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EX-32.2 - CERTIFICATION OF CFO - tw telecom inc.twtc2q14exhibit322.htm
EX-31.1 - CERTIFICATION OF CEO - tw telecom inc.twtc2q14exhibit311.htm
EX-31.2 - CERTIFICATION OF CFO - tw telecom inc.twtc2q14exhibit312.htm
EXCEL - IDEA: XBRL DOCUMENT - tw telecom inc.Financial_Report.xls
EX-32.1 - CERTIFICATION OF CEO - tw telecom inc.twtc2q14exhibit321.htm

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 FORM 10-Q
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2014
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to             
Commission File Number 1-34243

tw telecom inc.
(Exact name of Registrant as specified in its charter)
 
 
 
 
Delaware
 
84-1500624
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
 
 
10475 Park Meadows Drive
Littleton, Colorado
 
80124
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (303) 566-1000
 Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
 
 
 
 
 
 
Large accelerated filer
 
ý
  
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
o (Do not check if a smaller reporting company)
  
Smaller reporting company
 
¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
The number of shares outstanding of tw telecom inc.’s common stock as of July 31, 2014 was 138,067,739 shares.
 
 
 
 
 



INDEX TO FORM 10-Q
 
 
 
 
 
 
Page
 
Item 1.
Financial Statements:
 
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
Item 1.
Item 1A.
Item 2.
Item 6.


2


Part I. Financial Information
Item 1. Financial Statements
tw telecom inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
 
 
June 30,
2014
 
December 31,
2013
 
 
(unaudited)
 
 
 
 
(amounts in thousands, except per share amounts)
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
190,163

 
$
284,419

Investments
 
173,564

 
194,576

Receivables, less allowances of $7,087 and $6,748, respectively
 
106,335

 
107,258

Prepaid expenses and other current assets
 
25,745

 
22,545

Deferred income taxes
 
54,026

 
54,026

Total current assets
 
549,833

 
662,824

Property, plant and equipment
 
4,849,680

 
4,675,335

Less accumulated depreciation
 
(3,115,543
)
 
(2,980,379
)
 
 
1,734,137

 
1,694,956

Deferred income taxes
 
79,426

 
96,087

Goodwill
 
412,694

 
412,694

Intangible assets, net of accumulated amortization
 
9,089

 
11,555

Other assets, net
 
42,245

 
44,344

Total assets
 
$
2,827,424

 
$
2,922,460

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
70,732

 
$
38,454

Deferred revenue
 
49,248

 
48,371

Accrued taxes, franchise and other fees
 
54,029

 
55,043

Accrued interest
 
22,732

 
21,606

Accrued payroll and benefits
 
54,469

 
52,604

Accrued carrier costs
 
4,439

 
25,507

Current portion debt and capital lease obligations, net
 
8,147

 
32,470

Other current liabilities
 
31,160

 
35,241

Total current liabilities
 
294,956

 
309,296

Long-term debt and capital lease obligations, net
 
1,914,878

 
1,916,775

Long-term deferred revenue
 
19,792

 
20,046

Other long-term liabilities
 
42,838

 
40,274

Commitments and contingencies (Note 8)
 


 


Stockholders’ equity:
 
 
 
 
Preferred stock, $0.01 par value, 20,000 shares authorized, no shares issued and outstanding
 

 

Common stock, $0.01 par value, 439,800 shares authorized, 153,760 shares issued
 
1,538

 
1,538

Additional paid-in capital
 
1,701,063

 
1,701,356

Treasury stock, 15,708 and 12,593 shares, at cost, respectively
 
(455,082
)
 
(357,974
)
Accumulated deficit
 
(692,717
)
 
(708,979
)
Accumulated other comprehensive income
 
158

 
128

Total stockholders’ equity
 
554,960

 
636,069

Total liabilities and stockholders’ equity
 
$
2,827,424

 
$
2,922,460

See accompanying notes to condensed consolidated financial statements.

3


tw telecom inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(amounts in thousands, except per share amounts)
Revenue:
 
 
 
 
 
 
 
 
Data and Internet services
 
$
253,031

 
$
220,063

 
$
496,702

 
$
431,784

Voice services
 
77,919

 
76,437

 
155,280

 
152,467

Network services
 
56,667

 
64,079

 
115,034

 
129,034

Service revenue
 
387,617

 
360,579

 
767,016

 
713,285

Taxes and fees
 
25,412

 
20,622

 
48,164

 
41,216

Intercarrier compensation
 
6,674

 
8,282

 
12,816

 
16,191

Total revenue
 
419,703

 
389,483

 
827,996

 
770,692

Costs and expenses (a):
 
 
 
 
 
 
 
 
Operating (exclusive of depreciation, amortization and accretion shown separately below)
 
181,391

 
164,131

 
355,430

 
325,213

Selling, general and administrative
 
108,613

 
96,438

 
215,445

 
190,000

Depreciation, amortization and accretion
 
84,185

 
75,652

 
166,641

 
150,047

Total costs and expenses
 
374,189

 
336,221

 
737,516

 
665,260

Operating income
 
45,514

 
53,262

 
90,480

 
105,432

Interest expense
 
(24,873
)
 
(21,544
)
 
(50,521
)
 
(49,884
)
Debt extinguishment costs
 

 
(399
)
 
(1,282
)
 
(399
)
Interest income
 
109

 
173

 
257

 
450

Income before income taxes
 
20,750

 
31,492

 
38,934

 
55,599

Income tax expense
 
9,601

 
14,145

 
17,994

 
25,108

Net income
 
$
11,149

 
$
17,347

 
$
20,940

 
$
30,491

Earnings per share:
 
 
 
 
 
 
 
 
Basic
 
$
0.08

 
$
0.12

 
$
0.15

 
$
0.20

Diluted
 
$
0.08

 
$
0.11

 
$
0.15

 
$
0.20

Weighted average shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
136,360

 
147,071

 
137,219

 
148,095

Diluted
 
137,814

 
148,342

 
139,172

 
151,081


(a) Includes non-cash stock-based employee compensation expense (Note 7):
Operating
 
$
545

 
$
545

 
$
1,084

 
$
1,128

Selling, general and administrative
 
$
8,107

 
$
7,869

 
$
16,954

 
$
16,748


See accompanying notes to condensed consolidated financial statements.

4


tw telecom inc.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)

 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(amounts in thousands)
Net income
 
$
11,149

 
$
17,347

 
$
20,940

 
$
30,491

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
Unrealized gain (loss) on available-for-sale securities
 
40

 
(28
)
 
30

 
(20
)
Other comprehensive income (loss), net of tax
 
40

 
(28
)
 
30

 
(20
)
Comprehensive income
 
$
11,189

 
$
17,319

 
$
20,970

 
$
30,471


See accompanying notes to condensed consolidated financial statements.

5


tw telecom inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
 
 
Six Months Ended
June 30,
 
 
2014
 
2013
 
 
(amounts in thousands)
Cash flows from operating activities:
 
 
 
 
Net income
 
$
20,940

 
$
30,491

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation, amortization and accretion
 
166,641

 
150,047

Deferred income taxes
 
17,252

 
24,289

Stock-based compensation expense
 
18,038

 
17,876

Loss on debt extinguishment
 
1,282

 
399

Amortization of discount on debt and deferred debt issue costs
 
3,212

 
7,850

Changes in operating assets and liabilities:
 
 
 
 
Receivables, prepaid expenses and other assets
 
(1,629
)
 
(14,046
)
Accounts payable, deferred revenue and other liabilities
 
(1,231
)
 
(10,346
)
Net cash provided by operating activities
 
224,505

 
206,560

Cash flows from investing activities:
 
 
 
 
Capital expenditures
 
(195,998
)
 
(187,509
)
Purchases of investments
 
(109,275
)
 
(157,523
)
Proceeds from sale of investments
 
129,509

 
125,041

Other investing activities, net
 
5,841

 
(465
)
Net cash used in investing activities
 
(169,923
)
 
(220,456
)
Cash flows from financing activities:
 
 
 
 
Proceeds from issuance of common stock upon exercise of stock options
 
10,778

 
50,874

Taxes paid related to net share settlement of equity awards
 
(18,941
)
 
(18,315
)
Purchases of treasury stock
 
(112,564
)
 
(197,310
)
Excess tax benefits from stock-based compensation
 
794

 
944

Proceeds from modification of debt, net of financing costs
 

 
49,684

Retirement of debt obligations
 
(24,418
)
 
(256,348
)
Payment of debt and capital lease obligations
 
(4,487
)
 
(2,096
)
Net cash used in financing activities
 
(148,838
)
 
(372,567
)
Decrease in cash and cash equivalents
 
(94,256
)
 
(386,463
)
Cash and cash equivalents at beginning of period
 
284,419

 
806,728

Cash and cash equivalents at end of period
 
$
190,163

 
$
420,265

Supplemental disclosures of cash flow information:
 
 
 
 
Cash paid for interest
 
$
46,632

 
$
43,540

Cash paid for income taxes, net of refunds
 
$
2,314

 
$
4,477

Cash paid for debt extinguishment costs
 
$
939

 
$
469

Non-cash investing & financing activities:
 
 
 
 
Addition of capital lease obligations
 
$
1,352

 
$
4,302

See accompanying notes to condensed consolidated financial statements.

6


tw telecom inc.
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
Six Months Ended June 30, 2014
(Unaudited)
 
 
 
Common Stock
 
Treasury Stock
 
Additional
paid-in
capital
 
Accumulated
deficit
 
Accumulated
other
comprehensive
income
 
Total
stockholders’
equity
 
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
(amounts in thousands)
Balance at December 31, 2013
 
153,760

 
$
1,538

 
(12,593
)
 
$
(357,974
)
 
$
1,701,356

 
$
(708,979
)
 
$
128

 
$
636,069

Net income
 

 

 

 

 

 
20,940

 

 
20,940

Other comprehensive income, net of tax
 

 

 

 

 

 

 
30

 
30

Excess tax benefits from stock-based compensation, net
 

 

 

 

 
610

 

 

 
610

Purchases of treasury stock
 

 

 
(3,674
)
 
(112,564
)
 

 

 

 
(112,564
)
Exercise of stock options net of (withholdings) to satisfy employee tax obligations upon vesting of stock awards
 

 

 
651

 
18,670

 
(23,737
)
 
(3,096
)
 

 
(8,163
)
Stock-based compensation
 

 

 
(92
)
 
(3,214
)
 
22,834

 
(1,582
)
 

 
18,038

Balance at June 30, 2014
 
153,760

 
$
1,538

 
(15,708
)
 
$
(455,082
)
 
$
1,701,063

 
$
(692,717
)
 
$
158

 
$
554,960

See accompanying notes to condensed consolidated financial statements.

7


tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
Description of Business and Capital Structure
tw telecom inc. (together with its wholly-owned subsidiaries, the “Company”) is a leading national provider of managed network services, specializing in business Ethernet, data networking, converged, Internet Protocol ("IP") based virtual private network or "IP VPN", Internet access, voice, including voice over Internet Protocol or “VoIP”, and network security services to enterprise organizations, including public sector entities, and carriers throughout the United States, including their global locations.
The Company has one class of common stock outstanding with one vote per share. The Company also is authorized to issue shares of preferred stock. The Company’s Board of Directors has the authority to establish voting powers, preferences and special rights for the preferred stock. No shares of preferred stock have been issued.
See Note 2, "Recent Developments", for information regarding the Agreement and Plan of Merger with Level 3 Communications, Inc. ("Level 3").
Basis of Presentation
The accompanying unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for quarterly reports on Form 10-Q and do not include all of the information and note disclosures required by U.S. generally accepted accounting principles (“U.S. GAAP”) for complete financial statements. These condensed consolidated financial statements should therefore be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2013 filed with the SEC. The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with U.S. GAAP and include all adjustments of a normal, recurring nature that are, in the opinion of management, necessary to present fairly the financial position and results of operations for the interim periods presented. The results of operations for an interim period are not necessarily indicative of the results of operations for a full fiscal year.
Prior Year Reclassifications
Beginning January 1, 2014, the Company is reporting revenue from taxes and fees in a separate line item on the condensed consolidated statements of operations and is reporting revenue from dedicated high capacity Ethernet services in data and Internet services rather than network services. These reclassifications have been made in the prior year condensed consolidated statement of operations to conform to the current year presentation. Neither of these changes affects total revenue for the current period or prior periods. The following table provides revenue as currently reported and previously reported for the three and six months ended June 30, 2013:
 
 
Three Months Ended June 30, 2013
 
Six months ended June 30, 2013
 
 
As Currently Reported
 
As Previously Reported
 
As Currently Reported
 
As Previously Reported
 
 
(amounts in thousands)
Revenue:
 
 
 
 
 
 
 
 
Data and Internet services
 
$
220,063

 
209,634

 
431,784

 
411,716

Voice services
 
76,437

 
93,080

 
152,467

 
185,435

Network services
 
64,079

 
78,487

 
129,034

 
157,350

Service revenue
 
360,579

 
381,201

 
713,285

 
754,501

Taxes and fees
 
20,622

 

 
41,216

 

Intercarrier compensation
 
8,282

 
8,282

 
16,191

 
16,191

Total revenue
 
$
389,483

 
$
389,483

 
$
770,692

 
$
770,692


8

tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Accumulated Other Comprehensive Income
The balance in accumulated other comprehensive income as of June 30, 2014 and December 31, 2013 relates to the Company's investments that are classified as available-for-sale securities. The Company recognized no material changes in accumulated other comprehensive income for the three and six months ended June 30, 2014 or 2013. There were no significant items reclassified out of accumulated other comprehensive income for the three and six months ended June 30, 2014 or 2013.
Revenue
The Company’s revenue is derived primarily from business communications services comprised of the following:
Data and Internet services include services that enable customers to connect their internal computer networks between locations and to access external networks, including Internet access and data transport at high speeds using Ethernet protocol, local and wide-area business Ethernet and IP VPN solutions, including service enhancements that provide customers with more visibility and control over their Ethernet services, which we refer to as the "Intelligent Network". Data and Internet services also include a portfolio of managed services including the data and Internet components of converged services, which fully integrates a combination of certain communication applications including IP VPN, Internet, enterprise Session Initiation Protocol ("SIP") trunking (a VoIP solution), security and managed router service into a single managed IP solution; and the data and Internet components of integrated services, which enable customers to purchase a full array of access options that include Internet services.
Voice services are traditional voice capabilities, whether provided over Time Division Multiplexing ("TDM") or VoIP, including those provided as standalone and bundled services, long distance and toll free services. Voice services also include the voice components of managed and integrated services.
Network services are point-to-point services that transmit voice, data and images using state-of-the-art fiber optics, and collocation services that provide secure space with controlled climate and power where customers can locate their equipment to connect to the Company’s network in facilities equipped for enterprise information technology environmental requirements.
The Company also generates revenue from intercarrier compensation, which is comprised of switched access services and reciprocal compensation. Switched access represents the compensation from another carrier for the delivery of traffic from a long distance carrier’s point of presence to an end-user’s premises provided through the Company’s switching facilities. The Federal Communications Commission ("FCC") and state public utility commissions regulate switched access rates in their respective jurisdictions. Reciprocal compensation represents compensation from local exchange carriers (“LECs”) for local exchange traffic originated on another LEC’s facilities and terminated on the Company’s facilities.
The Company classifies taxes and fees billed to customers and remitted to government authorities on a gross versus net basis in revenue and expense. In making this determination, the Company assesses, among other things, whether the Company is the primary obligor or principal taxpayer for the taxes and fees assessed in each jurisdiction where the Company does business. In jurisdictions where the Company determines that it is the principal taxpayer, the Company records the taxes and fees on a gross basis, including the taxes and fees in revenue and expense. In jurisdictions where the Company determines that it is merely a collection agent for the government authority, the Company records the taxes on a net basis. The total amount of such taxes and fees classified as revenue is included in "Taxes and fees" on the Company's condensed consolidated statements of operations.
The Company’s 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 incumbent local exchange carriers ("ILECs"), competitive local exchange carriers ("CLECs"), wireless communications companies and cable companies.
Revenue for network, data and Internet, and the majority of 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

9

tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

and certain components of voice services, such as long distance, is generally billed on a transactional basis in arrears based on a customer’s actual usage; therefore, estimates are used to recognize revenue in the period earned.
The Company evaluates whether receivables are reasonably assured of collection based on certain factors, including the likelihood of billing being disputed by customers. If there is a billing dispute with a customer, revenue generally is not recognized until the dispute is resolved. The Company does not recognize revenue associated with contract termination charges until cash is received.
Significant Customers
The Company has substantial business relationships with a few large customers, including major telecommunications carriers. The Company’s 10 largest customers accounted for an aggregate of 17% and 18% of the Company’s total revenue for the six months ended June 30, 2014 and 2013, respectively. No customer accounted for 5% or more of total revenue for the six months ended June 30, 2014 or 2013.
Recently Issued Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board issued an accounting standards update that establishes a comprehensive new revenue recognition model designed to depict the transfer of goods or services to customers in an amount that reflects the consideration the entity expects to receive in exchange for those goods or services. The new standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016 and must be adopted using either a full retrospective approach for all periods presented in the period of adoption or a modified retrospective approach. The Company is currently evaluating the impact of this new standard on its consolidated financial statements as well as the transition method the Company intends to use.

2. Recent Developments

Level 3 Merger
On June 15, 2014, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with Level 3 Communications, Inc. ("Level 3") and certain of its subsidiaries whereby the Company agreed to merge with and into a wholly owned subsidiary of Level 3 (the "Level 3 merger").
Upon completion of the Level 3 merger, (i) each issued and outstanding share of common stock of the Company, other than dissenting shares, will be converted into 0.7 shares (the "Stock Consideration") of Level 3's common stock and the right to receive $10.00 in cash (the "Cash Consideration" and, together with the Stock Consideration, the "Merger Consideration"). The Merger Agreement also provides that the (i) issued and outstanding options to purchase the Company's common stock will be exchanged for Merger Consideration, as adjusted to reflect the exercise price of each such outstanding option and (ii) issued and outstanding restricted stock and restricted stock units covering the Company's common stock will vest and be exchanged for Merger Consideration. The Level 3 merger is expected to close during the fourth quarter of 2014, but not before October 4, 2014. The closing of the Level 3 merger is subject to the receipt of certain regulatory and governmental approvals and the satisfaction of certain conditions, including the approval of the Level 3 merger by the Company's stockholders and the approval of Level 3's proposed stock issuance and charter amendments by Level 3's stockholders.

3. Earnings per Common Share and Potential Common Share
Basic earnings per common share (“EPS”) is measured as the income allocated to common stockholders divided by the weighted average outstanding common shares for the period. Diluted EPS is similar to basic EPS but presents the dilutive effect on a per share basis of potential common shares (such as convertible securities and stock options) as if they had been converted to shares at the beginning of the period presented. Potential common shares that have an anti-dilutive effect (e.g., those that increase income per share) are excluded from diluted EPS.

10

tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

The following is a reconciliation of the numerators and denominators used in the basic and diluted EPS computations:
 
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(amounts in thousands, except per share amounts)
Numerator
 
 
 
 
 
 
 
 
Net income
 
$
11,149

 
$
17,347

 
$
20,940

 
$
30,491

Allocation of net income to unvested restricted stock
 
(199
)
 
(331
)
 
(378
)
 
(587
)
Net income allocated to common stockholders, basic
 
$
10,950

 
$
17,016

 
$
20,562

 
$
29,904

Net income allocated to common stockholders, diluted
 
$
10,950

 
$
17,016

 
$
20,562

 
$
29,904

Denominator
 
 
 
 
 
 
 
 
Basic weighted average shares outstanding
 
136,360

 
147,071

 
137,219

 
148,095

Dilutive potential common shares:
 
 
 
 
 
 
 
 
Stock options
 
269

 
886

 
330

 
1,180

Unvested restricted stock
 
1,185

 
385

 
1,623

 
1,806

Diluted weighted average shares outstanding
 
137,814

 
148,342

 
139,172

 
151,081

Basic earnings per share
 
$
0.08

 
$
0.12

 
$
0.15

 
$
0.20

Diluted earnings per share
 
$
0.08

 
$
0.11

 
$
0.15

 
$
0.20

 
There were no anti-dilutive shares for the three and six months ended June 30, 2014. Restricted stock awards to be settled in common stock upon vesting which were excluded from the computation of diluted weighted average shares outstanding because their inclusion would be anti-dilutive, totaled 2.9 million shares for the three months ended June 30, 2013. There were no anti-dilutive shares for the six months ended June 30, 2013.
4. Investments
The Company’s investments at June 30, 2014 and December 31, 2013 are summarized as follows:
 
 
 
June 30,
2014
 
December 31,
2013
 
 
(amounts in thousands)
Cash equivalents:
 
 
 
 
U.S. Treasury money market mutual funds
 
$
41,399

 
$
28,845

Commercial paper
 
9,998

 
1,335

Total cash equivalents
 
$
51,397

 
$
30,180

Investments:
 
 
 
 
Debt securities issued by the U.S. Treasury
 
$
60,028

 
$
69,628

Commercial paper
 
57,268

 
75,460

Debt securities issued by U.S. Government agencies
 
56,268

 
49,488

Total investments
 
$
173,564

 
$
194,576

Total cash equivalents and investments
 
$
224,961

 
$
224,756

At June 30, 2014 and December 31, 2013, the carrying values of investments included in cash and cash equivalents approximated fair value. The aggregate fair value of available-for-sale securities by major security type is included in Note 6. The amortized cost basis of the available-for-sale securities was not materially different from the aggregate fair value. The contractual maturities of the Company’s available-for-sale securities are all within one year.
Proceeds from the sale and maturity of available-for-sale securities were $60.0 million and $91.1 million during the three months ended June 30, 2014 and 2013, respectively, and $129.5 million and $125.0 million during the six months ended June 30, 2014 and 2013, respectively. Gains and losses on investments are calculated using the specific identification method and are

11

tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

recognized during the period the investment is sold. The Company recognized no material unrealized or realized net gains or losses during the three and six months ended June 30, 2014 and 2013. 

5. Long-Term Debt and Capital Lease Obligations
The components of long-term debt and capital lease obligations at June 30, 2014 and December 31, 2013 were as follows:
 
 
 
Date of
 
 
 
 
 
Outstanding Balance as of
 
 
Issuance / Amendment
 
Maturity
 
Interest Payments
 
Interest Rate
 
Original Principal
 
June 30,
2014
 
December 31,
2013
 
 
 
 
 
 
 
 
 
 
(amounts in thousands)
Term Loan B
 
Apr 2013
 
Apr 2020
 
At least quarterly
 
Eurodollar rate + 2.50%
 
$
520,000

 
$
514,800

 
$
517,400

8% Senior Notes
 
Mar 2010
 
Mar 2018
 
Mar/Sept
 
8%
 
430,000

 

 
23,479

53/8% Senior Notes
 
Oct 2012
 
Oct 2022
 
Apr/Oct
 
5 3/8%
 
480,000

 
480,000

 
480,000

53/8% Senior Notes
 
Aug 2013
 
Oct 2022
 
Apr/Oct
 
5 3/8%
 
450,000

 
450,000

 
450,000

63/8% Senior Notes
 
Aug 2013
 
Sept 2023
 
Mar/Sept
 
6 3/8%
 
350,000

 
350,000

 
350,000

Capital lease obligations
 
145,703

 
147,046

Total obligations
 
1,940,503

 
1,967,925

Unamortized discounts
 
(17,478
)
 
(18,680
)
Current portion
 
(8,147
)
 
(32,470
)
Total long-term debt and capital lease obligations
 
$
1,914,878

 
$
1,916,775

 
8% Senior Notes due 2018
As of December 31, 2013, tw telecom holdings inc. ("Holdings") had outstanding $23.5 million aggregate principal amount of 8% Senior Notes due 2018 (the "2018 Notes"). During the three months ended March 31, 2014, Holdings redeemed all remaining outstanding 2018 Notes at a redemption price of 104% of the principal amount. During the three months ended March 31, 2014, the Company recognized debt extinguishment costs of $1.3 million, comprised of $0.9 million for premiums associated with the redemption and $0.4 million for write-offs of unamortized deferred debt issuance costs and issuance discount related to the 2018 Notes.
Covenant Compliance
As of June 30, 2014, tw telecom inc. and its wholly-owned subsidiary, Holdings, were in compliance with all of their debt covenants.
6. Fair Value Measurements
Fair value, as defined by relevant accounting standards, is the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required to be recorded at fair value, the Company considers the principal or most advantageous market in which it would complete a transaction and considers assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions and risk of nonperformance.
 
Fair Value Hierarchy
Relevant accounting standards set forth a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Relevant accounting standards establish three levels of inputs that may be used to measure fair value:
Level 1—Quoted prices in active markets for identical assets or liabilities. Level 1 assets that are measured at fair value on a recurring basis consist of the Company’s investments in U.S. Treasury money market mutual funds that are traded in an active market with sufficient volume and frequency of transactions, and are included as a component of cash and cash equivalents in the condensed consolidated balance sheets.

12

tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

Level 2—Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets that are measured at fair value on a recurring basis consist of the Company’s investments in commercial paper and debt securities issued by the U.S. Treasury and other U.S. government agencies using observable inputs in less active markets and are included as a component of cash and cash equivalents and investments in the condensed consolidated balance sheets. Level 2 liabilities that are measured, but not carried, at fair value on a recurring basis include the Company’s long-term debt. The Company’s long-term debt has not been listed on any securities exchange or quoted on an inter-dealer automated quotation system. The Company has estimated the fair value of its long-term debt based on indicative pricing published by certain investment banks or trading levels in its long-term debt.
Level 3—Unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities. The Company did not have any Level 3 assets or liabilities that were measured at fair value at June 30, 2014 and December 31, 2013.
 
The following tables reflect assets that are measured and carried at fair value on a recurring basis at June 30, 2014 and December 31, 2013:
 
 
 
Fair Value Measurements At June 30, 2014
 
Assets
at Fair Value
 
 
Level 1
 
Level 2
 
Level 3
 
 
 
(amounts in thousands)
Assets
 
 
 
 
 
 
 
 
U.S. Treasury money market mutual funds
 
$
41,399

 
$

 
$

 
$
41,399

Commercial paper
 

 
9,998

 

 
9,998

Investments included in cash and cash equivalents
 
$
41,399

 
$
9,998

 
$

 
$
51,397

Debt securities issued by the U.S. Treasury
 

 
60,028

 

 
60,028

Commercial paper
 

 
57,268

 

 
57,268

Debt securities issued by U.S. Government agencies
 

 
56,268

 

 
56,268

Short-term investments
 
$

 
$
173,564

 
$

 
$
173,564

Total assets
 
$
41,399

 
$
183,562

 
$

 
$
224,961

 
 
 
Fair Value Measurements At December 31, 2013
 
Assets
at Fair Value
 
 
Level 1
 
Level 2
 
Level 3
 
 
 
(amounts in thousands)
Assets
 
 
 
 
 
 
 
 
U.S. Treasury money market mutual funds
 
$
28,845

 
$

 
$

 
$
28,845

Commercial paper
 

 
1,335

 

 
1,335

Investments included in cash and cash equivalents
 
$
28,845

 
$
1,335

 
$

 
$
30,180

Commercial paper
 

 
75,460

 

 
75,460

Debt securities issued by the U.S. Treasury
 

 
69,628

 

 
69,628

Debt securities issued by U.S. Government agencies
 

 
49,488

 

 
49,488

Short-term investments
 
$

 
$
194,576

 
$

 
$
194,576

Total assets
 
$
28,845

 
$
195,911

 
$

 
$
224,756

The following table summarizes the carrying amounts and estimated fair values of the Company’s long-term debt, including the current portion, at June 30, 2014 and December 31, 2013:

13

tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 
 
June 30, 2014
 
December 31, 2013
 
 
Carrying
Value
 
Fair Value
Level 2
 
Carrying
Value
 
Fair Value
Level 2
 
 
(amounts in thousands)
Term Loan B, net of discount
 
$
512,649

 
$
514,800

 
$
515,063

 
$
519,987

8% Senior Notes, net of discount
 

 

 
23,392

 
24,594

53/8% Senior Notes, issued October 2012
 
480,000

 
520,800

 
480,000

 
474,000

53/8% Senior Notes, net of discount, issued August 2013
 
434,673

 
488,250

 
433,744

 
444,375

63/8% Senior Notes
 
350,000

 
397,250

 
350,000

 
364,000

Total debt
 
$
1,777,322

 
$
1,921,100

 
$
1,802,199

 
$
1,826,956

7. Stock-Based Compensation
During the six months ended June 30, 2014, the Company granted restricted stock awards and restricted stock units with respect to 1.4 million shares and no stock options. As of June 30, 2014, the Company had 3.7 million restricted stock awards and restricted stock units that were unvested and 0.3 million stock options outstanding and exercisable.
As of June 30, 2014, there was $77.2 million of total unrecognized compensation expense related to unvested restricted stock awards and restricted stock units, which is expected to be recognized over a weighted-average period of 2.5 years, and no unrecognized compensation expense related to unvested stock options.
8. Commitments and Contingencies
Management routinely reviews the Company’s exposure to liabilities incurred in the normal course of its business operations. Where a probable contingency exists and the amount of the loss can be reasonably estimated, the Company records the estimated liability. Considerable judgment is required in analyzing and recording such liabilities and actual results may vary from the estimates.
Following the announcement of the execution of the Merger Agreement, three putative shareholder class action complaints (the "Class Action Complaints"), were filed in the Court of Chancery of the State of Delaware against the Company, its Board of Directors, Level 3, and certain subsidiaries of Level 3, challenging the proposed Level 3 merger: Veneros v. tw telecom, et al., Case No. 9835 (filed on or about June 27, 2014), Litman v. tw telecom, et al., Case No. 9838 (filed on or about June 27, 2014), and Carter v. tw telecom, et al., Case No. 9845 (filed on or about June 30, 2014).
The Class Action Complaints generally allege, among other things, that the individual members of the Company's Board of Directors breached their fiduciary duties owed to the public shareholders of the Company by approving its entry into the Merger Agreement and failing to take steps to maximize the value of the Company to its public shareholders, and that the Company, Level 3, and certain of Level 3's subsidiaries, aided and abetted such breaches of fiduciary duties. In addition, the Class Action Complaints allege, among other things, that the proposal regarding the Level 3 merger undervalues the Company, that the process leading up to the Merger Agreement was flawed, and that certain provisions of the Merger Agreement improperly favor Level 3 and impede a potential alternative transaction. The Class Action Complaints generally seek, among other things, declaratory and injunctive relief concerning the alleged fiduciary breaches, injunctive relief prohibiting the defendants from consummating the proposed Level 3 merger, and other forms of equitable relief. The Company intends to defend against these lawsuits vigorously, but is unable to predict the outcome of these lawsuits or reasonably estimate a range of possible loss.
The Company’s other pending legal proceedings are limited to litigation incidental to its business. In the opinion of management, the ultimate resolution of these matters are not expected to have a material adverse effect on the Company’s financial statements.
9. Supplemental Guarantor Information
The $480 million principal amount 53/8% Senior Notes due 2022 (the "2022 Notes"), $450 million principal amount 53/8% Senior Notes due 2022 (the "2022 Mirror Notes") and $350 million principal amount 63/8% Senior Notes due 2023 (the "2023 Notes") (collectively, the "Senior Notes") are unsecured obligations of Holdings ("Issuer") and are fully and unconditionally guaranteed by the Company (“Parent Guarantor”) and substantially all of the Issuer’s subsidiaries (“Combined Subsidiary Guarantors”). The guarantees are joint and several. The Combined Subsidiary Guarantors are directly or indirectly wholly owned by the Issuer, which is wholly owned by the Parent Guarantor. A significant amount of the Issuer’s cash flow is

14

tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

generated by the Combined Subsidiary Guarantors. As a result, funds necessary to meet the Issuer’s debt service obligations are provided in large part by distributions or advances from the Combined Subsidiary Guarantors. The Senior Notes are governed by indentures that contain certain restrictive covenants. These restrictions affect, and in many respects limit or prohibit, among other things, the ability of the Parent Guarantor, the Issuer and its subsidiaries to incur indebtedness, make prepayments of certain indebtedness, pay dividends, make investments, engage in transactions with stockholders and affiliates, issue capital stock of subsidiaries, create liens, sell assets and engage in mergers and consolidations.
The following information sets forth the Company’s Condensed Consolidating Balance Sheets as of June 30, 2014 and December 31, 2013, Condensed Consolidating Statements of Operations for the three and six months ended June 30, 2014 and 2013, Condensed Consolidating Statements of Comprehensive Income for the three and six months ended June 30, 2014 and 2013, and Condensed Consolidating Statements of Cash Flows for the six months ended June 30, 2014 and 2013.

15

tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)


tw telecom inc.
CONDENSED CONSOLIDATING BALANCE SHEET
June 30, 2014
(unaudited)


 
 
Parent
Guarantor
 
Issuer
 
Combined
Subsidiary
Guarantors
 
Eliminations
 
Consolidated
 
 
(amounts in thousands)
ASSETS
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
24,546

 
$
165,617

 
$

 
$

 
$
190,163

Investments
 

 
173,564

 

 

 
173,564

Receivables, net
 

 

 
106,335

 

 
106,335

Prepaid expenses and other current assets
 

 
15,703

 
10,042

 

 
25,745

Deferred income taxes
 

 
54,006

 
20

 

 
54,026

Intercompany receivable
 
804,463

 
1,570,131

 

 
(2,374,594
)
 

Total current assets
 
829,009

 
1,979,021

 
116,397

 
(2,374,594
)
 
549,833

Property, plant and equipment, net
 

 
83,873

 
1,650,264

 

 
1,734,137

Deferred income taxes
 

 
78,942

 
484

 

 
79,426

Goodwill
 

 

 
412,694

 

 
412,694

Intangible and other assets, net
 

 
34,280

 
17,054

 

 
51,334

Total assets
 
$
829,009

 
$
2,176,116

 
$
2,196,893

 
$
(2,374,594
)
 
$
2,827,424

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
 
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
 
Accounts payable
 
$

 
$
12,559

 
$
58,173

 
$

 
$
70,732

Current portion debt and capital lease obligations
 

 
5,247

 
2,900

 

 
8,147

Other current liabilities
 

 
84,443

 
131,634

 

 
216,077

Intercompany payable
 

 

 
2,374,594

 
(2,374,594
)
 

Total current liabilities
 

 
102,249

 
2,567,301

 
(2,374,594
)
 
294,956

Losses in subsidiary in excess of investment
 
274,690

 
831,084

 

 
(1,105,774
)
 

Long-term debt and capital lease obligations, net
 

 
1,772,122

 
142,756

 

 
1,914,878

Long-term deferred revenue
 

 

 
19,792

 

 
19,792

Other long-term liabilities
 

 
11,419

 
31,419

 

 
42,838

Stockholders’ equity (deficit)
 
554,319

 
(540,758
)
 
(564,375
)
 
1,105,774

 
554,960

Total liabilities and stockholders’ equity (deficit)
 
$
829,009

 
$
2,176,116

 
$
2,196,893

 
$
(2,374,594
)
 
$
2,827,424



16

tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 
tw telecom inc.
CONDENSED CONSOLIDATING BALANCE SHEET
December 31, 2013
 
 
 
Parent
Guarantor
 
Issuer
 
Combined
Subsidiary
Guarantors
 
Eliminations
 
Consolidated
 
 
(amounts in thousands)
ASSETS
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
24,546

 
$
259,873

 
$

 
$

 
$
284,419

Investments
 

 
194,576

 

 

 
194,576

Receivables, net
 

 

 
107,258

 

 
107,258

Prepaid expenses and other current assets
 

 
14,434

 
8,111

 

 
22,545

Deferred income taxes
 

 
54,006

 
20

 

 
54,026

Intercompany receivable
 
917,932

 
1,475,298

 

 
(2,393,230
)
 

Total current assets
 
942,478

 
1,998,187

 
115,389

 
(2,393,230
)
 
662,824

Property, plant and equipment, net
 

 
75,142

 
1,619,814

 

 
1,694,956

Deferred income taxes
 

 
95,603

 
484

 

 
96,087

Goodwill
 

 

 
412,694

 

 
412,694

Intangible and other assets, net
 

 
36,001

 
19,898

 

 
55,899

Total assets
 
$
942,478

 
$
2,204,933

 
$
2,168,279

 
$
(2,393,230
)
 
$
2,922,460

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
 
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
 
Accounts payable
 
$

 
$
8,298

 
$
30,156

 
$

 
$
38,454

Current portion debt and capital lease obligations, net
 

 
29,008

 
3,462

 

 
32,470

Other current liabilities
 

 
87,333

 
151,039

 

 
238,372

Intercompany payable
 

 

 
2,393,230

 
(2,393,230
)
 

Total current liabilities
 

 
124,639

 
2,577,887

 
(2,393,230
)
 
309,296

Losses in subsidiary in excess of investment
 
306,440

 
858,499

 

 
(1,164,939
)
 

Long-term debt and capital lease obligations, net
 

 
1,773,607

 
143,168

 

 
1,916,775

Long-term deferred revenue
 

 

 
20,046

 

 
20,046

Other long-term liabilities
 

 
10,526

 
29,748

 

 
40,274

Stockholders’ equity (deficit)
 
636,038

 
(562,338
)
 
(602,570
)
 
1,164,939

 
636,069

Total liabilities and stockholders’ equity (deficit)
 
$
942,478

 
$
2,204,933

 
$
2,168,279

 
$
(2,393,230
)
 
$
2,922,460

 

17

tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)


tw telecom inc.
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended June 30, 2014
(unaudited)
 
 
 
Parent
Guarantor
 
Issuer
 
Combined
Subsidiary
Guarantors
 
Eliminations
 
Consolidated
 
 
(amounts in thousands)
Total revenue
 
$

 
$

 
$
419,703

 
$

 
$
419,703

Costs and expenses:
 
 
 
 
 
 
 
 
 
 
Operating, selling, general and administrative
 

 
77,167

 
212,837

 

 
290,004

Depreciation, amortization and accretion
 

 
9,063

 
75,122

 

 
84,185

Corporate expense allocation
 

 
(86,230
)
 
86,230

 

 

Total costs and expenses
 

 

 
374,189

 

 
374,189

Operating income
 

 

 
45,514

 

 
45,514

Interest expense, net
 

 
(20,052
)
 
(4,712
)
 

 
(24,764
)
Interest expense allocation
 

 
20,052

 
(20,052
)
 

 

Income before income taxes and equity in undistributed earnings of subsidiaries
 

 

 
20,750

 

 
20,750

Income tax expense
 

 
9,236

 
365

 

 
9,601

Net income (loss) before equity in undistributed earnings of subsidiaries
 

 
(9,236
)
 
20,385

 

 
11,149

Equity in undistributed earnings of subsidiaries
 
11,149

 
20,385

 

 
(31,534
)
 

Net income
 
$
11,149

 
$
11,149

 
$
20,385

 
$
(31,534
)
 
$
11,149




18

tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 
tw telecom inc.
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended June 30, 2013
(unaudited)
 
 
 
Parent
Guarantor
 
Issuer
 
Combined
Subsidiary
Guarantors
 
Eliminations
 
Consolidated
 
 
(amounts in thousands)
Total revenue
 
$

 
$

 
$
389,483

 
$

 
$
389,483

Costs and expenses:
 
 
 
 
 
 
 
 
 
 
Operating, selling, general and administrative
 

 
67,167

 
193,402

 

 
260,569

Depreciation, amortization and accretion
 

 
6,707

 
68,945

 

 
75,652

Corporate expense allocation
 

 
(73,874
)
 
73,874

 

 

Total costs and expenses
 

 

 
336,221

 

 
336,221

Operating income
 

 

 
53,262

 

 
53,262

Interest expense, net
 
(1,569
)
 
(17,942
)
 
(1,860
)
 

 
(21,371
)
Debt extinguishment costs
 
(327
)
 
(72
)
 

 

 
(399
)
Interest expense allocation
 
1,896

 
18,014

 
(19,910
)
 

 

Income before income taxes and equity in undistributed earnings of subsidiaries
 

 

 
31,492

 

 
31,492

Income tax expense
 

 
13,672

 
473

 

 
14,145

Net income (loss) before equity in undistributed earnings of subsidiaries
 

 
(13,672
)
 
31,019

 

 
17,347

Equity in undistributed earnings of subsidiaries
 
17,347

 
31,019

 

 
(48,366
)
 

Net income
 
$
17,347

 
$
17,347

 
$
31,019

 
$
(48,366
)
 
$
17,347




19

tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)


tw telecom inc.
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Six Months Ended June 30, 2014
(unaudited)
 
 
 
Parent
Guarantor
 
Issuer
 
Combined
Subsidiary
Guarantors
 
Eliminations
 
Consolidated
 
 
(amounts in thousands)
Total revenue
 
$

 
$

 
$
827,996

 
$

 
$
827,996

Costs and expenses:
 
 
 
 
 
 
 
 
 
 
Operating, selling, general and administrative
 

 
149,108

 
421,767

 

 
570,875

Depreciation, amortization and accretion
 

 
17,654

 
148,987

 

 
166,641

Corporate expense allocation
 

 
(166,762
)
 
166,762

 

 

Total costs and expenses
 

 

 
737,516

 

 
737,516

Operating income
 

 

 
90,480

 

 
90,480

Interest expense, net
 

 
(40,540
)
 
(9,724
)
 

 
(50,264
)
Debt extinguishment costs
 

 
(1,282
)
 

 

 
(1,282
)
Interest expense allocation
 

 
41,822

 
(41,822
)
 

 

Income before income taxes and equity in undistributed earnings of subsidiaries
 

 

 
38,934

 

 
38,934

Income tax expense
 

 
17,253

 
741

 

 
17,994

Net income (loss) before equity in undistributed earnings of subsidiaries
 

 
(17,253
)
 
38,193

 

 
20,940

Equity in undistributed earnings of subsidiaries
 
20,940

 
38,193

 

 
(59,133
)
 

Net income
 
$
20,940

 
$
20,940

 
$
38,193

 
$
(59,133
)
 
$
20,940



20

tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)


tw telecom inc.
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Six Months Ended June 30, 2013
(unaudited)
 
 
 
Parent
Guarantor
 
Issuer
 
Combined
Subsidiary
Guarantors
 
Eliminations
 
Consolidated
 
 
(amounts in thousands)
Total revenue
 
$

 
$

 
$
770,692

 
$

 
$
770,692

Costs and expenses:
 
 
 
 
 
 
 
 
 
 
Operating, selling, general and administrative
 

 
131,974

 
383,239

 

 
515,213

Depreciation, amortization and accretion
 

 
13,286

 
136,761

 

 
150,047

Corporate expense allocation
 

 
(145,260
)
 
145,260

 

 

Total costs and expenses
 

 

 
665,260

 

 
665,260

Operating income
 

 

 
105,432

 

 
105,432

Interest expense, net
 
(9,705
)
 
(35,820
)
 
(3,909
)
 

 
(49,434
)
Debt extinguishment costs
 
(327
)
 
(72
)
 

 

 
(399
)
Interest expense allocation
 
10,032

 
35,892

 
(45,924
)
 

 

Income before income taxes and equity in undistributed earnings of subsidiaries
 

 

 
55,599

 

 
55,599

Income tax expense
 

 
24,289

 
819

 

 
25,108

Net income (loss) before equity in undistributed earnings of subsidiaries
 

 
(24,289
)
 
54,780

 

 
30,491

Equity in undistributed earnings of subsidiaries
 
30,491

 
54,780

 

 
(85,271
)
 

Net income
 
$
30,491

 
$
30,491

 
$
54,780

 
$
(85,271
)
 
$
30,491



21

tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)


tw telecom inc.
CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME
Three Months Ended June 30, 2014
(unaudited)

 
 
Parent
Guarantor
 
Issuer
 
Combined
Subsidiary
Guarantors
 
Eliminations
 
Consolidated
 
 
(amounts in thousands)
Net income
 
$
11,149

 
$
11,149

 
$
20,385

 
$
(31,534
)
 
$
11,149

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
 
 
 
Unrealized gain on available-for-sale securities
 
40

 
40

 

 
(40
)
 
40

Other comprehensive income, net of tax
 
40

 
40

 

 
(40
)
 
40

Comprehensive income
 
$
11,189

 
$
11,189

 
$
20,385

 
$
(31,574
)
 
$
11,189



22

tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 
tw telecom inc.
CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME
Three Months Ended June 30, 2013
(unaudited)

 
 
Parent
Guarantor
 
Issuer
 
Combined
Subsidiary
Guarantors
 
Eliminations
 
Consolidated
 
 
(amounts in thousands)
Net income
 
$
17,347

 
$
17,347

 
$
31,019

 
$
(48,366
)
 
$
17,347

Other comprehensive loss, net of tax:
 
 
 
 
 
 
 
 
 
 
Unrealized loss on available-for-sale securities
 
(28
)
 
(28
)
 

 
28

 
(28
)
Other comprehensive loss, net of tax
 
(28
)
 
(28
)
 

 
28

 
(28
)
Comprehensive income
 
$
17,319

 
$
17,319

 
$
31,019

 
$
(48,338
)
 
$
17,319



23

tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)


tw telecom inc.
CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME
Six Months Ended June 30, 2014
(unaudited)

 
 
Parent
Guarantor
 
Issuer
 
Combined
Subsidiary
Guarantors
 
Eliminations
 
Consolidated
 
 
(amounts in thousands)
Net income
 
$
20,940

 
$
20,940

 
$
38,193

 
$
(59,133
)
 
$
20,940

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
 
 
 
Unrealized gain on available-for-sale securities
 
30

 
30

 

 
(30
)
 
30

Other comprehensive income, net of tax
 
30

 
30

 

 
(30
)
 
30

Comprehensive income
 
$
20,970

 
$
20,970

 
$
38,193

 
$
(59,163
)
 
$
20,970



24

tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)


tw telecom inc.
CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME
Six Months Ended June 30, 2013
(unaudited)

 
 
Parent
Guarantor
 
Issuer
 
Combined
Subsidiary
Guarantors
 
Eliminations
 
Consolidated
 
 
(amounts in thousands)
Net income
 
$
30,491

 
$
30,491

 
$
54,780

 
$
(85,271
)
 
$
30,491

Other comprehensive loss, net of tax:
 
 
 
 
 
 
 
 
 
 
Unrealized loss on available-for-sale securities
 
(20
)
 
(20
)
 

 
20

 
(20
)
Other comprehensive loss, net of tax
 
(20
)
 
(20
)
 

 
20

 
(20
)
Comprehensive income
 
$
30,471

 
$
30,471

 
$
54,780

 
$
(85,251
)
 
$
30,471



25

tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)


tw telecom inc.
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Six Months Ended June 30, 2014
(unaudited)
 
 
 
Parent
Guarantor
 
Issuer
 
Combined
Subsidiary
Guarantors
 
Eliminations
 
Consolidated
 
 
(amounts in thousands)
Cash flows from operating activities:
 
 
 
 
 
 
 
 
 
 
Net income
 
$
20,940

 
$
20,940

 
$
38,193

 
$
(59,133
)
 
$
20,940

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
 
 
 
 
 
Depreciation, amortization and accretion
 

 
17,654

 
148,987

 

 
166,641

Deferred income taxes
 

 
17,252

 

 

 
17,252

Stock-based compensation expense
 

 

 
18,038

 

 
18,038

Extinguishment costs, amortization of discount on debt and deferred debt issue costs
 

 
4,494

 

 

 
4,494

Intercompany and equity investment changes
 
99,787

 
(122,248
)
 
(36,672
)
 
59,133

 

Changes in operating assets and liabilities
 

 
301

 
(3,161
)
 

 
(2,860
)
Net cash provided by (used in) operating activities
 
120,727

 
(61,607
)
 
165,385

 

 
224,505

Cash flows from investing activities:
 
 
 
 
 
 
 
 
 
 
Capital expenditures
 

 
(26,553
)
 
(169,445
)
 

 
(195,998
)
Purchases of investments
 

 
(109,275
)
 

 

 
(109,275
)
Proceeds from sale of investments
 

 
129,509

 

 

 
129,509

Other investing activities, net
 

 
169

 
5,672

 

 
5,841

Net cash used in investing activities
 

 
(6,150
)
 
(163,773
)
 

 
(169,923
)
Cash flows from financing activities:
 
 
 
 
 
 
 
 
 
 
Net proceeds (tax withholdings) from issuance of common stock upon exercise of stock options and vesting of restricted stock awards and units
 
(8,163
)
 

 

 

 
(8,163
)
Purchases of treasury stock
 
(112,564
)
 

 

 

 
(112,564
)
Excess tax benefits from stock-based compensation
 

 
794

 

 

 
794

Retirement of debt obligations
 

 
(24,418
)
 

 

 
(24,418
)
Payment of debt and capital lease obligations
 

 
(2,875
)
 
(1,612
)
 

 
(4,487
)
Net cash used in financing activities
 
(120,727
)
 
(26,499
)
 
(1,612
)
 

 
(148,838
)
Decrease in cash and cash equivalents
 

 
(94,256
)
 

 

 
(94,256
)
Cash and cash equivalents at beginning of period
 
24,546

 
259,873

 

 

 
284,419

Cash and cash equivalents at end of period
 
$
24,546

 
$
165,617

 
$

 
$

 
$
190,163


26

tw telecom inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)


tw telecom inc.
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Six Months Ended June 30, 2013
(unaudited)
 
 
 
Parent
Guarantor
 
Issuer
 
Combined
Subsidiary
Guarantors
 
Eliminations
 
Consolidated
 
 
(amounts in thousands)
Cash flows from operating activities:
 
 
 
 
 
 
 
 
 
 
Net income
 
$
30,491

 
$
30,491

 
$
54,780

 
$
(85,271
)
 
$
30,491

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
 
 
 
 
 
Depreciation, amortization and accretion
 

 
13,286

 
136,761

 

 
150,047

Deferred income taxes
 

 
24,289

 

 

 
24,289

Stock-based compensation expense
 

 

 
17,876

 

 
17,876

Amortization of discount on debt and deferred debt issue costs
 
6,244

 
2,005

 

 

 
8,249

Intercompany and equity investment changes
 
385,403

 
(466,631
)
 
(4,043
)
 
85,271

 

Changes in operating assets and liabilities
 
(1,039
)
 
15,973

 
(39,326
)
 

 
(24,392
)
Net cash provided by (used in) operating activities
 
421,099

 
(380,587
)
 
166,048

 

 
206,560

Cash flows from investing activities:
 
 
 
 
 
 
 
 
 
 
Capital expenditures
 

 
(22,465
)
 
(165,044
)
 

 
(187,509
)
Purchases of investments
 

 
(157,523
)
 

 

 
(157,523
)
Proceeds from sale of investments
 

 
125,041

 

 

 
125,041

Other investing activities, net
 

 
(83
)
 
(382
)
 

 
(465
)
Net cash used in investing activities
 

 
(55,030
)
 
(165,426
)
 

 
(220,456
)
Cash flows from financing activities:
 
 
 
 
 
 
 
 
 
 
Net proceeds (tax withholdings) from issuance of common stock upon exercise of stock options and vesting of restricted stock awards and units
 
32,559

 

 

 

 
32,559

Purchases of treasury stock
 
(197,310
)
 

 

 

 
(197,310
)
Excess tax benefits from stock-based compensation
 

 
944

 

 

 
944

Proceeds from modification of debt, net of financing costs
 

 
49,684

 

 

 
49,684

Retirement of convertible debt obligations
 
(256,348
)
 

 

 

 
(256,348
)
Payment of debt and capital lease obligations
 

 
(1,474
)
 
(622
)
 

 
(2,096
)
Net cash (used in) provided by financing activities
 
(421,099
)
 
49,154

 
(622
)
 

 
(372,567
)
Decrease in cash and cash equivalents
 

 
(386,463
)
 

 

 
(386,463
)
Cash and cash equivalents at beginning of period
 
24,544

 
782,184

 

 

 
806,728

Cash and cash equivalents at end of period
 
$
24,544

 
$
395,721

 
$

 
$

 
$
420,265


27

tw telecom inc.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis provides information regarding the results of operations and financial condition of the Company and should be read in conjunction with the accompanying condensed consolidated financial statements and notes thereto. This discussion and analysis also should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements included in Part II of our Annual Report on Form 10-K for the year ended December 31, 2013. References in this item to “we,” “our,” or “us” are to the Company and its subsidiaries on a consolidated basis unless the context otherwise requires.
In order to assist the reader in understanding certain terms relating to the telecommunications business that are used in this Quarterly Report on Form 10-Q, we refer you to the glossary included following Part III of our Annual Report on Form 10-K for the year ended December 31, 2013. Certain terms used in this Item 2 without definition have the meanings given them in Item 1 of this Quarterly Report on Form 10-Q.
Cautions Concerning Forward-Looking Statements
This document contains certain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995, including statements regarding, among other items, our expected financial position, capital expenditures, business and technology trends, fluctuations, the impact of the economic downturn, activities and results, revenue mix and revenue growth, Modified EBITDA and margin trends, the impact of regulatory changes, future tax benefits and expense, expense trends, growth initiatives, increases in sales personnel, future liquidity and capital resources, product plans, share repurchases, debt retirement, future cash balances, growth or stability from particular customer segments, the effects of consolidation in the telecommunications industry, anticipated customer disconnections and customer and revenue churn, market expansion, business and financing plans, and the expected merger with Level 3. These forward-looking statements are based on management’s current expectations and are naturally subject to risks, uncertainties, and changes in circumstances, certain of which are beyond our control. Actual results may differ materially from those expressed or implied by such forward-looking statements.
The words “believe,” “plan,” “target,” “expect,” “intend,” and “anticipate,” and expressions of similar substance identify forward-looking statements. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that those expectations will prove to be correct. Important factors that could cause actual results to differ materially from the expectations described in this report are set forth under “Risk Factors” in Item 1A and elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2013 and elsewhere in this report. In addition, actual results may differ from our expectations due to, among other things, the timing of disconnections, churn and service installations which may affect the extent to which those factors impact our results in a particular period, increased competition and pricing pressures, inability to obtain rights to build networks into commercial buildings, economic downturns, which may adversely affect our revenue growth, net income or Modified EBITDA, delays in launching new products that our customers desire, growth initiatives and market expansions that may not result in the intended revenue growth acceleration, delays in connecting new leased fiber to our network, inability of fiber lessors to deliver all fiber contracted for, decreased demand for our products, industry consolidation and other industry conditions, significant increases or decreases in the market prices of our common stock, an ownership change that results in limitations on our use of net operating loss carryforwards ("NOLs") under Section 382 of the Internal Revenue Code, increases in the prices we pay for use of facilities of ILECs, increased costs from healthcare reform and higher taxes or further deregulation of the ILECs or other factors that may adversely affect the cost and availability of ILEC facilities or other facilities that we use to reach certain customer locations, adverse regulatory rulings or legislative developments, interruptions to service delivery or corporate functions due to system failures or cyber-attacks, failure to complete the Level 3 merger and uncertainty among customers and employees regarding the Level 3 merger. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
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.

28

tw telecom inc.

Through our subsidiaries, we serve 77 metropolitan markets with local fiber networks that are connected to our regional fiber facilities and national IP backbone. As of June 30, 2014, our fiber network spanned approximately 34,000 route miles (the majority of which were metropolitan route miles) connecting to 21,332 buildings served directly by our metropolitan fiber facilities. Included in the total buildings served directly by our local fiber facilities are approximately 550 third party data centers across the country where customers deploy their own equipment or connect to cloud application providers. We are able to extend our reach beyond our fiber networks by providing off-network solutions to customers within and outside our 77 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.
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.
Level 3 Merger
On June 15, 2014, we entered into an Agreement and Plan of Merger (the "Merger Agreement") with Level 3 and certain of its subsidiaries whereby we agreed to merge with and into a wholly owned subsidiary of Level 3 (the "Level 3 merger").
Upon completion of the Level 3 merger, (i) each issued and outstanding share of our common stock, other than dissenting shares, will be converted into 0.7 shares (the "Stock Consideration") of Level 3's common stock and the right to receive $10.00 in cash (the "Cash Consideration" and, together with the Stock Consideration, the "Merger Consideration"). The Merger Agreement also provides that the (i) issued and outstanding options to purchase our common stock will be exchanged for Merger Consideration, as adjusted to reflect the exercise price of each such outstanding option and (ii) issued and outstanding restricted stock and restricted stock units covering our common stock will vest and be exchanged for Merger Consideration. The Level 3 merger is expected to close during the fourth quarter of 2014, but not before October 4, 2014. The closing of the Level 3 merger is subject to the receipt of certain regulatory and governmental approvals and the satisfaction of certain conditions contained in the Merger Agreement, including the approval of the Level 3 merger by our stockholders and the approval of Level 3's proposed stock issuance and charter amendments by Level 3's stockholders.
Strategic Market Expansion
In November 2013, we announced a strategic market expansion to increase our addressable market by significantly expanding our metropolitan fiber route miles, including entry into five new markets and accelerating the density of our metropolitan fiber footprint in 28 existing markets. Year-to-date through July 30, 2014, we activated our new Salt Lake City and Richmond markets and plan to activate the remaining new markets before the end of 2014. In addition, year-to-date through July 30, 2014 we completed integration and activation of 14 of our 28 existing markets and plan to activate the remaining existing markets before the end of 2014. 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 will 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.
Revenue Trends
Total Revenue
Our revenue has grown sequentially for the past 39 consecutive quarters through June 30, 2014, including throughout various economic cycles. During the three and six months ended June 30, 2014, our sales and service installations grew at a higher rate year-over-year, and our year-over-year revenue growth rate for the three and six months ended June 30, 2014 was 7.8% and 7.4%, respectively, compared to 6.9% and 6.5%, respectively, for the same periods in 2013.
In 2012, we began to experience lower year-over-year quarterly revenue growth rates compared to the same periods in the prior year. In 2013, we commenced several growth initiatives designed to increase our revenue growth rate by focusing on increased sales to capture growing market demand and share. We believe that higher growth in our sales, or "bookings" (i.e., signed contracts), and service installations year over year, as well as our increased revenue growth in 2014 were the result of these growth initiatives. Accordingly, we expect our 2014 annual revenue growth rate to be higher than our 6.4% 2013 annual revenue growth rate, 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 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

29

tw telecom inc.

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.
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 recurring revenue, retaining revenue from existing customers and a stronger economy. We expect our future revenue growth to be driven in part by greater demand for our data and Internet services due to the increasingly web-based economy that includes 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 expanded 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.
Revenue Reclassification
Beginning January 1, 2014, we are reporting revenue from taxes and fees in a separate line item on our condensed consolidated statements of operations in order to provide better visibility into the impact of changes in those items. Accordingly, revenue from taxes and fees that was previously reported by line of business is now classified as taxes and fees. Revenue from taxes and fees reported by customer type elsewhere in this report has been classified as taxes and fees as well. In addition, we are reporting revenue from dedicated high capacity Ethernet services in data and Internet services rather than network services for better alignment of our service categories, which does not impact revenue by customer type. These reclassifications have been made in the prior year condensed consolidated statements of operations to conform to the current year presentation. Neither of these changes affects total revenue for the current period or prior periods.
Enterprise Customer Revenue
Revenue from enterprise customers has increased sequentially for the past 48 consecutive quarters through June 30, 2014 and increased 8.7% and 9.0% for the three and six months ended June 30, 2014, respectively, as compared to 8.9% and 8.7% for the same periods in 2013, respectively, 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 76% of our total revenue in the three and six months ended June 30, 2014 compared to 75% in the same periods in 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 17% of our total revenue in the three and six months ended June 30, 2014 compared to 18% of our total revenue in the same periods last year. 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 as they transition from traditional network services to Ethernet-based technologies. Carrier revenue from wireless providers represented 27% of total carrier revenue for both the three and six months ended June 30, 2014 compared to 29% and 30% for the three and six months ended June 30, 2013, 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.
Taxes and Fees
We classify taxes and fees billed to customers and remitted to government authorities on a gross versus net basis in revenue and expense. Taxes and fees represented 6% of our total revenue in the three and six months ended June 30, 2014 compared to 5% in both the three and six months ended June 30, 2013. We expect that revenue from taxes and fees will fluctuate based on changes in rates and growth or declines in revenue subject to these taxes and fees.
Intercarrier Compensation Revenue
Intercarrier compensation revenue, consisting of switched access services and reciprocal compensation, represented 1% of our total revenue in each of the three and six months ended June 30, 2014, and is expected to decline in the future due to federal and state mandated rate reductions for terminating traffic and changes in the regulatory regime for 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 the third quarter of each year through 2017. As a result of the FCC order, we expect a reduction

30

tw telecom inc.

of approximately $3.0 million in intercarrier compensation revenue in the year ended December 31, 2014 compared to 2013, which may be somewhat offset by growth in minutes of use. Approximately $2.0 million of this reduction has already occurred through the six months ended June 30, 2014. 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 both the three and six months ended June 30, 2014, comparable to each of the years ended December 31, 2011, 2012 and 2013, reflecting improvement from the last recessionary period of late 2007 through 2009. We believe that this improvement in revenue churn is a result of improved economic conditions as well as our expanded service portfolio, measures we implemented 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 the years ended December 31, 2011, 2012 and 2013 and for each of the three and six months ended June 30, 2014. 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 0.8% for both the three and six months ended June 30, 2014 compared with 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 may 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' purchase 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, including services based on the two major technologies available in the industry, Ethernet and TDM, to expand the reach of our network and also provide special access services to customers over our fiber facilities in competition with ILECs. The ILECs have argued before the FCC that the high capacity telecommunications services that they sell, including interstate 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 interstate special access pricing flexibility rules to return these services to price-cap regulation to protect against unreasonable price increases for carriers like us and for regulation of ILEC service quality.
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 certain ILECs cannot qualify for pricing flexibility in additional geographic areas, pending further FCC review. If the special access services we buy from the ILECs were to be further deregulated, ILECs would have a greater ability to continue to increase the price and reduce the service quality of special access services they sell to us, but we may eventually experience less pricing pressure on the special access service we sell due to higher competitive pricing. As the prices we must pay for

31

tw telecom inc.

special access services increase, our margins may be pressured. If ILEC price reductions were to occur, we would likely experience downward pressure on the prices we charge our customers for special access services and reductions in the prices we pay ILECs for special access services that we purchase. We cannot predict when the FCC will conclude the proceeding on interstate special access pricing regulation or the impact of any such action.
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 price regulated and can increase. We and other carriers are seeking to reverse these forbearance requests. In the meantime, we have secured commercial agreements with the larger ILECs, and continue to pursue agreements with other providers, for those services.
We have expanded our reach by implementing commercial arrangements and connections with the ILECs, other competitive carriers and cable companies for the provision of Ethernet services to deliver certain of our advanced services to end users in areas not directly served by our fiber networks. We also have commercial arrangements with carriers to provide access to our customers' locations in areas outside of our 77 markets. With growing demand for multi-location customer solutions, both within and outside our markets, we are provisioning services to more off-network locations resulting in higher access costs.
Modified EBITDA Trends and Growth Initiatives
We regularly implement various initiatives designed to expand our revenue growth, Modified EBITDA margin (see Note 3 to the table under “Three Months Ended June 30, 2014 Compared to Three Months Ended June 30, 2013--Operating Income and Net Income” 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 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 2 to the table under “Three Months Ended June 30, 2014 Compared to Three Months Ended June 30, 2013--Operating Income and Net Income” for a definition of Modified EBITDA and 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) 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, and grew 0.7% in both the three and six months ended June 30, 2014 compared to the same period last 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 sales support staff, and IT and technical personnel. These margins were also impacted by the dilutive effect of taxes and fees that are reported on a gross versus net basis in revenue and expense (see “Revenue” in Note 1 to the condensed consolidated financial statements). Modified EBITDA margin was 33.0% and 33.2% for the three and six months ended June 30, 2014, respectively, compared to 35.3% and 35.5% in the same periods in the prior year, respectively. The decline was the result of merger-related costs, costs associated with our growth initiatives, taxes and fees and network access costs. Costs associated with growth initiatives had a greater impact on Modified EBITDA margin for the three and six months ended June 30, 2014 and the year ended December 31, 2013 than in the same periods in 2012 and 2011.
In 2013, our growth initiatives required both capital and operating investments and we continue to make these investments in 2014, including hiring additional sales, sales support and other operational personnel to support our strategic market expansion. For 2014, our investment plans for our growth initiatives and strategic market expansion include an expected increase in sales personnel of 7%; however, we are uncertain of the impact that the recent announcement of the Level 3 merger will have on our ability to meet this objective. Our capital investments in 2013 and 2014 in support of our growth initiatives include new service development, further automation and equipment to integrate and connect the strategic market expansion into our national network and operating infrastructure.
We expect the continued investments and expense associated with our growth initiatives and strategic market expansion (see "Strategic Market Expansion" 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. We expect our Modified EBITDA margin, excluding merger-related costs, to begin expanding toward the end of 2014 as a result of anticipated higher revenue, as discussed above in "Revenue Trends--Total Revenue". While the growth initiatives described above 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.

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tw telecom inc.

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 historically 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 expansions within our existing markets provide an opportunity to accelerate the increase of network density in many of these 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 taxes and fees, merger-related costs 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 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 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.
Critical Accounting Policies and Estimates
For a description of our critical accounting policies and estimates, see Item 7 in our Annual Report on Form 10-K for the year ended December 31, 2013, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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

33

tw telecom inc.


Three Months Ended June 30, 2014 Compared to Three Months Ended June 30, 2013
Revenue

The following table sets forth revenue by line of business presented in thousands of dollars and expressed as a percentage of total revenue:

 
 
Three Months Ended June 30,
 
 
 
 
 
 
2014
 
2013
 
$ Change
 
% Change
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
Data and Internet services
 
$
253,031

 
60
%
 
$
220,063

 
56
%
 
$
32,968

 
15.0
 %
Voice services
 
77,919

 
19
%
 
76,437

 
20
%
 
1,482

 
1.9
 %
Network services
 
56,667

 
14
%
 
64,079

 
17
%
 
(7,412
)
 
(11.6
)%
Service revenue
 
387,617

 
93
%
 
360,579

 
93
%
 
27,038

 
7.5
 %
Taxes and fees (1)
 
25,412

 
6
%
 
20,622

 
5
%
 
4,790

 
23.2
 %
Intercarrier compensation
 
6,674

 
1
%
 
8,282

 
2
%
 
(1,608
)
 
(19.4
)%
Total revenue
 
$
419,703

 
100
%
 
$
389,483

 
100
%
 
$
30,220

 
7.8
 %
___________________
(1) 
We classify taxes and fees billed to customers and remitted to government authorities on a gross versus net basis in revenue and expense. This has no impact on net income or Modified EBITDA 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 installations of strategic Ethernet and VPN-based services, Internet and other services to enterprise customers, partially offset by revenue churn and re-pricing of renewed customer contracts at lower rates. Strategic services, which includes Ethernet and IP VPN services, comprised 52.8% of data and Internet services revenue for the three months ended June 30, 2014 compared to 52.4% for the three months ended June 30, 2013, representing 16.0% period-over-period growth in revenue from these services.
Voice services revenue increased primarily as a result of installations of converged and other voice services and an increase in usage based services, partially offset by revenue churn. Revenue based on the minutes of service used by customers included in voice services was 3% of our total revenue for both the three months ended June 30, 2014 and 2013.
Network services revenue decreased primarily due to the impact of revenue churn and re-pricing of renewed customer contracts at lower rates, largely from carrier customers.
Revenue from taxes and fees increased, reflecting the initiation of billing for certain regulatory fees not previously charged, growth in revenue to which these charges apply and an increase in rates.
Intercarrier compensation revenue decreased primarily as a result of the impact of an FCC-mandated rate reduction in July 2013.


34

tw telecom inc.

Costs and Expenses
The major components of costs and expenses were as follows (amounts in thousands):

 
 
Three Months Ended
June 30,
 
 
 
 
 
 
2014
 
2013
 
$ Change
 
% Change
Costs and expenses:
 
 
 
 
 
 
 
 
Operating (exclusive of depreciation, amortization and accretion shown separately below) (1)
 
$
181,391

 
$
164,131

 
$
17,260

 
10.5
%
Operating expenses as percentage of total revenue
 
43.2
%
 
42.1
%
 
 
 
 
Selling, general and administrative (1)
 
108,613

 
96,438

 
12,175

 
12.6
%
Selling, general and administrative expenses as percentage of total revenue
 
25.9
%
 
24.8
%
 
 
 
 
Depreciation, amortization and accretion
 
84,185

 
75,652

 
8,533

 
11.3
%
Total costs and expenses
 
$
374,189

 
$
336,221

 
$
37,968

 
11.3
%
 
 
 
 
 
 
 
 
 
(1)  Includes the following non-cash stock-based employee compensation expense:
Operating
 
$
545

 
$
545

 
$

 
%
Selling, general and administrative
 
$
8,107

 
$
7,869

 
$
238

 
3.0
%

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 costs to purchase network services from other carriers, or access costs. The increase in operating expenses primarily related to higher network access costs as a result of revenue growth including increases in services to customer locations outside our markets, an increase in taxes and fees and higher employee-related costs to support ongoing revenue growth and our growth initiatives as well as annual merit-based salary increases.
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-related costs resulting from expansion of our sales and sales support personnel to support our growth initiatives, annual merit-based salary increases, commissions and incentives, somewhat offset by financing costs incurred in the prior year that did not recur. In addition, selling, general and administrative expenses were impacted by $4.1 million of costs related to the Level 3 merger.
Depreciation, Amortization and Accretion Expense. The increase in depreciation, amortization and accretion expense was attributable to an increase in property, plant and equipment additions and a reduction in the average useful life of additions, net of the impact of fully depreciated assets.


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tw telecom inc.

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):

 
 
Three Months Ended
June 30,
 
 
 
 
 
 
2014
 
2013
 
$ Change
 
% Change
Operating income
 
$
45,514

 
$
53,262

 
$
(7,748
)
 
(14.5
)%
Interest expense
 
(24,873
)
 
(21,544
)
 
3,329

 
15.5
 %
Debt extinguishment costs
 

 
(399
)
 
(399
)
 
NM

Interest income
 
109

 
173

 
(64
)
 
(37.0
)%
Income before income taxes
 
20,750

 
31,492

 
(10,742
)
 
(34.1
)%
Income tax expense
 
9,601

 
14,145

 
(4,544
)
 
(32.1
)%
Net income
 
$
11,149

 
$
17,347

 
$
(6,198
)
 
(35.7
)%
Basic income per common share
 
$
0.08

 
$
0.12

 
(0.04
)
 
(33.3
)%
Diluted income per common share
 
$
0.08

 
$
0.11

 
(0.03
)
 
(27.3
)%
Modified EBITDA (1)(2)
 
$
138,351

 
$
137,328

 
$
1,023

 
0.7
 %
Modified EBITDA margin (1)(2)(3)
 
33.0
%
 
35.3
%
 
 
 
 
___________________
NM - Not meaningful
(1) 
See Note 1 under "Revenue" above.
(2) 
“Modified EBITDA” is a non-GAAP financial measure and is defined by us as net income (loss) before depreciation, amortization and accretion expense, interest expense, interest income, debt extinguishment costs, other income (loss), impairment charges, income tax expense (benefit), cumulative effect of change in accounting principle, and non-cash stock-based employee compensation expense. Not all of the aforementioned items occur in each reporting period, but have been included in the definition based on historical activity. Modified EBITDA is not intended to replace operating income (loss), net income (loss), cash flow and other measures of financial performance and liquidity reported in accordance with accounting principles generally accepted in the United States. Rather, Modified EBITDA is a measure of operating performance and liquidity that investors may consider in addition to such measures. Our management believes that Modified EBITDA is a standard measure of operating performance and liquidity that is commonly reported and widely used by analysts, investors, and other interested parties in the telecommunications industry because it eliminates many differences in financial, capitalization, and tax structures, as well as non-cash and non-operating charges to earnings. We believe that Modified EBITDA trends are a valuable indicator of whether our operations are able to produce sufficient operating cash flow to fund working capital needs, service debt obligations and fund capital expenditures. We currently use Modified EBITDA for these purposes. Modified EBITDA also is used internally by our management to assess ongoing operations and is a measure used to test compliance with certain covenants of our senior notes, our Revolver and our Term Loan. The definition of EBITDA under our Revolver, our Term Loan and our senior notes differs, but not materially, from the definition of Modified EBITDA used in this table. Modified EBITDA as used in this document may not be comparable to similarly titled measures reported by other companies due to differences in accounting and disclosure policies. The reconciliation between Modified EBITDA and net income (loss), which is the most comparable GAAP measure for operating performance, is as follows (amounts in thousands):
 
 
Three Months Ended June 30,
 
 
2014
 
2013
Net income
 
$
11,149

 
$
17,347

Income tax expense
 
9,601

 
14,145

Interest income
 
(109
)
 
(173
)
Interest expense
 
24,873

 
21,544

Debt extinguishment costs
 

 
399

Depreciation, amortization and accretion
 
84,185

 
75,652

Non-cash stock-based compensation
 
8,652

 
8,414

Modified EBITDA
 
$
138,351

 
$
137,328



36

tw telecom inc.

The reconciliation between Modified EBITDA and net cash provided by operations, which is the most comparable GAAP measure for liquidity, is as follows (amounts in thousands):

 
 
Three Months Ended June 30,
 
 
2014
 
2013
Net cash provided by operations
 
$
109,280

 
$
124,960

Income tax expense
 
9,601

 
14,145

Deferred income taxes
 
(9,235
)
 
(13,672
)
Interest income
 
(109
)
 
(173
)
Interest expense
 
24,873

 
21,544

Discount on debt, amortization of deferred debt issue costs
 
(1,599
)
 
(1,055
)
Changes in operating assets and liabilities
 
5,540

 
(8,421
)
Modified EBITDA
 
$
138,351

 
$
137,328


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

Interest Expense. The increase in interest expense was largely attributable to the 2022 Mirror Notes and 2023 Notes issued in August 2013 as well as capital leases related to our strategic market expansion, somewhat offset by the retirement of the 2018 Notes and the retirement of the Convertible Debentures.
Debt Extinguishment Costs. Debt extinguishment costs for the three months ended June 30, 2013 resulted primarily from commissions paid on repurchases by us of the Convertible Debentures. There were no such costs for the three months ended June 30, 2014.
Income before Income Taxes. The decrease in income before income taxes resulted primarily from higher depreciation, amortization and accretion expense as discussed above.
Income Tax Expense. The decrease in income tax expense primarily resulted from lower income before income taxes.
Net Income and Modified EBITDA. The decrease in net income resulted from a decrease in income before income taxes, partially offset by lower income tax expense, as discussed above. Modified EBITDA was largely unchanged as revenue growth was largely offset by higher employee-related costs primarily to support our growth initiatives, costs related to the Level 3 merger and increased commissions and incentives. The decline in Modified EBITDA margin in the three months ended June 30, 2014 compared to the same period in the prior year is attributable to costs related to the Level 3 merger, costs associated with our growth initiatives, taxes and fees and network access costs. For the three months ended June 30, 2014 and 2013, 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.


37

tw telecom inc.

Six Months Ended June 30, 2014 Compared to Six Months Ended June 30, 2013
Revenue

The following table sets forth revenue by line of business presented in thousands of dollars and expressed as a percentage of total revenue:

 
 
Six Months Ended June 30,
 
 
 
 
 
 
2014
 
2013
 
$ Change
 
% Change
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
Data and Internet services
 
$
496,702

 
60
%
 
$
431,784

 
56
%
 
$
64,918

 
15.0
 %
Voice services
 
155,280

 
19
%
 
152,467

 
20
%
 
2,813

 
1.8
 %
Network services
 
115,034

 
14
%
 
129,034

 
17
%
 
(14,000
)
 
(10.8
)%
Service revenue
 
767,016

 
93
%
 
713,285

 
93
%
 
53,731

 
7.5
 %
Taxes and fees (1)
 
48,164

 
6
%
 
41,216

 
5
%
 
6,948

 
16.9
 %
Intercarrier compensation
 
12,816

 
1
%
 
16,191

 
2
%
 
(3,375
)
 
(20.8
)%
Total revenue
 
$
827,996

 
100
%
 
$
770,692

 
100
%
 
$
57,304

 
7.4
 %
___________________
(1) 
We classify taxes and fees billed to customers and remitted to government authorities on a gross versus net basis in revenue and expense. This has no impact on net income or Modified EBITDA 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 installations of strategic Ethernet and VPN-based services, Internet and other services to enterprise customers, partially offset by revenue churn and re-pricing of renewed customer contracts at lower rates. Strategic services, which includes Ethernet and IP VPN services, comprised 52.9% of data and Internet services revenue for the six months ended June 30, 2014 compared to 52.2% for the six months ended June 30, 2013, representing 16.6% period-over-period growth in revenue from these services.
Voice services revenue increased primarily as a result of installations of converged and other voice services and an increase in usage based services, partially offset by revenue churn. Revenue based on the minutes of service used by customers included in voice services was 3% of our total revenue for both the six months ended June 30, 2014 and 2013.
Network services revenue decreased primarily due to the impact of revenue churn and re-pricing of renewed customer contracts at lower rates, largely from carrier customers.
Revenue from taxes and fees increased reflecting the initiation of billing for certain regulatory fees not previously charged, growth in revenue to which these charges apply and an increase in rates.
Intercarrier compensation revenue decreased primarily as a result of the impact of an FCC-mandated rate reduction in July 2013 as well as lower favorable settlements in the current period as compared to the same period in the prior year.


38

tw telecom inc.

Costs and Expenses
The major components of costs and expenses were as follows (amounts in thousands):

 
 
Six Months Ended
June 30,
 
 
 
 
 
 
2014
 
2013
 
$ Change
 
% Change
Costs and expenses:
 
 
 
 
 
 
 
 
Operating (exclusive of depreciation, amortization and accretion shown separately below) (1)
 
$
355,430

 
$
325,213

 
$
30,217

 
9.3
 %
Operating expenses as percentage of total revenue
 
42.9
%
 
42.2
%
 
 
 
 
Selling, general and administrative (1)
 
215,445

 
190,000

 
25,445

 
13.4
 %
Selling, general and administrative expenses as percentage of total revenue
 
26.0
%
 
24.7
%
 
 
 
 
Depreciation, amortization and accretion
 
166,641

 
150,047

 
16,594

 
11.1
 %
Total costs and expenses
 
$
737,516

 
$
665,260

 
$
72,256

 
10.9
 %
 
 
 
 
 
 
 
 
 
(1)  Includes the following non-cash stock-based employee compensation expense:
Operating
 
$
1,084

 
$
1,128

 
$
(44
)
 
(3.9
)%
Selling, general and administrative
 
$
16,954

 
$
16,748

 
$
206

 
1.2
 %

Operating Expenses. The increase in operating expenses primarily related to higher network access costs as a result of revenue growth including increases in services to customer locations outside our markets, higher employee-related costs to support ongoing revenue growth, our growth initiatives and annual merit-based salary increases and higher taxes and fees.
Selling, General and Administrative Expenses. The increase in these expenses primarily related to higher employee-related costs resulting from expansion of our sales and sales support personnel to support our growth initiatives, higher commissions and incentives and annual merit-based salary increases. In addition, $4.1 million of costs related to the Level 3 merger were included in selling, general and administrative expenses for the six months ended June 30, 2014.
Depreciation, Amortization and Accretion Expense. The increase in depreciation, amortization and accretion expense was attributable to an increase in property, plant and equipment additions and a reduction in the average useful life of additions, net of the impact of fully depreciated assets.

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):

 
 
Six Months Ended
June 30,
 
 
 
 
 
 
2014
 
2013
 
$ Change
 
% Change
Operating income
 
$
90,480

 
$
105,432

 
$
(14,952
)
 
(14.2
)%
Interest expense
 
(50,521
)
 
(49,884
)
 
637

 
1.3
 %
Debt extinguishment costs
 
(1,282
)
 
(399
)
 
883

 
221.3
 %
Interest income
 
257

 
450

 
(193
)
 
(42.9
)%
Income before income taxes
 
38,934

 
55,599

 
(16,665
)
 
(30.0
)%
Income tax expense
 
17,994

 
25,108

 
(7,114
)
 
(28.3
)%
Net income
 
$
20,940

 
$
30,491

 
$
(9,551
)
 
(31.3
)%
Basic income per common share
 
$
0.15

 
$
0.20

 
(0.05
)
 
(25.0
)%
Diluted income per common share
 
$
0.15

 
$
0.20

 
(0.05
)
 
(25.0
)%
Modified EBITDA (1)(2)
 
275,159

 
273,355

 
$
1,804

 
0.7
 %
Modified EBITDA margin (1)(2)(3)
 
33.2
%
 
35.5
%
 
 
 
 
___________________

39

tw telecom inc.

NM - Not meaningful
(1) 
See Note 1 under "Revenue" above.
(2) 
See Note 2 above under "Three Months Ended June 30, 2014 Compared to Three Months Ended June 30, 2013--Operating Income and Net Income" for a definition of Modified EBITDA. The reconciliation between Modified EBITDA and net income, which is the most comparable GAAP measure for operating performance, is as follows (amounts in thousands):
 
 
Six Months Ended June 30,
 
 
2014
 
2013
Net income
 
$
20,940

 
$
30,491

Income tax expense
 
17,994

 
25,108

Interest income
 
(257
)
 
(450
)
Interest expense
 
50,521

 
49,884

Debt extinguishment costs
 
1,282

 
399

Depreciation, amortization and accretion
 
166,641

 
150,047

Non-cash stock-based compensation
 
18,038

 
17,876

Modified EBITDA
 
$
275,159

 
$
273,355


The reconciliation between Modified EBITDA and net cash provided by operations, which is the most comparable GAAP measure for liquidity, is as follows (amounts in thousands):

 
 
Six Months Ended June 30,
 
 
2014
 
2013
Net cash provided by operations
 
$
224,505

 
$
206,560

Income tax expense
 
17,994

 
25,108

Deferred income taxes
 
(17,252
)
 
(24,289
)
Interest income
 
(257
)
 
(450
)
Interest expense
 
50,521

 
49,884

Discount on debt, amortization of deferred debt issue costs
 
(3,212
)
 
(7,850
)
Changes in operating assets and liabilities
 
2,860

 
24,392

Modified EBITDA
 
$
275,159

 
$
273,355


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

Interest Expense. The increase in interest expense was largely attributable to the 2022 Mirror Notes and 2023 Notes issued in August 2013 and capital leases related to our strategic market expansion, somewhat offset by the retirement of the 2018 Notes and the Convertible Debentures and discount on the Convertible Debentures becoming fully accreted at the end of the first quarter of 2013.
Debt Extinguishment Costs. Debt extinguishment costs for the six months ended June 30, 2014 resulted from the redemption of the remaining 2018 Notes and consisted of cash paid for redemption premiums of $0.9 million and non-cash write-offs of unamortized deferred debt issuance costs and issuance discount of $0.4 million. Debt extinguishment costs for the same period in 2013 primarily resulted from commissions paid on repurchases of our Convertible Debentures.
Income before Income Taxes. The decrease in income before income taxes resulted primarily from higher depreciation, amortization and accretion expense discussed above.
Income Tax Expense. The decrease in income tax expense primarily resulted from lower income before income taxes.
Net Income and Modified EBITDA. The decrease in net income resulted from an increase in depreciation, amortization and accretion expense, partially offset by lower income tax expense, as discussed above. Modified EBITDA was largely unchanged as revenue growth was largely offset by costs associated with an increase in personnel primarily to support our growth initiatives, increased commissions and incentives and annual merit-based salary increases as well as costs related to the Level 3 merger. The decline in Modified EBITDA margin in the six months ended June 30, 2014 compared to the same period in the prior year is attributable to costs associated with our growth initiatives, increased commissions and incentives, taxes and

40

tw telecom inc.

fees, costs related to the Level 3 merger and higher network access costs. For the six months ended June 30, 2014 and 2013, Modified EBITDA, together with cash, cash equivalents and investments, has been 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.
The Merger Agreement contains covenants that limit our ability, among other things, to repurchase our common stock, pay dividends, retire or repurchase our indebtedness and make capital expenditures in excess of our current year forecast during the period prior to closing of the merger, which we refer to as the interim operating covenants.
In September 2013, we completed a tender offer for $406.5 million aggregate principal amount of the 2018 Notes. On March 1, 2014, we redeemed all of the remaining $23.5 million principal amount of 2018 Notes at a redemption price of 104% of the principal amount. The redemption resulted in a total use of cash for the three months ended March 31, 2014 of $24.4 million, which included $0.9 million of redemption premiums. Additionally, we used $112.6 million of cash during the six months ended June 30, 2014 to repurchase our common stock under the $500 million multi-year common stock repurchase program our Board of Directors authorized on August 6, 2013, which was suspended in June 2014 due to the interim operating covenants (see "Possible Future Uses of Cash" below).
The change in our net debt was as follows:
 
 
June 30, 2014
 
December 31, 2013
 
$ Change
 
 
(amounts in thousands)
Current portion of debt and capital lease obligations
 
$
8,147

 
$
32,470

 
$
(24,323
)
Long term portion of debt and capital lease obligations
 
1,914,878

 
1,916,775

 
(1,897
)
Total debt and capital lease obligations
 
$
1,923,025

 
$
1,949,245

 
$
(26,220
)
Less: Cash, cash equivalents and short-term investments
 
363,727

 
478,995

 
(115,268
)
Net debt
 
$
1,559,298

 
$
1,470,250

 
$
89,048

Net debt increased $89.0 million from December 31, 2013 to June 30, 2014, primarily due to capital expenditures, our use of cash to repurchase shares of our common stock and withholding taxes paid by us on behalf of employees in net share settlements of restricted stock, partially offset by cash provided by operating activities and proceeds from employee stock option exercises.
The change in our working capital and working capital ratio were as follows:
 
June 30, 2014
 
December 31, 2013
 
$ Change
 
(amounts in thousands)
Current assets
$
549,833

 
$
662,824

 
$
(112,991
)
Current liabilities
294,956

 
309,296

 
(14,340
)
Working capital
$
254,877

 
$
353,528

 
$
(98,651
)
Working capital ratio
1.86

 
2.14

 
N/A

The decrease in working capital is primarily a result of capital expenditures, repurchases of our common stock and withholding taxes paid by us on behalf of employees in net share settlements of restricted stock, somewhat offset by cash provided by operations, timing of payments to vendors and proceeds from employee stock option exercises.
Cash Flow Activity
Cash and cash equivalents were $190.2 million and $420.3 million as of June 30, 2014 and 2013, respectively. In addition, we had investments of $173.6 million and $194.2 million as of June 30, 2014 and 2013, respectively, which were

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short-term in nature and generally available to fund our operations. The change in cash and cash equivalents during the periods presented was as follows:
 
 
Six Months Ended June 30,
 
 
 
 
 
 
2014
 
2013
 
$ Change
 
% Change
 
 
(amounts in thousands)
 
 
Cash provided by operating activities
 
$
224,505

 
$
206,560

 
$
17,945

 
8.7
%
Cash used in investing activities
 
(169,923
)
 
(220,456
)
 
50,533

 
22.9
%
Cash used in financing activities
 
(148,838
)
 
(372,567
)
 
223,729

 
60.1
%
Decrease in cash and cash equivalents
 
$
(94,256
)
 
$
(386,463
)
 
$
292,207

 
75.6
%
Cash Flow from Operating Activities
The increase in cash provided by operating activities in the six months ended June 30, 2014 compared to the six months ended June 30, 2013 primarily related to changes in working capital, which were largely due to the timing of payments to vendors and collection of receivables.
Cash Flow from Investing Activities
The change in cash used in investing activities in the six months ended June 30, 2014 compared to the six months ended June 30, 2013 was primarily the result of a net increase in proceeds from the sale and purchase of investments in 2014, somewhat offset by higher capital expenditures in 2014. 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 six months ended June 30, 2014 was $196.0 million, the majority of which was success-based (see "Capital Expenditures and Requirements" below) compared to $187.5 million for the six months ended June 30, 2013.
Cash Flow from Financing Activities
Cash used in financing activities for the six months ended June 30, 2014 primarily consisted of the following:
Repurchases of $112.6 million of our common stock;
Redemption of the remaining 2018 Notes for $24.4 million (including $0.9 million of redemption premiums);
Withholding taxes paid by us on behalf of employees in net share settlements of restricted stock of $18.9 million; and
Payments of $4.5 million on the Term Loan and capital lease obligations,
partially offset by:
Proceeds of $10.8 million from employee exercises of stock options.
Cash used in financing activities for the six months ended June 30, 2013 primarily consisted of the following:
Repurchases and settlements of conversions of Convertible Debentures of $256.3 million (including $0.5 million of transaction costs);
Repurchases of $197.3 million of our common stock;
Withholding taxes paid by us on behalf of employees in net share settlements of restricted stock of $18.3 million; and
Payments of $2.1 million on the Term Loan and capital lease obligations,
partially offset by:
Proceeds of $50.9 million from employee exercises of stock options; and
Net proceeds of $49.7 million from the Term Loan refinancing.
Our financing activities from January 1, 2013 through the six months ended June 30, 2014 were comprised of the following:
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. Principal and interest payments on the Term Loan and Revolver, if drawn, are as follows:

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Repayments of the Term Loan are due quarterly in an amount equal to 0.25% 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 June 30, 2014, the effective interest rate was 2.65%.
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 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 $450 million principal amount and the 2023 Notes at an offering price of 100% of the $350 million 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. In January 2014, we completed exchange offers in which the 2022 Mirror Notes and the 2023 Notes were exchanged for a like principal amount of registered notes with substantially identical terms. Approximately $23.5 million principal amount of the 2018 Notes remained outstanding as of December 31, 2013.
During the three months ended March 31, 2014, we redeemed the remaining outstanding $23.5 million principal amount of 2018 Notes at a redemption price of 104% of the principal amount, which resulted in $0.9 million of premiums associated with the redemption.
Indebtedness Outstanding or Available as of June 30, 2014:
Instrument
 
Principal Amount
Outstanding
 
Aggregate Annual
Estimated  Interest
Payments
 
 
(amounts in thousands)
Term Loan, Eurodollar rate + 2.5% due 2020 (1)
 
$
514,800

 
$
13,642

5 3/8% Senior Notes due 2022 issued October 2012
 
480,000

 
25,800

3/8% Senior Notes due 2022 issued August 2013
 
450,000

 
24,188

6 3/8% Senior Notes due 2023
 
350,000

 
22,313

Undrawn $100 million Revolver expires 2018 (2)
 

 

(1) 
The aggregate annual estimated interest payments are based on the principal amount outstanding and the effective interest rate of 2.65% at June 30, 2014.
(2) 
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 June 30, 2014. 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.


43

tw telecom inc.


a
TWTC and substantially all of these subsidiaries guarantee the 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.
Capital Expenditures and Requirements
Our capital expenditures were $197.4 million in total for the six months ended June 30, 2014, or $180.8 million excluding expenditures in connection with integration of the strategic market expansion into our network, compared to $191.8 million of total capital expenditures for the same period in 2013. We made the majority of capital expenditures in each period 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. Capital expenditures increased over the prior year period primarily due to capital expenditures related to our strategic market expansion, somewhat offset by efficiency gains as described below, favorable equipment pricing and the timing of projects.
In each of the years ended 2005 through 2013, over 75% of our total annual capital expenditures, excluding capital expenditures for integration of a 2006 acquisition 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 can fluctuate as our volume of sales and service installations increases or decreases or as a result of economies of scale as described below.
For the full year 2014, we expect capital expenditures to be in the range of $420 million to $440 million (see “Future Sources of Cash” below for discussion of anticipated funding sources), which is lower than our previously disclosed expectations of $440 million to $460 million, as a result of lower equipment pricing and more efficient deployment of network assets to integrate and connect our strategic market expansion into our national network and operating infrastructure. Additionally, success-based investments are expected to be lower than originally anticipated due to our ability to deliver

44

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enhancements more economically than previously expected, as well as effective equipment redeployment as we continue to gain economies of scale and advance our capabilities on equipment logistics. We expect the majority of our 2014 capital expenditures to be related to success-based opportunities. The amount of our expected 2014 capital expenditures is within the forecast amount permitted under the interim operating covenants. Our anticipated capital expenditures include approximately $35 million of capital expenditures to integrate and connect the strategic market expansion fiber 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, which are expenditures 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.

The Revolver, Term Loan and Senior Notes (the "Revolver and Long-Term Debt Obligations"), as well as the interim operating covenants, 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 any amounts under that facility. If we do not comply with the covenants under the Revolver, we would not be able to draw additional funds under the Revolver and the lenders could cancel the Revolver unless the respective lenders agree to further modify the covenants. Covenant defaults under the credit agreement for the Revolver and Term Loan also may constitute an event of default under the indentures 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 indentures for the Senior Notes and the Term Loan covenants under our credit agreement. As of June 30, 2014, 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, purchase or redeem our outstanding Senior Notes for cash in the open market or privately negotiated transactions, or engage in other

45

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transactions to reduce the principal amount of outstanding Senior Notes. As of June 30, 2014, 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 cash equivalents and borrowing availability under our Revolver is a minimum of $200 million after giving effect to the repurchase, provided that we do not use the Revolver proceeds for this purpose and we meet certain other conditions. However, the interim operating covenants prohibit us from repurchasing or retiring indebtedness.
In August, 2013, our Board of Directors authorized a $500 million multi-year common stock repurchase program, of which approximately $112.6 million was repurchased during the six months ended June 30, 2014. As of June 30, 2014, we had repurchased $250.1 million of our common stock and a total of $249.9 million remains available under the Board's stock repurchase authorization. The repurchase authorization does not have an expiration date, but can be withdrawn by the Board at any time. We suspended our stock repurchase program indefinitely in June 2014 in compliance with our interim operating covenants, which prohibit additional share repurchases. 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. At June 30, 2014, we had repurchased $250.1 million of our common stock of the maximum $500 million permissible under our Revolver covenants through December 31, 2014.
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.
Risk Management
As of June 30, 2014, 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 June 30, 2014, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
Commitments
Our long-term commitments have not materially changed from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013, except for the redemption of the remaining $23.5 million principal amount of our 2018 Notes during the first quarter of 2014. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources."
Item 3. Quantitative and Qualitative Disclosures About Market Risk
For quantitative and qualitative disclosures about market risk, see Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” in our Annual Report on Form 10-K for the year ended December 31, 2013. Our exposures to market risk have not changed materially since December 31, 2013.

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Item 4. Controls and Procedures
Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 as of June 30, 2014 and concluded that our disclosure controls and procedures were effective as of that date. Management recognizes that any disclosure controls and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
There were no changes in our internal control over financial reporting that occurred during the three months ended June 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Part II. Other Information
Item 1. Legal Proceedings
Stockholder Litigation
Following the announcement of the execution of the Merger Agreement, three putative shareholder class action complaints, which we refer to as the "Class Action Complaints," were filed in the Court of Chancery of the State of Delaware against the Company, our Board of Directors, Level 3, and certain of Level 3's subsidiaries, challenging the proposed Level 3 merger: Veneros v. tw telecom, et al., Case No. 9835 (filed on or about June 27, 2014), Litman v. tw telecom, et al., Case No. 9838 (filed on or about June 27, 2014), and Carter v. tw telecom, et al., Case No. 9845 (filed on or about June 30, 2014).
The Class Action Complaints generally allege, among other things, that the individual members of our Board of Directors breached their fiduciary duties owed to our public shareholders by approving our entry into the Merger Agreement, and failing to take steps to maximize the value of the Company to our public shareholders, and that we, Level 3, and certain of Level 3's subsidiaries aided and abetted such breaches of fiduciary duties. In addition, the Class Action Complaints allege, among other things, that the proposal regarding the Level 3 merger undervalues the Company, that the process leading up to the Merger Agreement was flawed, and that certain provisions of the Merger Agreement improperly favor Level 3 and impede a potential alternative transaction. The Class Action Complaints generally seek, among other things, declaratory and injunctive relief concerning the alleged fiduciary breaches, injunctive relief prohibiting the defendants from consummating the proposed Level 3 merger, and other forms of equitable relief. We intend to defend against these lawsuits vigorously, but are unable to predict the outcome of these lawsuits or reasonably estimate a range of possible loss.
In addition, we are party to various claims and legal and regulatory proceedings in the ordinary course of business, which we do not believe, individually or in the aggregate, are material or will have a material adverse effect on our business, financial condition or results of operations.
Item 1A. Risk Factors
Risk Factors Relating to the Level 3 Merger
Our pending merger with Level 3 is subject to conditions, including certain conditions that may not be satisfied, and may not be completed on a timely basis, or at all. Failure to complete the Level 3 merger and the transactions contemplated thereby could have material and adverse effects on us.
The completion of our pending merger with Level 3 is subject to a number of conditions, including the receipt of required regulatory approvals, the approval and adoption of the Merger Agreement and approval of the Level 3 merger by our stockholders, and the approval of Level 3’s stock issuance in connection with the Level 3 merger and the adoption of the Level 3’s proposed charter amendment by Level 3’s stockholders, which make the completion and timing of the completion of the Level 3 merger uncertain. Also, either we or Level 3 may terminate the Merger Agreement if the Level 3 merger has not been completed by March 16, 2015 (subject to extension under certain circumstances), unless the failure of the Level 3 merger to be completed has resulted from the failure of the party seeking to terminate the Merger Agreement to perform its obligations.
If the Level 3 merger is not completed on a timely basis, or at all, our ongoing business may be adversely affected. Additionally, in the event the Level 3 merger is not completed, we will be subject to a number of risks without realizing any of the benefits of having completed the Level 3 merger, including the following:
We may be required to pay to Level 3 a termination fee of $200 million and, in some cases, expenses of Level 3 up to $10 million if the Level 3 merger is terminated under qualifying circumstances, as described in the Merger Agreement;

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We will be required, subject to certain exceptions, to pay our costs relating to the Level 3 merger, such as legal, accounting, financial advisor and printing fees, whether or not the Level 3 merger is completed;
Time and resources committed by our management to matters relating to the Level 3 merger (including integration planning) could otherwise have been devoted to pursuing other beneficial opportunities;
The market price of our common stock could decline to the extent that the current market price reflects a market assumption that the Level 3 merger will be completed; and
If the Merger Agreement is terminated and our Board of Directors seeks another business combination, our stockholders cannot be certain that we will be able to find a party willing to enter into a merger agreement on terms equivalent to or more attractive than the terms that Level 3 has agreed to in the Level 3 merger.
Uncertainty regarding the completion of the Level 3 merger may cause our customers to delay or defer decisions concerning us and may adversely affect our ability to attract and retain key employees.
The Level 3 merger will be consummated only if stated conditions are met, including, among others, the approval and adoption of the Merger Agreement and approval of the merger by our stockholders, the approval of Level 3’s proposed stock issuance in connection with the Level 3 merger and the adoption of Level 3's proposed charter amendment by Level 3’s stockholders and the receipt of regulatory approvals. Many of the conditions are beyond our control. In addition, both the Company and Level 3 have rights to terminate the Merger Agreement under various circumstances. As a result, there may be uncertainty regarding the completion of the Level 3 merger. This uncertainty, along with potential customer uncertainty regarding the service to be provided by the combined company following the Level 3 merger, may cause our customers to delay or defer decisions concerning purchases from us, which could negatively impact our revenues, earnings and cash flow, regardless of whether the Level 3 merger is ultimately completed. Similarly, uncertainty regarding the completion of the Level 3 merger may foster uncertainty among employees about their future roles. This may adversely affect our ability to attract and retain key management, sales, marketing, operational and technical personnel, which could have an adverse effect on our ability to generate revenues at anticipated levels prior to the completion of the Level 3 merger.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table presents our purchases of equity securities reportable during the three months ended June 30, 2014:

Period
 
Total Number of
Shares Purchased
 
Average Price
Paid per Share
 
Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Programs (2)
 
Approximate Dollar
Value of Shares that
May Yet Be Purchased
Under the Plans or
Programs (2)
April 1 - April 30, 2014
 

 
$

 

 
$
249,941,459

May 1 - May 31, 2014
 

 

 

 
249,941,459

June 1 - June 30, 2014
 
694

(1) 
41.40

 

 
249,941,459

Total
 
694

 
 
 

 
 
_______________

(1) 
Represents restricted stock delivered back to us by certain employees to satisfy minimum tax withholding obligations that arise upon the vesting of restricted stock. Pursuant to our equity compensation plans, we give employees the opportunity to tender back to us the number of shares from the award sufficient to satisfy their minimum tax withholding obligations, which we pay on behalf of the employee.
(2) 
On August 6, 2013, our Board of Directors authorized a multi-year repurchase program of up to $500 million of our common stock from time to time using a variety of methods, including open market purchases, block trades and privately negotiated transactions. Our open market purchases may be carried out pursuant to a pre-established trading plan under Rule 10b5-1 under the Securities Exchange Act of 1934. The authorization has no time limit, and may be suspended or discontinued at any time. As of June 30, 2014, approximately $249.9 million remained available under the authorization. The stock repurchase program was suspended in June 2014 in compliance with our interim operating covenants, which prohibit share repurchases.
Item 6. Exhibits
The exhibits listed on the accompanying Exhibit Index are filed or incorporated by reference as part of this report and the Exhibit Index is incorporated herein by reference.

48




Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
 
 
 
 
 
tw telecom inc.
 
 
 
Date: August 8, 2014
 
By: 
 
/S/    JILL R. STUART        
 
 
 
 
Jill R. Stuart
Sr. Vice President, Accounting and Finance
and Chief Accounting Officer



49


EXHIBIT INDEX
 
 
 
 
Exhibit
Number
  
Description of Exhibit
 
 
2.1 –

 
Agreement and Plan of Merger, dated as of June 15, 2014, among Level 3 Communications, Inc., Saturn Merger Sub 1, LLC, Saturn Merger Sub 2, LLC, and the Company (filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed June 17, 2014)*
 
 
 
3.1 –
  
Restated Certificate of Incorporation of the Company (filed as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007)*
 
 
3.2 –
  
Certificate of Amendment to Restated Certificate of Incorporation of the Company (filed as Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2008)*
 
 
3.3 –
  
Amended By-laws of the Company (filed as Exhibit 3.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2012)*
 
 
4.1 –
  
Indenture, dated as of October 2, 2012, among tw telecom holdings inc., the Company, the Subsidiary Guarantors parties thereto and Wells Fargo Bank, National Association, as Trustee, for the 5 3/8% Senior Notes due 2022 (filed as Exhibit 4.1 to the Company's Current Report on Form 8-K filed October 4, 2012)*
 
 
4.2 –
  
Second Amended and Restated Credit Agreement dated as of April 17, 2013, among the Company, tw telecom holdings inc., the Subsidiary Guarantors parties thereto, the lenders parties thereto and Wells Fargo Bank, National Association, as administrative agent (filed as Exhibit 4.1 to the Company's Current Report on Form 8-K filed April 18, 2013)*
 
 
 
4.3 –
 
First Amendment to Second Amended and Restated Credit Agreement dated August 12, 2013 among tw telecom inc., tw telecom holdings inc., Wells Fargo Bank, National Association, as Administrative Agent and Collateral Agent and the lenders named therein (filed as Exhibit 4.1 to the Company's Current Report on Form 8-K filed August 12, 2013)*
 
 
4.4 –
  
Certification of Designations of Series A Junior Participating Preferred Stock of tw telecom inc. (filed as Exhibit 4.6 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2009)*
 
 
 
4.5 –
 
Indenture, dated as of August 26, 2013, among tw telecom holdings inc., tw telecom inc., the subsidiaries of tw telecom holdings inc. named therein, and Wells Fargo Bank, National Association, as trustee, relating to the 5.375% Senior Notes due 2022 of tw telecom holdings inc. (filed as Exhibit 4.1 to the Company's Current Report on Form 8-K filed August 26, 2013)*
 
 
 
4.6 –
 
First Supplemental Indenture of Trust, dated as of November 20, 2013, among tw telecom holdings inc., the Company, the subsidiary guarantors named therein, and Wells Fargo Bank, National Association, as trustee, relating to the 5.375% Senior Notes due 2022 (filed as Exhibit 4.2 to tw telecom holdings inc.’s Registration Statement on Form S-4 (Registration No. 333-192450))*
 
 
 
4.7 –
 
Indenture, dated as of August 26, 2013, among tw telecom holdings inc., tw telecom inc., the subsidiaries of tw telecom holdings inc. named therein, and Wells Fargo Bank, National Association, as trustee, relating to the 6.375% Senior Notes due 2023 of tw telecom holdings inc. (filed as Exhibit 4.2 to the Company's Current Report on Form 8-K filed August 26, 2013)*
 
 
 
4.8 –
 
First Supplemental Indenture of Trust, dated as of November 20, 2013, among tw telecom holdings inc., the Company, the subsidiary guarantors named therein, and Wells Fargo Bank, National Association, as trustee, relating to the 6.375% Senior Notes due 2023 (filed as Exhibit 4.4 to tw telecom holdings inc.’s Registration Statement on Form S-4 (Registration No. 333-192450))*

50


 
 
 
Exhibit
Number
  
Description of Exhibit
 
 
 
10.1 –

 
Voting Agreement, dated as of June 15, 2014, among the Company, STT Crossing Ltd. and, for specific purposes, Level 3 Communications, Inc. (filed as Exhibit 10.1 to the Company's Current Report on Form 8-K filed June 17, 2014)*
 
 
 
31.1 –
  
Certification of Chief Executive Officer pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
31.2 –
  
Certification of Chief Financial Officer pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
32.1 –
  
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
32.2 –
  
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
101.INS –
  
XBRL Instance Document
 
 
 
101.SCH –
  
XBRL Taxonomy Extension Schema Document
 
 
101.CAL –
  
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
101.DEF –
  
XBRL Taxonomy Extension Definition Linkbase Document
 
 
101.LAB –
  
XBRL Taxonomy Extension Label Linkbase Document
 
 
101.PRE –
  
XBRL Taxonomy Extension Presentation Linkbase Document
 
 
 
 
 
*
Incorporated by reference.
 
 


51