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

(Edgar Glimpses Via Acquire Media NewsEdge) 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, among others, enterprise organizations in the financial services, technology and scientific, health care, distribution, manufacturing and professional services industries, public sector entities, system integrators and communications service providers, including ILECs, competitive local exchange carriers ("CLECs"), wireless communications companies and cable companies.

Through our subsidiaries, we serve 75 metropolitan markets with local fiber networks that are connected by our regional fiber facilities and national IP backbone. As of December 31, 2012, our fiber network spanned approximately 29,000 route miles (including approximately 22,000 metropolitan route miles) connecting to 17,948 buildings served directly by our local fiber facilities. In 2012 we added approximately 2,500 new buildings directly connected to our network, including 532 previously connected buildings that were identified during an alignment of key operating systems. Our fiber networks also connect to over 400 key third party data centers across the country where customers deploy their own equipment or connect to cloud service providers. 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.

Our objective is to be the leading national provider of high quality, business networking solutions leveraging our integrated network, operational capabilities, dedicated people, local presence, personalized customer experience and advanced support systems to meet the complex and evolving needs of our customers and increase stockholder value. The key elements of our business strategy include: • Focusing our service offerings on meeting our customers' complex evolving needs, emphasizing business Ethernet and IP VPN services (which we refer to as strategic services), Internet-based services and converged service offerings and developing our advanced service capabilities, which we refer to as the "Intelligent Network". We launched the initial phase of the Intelligent Network, Enhanced Management, in June 2012 for IP VPN, converged and Ethernet services, and the second phase, Dynamic Capacity, which allows customers to manage or schedule bandwidth, in August 2012; • Enabling enterprise cloud computing and other developing customer IT and business strategies by leveraging our fiber network, data services portfolio, Intelligent Network capabilities and the numerous third party and customer data centers connected to our network; • Delivering a differentiated customer care strategy by engaging all of our employees and continually incorporating customer feedback to provide the best possible customer service; • Leveraging our local fiber assets and national IP backbone and integrating and managing other carriers' facilities to enable our customers to connect to any of their locations with our network solutions, and using our local presence and local sales, sales engineering, customer support and operational resources, backed by a national organization, to provide personalized service and customized solutions for our customers; • Enhancing our multi-channel sales strategy; • Employing a disciplined capital allocation strategy to invest for growth in the near and long term to broaden our reach and capabilities and increase operational efficiencies; and • Investing in our people to drive the execution of our strategies.

Our revenue is derived from business communications services, including data, high-speed Internet access, voice and network services. Although we analyze revenue by customer type, we present our financial results as one segment across the 35 --------------------------------------------------------------------------------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 2012 2011 2010 Enterprise / End Users 79 % 77 % 75 % Carrier 19 % 21 % 22 % Intercarrier Compensation 2 % 2 % 3 % 100 % 100 % 100 % Revenue Trends Total Revenue Our revenue has grown for the past consecutive 33 quarters through December 31, 2012, including throughout the various economic cycles. 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 enhanced service capabilities will drive more demand for our existing Ethernet and VPN product suite and enhance our future data services revenue growth. Our national footprint and new and enhanced service capabilities enable us to serve customers with multi-point, multi-city locations. Our year-over-year growth rate increased over each of the prior years ended December 31, 2010, 2011 and 2012 and was 5.1%, 7.4% and 7.6%, respectively. These higher year-over-year growth rates were primarily due to higher 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 newer and enhanced services, our customer experience initiatives to increase customer loyalty and retention and improved economic conditions contributed to our growing revenue. In 2012, our service installations increased year-over-year, although at a growth rate lower than our total overall revenue growth rate. As a result, beginning in the three months ended March 31, 2012, we experienced a trend of lower quarterly year-over-year revenue growth rates, including for the three months ended December 31, 2012 (excluding the impact of a large customer settlement) and expect this trend to continue into 2013. Increasing our rate of revenue growth will be dependent on higher service installations to keep pace with the growing total base of revenue as well as retaining revenue from existing customers. To capture growing market demand and share, we are implementing several initiatives in 2013 focused on increasing sales to contribute to an accelerating growth rate over time (see "Modified EBITDA Trends and Growth Initiatives" below).

Revenue for data and Internet, network and the majority of our voice services is generally billed in advance on a monthly fixed-rate basis and recognized over the period the services are provided. Revenue for the majority of intercarrier compensation and certain components of voice services, such as certain components of long distance, is generally billed on a transactional basis in arrears based on a customer's actual usage; therefore, we use estimates to recognize revenue in the period earned. 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 time lag between the time a sale, or "booking" (i.e., signed contract) is made, and the time revenue commences. Our installation intervals are generally longer for the 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 the more complex solutions.

Enterprise Customer Revenue Revenue from enterprise customers has increased for the past 42 consecutive quarters through December 31, 2012 and increased 6.3%, 9.4% and 10.5% for the years ended December 31, 2010, 2011 and 2012 over the respective prior years primarily due to increased installations of our data and Internet services such as business Ethernet and VPN and other services and an increase in certain taxes and fees. Revenue from our enterprise customers represented 79% of our total revenue for the year ended December 31, 2012. We expect our future revenue growth to come primarily from our enterprise customer base.

36 -------------------------------------------------------------------------------- Carrier Customer Revenue Our carrier revenue represented 19% of total revenue for the year ended December 31, 2012. Carrier revenue has been gradually 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 installed sales of Ethernet services to carriers to serve their end users' needs. Carrier revenue from wireless providers represented 30% of total carrier revenue for both the years ended December 31, 2012 and 2011.

While we expect some contribution to carrier revenue as we expand our data and Internet service offerings to our wholesale customer base, 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, customer cost cutting measures and carrier consolidation. We expect these impacts on our carrier revenue to continue.

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, 2012, and is expected to continue to decline in the future as a percentage of total revenue due to federal and state mandated rate reductions and changes in the regulatory regime for intercarrier compensation. We lowered our rates in July 2012 to comply with a 2011 FCC Order. Another mandated rate decrease will occur in July of 2013. As a result of the order, we lost approximately $2.0 million in intercarrier compensation revenue in the year ended December 31, 2012 and expect to lose approximately $4.0 million in the year ended December 31, 2013 compared to the full year 2012. The order mandates further rate declines through 2018 when carriers will be required to exchange local traffic on a "bill and keep" basis, meaning that the exchange of traffic will not be compensatory. Intercarrier compensation revenue also may fluctuate based on variations in minutes of use originating and terminating on our network and changes in customer 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 customers' cost cutting, business contractions, financial difficulties and consolidation, among other reasons. After higher churn beginning in late 2007 and continuing through 2009, revenue churn improved in the year ended December 31, 2010 to pre-recession levels of 1.0% of monthly revenue and further improved to 0.9% in each of the years ended December 31, 2011 and 2012. We believe that the improvement in revenue churn is a result of improved economic conditions as well as our 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, 2010, 2011 and 2012, respectively. 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. 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 1.1%, 1.0% and 1.0% for the years ended December 31, 2010, 2011 and 2012, respectively. The majority of this churn came from our smaller customers, which we expect will continue.

Pricing We experience significant price competition 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.

In our industry, service agreements 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. In addition, during the terms of agreements, customers often purchase additional services or increase or decrease the capacity of existing services, subject to applicable early termination charges, depending on their business needs. During periods of economic downturn, our customers' needs may contract, resulting in fewer service additions.

37 -------------------------------------------------------------------------------- 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 and also provide special access services to our customers over our fiber facilities in competition with the ILECs. The ILECs have argued before the FCC that the high capacity telecommunications services that they sell, including special access services we buy from them, should no longer be subject to regulations governing price and quality of service. We have advocated that the FCC modify certain of its special access pricing flexibility rules to return these services to price-cap regulation to protect against unreasonable price increases for carriers such as us. The FCC is reviewing its regulation of special access pricing in a pending proceeding commenced in 2005 that has not yet resulted in proposed rules. In 2012, the FCC suspended the operation of the pricing flexibility triggers, which means that ILECs cannot expand the geographic scope of their capability to raise prices, pending further FCC review. We cannot predict when the FCC will act on interstate special access pricing regulation or the impact of any such action.

If the special access services we buy from the ILECs were to be further deregulated, ILECs would have a greater ability to increase the price 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 are pressured.

In addition, the FCC has granted ILEC requests for forbearance from regulation of certain Ethernet and OC-n high capacity services offered by the ILECs as special access, with the result that prices we would pay for those services are no longer regulated and can increase. We are advocating reversal of these forbearance requests. We also continue to pursue and implement commercial arrangements with the ILECs and cable companies for these services on acceptable terms and conditions. In an attempt to stabilize the prices we pay for these services, we entered into a wholesale service agreement with a large ILEC for tariffed special access and other services for end-user access. However, since mid-2010, costs for some special access services subject to this agreement and those we buy from other significant ILEC suppliers of special access service have trended up. Expiration of the current wholesale agreement, without a new agreement with similar terms to replace it, could result in additional increases to our special access costs, which could be material.

Bad Debt Expense Trends Due to the quality of our customer base, successful collection efforts, internal controls, bad debt recoveries, and our revenue recognition policies, including recognition of contract termination charges upon cash receipt, our bad debt expense was less than 1% of our total revenue for the year ended December 31, 2012, comparable to the years ended December 31, 2011 and 2010. We cannot assure that we will be able to maintain bad debt expense at this low level.

Modified EBITDA Trends and Growth Initiatives We have had initiatives to expand our revenue growth, margins and cash flow that required both capital and operating investments. During the past three years ended December 31, 2012, these operating investments included expansion of our sales and sales support staff as well as IT and technical personnel and contract labor to support our growing customer base and new product and technology investments to provide future capabilities which differentiate our products and services from the competition. Our capital spending investments during these periods consisted of incremental success-based expenditures to support growing sales, new service portfolio enhancements, including our expanded Ethernet service portfolio and our Intelligent Network capabilities, including sales to wireless providers, strategic market expansion through fiber purchases to extend our network reach and corporate and IT initiatives that support the evolution of our services, enable our customer experience and drive increased scale and efficiency. We believe that these initiatives resulted in expansion of our revenue growth, margins and cash flows.

Our Modified EBITDA (see Note 4 to the table under Item 6. Selected Financial Data for a definition of Modified EBITDA) has increased sequentially for 23 consecutive quarters due to the contribution from revenue growth and the initiatives described above, among other factors. Modified EBITDA grew 6.2%, 7.4%, and 8.6% in the years ended December 31, 2010, 2011 and 2012, respectively, each compared to the respective period in the prior year. Modified EBITDA margin was 36.4%, 36.4% and 36.8% for the years ended December 31, 2010, 2011 and 2012, respectively. These margins included the absorption of increased costs for special access due to higher prices and costs associated with additions to our sales and support staff and IT and technical personnel and were impacted by the dilutive effect of volume and rate increases in 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).

38 -------------------------------------------------------------------------------- The initiatives that we are implementing in 2013 are designed to reverse the 2012 trend of lower quarterly year-over-year growth rates and consist of further increasing investments in our sales and support staff to expand our market penetration, in new technologies to deliver new innovative capabilities to further drive our strategic data and Internet services, in further automation of network functionality to enable more dynamic customer network capacity and connections and in continuing the expansion of our network in existing and adjacent markets to reach more customers. While these initiatives are designed to increase sales in the near term to enable us to accelerate our revenue growth rate over the long term, we cannot assure that these and other initiatives will be sufficient to achieve our objectives of increased revenue growth, margins and cash flows or the timing of such anticipated benefits.

We believe that increasing our sales and support staff to leverage our service offerings and support our increasingly complex solutions will enable us to attract new customers, sell more services to existing customers and retain customers. However, we expect that the higher investments in this and the other growth initiatives discussed above will dampen our Modified EBITDA margin and cash flow in the near term until we can achieve higher service installations and an expansion in our rate of revenue growth that we expect will absorb the cost of the expanded sales reach and allow margins to expand again. 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. Our continued cost efficiency efforts are also intended to contribute to our overall margins. Our revenue and margins may also be impacted by, among other risks, competitive pressures, higher special access, 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, expenses, capital expenditures and certain taxes and fees.

Historically our revenue and expense in the first quarter has been impacted by the slowing of our customers' purchasing activities during the holidays and the resetting of payroll taxes in the new year. Our historical 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 and may not be indicative of future financial performance.

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 and indefinite-lived intangible assets 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.

39 -------------------------------------------------------------------------------- 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, 2012, 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, 2012, we considered our five-year historical cumulative annualized growth rates for unlevered free cash flow (Modified EBITDA less capital expenditures) of 11.1%, excluding 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 2012 assessment was consistent with the methodology used in the prior year period. Our 2012 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 2012 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 impairment under our 2012 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.

40 -------------------------------------------------------------------------------- Although events and circumstances in 2012 did not indicate that the carrying amount of such assets may not be recoverable, we performed a recoverability test. Our 2012 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, 2012.

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 an $8.3 million decrease or $5.0 million increase, respectively, in net income for the year ended December 31, 2012.

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. During 2010, we determined that it is more likely than not that the vast majority of our deferred tax assets, including NOLs, will be realized, and as a result reversed $299.0 million of the valuation allowance. In making this determination, we analyzed, among other things, our recent history of earnings, cumulative earnings for the last 12 quarters, and forecasts of future earnings. The reversal of the valuation allowance recorded during 2010 resulted in an income tax benefit of $299.0 million, or $1.98 per basic share and $1.72 per diluted share, for the year ended December 31, 2010.

We continue to maintain a valuation allowance against certain deferred tax assets totaling $33.2 million. 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.

As of December 31, 2012, we had NOLs for federal income tax purposes of approximately $823.0 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, 2011, 2010, 2009 and 2008.

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 did 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.

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.

41 -------------------------------------------------------------------------------- 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 9% at December 31, 2010 to 8% at December 31, 2011 and 7% at December 31, 2012. 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, 2012.

Stock-Based Compensation We recognize the cost of stock-based payments as compensation expense over the requisite service period, which is generally the vesting period of the award.

The fair value of restricted stock awards and restricted stock units granted is determined based on the market price of our common stock at the date of grant.

We use the Black-Scholes pricing model to estimate the fair value of options as of the grant date. The Black-Scholes model by its design is dependent upon key data inputs estimated by management such as expected volatility, expected term and expected dividend yield. See Note 1 and Note 10 to the consolidated financial statements for a further discussion of our stock-based compensation plans.

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: 2012 Compared to 2011 Revenue Revenue by line of business was as follows: Year Ended December 31, (dollars in thousands) 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.

42-------------------------------------------------------------------------------- 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.

Costs and Expense The major components of costs and expenses were as follows: Year Ended December 31, (dollars in thousands) 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. 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, which enhances our ability to minimize and control access costs, which are the costs to purchase network services from other carriers. The increase in operating expenses primarily related to revenue growth, largely due to higher network access costs.

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. 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 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 costs 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.

43 -------------------------------------------------------------------------------- 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: Year Ended December 31, (dollars in thousands, except per share amounts) 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 % ___________________ 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 (loss), 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%. We expect our effective tax rate for the year ended December 31, 2013 to be similar to that for 2012.

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 has been sufficient to cover our capital expenditures and service our debt, and 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, common stock (if used to satisfy our Convertible Debentures obligation in whole or in part) 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 (loss), 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.

44 --------------------------------------------------------------------------------2011 Compared to 2010 Revenue Revenue by line of business was as follows: Year Ended December 31, (dollars in thousands) 2011 2010 $ Change % Change Revenue (1): Data and Internet services $ 646,682 $ 547,218 $ 99,464 18.2 % Network services 350,709 359,169 (8,460 ) (2.4 )% Voice services 338,655 332,870 5,785 1.7 % Intercarrier compensation 30,845 33,914 (3,069 ) (9.0 )% Total revenue $ 1,366,891 $ 1,273,171 $ 93,720 7.4 % ___________________(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 $63.5 million and $51.3 million for the years ended December 31, 2011 and 2010, respectively. This has no impact on Modified EBITDA or net income but is dilutive to Modified EBITDA margin.

The primary driver of growth in total revenue 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 Ethernet and IP-based product sales to enterprise customers.

The decrease in network services revenue was primarily from revenue churn and repricing of renewed customer contracts largely in transport services partially offset by growth primarily in high capacity and collocation services revenue.

The increase in voice services revenue resulted primarily from increases in both rates and volume of certain taxes and fees remitted to government authorities that we classify on a gross versus net basis in revenue and expense. Installed sales of converged and other voice solutions were more than offset by revenue churn and a reduction in usage-based services. Revenue based on the minutes of service used by customers included in voice services was 3% and 4% of our total revenue for the years ended December 31, 2011 and 2010, respectively.

The decrease in intercarrier compensation was primarily due to fluctuations in dispute settlements and rate reductions somewhat offset by an increase in minutes of use terminated on our network. As a result of a November 2011 FCC order, we expect that approximately half of this revenue will be eliminated over a six year period that began in July 2012 and ends in July 2018.

45 -------------------------------------------------------------------------------- Costs and Expense The major components of costs and expenses were as follows: Year Ended December 31, (dollars in thousands) 2011 2010 $ Change % Change Costs and expenses: Operating (exclusive of depreciation, amortization and accretion shown separately below) (1) $ 571,461 $ 528,965 $ 42,496 8.0 % Operating costs as percentage of total revenue 41.8 % 41.5 % Selling, general and administrative (1) 325,538 308,470 17,068 5.5 % Selling, general and administrative costs as percentage of total revenue 23.8 % 24.2 % Depreciation, amortization and accretion 283,329 289,564 (6,235 ) (2.2 )% Total costs and expenses $ 1,180,328 $ 1,126,999 $ 53,329 4.7 % (1) Includes the following non-cash stock-based employee compensation expense: Operating $ 2,327 $ 3,261 $ (934 ) (28.6 )% Selling, general, and administrative $ 25,490 $ 24,571 $ 919 3.7 % Operating Expenses. The increase in operating expenses is primarily due to increased network access costs, certain taxes and fees and employee costs to support higher revenue growth.

Selling, General and Administrative Expenses. The increase in selling, general and administrative expenses was primarily due to higher employee costs and property taxes. The higher employee costs resulted from incentive-based compensation for sales employees due to increased customer installations of service, expansion of our sales and sales support personnel, annual merit-based salary increases, and other employee-related costs.

Depreciation, Amortization and Accretion Expense. The decrease in depreciation, amortization and accretion was primarily attributable to fully depreciated and retired assets partially offset by additions to property, plant and equipment in 2011 and 2010.

Operating Income and Net Income The following table provides the components from operating income to net income for purposes of the discussions that follow: Year Ended December 31, (dollars in thousands, except per share amounts) 2011 2010 $ Change % Change Operating income $ 186,563 $ 146,172 $ 40,391 27.6 % Interest expense (87,718 ) (80,952 ) 6,766 8.4 % Debt extinguishment costs - (17,070 ) (17,070 ) NM Interest income 545 608 (63 ) (10.4 )% Other income, net - 825 (825 ) NM Income before income taxes 99,390 49,583 49,807 100.5 % Income tax expense (benefit) 41,479 (291,295 ) 332,774 NM Net income $ 57,911 $ 340,878 $ (282,967 ) NM Basic income per common share $ 0.39 $ 2.26 $ (1.87 ) NM Diluted income per common share $ 0.38 $ 2.12 $ (1.74 ) NM Modified EBITDA (1)(2) $ 497,709 $ 463,568 $ 34,141 7.4 % Modified EBITDA margin (1)(2)(3) 36.4 % 36.4 % ___________________ NM - Not meaningful (1) See Note 1 under "Revenue" above.

46 --------------------------------------------------------------------------------(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 (loss), 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 was primarily due to higher effective interest rates on the variable rate Term Loan and as a result of a debt refinancing in the fourth quarter of 2010 that extended the term of a portion of that loan and an increase in non-cash interest expense associated with our Convertible Debentures.

Debt Extinguishment Costs. Debt extinguishment costs for the year ended December 31, 2010 resulted from the early retirement of $400 million principal amount of our 9 1/4% Senior Notes due February 2014 (the "2014 Notes") and primarily consisted of $13.7 million in cash paid for call premiums and $3.6 million in non-cash write offs of deferred debt issuance costs. There were no such costs for the year ended December 31, 2011.

Other Income. During the year ended December 31, 2010, we recognized a gain of $0.8 million related to proceeds received upon liquidation of previously impaired commercial paper. There was no such gain during the year ended December 31, 2011. See Note 3 to our consolidated financial statements.

Income Before Income Taxes. The increase in income before income taxes primarily resulted from debt extinguishment costs in 2010 that did not recur, an increase in Modified EBITDA and lower depreciation, amortization and accretion, partially offset by an increase in interest expense.

Income Tax Expense (Benefit). The change in income tax expense (benefit) primarily related to a $299.0 million non-cash income tax benefit recognized during the three months ended June 30, 2010 resulting from the recognition of the value of deferred tax assets that we believe are realizable (see Note 9 to the consolidated financial statements), as well as a higher effective tax rate in 2011 and an increase in income before income taxes for the year ended December 31, 2011.

Net Income and Modified EBITDA. The decrease in net income resulted from the income tax expense (benefit) described above, partially offset by the increase in income before income taxes. The increase in Modified EBITDA was primarily the result of the contribution from revenue growth partially offset by an increase in employee and field related costs. Modified EBITDA margins included the absorption of higher costs associated with the expansion of our employee base for sales, sales support, IT and technical personnel, increases in access costs due to higher prices and increased volume and increases in revenue and expenses for certain taxes and fees. For the years ended December 31, 2011 and 2010, 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 business communications 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 and fund acquisitions. Additionally, we have also used cash to repurchase our common stock. In November 2011, our Board of Directors authorized a multi-year repurchase program of up to $300 million of our common stock, of which approximately $22.0 million was repurchased as of December 31, 2012. We may also use cash on hand in the future to repay current debt maturities or to satisfy debt repurchase obligations. Holders of our outstanding Convertible Debentures have the option to require us to purchase all or part of the Convertible Debentures on April 1, 2013, April 1, 2016, or April 1, 2021, or at any time prior to April 1, 2026 to convert the debentures into shares of our common stock. See "Capital Resources--Possible Future Uses of Cash" below.

At December 31, 2012, we had approximately $1.8 billion of total debt and capital lease obligations and $974.3 million of cash, cash equivalents and short-term investments compared to approximately $1.4 billion of total debt and capital lease obligations and $484.9 million of cash, cash equivalents and short-term investments at December 31, 2011. Net debt of $784.9 million (defined as total debt and capital lease obligations less cash, cash equivalents and short-term investments) decreased $90.7 million primarily due to cash provided by operating activities resulting from higher Modified EBITDA and net proceeds from stock option exercises partially offset by capital expenditures, repurchases of our common stock, payment of deferred financing costs in connection with the issuance of the 2022 Notes and an increase in our debt resulting from accretion of the discount on our Convertible Debentures.

47 -------------------------------------------------------------------------------- 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. Interest expense will increase $25.8 million annually as a result of issuance of the 2022 Notes. We may use the net proceeds of this offering to settle the conversion obligations for the Convertible Debentures to the extent holders elect to convert their Convertible Debentures and we elect to settle the conversion obligations in whole or in part in cash, or if we otherwise redeem the Convertible Debentures. See "Capital Resources--Possible Future Uses of Cash" below for the terms under which the Convertible Debentures may be settled or redeemed. Any net proceeds not used for these purposes would be used for general corporate purposes. Pending the application of the net proceeds to these uses, we have invested the proceeds in cash equivalents.

Working capital, defined as current assets less current liabilities, was $506.2 million as of December 31, 2012, an increase of $134.7 million from December 31, 2011. The increase in working capital is primarily a result of cash provided by operations and the proceeds from the issuance of the 2022 Notes somewhat offset by capital spending, an increase in the current portion of long-term debt for our Convertible Debentures and prepayment of a portion of our Term Loan. Our working capital ratio, defined as current assets divided by current liabilities, was 1.76 as of December 31, 2012 as compared to 2.27 as of December 31, 2011.

Cash Flow Activity Cash and cash equivalents were $806.7 million and $353.4 million as of December 31, 2012 and 2011, respectively. In addition, we had investments of $167.6 million and $131.5 million as of December 31, 2012 and 2011, respectively, which were short-term in nature and generally available to fund our operations. The change in cash and cash equivalents during the periods presented were as follows: Years ended December 31, 2012 2011 2010 (amounts in thousands) Cash provided by operating activities $ 463,676 $ 403,588 $ 385,752 Cash used in investing activities (373,971 ) (352,799 ) (418,049 ) Cash provided by (used in) financing activities 363,629 (54,317 ) (56,688 ) Increase (decrease) in cash and cash equivalents $ 453,334 $ (3,528 ) $ (88,985 ) Operations. The increase in cash provided by operating activities in 2012 compared to 2011 primarily related to higher Modified EBITDA and changes in working capital, which were largely due to the timing of payments to vendors and employees and the collection of receivables.

The increase in cash provided by operating activities in 2011 compared to 2010 primarily related to higher Modified EBITDA somewhat offset by changes in working capital and other noncurrent assets and liabilities, which were largely due to the timing of payments to vendors and employees and the collection of receivables.

Investing. The change in cash used in investing activities in 2012 compared to 2011 is primarily a result of 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 December 31, 2012 was $338.1 million, the majority of which was success-based spending initiatives (see "Capital Expenditures and Requirements" below), compared to $340.7 million for the year ended December 31, 2011.

The change in cash used in investing activities in 2011 compared to 2010 is primarily a result of the net decrease in cash used for the purchase and sale of investments in 2011 somewhat offset by an increase in capital expenditures. 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 December 31, 2011 was $340.7 million, the majority of which was success-based spending initiatives, compared to $321.8 million in capital expenditures for the year ended December 31, 2010.

Financing. Cash provided by financing activities for 2012 was primarily due to the $470.8 million in net proceeds from the issuance of the 2022 Notes and $23.4 million in proceeds from option exercises, somewhat 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. Cash used in financing activities for 2011 primarily consisted of repurchases of $58.6 million of our common stock. Cash used in financing activities for 2010 primarily consisted of repurchases of $49.9 million of our common stock and payments of $7.2 million on the Term Loan and capital lease obligations.

48 -------------------------------------------------------------------------------- Our financing activities from 2010 to 2012 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, as discussed above. For a description of the significant terms of the 2022 Notes, see Note 6 to the consolidated financial statements.

•In March 2010, we completed an offering of the 2018 Notes at an offering price of 99.284% of the principal amount. The purpose of the 2018 Notes offering was to extend our debt maturities and reduce interest rates. The net proceeds from the offering were used to fund extinguishment of the 2014 Notes, of which $366.5 million principal amount were purchased at a price of 103.45% of the principal amount in a concurrent tender offer. Notes representing the remaining $33.5 million principal amount of the 2014 Notes were either tendered or redeemed at a price of 103.083% of the principal amount. For a description of the significant terms of the 2018 Notes, see Note 6 to the consolidated financial statements.

•In December 2010, we amended and restated our 2006 Credit Agreement to extend $474.1 million of the total $577.5 million outstanding principal amount of our Term Loan at that date from January 2013 to December 2016 (the "extended tranche"). The January 2013 maturity of the remaining $103.4 million of outstanding principal was unchanged (the "January 2013 tranche"). The term of our undrawn Revolver was extended from October 2011 to December 2014. In August 2012, we extinguished in full the outstanding principal amount of $101.5 million of the January 2013 tranche by utilizing cash and cash equivalents.

As of December 31, 2012, we had the following indebtedness outstanding or available: Aggregate annual Principal amount estimated interest Instrument outstanding payments (amounts in thousands) 8% Senior Notes due 2018 $ 430,000 $ 34,400 5 3/8% Senior Notes due 2022 480,000 25,800 2 3/8% Convertible Senior Debentures due 2026 (1) 373,743 8,876 Term Loan, Eurodollar rate + 3.25% due 2016 (2) 463,019 16,003 Undrawn $80 million Revolver expires 2014 (3) - - ___________________ (1) The Convertible Debentures are redeemable in whole or in part at our option at any time on or after April 6, 2013 at a redemption price equal to 100% of the principal amount of the debentures to be redeemed, plus accrued and unpaid interest. Holders of the Convertible Debentures have the option to require us to purchase all or part of the Convertible Debentures on April 1, 2013, April 1, 2016, or April 1, 2021, or at any time prior to April 1, 2026 to convert the debentures into shares of our common stock. Upon conversion, we will have the right to deliver, in lieu of shares of common stock, cash or a combination of cash and shares of common stock.

(2) The aggregate annual estimated interest payments are based on the effective interest rate of 3.47% at December 31, 2012.

(3) Interest on outstanding amounts, if any, will be computed on a specified Eurodollar rate plus 2.5% to 3.5% and will be reset periodically. We are required to pay a commitment fee on the undrawn commitment amounts on a quarterly basis of 0.5% per annum.

49--------------------------------------------------------------------------------The following diagram summarizes our corporate structure in relation to our outstanding indebtedness and credit facility as of December 31, 2012. 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 and 2022 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 December 2016. The principal amount is reduced by quarterly principal payments.

d The Convertible Debentures are redeemable in whole or in part at our option at any time on or after April 6, 2013 at a redemption price equal to 100% of the principal amount of the debentures to be redeemed, plus accrued and unpaid interest. Holders of the Convertible Debentures have the option to require us to purchase all or part of the Convertible Debentures on April 1, 2013, April 1, 2016, or April 1, 2021, or at any time prior to April 1, 2026 to convert the debentures into shares of our common stock.

Capital Expenditures and Requirements Our total capital expenditures were $343.4 million for the year ended December 31, 2012 compared to $342.7 million for the year ended December 31, 2011, with the majority of capital expenditures in each period for success-based initiatives. The increase in capital expenditures over the prior year reflects higher strategic fiber purchases to extend our network reach as well as product and technology investments to enable future capabilities offset by certain cell site projects and infrastructure and technology upgrades in 2011 that did not recur and equipment-related capital efficiencies. In each of the full years ended 2005 through 2012, over 75% of our total annual capital expenditures, excluding capital expenditures for integration and branding, were for what we deem success-based opportunities that were linked to new installations and capacity requirements. Success-based spending consists of short-to-medium length capital projects, in terms of anticipated time between capital spending and return on investment, driven by customer 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 can fluctuate as our volume of sales and service installations increases or decreases.

For 2013, we expect capital expenditures of approximately $360 million to $370 million (see "Capital Resources" below for discussion of anticipated funding sources), the majority of which we expect to be related to success-based opportunities. Included in our 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. We generally do not make long-term commitments for capital expenditures and have the ability to adjust our capital expenditures if our cash from operations is lower than anticipated or in response to a change in demand.

50 -------------------------------------------------------------------------------- Capital Resources Based on current assumptions, we expect to generate sufficient cash from operations along with available cash on hand (including cash equivalents and investments), common stock (if used to settle our Convertible Debentures in whole or in part) 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 or enter into joint ventures, 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 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.

The Revolver, Term Loan, 2018 Notes and 2022 Notes limit our ability to declare cash dividends, incur indebtedness, incur liens on property and undertake acquisitions, among other things. The Revolver, Term Loan, 2018 Notes and 2022 Notes 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 2018 Notes and 2022 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 2018 Notes, 2022 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 2018 Notes, 2022 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, 2012, we were in compliance with all of our debt covenants.

Possible Future Uses of Cash. Our consistent financial performance and cash, cash equivalent and short-term investments of $974.3 million allow us flexibility to make strategic choices in the use of our cash. In order to reduce future cash interest payments, as well as future amounts due at maturity or mandatory redemption and reduce our leverage, we or our affiliates may, from time to time, enter into interest rate swap agreements or purchase or redeem our outstanding 2018 Notes, 2022 Notes or Convertible Debentures for cash or equity securities in the open market or privately negotiated transactions or engage in other transactions to reduce the principal amount of outstanding 2018 Notes, 2022 Notes or Convertible Debentures. We also may seek to refinance or otherwise replace or prepay all or a portion of our Term Loan and Revolver.

51 -------------------------------------------------------------------------------- Under the terms of our Revolver, which is more restrictive than our Term Loan and the indenture for the 2018 Notes, we currently may repurchase a portion of our 2018 Notes or Convertible Debentures if we have a minimum of $225 million in cash and equivalents after giving effect to the repurchase and meet certain other conditions, which we met as of December 31, 2012, and do not use the Revolver proceeds for this purpose. The Convertible Debentures are redeemable in whole or in part at our option at any time on or after April 6, 2013 at a redemption price equal to 100% of the principal amount plus accrued and unpaid interest. In addition, holders of our outstanding Convertible Debentures have the option to require us to purchase all or part of the Convertible Debentures on April 1, 2013, April 1, 2016, or April 1, 2021 at a redemption price equal to 100% of the principal amount plus accrued and unpaid interest. The holders of the Debentures also have the right at any time prior to April 1, 2026 to convert the Convertible Debentures into shares of our common stock at a conversion rate of 53.6466 shares per $1,000 principal amount of debentures, representing a conversion price of $18.64 per share. Upon conversion, we will have the right to deliver, in lieu of shares of common stock, cash or a combination of cash and shares of common stock. If we elect to settle the conversion obligations other than by delivering only shares of common stock, and the price of our common stock exceeds $18.64 per share when the Convertible Debentures are converted, then for every $1,000 in principal amount of the Convertible Debentures surrendered for conversion, the holder will receive (i) $1,000 for the principal value of the Convertible Debentures, and (ii) the amount by which the conversion value (calculated as the product of the initial conversion rate and the average closing price of our common stock as described in the indenture) exceeds $1,000 ("principal plus premium"). As of December 31, 2012, the if-converted value of the Convertible Debentures exceeded the principal amount by $136.9 million. This amount could increase or decrease depending on the market price of our common stock at the time of conversion. See Note 1 to "Commitments" below for more information on the calculation upon conversion. If we notify the holders of our outstanding Convertible Debentures of redemption at a price equal to 100% of the principal amount plus accrued and unpaid interest, the holders instead would likely convert the debentures into shares of our common stock at principal plus premium, as discussed above, which they may do until one day prior to the redemption date.

On November 16, 2011, our Board of Directors authorized a multi-year repurchase program of up to $300 million of our common stock, of which approximately $22.0 million was repurchased as of December 31, 2012. This authorization does not have an expiration date, but can be withdrawn by the Board at any time. Our Revolver permits repurchases of our common stock up to $150 million annually in the aggregate if after the transaction we have a minimum of $225 million in cash and cash equivalents, have not used that basket for other permissible purposes, including dividend payments, and meet certain other conditions, which conditions we met as of December 31, 2012. Up to $50 million of this permitted amount that remains unused in any fiscal year may be carried over and used in the immediately succeeding calendar year for permissible purposes. This test under the Revolver is also more restrictive than our other debt agreements. We may consider repurchasing additional shares of our common stock in public or private transactions or may consider paying dividends to the extent permitted by our debt covenants. Additionally, we may consider merger and acquisition opportunities that could impact our cash usage. 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.

Risk Management. As of December 31, 2012, our cash, cash equivalents and short-term investments were held in financial institutions, prime money market mutual funds, U.S. Treasury money market mutual funds, certificates of deposit, commercial paper and debt securities issued by the U.S. Treasury and other U.S.

government agencies. Although we actively monitor the depository institutions 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 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, 2012, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

52 --------------------------------------------------------------------------------Commitments. The following table summarizes our long-term commitments as of December 31, 2012, and after giving effect to a real estate lease that was executed in January 2013, including commitments pursuant to debt agreements, lease obligations, fixed maintenance contracts, and other purchase obligations.

Contractual Obligations Total 2013 2014 2015 2016 2017 Thereafter (amounts in thousands) Principal payments on long-term debt: Term Loan B (extended tranche) due 2016 $ 463,019 $ 4,926 $ 4,926 $ 4,926 $ 448,241 $ - $ - 8% Senior Notes due 2018 430,000 - - - - - 430,000 5 3/8% Senior Notes due 2022 480,000 - - - - - 480,000 2 3/8% Convertible Senior Debentures due 2026 (1) 373,743 373,743 - - - - - Total principal payments $ 1,746,762 $ 378,669 $ 4,926 $ 4,926 $ 448,241 $ - $ 910,000 Interest payments on long-term debt (2) 515,437 81,047 76,439 75,861 75,690 60,200 146,200 Capital lease obligations including interest (3) 30,318 3,398 2,885 2,570 2,445 2,055 16,965 Operating lease obligations 329,760 51,974 47,546 41,466 34,395 29,739 124,640 Fixed maintenance obligations 38,779 3,047 3,047 3,047 3,047 3,047 23,544 Purchase obligations Purchase orders (4) 46,916 46,916 - - - - -Network costs (5) 240,605 83,895 70,019 48,342 27,277 9,605 1,467 Total $ 2,948,577 $ 648,946 $ 204,862 $ 176,212 $ 591,095 $ 104,646 $ 1,222,816 ___________________ (1) Holders of the Convertible Debentures have the option to require us to purchase all or part of the Convertible Debentures on April 1, 2013, April 1, 2016, or April 1, 2021 at a purchase price equal to 100% of the principal amount plus accrued and unpaid interest, or at any time prior to April 1, 2026 to convert the debentures into shares of our common stock (see Note 6 to the consolidated financial statements); therefore, the repayment obligation is presented in full at the earliest maturity date. Upon conversion, we have the right to deliver, in lieu of common stock, cash or a combination of cash and shares of common stock. The amount presented in the table above assumes that the repayment obligation is repaid at par value. If the price of our common stock exceeds $18.64 per share when the Convertible Debentures are converted, then for every $1,000 in principal amount of the Convertible Debentures surrendered for conversion, the holder will receive (i) $1,000 for the principal value of the Convertible Debentures, and (ii) the amount by which the conversion value (calculated as the product of the initial conversion rate and the average closing price of our common stock as described in the indenture) exceeds $1,000. Accordingly, if the Convertible Debentures are settled entirely in shares of our common stock, 20.1 million shares would be issued regardless of the market price of our common stock.

53-------------------------------------------------------------------------------- If any Convertible Debentures are converted, we will consider all alternatives available to us to settle our obligations under the Convertible Debentures. The examples illustrated below are hypothetical only and should not be construed to mean that we will consider only the combinations of cash and shares of our common stock demonstrated in the examples. The table shown below illustrates two hypothetical examples of settlement scenarios upon conversion for stock prices ranging from $18.64-$43.64 whereby (i) the principal amount of the notes, $373.7 million, is paid in cash and the incremental value is delivered in shares of our common stock, or (ii) both the principal value of the notes and the incremental value is delivered in shares of our common stock: Hypothetical Settlement Scenarios Scenario 1 Scenario 2 Principal amount Principal Incremental and incremental Per Incremental amount value settled value Share Value Over paid in cash in shares settled in shares Price Obligation Par Value Cash No. of Shares No. of Shares (amounts in thousands except per share price) $ 18.64 $ 373,743 $ - $ 373,743 - 20,050 23.64 473,983 100,240 373,743 4,240 20,050 28.64 574,233 200,490 373,743 7,000 20,050 33.64 674,483 300,740 373,743 8,940 20,050 38.64 774,734 400,991 373,743 10,378 20,050 43.64 874,984 501,241 373,743 11,486 20,050 (2) Interest payments on the Term Loan are calculated using the rate in effect as of December 31, 2012.

(3) Includes amounts representing interest of $10.2 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.

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