News Column

TW TELECOM INC. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

February 14, 2014

The following discussion and analysis should be read in conjunction with the "Selected Financial Data" and the accompanying consolidated financial statements and related notes thereto, included elsewhere in this report. This section and other parts of this report contain forward-looking statements that involve risks and uncertainties. See "Caution Regarding Forward-Looking Statements" at the beginning of this report. Forward-looking statements are not guarantees of future performance, and our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in the subsection entitled "Risk Factors" above. We assume no obligation to revise or update any forward-looking statements for any reason, except as required by law. Overview We are a leading national provider of managed network services, specializing in business Ethernet, data networking, converged, IP VPN, Internet access, voice, including VoIP, and network security services to enterprise organizations, including public sector entities, and carriers throughout the U.S., including their global locations. Our revenue is derived from business communication services, including data, high-speed Internet access, network and voice services. Our customers include enterprise organizations in a wide variety of industry segments including, among others, the financial services, technology and scientific, health care, distribution, manufacturing and professional services industries, data centers, cloud application providers, public sector entities, system integrators and communications service providers, including ILECs, CLECs, wireless communications companies and cable companies. Through our subsidiaries, we serve 75 metropolitan markets with local fiber networks that are connected to our regional fiber facilities and national IP backbone. As of December 31, 2013, our fiber network spanned over 30,000 route miles (including approximately 23,000 metropolitan route miles) connecting to 20,255 buildings served directly by our metropolitan fiber facilities. Included in the total buildings served directly by our local fiber facilities are approximately 470 third party data centers across the country where customers deploy their own equipment or connect to cloud application providers. In 2013, we added approximately 2,300 new buildings directly connected to our network. In addition, we are able to extend our reach beyond our fiber networks by providing off-network solutions to customers within and outside our 75 markets. We continue to extend our fiber footprint within our existing markets by connecting our network into additional locations and to expand our data, voice and IP networking capabilities between our markets, supporting secure end-to-end business Ethernet, IP VPN and converged solutions for customers. Unless otherwise indicated, information contained in this Annual Report on Form 10-K regarding our U.S. metropolitan markets and fiber network route miles does not give effect to our strategic market expansion discussed below. In November 2013, we announced a strategic market expansion, which we expect to increase our addressable market by expanding our metropolitan fiber route miles by approximately 17%, including entry into five new markets and accelerating density of our metropolitan fiber footprint in 27 existing markets. The new markets are Boston, Philadelphia, Cleveland, Richmond and Salt Lake City. As part of this expansion, we are also increasing our regional fiber footprint for greater capacity, increased network control and more cost effective connectivity. To facilitate this expansion, we entered into long-term capital leases for fiber that we plan to light with our own electronics. The initial term of the leases is 20 years, with two ten-year renewals at our option, and automatic annual renewals thereafter until termination by either party. We plan to integrate our expanded fiber with our networks, technology, data and tools by the end of 2014 in order to be able to provide our advanced services to those areas, and throughout 2013 to activate new routes in our new and existing markets for sales of services to our customers. We recognized a right-to-use asset and corresponding capital lease obligation of $119.8 million in the three months ended December 31, 2013, representing the present value of the minimum commitment under the fiber leases, which are expected to result in aggregate committed lease payments over the initial 20 year lease term of $216.5 million. Revenue Trends Although we analyze revenue by customer type, we present our financial results as one segment across the U.S. because our business is centrally managed. The percentage of revenue by customer type for each of the past three years is as follows: Revenue 2013 2012 2011 Enterprise / End Users 80 % 79 % 77 % Carrier 18 % 19 % 21 %



Intercarrier Compensation 2 % 2 % 2 %

100 % 100 % 100 % 33



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

Table of Contents

Total Revenue Our revenue has grown sequentially for the past 37 consecutive quarters through December 31, 2013, including throughout various economic cycles. Our annual year-over-year revenue growth rate increased over each of the years ended December 31, 2010, 2011 and 2012 and was 5.1%, 7.4% and 7.6%, respectively. These higher year-over-year revenue growth rates were primarily due to increased demand, low revenue churn and an increase in certain taxes and fees that are reported on a gross versus net basis in revenue and expense. We also believe that our new and enhanced services, our customer experience initiatives to increase customer loyalty and retention and improved economic conditions contributed to our growing revenue. In 2012, we began to experience lower year-over-year quarterly revenue growth rates compared to the same periods in the prior year and continued to experience a lower year-over-year revenue growth rate in the three months ended December 31, 2013. In addition, our 2013 annual revenue growth rate of 6.4% was lower than the prior year. In 2013, we commenced several growth initiatives focused on increasing sales to capture growing market demand and share and designed to increase our revenue growth rate. In the second half of 2013, we had higher growth in our sales, or "bookings" (i.e., signed contracts), and service installations year over year, which we believe was the result of our growth initiatives. Accordingly, we expect our 2014 revenue growth rate to be higher than our 2013 revenue growth rate, absent unforeseen circumstances, although we may experience fluctuations in our quarterly revenue growth rates. Due to the time required to obtain or build necessary facilities, obtain rights to install equipment in multi-tenant buildings and other factors related to service installation, some of which are not within our control, there is often a lag between the time that a sale is made, and the time revenue commences. Our installation intervals are generally longer for more complex solutions delivered to our customers. In some situations, the timing of service installations may be subject to factors that our customers control, such as their readiness for us to install equipment on their premises or the readiness of their equipment. Due to all of these factors, installation intervals may range between two weeks for single-site, less complex services to 6 to 12 months or longer for more complex solutions. We believe that increasing our rate of revenue growth will depend on increasing sales and service installations to keep pace with the growing total base of revenue, retaining revenue from existing customers and a stronger economy. We expect our future revenue growth to be driven in part by the increasingly web-based economy and developing IT strategies such as cloud computing, collaboration, data center connectivity and disaster recovery, all of which require the reliable connectivity and network capacity that we provide. We also expect that our advanced service capabilities and national footprint will drive more demand for our existing Ethernet, managed and Internet service suites, enhance our future data and Internet services revenue growth and enable us to serve more customers with multi-point, multi-city locations. Enterprise Customer Revenue Revenue from enterprise customers has increased sequentially for the past 46 consecutive quarters through December 31, 2013 and increased 9.4%, 10.5% and 8.2% for the years ended December 31, 2011, 2012 and 2013 over the respective prior years primarily due to increased installations of our data and Internet services such as business Ethernet, managed and Internet services. Revenue from our enterprise customers represented 80% of our total revenue for the year ended December 31, 2013. We expect our future revenue growth to come primarily from enterprise customers, including our current customer base, largely due to our advanced network capabilities, growth initiatives, including the expansion of our sales and sales support personnel and services portfolio, and strategic market expansion. Carrier Customer Revenue Our carrier revenue represented 18% of total revenue for the year ended December 31, 2013. Carrier revenue has been declining as a percentage of revenue due to the higher contribution from enterprise customer revenue coupled with continued disconnections and repricing of carrier contracts upon renewals somewhat offset by higher installed sales of Ethernet services to carriers to serve their end users' needs. Carrier revenue from wireless providers represented 28% and 30% of total carrier revenue for the years ended December 31, 2013 and 2012, respectively. We expect that our expanded service offerings to our wholesale customers will continue to contribute to carrier revenue; however, our carrier revenue historically has been impacted by pricing declines in connection with carrier customer contract renewals, disconnections resulting from price competition from other carriers, network grooming and carrier consolidation that inhibits the growth rate of carrier revenue. We expect these impacts on our carrier revenue to continue and to fluctuate from quarter to quarter. Intercarrier Compensation Revenue Intercarrier compensation revenue, which consists of switched access services and reciprocal compensation, represented 2% of our total revenue for the year ended December 31, 2013, and is expected to decline in the future as a percentage of total revenue due to federal and state mandated rate reductions for terminating traffic and changes in the regulatory regime for 34



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

Table of Contents

intercarrier compensation. Under a 2011 FCC order, intercarrier compensation rates are declining over a six-year period that began in 2012 with rate decreases occurring in July of each year through 2017. These rate decreases resulted in an approximately $4.0 million decline in intercarrier compensation revenue in the year ended December 31, 2013 compared to 2012 and we expect to lose approximately $4.0 million in the year ended December 31, 2014 compared to 2013 that we believe may be somewhat offset by growth in minutes of use. In addition, we expect that intercarrier compensation revenue will fluctuate based on variations from period to period in minutes of use originating and terminating on our network and fluctuations in carrier settlements. Revenue and Customer Churn Revenue churn, defined as the average lost recurring monthly billing for the period from a customer's partial or complete disconnection of services (excluding pricing declines upon contract renewals and lost usage revenue) compared to reported revenue, is a measure used by management to evaluate revenue retention. Customer and service disconnections occur as part of the normal course of business and are primarily associated with price competition from other providers, customers moving facilities to other locations and network grooming, business contractions, financial difficulties and consolidation, among other reasons. Revenue churn was 0.9% of monthly revenue in each of the years ended December 31, 2011, 2012 and 2013, reflecting improvement from the last recessionary period. We believe that this improvement in revenue churn is a result of improved economic conditions as well as our expanded service portfolio, measures we put in place to increase revenue retention and our customer experience initiatives. As a component of revenue churn, revenue lost from customers fully disconnecting services was 0.2% for each of the years ended December 31, 2011, 2012 and 2013. We continue our initiatives to maintain revenue churn that is low relative to our industry, but do not expect contribution to our revenue growth rate from a lower revenue churn rate. If our revenue churn were to increase, our revenue growth would likely be negatively impacted. If we experience another adverse economic cycle, we could experience higher revenue churn that would likely negatively impact our revenue growth. We cannot predict the total impact on revenue from future customer disconnections or the timing of such disconnections or whether these favorable churn trends will continue. Customer churn, defined as the average monthly customer turnover for the period compared to the average monthly customer count for the period, was 1.0%, 1.0% and 0.9% for the years ended December 31, 2011, 2012 and 2013, respectively. The majority of this churn came from our smaller customers, which we expect will continue. Pricing We experience significant price competition from the ILECs, CLECs and cable companies across our service categories that impacts our revenue. We also believe that technology advancements over the years in the telecommunications industry have resulted in lower unit costs for some electronics and equipment that drives customer demand for higher bandwidth at the same or lower prices. Service agreements in our industry typically range from two to five years, with fixed pricing for the contract term. When contracts are renewed with no changes to the services, pricing is frequently reduced to current market levels as a renewal incentive. The impact of those price reductions on our revenue may fluctuate from quarter to quarter. In addition, during the terms of agreements, customers often purchase additional services or increase or decrease the bandwidth of existing services, subject to applicable early termination charges, depending on their business needs. In some cases, the impact of re-pricing is mitigated by customers' purchases of additional bandwidth or services. Expenses and Modified EBITDA Trends Pricing of Special Access Services We purchase a substantial amount of special access services primarily from ILECs to expand the reach of our network. While these ILEC services are regulated in part, the ILECs are advocating before the FCC for less regulation (see "Business--Regulatory Environment"). If the special access services we buy from the ILECs were to be further deregulated, ILECs would have a greater ability to increase the prices and reduce the service quality of special access services they sell to us. As the prices we must pay for special access services increase, our margins may be pressured. Modified EBITDA Trends and Growth Initiatives We regularly implement various initiatives designed to expand our revenue growth, Modified EBITDA margin (see Note 6 to the table under "Item 6. Selected Financial Data" for a definition of Modified EBITDA margin) and cash flow that require both capital and operating investments, which can temporarily impact our Modified EBITDA margin until growth in revenue 35



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

Table of Contents

absorbs the increased costs. We believe that these initiatives resulted in growth of our revenue, Modified EBITDA margin and cash flows during the three years ended December 31, 2012. Modified EBITDA (see Note 4 to the table under Item 6. Selected Financial Data for a definition of Modified EBITDA) grew 7.4%, 8.6%, and 2.2% in the years ended December 31, 2011, 2012 and 2013, respectively, each compared to the prior year. Modified EBITDA margin was 36.4%, 36.8% and 35.3% for the years ended December 31, 2011, 2012 and 2013, respectively. These margins reflected the absorption of increased costs for network access due to higher prices and greater off-network reach and costs associated with growth initiatives designed to increase the rate of revenue growth, including further expansion of our sales and support staff and IT and technical personnel. These margins were also impacted by the dilutive effect of certain taxes and fees that are reported on a gross versus net basis in revenue and expense (see "Revenue" in Note 1 to the consolidated financial statements). Costs associated with growth initiatives had a greater impact on Modified EBITDA margin in the year ended December 31, 2013 than in the years ended December 31, 2012 and 2011. In 2013 our growth initiatives required both capital and operating investments and we expect to continue these investments in 2014, including hiring additional sales, support and other operational personnel to support our strategic market expansion. Our capital investments in support of our growth initiatives include new service development, automation and strategic network expansions to reach additional customers. The majority of the decline in Modified EBITDA margin for the year ended December 31, 2013 compared to the prior year, was the result of the costs associated with our growth initiatives. We expect the continued investments and expenses associated with our growth initiatives and market expansion (see "Overview" above) will continue to pressure our Modified EBITDA margin and cash flow in the near term until we can achieve consistently higher service installations and an acceleration of our rate of revenue growth sufficient to absorb these higher costs. While these initiatives and market expansion are designed to increase sales in the longer term to accelerate our future revenue growth rate, we cannot assure that these and other initiatives will be sufficient to achieve our objectives of increased revenue growth, margins and cash flow or the timing of such anticipated benefits. We believe that future margin expansion will come from higher service installations, further leveraging our on-network facilities and increasing the network density of our less mature markets, since over the long term we have generally experienced margin improvement and increased cash flow from our less dense markets as those markets are expanded through on-net building additions and other network expansions. We believe that our strategic market expansion within our existing markets gives us an opportunity to accelerate the increase of network density in many of our existing markets which, if successful, we expect to lead to margin improvement and stronger cash flow generation over time. The expected reductions in intercarrier compensation revenue discussed above under "Revenue Trends" are also expected to pressure our margins because of the relatively high margins associated with that revenue. Our revenue and margins may also be impacted by, among other risks, economic fluctuations, competitive pressures, higher special access costs including from growth in multi-location customer solutions driven by demand, fuel and energy costs, fluctuations in certain taxes and fees and any future inflationary pressures. Seasonality and Fluctuations We continue to expect business fluctuations to impact sequential quarterly trends in revenue, margins and cash flow. This includes the timing, as well as any seasonality, of sales and service installations, usage, rate changes, disputes, settlements, repricing for contract renewals and fluctuations in revenue churn, especially from carrier customers, expenses, capital expenditures and certain taxes and fees. Historically, our expense in the first quarter has been impacted by the resetting of payroll taxes in the new year. Our past experience with quarterly fluctuations may not necessarily be indicative of future results. Because we generally do not recognize revenue subject to billing disputes until the dispute is resolved, the timing of dispute resolutions and settlements may positively or negatively affect our revenue in a particular quarter. The timing of disconnections may also impact our results in a particular quarter, with disconnections early in the quarter generally having a greater impact. The timing of capital and other expenditures may affect our margins or cash flow. The convergence of any of these or other factors such as fluctuations in usage, increases or decreases in certain taxes and fees or pricing declines upon contract renewals in a particular quarter may result in our revenue growing more or less than previous trends, may impact our margins and other financial results. 36



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

Table of Contents

Critical Accounting Policies and Estimates We prepare our financial statements in accordance with accounting principles generally accepted in the United States, which require us to make estimates and assumptions that affect reported amounts and related disclosures. We consider an accounting estimate to be critical if: it requires assumptions to be made that were uncertain at the time the estimate was made; and changes in the estimate or different estimates that could have been selected could have a material impact on our consolidated results of operations or financial condition. Goodwill We perform impairment tests at least annually on all goodwill as required by relevant accounting standards, which require goodwill to be assigned to a reporting unit and tested using a consistent measurement date. For purposes of testing goodwill for impairment, our goodwill has been assigned to our one consolidated reporting unit and our test is performed in the fourth quarter of each year or more frequently if impairment indicators arise. In reviewing goodwill for impairment we have the option to (i) assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount or (ii) bypass the qualitative assessment and proceed directly to a quantitative assessment. For our assessment in the year ended December 31, 2013, we opted to bypass the qualitative assessment and proceed directly to the quantitative assessment, which utilizes a two-step process. The first step is to identify if a potential impairment exists by comparing the fair value of the reporting unit to its carrying amount. If the fair value of the reporting unit exceeds its carrying amount, goodwill is not considered to have a potential impairment and the second step of the impairment test is not necessary. However, if a potential impairment exists, the fair value of the reporting unit is compared to the fair value of its assets and liabilities, excluding goodwill, to estimate the implied value of the reporting unit's goodwill. If an impairment charge is deemed necessary, a charge is recognized for any excess of the carrying amount of the reporting unit's goodwill over the implied fair value. Considerable management judgment is necessary to estimate the fair value of our reporting unit and goodwill. We determine the fair value of our reporting unit based on the income approach, using a discounted projection of future cash flows which includes a five-year annual discounted cash flow ("DCF") analysis with a terminal value to value the long-term future cash flows. This DCF analysis was used solely for the purpose of evaluating our goodwill for impairment and should not be interpreted as our prediction of future performance. The assumptions used in our DCF analysis are consistent with the assumptions we believe hypothetical marketplace participants would use. With respect to our DCF analysis, the timing and amount of future cash flows requires critical management assumptions, including estimates of expected future revenue growth rates, Modified EBITDA contributions, expected capital expenditures and an appropriate discount rate and terminal value. Our growth rate assumptions for this purpose are based on product and technology investments, fiber network expansions, changes in our underlying cost structure, market trends and historical results, among other items. In determining the fair value of our reporting unit for purposes of our assessment for the year ended December 31, 2013, we considered our five-year historical cumulative annualized growth rates for unlevered free cash flow (Modified EBITDA less capital expenditures) of 5.1%, excluding a large capital lease commitment and integration and branding costs that are not expected to recur. We applied a terminal multiple to estimated year five Modified EBITDA based on our long-term cash flow growth expectations, which considers our expected operating performance and industry performance, to determine terminal value. The terminal value represents a significant portion of the resulting fair value of our reporting unit and therefore we compared the results to a growth model that estimates the value of future cash flow to perpetuity to assess the reasonableness. Projected cash flows were discounted to their present value using a discount rate of 8%, which represents a market-based participant weighted average cost of capital and may reflect the rate of return an outside investor would expect to earn. To corroborate the reasonableness of the resulting fair value of our reporting unit, we also considered our market capitalization at the date the test was performed. The determination of fair value requires significant estimates and assumptions, which are subject to inherent uncertainties. Although our cash flow projections over the most recent three-year period have been reasonable compared to our actual results, actual results may vary significantly from estimates. Our methodology for our 2013 assessment was consistent with the methodology used in the prior year period. Our 2013 assessment resulted in the determination that the carrying value of our reporting unit does not exceed its fair value. To assess the sensitivity of the assumptions used in our DCF analysis, we applied reductions of 20% to our critical estimates to test for impairment, which we believe represents a reasonable change to our assumptions. When we applied a hypothetical two percentage point increase in the weighted average cost of capital, the resultant reduction in our fair value calculation would not have resulted in an impairment under our 2013 assessment. To assess the sensitivity of our future cash flow estimates including the terminal value used to derive the reporting unit's fair value, we applied a hypothetical reduction of 20% to the estimated fair value of our reporting unit. The resultant reduction in fair value would not have resulted in an 37



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

Table of Contents

impairment under our 2013 assessment. We are not aware of any reasonably likely changes in our assumptions that would result in an impairment. Impairment of Long-lived Assets We perform an assessment of our long-lived assets, including property, plant and equipment and finite-lived intangible assets, whenever events and circumstances indicate that the carrying amount of such assets may not be recoverable. An impairment loss may exist when the estimated undiscounted cash flows attributable to the assets are less than their carrying amount. If an asset is deemed to be impaired, the amount of the impairment loss recognized represents the excess of the long-lived asset's carrying value as compared to its estimated fair value, based on management's assumptions and projections. Estimates are used to determine whether sufficient cash flows will be generated to recover the carrying amount of our investments in long term assets. The estimates are made for each of our seven geographic regions. Expected future cash flows are based on historical experience and management's expectations of future performance. The assumptions used represent our best estimates including market growth rates, future pricing, market acceptance of our products and services and the future capital investments necessary. Although events and circumstances in 2013 did not indicate that the carrying amount of such assets may not be recoverable, we performed a recoverability test. Our 2013 assessment did not result in any impairment charges. A hypothetical 20% reduction in our projected Modified EBITDA for each region would not have resulted in an impairment as of December 31, 2013. Regulatory and Other Contingencies We are subject to significant government and jurisdictional regulation, some of which is uncertain due to legal challenges of existing rules. Such regulation is subject to differing interpretations and inconsistent application, and has historically resulted in disputes with other carriers, regulatory authorities and municipalities regarding the classification of traffic, rates, minutes of use and right-of-way fees. Management estimates and accrues for its estimate of probable losses associated with regulatory and other contingencies. These estimates are based on assumptions and other considerations including expectations regarding regulatory rulings, historic experience and ongoing negotiations. We evaluate these reserves on an ongoing basis and make adjustments as necessary. A 10% unfavorable or favorable change in the estimates used for such reserves would have resulted in approximately a $6.1 million decrease or $3.8 million increase, respectively, in net income for the year ended December 31, 2013. Deferred Tax Accounting We have had a history of NOLs for tax purposes. When it is more likely than not that all or some portion of deferred tax assets may not be realized, we establish a valuation allowance for the amount that may not be realized. Each quarter we evaluate the need to retain all or a portion of the valuation allowance on our net deferred tax assets. We believe it is more likely than not that deferred tax assets resulting from NOLs subject to certain limitations and those that require future income of special character will not be realized. Additionally, we have certain deferred tax assets attributable to stock option deductions for which the related valuation allowance cannot be reversed due to relevant accounting guidance concerning tax benefits related to the exercise of non-qualified stock options prior to the adoption of such accounting guidance. Therefore, we continue to maintain a valuation allowance against deferred tax assets totaling $27.0 million. As of December 31, 2013, we had NOLs for federal income tax purposes of approximately $800 million. If not utilized to reduce taxable income in future periods, these NOLs generally expire in various amounts beginning in 2022 and ending in 2026. We utilized NOLs to offset income tax obligations in each of the tax returns filed for the years ended December 31, 2008 through 2012. The Tax Reform Act of 1986 contains provisions that limit the utilization of NOLs if there has been an "ownership change" as described in Section 382 of the Internal Revenue Code. In general, this would occur if certain ownership changes related to our stock that is held by 5% or greater stockholders exceeds 50 percent measured over a rolling three year period. If we experience such an ownership change, our utilization of NOLs to reduce future federal income tax obligations could be limited. In order to reduce the likelihood of an ownership change as defined by Section 382, our Board may adopt a rights plan in the future as they have previously, subject to subsequent ratification by our stockholders, if it determines that our substantial NOLs are at risk of limitation under Section 382 or that such action otherwise is in the best interests of our stockholders. 38



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

Table of Contents

Revenue and Receivables Our services are complex and our tariffs and contracts may be correspondingly complex and subject to interpretations that cause disputes regarding amounts billed. In addition, changes in and interpretations of regulatory rulings create uncertainty and may cause disputes over minutes of use, rates or other provisions of our service. As such, we defer recognition of revenue until cash is collected on certain components of revenue, such as contract termination charges. We also reserve for customer billing disputes until they are resolved even if the customer has already paid the disputed amount. We estimate the ability to collect our receivables by performing ongoing credit evaluations of our customers' financial condition, and provide an allowance for doubtful accounts based on expected collection of our receivables. Our estimates are based on assumptions and other considerations, including payment history, credit ratings, customer financial performance, industry financial performance and aging analysis. As a result of an improvement in our collection activities, our overall receivables management and an improving economy, our allowance for doubtful accounts as a percentage of gross receivables has improved from 8% at December 31, 2011 to 7% at December 31, 2012 and 6% at December 31, 2013. A 10% change in the estimates used for our allowance for doubtful accounts would not have resulted in a material change in net income for the year ended December 31, 2013. Other Estimates There are other accounting estimates reflected in our consolidated financial statements, including contingent loss accruals, compensation accruals, unpaid claims for medical and other self-insured plans, property and other tax exposures and asset retirement obligations and asset lives that require judgment but are not deemed critical in nature. We believe that the current assumptions and other considerations used to estimate amounts reflected in the consolidated financial statements are appropriate. However, if actual experience differs from the assumptions and other considerations used in estimating amounts reflected in the consolidated financial statements, the resulting changes could have a material adverse effect on our results of operations and, in certain situations, on our financial condition.



Results of Operations The following discussion provides analysis of our results of operations and should be read together with our audited consolidated financial statements, including the notes thereto, appearing elsewhere in this report:

2013 Compared to 2012

Revenue

Revenue by line of business was as follows (amounts in thousands):

Year Ended December 31, 2013 2012 $ Change % Change Revenue (1): Data and Internet services $ 851,297$ 746,297$ 105,000 14.1 % Voice services 373,666 363,743 9,923 2.7 % Network services 308,818 330,088 (21,270 ) (6.4 )% Intercarrier compensation 30,120 30,127 (7 ) - % Total revenue $ 1,563,901$ 1,470,255$ 93,646 6.4 % ___________________



(1) We classify certain taxes and fees billed to customers and remitted to

government authorities on a gross versus net basis in revenue and expense.

The total amounts classified as revenue, primarily included in voice

services, associated with such taxes and fees were approximately $83.2

million and $79.8 million for the years ended December 31, 2013 and 2012,

respectively. This has no impact on Modified EBITDA or net income but is dilutive to Modified EBITDA margin. 39



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

Table of Contents

The primary driver of total revenue growth was increased data and Internet services revenue from installed services to enterprise customers. The increase in data and Internet services revenue primarily resulted from installations of strategic Ethernet and VPN-based services and other services to enterprise customers, partially offset by service disconnections and re-pricing of renewed customer contracts at lower rates. Strategic services, which includes Ethernet and IP VPN services, constituted 55% of data and Internet services revenue for the year ended December 31, 2013 compared to 53% for the year ended December 31, 2012, representing 19% year over year growth in revenue from these services. Voice services revenue increased primarily as a result of certain taxes and fees remitted to government authorities that we classify on a gross versus net basis in revenue and expense and installations of converged and other voice services, partially offset by service disconnections and re-pricing of renewed customer contracts at lower rates. Revenue from services based on minutes of use by customers included in voice services was 3% of our total revenue for both of the years ended December 31, 2013 and 2012. Network services revenue decreased primarily due to service disconnections largely from carriers and re-pricing of renewed customer contracts at lower rates, somewhat offset by growth in high capacity dedicated Ethernet services and collocation services. Intercarrier compensation revenue was unchanged from the prior year, primarily as a result of the impact of the FCC-mandated rate reductions in July 2012 and 2013 offset by dispute settlements and an increase in minutes of use originating and terminating on our network. Costs and Expenses The major components of costs and expenses were as follows (amounts in thousands): Year Ended December 31, 2013 2012 $ Change % Change Costs and expenses: Operating (exclusive of depreciation, amortization and accretion shown separately below) (1) $ 658,080$ 617,553$ 40,527 6.6 % Operating costs as percentage of total revenue 42.1 % 42.0 % Selling, general and administrative (1) 392,132 341,423 50,709 14.9 % Selling, general and administrative costs as percentage of total revenue 25.1 % 23.2 % Depreciation, amortization and accretion 308,768 284,292 24,476 8.6 % Total costs and expenses $ 1,358,980$ 1,243,268$ 115,712 9.3 % (1) Includes the following non-cash stock-based employee compensation expense: Operating $ 2,178$ 1,904$ 274 14.4 % Selling, general, and administrative $ 36,654$ 27,396$ 9,258 33.8 % Operating Expenses. Our operating expenses consist of costs directly related to the operation and maintenance of our network and the provisioning of our services. These costs, which are net of capitalized labor and overhead costs on capital projects, include the salaries and related expenses of customer care, provisioning, network maintenance, technical field and network operations and engineering personnel, costs to repair and maintain our network, and costs paid to other carriers for access to their facilities, interconnection, and facilities leased and associated utilities. We carry a significant portion of our traffic on our own fiber infrastructure, enhancing our ability to minimize and control access costs--the costs to purchase network services from other carriers. The increase in operating expenses was largely due to: Higher network access costs, primarily as a result of revenue growth and growth in demand for multi-location customer solutions, both within and outside our markets;



Higher network maintenance costs;

An increase in employees and related costs associated both with revenue

growth and our growth initiatives; and

An increase in certain taxes and fees remitted to government authorities

that we classify on a gross versus net basis in revenue and expense.

Selling, General and Administrative Expenses. Selling, general and administrative expenses consist of salaries and related costs for employees and other expenses related to sales and marketing, bad debt, IT, billing, regulatory, administrative and legal functions. The increase in these expenses primarily related to higher employee costs resulting from incentive-based compensation due to expansion of our indirect sales channel and increased customer installations of service, expansion of our 40



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

Table of Contents

sales and sales support personnel and IT personnel associated both with revenue growth and our growth initiatives, higher non-cash stock-based compensation expense, annual merit-based salary increases and other administrative costs, including property and other taxes and regulatory fees. For the year ended December 31, 2013, selling, general and administrative expenses included compensation expense of $5.3 million associated with executive retirement, including $4.3 million in non-cash stock-based compensation expense resulting from accelerated vesting of outstanding equity awards. Selling, general and administrative costs as a percentage of total revenue increased primarily due to expansion of personnel as discussed above and the increase in non-cash stock-based compensation expense. Depreciation, Amortization and Accretion Expense. The increase in depreciation, amortization and accretion expense was attributable to property, plant and equipment additions during 2012 and 2013 net of the impact of fully depreciated assets. We expect to recognize $3.5 million of depreciation expense in 2014 related to right-to-use assets associated with our strategic market expansion. Operating Income and Net Income The following table provides the components from operating income to net income for purposes of the discussions that follow (amounts in thousands, except per share amounts): Year Ended December 31, 2013 2012 $ Change % Change Operating income $ 204,921$ 226,987$ (22,066 ) (9.7 )% Interest expense (96,136 ) (93,757 ) 2,379 2.5 % Debt extinguishment costs (39,314 ) (77 ) (39,237 ) NM Interest income 692 793 (101 ) (12.7 )% Income before income taxes 70,163 133,946 (63,783 ) (47.6 )% Income tax expense 33,705 57,058 (23,353 ) (40.9 )% Net income $ 36,458$ 76,888$ (40,430 ) (52.6 )% Basic income per common share $ 0.25$ 0.51$ (0.26 ) (51.0 )% Diluted income per common share $ 0.24$ 0.50$ (0.26 ) (52.0 )% Modified EBITDA (1)(2) $ 552,521$ 540,579$ 11,942 2.2 % Modified EBITDA margin (1)(2)(3) 35.3 % 36.8 %



___________________

NM - Not meaningful (1) See Note 1 under "Revenue" above.



(2) See Note 4 and 5 in "Item 6. Selected Financial Data" for a definition of

"Modified EBITDA" and for reconciliations of Modified EBITDA to net income,

the most comparable GAAP measure for operating performance, and Modified

EBITDA, as a measure of liquidity, to net cash provided by operating

activities.

(3) Modified EBITDA margin represents Modified EBITDA as a percentage of revenue.

Interest Expense. The increase in interest expense is primarily related to the issuance of the 53/8% Senior Notes due 2022 (the "2022 Notes") in October 2012 and the issuance of the $450 million principal amount of 53/8% Senior Notes due 2022 (the "2022 Mirror Notes") and the $350 million principal amount of 63/8% Senior Notes due 2023 (the "2023 Notes") in August 2013, partially offset by the discount on the $373.7 million principal amount of 23/8% Convertible Senior Debentures (the "Convertible Debentures") becoming fully accreted in the first quarter of 2013, retirement of the Convertible Debentures, the repurchase of $406.5 million principal amount of 8% Senior Notes due 2018 (the "2018 Notes") in August 2013 ("the 2018 Notes Tender") and the impact of the rate decrease on the Term Loan in connection with a refinancing in April 2013. We expect to recognize $6.5 million of interest expense in 2014 for the capital lease associated with our strategic market expansion. Debt Extinguishment Costs. Debt extinguishment costs for the year ended December 31, 2013 resulted primarily from the 2018 Notes Tender, consisting of cash paid for call premiums and fees of $32.2 million, non-cash write-offs of unamortized deferred debt issuance costs and issuance discounts of $5.1 million and $1.6 million, respectively, as well as transaction costs paid for repurchases of our Convertible Debentures. Income Before Income Taxes. The decrease in income before income taxes resulted primarily from debt extinguishment costs incurred in connection with the 2018 Notes Tender, higher depreciation, amortization and accretion expense and non-cash stock-based compensation expense, partially offset by higher Modified EBITDA as discussed below. 41



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

Table of Contents

Income Tax Expense. The decrease in income tax expense resulted from lower income before income taxes. Our effective tax rate in the year ended December 31, 2013 was 48%. Net Income and Modified EBITDA. The decrease in net income resulted from the decrease in income before income taxes, partially offset by lower income tax expense, as discussed above. Included in net income (after giving effect to income tax expense) was $27.9 million, or $0.19 per share, of cash and non-cash debt extinguishment costs and compensation expense associated with executive retirement. The increase in Modified EBITDA was primarily the result of revenue growth that was somewhat offset by costs associated with both revenue growth and our growth initiatives, incentive-based compensation in connection with our indirect sales channel, network maintenance costs, property and other taxes and regulatory fees as discussed above under "Operating Expenses". The majority of the decline in Modified EBITDA margin was attributable to employee and other costs associated with our growth initiatives that were incurred ahead of the anticipated revenue, with the remainder the result of higher access costs from growth in demand for multi-location customer solutions, both within and outside of our markets. For the years ended December 31, 2013 and 2012, Modified EBITDA, together with cash, cash equivalents and investments, has been sufficient to cover our capital expenditures and service our debt. We expect to generate sufficient Modified EBITDA in the foreseeable future to cover our expected capital expenditures and debt service requirements together with cash on hand and borrowing capacity under our existing Revolver. See "Item 6. Selected Financial Data" Note 4 for a definition of Modified EBITDA and Note 5 for reconciliations of Modified EBITDA to net income, which is the most comparable GAAP measure for operating performance, and Modified EBITDA to net cash provided by operations, which is the most comparable GAAP measure for liquidity.



2012 Compared to 2011

Revenue

Revenue by line of business was as follows (amounts in thousands):

Year Ended December 31, 2012 2011 $ Change % Change Revenue (1): Data and Internet services $ 746,297$ 646,682$ 99,615 15.4 % Voice services 363,743 338,655 25,088 7.4 % Network services 330,088 350,709 (20,621 ) (5.9 )% Intercarrier compensation 30,127 30,845 (718 ) (2.3 )% Total revenue $ 1,470,255$ 1,366,891$ 103,364 7.6 % ___________________



(1) We classify certain taxes and fees billed to customers and remitted to

government authorities on a gross versus net basis in revenue and expense.

The total amounts classified as revenue, primarily included in voice

services, associated with such taxes and fees were approximately $79.8

million and $63.5 million for the years ended December 31, 2012 and 2011,

respectively. This has no impact on Modified EBITDA or net income but is

dilutive to Modified EBITDA margin.

The primary driver of total revenue growth was increased data and Internet services revenue from installed services to enterprise customers. The increase in data and Internet services revenue primarily resulted from installed sales of strategic Ethernet and VPN-based services and other services to enterprise customers, somewhat offset by revenue churn and re-pricing of renewed customer contracts at lower rates. Strategic services represented 53% of data and Internet services revenue for the year ended December 31, 2012 compared to 50% for the year ended December 31, 2011, resulting in 22% year over year growth. More than half of the increase in voice services revenue resulted from an increase in both the volume and rate of certain taxes and fees remitted to government authorities that we classify on a gross versus net basis in revenue and expense, with the balance from installed sales of converged and other voice services, partially offset by revenue churn. Revenue based on minutes of use, including long distance, within voice services was 3% of our total revenue for both of the years ended December 31, 2012 and 2011. The decrease in network services revenue was primarily from revenue churn (particularly from carrier customers) and re-pricing of renewed customer contracts at lower rates largely in transport services and customers transitioning to Ethernet services, partially offset by growth in high capacity and collocation services revenue. 42



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

Table of Contents

Costs and Expenses The major components of costs and expenses were as follows (amounts in thousands): Year Ended December 31, 2012 2011 $ Change % Change Costs and expenses: Operating (exclusive of depreciation, amortization and accretion shown separately below) (1) $ 617,553$ 571,461$ 46,092 8.1 % Operating costs as percentage of total revenue 42.0 % 41.8 % Selling, general and administrative (1) 341,423 325,538 15,885 4.9 % Selling, general and administrative costs as percentage of total revenue 23.2 % 23.8 % Depreciation, amortization and accretion 284,292 283,329 963 0.3 % Total costs and expenses $ 1,243,268$ 1,180,328$ 62,940 5.3 % (1) Includes the following non-cash stock-based employee compensation expense: Operating $ 1,904$ 2,327$ (423 ) (18.2 )% Selling, general, and administrative $ 27,396$ 25,490$ 1,906 7.5 % Operating Expenses. Operating expenses increased primarily due to higher network access costs associated with revenue growth. Additionally, approximately a third of the increase in operating expenses resulted from an increase in both the volume and rate of certain taxes and fees. Operating costs as a percentage of revenue increased primarily as a result of growth in certain taxes and fees which we classify on a gross versus net basis in revenue and expense. Selling, General and Administrative Expenses. The increase was primarily due to higher employee costs, regulatory fees and property and other taxes. The higher employee costs resulted primarily from incentive-based compensation due to expansion of the indirect sales channel, expansion of our sales, sales support and IT personnel, annual merit-based salary increases and non-cash stock-based compensation. The improvement in selling, general and administrative expenses as a percentage of total revenue is primarily attributed to scaling of employee costs which as a percentage of revenue declined in 2012 compared to 2011. Depreciation, Amortization and Accretion Expense. Although we experienced only a modest increase in total depreciation, amortization and accretion expense, depreciation expense increased as a result of additions to property, plant and equipment in 2012 and 2011, which was substantially offset by fully depreciated assets that can fluctuate based on the timing of assets becoming fully depreciated. Operating Income and Net Income The following table provides the components from operating income to net income for purposes of the discussions that follow (amounts in thousands, except per share amounts): Year Ended December 31, 2012 2011 $ Change % Change Operating income $ 226,987$ 186,563$ 40,424 21.7 % Interest expense (93,757 ) (87,718 ) 6,039 6.9 % Debt extinguishment costs (77 ) - (77 ) NM Interest income 793 545 248 45.5 % Income before income taxes 133,946 99,390 34,556 34.8 % Income tax expense 57,058 41,479 15,579 37.6 % Net income $ 76,888$ 57,911$ 18,977 32.8 % Basic income per common share $ 0.51$ 0.39$ 0.12 30.8 % Diluted income per common share $ 0.50$ 0.38$ 0.12 31.6 % Modified EBITDA (1)(2) $ 540,579$ 497,709$ 42,870 8.6 % Modified EBITDA margin (1)(2)(3) 36.8 % 36.4 % 43



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

Table of Contents

___________________

NM - Not meaningful (1) See Note 1 under "Revenue" above.



(2) See Note 4 and 5 in "Item 6. Selected Financial Data" for a definition of

"Modified EBITDA" and for reconciliations of Modified EBITDA to net income,

the most comparable GAAP measure for operating performance, and Modified

EBITDA, as a measure of liquidity, to net cash provided by operating

activities.

(3) Modified EBITDA margin represents Modified EBITDA as a percentage of revenue.

Interest Expense. The increase in interest expense is primarily due to the issuance of the 2022 Notes in October 2012.

Income Before Income Taxes. The increase in income before income taxes primarily resulted from higher Modified EBITDA as discussed below, somewhat offset by the increase in interest expense as a result of the issuance of the 2022 Notes. Income Tax Expense. The increase in income tax expense resulted from higher income before income taxes. Our effective tax rate in the year ended December 31, 2012 was 43%. Net Income and Modified EBITDA. The increase in net income resulted from an increase in income before income taxes, partially offset by higher income tax expense, as discussed above. The increase in Modified EBITDA was primarily the result of the contribution from revenue growth somewhat offset by higher employee costs, as discussed above. The improvement in Modified EBITDA margin primarily resulted from lower employee costs as a percentage of revenue. For the years ended December 31, 2012 and 2011, Modified EBITDA was sufficient to cover our capital expenditures and service our debt. Liquidity and Capital Resources Historically, we have generated cash flow from operations consisting primarily of payments received from customers for the provision of our services offset by payments to other telecommunications carriers, payments to employees, and payments for interest and other operating, selling, general and administrative expenses. We have also generated cash from debt and equity financing activities and have used these funds and cash flows from operations to service or repay our debt obligations, make capital expenditures to expand our network, repurchase our common stock and fund acquisitions. During the year ended December 31, 2013, we redeemed the $373.7 million principal amount of Convertible Debentures, resulting in a total use of cash of $553.2 million, including $0.5 million of transaction costs. Additionally, during the year ended December 31, 2013, we used $406.5 million of cash to repurchase our common stock under a $300 million repurchase program that our Board of Directors authorized in November 2011 and was completed as of August 6, 2013 and a $500 million multi-year common stock repurchase program that our Board of Directors authorized on August 6, 2013 (see "Possible Future Uses of Cash" below). On August 26, 2013, we completed a private offering of $800 million of senior notes (see "Cash Flow Activity--Cash Flow from Financing Activities" below). The net proceeds from this offering were used to fund the 2018 Notes Tender for $438.7 million, including $32.2 million in tender premium and fees, and for general corporate purposes. The change in our net debt was as follows: Year Ended December 31, 2013 2012 $ Change (amounts in thousands) Current portion of debt and capital lease obligations $ 32,470$ 374,969$ (342,499 ) Long term portion of debt and capital lease obligations 1,916,775 1,384,242



532,533

Total debt and capital lease obligations $ 1,949,245$ 1,759,211 $



190,034

Less: Cash, cash equivalents and short-term investments 478,995 974,292 (495,297 ) Net debt $ 1,470,250$ 784,919$ 685,331 The increase in net debt was primarily due to cash used for repurchases of our common stock, capital expenditures, reacquisition of the equity component of the Convertible Debentures upon retirement, debt extinguishment costs associated with the 2018 Notes Tender, debt issuance costs for the 2022 Mirror Notes, 2023 Notes and the Term Loan refinancing and capital lease additions, partially offset by cash provided by operating activities resulting from higher Modified EBITDA and net proceeds from stock option exercises. 44



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

Table of Contents

The changes in our working capital and working capital ratio were as follows: Year Ended December 31, 2013 2012 $ Change (amounts in thousands) Current assets $ 662,824$ 1,169,319$ (506,495 ) Current liabilities 309,296 663,139 (353,843 ) Working capital $ 353,528$ 506,180$ (152,652 ) Working capital ratio 2.14 1.76 N/A The decrease in working capital is primarily a result of the 2018 Notes Tender, repurchases of our common stock, capital spending, the reacquisition of the equity component of the Convertible Debentures upon retirement and the reclassification of the remaining 2018 Notes from long-term debt to current debt, somewhat offset by net proceeds from the issuance of the 2022 Mirror Notes and 2023 Notes, cash provided by operations, net proceeds from the Term Loan refinancing and net proceeds from employee stock option exercises. Cash Flow Activity Cash and cash equivalents were $284.4 million, $806.7 million and $353.4 million as of December 31, 2013, 2012 and 2011, respectively. In addition, we had investments of $194.6 million, $167.6 million and $131.5 million as of December 31, 2013, 2012 and 2011, respectively, which were short-term in nature and generally available to fund our operations. The changes in cash and cash equivalents during the periods presented were as follows: Years ended December 31, $ Change % Change 2013 2012 2011 2013



vs 2012 2012 vs 2011 2013 vs 2012 2012 vs 2011

(amounts in thousands) Cash provided by operating activities $ 438,461$ 463,676$ 403,588$ (25,215 )$ 60,088 (5.4 )% 14.9 % Cash used in investing activities (416,119 ) (373,971 ) (352,799 )



(42,148 ) (21,172 ) (11.3 )% (6.0 )% Cash provided by (used in) financing activities (544,651 ) 363,629 (54,317 ) (908,280 ) 417,946

NM NM Increase (decrease) in cash and cash equivalents $ (522,309 )$ 453,334$ (3,528 )$ (975,643 )$ 456,862 NM NM ___________________ NM - Not meaningful Cash Flow from Operating Activities The decrease in cash provided by operating activities in 2013 compared to 2012 primarily related to changes in working capital, largely due to the timing of payments to vendors and the collection of receivables, somewhat offset by higher Modified EBITDA. The increase in cash provided by operating activities in 2012 compared to 2011 primarily related to higher Modified EBITDA somewhat offset by changes in working capital and other non-current assets and liabilities, largely due to the timing of payments to vendors and employees and the collection of receivables. Cash Flow from Investing Activities The change in cash used in investing activities in 2013 compared to 2012 was primarily a result of the increase in capital expenditures and purchases of equipment in advance of installations. Cash used for capital expenditures for the year ended December 31, 2013 was $372.9 million, the majority of which was used for success-based spending (see "Capital Expenditures and Requirements" below), compared to $338.1 million for the year ended December 31, 2012. The change in cash used in investing activities in 2012 compared to 2011 was primarily from the net increase in cash used for the purchase and sale of investments in 2012. Our balances of cash, cash equivalents and investments fluctuate over time based on our cash requirements and market interest yields. Cash used for capital expenditures for the year ended 45



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

Table of Contents

December 31, 2012 was $338.1 million, the majority of which was success-based spending, compared to $340.7 million in capital expenditures for the year ended December 31, 2011. Cash Flow from Financing Activities Cash used in financing activities for 2013 primarily consisted of the following: Repurchases and settlements of conversions of Convertible Debentures of



$553.2 million;

$438.7 million for the 2018 Notes Tender (including $32.2 million of

tender premium and fees);

Repurchases of $406.5 million of our common stock; and

Withholding taxes paid by us on behalf of employees in net share settlements of restricted stock of $20.8 million partially offset by: Net proceeds of $765.8 million from the issuance of the 2022 Mirror Notes and the 2023 Notes;



Proceeds of $64.3 million from exercises of stock options; and

Net proceeds of $49.7 million from the Term Loan refinancing.

Cash provided by financing activities for 2012 primarily consisted of: $470.8 million in net proceeds from the issuance of the 2022 Notes and

$23.4 million in proceeds from option exercises,

partially offset by: Prepayment of the $101.5 million tranche of the Term Loan B due January 2013;

Repurchases of $13.4 million of our common stock; and

Withholding taxes paid by us on behalf of employees in net share settlements of restricted stock of $10.0 million.



Our financing activities from 2011 to 2013 were comprised of the following: In October 2012, we completed an offering of the 2022 Notes at an offering

price of 100% of the principal amount of $480 million. For a description

of the significant terms of the 2022 Notes, see Note 6 to the consolidated

financial statements.

In April 2013, we refinanced our outstanding $461.8 million Term Loan due

December 2016 and replaced an undrawn $80 million revolving credit

facility expiring December 2014 with a new senior secured credit facility

consisting of a $520 million Term Loan due April 2020 and an undrawn $100

million Revolver expiring April 2018. Interest and payments on the Term

Loan and Revolver, if drawn, are as follows:

? Repayments of the Term Loan are due quarterly in an amount equal to 1/4 of 1% of the aggregate principal amount on the last day of each quarter commencing September 30, 2013. Interest on the Term Loan is computed based on a specified Eurodollar rate plus 2.5%.



Interest is

reset periodically and payable at least quarterly. Based on the Eurodollar rate in effect at December 31, 2013, the effective interest rate was 2.67%. ? Interest on outstanding amounts under the Revolver, if any,



will be

computed based on a specified Eurodollar rate plus 1.75% to



2.75%

and will be reset periodically and payable quarterly. The



Company is

required to pay a commitment fee on the undrawn commitment



amounts

on a quarterly basis of 0.375% to 0.5% per annum. The new



senior

secured credit facility contains customary affirmative and



negative

covenants. Most of the Revolver covenants apply whether or not



we

draw on that facility. In addition, if the Revolver were



drawn,

certain financial maintenance covenants would apply.



During the year ended December 31, 2013, we settled the $373.7 million

principal amount of Convertible Debentures outstanding as of December 31,

2012 for $552.7 million in cash as a result of our redemptions and other

repurchases and conversions by holders of the Convertible Debentures. We

also used $0.5 million in cash for transaction costs associated with the retirement of the Convertible Debentures.



In August 2013, we completed a private offering of $800 million of Senior

Notes, including the 2022 Mirror Notes at an offering price of 96.250% of

the principal amount and the 2023 Notes at an offering price of 100% of

the principal amount. The net proceeds from the offering were used to fund

the repurchase of $406.5 million principal amount of the 2018 Notes for

$438.7 million and for general corporate purposes. For a description of

the significant terms of the 2022 Mirror Notes and 2023 Notes, see Note 6

to the consolidated financial statements.

Approximately $23.5 million principal amount of the 2018 Notes remained outstanding as of December 31, 2013. On January 30, 2014, we notified holders of the 2018 Notes that all outstanding 2018 Notes will be redeemed on March 1, 2014 at a redemption price of 104% of the principal amount. 46



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

Table of Contents

Indebtedness Outstanding or Available as of December 31, 2013:

Aggregate annual Principal amount estimated interest Instrument outstanding payments (amounts in thousands)



Term Loan, Eurodollar rate + 2.5% due 2020 (1) $ 517,400 $

13,815 8% Senior Notes due 2018 (2) 23,479 313 53/8% Senior Notes due 2022 issued October 2012 480,000 25,800 53/8% Senior Notes due 2022 issued August 2013 450,000 24,188 63/8% Senior Notes due 2023 350,000 22,313 Undrawn $100 million Revolver expires 2018 (3) - -



___________________

(1) The aggregate annual estimated interest payments are based on the

principal amount outstanding and the effective interest rate of 2.67% at

December 31, 2013. (2) On January 30, 2014, we notified holders of the 2018 Notes that all



outstanding notes will be redeemed on March 1, 2014. Therefore, aggregate

annual estimated interest payments are based on interest through the redemption date.



(3) Interest on outstanding amounts, if any, will be computed on a specified

Eurodollar rate plus 1.75% to 2.75% and will be reset periodically. We are

required to pay a commitment fee on the undrawn commitment amounts on a quarterly basis of 0.375% to 0.5% per annum. The following diagram summarizes our corporate structure in relation to our outstanding indebtedness and credit facility, including our undrawn Revolver, as of December 31, 2013. The diagram does not depict all aspects of the ownership structure among the operating and holding entities, but rather summarizes the significant elements relative to our debt in order to provide a basic overview. [[Image Removed]]



a TWTC and substantially all of these subsidiaries guarantee the 2018 Notes,

2022 Notes, 2022 Mirror Notes and 2023 Notes on an unsecured basis and the

Revolver and the Term Loan on a secured basis. b The assets and equity interests of these subsidiaries are pledged to secure the Revolver and the Term Loan. c The Term Loan matures in April 2020. The principal amount is reduced by quarterly principal payments. 47



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

Table of Contents

Capital Expenditures and Requirements For the year ended December 31, 2013, our total capital expenditures were $501.9 million, or $382.1 million excluding a capital lease commitment for our strategic market expansion of $119.8 million, compared to $343.4 million for the year ended December 31, 2012. Excluding the capital lease commitment for our strategic market expansion, the majority of capital expenditures in 2013 and 2012 were for what we deem success-based opportunities that were linked to new installations and related network capacity increases. Success-based spending generally consists of short-to-medium length capital projects, in terms of anticipated time between capital spending and return on investment, driven by customer opportunities. The increase in capital expenditures over the prior year, apart from the capital lease commitment for our strategic market expansion, primarily resulted from higher success-based spending for building entries and an increase in investments to support our growth initiatives, including new service development, automation and strategic network expansions to extend our reach. We expect to accept the fiber from the capital lease commitments for our strategic market expansion and launch our new markets throughout 2014. In each of the years ended 2005 through 2013, over 75% of our total annual capital expenditures, excluding capital expenditures for integration and branding and a capital lease commitment for our strategic market expansion, were for what we deem success-based opportunities. This includes costs to connect to new customer locations with our fiber network and increase capacity in our network, IP backbone enhancements, collocation facility expansion and central office infrastructure to serve growing customer demands. These types of expenditures often fluctuate as our volume of sales and service installations increases or decreases. For 2014, we expect capital expenditures of approximately $440 million to $460 million (see "Future Sources of Cash" below for discussion of anticipated funding sources), the majority of which we expect to be related to success-based opportunities. Our anticipated capital expenditures include approximately $50 million of capital expenditures to integrate and connect the strategic market expansion into our national network and operating infrastructure. Also, included in expected capital expenditures are amounts we must spend to replace older network components, especially electronics, that we expect will continue to grow over time. We expect quarterly fluctuations in our capital spending due to the timing of large projects and other external factors such as customer readiness, permitting and weather. Future Sources of Cash Based on current assumptions, we expect to generate sufficient cash from operations along with available cash on hand (including cash equivalents and investments) and borrowing capacity under our undrawn Revolver to provide sufficient funds to meet our expected capital expenditure and liquidity needs to operate our business and service our debt for the foreseeable future. However, if our assumptions prove incorrect or if there are other factors that negatively affect our cash position such as material unanticipated losses, a significant reduction in demand for our services, an acceleration of customer disconnections, or other adverse factors, or if we make acquisitions, enter into joint ventures or repurchase additional shares of our common stock, we may need to seek additional sources of funds through financing or other means. There is no assurance that other sources of financing on acceptable terms will be available in the future. Other risks, such as a rating downgrade on our debt or adverse debt market conditions, could further impact our potential access to or the cost of financing sources. Our ability to draw upon the available commitments under our Revolver is subject to compliance with all of the covenants contained in the credit agreement and our continued ability to make certain representations and warranties. In the case of the Revolver, the covenants include financial maintenance covenants, such as leverage and interest coverage ratios and limitations on capital expenditures that are primarily derived from Modified EBITDA and debt levels. We are required to comply with these ratios as a condition to any borrowing under the Revolver and for as long as any loans are outstanding under the Revolver. The representations and warranties include the absence of liens on our properties other than certain permitted liens, the absence of litigation or other developments that have or could reasonably be expected to have a material adverse effect on us and our subsidiaries as a whole, and continued effectiveness of the documents granting security for the loans. A lack of revenue growth or an inability to control costs could negatively impact Modified EBITDA and cause our failure to meet the required minimum ratios under the Revolver if we have loans outstanding under the Revolver or wish to draw on it. Although we currently believe that we will continue to be in compliance with the covenants, various factors, including deterioration of the economy, increased competition and pricing pressure and loss of revenue from significant customers, an acceleration of customer disconnections, a significant reduction in demand for our products without adequate reductions in capital expenditures and operating expenses or an uninsured catastrophic loss of physical assets or other risk factors could cause us to fail to meet our covenants. If our revenue growth is not sufficient to sustain the Modified EBITDA performance required to meet the debt covenants described above, and we have loans outstanding under the Revolver or wish to draw on it, we would have to consider cost cutting or other measures to maintain required Modified EBITDA levels or to enhance liquidity. 48



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

Table of Contents

The Revolver, Term Loan, 2022 Notes, 2022 Mirror Notes and 2023 Notes (the "Revolver and Long-Term Debt Obligations") limit our ability to declare cash dividends, repurchase shares, incur indebtedness, incur liens on property and undertake acquisitions, among other things. The agreements governing the Revolver and Long-Term Debt Obligations also include cross-default provisions under which we are deemed to be in default if we default under any of the other material outstanding obligations. If we are in default under any of the covenants under the Term Loan and Revolver, we also could potentially be subject to an acceleration of the repayment date of the Term Loan and the Revolver if we have borrowed under that facility. Covenant defaults under the credit agreement for the Revolver and Term Loan also may constitute an event of default under the indenture for the Senior Notes. In addition, the lenders under the Revolver may require prepayment of outstanding revolving loans if a change of control and ratings decline occurs as defined in the credit agreement. We are required to offer to prepay the Senior Notes and the Term Loan on an individual basis if a change of control and a debt rating decline occur, as defined in the indenture for the Senior Notes and the Term Loan agreement. If we do not comply with the covenants under the Revolver, we would not be able to draw funds under the Revolver, outstanding revolving loans could be accelerated or the lenders could cancel the Revolver unless the respective lenders agree to further modify the covenants. As of December 31, 2013, we were in compliance with all of our debt covenants. Possible Future Uses of Cash In order to mitigate potential variability in interest rates, reduce future cash interest payments, reduce principal amounts outstanding or reduce our leverage, we or our affiliates may, from time to time, enter into interest rate derivatives, or purchase or redeem our outstanding Senior Notes for cash in the open market or privately negotiated transactions, or engage in other transactions to reduce the principal amount of outstanding Senior Notes. As of December 31, 2013, we had not entered into any interest rate derivative transactions. Under the terms of our Revolver, which is more restrictive than our Term Loan and the indentures for the Senior Notes, we currently may repurchase a portion of our outstanding Senior Notes if the sum of our cash and equivalents and availability under our Revolver is a minimum of $200 million after giving effect to the repurchase, we do not use the Revolver proceeds for this purpose and we meet certain other conditions. In November 2011, our Board of Directors authorized a multi-year repurchase program for up to $300 million of our common stock, of which approximately $278.0 million was repurchased during 2013, completing the $300 million share repurchase program. In August 2013, our Board of Directors authorized a new $500 million multi-year common stock repurchase program, of which approximately $137.5 million was repurchased as of December 31, 2013. Total purchases under both programs were $415.5 million for the year ended December 31, 2013. The $500 million repurchase authorization does not have an expiration date, but can be withdrawn by the Board at any time. Our Revolver, as amended in August 2013, permits repurchases of our common stock, or restricted payments, up to $500 million from August 9, 2013 to December 31, 2014, and thereafter $250 million annually in the aggregate if after the transaction the sum of our cash and cash equivalents and availability under our Revolver is a minimum of $200 million, we have not used that basket for other permissible purposes, including dividend payments, and we meet certain other conditions. Up to $200 million of the restricted payments capacity not used through December 31, 2014 may be carried over to the fiscal year ending December 31, 2015. For the fiscal years ending December 31, 2015 and thereafter, up to $100 million of unused restricted payments capacity may be carried over to the next subsequent fiscal year. The test under the Revolver is more restrictive than our other debt agreements. At December 31, 2013, we had repurchased $137.5 million of our common stock of the maximum $500 million permissible under our Revolver covenants through December 31, 2014. We do not anticipate that the planned spending for our market expansion (see "Overview" above) will limit our ability to execute our common stock repurchase program. We plan to evaluate additional repurchases of shares of our common stock in public or private transactions under the $500 million authorization described above based on market conditions and other considerations or may consider paying dividends to the extent permitted by our debt covenants. We may also consider merger and acquisition opportunities or other strategic transactions that could impact our cash usage. Additionally, we may increase our leverage for these purposes. We will evaluate any such transactions in light of market conditions, taking into account our liquidity and prospects for access to capital, benefits to us of any such transaction and contractual constraints. We generally expect to maintain approximately $300 million in cash, cash equivalents and short-term investments in order to provide ongoing liquidity and flexibility for other operating and strategic initiatives. The actual balance of cash, cash equivalents and short-term investments will depend on the timing of collections, payments, our business operations in general and any financing activities we may undertake and is likely to fluctuate from quarter to quarter. 49



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

Table of Contents

Risk Management As of December 31, 2013, our cash, cash equivalents and short-term investments were held in financial institutions, U.S. Treasury money market mutual funds, commercial paper and debt securities issued by the U.S. Treasury and other U.S. government agencies. Although we actively monitor the depository institutions, credit quality of the U.S. government and its entities and the performance and quality of our investments and the mutual funds that hold our cash and cash equivalents, we are exposed to risks resulting from deterioration in the financial condition of the U.S. government and its entities, deterioration in the financial condition or failure of financial institutions holding our cash deposits, decisions of our investment advisors and the investment managers of the money market funds and defaults in securities underlying the funds and investments. We prioritize safety over investment return in choosing the investment vehicles for cash, cash equivalents and investments and have diversified these investments to the extent practical in an effort to minimize our exposure to any one investment vehicle or financial institution. We may change the nature of our cash, cash equivalent and short-term investments as market conditions change. Off-Balance Sheet Arrangements As of December 31, 2013, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K. Contractual Obligations The following table summarizes our contractual obligations and long-term commitments as of December 31, 2013, including commitments pursuant to debt agreements, lease obligations, fixed maintenance contracts and other purchase obligations. For the years ending December 31, Contractual Obligations Total 2014 2015 - 2016 2017 - 2018 Thereafter (amounts in thousands) Principal payments on long-term debt (1) $ 1,820,879$ 28,679$ 10,400$ 10,400$ 1,771,400 Interest payments on long-term debt (1) (2) 759,831 87,614 172,355 171,496 328,366 Capital lease obligations including interest (3) 259,289 10,517 20,113 21,317 207,342 Operating lease obligations 359,509 55,192 92,133 73,195 138,989 Fixed maintenance obligations 87,666 4,380 10,484 10,484 62,318 Purchase obligations Purchase orders (4) 70,312 70,312 - - - Network costs (5) 267,664 90,193 112,741 43,098 21,632 Total $ 3,625,150$ 346,887$ 418,226$ 329,990$ 2,530,047 ___________________



(1) In January 2014, we notified holders of the 2018 Notes that all

outstanding notes will be redeemed on March 1, 2014. Therefore, the

maturity date of the 2018 Notes is reflected in 2014 and interest payments

are based on interest through the redemption date.

(2) Interest payments on the Term Loan are calculated using the rate in effect

as of December 31, 2013. (3) Includes amounts representing interest of $112.2 million.



(4) Includes outstanding purchase orders initiated in the ordinary course of

business for operating and capital expenditures.

(5) Includes services purchased from other carriers to transport a portion of

our traffic to the end-user, to interconnect with the ILECs, to lease our

IP backbone, or to provide other ancillary services under contracts that

can vary from month-to-month up to 60 months. Some services are purchased

under volume plans that require us to maintain certain commitment levels

to obtain favorable pricing. Some services are purchased under contracts

that are subject to contract termination costs or penalties if services

are disconnected before the end of the term.

Effects of Inflation Historically, inflation has not had a material effect on us. 50



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

Table of Contents


For more stories covering the world of technology, please see HispanicBusiness' Tech Channel



Source: Edgar Glimpses


Story Tools