ITEM 1A. RISK FACTORS
Any of the following risks could materially and adversely affect our business, financial condition, results of operations, liquidity or
prospects. The risks described below are not the only risks facing us. Please be aware that additional risks and uncertainties not currently known to us or that we currently deem to be immaterial
could also materially and adversely affect our business operations.
Risks Affecting Our Business
Increasing competition, including product substitution, continues to cause access line losses, which have adversely affected and could continue to adversely affect our
operating results and financial condition.
We compete in a rapidly evolving and highly competitive market, and we expect competition to continue to intensify. In addition to
competition from larger national telecommunications providers, we are facing increasing competition from a variety of other sources, including cable and satellite companies, wireless providers,
broadband providers, resellers, sales agents and facilities-based providers using their own networks as well as those leasing parts of our network. In addition, regulatory developments over the past
several years have generally increased competitive pressures on our business. Due to some of these and other factors, we continue to lose access lines.
Some
of our current and potential competitors (i) offer a more comprehensive range of communications products and services, (ii) have market presence, engineering and
technical capabilities, and financial and other resources greater than ours, (iii) own larger or more diverse networks with greater transmission capacity or other advantages,
(iv) conduct operations or raise capital at a lower cost than us, (v) are subject to less regulation, (vi) offer greater online content or (vii) have substantially stronger
brand names. Consequently, these competitors may be better equipped to provide more attractive offerings, to charge lower prices for their products and services, to develop and expand their
communications and network infrastructures more quickly, to adapt more swiftly to new or emerging technologies and changes in customer requirements, and to devote greater resources to the marketing
and sale of their products and services.
Competition
could adversely impact us in several ways, including (i) the loss of customers and market share, (ii) the possibility of customers reducing their usage of our
services or shifting to less profitable services, (iii) reduced traffic on our networks, (iv) our need to expend substantial time or money on new capital improvement projects,
(v) our need to lower prices or increase marketing expenses to remain competitive and (vi) our inability to diversify by successfully offering new products or services.
We
are continually taking steps to respond to these competitive pressures, but these efforts may not be successful. Our operating results and financial condition would be adversely
affected if these initiatives are unsuccessful or insufficient and if we otherwise are unable to sufficiently stem or offset our continuing access line losses and our revenue declines significantly
without corresponding cost reductions. If this occurred, our ability to service debt and pay other obligations would also be adversely affected.
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Rapid changes in technology and markets could require substantial expenditure of financial and other resources in excess of contemplated levels, and any inability to respond
to those changes could reduce our market share and adversely affect our operating results and financial condition.
The communications industry is experiencing significant technological changes, many of which are reducing demand for our traditional
voice services or are enabling our current customers to reduce or bypass use of our networks. Similarly, the information technology services industry is experiencing rapid changes in technologies.
Further technological change could require us to expend capital or other resources in excess of currently contemplated levels or to forgo the development or provision of products or services that
others can provide more efficiently. If we are not able to develop new products and services to keep pace with technological advances, or if those products and services are not widely accepted by
customers, our ability to compete could be adversely affected and our market share could decline. Any inability to effectively respond to changes in technology and markets could also adversely affect
our operating results and financial condition, as well as our ability to service debt and pay other obligations.
For
additional information on the risks of increased expenditures, see "Risk FactorsRisks Affecting our Liquidity and Capital ResourcesOur business requires us
to incur substantial capital and operating expenses, which reduces our available free cash flow."
Our legacy services continue to experience declining revenues, and our efforts to offset these declines may not be successful.
The telephone industry has experienced a decline in access lines and network access revenues, which, coupled with the other changes
resulting from competitive, technological and regulatory developments, continue to place downward pressure on the revenues we generate from our legacy services.
We
have taken a variety of steps to counter these declines, including:
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an increased focus on selling a broader range of higher-growth strategic services which are described in detail in
Item 2 of Part I of this report;
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an increased focus on serving a broader range of business, governmental and wholesale customers; and
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greater use of service bundles.
However,
some of these strategic services generate lower profit margins than our traditional services, and some can be expected to experience slowing growth as increasing numbers of our
existing or potential customers subscribe to these newer products. Moreover, we cannot assure you that the revenues generated from our new offerings will offset revenue losses associated from reduced
sales of our legacy products. Similarly, we cannot assure you that our new service offerings will be as successful as anticipated. In addition, our reliance on third parties to provide certain of
these strategic services could constrain our flexibility, as described further below.
If we fail to extend or renegotiate our collective bargaining agreements with our labor unions as they expire from time to time, or if our unionized employees were to engage
in a strike or other work stoppage, our business and operating results could be materially harmed.
Approximately 12,000 or 52% of our employees are members of various bargaining units represented by the Communications Workers of
America or the International Brotherhood of Electrical Workers and are subject to collective bargaining agreements that expired October 6, 2012. Since then, we have been negotiating the terms
of new agreements. In the meantime, the predecessor agreements have been extended, and the applicable unions have agreed to provide us with at least twenty-four hour
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advance
notice before terminating those predecessor agreements. On July 30, 2013, we reached a tentative agreement in our contract negotiations with the Communication Workers of America for a
four-year labor contract covering approximately 12,000 of our employees. The new contract must be approved by the union's membership. The union has advised us that it plans to seek this approval
before the end of September 2013.
We
may be unable to reach new agreements acceptable to our unions and their membership, and union employees may engage in strikes, work slowdowns or other labor actions, which could
materially disrupt our ability to provide services and result in increased cost to us. In addition, new labor agreements may impose significant new costs on us, which could impair our financial
condition or results of operations in the future. To the extent they contain benefit provisions, these agreements may also limit our flexibility to change benefits in response to industry or
competitive changes. In particular, the post-employment benefits provided under these agreements could cause us to incur costs not faced by many of our competitors, which could ultimately hinder our
competitive position.
Our future results will suffer if we do not effectively adjust to changes in our business.
The above-described changes in our industry have placed a higher premium on marketing, technological, engineering and provisioning
skills. Our future success depends, in part, on our ability to retrain our staff to acquire or strengthen skills necessary to address these changes, and, where necessary, to attract and retain new
personnel that possess these skills.
Unfavorable general economic conditions could negatively impact our operating results and financial condition.
Unfavorable general economic conditions, including the unstable economy and credit market, could negatively affect our business.
Worldwide economic growth has been sluggish since 2008, and many experts believe that a confluence of factors in the United States, Europe, Asia and developing countries may result in a prolonged
period of economic downturn, slow growth or economic uncertainty. While it is difficult to predict the ultimate impact of these general economic conditions, they could adversely affect the
affordability of and consumer demand for some of our products and services and could cause customers to shift to lower priced products and services or to delay or forgo purchases of our products and
services. These conditions impact, in particular, our ability to sell discretionary products or services to business customers that are under pressure to reduce costs or to governmental customers that
have recently suffered substantial budget cuts with the prospects of additional future budget cuts. Any one or more of these circumstances could cause our revenues to continue declining. Also, our
customers may encounter financial hardships or may not be able to obtain adequate access to credit, which could negatively impact their ability to make timely payments to us. In addition, as discussed
further below, unstable economic and credit markets may preclude us from refinancing maturing debt at terms that are as favorable as those from which we previously benefited, at terms that are
acceptable to us or at all. For these reasons, among others, if the current economic conditions persist or decline, this could adversely affect our operating results and financial condition, as well
as our ability to raise capital.
We could be harmed by security breaches, damages or other significant disruptions or failures of our networks, IT infrastructure or related systems, or of those we operate
for certain of our customers.
To be successful, we will need to continue providing our customers with a high-capacity, reliable and secure network. We face the risk,
as does any company, of a security breach or significant disruption of our IT infrastructure and related systems (including our billing systems). As a communications and IT company, we face an added
risk that a security breach or other significant disruption of our public networks or IT infrastructure and related systems that we develop, install, operate and maintain for certain of our business
and governmental customers could lead to material interruptions or curtailments of service. Moreover, due to the nature of our customers and services, we
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face
a heightened risk that a security breach or disruption could result in unauthorized access to our customers' proprietary or classified information on our public networks or internal systems or
the systems that we operate and maintain for certain of our customers.
We
make significant efforts to maintain the security and integrity of these types of information and systems and maintain contingency plans in the event of security breaches or other
system disruptions. Nonetheless, we cannot assure you that our security efforts and measures will prevent unauthorized access to our systems, loss or destruction of data (including confidential client
information), account takeovers, unavailability of service, computer viruses, malware, or other forms of cyber attacks or similar events. These threats may derive from human error, fraud, malice or
sabotage on the part of employees, third parties or other nations, or could result from accidental technological failure. Similar to other large telecommunications companies, we have been subject to a
variety of security breaches and cyber attacks, although to date none of these have resulted in a material adverse effect on our operating results or financial condition. We cannot assure you,
however, that future security breaches or disruptions would not be successful or damaging, especially in light of the growing frequency and sophistication of cyber attacks and intrusions. We may be
unable to anticipate all potential types of attacks or intrusions or to implement adequate security barriers or other preventative measures, and any resulting damages could be material.
Additional
risks to our network and infrastructure include:
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power losses or physical damage, whether caused by fire, adverse weather conditions, terrorism or otherwise;
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capacity limitations;
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software and hardware defects or malfunctions;
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programming, processing and other human error; and
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-
other disruptions that are beyond our control.
Network
disruptions, security breaches and other significant failures of the above-described systems could:
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-
disrupt the proper functioning of these networks and systems and therefore our operations or those of certain of our
customers;
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result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of proprietary,
confidential, sensitive or otherwise valuable information of ours, our customers or our customers' end users, including trade secrets, which others could use for competitive, disruptive, destructive
or otherwise harmful purposes and outcomes;
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require significant management attention or financial resources to remedy the damages that result or to change our
systems, including expenses to repair systems, add new personnel or develop additional protective systems;
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require us to offer expensive incentives to retain existing customers or subject us to claims for contract breach,
damages, credits, fines, penalties, termination or other remedies, particularly with respect to service standards set by state regulatory commissions; or
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result in a loss of business, damage our reputation among our customers and the public generally, subject us to additional
regulatory scrutiny or expose us to litigation.
Likewise,
our ability to expand and update our information technology infrastructure in response to our growth and changing needs is important to the continued implementation of our new
service offering initiatives. Our inability to expand or upgrade our technology infrastructure could have adverse consequences, which could include the delayed implementation of new service offerings,
increased
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acquisition
integration costs, service or billing interruptions, and the diversion of development resources.
Any
or all of the foregoing developments could have a negative impact on our results of operations, financial condition and cash flows.
Increases in broadband usage may cause network capacity limitations, resulting in service disruptions, reduced capacity or slower transmission speeds for our customers.
Video streaming services and peer-to-peer file sharing applications use significantly more bandwidth than traditional Internet activity
such as web browsing and email. As utilization rates and availability of these services continue to grow, our high-speed Internet customers may use much more bandwidth than in the past. If this
occurs, we could be required to make significant capital expenditures to increase network capacity in order to avoid service disruptions, service degradation or slower transmission speeds for our
customers. Alternatively, we could choose to implement network management practices to reduce the network capacity available to bandwidth-intensive activities during certain times in market areas
experiencing congestion, which could negatively affect our ability to retain and attract customers in affected markets. While we believe demand for these services may drive high-speed Internet
customers to pay for faster broadband speeds, we may not be able to recover the costs of the necessary network investments. This could result in an adverse impact to our operating margins, results of
operations and financial condition.
We may need to defend ourselves against claims that we infringe upon others' intellectual property rights, or we may need to seek third-party licenses to expand our product
offerings.
From time to time, we receive notices from third parties or are named in lawsuits filed by third parties claiming we have infringed or
are infringing upon their intellectual property rights. We may receive similar notices or be involved in similar lawsuits in the future. Responding to these claims may require us to expend significant
time and money defending our use of affected technology, may require us to enter into licensing agreements requiring royalty payments that we would not otherwise have to pay or may require us to pay
damages. If we are required to take one or more of these actions, our profit margins may decline. In addition, in responding to these claims, we may be required to stop selling or redesign one or more
of our products or services, which could significantly and adversely affect the way we conduct business.
Similarly,
from time to time, we may need to obtain the right to use certain patents or other intellectual property from third parties to be able to offer new products and services. If
we cannot license or otherwise obtain rights to use any required technology from a third party on reasonable terms, our ability to offer new products and services may be restricted, made more costly
or delayed.
Our reseller and sales agency arrangements expose us to a number of risks, one or more of which may adversely affect our business and operating results.
We rely on reseller and sales agency arrangements with other companies to provide some of the services that we sell to our customers,
including video services and wireless products and services. If we fail to extend or renegotiate these arrangements as they expire from time to time or if these other companies fail to fulfill their
contractual obligations to us or our customers, we may have difficulty finding alternative arrangements and our customers may experience disruptions to their services. In addition, as a reseller or
sales agent, we do not control the availability, retail price, design, function, quality, reliability, customer service or branding of these products and services, nor do we directly control all of
the marketing and promotion of these products and services. To the extent that these other companies make decisions that negatively impact our ability to market and sell their products and services,
our business plans and goals and our reputation could be negatively impacted. If these reseller and sales agency arrangements are unsuccessful due to one or more of these risks, our business and
operating results may be adversely affected.
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Consolidation among other participants in the communications industry may allow our competitors to compete more effectively against us, which could adversely affect our
operating results and financial condition.
The telecommunications and cable industries have experienced substantial consolidation over the last couple of decades, and some of our
competitors have combined with other communications providers, resulting in larger competitors that have greater financial and business resources and broader service offerings. Further consolidation
could increase competitive pressures, and could adversely affect our operating results and financial condition, as well as our ability to service debt and pay other obligations.
We have a significant amount of goodwill and other intangible assets on our balance sheet. If our goodwill or other intangible assets become impaired, we may be required to
record a significant charge to earnings and reduce our stockholders' equity.
Under generally accepted accounting principles, intangible assets are tested for impairment on an annual basis or more frequently
whenever events or circumstances indicate
that its carrying value may not be recoverable. If our intangible assets are determined to be impaired in the future, we may be required to record a significant, non-cash charge to earnings during the
period in which the impairment is determined.
We rely on a limited number of key suppliers, vendors, landlords and other third parties to operate our business.
We depend on a limited number of suppliers and vendors for equipment and services relating to our network infrastructure. Our local
exchange carrier networks consist of central office and remote sites, all with advanced digital switches. If any of these suppliers experience interruptions or other problems delivering or servicing
these network components on a timely basis, our operations could suffer significantly. To the extent that proprietary technology of a supplier is an integral component of our network, we may have
limited flexibility to purchase key network components from alternative suppliers. In addition, we rely on a limited number of software vendors to support our business management systems. In the event
it becomes necessary to seek alternative suppliers and vendors, we may be unable to obtain satisfactory replacement supplies, services, space or utilities on economically attractive terms, on a timely
basis, or at all, which could increase costs or cause disruptions in our services.
Portions of our property, plant and equipment are located on property owned by third parties.
Over the past few years, certain utilities, cooperatives and municipalities in certain of the states in which we operate have requested
significant rate increases for attaching our plant to their facilities. To the extent that these entities are successful in increasing the amount we pay for these attachments, our future operating
costs will increase.
In
addition, we rely on rights-of-way, colocation agreements and other authorizations granted by governmental bodies and other third parties to locate our cable, conduit and other
network equipment on their respective properties. If any of these authorizations terminate or lapse, our operations could be adversely affected.
We depend on key members of our senior management team.
Our success depends largely on the skills, experience and performance of a limited number of senior officers. Competition for senior
management in our industry is intense and we may have difficulty retaining our current senior officers or attracting new ones in the event of
terminations or resignations. For a discussion of similar retention concerns relating to our recent mergers, please see the risks described below under the heading "Risk FactorsRisks
Relating to our Recent Acquisition."
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Risks Relating to our Recent Acquisition
We may be unable to integrate successfully into CenturyLink and realize the anticipated benefits of its recent acquisition of control of us.
CenturyLink's acquisition of control of us in 2011 involved the combination of two companies which previously operated as independent
public companies. We have devoted, and will continue to devote, significant management attention and resources to integrating the business practices and operations of CenturyLink and Qwest. We may
encounter difficulties in the integration process, including the following:
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the inability to successfully combine our businesses in a manner that permits the combined company to achieve the cost
savings and operating synergies anticipated to result from the acquisition, either due to technological challenges, personnel shortages, strikes or otherwise, any of which would result in the
anticipated benefits of the acquisition not being realized partly or wholly in the time frame anticipated or at all;
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lost sales as a result of customers deciding not to do business with the combined company;
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the complexities associated with managing the combined businesses out of several different locations and integrating
personnel from multiple companies, while at the same time attempting to provide consistent, high quality products and services under a unified culture;
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the additional complexities of combining two companies with different histories, regulatory restrictions, sales forces,
marketing strategies, product markets and customer bases;
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the failure to retain key employees, some of whom could be critical to integrating or expanding the companies;
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potential unknown liabilities and unforeseen increased expenses or regulatory conditions associated with the acquisition;
and
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performance shortfalls at one or both of the two companies as a result of the diversion of management's attention caused
by integrating the companies' operations.
For
all these reasons, you should be aware that it is possible that the integration process could result in the distraction of our management, the disruption of our ongoing business or
inconsistencies in our products, services, standards, controls, procedures and policies, any of which could adversely affect our ability to maintain relationships with customers, vendors and employees
or to achieve the anticipated benefits of the acquisition, or could otherwise adversely affect our business and financial results.
CenturyLink cannot assure you whether, when or in what amounts they will be able to use QCII's net operating losses.
At December 31, 2012, Qwest Communications International Inc. ("QCII") had approximately $5.3 billion of federal
net operating losses, or NOLs. These NOLs can be used to offset their future federal taxable income.
CenturyLink's
acquisition of QCII caused an "ownership change" under federal tax laws relating to the use of NOLs. As a result, these laws could limit CenturyLink's ability to use QCII's
NOLs and certain other deferred tax attributes to reduce future federal taxable income. CenturyLink currently expects to use substantially all of QCII's NOLs and certain other deferred tax attributes.
However, if CenturyLink is unable to realize these benefits, CenturyLink's future income tax payments would be higher than expected, which would adversely affect its financial results and liquidity.
As a wholly owned subsidiary of these companies, our financial results and liquidity could be similarly affected.
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Risks Relating to Legal and Regulatory Matters
Any adverse outcome of the KPNQwest litigation, or other material litigation of CenturyLink could have a material adverse impact on our financial condition and operating
results, on the trading price of our debt securities and on our ability to access the capital markets.
As described in Note 15Commitments and Contingencies to the consolidated financial statements in Item 8 of
Part II of CenturyLink's Annual Report on Form 10-K for the year ended December 31, 2012, CenturyLink and QCII are involved in several legal proceedings that, if resolved against
them, could have a material adverse effect on their business and financial condition. As a wholly owned subsidiary of CenturyLink, our business and financial condition could be similarly affected.
These matters include certain KPNQwest matters, which present material and significant risks to QCII and us. In the aggregate, the plaintiffs in the KPNQwest matters seek billions of dollars in
damages. QCII continues to defend against these matters vigorously and is currently unable to provide any estimate as to the timing of their resolution.
We
can give no assurance as to the impacts on QCII's and our financial results or financial condition that may ultimately result from these matters. The ultimate outcomes of these
matters are still uncertain, and substantial settlements or judgments in these matters could have a significant impact on QCII and us. The magnitude of such settlements or judgments resulting from
these matters could materially and adversely affect QCII's financial condition and ability to meet its debt obligations, potentially impacting its credit ratings, its ability to access capital markets
and its compliance with debt covenants. In addition, the magnitude of any such settlements or judgments may cause QCII to draw down significantly on its cash balances, which might force it to obtain
additional financing or explore other methods to generate cash. Such methods could include issuing additional debt securities or selling
assets. As a wholly owned subsidiary of QCII, our business operations and financial condition could be similarly affected.
There
are other material proceedings pending against CenturyLink and QCII, as described in the above-referenced Note 15. Depending on their outcome, any of these matters could
have a material adverse effect on our financial position or operating results. We can give you no assurances as to the impact of these matters on our operating results or financial condition.
We operate in a highly regulated industry and are therefore exposed to restrictions on our manner of doing business and a variety of claims relating to such regulation.
General.
We are subject to significant regulation by the Federal Communications Commission ("FCC"), which regulates interstate communications, and
state utility commissions, which regulate intrastate communications. Generally, we must obtain and maintain certificates of authority from the FCC and regulatory bodies in most states where we offer
regulated services, and we are subject to numerous, and often quite detailed, requirements and interpretations under federal, state and local laws, rules and regulations. Accordingly, we cannot ensure
that we are always considered to be in compliance with all these requirements at any single point in time. The agencies responsible for the enforcement of these laws, rules and regulations may
initiate inquiries or actions based on customer complaints or on their own initiative.
Regulation
of the telecommunications industry continues to change rapidly, and the regulatory environment varies substantially from jurisdiction to jurisdiction. Notwithstanding a recent
movement towards alternative regulation, a substantial portion of our local voice services revenue remains subject to FCC and state utility commission pricing regulation, which periodically exposes us
to pricing or earnings disputes and could expose us to unanticipated price declines. Interexchange carriers have filed complaints in various forums requesting reductions in our access rates. In
addition, several long-distance providers are disputing amounts owed to us for carrying Voice over Internet Protocol ("VoIP") traffic, or traffic they claim to be VoIP traffic, and are refusing to pay
such amounts. There
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can
be no assurance that future regulatory, judicial or legislative activities will not have a material adverse effect on our operations, or that regulators or third parties will not raise material
issues with regard to our compliance or noncompliance with applicable regulations.
Risks associated with recent changes in federal regulation.
On October 27, 2011, the FCC adopted the Connect America and Intercarrier
Compensation Reform order ("CAF order") intended to reform the existing regulatory regime to recognize ongoing shifts to new technologies, including VoIP, and gradually re-direct federal universal
service funding to foster nationwide broadband coverage. This initial ruling provides for a multi-year transition over the next decade as intercarrier compensation charges are reduced, federal
universal service funding is explicitly targeted to broadband deployment, and subscriber line charges paid by end user customers are gradually increased. We expect these changes will substantially
increase the pace of reductions in the amount of switched access revenues we receive in our wholesale business, while creating opportunities for increases in federal Universal Service Fund ("USF") and
retail revenue streams. Several judicial challenges to the CAF order are pending and additional future challenges are possible, any of which could alter or delay the FCC's proposed changes. In
addition, based on the outcome of the FCC proceedings, various state commissions may consider changes to their universal service funds or intrastate access rates. Moreover, rulemaking designed to
implement the CAF order is not complete, and several FCC proceedings relating to the order remain pending. For these and other reasons, we cannot predict the ultimate impact of these proceedings at
this time.
In
addition, during the last few years Congress or the FCC has initiated various other changes, including (i) broadband stimulus projects, support funds and similar plans and
(ii) new "network neutrality" rules. The FCC is also considering changes in the regulation of special access services. Any of these recent or pending initiatives could adversely affect our
operations or financial results.
Risks posed by costs of regulatory compliance.
Regulations continue to create significant compliance costs for us. Challenges to our tariffs by
regulators or third parties or delays in obtaining certifications and regulatory approvals could cause us to incur substantial legal and administrative expenses, and, if successful, such challenges
could adversely affect the rates that we are able to charge our customers. Our business also may be impacted by legislation and regulation imposing new or greater obligations related to regulations or
laws related to broadband deployment, bolstering homeland security, increasing disaster recovery requirements, minimizing environmental impacts, enhancing privacy, or addressing other issues that
impact our business, including the Communications Assistance for Law Enforcement Act (which requires communications carriers to ensure that their equipment, facilities, and services are able to
facilitate authorized electronic surveillance), and laws governing local number portability and customer proprietary network information requirements. We expect our compliance costs to increase if
future laws or regulations continue to increase our obligations to assist other governmental agencies.
Risks posed by other regulations.
All of our operations are also subject to a variety of environmental, safety, health and other
governmental
regulations. We monitor our compliance with federal, state and local regulations governing the management, discharge and disposal of hazardous and environmentally sensitive materials. Although we
believe that we are in compliance with these regulations, our management, discharge or disposal of hazardous and environmentally sensitive materials might expose us to claims or actions that could
have a material adverse effect on our business, financial condition and operating results.
Regulatory changes in the communications industry could adversely affect our business by facilitating greater competition against us.
For over 15 years, Congress and the FCC have taken several steps that have resulted in increased competition among
communications service providers. Many of the FCC's regulations remain subject to
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judicial
review and additional rulemakings, thus making it difficult to determine the ultimate impact of these changes on us and our competitors.
"Net neutrality" legislation or regulation could limit our ability to operate our high-speed data business profitably and to manage our broadband facilities
efficiently
.
In order to continue to provide quality high-speed data service at attractive prices, we believe we need the continued flexibility to
respond to changing consumer demands, to manage bandwidth usage efficiently and to invest in our networks. The FCC's "net neutrality" regulations, which are currently on appeal to the federal circuit
court, could adversely impact our ability to operate our high-speed data network profitably and to undertake the upgrades and implement network management practices that may be needed to continue to
provide high quality high-speed data services, and could therefore negatively impact our ability to compete effectively.
We may be liable for the material that content providers distribute over our network.
The law relating to the liability of private network operators for information carried on, stored or disseminated through their
networks is still unsettled. As such, we could be exposed to legal claims relating to content disseminated on our networks. Claims could challenge the accuracy of materials on our network, or could
involve matters such as defamation, invasion of privacy or copyright infringement. If we need to take costly measures to reduce our exposure to these risks, or are required to defend ourselves against
such claims, our financial results could be negatively affected.
We are subject to significant regulations that limit our flexibility.
As a diversified full service incumbent local exchange carrier in most of our key markets, we have traditionally been subject to
significant regulation that does not apply to many of our competitors. This regulation imposes substantial compliance costs on us and restricts our ability to change rates, to compete and to respond
rapidly to changing industry conditions. As our business becomes increasingly competitive, regulatory disparities between us and our competitors could impede our ability to compete.
We are subject to franchising requirements that could impede our expansion opportunities.
We may be required to obtain from municipal authorities operating franchises to install or expand facilities. Some of these franchises
may require us to pay franchise fees. These franchising requirements generally apply to our fiber transport and competitive local exchange carrier operations, and to our facilities-based video
services. These requirements could delay us in expanding our operations or increase the costs of providing these services.
We are exposed to risks arising out of recent legislation affecting U.S. public companies.
Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act and
the Dodd-Frank Wall Street Reform and Consumer Protection Act, and related regulations implemented thereunder, are increasing legal and financial compliance costs and making some activities more time
consuming. Any failure to successfully
or timely complete annual assessments of our internal controls required by Section 404 of the Sarbanes-Oxley Act could subject us to sanctions or investigation by regulatory authorities. Any
such action could adversely affect our financial results or investors' confidence in us.
For
a more thorough discussion of the regulatory issues that may affect our business, see "Regulation" in Item 1 of Part I of our Annual Report on Form 10-K for the
year ended December 31, 2012.
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Risks Affecting our Liquidity and Capital Resources
CenturyLink's and our high debt levels pose risks to our viability and may make us more vulnerable to adverse economic and competitive conditions, as well as other adverse
developments.
Our ultimate parent, CenturyLink, and we continue to carry significant debt. As of June 30, 2013, our consolidated debt was
approximately $7.6 billion, which was included in CenturyLink's consolidated debt of approximately $20.6 billion as of that date. Approximately $2.7 billion of CenturyLink's debt
securities, which includes approximately $0.9 billion of our debt securities, come due over the next thirty-six months.
Our
significant levels of debt can adversely affect us in several other respects, including (i) limiting our ability to access the capital markets, (ii) exposing us to the
risk of credit rating downgrades, which would raise our borrowing costs and could further limit our access to capital as described further below in the next captioned risk factor,
(iii) hindering our flexibility to plan for or react to changing market, industry or economic conditions, (iv) limiting the amount of cash flow available for future operations,
acquisitions, dividends, or other uses, (v) making us more vulnerable to economic or industry downturns, including interest rate increases, and (vi) placing us at a competitive
disadvantage compared to less leveraged competitors. The effects of each of these factors could be intensified if we increase our borrowings.
We
expect to periodically require financing to meet our debt obligations as they come due. While we currently believe that we will have access to financial resources sufficient to meet
or refinance our obligations when they come due, we cannot fully anticipate our future financial condition or the future condition of the credit markets or the economy generally. Due to the unstable
economy and credit markets, we may not be able to refinance maturing debt at terms that are as favorable as those from which we previously benefited, at terms that are acceptable to us or at all. We
may also need to obtain additional financing or investigate other methods to generate cash (such as further cost reductions or the sale of assets) under a variety of circumstances, including if
revenues and cash provided by operations decline, if economic conditions weaken, if competitive pressures increase, if regulatory requirements change, if CenturyLink or QCII are required to contribute
a material amount of cash to their pension plans, if CenturyLink or QCII are required to begin to pay other post-retirement benefits significantly earlier than anticipated, if CenturyLink or QCII
become subject to significant judgments or settlements in one or more of the matters discussed in Note 15Commitments and Contingencies to the consolidated financial statements in
Item 8 of CenturyLink's Annual Report on Form 10-K for the year ended December 31, 2012. We can give no assurance that this additional financing will be available on terms that
are acceptable to us or at all.
Certain
of CenturyLink's and QCII's debt instruments have cross payment default or cross acceleration provisions. When present, these provisions could have a wider impact on liquidity
than might otherwise arise from a default or acceleration of a single debt instrument. Any such event could adversely affect our ability to conduct business or access the capital markets and could
adversely impact our credit ratings.
Any downgrade in our credit ratings could limit our ability to obtain future financing, increase our borrowing costs and adversely affect the market price of our existing
debt securities or otherwise impair our business, financial condition and results of operations.
As noted above in Item 2 of Part I of this report, our long-term debt is currently rated BBB- by Standard and Poor's
Ratings Services; Baa3 by Moody's Investors Services; and BBB- by Fitch Ratings, all three of which are the lowest investment-grade ratings issued by each of these agencies. Credit rating agencies
continually review their ratings for the companies that they follow, including us. Credit rating agencies also evaluate the industries in which we operate as a whole and may change their credit rating
for us based on their overall view of such industries. There can be no assurance that any rating
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to any of our debt securities will remain in effect for any given period of time or that a rating will not be lowered, suspended or withdrawn entirely by a rating agency if, in that rating
agency's judgment, circumstances so warrant. A downgrade of our credit ratings could adversely affect the market price of some or all of our outstanding debt securities, limit our access to the
capital markets or
otherwise adversely affect the availability of other new financing on favorable terms, if at all, result in more restrictive covenants in agreements governing the terms of any future indebtedness that
we may incur, increase our cost of borrowing, and impair our business, financial condition and results of operations.
Our debt agreements and the debt agreements of CenturyLink and its other subsidiaries allow us to incur significantly more debt, which could exacerbate the other risks
described in this report.
The terms of our debt instruments and the debt instruments of CenturyLink and its other subsidiaries permit additional indebtedness.
Additional debt may be necessary for many reasons, including those discussed immediately above. Incremental borrowings on terms that impose additional financial risks could exacerbate the other risks
described in this report.
Our business requires us to incur substantial capital and operating expenses, which reduce our available free cash flow.
Our business is capital intensive, and we anticipate that our capital requirements will continue to be significant in the coming years.
As discussed further under "Risk FactorsRisks Affecting Our BusinessIncreases in broadband usage may cause network capacity limitations, resulting in service disruptions,
reduced capacity or slower transmission speeds for our customers," increased bandwidth consumption by consumers and businesses have placed increased demands on the transmission capacity of our
networks. If we determine that our networks must be expanded to handle these increased demands, we may be required to make substantial capital expenditures, even though there is no assurance that the
return on our investment will be satisfactory. In addition, many of our growth initiatives are capital intensive and changes in technology could require further spending. In addition to investing in
expanded networks, new products or new technologies, we must from time to time replace some of the equipment that supports our traditional services as that equipment ages, even though the revenue base
from those services is not growing. While we believe that our planned level of capital expenditures will meet both our maintenance and core growth requirements, this may not be the case if demands on
our network continue to accelerate or other circumstances underlying our expectations change. Increased spending could, among other things, adversely affect our operating margins, cash flows, results
of operations and financial position.
Similarly,
we continue to anticipate incurring substantial operating expenses to support our incumbent services and growth initiatives. Although we have successfully reduced our
operating expenses over the past few years, we may be unable to further reduce these costs, even if revenues in some of our lines of business are decreasing. If so, our operating margins will be
adversely impacted.
Adverse changes in the value of assets or obligations associated with QCII's qualified pension plan could negatively impact QCII's liquidity, which may in turn affect our
business and liquidity.
A substantial amount of our employees participate in a qualified pension plan sponsored by QCII.
The
funded status of QCII's qualified pension plan is the difference between the value of plan assets and the benefit obligation. Adverse changes in interest rates or market conditions,
among other assumptions and factors, could cause a significant increase in QCII's benefit obligation or a significant decrease in the value of plan assets. These adverse changes could require QCII to
contribute a material amount of cash to its pension plan or could accelerate the timing of required cash payments. The amounts contributed by us through QCII are not segregated or restricted and may
be used to provide
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to employees of QCII's other subsidiaries. QCII determines our cash contribution and, historically, has only required us to pay our portion of its required pension contribution. Based on
current laws and circumstances, QCII was not required to make a cash contribution to this plan in 2012 and QCII does not expect it will be required to make a contribution in 2013 or 2014. The actual
amount of required contributions to our plan in future periods will depend upon a variety of factors, including earnings on plan investments, prevailing interest rates, demographic experience, changes
in plan benefits and changes in funding laws and regulations. Any future material cash contributions could have a negative impact on QCII's liquidity by reducing its cash flows, which in turn could
affect our liquidity.
CenturyLink and QC plan to access the public debt markets, and we cannot assure you that these markets will remain free of disruptions.
CenturyLink has a significant amount of consolidated indebtedness that it intends to refinance over the next several years, principally
it expects through the issuance of debt securities of CenturyLink, QC or both. CenturyLink's ability to arrange additional financing will depend on, among other factors, the financial position,
performance, and credit ratings of CenturyLink and QC, as well as prevailing market conditions and other factors beyond its control. Prevailing market conditions could be adversely affected by the
ongoing disruptions in the European sovereign debt markets, the failure of the United States to reduce its deficit in amounts deemed to be sufficient, possible further downgrades in the credit ratings
of the U.S. debt, contractions or limited growth in the economy or other similar adverse economic developments in the U.S. or abroad. Instability in the
global financial markets has from time to time resulted in periodic volatility in the capital markets. This volatility could limit CenturyLink's or our access to the credit markets, leading to higher
borrowing costs or, in some cases, the inability to obtain financing on acceptable terms, or at all. Any such failure to obtain additional financing could jeopardize its and our ability to repay,
refinance or reduce debt obligations.
Other Risks
We regularly transfer our cash to CenturyLink, which exposes us to certain risks.
Under our cash management arrangement with CenturyLink, we regularly transfer our cash to CenturyLink, which we recognize on our
balance sheet as advances to affiliates. Although CenturyLink periodically repays these advances to fund our cash requirements throughout the year, at any given point in time CenturyLink may owe us a
substantial sum under this arrangement. Accordingly, developments that adversely impact CenturyLink could adversely impact our ability to collect these advances.
If conditions or assumptions differ from the judgments, assumptions or estimates used in our critical accounting policies, our consolidated financial statements and related
disclosures could be materially affected.
The preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principles
requires management to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Our critical accounting policies,
which are described in "Management's Discussion and Analysis of Financial Condition and Results of OperationsCritical Accounting Policies and Estimates" in Item 7 of Part II
of our Annual Report on Form 10-K for the year ended December 31, 2012, describe those significant accounting policies and methods used in the preparation of our consolidated financial
statements that are considered "critical" because they require judgments, assumptions and estimates that materially impact our consolidated financial statements and related disclosures. As a result,
if future events or assumptions differ significantly from the judgments, assumptions and estimates in our critical accounting policies, these events or assumptions could have a material impact on our
consolidated financial statements and related disclosures.
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Tax audits or changes in tax laws could adversely affect us.
For periods after the April 1, 2011 closing of CenturyLink's acquisition of QCII, we are included in the consolidated federal
income tax return of CenturyLink. As such, we could be severally liable for tax examinations and adjustments attributable to other members of the QCII or CenturyLink affiliated groups, as applicable.
Significant taxpayers (such as QCII for periods prior to the CenturyLink acquisition and CenturyLink for periods after the CenturyLink acquisition) are subject to frequent and regular audits by the
Internal Revenue Service as well as state and local tax authorities. These audits could subject us to tax liabilities if adverse positions are taken by these tax authorities.
Tax
sharing agreements have been executed between QCII and previous affiliates, and QCII believes the liabilities, if any, arising from adjustments to previously filed returns would be
borne by the affiliated group member determined to have a deficiency under the terms and conditions of such agreements and applicable tax law. We have not generally provided for liabilities
attributable to former affiliated companies or for claims they have asserted or may assert against us.
We
believe that we have adequately provided for tax contingencies. However, tax audits and examinations may result in tax liabilities that differ materially from those that we have
recognized in our consolidated financial statements. Because the ultimate outcomes of all of these matters are uncertain, we can give no assurance as to whether an adverse result from one or more of
them will have a material effect on our financial results.
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