rates" and thus are not subject to the wholesale rate obligation.
ILECs may not offer consecutive 90-day promotions to avoid these resale
obligations. Nonetheless, some RBOCs, including Ameritech and Bell Atlantic,
still seek to restrict resale of certain services such as voice mail and
contract or customer-specific offerings, thus forcing the Company to avoid
resale of such items or to substitute vendors. USN anticipates that these
restrictions will be set aside, thus enabling the Company a greater access to
the RBOC services.

  The Telecommunications Act also provides that state commissions shall be
given an opportunity to determine the wholesale rates for local
telecommunications services (i.e., the rates charged by ILECs to resellers
such as the Company) on the basis of retail rates less "avoided costs" (i.e.,
marketing, billing, collection and other administrative costs avoided by the
ILEC when it sells at wholesale). In August 1996, the FCC issued detailed
regulations establishing an interim default discount of 17% to 25%. Although
this portion of the FCC's rules has been overturned on appeal (see below), in
practice state commissions have generally adopted discount percentages that
fall within the 17-25% default range.

  In August 1996, the FCC also issued regulations that, among other things,
set minimum standards governing the terms and prices of interconnection and
access to unbundled ILEC network elements. These regulations indirectly affect
the price at which the Company's facilities-based competitors may ultimately
provide service. The Telecommunications Act provides that state commissions
shall determine the rates charged for such unbundled elements on the basis of
cost plus a reasonable profit. The FCC declined to issue detailed regulations
governing the relationship between these two pricing standards, leaving the
interpretation and implementation of the two standards to the states. The
Company is unable to predict the final form of such state regulation, or its
potential impact on the Company or the local exchange market in general. At
the same time, the FCC imposed minimum obligations regarding the duty of ILECs
to negotiate interconnection or resale arrangements in good faith.

  A number of RBOCs, state regulatory commissions and other parties filed
requests for reconsideration by the FCC of various parts of the rules
announced by the FCC in August 1996, including those provisions (a) limiting
competitors' ability to purchase for resale certain types of service that the
RBOC is no longer marketing to new customers ("grandfathered services"), and
(b) establishing pricing methodologies and interim default rates for resold
services and unbundled network elements. The FCC is conducting a proceeding to
consider the various petitions for reconsideration, and a decision is expected
in the first half of 1998. In addition, many of the same parties and certain
other parties have filed court appeals challenging the same FCC rules. In July
1997, the Eighth Circuit Federal Court of Appeals struck down certain parts of
the rules (including the provisions establishing pricing methodologies and
default rates for resold services and unbundled network elements). The FCC,
numerous IXCs and various other parties filed petitions for certiorari with
the U.S. Supreme Court, which accepted the case for review on January 26,
1998. The Supreme Court is not expected to issue a decision before the end of
1998. Some of the same parties and certain other parties also have asked the
FCC to reconsider these and other regulations implementing the
Telecommunications Act. In October 1997, the Eighth Circuit issued an order
clarifying that the RBOCs were not required to rebundle unbundled network
elements that competing carriers had purchased separately. If upheld, this
ruling would make it more difficult for the Company and its competitors to use
rebundled unbundled network elements or the "UNE Platform" to enter and
compete in the local exchange market. On January 22, 1998, the same court
ruled that the FCC cannot apply its local competition pricing rules in
reviewing applications of the RBOCs for authorization to provide long distance
service that originates and certain long distance services that terminate in
one of their in-region states. If upheld, this decision would make it somewhat
easier for the RBOCs to enter the market for in-region long distance services
and would make it more costly for facilities-based competitors to enter the
local exchange market. The Company cannot predict the outcome of the FCC's
reconsideration or the Supreme Court proceedings.

  In August 1997, the FCC issued rules transferring responsibility for
administering and assigning local telephone numbers from the RBOCs and a few
other LECs to a neutral entity in each geographic region in the

                                      11
<PAGE>

United States. This process is ongoing and should be completed by the end of
1998. In August 1996, the FCC issued new numbering regulations that (a)
prohibit states from creating new area codes that could unfairly hinder LEC
competitors (including the Company) by requiring their customers to use 10
digit dialing while existing ILEC customers use 7 digit dialing, and (b)
prohibit ILECs (which are still administering central office numbers pending
selection of the neutral administrator) from charging "code opening" fees to
competitors (such as the Company) unless they charge the same fee to all
carriers including themselves. In addition, each carrier is required to
contribute to the cost of numbering administration through a formula based on
net telecommunications revenues. In July 1996, the FCC released rules to
permit both residential and business consumers to retain their telephone
numbers when switching from one local service provider to another (known as
"number portability"). RBOCs have begun to implement number portability in the
top 100 markets, and are required to complete it by December 31, 1998. In
smaller markets, RBOCs must implement number portability within six months of
a request therefore commencing December 31, 1998. Non-RBOC LECs are not
required to implement number portability in additional markets until December
31, 1998 and then only in markets where the feature is requested by another
LEC. The Company already offers number portability, as it provides local
service obtained from the incumbent RBOCS. This allows customers to switch to
the Company's services and still retain their existing telephone numbers.

  The FCC has authorized cellular and other CMRS providers to provide for
other wireless services to fixed locations (rather than to mobile customers),
including offering wireless local loop service, in whatever capacity such
provider determines. Previously, many CMRS providers could provide fixed
services on only an ancillary or incidental basis. The FCC regulations
classify CMRS providers as telecommunications carriers, thus giving them the
same rights to interconnection and reciprocal compensation under the
Telecommunications Act as other non-LEC telecommunications carriers, including
the Company.

  State Regulation. Historically, certain of the Company's resold local and
long distance services have been classified as intrastate and therefore
subject to state regulation. As its local service business and product lines
have expanded, the Company has offered more intrastate service and become
increasingly subject to state regulation. The Telecommunications Act maintains
the authority of individual state utility commissions to impose their own
regulation of local exchange services except as expressly provided in the
Telecommunications Act. In all states where certification is required, the
Company's operating subsidiaries are certificated as common carriers. In all
states, the Company believes that it operates with the appropriate state
regulatory authorization. The Company currently is authorized to provide
intrastate toll or a combination of local and intrastate toll service in more
than 40 states. These authorizations vary in the scope of the intrastate
services permitted.

  The Telecommunications Act provides that the Company's resale agreements
must be submitted to the applicable state utility commission for approval, and
it places strict limitations on the bases on which a state commission can
reject such an agreement. If the state commission does not act within 90 days
after the agreement is submitted for approval, then the agreement is deemed
approved. In addition, if a state commission fails to act to enforce an
agreement, the FCC can (upon request of a party) take jurisdiction over the
matter. A state commission's decisions regarding implementation and
enforcement of an agreement are appealable to the federal district court in
that state.

EMPLOYEES

  As of March 30, 1998, the Company employed approximately 1,430 people, which
includes approximately 180 employees added due to the Acquisition. The
Company's employees are not unionized, and the Company believes its relations
with its employees are good. In connection with its marketing and sales
efforts and the conduct of its other business operations, the Company uses
third party contractors, some of whose employees may be represented by unions
or collective bargaining agreements. The Company believes that its success
will depend in part on its ability to attract and retain highly qualified
employees.

                                      12
<PAGE>

ITEM 2. PROPERTIES

  The Company leases 44 facilities, principally sales facilities, in the
metropolitan areas of Boston, Massachusetts, Chicago, Illinois, Detroit,
Michigan, Cleveland and Columbus, Ohio and New York, New York, as well as in a
number of areas surrounding such cities and in other significant urban areas
in Michigan, New York, Ohio, Connecticut, Wisconsin, Indiana, New Hampshire
and Rhode Island. The Company maintains its corporate headquarters in Chicago,
Illinois. Although the Company's facilities are adequate at this time, the
Company believes that it will be required to lease additional facilities,
particularly in new metropolitan areas where the Company enters into RBOC
resale agreements.

ITEM 3. LEGAL PROCEEDINGS

  From time to time the Company is party to routine litigation and proceedings
in the ordinary course of its business. The Company and its subsidiaries are
not aware of any current or pending litigation that the Company believes would
have a material adverse effect on the Company's results of operations or
financial condition. The Company and its subsidiaries continue to participate
in regulatory proceedings before the FCC and state regulatory agencies
concerning the authorization of services and the adoption of new regulations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS

  None.

                      EXECUTIVE OFFICERS OF THE COMPANY.

  Pursuant to General Instruction G(3) of Form 10-K, the following list is
included as an unnumbered Item in Part I of this Report in lieu of being
included in the Proxy Statement for the 1998 Annual Meeting.

  The following is a list of names and ages of all of the executive officers
of the Company indicating current positions and offices with the Company held
by each such person. All such persons have been elected by, and hold office at
the pleasure of, the Board of Directors. No person other than those listed
below has been chosen to become an executive officer of the Company.

<TABLE>
<CAPTION>
                           AGE AS OF                                  EXECUTIVE
                           MARCH 15,           OFFICES AND             OFFICER
      NAME                   1998             POSITIONS HELD            SINCE
      ----                 ---------          --------------          ---------
<S>                        <C>       <C>                              <C>
J. Thomas Elliott.........     51    Chairman of the Board,             1995
                                     President, Chief Executive
                                     Officer and Director
Dennis B. Dundon..........     53    Chief Operating Officer            1997
Ronald W. Gavillet........     38    Executive Vice President,          1994
                                     Strategy & External Affairs
Gerald J. Sweas...........     50    Executive Vice President and       1996
                                     Chief Financial Officer
Ryan Mullaney.............     41    Executive Vice President, Sales    1996
                                     and Marketing
Steven J. Parrish.........     42    Executive Vice President,          1996
                                     Operations
Thomas A. Monson..........     37    Vice President, General Counsel    1997
                                     and Secretary
Thad J. Pellino...........     36    Vice President, Business           1995
                                     Assurance and Analysis
Neil A. Bethke............     37    Vice President, Information        1996
                                     Systems
Ellen C. Craig............     59    Vice President, Regulatory         1997
                                     Affairs
Lane Foster...............     53    Vice President, Human Resources    1997
                                     and Organizational Development
</TABLE>

  Other information relating to the directors and executive officers of the
Company will be set forth in the Company's Proxy Statement for the 1998 Annual
Meeting of Stockholders and is incorporated herein by reference.

                                      13
<PAGE>

                                    PART II

ITEM5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

  The Company's Common Stock, par value $.01 per share, began trading on the
Nasdaq National Market on February 4, 1998 under the symbol "USNC." The high
and low closing sales prices for the Common Stock from February 4, 1998
through March 27, 1998, as reported on the Nasdaq National Market, were $23.00
and $16.00, respectively. On March 27, 1998, the last reported sales price of
the Common Stock, as reported on the Nasdaq National Market, was $18 1/8 per
share. There were approximately 45 holders of record on such date.

  The Company has never declared or paid any cash dividends on its Common
Stock. In addition, under the terms of the indentures governing the Company's
14% Senior Discount Notes due 2003 (the "14% Senior Notes") and the Company's
14 5/8% Senior Discount Notes due 2004 (the "14 5/8% Senior Notes"), the
Company may not declare any dividend or make any distribution on any of its
capital stock (other than dividends, distributions or payments made solely in
nonredeemable capital stock of the Company) unless certain financial
conditions are satisfied and no default under such indenture has occurred or
shall occur as a consequence thereof.

RECENT SALES OF UNREGISTERED SECURITIES

  (1) On August 18, 1997, the Registrant sold to Merrill Lynch, Pierce, Fenner
& Smith Incorporated and Donaldson Lufkin & Jenrette Securities Corporation
152,725 units (the "1997 Private Placement"), each consisting of $1,000
aggregate principal amount at maturity of 14 5/8% Senior Notes and ten
warrants, each warrant entitling the holder to purchase .134484 shares of
Common Stock (on a pre-split basis), subject to adjustment under certain
circumstances for an aggregate purchase price of $100 million. In connection
with this sale, Merrill Lynch, Pierce, Fenner & Smith Incorporated received
approximately $2.3 million in commissions and Donaldson, Lufkin & Jenrette
Securities Corporation received approximately $1.2 million in commissions.
These securities were immediately resold to certain institutional investors
pursuant to Rule 144A of the Securities Act.

  (2) On August 18, 1997, Chase Venture Capital Associates, L.P., CIBC Wood
Gundy Ventures, Inc., Northwood Capital Partners LLC, Northwood Ventures, BT
Capital Partners, Inc., HarbourVest Venture Partners V-Direct Fund L.P. and
Prime VIII, L.P. purchased, in the aggregate, 30,209 shares of 9.0% Cumulative
Convertible Pay-In-Kind Preferred Stock, Series A (the "Series A Preferred
Stock"), for an aggregate purchase price of $30.2 million. The shares of
Series A Preferred Stock were not registered under the Securities Act on the
basis that it was a transaction by an issuer not involving any public
offering, in accordance with Section 4(2) under the Securities Act.

  (3) On August 25, 1997, the Registrant issued to Merrill Lynch Global
Association Fund, Inc. and Merrill Lynch Equity/Convertible Series
(collectively, "MLAM"), warrants to purchase an aggregate of 145,160 shares of
Common Stock at an exercise price of $.01 per share for no cash consideration.
The warrants were issued in exchange for MLAM's consent, as the holder of all
of the 14% Senior Notes and the 9% Convertible Subordinated Notes due 2004
(the "Convertible Notes"), to allow the Company to consummate the 1997 Private
Placement. The shares of Common Stock were not registered under the Securities
Act on the basis that it was a transaction not involving any public offering,
in accordance with Section 4(2) under the Securities Act.

  (4) On October 17, 1997, Fidelity Communications International, Inc. and
Fidelity Investors Limited Partnership purchased, in the aggregate, 15,000
shares of Series A Preferred Stock, for an aggregate purchase price of $15
million. The shares of Series A Preferred Stock were not registered under the
Securities Act on the basis that it was a transaction by an issuer not
involving any public offering, in accordance with Section 4(2) under the
Securities Act.

  (5) On January 13, 1998, MLAM purchased approximately $13.0 million
aggregate principal at maturity of 9% Consent Convertible Subordinated Notes
due 2006 (the "Consent Notes") for an aggregate purchase price of $10.0
million. The Consent Notes were not registered under the Securities Act on the
basis that it was a transaction by an issuer not involving any public
offering, in accordance with Section 4(2) under the Securities Act.

  (6) On February 9, 1998, concurrent with the consummation of the Company's
initial public offering, all outstanding shares of Series A Preferred Stock
and 9% Cumulative Convertible Pay-In-Kind Preferred Stock were converted into
6,130,175 shares of Common Stock. The shares of Common Stock were not
registered under the Securities act pursuant to the exemption from
registration set forth in section 3(a)(9) of the Securities Act.

  (7) On March 13, 1998, MLAM exchanged $31.5 million aggregate principal
amount at maturity of 14% Senior Notes for $33.6 million aggregate principal
amount at maturity of 14 5/8% Senior Notes. The 14 5/8% Senior Notes were not
registered in reliance upon the exemption from registration set forth in
Section 3(a)(9) of the Securities Act.

                                      14
<PAGE>

ITEM 6. SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA
               (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

  The following table presents selected historical consolidated financial data
for the periods from inception of the Company in April 1994 to December 31,
1994 and for the fiscal years ended December 31, 1995, 1996 and 1997. The
selected financial data has been derived from consolidated financial
statements of the Company. The selected financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the audited consolidated financial statements,
including the notes thereto, of the Company appearing elsewhere in this
report.

<TABLE>
<CAPTION>
                                                      FISCAL YEAR ENDED
                                   INCEPTION TO         DECEMBER 31,
                                   DECEMBER 31, -------------------------------
                                       1994       1995       1996       1997
                                   ------------ ---------  ---------  ---------
<S>                                <C>          <C>        <C>        <C>
STATEMENT OF OPERATIONS DATA:
 Net service revenue.............   $   1,737   $   7,884  $   9,814  $  47,200
 Cost of services................       1,455       9,076      9,256     41,272
                                    ---------   ---------  ---------  ---------
 Gross margin....................         282      (1,192)       558      5,928
 Sales and marketing expense.....       2,869       5,867     12,612     62,375
 General and administrative
  expense........................       4,686      11,100     20,665     41,538
 Interest expense................          26         734      1,797     15,333
 Interest and other income (1)...         152         646      9,469      3,426
 Minority interest...............         --          150        --         --
                                    ---------   ---------  ---------  ---------
 Net loss........................   $  (7,147)  $ (18,097) $ (25,047) $(109,892)
                                    =========   =========  =========  =========
 Accumulated preferred dividends.   $     707   $   3,103  $   3,691  $   2,211
 Net loss to common shareholders.   $  (7,854)  $ (21,200) $ (28,738) $(112,103)
 Net loss per common share--basic
  and diluted....................   $   (6.56)  $   (7.01) $   (5.65) $  (15.55)
 Weighted average shares
  outstanding....................   1,196,780   3,025,200  5,082,028  7,206,886
OTHER DATA:
 EBITDA (2)......................   $  (7,087)  $ (15,901) $ (30,390) $ (94,413)
 Cash flows from operating
  activities.....................      (6,141)    (14,247)   (23,910)   (96,009)
 Cash flows from investing
  activities.....................      (1,708)     (2,556)     7,274    (16,101)
 Cash flows from financing
  activities.....................      13,828      24,589     63,689    138,745
 Depreciation and amortization...         186       2,258      2,329      3,572
 Capital expenditures............       1,728       1,740      2,259     15,201
 Ratio of earnings to fixed
  charges (3)....................         --          --         --         --
<CAPTION>
                                                  DECEMBER 31,
                                   --------------------------------------------
                                       1994       1995       1996       1997
                                   ------------ ---------  ---------  ---------
<S>                                <C>          <C>        <C>        <C>
BALANCE SHEET DATA:
 Cash and cash equivalents.......   $   5,979   $  13,766  $  60,818  $  87,454
 Total assets....................      12,747      20,471     78,052    171,200
 Long-term debt (net of current
  maturities)....................       3,176         518     59,864    172,700
 Redeemable preferred stock......      15,306      44,396     10,045     57,277
 Common stockholders' deficit....      (7,830)    (28,768)    (3,606)   (87,000)
</TABLE>
--------
(1) Interest and other income for the year ended December 31, 1996 includes a
    gain of $8.1 million realized on the sale of the Company's network
    facilities in Ohio.
(2) EBITDA consists of operating income (loss) before depreciation and
    amortization. While EBITDA should not be construed as a substitute for
    operating income or a better indicator of liquidity than cash flow from
    operating activities, which are determined in accordance with generally
    accepted accounting principles, EBITDA is a measure commonly used in the
    telecommunications industry and is presented to assist in understanding
    the Company's operating results and as a tool for measuring the ability of
    the Company to service its debt. EBITDA is not necessarily a measure of
    the Company's ability to fund its cash needs. See the Consolidated
    Statements of Cash Flows of the Company and the related notes to the
    Consolidated Financial Statements thereto included herein.
(3) The ratio of earnings to fixed charges is computed by dividing pretax
    income (loss) from operations before interest charges by interest expense.
    Earnings were insufficient to cover fixed charges for the periods ended
    December 31, 1994, 1995, 1996 and 1997 by $7.1 million, $17.4 million,
    $23.2 million and $94.6 million, respectively.

                                      15
<PAGE>

ITEM7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
       OF OPERATIONS

OVERVIEW

  Initially, the Company entered the local telecommunications market as a
facilities-based CLEC with network facilities in Ohio. Due to the high costs
associated with the initial construction, installation and expansion of each
local network facility, including right-of-way costs, franchise fees,
interconnection charges and other operating expenses and in anticipation of
the impact of the passage of the Telecommunications Act of 1996, the Company
refocused its operations. The Company sold its existing facilities in Ohio and
certain other assets in February 1996, and transferred certain liabilities
with respect to those facilities, to pursue a non-facilities-based approach to
the local telecommunications market. As part of the Company's strategy to
refocus its operations, the Company, through a newly formed wholly owned
acquisition subsidiary, Quest United, Inc. ("Quest"), acquired certain assets
and assumed certain liabilities of Quest America, LP., a telecommunications
reseller and consulting firm (the "Quest Acquisition").

  The Company negotiated for the first total service resale agreement with
Ameritech for local services, which was signed in November 1995, and
negotiated with NYNEX for a comprehensive local resale agreement which was
signed in July 1996. The Company also consummated various other agreements in
1996 with certain carriers for the resale of long distance and enhanced and
other value-added services. The Company commenced the marketing and
provisioning of services under those agreements during the latter half of
1996. Although management believes that its current strategy will have a
positive effect on the Company's results of operations over the long-term,
through an increase in its customer base and product offerings, this strategy
is expected to have a negative effect on the Company's results of operations
over the short-term. The Company anticipates losses and negative cash flow for
the foreseeable future, attributable in part to significant investments in
operating, sales, marketing, management information systems and general and
administrative expenses. To date, the Company's growth, including capital
expenditures, has been funded primarily by the capital contributions, sales of
preferred stock and by the proceeds from the private placement or public
offering of debt and equity securities.

  In connection with the 1997 Private Placement, MLAM, the current beneficial
holders of all of the 14% Senior Notes and the 9% Convertible Subordinated
Notes due 2003 (the "Convertible Notes") consented (the "Consent") to the
amendment of the indentures with respect to the Senior Notes and the
Convertible Notes to allow the Company to consummate the 1997 Private
Placement. In connection with the Consent, the Company paid a consent fee to
MLAM consisting of warrants to purchase 145,160 shares of Common Stock, at an
exercise price of $.01 per share. The Company also granted to MLAM an option
to purchase the Consent Notes, which have terms substantially similar to the
Convertible Notes, for an aggregate purchase price of $10.0 million. The
Consent Notes were issued on January 13, 1998. Additionally, the Company has
granted to holders of the 14% Senior Notes an option, for a specified period
of time, to exchange all, or a portion, of the 14% Senior Notes for 14 5/8%
Senior Notes having an accreted value equal to the accreted value of such 14%
Senior Notes at the time of such exchange. On March 13, 1998, MLAM exchanged
$31.5 million aggregate principal amount at maturity of 14% Senior Notes for
$33.6 million aggregate principal amount at maturity of 14 5/8% Senior Notes.

  On February 20, 1998, the Company completed its previously announced
acquisition of Hatten Communications for approximately $68.0 million, which
included the repayment of approximately $14.0 million of existing
indebtedness. See "Business--Introduction."

  The Company's net service revenue consists primarily of sales revenue from
telecommunications resale services net of certain adjustments, including
unbillable call records. The Company bills its subscribers for local, long
distance and other service usage based on the type of service utilized, the
number, time and duration of calls, the geographic location of the terminating
phone numbers and the applicable rate plan in effect at the time of the call.

  Cost of services includes the cost of local, long distance and other
services charged by carriers for recurring charges, per minute usage charges
and feature charges, as well as the cost of fixed facilities for dedicated
services and special regional calling plans.

                                      16
<PAGE>

  Sales and marketing expense consists of the costs of providing sales and
other support services for customers including salaries of salesforce
personnel. General and administrative expense consists of the costs of the
billing and information systems and personnel required to support the
Company's operations and growth as well as bad debts, customer allowances and
all amortization expenses. Depreciation is allocated throughout sales,
marketing, general and administrative expense based on asset ownership.

  The Company has experienced significant growth in the past and, depending on
the extent of its future growth, may experience significant strain on its
management, personnel and information systems. To accommodate this growth, the
Company will continue to implement and improve operational, financial and
management information systems. In an effort to support its growth, the
Company added several senior management positions and over 250 employees in
1996 and over 600 employees in 1997. Also, the Company is implementing new
information systems that will provide improved recordkeeping for customer
information and management of uncollectible accounts and fraud control.

  The significant growth experienced by the Company over the past 18 months
has strained the capabilities of the Company's internal billing systems and
those of the Company's outside billing vendor. As a result, the Company has
experienced deficiencies in accurately billing its customers in a timely
manner and instances of toll fraud. Due to these factors, the Company recorded
a charge of $2.8 million in the third quarter of 1997. In response to these
events, the Company is in the process of strengthening its revenue assurance
and margin utilization systems and operating controls. Gross margins were
lower than originally anticipated for 1997, and bad debt provisions and
customer allowances as a percentage of revenue will be higher for the
foreseeable future than previously expected, since some billings from carriers
may not be billed to customers.

  As a result of evaluating the capabilities of the Company's two billing
vendors to support the anticipated growth of the Company, a decision was made
to transition to a single vendor that has the strongest current capabilities
and the best potential to support the expansion and related increased number
of customers and access lines of the Company. The Company selected the billing
vendor that has supported its sales pursuant to the Bell Atlantic resale
agreement for the past two years. The transition to a single vendor was
completed during the fourth quarter of 1997. Connecticut Telephone continues
to use a separate vendor for its billing services.

RESULTS OF OPERATIONS

 Year Ended December 31, 1997 Compared to Year Ended December 31, 1996

  Net service revenue increased to $47.2 million for the year ended December
31, 1997 from $9.8 million for the year ended December 31, 1996. The
cumulative number of local access lines sold as of December 31, 1997 was
191,069 compared to 10,283 lines sold as of December 31, 1996. The cumulative
number of local access lines provisioned as of December 31, 1997 was 171,962
compared to 8,364 lines provisioned as of December 31, 1996. The substantial
increases in net service revenue and local access lines were due primarily to
the significant change in the Company's business strategy and the
corresponding deployment of a large direct sales organization commencing in
August 1996. This business strategy change has resulted in an approximately
ten-fold increase in the subscriber base in the Company's geographic markets
(from approximately 1,700 customers at the end of 1996 to approximately 17,000
customers at the end of 1997).

  Gross profit of $5.9 million for the year ended December 31, 1997 improved
from $0.6 million for the year ended December 31, 1996. Due to the significant
change in the Company's business strategy and corresponding change in cost
structure from the original facilities-based business, the year to year gross
margins are not comparable. Gross margins steadily improved in each quarter of
1997, from 9.2% in the second quarter to 11.9% in the third quarter and 14.4%
in the fourth quarter. Consolidated gross margins are expected to continue to
improve each quarter primarily as revenue assurance and margin utilization
systems and operating controls are being strengthened and as the mix of
revenues from higher margin products increases and the mix of revenue from
lower margin legacy products decreases. In addition, the Company will continue
to attempt to negotiate more favorable terms with its carriers.

                                      17
<PAGE>

  Sales and marketing expenses increased $49.8 million from $12.6 million for
the year ended December 31, 1996 to $62.4 million for the year ended December
31, 1997. The increase was due primarily to the substantial increase in the
number of sales and marketing employees from approximately 300 at the end of
1996 to approximately 700 at the end of 1997. The higher headcount resulted in
increases to salaries and benefits of $30.7 million, facilities related costs
of $6.6 million, training and travel and entertainment costs of $5.3 million
and recruitment costs of $2.7 million. Additionally, advertising and
promotional costs increased $4.4 million due to product launches in the
Company's target markets.

  General and administrative expenses increased $20.8 million to $41.5 million
for the year ended December 31, 1997 versus $20.7 million for the year ended
December 31, 1996. The increase was due primarily to the substantial increase
in the number of operations and administrative employees from approximately
160 at the end of 1996 to approximately 380 at the end of 1997. The higher
headcount resulted in increases to salaries and benefits of $9.6 million and
facilities related costs of $3.2 million. Fees paid to consultants and other
professionals increased over $2.9 million, primarily relating to the
development and expansion of the Company's customer service, billing and
information systems and facilities. Billing processing costs increased
approximately $2.4 million due to the corresponding increase in revenue.

  Interest and other income decreased to $3.4 million for the year ended
December 31, 1997 from $9.5 million for the year ended December 31, 1996 due
primarily to an $8.1 million non-recurring gain on the sale of the Company's
network facilities in Ohio in February 1996 which was somewhat offset by
additional interest income earned on the higher average cash balance in 1997.

  Interest expense increased to $15.3 million for the year ended December 31,
1997 from $1.8 million for the year ended December 31, 1996. This increase was
due primarily to interest expense attributable to the 14% Senior Notes and
Convertible Notes issued in September 1996 and the 14 5/8% Senior Notes issued
in August 1997.

  As a result of the factors described above, the Company's net loss increased
to $109.9 million for the year ended December 31, 1997 from $25.0 million for
the year ended December 31, 1996.

 Year Ended December 31, 1996 Compared to Year Ended December 31, 1995

  Net service revenue increased to $9.8 million for the year ended December
31, 1996 from $7.9 million for the year ended December 31, 1995. The increase
in net service revenue was due primarily to a 36% increase in the subscriber
base in the Company's geographic markets (from approximately 1,250 customers
at the end of 1995 to approximately 1,700 customers at the end of 1996) and
the revenues attributable to the Quest Acquisition which primarily consist of
commissions earned from carriers on telecommunications services provided to
their subscribers. Approximately $1.4 million in increased revenues is
attributable to the addition of new customers, primarily in Ohio, and
approximately $0.5 million is attributable to revenues gained from the Quest
Acquisition.

  Gross margin of $0.6 million for the year ended December 31, 1996 improved
from the negative margin of $1.2 million for the year ended December 31, 1995
due primarily to the elimination of fixed costs upon the sale of the network
facilities in Ohio and a $1.4 million sales and related margin adjustment for
1995 revenue purportedly not billed by NYNEX Corporation to the Company's
customers under a then existing billing and collection agreement.

  Sales and marketing expenses increased $6.7 million, or 114%, from $5.9
million for the year ended December 31, 1995 to $12.6 million for the year
ended December 31, 1996. The increase was due primarily to an increase in the
number of sales and marketing employees from approximately 115 at the end of
1995 to over 300 at the end of 1996, which resulted in increases to salaries
and benefits of $3.9 million, travel, training and entertainment costs of $1.0
million and recruitment costs of $0.8 million. Additionally, advertising costs
increased $0.9 million due to product launches in the Company's target
markets.

                                      18
<PAGE>

  General and administrative expenses increased $9.6 million, or 86%, to $20.7
million for the year ended December 31, 1996 versus $11.1 million for the year
ended December 31, 1995. The increase was due primarily to an increase in the
number of operations and administrative employees from approximately 90 at the
end of 1995 to approximately 160 at the end of 1996, which resulted in
increases to salaries and benefits of $2.5 million and facility costs of $1.2
million. Additionally, fees paid to consultants and other professionals
increased over $1.0 million, primarily relating to the development and
expansion of the Company's customer service, billing and administrative
information systems and facilities. Amortization expense increased $0.8
million due primarily to a full year of amortization expense related to the
Quest Acquisition in 1996 versus eight months in 1995. Additionally, $1.7
million of expense was incurred relating to the settlement of a derivative
action filed by a minority shareholder.

  Interest and other income increased to $9.5 million for the year ended
December 31, 1996 from $646,000 for the year ended December 31, 1995 due
primarily to an $8.1 million non-recurring gain on the sale of the Company's
network facilities in Ohio in February 1996.

  Interest expense increased to $1.8 million for the year ended December 31,
1996 from $734,000 for the year ended December 31, 1995. This increase was due
primarily to interest expense attributable to the 14% Senior Notes and
Convertible Notes issued in September 1996, which are described in more detail
under the caption "Liquidity and Capital Resources."

  As a result of the factors described above, the Company's net loss increased
to $25.1 million for the year ended December 31, 1996 from $18.1 million for
the year ended December 31, 1995.

LIQUIDITY AND CAPITAL RESOURCES

  Since inception, the Company funded its operations primarily through
proceeds from the issuance of debt and equity securities. As of December 31,
1997, the Company had cash and cash equivalents of $87.5 million and working
capital of $92.8 million. The Company's operating activities utilized cash of
approximately $96.0 million for the year ended December 31, 1997, $23.9
million for the year ended December 31, 1996 and $14.2 million for the year
ended December 31, 1995.

  The Company's investing activities in 1997 have consisted primarily of
property and equipment purchases of $15.2 million for the year ended December
31, 1997, primarily related to development of systems infrastructure and sales
office expansion in several of the Company's target markets. In 1998, the
Company anticipates substantial additional capital expenditures, a substantial
portion of which relates to investments in information technology to support
the growth of the customer base with more robust provisioning, billing and
customer care systems. In 1996, the Company's investing activities consisted
of $9.5 million in proceeds received in February 1996 from the December 1995
sale of facilities in Ohio, partially offset by capital expenditures of $2.3
million for the buildout of new office space. In 1995, capital expenditures
amounted to $1.7 million and were primarily for fiber optic rings, leasehold
improvements and furniture in Ohio that were sold in February 1996.

  The Company's financing activities generated $138.7 million for the year
ended December 31, 1997. In August 1997, the Company raised $30.2 million
through the sale of its Series A Preferred Stock and $96.5 million of net
proceeds through the 1997 Private Placement. Additionally, in October 1997,
the Company issued and sold Series A Preferred Stock for an aggregate purchase
price of $15.0 million.

  In February 1998, the Company issued and sold 8,600,000 shares of Common
Stock (of which 600,000 shares were sold pursuant to the underwriters' over-
allotment options) in its initial public offering for net proceeds of
approximately $127.0 million. In connection with the Company's initial public
offering, all of the Company's outstanding 9% Preferred Stock and Series A
Preferred Stock, including dividends accrued through the conversion date, were
converted into 6,130,175 shares of Common Stock. In March 1998, the Company
issued and sold 28,861 additional shares solely to cover underwriters' over-
allotment options for net proceeds of

                                      19
<PAGE>

$0.4 million. $68.0 million of the net proceeds of the initial public offering
were used to finance the Acquisition, including the purchase of the
outstanding capital stock of Hatten Communications, the repayment of
indebtedness and the payment of certain fees and expenses related to the
Acquisition. Assuming that these transactions had occurred at December 31,
1997, the pro forma cash balance and common stockholders' equity at December
31, 1997 would have been approximately $156.2 million and approximately $97.3
million, respectively. As a result of these transactions the Company's
management believes that there are sufficient capital resources available to
maintain operations throughout 1998.

  The Company's financing activities generated $63.7 for the year ended
December 31, 1996. In September 1996, the Company raised $10.0 million through
the sale to the original purchasers of its 9% Preferred Stock. Also in
September 1996, the Company raised approximately $55.0 million, net of
issuance costs, through the sale to Merrill Lynch Global Allocation Fund, Inc.
of (i) 48,500 Units consisting of $48.5 million in aggregate principal amount
at maturity of 14% Senior Discount Notes and warrants to purchase Common
Stock, and (ii) $36.0 million in aggregate principal amount at maturity of
Convertible Notes. The aggregate purchase price of the Units was $30.2
million, and the aggregate purchase price of the Convertible Notes was $27.6
million. In 1995 the Company's financing activities consisted primarily of
raising capital in the form of equity investments from venture capital
organizations. During 1995 the Company raised $26.3 million, net of issuance
costs. In 1995, the Company also assumed notes payable to investors in the
Quest Acquisition.

  The Company incurred net losses of $109.9 million, $25.0 million and $18.1
million in 1997, 1996 and 1995, respectively. Accordingly, no provision for
current federal or state income taxes has been made to the financial
statements. At December 31, 1997, the Company and its subsidiaries had net
operating loss carry-forwards for Federal income tax purposes of approximately
$151.7 million. The ability of the Company or the Company's subsidiaries, as
the case may be, to utilize their net operating loss carry-forwards to offset
future taxable income may be subject to certain limitations contained in the
Internal Revenue Code of 1986, as amended (the "Code"). These operating losses
begin to expire in 2009 for Federal income tax purposes. Of the net operating
loss carry-forwards remaining at December 31, 1997, $12.3 million can be
applied only against future taxable income of the Company's subsidiary USN
Communications Northeast, Inc.

YEAR 2000

  The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any computer
programs that have time-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a system failure
or miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.

  The Company invests in and develops computer programs used for its
administrative and financial systems operations with a view towards Year 2000
compliance. Furthermore, the Company has assessed, and continues to assess,
compliance of its existing computer programs. At this time, management
believes that any costs associated with achieving Year 2000 compliance will
not be material to the business, operations or financial condition of the
Company.

  In addition, the Company has communicated with others with whom it does
significant business to determine their Year 2000 compliance readiness and the
extent to which the Company is vulnerable to any third party Year 2000 issues.
However, there can be no guarantee that the systems of other companies on
which the Company's systems rely will be timely converted, or that a failure
to convert by another company, or a conversion that is incompatible with the
Company's systems, would not have a material adverse effect on the Company.

INFLATION

  Management believes that inflation has not had a material effect on the
Company's results of operations.

                                      20
<PAGE>

RECENT ACCOUNTING PRONOUNCEMENTS

  In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" and
Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information" and, in 1998, Statement of
Financial Accounting Standards No. 132, "Employers' Disclosure about Pensions
and Other Postretirement Benefits." The statements, which will not impact the
results of operations, financial position or cash flows of the Company, are
effective for financial statements issued for fiscal years beginning after
December 15, 1997 and will be adopted by the Company in 1998.

ITEM8.FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

  The financial statements required by this Item are set forth on pages F-1
through F-19.

ITEM9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
       FINANCIAL DISCLOSURES

  None.

                                   PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.

  For information with respect to the executive officers of the Company see
"Executive Officers of the Company" on page 13 of this Report. For information
with respect to the directors of the Company see "Election of Directors" in
the Proxy Statement for the 1998 Annual Meeting of Stockholders, which is
incorporated herein by reference. Certain additional information required by
this Item is set forth in the Proxy Statement for the 1998 Annual Meeting of
Stockholders, which is incorporated by reference.

ITEM 11. EXECUTIVE COMPENSATION.

  The information required by this Item is set forth in the Company's Proxy
Statement for the 1998 Annual Meeting of Stockholders and is incorporated
herein by reference.

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

  The information required by this Item is set forth in the Company's Proxy
Statement for the 1998 Annual Meeting of Stockholders and is incorporated
herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

  The information required by this Item is set forth in the Company's Proxy
Statement for the 1998 Annual Meeting of Stockholders and is incorporated
herein by reference.

                                      21
<PAGE>

ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 10-K

FINANCIAL STATEMENTS AND SCHEDULES

  The financial statements which are filed with this Form 10-K are set forth
in the Index to Financial Statements at page F-1 which immediately precedes
such documents.

EXHIBITS

  The following exhibits are, as indicated below, either filed herewith or
have heretofore been filed with the Securities and Exchange Commission under
the Securities Act, and are referred to and incorporated herein by reference
to such filings.

<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                                DESCRIPTION
 -------                               -----------
 <C>     <S>
  3.1    Amended and Restated Certificate of Incorporation of the Registrant.
         (Incorporated by reference to the Registrant's Registration Statement
         on Form S-1 (File No. 333-38381).)
  3.3    Amended and Restated Bylaws of the Registrant. (Incorporated by
         reference to the Registrant's Registration Statement on Form S-1 (File
         No. 333-38381).)
  4.1    Indenture, dated as of August 15, 1997, by and between the Registrant
         and Harris Trust and Savings Bank, as Trustee, for the Registrant's 14
         5/8% Senior Discount Notes due 2004 (the "14 5/8% Senior Note
         Indenture"). (Incorporated by reference to the Registrant's
         Registration Statement on Form S-4 (File No. 333-37621).)
  4.2*   Supplemental Indenture No. 1, dated March 5, 1998, by and between the
         Registrant and Harris Trust and Savings Bank, as Trustee, to the 14
         5/8% Senior Note Indenture.
  4.3    Indenture, dated as of September 30, 1996, by and between the
         Registrant and Harris Trust and Savings Bank, as Trustee, for the
         Registrant's 9% Convertible Subordinated Discount Notes due 2004 (the
         "Convertible Note Indenture"). (Incorporated by reference to the
         Registrant's Registration Statement on Form S-4 (File No. 333-16265).)
  4.4    Supplemental Indenture No. 1, dated as of August 12, 1997, by and
         between the Registrant and the Trustee, to the Convertible Note
         Indenture. (Incorporated by reference to the Registrant's Registration
         Statement on Form S-4 (File No. 333-37621).)
  4.5*   Supplemental Indenture No. 2, dated March 5, 1998, by and between the
         Registrant and Harris Trust and Savings Bank, as Trustee, to the
         Convertible Note Indenture.
  4.6    Indenture, dated as of September 30, 1996, by and between the
         Registrant and Harris Trust and Savings Bank, as Trustee, for the
         Registrant's 14% Senior Discount Notes due 2003 (the "14% Senior Note
         Indenture"). (Incorporated by reference to the Registrant's
         Registration Statement on Form S-4 (File No. 333-16265).)
  4.7    Supplemental Indenture, dated as of March 17, 1997, by and between the
         Registrant and the Trustee, to the 14% Senior Note Indenture.
         (Incorporated by reference to the Registrant's 1996 Annual Report on
         Form 10-K (File No. 333-16265).)
  4.8    Supplemental Indenture No. 2, dated as of August 18, 1997, by and
         between the Registrant and the Trustee, to the 14% Senior Note
         Indenture. (Incorporated by reference to the Registrant's Registration
         Statement on Form S-4 (File No. 333-37621).)
  4.9*   Supplemental Indenture No. 3, dated March 5, 1998, by and between the
         Registrant and Harris Trust and Savings Bank, as Trustee, to the 14%
         Senior Note Indenture.
</TABLE>

                                      22
<PAGE>

<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                                DESCRIPTION
 -------                               -----------
 <C>     <S>
 4.10    Form of Common Stock Certificate. (Incorporated by reference to the
         Registrant's Registration Statement on Form S-1 (File No. 333-38381).)
 4.11    Indenture, dated as of January 13, 1998, by and between the Registrant
         and Harris Trust and Savings Bank, as Trustee, for the Registrant's 9%
         Consent Convertible Subordinated Notes due 2006 (the "Consent Note
         Indenture"). (Incorporated by reference to the Registrant's
         Registration Statement on Form S-1 (File No. 333-38381).)
 10.1    Employment Agreement, dated as of July 18, 1996, by and between the
         Registrant and J. Thomas Elliott. (Incorporated by reference to the
         Registrant's Registration Statement on Form S-4 (File No. 333-16265).)
 10.2    Employment Agreement, dated as of July 18, 1996, by and between the
         Registrant and Ronald W. Gavillet. (Incorporated by reference to the
         Registrant's Registration Statement on Form S-4 (File No. 333-16265).)
 10.3    Employment Agreement, dated as of November 18, 1996, by and between
         the Registrant and Gerald J. Sweas. (Incorporated by reference to the
         Registrant's 1996 Annual Report on Form 10-K (File No. 333-16265).)
 10.4    Employment Agreement, dated as of October 21, 1996, by and between the
         Registrant and Ryan Mullaney. (Incorporated by reference to the
         Registrant's 1996 Annual Report on Form 10-K (File No. 333-16265).)
 10.5    Form of Employment Agreement between the Registrant and certain
         officers of the Registrant. (Incorporated by reference to the
         Registrant's Registration Statement on Form S-4 (File No. 333-16265).)
 10.6    Amended and Restated 1994 Stock Option Plan of the Registrant.
         (Incorporated by reference to the Registrant's Registration Statement
         on Form S-4 (File No. 333-37621).)
 10.7    Omnibus Securities Plan. (Incorporated by reference to the
         Registrant's Registration Statement on Form S-4 (File No. 333-37621).)
 10.8    Consulting Agreement, dated January 24, 1995, by and between the
         Registrant and Eugene A. Sekulow. (Incorporated by reference to the
         Registrant's Registration Statement on Form S-4 (File No. 333-16265).)
 10.9    Form of Indemnification Agreement between the Registrant and certain
         directors and officers of the Registrant. (Incorporated by reference
         to the Registrant's Registration Statement on Form S-4 (File No. 333-
         16265).)
 10.10   Promissory Note, dated December 15, 1995, between the Registrant and
         J. Thomas Elliott. (Incorporated by reference to the Registrant's
         Registration Statement on Form S-4 (File No. 333-16265).)
 10.11*  Form of Promissory Note between the Registrant and Ryan Mullaney.
 10.12   Amended and Restated Registration Agreement, dated as of June 22,
         1995, by and among the Registrant and the Investors. (Incorporated by
         reference to the Registrant's Registration Statement on Form S-4 (File
         No. 333-16265).)
 10.13   First Amendment to Amended and Restated Registration Agreement, dated
         as of October 17, 1997, by and among the Registrant and the Investors.
         (Incorporated by reference to the Registrant's Registration Statement
         on Form S-4 (File No. 333-37621).)
 10.14*  Second Amendment to Amended and Restated Registration Agreement, dated
         as of January 30, 1998, by and among the Registrant and the Investors.
 10.15   Asset Purchase Agreement, dated as of June 13, 1995, by and among
         United Telemanagement Services, Inc. ("UTS"), Quest United, Inc.
         ("Quest United"), Quest America Management, Inc. ("QAM"), Edward H.
         Lavin, Jr. ("Lavin"), J. Thomas Elliott ("Elliott") and Quest America,
         LP ("Quest"). (Incorporated by reference to the Registrant's
         Registration Statement on Form S-4 (File No. 333-16265).)
</TABLE>


                                       23
<PAGE>

<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                                DESCRIPTION
 -------                               -----------
 <C>     <S>
 10.16   Amendment No. 1 to Asset Purchase Agreement, dated as of October 27,
         1995, by and among UTS, Quest United, QAM, Lavin, Elliott, and Quest.
         (Incorporated by reference to the Registrant's Registration Statement
         on Form S-4 (File No. 333-16265).)
 10.17   Resale Local Exchange Service Agreement, dated July 8, 1996, by and
         between New York Telephone Company and UTS. (Incorporated by reference
         to the Registrant's Registration Statement on Form
         S-4 (File No. 333-16265).)
 10.18   Resale Local Exchange Service Confirmation of Service Order, dated
         October 31, 1995, by and between the Registrant and Ameritech
         Information Industry Services ("Ameritech") on behalf of Illinois Bell
         Telephone Company. (Incorporated by reference to the Registrant's
         Registration Statement on Form S-4 (File No. 333-16265).)
 10.19   Agreement for Resale Services, dated as of April 26, 1996, by and
         between the Registrant and Ameritech on behalf of Ameritech Michigan.
         (Incorporated by reference to the Registrant's Registration Statement
         on Form S-4 (File No. 333-16265).)
 10.20   Local Exchange Telecommunications Services Resale Agreement, dated May
         21, 1996, by and between the Registrant and Ameritech on behalf of The
         Ohio Bell Telephone Company. (Incorporated by reference to the
         Registrant's Registration Statement on Form S-4 (File No. 333-16265).)
 10.21   Registration Rights Agreement dated as of September 30, 1996, by and
         among the Registrant and the Initial Purchasers named therein.
         (Incorporated by reference to the Registrant's Registration Statement
         on Form S-4 (File No. 333-16265).)
 10.22   Warrant Agreement, dated as of September 30, 1996, by and between the
         Registrant and Harris Trust and Savings Bank, as Warrant Agent and
         Amendment 1 thereto. (Incorporated by reference to the Registrant's
         Registration Statement on Form S-4 (File No. 333-16265).)
 10.23   Registration Rights Agreement dated as of August 15, 1997, by and
         among the Registrant and the Initial Purchasers named therein.
         (Incorporated by reference to the Registrant's Registration Statement
         on Form S-4 (File No. 333-37621).)
 10.24   Warrant Agreement, dated as of August 15, 1997, by and between the
         Registrant and Harris Trust and Savings Bank, as Warrant Agent.
         (Incorporated by reference to the Registrant's Registration Statement
         on Form S-1 (File No. 333-38381).)
 10.25   Consent Warrant Agreement dated as of August 25, 1997, by and between
         the Registrant and Harris Trust and Savings Bank, as Warrant Agent.
         (Incorporated by reference to the Registrant's Registration Statement
         on Form S-1 (File No. 333-38381).)
 10.26   Stock Purchase Agreement dated as of January 7, 1998, by and between
         the Registrant, Mark C. Hatten, Triumph-Connecticut Limited
         Partnership, Solomon Schechter Day School of Greater Hartford, Inc.,
         FSC Corp. and Hatten Communications Holding Company, Inc.
         (Incorporated by reference to the Registrant's Registration Statement
         on Form S-1 (File No. 333-38381).)
 12.1    Computation of Earnings to Fixed Charges, (Incorporated by reference
         to the Registrant's Registration Statement on Form S-4 (File No.333-
         16265).)
 21.1*   Subsidiaries of the Registrant.
 27.1*   Financial Data Schedule.
</TABLE>
--------
*  Filed herewith.

                                       24
<PAGE>

EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS

  Included in the preceding list of exhibits are the following management
contracts or compensatory plans or arrangements:

<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                                DESCRIPTION
 -------                               -----------
 <C>     <S>
 10.1    Employment Agreement, dated as of July 18, 1996, by and between the
         Registrant and J. Thomas Elliott. (Incorporated by reference to the
         Registrant's Registration Statement on Form S-4 (File No. 333-16265).)
 10.2    Employment Agreement, dated as of July 18, 1996, by and between the
         Registrant and Ronald W. Gavillet. (Incorporated by reference to the
         Registrant's Registration Statement on Form S-4 (File No. 333-16265).)
 10.3    Employment Agreement, dated as of November 18, 1996, by and between
         the Company and Gerald J. Sweas. (Incorporated by reference to the
         Registrant's 1996 Annual Report on Form 10-K (File No. 333-16265).)
 10.4    Employment Agreement, dated as of October 21, 1996, by and between the
         Company and Ryan Mullaney. (Incorporated by reference to the
         Registrant's 1996 Annual Report on Form 10-K (File No. 333-16265).)
 10.5    Form of Employment Agreement between the Registrant and certain
         officers of the Registrant. (Incorporated by reference to the
         Registrant's Registration Statement on Form S-4 (File No. 333-16265).)
 10.6    Amended and Restated 1994 Stock Option Plan of the Registrant.
         (Incorporated by reference to the Registrant's Registration Statement
         on Form S-4 (File No. 333-37621).)
 10.7    Omnibus Securities Plan. (Incorporated by reference to the
         Registrant's Registration Statement on Form S-4 (File No. 333-37621).)
 10.8    Consulting Agreement, dated January 24, 1995, by and between the
         Registrant and Eugene A. Sekulow. (Incorporated by reference to the
         Registrant's Registration Statement on Form S-4 (File No. 333-16265).)
</TABLE>

CURRENT REPORTS ON FORM 8-K

  No reports on Form 8-K were filed during the quarter ended December 31,
1997.

                                      25
<PAGE>

                                  SIGNATURES

  PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, USN COMMUNICATIONS, INC. HAS DULY CAUSED THIS REPORT TO
BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED THEREUNTO DULY AUTHORIZED, IN THE
CITY OF CHICAGO, STATE OF ILLINOIS ON MARCH 31, 1998.

                                          USN COMMUNICATIONS, INC.

                                                 /s/ J. Thomas Elliott
                                          By: _________________________________
                                                    J. Thomas Elliott
                                                  Chairman of the Board,
                                              President and Chief Executive
                                                         Officer

  PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED, THIS REPORT HAS BEEN SIGNED ON MARCH 31, 1998 BY THE FOLLOWING
PERSONS IN THE CAPACITIES INDICATED.

<TABLE>
<CAPTION>
             SIGNATURE                           TITLE
             ---------                           -----
<S>                                  <C>                           <C>
      /s/ J. Thomas Elliott          Chairman of the Board,
____________________________________   President and Chief
         J. Thomas Elliott             Executive Officer
                                       (Principal Executive
                                       Officer)

      /s/ Richard J. Brekka          Director
____________________________________
         Richard J. Brekka

       /s/ Dennis B. Dundon          Chief Operating Officer and
____________________________________   Director
          Dennis B. Dundon

      /s/ Ronald W. Gavillet         Executive Vice President,
____________________________________   Strategy & External
         Ronald W. Gavillet            Affairs, and Director

        /s/ James P. Hynes           Director
____________________________________
           James P. Hynes

    /s/ Donald J. Hofmann, Jr.       Director
____________________________________
       Donald J. Hofmann, Jr.

     /s/ William A. Johnston         Director
  __________________________________
        William A. Johnston

          /s/ Ian Kidson             Director
____________________________________
             Ian Kidson

      /s/ David C. Mitchell          Director
____________________________________
         David C. Mitchell

      /s/ Eugene A. Sekulow          Director
____________________________________
         Eugene A. Sekulow

       /s/ Gerald J. Sweas           Executive Vice President and
____________________________________   Chief Financial Officer
          Gerald J. Sweas              (Principal Financial
                                       Officer)

</TABLE>

                                      26
<PAGE>

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                            PAGE
                                                                            ----
<S>                                                                         <C>
INDEPENDENT AUDITORS' REPORT...............................................  F-2
CONSOLIDATED FINANCIAL STATEMENTS:
  Consolidated Balance Sheets..............................................  F-3
  Consolidated Statements of Operations....................................  F-4
  Consolidated Statements of Redeemable Preferred Stock....................  F-5
  Consolidated Statements of Common Stockholders' Deficit..................  F-6
  Consolidated Statements of Cash Flows....................................  F-7
  Notes to Consolidated Financial Statements...............................  F-8
  Schedule of Valuation and Qualifying Accounts............................ F-19
</TABLE>

                                      F-1
<PAGE>

                         INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders of
USN Communications, Inc.
Chicago, Illinois

  We have audited the accompanying consolidated balance sheets of USN
Communications, Inc. and subsidiaries (the "Company") as of December 31, 1997
and 1996, and the related consolidated statements of operations, redeemable
preferred stock, common stockholders' deficit and cash flows for each of the
three years in the period ended December 31, 1997. Our audits also included
the financial statement schedule listed in the Index to Consolidated Financial
Statements. These consolidated financial statements and the financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and the
financial statement schedule based on our audits.

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

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

Deloitte & Touche LLP

Chicago, Illinois
March 9, 1998

                                      F-2
<PAGE>

                   USN COMMUNICATIONS, INC. AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                          DECEMBER 31
                                                  ------------------------------
                     ASSETS                           1997         1996
                     ------                       ------------  -----------
<S>                                               <C>           <C>          <C>
Current Assets:
  Cash and cash equivalents.....................  $ 87,454,418  $60,818,478
  Marketable equity securities..................     8,180,824          --
  Accounts receivable, net of allowances for
   doubtful accounts of $4,537,000 (1997) and
   $223,000 (1996)..............................    23,917,093    3,004,408
  Other current assets..........................     1,443,575      359,618
                                                  ------------  -----------
    Total current assets........................   120,995,910   64,182,504
Property and Equipment--Net.....................    16,802,065    3,507,350
Other Assets....................................    33,402,271   10,362,438
                                                  ------------  -----------
    Total Assets................................  $171,200,246  $78,052,292
                                                  ============  ===========
<CAPTION>
    LIABILITIES, REDEEMABLE PREFERRED STOCK,
        AND COMMON STOCKHOLDERS' DEFICIT
    ----------------------------------------
<S>                                               <C>           <C>          <C>
Current Liabilities:
  Accounts payable..............................  $ 20,485,168  $ 7,907,654
  Accrued expenses and other liabilities........     7,178,373    3,176,762
  Capital lease obligations and notes payable...       559,223      664,366
                                                  ------------  -----------
    Total current liabilities...................    28,222,764   11,748,782
14 5/8% Senior Discount Notes, net of Original
 Issue Discount.................................   105,486,381          --
14% Senior Discount Notes, net of Original Issue
 Discount.......................................    35,790,140   31,242,614
9% Convertible Subordinated Discount Notes, net
 of Original Issue Discount.....................    30,867,615   28,259,555
Capital lease obligations and notes payable.....       555,960      362,007
                                                  ------------  -----------
    Total liabilities...........................   200,922,860   71,612,958
Redeemable Preferred Stock:
  9% Cumulative Convertible Pay-in-Kind
   Preferred Stock..............................        10,920       10,000
  9% Cumulative Convertible Pay-in-Kind
   Preferred Stock, Series A....................        45,209          --
  Accumulated unpaid dividends..................     1,516,355      225,000
  Additional paid-in capital....................    55,704,861    9,810,185
                                                  ------------  -----------
    Total redeemable preferred stock............    57,277,345   10,045,185
Commitments and Contingencies (Notes 9 and 17)..           --           --
Common Stockholders' Deficit:
  Common stock, $.01 par value; 30,000,000 and
   25,000,000 shares authorized at 1997 and
   1996; 7,282,511 and 7,185,260 shares issued
   at 1997 and 1996.............................        72,826       71,853
  Additional paid-in capital....................    74,642,145   54,114,755
  Treasury stock, 10,000 shares at 1997 and
   1996.........................................        (1,077)      (1,077)
  Unrealized gain on available-for-sale
   securities...................................     8,180,824          --
  Accumulated deficit...........................  (169,894,677) (57,791,382)
                                                  ------------  -----------
    Total common stockholders' deficit..........   (86,999,959)  (3,605,851)
                                                  ------------  -----------
Total Liabilities, Redeemable Preferred Stock
 and
 Common Stockholders' Deficit...................  $171,200,246  $78,052,292
                                                  ============  ===========
</TABLE>

                See notes to consolidated financial statements.

                                      F-3
<PAGE>

                   USN COMMUNICATIONS, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                             YEARS ENDED DECEMBER 31,
                                      -----------------------------------------
                                          1997           1996          1995
                                      -------------  ------------  ------------
<S>                                   <C>            <C>           <C>
Net Service Revenue.................  $  47,200,433  $  9,814,479  $  7,883,890
Cost of Services....................     41,272,598     9,256,472     9,075,749
                                      -------------  ------------  ------------
    Gross margin....................      5,927,835       558,007    (1,191,859)
Expenses:
  Sales and marketing...............     62,375,506    12,612,172     5,867,200
  General and administrative........     41,537,671    20,664,612    11,100,661
                                      -------------  ------------  ------------
Operating Loss......................    (97,985,342)  (32,718,777)  (18,159,720)
Other Income (Expense):
  Interest income...................      3,420,140     1,376,429       586,946
  Interest expense..................    (15,332,561)   (1,797,112)     (733,566)
  Gain on sale of switch-based
   facilities.......................            --      8,078,901           --
  Other income......................          6,074        13,968        59,314
                                      -------------  ------------  ------------
    Other income (expense)--net.....    (11,906,347)    7,672,186       (87,306)
                                      -------------  ------------  ------------
Loss Before Minority Interest.......   (109,891,689)  (25,046,591)  (18,247,026)
Minority Interest Share in Loss of
 USNCN..............................            --            --        150,000
                                      -------------  ------------  ------------
Net Loss............................  $(109,891,689) $(25,046,591) $(18,097,026)
                                      =============  ============  ============
Accumulated Preferred Dividends.....  $   2,211,605  $  3,690,968  $  3,103,000
                                      =============  ============  ============
Net Loss to Common Shareholders.....  $(112,103,294) $(28,737,559) $(21,200,026)
                                      =============  ============  ============
Net Loss Per Common Share--Basic and
 Diluted............................  $      (15.55) $      (5.65) $      (7.01)
                                      =============  ============  ============
Weighted Average Common Shares
 Outstanding........................      7,206,886     5,082,028     3,025,200
                                      =============  ============  ============
</TABLE>



                See notes to consolidated financial statements.

                                      F-4
<PAGE>

                   USN COMMUNICATIONS, INC. AND SUBSIDIARIES

             CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK
                      THREE YEARS ENDED DECEMBER 31, 1997

<TABLE>
<CAPTION>
                                   SERIES A  SERIES A-
                          9% PIK    9% PIK       2      SERIES A   ACCUMULATED  ADDITIONAL
                         PREFERRED PREFERRED PREFERRED  PREFERRED    UNPAID       PAID-IN
                           STOCK     STOCK     STOCK      STOCK     DIVIDENDS     CAPITAL       TOTAL
                         --------- --------- ---------  ---------  -----------  -----------  -----------
<S>                      <C>       <C>       <C>        <C>        <C>          <C>          <C>
BALANCE, JANUARY 1,
 1995...................                                $ 16,200   $  707,000   $14,582,350  $15,305,550
  Issuance of 26,235
   shares of Series A-2
   10% Senior Cumulative
   Preferred Stock......                     $ 26,235                            26,208,765   26,235,000
  Costs incurred related
   to issuance of stock.                                                           (247,510)    (247,510)
  Accumulated dividends
   on Series A and A-2
   Preferred Stock......                                            3,103,000                  3,103,000
                          -------   -------  --------   --------   ----------   -----------  -----------
BALANCE, DECEMBER 31,
 1995...................                       26,235     16,200    3,810,000    40,543,605   44,396,040
  Accumulated dividends
   on Series A and A-2
   Preferred Stock......                                            3,465,976                  3,465,976
  Conversion of Series A
   and A-2 Preferred
   Stock to Class A
   Common Stock.........                      (26,235)   (16,200)  (7,275,976)  (40,543,605) (47,862,016)
  Issuance of 10,000
   shares of 9% PIK
   Preferred Stock......  $10,000                                                 9,990,000   10,000,000
  Costs incurred related
   to issuance of 9% PIK
   Preferred Stock......                                                           (179,815)    (179,815)
  Accumulated dividends
   on 9% PIK Preferred
   Stock................                                              225,000                    225,000
                          -------   -------  --------   --------   ----------   -----------  -----------
BALANCE, DECEMBER 31,
 1996...................   10,000                                     225,000     9,810,185   10,045,185
  Issuance of 920 shares
   of 9% PIK Preferred
   Stock as payment of
   dividends............      920                                    (920,251)      919,331          --
  Issuance of 45,209
   shares of Series A 9%
   PIK Preferred Stock..            $45,209                                      45,163,863   45,209,072
  Costs incurred related
   to issuance of Series
   A 9% PIK Preferred
   Stock................                                                           (188,518)    (188,518)
  Accumulated dividends
   on 9% PIK Preferred
   Stock................                                              940,957                    940,957
  Accumulated dividends
   on Series A 9% PIK
   Preferred Stock......                                            1,270,649                  1,270,649
                          -------   -------  --------   --------   ----------   -----------  -----------
BALANCE, DECEMBER 31,
 1997...................  $10,920   $45,209  $    --    $    --    $1,516,355   $55,704,861  $57,277,345
                          =======   =======  ========   ========   ==========   ===========  ===========
</TABLE>


                See notes to consolidated financial statements.

                                      F-5
<PAGE>

                   USN COMMUNICATIONS, INC. AND SUBSIDIARIES

            CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' DEFICIT
                      THREE YEARS ENDED DECEMBER 31, 1997

<TABLE>
<CAPTION>
                                                           UNREALIZED
                                                              GAIN
                                 ADDITIONAL     COMMON    ON AVAILABLE-
                         COMMON    PAID-IN    STOCK HELD    FOR-SALE     ACCUMULATED
                          STOCK    CAPITAL    IN TREASURY  SECURITIES      DEFICIT         TOTAL
                         ------- -----------  ----------- ------------- -------------  -------------
<S>                      <C>     <C>          <C>         <C>           <C>            <C>
BALANCE, JANUARY 1,
 1995................... $17,784 $     5,795                            $  (7,853,789) $  (7,830,210)
  Issuance of 1,358,990
   shares of common
   stock................  13,590     251,413                                                 265,003
  Costs incurred related
   to issuance of stock.              (2,490)                                                 (2,490)
  Accumulated unpaid
   preferred dividends..                                                   (3,103,000)    (3,103,000)
  Net loss..............                                                  (18,097,026)   (18,097,026)
                         ------- -----------   --------    ----------   -------------  -------------
BALANCE, DECEMBER 31,
 1995...................  31,374     254,718                              (29,053,815)   (28,767,723)
  Conversion of Series A
   and A-2 Preferred
   Stock to Class A
   Common Stock.........  26,763  47,835,253                                              47,862,016
  Issuance of 50,000
   shares of common
   stock................     500       5,000                                                   5,500
  Compensation grants of
   220,000 shares of
   common stock.........   2,200      30,800                                                  33,000
  Repricing of common
   stock................  11,016     (11,016)
  Repurchase of 10,000
   shares of common
   stock................                        $(1,077)                                      (1,077)
  Issuance of stock
   warrants.............           6,000,000                                               6,000,000
  Accumulated unpaid
   preferred dividends..                                                   (3,690,976)    (3,690,976)
  Net loss..............                                                  (25,046,591)   (25,046,591)
                         ------- -----------   --------    ----------   -------------  -------------
BALANCE, DECEMBER 31,
 1996...................  71,853  54,114,755     (1,077)                  (57,791,382)    (3,605,851)
  Issuance of 97,251
   shares of common
   stock................     973     531,125                                                 532,098
  Compensation expense
   on stock options.....             644,538                                                 644,538
  Issuance of stock
   warrants.............          19,351,727                                              19,351,727
  Accumulated dividends
   on 9% PIK preferred
   stock................                                                     (940,957)      (940,957)
  Accumulated dividends
   on Series A 9% PIK
   preferred stock......                                                   (1,270,649)    (1,270,649)
  Unrealized gain on
   available-for-sale
   securities...........                                   $8,180,824                      8,180,824
  Net loss..............                                                 (109,891,689)  (109,891,689)
                         ------- -----------   --------    ----------   -------------  -------------
BALANCE, DECEMBER 31,
 1997................... $72,826 $74,642,145   $(1,077)    $8,180,824   $(169,894,677) $(86,999,959)
                         ======= ===========   ========    ==========   =============  =============
</TABLE>



                See notes to consolidated financial statements.

                                      F-6
<PAGE>

                   USN COMMUNICATIONS, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                             YEARS ENDED DECEMBER 31,
                                      -----------------------------------------
                                          1997           1996          1995
                                      -------------  ------------  ------------
<S>                                   <C>            <C>           <C>
Cash flows from operating
 activities:
  Net loss..........................  $(109,891,689) $(25,046,591) $(18,097,026)
  Adjustments to reconcile net loss
   to net cash flows from operating
   activities:
    Depreciation and amortization...      2,833,794       558,236     1,288,991
    Amortization of organization
     costs and intangibles..........        738,207     1,770,936       969,271
    Non-cash interest on debt
     obligations....................     15,178,742     1,654,394           --
    Stock compensation award
     expense........................        644,538        33,000           --
    Gain on disposal of assets......            --     (8,078,901)      (16,274)
    Changes in:
      Accounts receivable...........    (25,226,685)   (1,849,956)     (433,915)
      Allowance for doubtful
       accounts.....................      4,314,000        30,000       111,670
      Other current assets..........     (1,083,957)     (211,035)       13,082
      Other assets..................        (95,078)      (14,948)          --
      Accounts payable..............     12,577,514     4,819,840     1,578,757
      Accrued expenses..............      4,001,611     2,424,642       338,412
                                      -------------  ------------  ------------
        Net cash flows from
         operating activities.......    (96,009,003)  (23,910,383)  (14,247,032)
Cash flows from investing
 activities:
  Purchase of property and
   equipment........................    (15,200,557)   (2,258,969)   (1,739,542)
  Purchase of licensing agreement...       (900,000)          --            --
  Proceeds from sale of assets......            --      9,532,600           --
  Purchase of subsidiary............            --            --       (892,287)
  Proceeds from note receivable.....            --            --         76,204
                                      -------------  ------------  ------------
        Net cash flows from
         investing activities.......    (16,100,557)    7,273,631    (2,555,625)
Cash flows from financing
 activities:
  Proceeds from Senior Notes........    100,001,902    30,203,375           --
  Proceeds from Convertible
   Subordinated Discount Notes......            --     27,644,400           --
  Debt acquisition costs............     (4,714,829)   (2,920,239)          --
  Issuance of preferred stock.......     45,209,072    10,000,000    26,235,000
  Issuance of common stock..........        532,098         5,500       265,003
  Cost incurred related to issuance
   of stock.........................       (484,775)     (179,815)     (250,000)
  Repurchase of common stock........            --         (1,077)          --
  Deposits..........................       (958,824)     (494,603)      (20,855)
  Repayment of capital lease
   obligations and notes payable....       (839,144)     (217,939)     (180,215)
  Payments on assumed indebtedness..            --       (350,412)   (1,459,458)
                                      -------------  ------------  ------------
        Net cash flows from
         financing activities.......    138,745,500    63,689,190    24,589,475
                                      -------------  ------------  ------------
Net increase in cash................     26,635,940    47,052,438     7,786,818
Cash and cash equivalents--Beginning
 of year............................     60,818,478    13,766,040     5,979,222
                                      -------------  ------------  ------------
Cash and cash equivalents--End of
 year...............................  $  87,454,418  $ 60,818,478  $ 13,766,040
                                      =============  ============  ============
</TABLE>

Supplemental cash flow information--See Note 3

                See notes to consolidated financial statements.

                                      F-7
<PAGE>

                   USN COMMUNICATIONS, INC. AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                         YEARS ENDED DECEMBER 31, 1997

1. ORGANIZATION

  USN Communications, Inc. ("USN"), was incorporated under the laws of the
State of Delaware on April 20, 1994 and was initially funded in 1994 through
capital contributions totaling $15 million in cash, before financing costs. In
1995, 1996 and 1997, USN received additional capital contributions of
approximately $26 million, $10 million and $45 million, respectively. USN
holds controlling investments in four companies: US Network Corporation, USN
Communications Northeast, Inc. ("USNCN"), USN Communications Midwest, Inc and
USN Solutions, Inc. USN and its subsidiaries operate in a single business
segment, primarily as a reseller of a broad range of telecommunication
services in various cities in the Midwest and the Northeast regions of the
United States.

2. SUMMARY OF ACCOUNTING POLICIES

  A summary of the significant accounting policies applied in the preparation
of the accompanying consolidated financial statements follows:

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

  Principles of Consolidation--The accompanying consolidated financial
statements include the accounts of USN Communications, Inc. and its
subsidiaries (the "Company"). Significant intercompany balances and
transactions have been eliminated in consolidation.

  Revenue Recognition--The Company recognizes revenues in the period in which
telephone services are provided. For the operating unit which the Company has
operated as a commission agent only, revenues are recorded at the net
commissions earned.

  Cash and Cash Equivalents--Cash and cash equivalents are defined as cash in
banks, time deposits and highly liquid short-term investments with initial
maturities from dates of acquisition of three months or less.

  Fair Value of Financial Instruments--The carrying values of financial
instruments included in current assets and liabilities approximate fair values
due to the short-term maturities of these instruments. At December 31, 1997
and 1996, the fair value of long-term liabilities was approximately
$186,339,000 and $59,864,000, respectively.

  Marketable Equity Securities--All marketable securities are classified as
available-for-sale and are available to support current operations or to take
advantage of other investment opportunities. These securities are stated at
estimated fair value based upon market quotes. Unrealized gains and losses are
computed on the basis of specific identification and are included in Common
Stockholders' Deficit.

  Concentration of Credit Risk--Financial instruments which potentially
subject the Company to concentration of credit risk consist principally of
trade receivables. The Company's customers are concentrated in two specific
geographic regions, the Midwest and the Northeast. No single customer
accounted for a significant amount of the Company's sales in 1997, 1996 or
1995, and there were no significant accounts receivable from a single customer
at December 31, 1997 or 1996. The Company reviews a customer's credit history
before extending credit. The Company establishes an allowance for doubtful
accounts based upon factors surrounding the credit risk of specific customers,
historical trends and other information.


                                      F-8
<PAGE>

                   USN COMMUNICATIONS, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

  Property and Equipment--Purchases of property and equipment are carried at
cost. Depreciation is provided on the straight-line basis. Furniture and
equipment are depreciated over five to ten years. Computer hardware and
software are depreciated over three to five years. Leasehold improvements and
assets leased under capital leases are amortized over the shorter of the
related lease term or the estimated useful life of the asset.

  Intangible Assets and Deferred Charges--Costs incurred in the formation of
the Company are being amortized on a straight-line basis over five years. Debt
acquisition costs are being amortized over the life of the related debt. The
value of the warrants issued with the Senior Notes is being amortized over the
life of those notes. The cost of a licensing agreement for teleconferencing
technology is being amortized over the period of its estimated benefit life.

  Impairment of Long-Lived Assets--Management reviews long-lived assets and
the related intangible assets for impairment of value whenever events or
changes in circumstances indicate the carrying amount of such assets may not
be recoverable. If the Company determines it is unable to recover the carrying
value of the assets, the assets will be written down using an appropriate
method. Management does not believe current events or circumstances provide
evidence that suggest asset values have been impaired.

  Stock-Based Compensation--During 1996, the Company implemented Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"). In accordance with the provisions of SFAS No.
123, the Company has elected to recognize compensation under the "intrinsic
value" method prescribed by Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," which requires the proforma
disclosure of net income and earnings per share as if the fair value method
had been applied.

  Earnings per Share Calculations--On December 31, 1997, the Company adopted
Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
("SFAS No. 128"), which requires the disclosure of two earnings per common
share computations; basic and diluted. Earnings per common share ("EPS") are
computed by dividing net income or loss by the weighted average number of
shares of common stock (basic) plus common stock equivalents (diluted)
outstanding during the year. As all of the Company's warrants and options are
antidilutive, they have been excluded from the calculation of diluted EPS.
Accordingly, basic EPS is equal to diluted EPS. The weighted-average number of
shares outstanding has been calculated based on historical issuances of common
stock and excludes the effect of the common stock issued in February 1998 as a
result of the initial public offering and the preferred stock conversion (see
Note 18). EPS computations for prior years have been restated to reflect this
new standard.

  New Accounting Pronouncements--In 1997, the Financial Accounting Standards
Board issued SFAS No. 130, "Reporting Comprehensive Income" ("SFAS No. 130")
and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS No. 131") and, in 1998, SFAS No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits" ("SFAS No.
132"). SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components. SFAS No. 131 establishes standards
for reporting information about operating segments and related disclosures
about products and services, geographic areas and major customers. SFAS No.
132 revises current disclosure requirements for employers' pensions and other
retiree benefits. These standards are effective for years beginning after
December 15, 1997. These standards expand or modify current disclosures and,
accordingly, will have no impact on the Company's reported financial position,
results of operations and cash flows.

  Reclassifications--Certain prior year amounts have been reclassified to
conform to the current year presentation.

                                      F-9
<PAGE>

                   USN COMMUNICATIONS, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


3. SUPPLEMENTAL CASH FLOW INFORMATION

  Supplemental cash flow information is as follows:

<TABLE>
<CAPTION>
                                                 1997        1996       1995
                                              ----------- ---------- ----------
      <S>                                     <C>         <C>        <C>
      Issuance of stock warrants............  $19,351,727 $6,000,000
                                              =========== ==========
      Capital lease obligations incurred....  $   927,954 $  591,967 $3,398,105
                                              =========== ========== ==========
      Issuance of preferred stock as payment
       of dividends.........................  $   920,251
                                              ===========
      Fair value of noncash assets acquired.                         $  414,726
      Consideration incurred in connection
       with an acquisition (including
       $950,000 in cash advances)...........                          3,104,588
                                                                     ----------
      Liabilities assumed...................                         $2,689,862
                                                                     ==========
      Note payable incurred to finance
       insurance policies...................                         $   58,650
                                                                     ==========
</TABLE>

  Cash paid for interest in 1997, 1996 and 1995 was approximately $137,500,
$32,000 and $613,000, respectively. No cash was paid in 1997, 1996 and 1995
for income taxes.

4. ACCOUNTS RECEIVABLE

  Accounts receivable at December 31 consists of the following:

<TABLE>
<CAPTION>
                                                           1997         1996
                                                        -----------  ----------
      <S>                                               <C>          <C>
      Billed........................................... $10,790,438  $3,202,338
      Unbilled.........................................  17,663,655      25,070
                                                        -----------  ----------
      Gross accounts receivable........................  28,454,093   3,227,408
      Allowance for doubtful accounts..................  (4,537,000)   (223,000)
                                                        -----------  ----------
      Net accounts receivable.......................... $23,917,093  $3,004,408
                                                        ===========  ==========
</TABLE>

  Unbilled accounts receivable comprises access charges, features and usage
for revenue earned but not yet billed to customers. Substantially all unbilled
accounts receivable were billed within 90 days after year-end.

5. SALE OF SWITCHED BASED FACILITIES

  On December 29, 1995, the Company entered into an agreement to sell its
switch-based facilities in Ohio for $9.5 million in cash and common stock of
the non-public acquiring company (the "Acquiring Company") plus the assumption
of capital and operating leases. The transaction closed on February 29, 1996
and a gain of approximately $8.1 million was realized and recorded at that
time. The Company continues to serve its Ohio customer base as a reseller of
telecommunication services. The Company remains contingently liable on capital
and operating leases assumed by the buyer until expiration. During 1998, the
Acquiring Company completed an initial public offering. Subsequently, the
Company recorded the common stock of the Acquiring Company as available-for-
sale securities and as an unrealized gain as a component of Common
Stockholders' Deficit.

                                     F-10
<PAGE>

                   USN COMMUNICATIONS, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


6. PROPERTY AND EQUIPMENT

  Property and equipment at December 31 consist of:

<TABLE>
<CAPTION>
                                                           1997         1996
                                                        -----------  ----------
      <S>                                               <C>          <C>
      Computer hardware................................ $ 6,710,094  $1,434,719
      Computer software................................   6,310,586      20,309
      Furniture and equipment..........................   5,343,297   2,485,692
      Leasehold improvements...........................   2,097,852     392,600
                                                        -----------  ----------
                                                         20,461,829   4,333,320
      Less accumulated depreciation....................  (3,659,764)   (825,970)
                                                        -----------  ----------
        Total.......................................... $16,802,065  $3,507,350
                                                        ===========  ==========
</TABLE>

7. OTHER ASSETS

  Other assets at December 31 consist of:

<TABLE>
<CAPTION>
                                                           1997        1996
                                                        ----------- -----------
      <S>                                               <C>         <C>
      Stock warrants (net of accumulated amortization:
       1997--$2,108,126; 1996--$214,286)............... $23,243,602 $ 5,785,714
      Debt acquisition costs (net of accumulated
       amortization:
       1997--$742,901; 1996--$98,064)..................   6,892,167   2,822,175
      Deposits.........................................   2,002,922   1,044,098
      Licensing agreement (net of accumulated
       amortization:
       1997--$103,968).................................     796,032
      Other............................................     467,548     710,451
                                                        ----------- -----------
        Total.......................................... $33,402,271 $10,362,438
                                                        =========== ===========
</TABLE>

8. ACCRUED EXPENSES

  Accrued expenses at December 31 consist of:

<TABLE>
<CAPTION>
                                                              1997       1996
                                                           ---------- ----------
      <S>                                                  <C>        <C>
      Payroll and benefits................................ $5,534,405 $1,515,197
      Professional services...............................    945,436    814,388
      Excise taxes........................................    110,607    575,790
      Other...............................................    587,925    271,387
                                                           ---------- ----------
        Total............................................. $7,178,373 $3,176,762
                                                           ========== ==========
</TABLE>

9. OPERATING LEASES

  The Company leases certain office space and equipment under operating leases.
Future minimum lease
commitments under noncancelable operating leases as of December 31, 1997 are as
follows:

<TABLE>
      <S>                                                            <C>
      1998.......................................................... $ 6,082,000
      1999..........................................................   5,600,000
      2000..........................................................   5,283,000
      2001..........................................................   4,885,000
      Thereafter....................................................   7,637,000
                                                                     -----------
        Total....................................................... $29,487,000
                                                                     ===========
</TABLE>

                                      F-11
<PAGE>

                   USN COMMUNICATIONS, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


  Rent expense for the years ended December 31, 1997, 1996 and 1995 was
approximately $3,869,000, $1,024,000 and $867,000, respectively.

10. PRIVATE PLACEMENT OFFERINGS

  14% Senior Notes and 9% Convertible Notes--In September 1996, the Company
received approximately $55 million in cash, net of commissions paid, in
exchange for 48,500 units consisting of $48.5 million aggregate principal
amount at maturity of 14% Senior Discount Notes ("14% Senior Notes") due 2003
and warrants to purchase 790,780 shares of Class A Common Stock, and 36,000
units consisting of $36 million aggregate principal amount at maturity of 9%
Convertible Subordinated Notes ("Convertible Notes") due 2004.

  The 14% Senior Notes were sold at a unit price, before commissions, of
$622.75 per $1,000 face amount. These notes will accrete interest at an annual
rate of 14% from September 30, 1996 to March 31, 2000. Thereafter, the notes
will bear interest at an annual rate of 14%, and will be paid semiannually in
arrears in cash.

  The Convertible Notes were sold at a unit price, before commissions, of
$767.90 per $1,000 face amount and are convertible into Class A Common Stock
at a conversion price of $10.436 per share. These notes will accrete interest
at an annual rate of 9% from September 30, 1996 to September 30, 1999.
Thereafter, the notes will bear interest at an annual rate of 9%, and will be
paid semiannually in arrears in cash.

  14 5/8% Senior Notes--In August 1997, the Company received approximately
$96.5 million in cash, net of commissions paid, in exchange for 152,725 units
consisting of $152.7 million aggregate principal amount at maturity of 14 5/8%
Senior Discount Notes due 2004 ("14 5/8% Senior Notes") and warrants to
purchase 2,053,900 shares of Class A Common Stock. In connection with this
offering, the Company paid a consent fee to the holders of the outstanding 14%
Senior Notes and Convertible Notes consisting of warrants to purchase 145,160
shares of Class A Common Stock at an exercise price of $.01 per share. The
Company also granted those holders an option, which was exercised in October
1997, to purchase up to $10.0 million in aggregate proceeds to the Company of
convertible notes of the Company ("Consent Convertible Notes") on terms
substantially similar to the existing Convertible Notes (see Note 18).
Additionally, the Company granted to holders of the 14% Senior Notes an
option, for a specified period of time, to exchange all of the 14% Senior
Notes for 14 5/8 Senior Notes having an accreted value equal to the accreted
value of such 14% Senior Notes at the time of such exchange. A portion of this
option was exercised in March 1998 (see Note 18).

  The 14 5/8% Senior Notes were sold at a unit price, before commissions, of
$654.78 per $1,000 face amount. These notes will accrete interest at an annual
rate of 14 5/8% from August 18, 1997 to August 15, 2000. Thereafter, the notes
will bear interest at an annual rate of 14 5/8% payable semiannually in
arrears in cash.

11. REDEEMABLE PREFERRED STOCK

  In September 1996, the Board of Directors and the existing shareholders
approved the conversion of all outstanding Series A 10% Senior Cumulative
Preferred Stock ("Series A") and Series A-2 10% Senior Cumulative Preferred
Stock ("Series A-2") to shares of Class A Common Stock. Prior to this
conversion, 16,200 shares of Series A and 26,235 shares of Series A-2, each
with par values of $1, were outstanding. The conversion was consummated on
September 30, 1996 and 2,676,300 shares of Class A Common Stock were issued in
exchange for the outstanding Series A and Series A-2 Preferred Stock,
including dividends accrued through the conversion date.

  In September 1996, the Board of Directors authorized the issuance of up to
30,000 shares of $1 par value preferred stock designated as 9% Cumulative
Convertible Pay-in-Kind Preferred Stock ("9% Preferred Stock"). In connection
with the private placement offering on September 30, 1996, described in Note
10, the Company

                                     F-12
<PAGE>

                   USN COMMUNICATIONS, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

issued 10,000 shares of its 9% Preferred Stock to its existing shareholders,
for an aggregate purchase price of $10.0 million.

  In August 1997, the Board of Directors authorized the issuance of up to
150,000 shares of a second series of $1 par value preferred stock designated
at 9% Cumulative Convertible Pay-In-Kind Preferred Stock, Series A ("Series A
9% Preferred Stock"). In connection with the private placement offering in
August 1997, described in Note 10, the Company issued 30,209 shares of its
Series A 9% Preferred Stock to certain of its existing stockholders and their
affiliates for an aggregate purchase price of $30.2 million.

  In October 1997, the Company issued an additional 15,000 shares of its
Series A 9% Preferred Stock for an aggregate purchase price of $15.0 million.

  Dividends--Dividends on the 9% Preferred Stock and the Series A 9% Preferred
Stock accrue semiannually at a rate of 9% per annum, are fully cumulative, and
are payable through the issuance of additional shares of 9% Preferred Stock
and Series A 9% Preferred Stock, respectively.

  Liquidation--Upon any liquidation, dissolution or winding up of the Company,
holders of the 9% Preferred Stock and the Series A 9% Preferred Stock will be
entitled to receive their full liquidation preference and stated value of
$1,000 per share, together with accrued and unpaid dividends, prior to the
distribution of any assets of the Company to the holders of Class A Common
Stock.

  Redemption--Shares of 9% Preferred Stock and Series A 9% Preferred Stock are
not redeemable at the option of the Company, but are subject to mandatory
redemption in 2006 at the stated value, together with all accrued and unpaid
dividends to the redemption date.

  Conversion--Each share of the 9% Preferred Stock and the Series A 9%
Preferred Stock is convertible into 70.623 and 113.62 shares of Class A Common
Stock, respectively, at any time, in whole or in part, at the option of the
holders thereof.

12. COMMON STOCK

  In 1996, a 1995 issuance of Class A Common Stock was repriced, whereby the
number of shares issued increased from 1,358,990 to 2,460,560 and the purchase
price decreased from $0.20 to $0.11 per share.

  In September 1997, the Board of Directors approved a nine-for-one dividend
on the Class A Common Stock. All share and per share data in these financial
statements have been retroactively adjusted to reflect this stock dividend.

  Dividends--The holders of Class A Common Stock are entitled to receive
dividends as dividends are declared by the Board of Directors of the Company
out of funds legally available therefor, provided that, if any shares of
preferred stock are at the time outstanding, the payment of dividends on the
Class A Common Stock or other distributions may be subject to the declaration
and payment of full cumulative dividends on outstanding shares of preferred
stock.

  Liquidation--Upon any liquidation, dissolution or winding up of the affairs
of the Company, whether voluntary or involuntary, any assets remaining after
the satisfaction in full of the prior rights of creditors and the aggregate
liquidation preference of any preferred stock then outstanding will be
distributed to the holders of Class A Common Stock.

                                     F-13
<PAGE>

                   USN COMMUNICATIONS, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


13. STOCK OPTION PLAN

  The Company has granted options to acquire shares of Class A Common Stock to
certain officers and other employees under the 1994 Stock Option Plan. These
options generally become exercisable at a rate of 25% every six months over a
period of two years after the date of grant, although with respect to certain
grants no vesting occurs until twelve months after the grant date.

  In connection with the financing described in Note 10 and the issuance of
the 9% Preferred Stock described in Note 11, the Company granted options to
purchase 319,610 shares of Class A Common Stock at an exercise price of $0.15
per share. These options were not issued under the 1994 Stock Option Plan, but
rather, were issued pursuant to separate stock option agreements between the
Company and the holders. As the Convertible Notes are converted to Class A
Common Stock, 66,370 of these options become exercisable and as shares of the
9% Preferred Stock are converted to Class A Common Stock, 25,324 of these
options become exercisable.

  In 1997, the Board of Directors authorized the grant of options to purchase
993,400 shares of Class A Common Stock to substantially all non-executive
officer employees of the Company and 1,137,000 shares of Class A Common Stock
to the Company's executive officers. These options have an exercise price of
$8.80 per share, with one-third of the options vesting on the earlier of the
completion of a qualified public offering of the Company's Class A Common
Stock or the first anniversary date of the grant, and an additional one-third
of the options vesting on each of the two anniversaries following the initial
vesting date. In addition, in September 1997, the Board of Directors
authorized a grant of options for 75,000 shares of Class A Common Stock to the
Company's then Chairman. These options also have an exercise price of $8.80
per share and vest upon issuance.

  Stock option transactions are summarized as follows:

<TABLE>
<CAPTION>
                                         PRICE                 PRICE             PRICE
                                          PER                   PER               PER
                              1997       SHARE      1996       SHARE     1995    SHARE
                            ---------  ---------- ---------  ---------- -------  -----
   <S>                      <C>        <C>        <C>        <C>        <C>      <C>
   Outstanding at January
    1...................... 1,108,990  $0.11-8.80   190,500  $     0.11 213,000  $0.11
   Granted................. 2,355,400   0.15-8.80 1,033,240   0.11-8.80
   Exercised...............   (37,250)       0.11   (50,000)       0.11
   Cancelled...............  (181,600)       8.80   (64,750)       0.11 (22,500)  0.11
                            ---------             ---------             -------
   Outstanding at December
    31..................... 3,245,540   0.11-8.80 1,108,990   0.11-8.80 190,500   0.11
                            =========             =========             =======
   Options exercisable at
    December 31............   557,190   0.11-8.80   106,620   0.11-8.80 100,240   0.11
                            =========             =========             =======
</TABLE>

  The following table summarizes information about options outstanding at
December 31, 1997:

<TABLE>
<CAPTION>
                                WTD. AVG.
                                REMAINING WTD. AVG.             WTD. AVG.
      RANGE OF        NUMBER     LIFE OF  EXERCISE    NUMBER    EXERCISE
   EXERCISE PRICE   OUTSTANDING CONTRACT    PRICE   EXERCISABLE   PRICE
   --------------   ----------- --------- --------- ----------- ---------
   <S>              <C>         <C>       <C>       <C>         <C>
   $0.11 to $0.15    1,016,740  8.65 yrs.   $0.15     419,690     $0.15
   $0.16 to $4.80       20,000  8.89 yrs.    4.80      10,000      4.80
   $4.81 to $8.80    2,208,800  6.88 yrs.    8.80     127,500      8.80
                     ---------                        -------
                     3,245,540                        557,190
                     =========                        =======
</TABLE>

  For proforma information regarding net loss and loss per share, the fair
value for the options awarded in 1997 and 1996 was estimated as of the date of
the grant using a Black-Scholes option valuation model with the following
weighted average assumptions for 1997 and 1996, respectively: risk-free
interest rates of 6.15% and 4.95%; dividend yields of 0%; volatility of 0%;
and an expected life of the option of ten years.

                                     F-14
<PAGE>

                   USN COMMUNICATIONS, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


  For purposes of proforma disclosures, the estimated fair value of the
options is amortized over the options' vesting period. Therefore, in the year
of adoption and subsequently affected years, the effect of applying SFAS No.
123 for providing proforma loss and loss per share are not likely to be
representative of the effects on reported income or loss in future years.

  Had compensation cost for these plans been determined based on the Black-
Scholes value at the grant dates for awards as prescribed by SFAS No. 123,
proforma net loss and loss per share for the year ended December 31, 1997
would have been:

<TABLE>
      <S>                                                         <C>
      Proforma net loss to common stockholders................... $(114,609,104)
      Proforma net loss per common share--basic and diluted......        (15.90)
</TABLE>

  The effect on the Company's reported net loss, on a proforma basis, was not
material for 1996 and 1995.

  The Black-Scholes option valuation model used by the Company was developed
for use in estimating the fair value of fully tradable options which have no
vesting restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions including the
expected stock price volatility. It is management's opinion that the Company's
stock options have characteristics significantly different from those of
traded options and, because changes in the subjective input assumptions can
materially affect the fair value estimate, the existing models do not
necessarily provide a reliable single measure of the fair value of its stock
options.

14. EMPLOYEE BENEFIT PLAN

  On January 1, 1995, the Company adopted a qualified 401(k) plan covering all
eligible employees in which the Company contributions are discretionary.
Employees are permitted to make annual contributions through salary deductions
up to 15% of their annual salary. The plan can be amended or terminated at any
time by the Board of Directors. The Company made no contributions to the plan
in 1997, 1996 or 1995.

15. INCOME TAXES


  The Company incurred net losses of $109,891,689, $25,046,591 and $18,097,026
in 1997, 1996 and 1995, respectively. Accordingly, no provision for current
federal or state income taxes has been made to the financial statements.

  The Company's deferred tax asset components at December 31 comprise:

<TABLE>
<CAPTION>
                                                        1997          1996
                                                    ------------  ------------
      <S>                                           <C>           <C>
      Net operating loss carry-forwards............ $ 57,977,000  $ 18,285,000
      Accrued liabilities and asset valuation
       reserves....................................    1,715,000       172,000
      Amortization of intangibles..................      146,000       790,000
                                                    ------------  ------------
      Subtotal.....................................   59,838,000    19,247,000
      Valuation allowance..........................  (59,838,000)  (19,247,000)
                                                    ------------  ------------
        Total...................................... $        --   $        --
                                                    ============  ============
</TABLE>

  As of December 31, 1997 and 1996, the Company had not recognized deferred
income tax assets related to deductible temporary differences and cumulative
net operating losses. The ability of the Company to fully realize

                                     F-15
<PAGE>

                   USN COMMUNICATIONS, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

deferred tax assets in future years is contingent upon its success in
generating sufficient levels of taxable income before the statutory expiration
periods for utilizing such net operating losses lapse. After an assessment of
all available evidence, including historical and projected operating trends,
the Company was unable to conclude that realization of such deferred tax
assets in the near future was more likely than not. Accordingly, a valuation
allowance was recorded to offset the full amount of such assets.

  At December 31, 1997, the Company had net operating loss carry-forwards for
income tax purposes of approximately $151,665,000. The ability of the Company
or the Company's subsidiaries, as the case may be, to utilize their net
operating loss carry-forwards to offset future taxable income may be subject
to certain limitations contained in the Internal Revenue Code of 1986, as
amended (the "Code"). These operating losses begin to expire in 2009 for
Federal income tax purposes. Of the net operating loss carry-forwards
remaining at December 31, 1997, $26,286,000 can be applied only against future
taxable income of the Company's subsidiary, USNCN.

16. MINORITY INTEREST IN USNCN

  In July 1996, all minority shareholders' interests in USNCN were
repurchased, increasing the Company's ownership of USNCN's outstanding common
stock to 100%. Prior to this transaction, no minority interest in USNCN had
been recorded, as losses applicable to the minority interest in USNCN exceeded
the minority interest in the equity capital of USNCN, and there was no
obligation of the minority interest to fund such losses.

17. COMMITMENTS

  In 1995 and 1996, the Company entered into agreements with two non-
affiliated telecommunications companies ("TelCos") to allow the Company to
resell the TelCos' local telephone service in various regional markets. The
agreements have terms of up to ten years and contain minimum purchase
commitments of local access lines, ranging from zero to 150,000 lines. These
commitments are measured by the number of lines in place on the last day of
each 12-month period. The agreements allow for ramp-up periods before any
commitment levels are required to be met. So long as the Company maintains
cumulative net shortfalls lower than established caps, no payments will be due
to the TelCos other than for normal usage. Even if no lines were sold by the
Company, the earliest required payment for any shortfall amount is in 1999.

  In July 1996, the Company entered into an agreement with a third
telecommunications company to allow the Company to resell long-distance
telephone service. The agreement is for a term of 33 months and contains an
annual purchase commitment of $12 million, with a minimum monthly commitment
of $600,000 to qualify for the contract rates. The agreement allows for a
ramp-up period before commitment levels are required to be met.

  In 1994, USNCN executed an exclusive agreement with a non-affiliated
telecommunications company ("TelCo One"), whereby TelCo One allows USNCN to
establish a local private network on its infrastructure in which to provide
service to customers. Under this agreement, TelCo One provides network
maintenance and access to telephone switches. The initial term of the
agreement expires in 2004.

18. SUBSEQUENT EVENTS

  In January 1998, the holders of the outstanding 14% Senior Notes purchased
$13.0 million aggregate principal amount at maturity of the Company's Consent
Convertible Notes, due 2006, for an aggregate purchase price of $10.0 million,
pursuant to the option exercised by the holders in October, 1997 (see Note
10). The Consent Convertible Notes were sold at a unit price, before
commissions, of $767.90 per $1,000 face amount and are convertible into Common
Stock at a conversion price of $10.121 per share. These notes will accrete
interest at an annual rate of 9% until January 13, 2001 and interest will be
paid semiannually in arrears in cash.

                                     F-16
<PAGE>

                   USN COMMUNICATIONS, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)


  In February 1998, the Company completed its initial public offering of
8,600,000 shares of its Common Stock at a price of $16.00 per share, including
600,000 shares sold in conjunction with the underwriters' over-allotment
options. In March 1998, the Company issued and sold an additional 28,861
shares of Common Stock also in conjunction with the exercise of the
underwriters' over-allotment options. The net proceeds to the Company were
approximately $127.0 million (after deducting underwriting discounts,
commissions and offering expenses). In conjunction with the initial public
offering, all of the Company's outstanding 9% Preferred Stock and Series A 9%
Preferred Stock, including dividends accrued through the conversion date, were
converted to 6,130,175 shares of Class A Common Stock. Subsequently, all of
the Company's Class A Common Stock was converted to an equal amount of the
Company's newly created Common Stock.

  In February 1998, the Company used a portion of the net proceeds from its
initial public offering to acquire all of the outstanding capital stock of
Hatten Communications Holding Company, Inc., a Connecticut corporation
("Hatten Communications"), pursuant to a Stock Purchase Agreement dated
January 7, 1998, for approximately $68.0 million, including the repayment of
approximately $14.0 million of existing indebtedness. Hatten Communications
had net revenues for the year ended December 31, 1997 of $41.1 million
(unaudited).

  The unaudited pro forma information below presents redeemable preferred
stock and common stockholders' equity as if the initial public offering, the
Acquisition, and the conversion of all of the Company's outstanding preferred
stock had occurred at December 31, 1997 and presents combined results of
operations as if such events had occurred at the beginning of the respective
years presented. The unaudited information is not necessarily indicative of
the results of operations of the combined company had the acquisition occurred
at the beginning of the years presented, nor is it necessarily indicative of
future results.

<TABLE>
<CAPTION>
                                                        DECEMBER 31, 1997
                                                   ----------------------------
                                                    HISTORICAL      PRO FORMA
                                                   -------------  -------------
      <S>                                          <C>            <C>
      Redeemable preferred stock.................. $  57,277,345
                                                   =============
      Common stockholders' equity (deficit):
        Common stock.............................. $      72,826  $     219,810
        Additional paid-in capital................    74,642,145    258,769,958
        Treasury stock............................        (1,077)        (1,077)
        Unrealized gain on available-for-sale
         securities...............................     8,180,824      8,180,824
        Accumulated deficit.......................  (169,894,677)  (169,894,677)
                                                   -------------  -------------
          Total common stockholders' equity
           (deficit).............................. $ (86,999,959) $  97,274,838
                                                   =============  =============
<CAPTION>
                                                     PRO FORMA      PRO FORMA
                                                       1997           1996
                                                   -------------  -------------
      <S>                                          <C>            <C>
      Net service revenue......................... $  88,309,027  $  40,131,404
      Net loss....................................  (119,327,927)   (33,805,690)
      Net loss per common share--basic and
       diluted....................................         (5.45)         (1.72)
</TABLE>

  In March 1998, the holders of the 14% Senior Notes exchanged $31.5 million
aggregate principal amount at maturity of the Company's 14% Senior Discount
Notes due 2003 for $33.6 million aggregate principal amount at maturity of the
Company's 14 5/8% Senior Discount Notes due 2004 pursuant to an option
previously granted by the Company.

                                     F-17
<PAGE>

                   USN COMMUNICATIONS, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)


19. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

<TABLE>
<CAPTION>
                            FIRST         SECOND        THIRD         FOURTH
                           QUARTER       QUARTER       QUARTER       QUARTER
                         ------------  ------------  ------------  ------------
<S>                      <C>           <C>           <C>           <C>
1997
  Net service revenue... $  3,916,839  $  7,804,451  $ 15,277,025  $ 20,202,118
  Gross margin..........      481,817       719,638     1,813,735     2,912,645
  Net loss..............  (17,560,905)  (26,701,836)  (29,374,688)  (36,254,260)
  Net loss per common
   share--basic and
   diluted..............        (2.48)        (3.73)        (4.15)        (5.18)
1996
  Net service revenue... $  2,280,629  $  2,522,928  $  2,795,148  $  2,215,774
  Gross margin..........      319,976       405,345       286,258      (453,572)
  Net income (loss).....    3,987,517    (4,714,636)   (6,492,025)  (17,827,447)
  Net income (loss) per
   common share--basic
   and diluted..........         0.23         (2.54)        (1.65)        (3.54)
</TABLE>

  The total of quarterly net income or loss per common share may not equal the
annual amount because net income or loss per common share is calculated
independently for each quarter.

                                      F-18
<PAGE>

                 SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
                                              ADDITIONS
                                   BALANCE AT CHARGED TO ADJUSTMENTS BALANCE AT
                                   BEGINNING  COSTS AND      AND        END
           DESCRIPTION             OF PERIOD   EXPENSES  CHARGE-OFFS OF PERIOD
           -----------             ---------- ---------- ----------- ----------
<S>                                <C>        <C>        <C>         <C>
Year Ended December 31, 1997:
  Allowance for Doubtful Accounts.  $223,000  $4,705,000  $(391,000) $4,537,000
                                    ========  ==========  =========  ==========
Year Ended December 31, 1996:
  Allowance for Doubtful Accounts.  $193,000  $   30,000  $     --   $  223,000
                                    ========  ==========  =========  ==========
Year Ended December 31, 1995:
  Allowance for Doubtful Accounts.  $    --   $  193,000  $     --   $  193,000
                                    ========  ==========  =========  ==========
</TABLE>

                                      F-19