Table of Contents

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2016

or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period to

Commission file number 001-35134

LEVEL 3 COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware
 
47-0210602
(State of Incorporation)
 
(I.R.S. Employer
 
 
Identification No.)
 
 
 
1025 Eldorado Blvd., Broomfield, CO
 
80021-8869
(Address of principal executive offices)
 
(Zip Code)
(720) 888-1000
(Registrant’s telephone number,
including area code)

Securities registered pursuant to section 12(b) of the Act:

Common Stock, par value $.01 per share
 
New York Stock Exchange

Securities registered pursuant to section 12(g) of the Act
None

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act.  Yes x No o

Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o  No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No o

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 (§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 x  No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x
 
Accelerated filer o
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a 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 o  No x

As of June 30, 2016, the aggregate market value of common stock held by non-affiliates of the registrant approximated $15.008 billion based upon the closing price of the common stock as reported on the New York Stock Exchange as of the close of business on that date. Shares of common stock held by each executive officer and director and by each entity that owns 10% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.

Title
 
Outstanding
Common Stock, par value $.01 per share
 
360,678,324 as of February 22, 2017


DOCUMENTS INCORPORATED BY REFERENCE

List hereunder the following documents if incorporated by reference and the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is incorporated: (1) Any annual report to security holders; (2) Any proxy or information statement; and (3) Any prospectus filed pursuant to Rule 424(b) and (c) under the Securities Act of 1933. The listed documents should be clearly described for identification purposes (e.g., annual report to security holders for fiscal year ended December 24, 1980.)

Portions of Our Definitive Proxy Statement for the 2017 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K.


 





Table of Contents

LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Table of Contents
 
 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2

Table of Contents

Unless the context otherwise requires or expressly stated herein, when we use the words “Level 3,” “we,” “us,” or “our company” in this annual report on Form 10-K, we are referring to Level 3 Communications, Inc., a Delaware corporation, and its subsidiaries. Throughout this Form 10-K, we use various industry terms and abbreviations, which we have defined in the Glossary of Terms at the end of Item 1, “Business.” The Level 3 logo and Level 3 are registered service marks of our wholly owned subsidiary, Level 3 Communications, LLC, in the United States and other countries. All rights are reserved. This Form 10-K refers to trade names and trademarks of other companies. The mention of these trade names and trademarks in this Form 10-K is made with due recognition of the rights of these companies and without any intent to misappropriate those names or marks. All other trade names and trademarks appearing in this Form 10-K are the property of their respective owners.
Cautionary Factors That May Affect Future Results
(Cautionary Statements Under the Private Securities Litigation Reform Act of 1995)
This Form 10-K contains statements and information that are based on the beliefs of our management as well as assumptions made by and information currently available to us. When we use words like “plan”, “estimate,” “expect,” “anticipate,” “believe,” “intend,” “goal,” “seek,” “project,” “strategy,” “future,” “likely,” “may,” “should,” “will” and similar expressions with respect to future periods in this Form 10-K, as they relate to us or our management, we are intending to identify forward-looking statements. These statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions.
Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, our actual results may vary materially from those described in this document.
These statements regarding our pending acquisition by CenturyLink, Inc. include, among others, statements concerning:
the ability of the parties to timely and successfully receive the required approvals for the combination from regulatory agencies free of conditions materially adverse to the parties and from their respective shareholders; and

the possibility that the anticipated benefits from the proposed transaction cannot be fully realized or may take longer to realize than expected

These statements regarding our business include, among others, statements concerning:
expectations as to our future revenue, margins, expenses, cash flows, profitability and capital requirements;

our communications business, its advantages and our strategy for continuing to pursue our business;

anticipated development and launch of new services in our business;

anticipated dates on which we will begin providing certain services or reach specific milestones;

growth of the communications industry;

our integration of the operations of companies that we acquire and the anticipated benefits and synergies in connection with that acquisition; and


3

Table of Contents

other statements of expectations, beliefs, future plans and strategies, anticipated developments and other matters that are not historical facts.

These statements are subject to risks and uncertainties, including financial, regulatory, environmental, industry growth and trend projections, that could cause actual events or results to differ materially from those expressed or implied by the statements. The most important factors that could prevent us from achieving our stated goals include, but are not limited to, the effects on our business and our customers of general economic and financial market conditions as well as our failure to:
increase revenue and free cash flow from the services we offer;

successfully use new technology and information systems to support new and existing services;

prevent process and system failures that significantly disrupt the availability and quality of the services that we provide;

prevent our security measures from being breached, or our services from being degraded as a result of security breaches;

develop new services that meet customer demands and generate acceptable margins;

effectively manage expansions to our operations;

provide services that do not infringe the intellectual property and proprietary rights of others;

attract and retain qualified management and other personnel; and

meet all of the terms and conditions of our debt obligations.

Except as required by applicable law and regulations, we undertake no obligation to publicly update any statements, whether as a result of new information, future events or otherwise. Further disclosures that we make on related subjects in our additional filings with the Securities and Exchange Commission, or the SEC, should be consulted. For further information regarding the risks and uncertainties that may affect our future results, please review the information set forth below under Item 1A, “Risk Factors.”

Part I
ITEM 1. BUSINESS

Introduction
We are an international facilities-based provider of a broad range of integrated communications services. A facilities-based provider is a provider that owns or leases a substantial portion of the plant, property and equipment necessary to provide its services. We have created our international communications network by constructing our own assets and through a combination of purchasing other companies and purchasing or leasing facilities from others. We designed our network to provide communications services that employ and take advantage of rapidly improving underlying optical, Internet Protocol, computing and storage technologies.
On October 31, 2016, we and CenturyLink, Inc., a Louisiana corporation (“CenturyLink”), entered into a Merger Agreement pursuant to which Wildcat Merger Sub 1 LLC, a wholly owned subsidiary of CenturyLink, will merge with and into Level 3 (the “Initial Merger”) with Level 3 continuing as the surviving

4

Table of Contents

corporation and, immediately following the Initial Merger, the surviving corporation will merge with and into WWG Merger Sub LLC, another wholly owned subsidiary of CenturyLink, with WWG Merger Sub LLC continuing as the surviving company (together with the Initial Merger, the “CenturyLink Acquisition”). The combined company will have the ability to offer CenturyLink’s larger enterprise customer base the benefits of our global footprint with a combined presence in more than 60 countries. In addition, the combined company will be positioned to further enhance the scope and transmission speeds of its broadband infrastructure.
If the CenturyLink Acquisition is completed, our stockholders will have the right to receive $26.50 in cash and 1.4286 shares of CenturyLink common stock for each share of Level 3 common stock they own at the effective time of the Initial Merger (the “exchange ratio”), with cash paid in lieu of fractional shares. The exchange ratio is fixed and will not be adjusted to reflect stock price changes prior to the closing of the combination. Based on the closing price of CenturyLink common stock on the New York Stock Exchange of $28.25 on October 26, 2016, the last trading day before public reports of a possible transaction, the merger consideration represented approximately $66.86 of aggregate value for each share of Level 3 common stock.
The descriptions of our business in this Form 10-K do not assume that the CenturyLink Acquisition has been completed. However we do describe certain risk factors associated with the pending transaction below under Item 1A, “Risk Factors.”

Our company was incorporated as Peter Kiewit Sons’, Inc. in Delaware in 1941 to continue a construction business founded in Omaha, Nebraska in 1884. In subsequent years, we invested a portion of the cash flow generated by our construction activities in a variety of other businesses, including, among other things, the communications business. In 1998, our historical construction business was split off from the remainder of our operations. In conjunction with the split-off, we changed our name to “Level 3 Communications, Inc.,” and the entity that was split-off and held the prior construction business was named “Peter Kiewit Sons’, Inc.”

We sold various businesses subsequent to the split-off, including our coal mining business in November 2011, as part of our long-term strategy to focus on core communications business operations. Most recently, in October 2011, we acquired Global Crossing Limited and in October 2014 we acquired tw telecom inc. The results of operations of the companies that we have acquired have been included in our consolidated results of operations since the respective closing date of the acquisition.
As of December 31, 2016, we had approximately 12,600 total employees. We believe that our success depends in large part on our ability to attract and retain qualified employees.
We file annual, quarterly and current reports, proxy statements and other information with the SEC. These filings are available to the public on the Internet at the SEC’s website at www.sec.gov. You may also read and copy any document we file with the SEC at the SEC’s public reference room, located at 100 F Street, N.E. Room 1580, Washington, D.C. 20549. Our Form 10-K and all other reports and amendments filed with or furnished to the SEC are publicly available free of charge on the investor relations section of our website as soon as reasonably practicable after we file such materials with, or furnish them to, the SEC. Our website is www.level3.com. We caution you that the information on our website is not part of this or any other report we file with, or furnish to, the SEC.

5

Table of Contents

Business Overview, Vision and Strategy
Level 3’s vision is to be the trusted connection to the networked world. We seek to achieve this vision by focusing on:
maximizing the value of our network for our customers by expanding the breadth and depth of our local to global network, and connecting our customers to their digital ecosystem of data and applications, which we refer to as “digital transformation;”

delivering an exceptional and consistent customer experience by innovating to improve the efficiency and scalability of our operating platform; and

generating profitable growth by expanding our enterprise customer base and layering value-added services onto existing network and operational capabilities.

We strive to create a culture and business environment that makes it easy for customers to do business with us, and providing high-performing, reliable and secure services on our local-to-global network with superior price value. We focus on operational excellence to streamline our systems and business processes to deliver a superior customer experience, and to reduce overhead costs and transactional costs for ourselves and for our customers.
We believe that we can be successful by making our customers the focal point of all we do. Our value proposition is structured to be fully aligned with helping our customers meet their growth, efficiency and security business challenges both today and in the future and across the globe wherever our services are available.
We believe that advances in optical and Internet Protocol, or IP, technologies have facilitated, and will continue to facilitate, decreases in unit costs for communications service providers that are able to most effectively take advantage of these technology advances. We believe that, over time, rapidly improving technologies and high demand elasticity will continue to drive this market dynamic.
Enterprises are increasingly moving their content and applications to third party providers of on-demand server and storage resources to reduce the costs and complexity of their information technology, or IT, operations. Since these server and storage resources can be offsite in any location and are often virtualized (as opposed to residing on dedicated hardware in a known location) they are referred to as “Cloud Services.” We believe that this migration of enterprise data and applications to the Cloud will drive increased demand for our high-performing, reliable and secure network services.
Today’s market drivers can be broken into three categories as they pertain to our core business strategy:
Growth. We expect digital data creation and the associated demand for bandwidth to keep growing, as business relationships and supply chains become increasingly digital, and end users increasingly expect to be able to access their data and applications anytime and anywhere. Cloud application adoption continues to grow for all businesses, especially our enterprise customers. Mobility and Internet connected device proliferation continue to increase the rate at which content - especially video - is consumed, which in turn results in increased demand for higher bandwidth to enable that delivery and consumption. A rapidly increasing number of smart homes, cars, and everyday objects are getting connected to the network (the “Internet of Things”), further increasing demand for scalable and secure bandwidth. Globalization trends continue as customers look for growth from emerging markets, particularly with respect to enterprise customers. Additional opportunities for growth are present as a result of changing regulatory requirements in industries such as healthcare, consumer privacy, and financial services.

6

Table of Contents


Efficiency. As traffic volumes grow, our customers are not only under pressure to keep up with this growth but also to do so more efficiently. Accordingly, our product and technology teams take advantage of the scale and capabilities of our network and continuously innovate to deliver cost-effective services that meet customer needs.

Security. Cyber threats continue to escalate, which affects both us and our customers. As more enterprise customer data and applications move to the Cloud, and as more and more consumer devices and personal information become reachable through the Internet, maintaining a secure network and collection of systems and processes is more important than ever.

Technology innovation in Internet Protocol and optical networking technologies has resulted in improvement in the functionality of applications supported by these technologies. We believe that this rapid innovation will continue well into the future across a number of different aspects of the communications marketplace.
We believe that decreases in communications services costs and prices enable the development of new bandwidth intensive applications, which, over time, result in even more significant increases in bandwidth demand. In addition, we believe that communications services are direct substitutes for other existing modes of information distribution from sources such as traditional broadcast entertainment as well as distribution of software, audio and video content using physical media delivered through physical transportation systems. An example of this dynamic is the use of the Internet for the distribution of video. We believe that as communications services improve more rapidly than traditional content distribution systems, demand for Internet delivered video will continue to grow rapidly. We also believe that high elasticity of demand for both new applications and the substitution for existing distribution systems will continue for the foreseeable future.
We also believe that there are significant implications that result from these market dynamics. First, given the improvement in optical and Internet Protocol technologies, communications service providers that are most effective at rapidly deploying new services that take advantage of these technologies will have an inherent cost and service advantage over companies that are less effective at deploying new services that use these technologies. In addition, given the consolidation in the number of local access providers (that is, the providers of connections from intercity networks to traffic aggregation points or end user locations), communications service providers that have ownership of local and/or metropolitan network facilities will have an inherent cost and service advantage over companies that do not have ownership over these types of assets. With respect to the migration to Cloud Services, this market dynamic creates opportunities for us to provide secure and high performance network connections to our enterprise customers, enabling their employees to connect seamlessly and efficiently to their content and applications in the Cloud.
In view of these market and technology opportunities, we seek to serve business customers by using a customer-first focus and providing a broad range of communications services over our advanced and extensive fiber optic network. With our network’s extensive geographic reach and deep reach into major metropolitan areas of the United States, Europe and Latin America, we are positioned to provide end-to-end services for business customers entirely on our own facilities across multiple continents.
We have and will continually expand our fiber optic network to new locations where the demands of our customers and potential customers justify the upfront costs of expansion. This allows us to provide an end-to-end connection for the customer across our own fiber optic network, which is more secure and efficient and allows us to deliver a superior customer experience. Today and for the foreseeable future, we will need to connect to some locations using the networks of other carriers. We manage these relationships with other carriers to make the interconnection as efficient and effective as possible. We seek to minimize the need for these “off network” connections by targeting customers whose needs can

7

Table of Contents

be met primarily over our network and by building our network to as many high-traffic locations as possible.
Our fiber optic network has extensive reach across North America, Europe and Latin America. Our network reaches not only hundreds of cities (we refer to the part of our network connecting the larger cities as our “intercity” network) but also includes fiber optic routes around the various parts of the larger metropolitan areas (we refer to this part of our network as our “metropolitan” or “metro” networks), which allows us to connect directly with wholesale customers in major traffic aggregation centers (such as central offices of local exchange carriers) and with many medium and large enterprise customers at their offices and data centers. In addition, the fact that our metro networks have significant reach throughout major metropolitan areas means that we can make relatively short network extensions to reach customer locations that our network does not currently reach.
To connect our networks in North America, Europe and Latin America, as well as to connect our network to cities in other parts of the world, we own several undersea cables and have purchased capacity on cables owned by others. Since subsea cables require very large upfront investment and have very large capacity compared to the needs of any one carrier, they typically are either owned by consortia of carriers or are financed significantly by selling a large amount of capacity to other carriers either before the cable is built or shortly thereafter. We historically have been active both in building undersea cables and in buying capacity from others. Today we own more than 37,500 route miles of undersea fiber optic cables around the world. In addition, as we have points of presence (PoPs) in Asia, Africa and Australia, we have also purchased capacity on others’ undersea cables to allow us to offer services in those regions despite the fact that we do not have extensive fiber optic networks of our own in these regions. This is important to our ability to handle the global needs of our multinational customers. For more information about our network, see Item 1, “Business - Our Communication Network” below.
For larger customers, specialized real estate is often required to house the equipment that we and the customer use to exchange traffic. This space requires a concentrated amount of electric power and cooling, as well as server racks, fiber optic cables and other technical equipment. Such specialized real estate, depending upon its nature and the type of companies that use it, is referred to variously as “colocation” or “data center” space. For interconnection among wholesale carriers and some of the largest enterprise customers, we also use real estate owned by third parties. We own or lease more than 250 colocation facilities in North America, approximately 100 colocation facilities in Europe, and approximately 15 colocation facilities in Latin America. In addition, we operate approximately 20 data center facilities in Latin America, Europe and North America.
Our business includes voice services. Historically, end-user voice services were provided over a network of local exchange carriers whose copper wire networks were dedicated to that service. Today, voice services can be carried over the Internet as a data service. This type of voice service usually is referred to as “voice over Internet Protocol,” or “VoIP”. Since many calls include a connection to the traditional voice network on one end and a VoIP connection on the other, early in our existence we became deeply involved in managing connections between VoIP customers and those on the traditional public switched telephone network. This involves not only developing and managing equipment and software specialized for that purpose but also developing physical connections of our Internet Protocol network with the traditional networks of the various local exchange carriers. Additionally, we have also physically interconnected our IP network with the networks of many cellular telephone carriers. This enables us to provide what we believe is a more comprehensive service than most other carriers can provide to handle customers’ needs for voice connections in today’s changing communications environment. Our services that manage the initiation or termination of customers’ voice calls generally are referred to as “local voice” services. Our voice services also include our comprehensive suite of audio, web and video collaboration services.
We also provide services that handle the termination of large volumes of telephone calls on behalf of other carriers. We refer to these as “wholesale voice” services. These services are provided in a

8

Table of Contents

very competitive environment in which many carriers participate and the customer typically uses automated systems to choose the least expensive way to terminate traffic to each city around the world on a minute-by-minute basis.
We provide specialized communications services for companies that distribute video or other digitized content across the Internet. Because the amount of bandwidth required by such media is large, special services are used to ensure delivery of such content at desired levels of quality. We have developed a system of servers, with software to control them, that store more popular content in various locations around the world. The aim is to store content so that it is not transferred very far across the Internet. This type of service typically is referred to as a “Content Delivery Network,” or “CDN.” We also have specialized video services to handle the needs of broadcasters for the rapid transmission of the very large streams of information that emerge when live events are broadcast. We carry these video streams across our network to locations specified by the broadcasters and from which these customers broadcast their final edited content.
Managing the transmission of information across our network requires the proper management of many interconnected technologies, processes and systems to provide high quality, convenient secure and reliable services for our customers. Some of these services may be charged for separately, while others are included as an integral part of our more basic services. Examples of services that are typically charged separately include network security (i.e., helping customers keep their information safe) and network monitoring (i.e., keeping customers informed of the status of various equipment and sub-parts of their connections). We regularly develop new features and ancillary services to keep our network services as valuable as possible to our target customers.
Since a large portion of our communications services are purchased by companies to interconnect their own information technology applications, often we find that certain customers need ancillary services that are not clearly part of communications network services and may more properly be described as information technology services. In an effort to ensure that our customers receive a superior overall experience, we frequently enter into partnerships with providers that specialize in these information technology services, so that we can assemble the full collection of services for the customer. In making the decision to add such services, we consider several factors including our core strengths, the existence of other parties with whom we can work to satisfy the customers’ needs, how important it is to customers that the new service be combined into a single Level 3 offering, and the size of the incremental market that would become addressable by offering such services. For more information about our service offerings, see Item 1, “Business - Our Service Offerings” below.
We are currently focusing our attention on a number of operational and financial objectives, including:
driving profitable revenue growth by increasing sales generated by our Core Network Services;

growing our Enterprise customer base as well as our share of their telecom spend, as this customer group has the largest potential for significant growth;

continually improving the customer experience to increase customer retention and reduce customer churn;

launching new products and services to meet customer needs, in particular for Enterprise customers;

reducing network costs and operating expenses relative to our revenue;

growing positive cash flows from operations;

9

Table of Contents


continuing to show improvement in Adjusted EBITDA (as defined in Item 7, “Management’s Discussions and Analysis of Financial Condition and Results of Operation”) as a percentage of revenue;

concentrating our capital expenditures on those technologies and assets that enable us to increase our Core Network Services revenue;
integrating our prior acquisitions, building on the strengths and capabilities of the acquired legacy companies to position the combined company as a premier global communications provider; and

managing our Wholesale Voice Services for margin contribution.

For a discussion of our Core Network Services and Wholesale Voice Services, see Item 1, “Business-Our Service Offerings” below.
Our Strengths
We believe that the following strengths will assist us in implementing our strategy:
Experienced Management Team. We have assembled a management team that we believe is well suited for our business objectives and strategy. Our senior management has substantial experience in leading the development, marketing and sale of communications services and in managing, designing and constructing metropolitan, intercity and international networks.

Recognized Industry Leadership. We have a proven track record among communication service providers for being the first to implement many new technologies, including: global MPLS network in 2001, first global provider with IPV6 natively deployed, first to introduce VoIP and MPLS, and the first converged IP solution.

Global Reach of Our Network. We deliver services to more than 60 countries around the world on our global network. Our network connects and crosses North America, Latin America, Europe and a portion of the Asia/Pacific region.

A Broad Range of Communications Services. We provide a broad range of communications services designed to meet the needs of our customers over our network. Our communications service offerings include:
Internet and data services, which includes Internet access and IP and Ethernet Virtual Private Networks, content distribution services including caching and downloading, streaming as well as video broadcast services;

Transport and fiber services, which includes services such as wavelengths and private line services (transoceanic, backhaul, intercity, metro and unprotected private line services) as well as dark fiber in both our intercity and metropolitan networks;

Voice and collaboration services, which includes enterprise or business voice services, wholesale VoIP component services, wholesale voice origination and termination services, voice, web and video conferencing and collaboration services; and

Colocation and data center services, which offer high quality data center space where customers can locate servers, content storage devices and communications network equipment in a safe and secure technical operating environment along with value-added

10

Table of Contents

services such as Managed Network Services and Managed Security, including protection against Distributed Denial of Service (DDoS) attacks.

The availability of these services varies by location.
For several years we have been developing services that take advantage of the investment that we have made in our network and that generally target large, existing markets. We have also expanded our existing markets for communications services through the acquisitions that we have completed, which has significantly increased the global reach of our network. Through our efforts we have increased significantly our addressable market by adding new addressable customers as well as new voice and data services that take advantage of the geographic coverage and cost advantages of our network.
Significant Metropolitan Network Platform. As of December 31, 2016, we have metropolitan fiber networks in approximately 350 markets in North America, Europe and Latin America, which currently contain approximately 69,000 route miles. The number of route miles may change in the future as we continue to optimize our network routes. Our metropolitan networks enable us to connect directly to points of traffic aggregation and customer locations and reduce our costs for the termination of our customers’ communications traffic on other carriers’ networks.

End-to-End Network Platform. Our strategy is to deploy network infrastructure in major metropolitan areas and to link these networks with significant intercity and trans-oceanic networks in North America, Europe and Latin America. We believe that the integration of our metropolitan and intercity networks with our colocation facilities will expand the scope and reach of our on-net customer coverage, facilitate the uniform deployment of technological innovations as we manage our future upgrade paths and allow us to grow or scale our service offerings rapidly. We believe that we have a unique combination of:

a substantial intercity and subsea network;

large fiber count metropolitan networks;

global network reach;

substantial colocation & data center facilities;

innovative content distribution technology and services; and

a growing set of security services.

Advanced IP Backbone. We operate one of the largest international IP networks or backbones. Our IP services deliver a broad range of IP transit and network interconnection solutions tailored to meet the varied needs of high bandwidth users.

Extensive Patent Portfolio. Our patent portfolio includes patents covering technologies ranging from data and voice services, to content distribution, to transmission and networking equipment. We utilize our patent portfolio in multiple ways. Developing or acquiring technologies and receiving the legal right to preclude others from using them may give us a competitive advantage. The breadth and depth of our patent portfolio may deter others, particularly telecommunications operators, from bringing patent infringement claims against us for fear of counter-claim by us and enhances our ability to enter into cross-licensing arrangements with other patent holders. We will continue to file new patent applications as we enhance and develop products and services, we will continue to seek opportunities to

11

Table of Contents

expand our patent portfolio through strategic acquisitions and licensing, and we will continue to appropriately enforce our patents against infringement by others.

A More Readily Upgradeable Network Infrastructure. We generally endeavor to design new networks to take advantage of technological innovations, incorporating many of the features that are not present in older communications networks. We design the transmission network to optimize aspects of fiber and optronics simultaneously as a system to provide an efficient cost structure for the services that we deliver to our customers. As fiber and optical transmission technology changes, we expect to realize new unit cost improvements by deploying more cost efficient technologies in our network. We believe that our network, process and system design will enable us to provide competitive services to our customers while also lowering our costs to provide those services.

Our Service Offerings
We offer a broad range of communications services. All of our services can be purchased by any of our customers, but some services may not be available in all locations or jurisdictions. The following is an overview description of some of the services that we offer.
Core Network Services. The following are the communications services that are included in our financial reporting of Core Network Services revenue.
IP and Data Services. Data services include Internet Services, virtual private network (“VPN”), content delivery network (“CDN”), media delivery, Vyvx broadcast service and Managed Services.

Internet Services. We offer wholesale and content provider customers with high speed access to the Internet over one of the largest international Internet backbones. Using largely our own intercity and metropolitan networks in North America, Europe and Latin America, we provide customers with high performance, reliability and scalability. Access to the Internet is enabled through interconnection among our customers across our network as well as interconnections with other Internet service provider “peers.”

The service is available stand-alone or in conjunction with managed services offerings, such as Managed Router where we deploy and manage a router that is on the customer premise or our network-based Distributed Denial of Service, or DDoS, Mitigation, which protects our business customers from Internet based DDoS attacks.
VPN Service. Built on our optical transport network, we offer customers the ability to create private point-to-point, point-to-multipoint, and full-mesh networks based on IP VPN, Virtual Private LAN service, or VPLS, Ethernet Virtual Private Line, or EVPL, or MPLS VPN technologies. These services allow service providers, enterprises and government entities to replace multiple networks with a single, cost-effective solution that simplifies the transmission of voice, video, and data over a single or converged network, while delivering high quality of service and security. These services are used for service provider and corporate data and voice networks, data center networking, disaster recovery and out-of-region or redundant customer connectivity for other service providers. VPN services are sold stand-alone or in conjunction with our managed services offerings.

Level 3 Ethernet Services or E-Services. Provide customers with geographically diverse, data intensive networks; scale, flexibility and reliability in order to meet existing and future networking demands.  Level 3 E-Services encompasses E-Line and E-Access.


12

Table of Contents

Level 3 SM E-Line services offers a secure, high-performance network solution that enables voice, video and data applications. With end-to-end availability, class of service, and latency service level commitments customers can rely on Level 3 E-Line service as the foundation for delivering applications such as high-performance computing, data replication, storage and archival, business continuity, voice communications and video conferencing.

Level 3SM E-Line Service with Adaptive Network Control offers secure, high availability and scalable network connections with dynamic bandwidth making it ideal for providing high-speed connections among corporate headquarters, data centers and other business locations around the world to migrate legacy networks and equipment to Ethernet, expand existing WANs and get new applications online faster.

Adaptive Network Control Solutions provide added capabilities that are layered on to network services to provide greater visibility, flexibility and control of applications traffic traversing your Metro or Wide Area Network:

Enhanced Management is real time visibility of end-to-end network performance metrics to assist planning, trouble shooting and fine tuning your network for optimal performance. Available for all managed locations and backed by comprehensive service level agreements.

Dynamic Capacity, which is the ability to make real-time bandwidth adjustments via our MyPortal customer portal to address fluctuating traffic demands.

CDN Services. Our content delivery network services combine our IP network, Gateway facilities and patented technology that directs a requestor or end user to the best location or server cluster in our network to retrieve the requested content based on location and network conditions. Our CDN service provides customers with improved performance, economics, scalability, reliability and reach for their web applications. Our caching and download services provide efficient http delivery of large files such as video, software, security patches, audio and graphics to mass audiences. Our streaming service can be used to deliver high performance streams, either live or on-demand, to end users using leading proprietary protocols. Each service set provides flexible features to enable customers to control their content delivery to ensure quality end-user experience, security, freshness and targeting. We also offer storage solutions enabling customers to upload and store content to our network as part of an optimized delivery platform. In addition to our delivery services, our patented Intelligent Traffic Management service enables customers to set rules to dynamically route traffic to meet failover or dual vendor objectives.

Media Delivery Service. We offer media delivery service to customers seeking to manage, protect and monetize content delivered over the Internet. Our media delivery service extends support for online distribution models and operation by providing customers with means to ingest and digitize live video content and to manage the organization and presentation of both live and on demand video to end users via a content management system. Additionally, support for content monetization via paid and advertising supported models is provided. Our media delivery services leverage our content delivery network for the delivery of managed content to end users.

Vyvx Broadcast Service. We offer various services to provide audio and video feeds over fiber or satellite for broadcast and production customers. These services vary in capacity

13

Table of Contents

provided, frequency of use (that is, may be provided on an occasional or dedicated basis) and price.

Managed Services. This category includes our complete portfolio of advanced performance and managed services, including professional services. Our teams of professionals work with customers to design and customize solutions that match their strategy and can help customers increase network efficiency, reduce overall operational costs, supplement skill sets, or provide specialist knowledge. Services included Managed Router, Application Performance Management, Managed WAN Optimization, Managed Ethernet Services and a variety of other professional services to meet customer needs. Managed Services are purchased in conjunction with our other network services.

Cloud and IT Services. Our multi-disciplinary cloud services draw on many products across our products that are described above. Our Cloud and IT-based services include Level 3 Cloud Connect Solutions, Communications as a Service and Data Center Services. These solutions are focused on the transport and delivery of enterprise data and applications.

Level 3 Cloud Connect Solutions. Level 3 Cloud Connect Solutions create a secure, reliable path for customers to realize the efficiency, scalability and flexibility of the cloud, providing a private network that connects enterprises with leading cloud and data center providers around the world, including Amazon Web Services (AWS), Google Cloud Platform and Microsoft Azure ExpressRoute.

Communications as a Service (CaaS). Our Communications as a Service (CaaS) product offering delivers a Session Initiated Protocol, or SIP, based audio collaboration and on-net web conferencing over a virtual private network using a hosted model.

Transport and Fiber Services. Transport services include wavelengths, private lines, transoceanic services, and dark fiber, as well as related professional services. These services are available across our metropolitan and intercity fiber network. Wavelength services provide unprotected point-to-point connections of a fixed amount of bandwidth with Ethernet or SONET interfaces. Wavelength services are available at a range of speeds from 1 Gbps to more than 100 Gbps. This service offering targets customers that require significant amounts of bandwidth, desire more direct control and provide their own network management. Private line services are also point-to-point connections of dedicated bandwidth but include SONET or Synchronous Digital Hierarchy (SDH) protection to provide resiliency to fiber or equipment outages. Private line services are available in a wide range of speeds with electrical, optical and Ethernet interfaces. We also provide transport services within our transatlantic cable system connecting North America, Europe and Latin America as well as via leased bulk capacity on other transoceanic systems. International backhaul transport services, interconnecting cable landing stations and our terrestrial North American, European and Latin American networks, are also available.

Our dark fiber service provides carriers, service providers, government entities and enterprises a fiber solution when unique applications, control or scale requirements make this service desirable. This includes fiber, colocation space in our Gateways and in our network facilities, power and physical operations and maintenance of the fiber and associated infrastructure. Professional services related to our transport and fiber services include network architectural design, engineering, installation and turn-up, ongoing network monitoring and management services, and field technical services.

14

Table of Contents

Voice Services. We offer a broad range of local and enterprise voice services including VoIP (Voice over Internet Protocol) services and traditional circuit-switch based services. Our local and enterprise voice services include VoIP enhanced local service, SIP Trunking, local inbound service, Primary Rate Interface (“PRI”) service, long distance service, toll free service and a comprehensive suite of audio, web and video collaboration services. The following is a general description of our voice services. Some of the following services are also offered to our wholesale voice customers. For financial reporting purposes, voice services also include our collaboration services that are described below.

VoIP Enhanced Local. Our VoIP enhanced local service is a VoIP service that enables broadband cable operators, IXCs, voice over IP providers, and other companies operating their own switching infrastructure to launch IP-based local and long-distance voice services via any broadband connection.

SIP Trunking. SIP Trunking is an IP-based local phone service offered to medium and large enterprises as a replacement for traditional fully featured enterprise TDM voice services. SIP Trunking allows customers with an IP PBX to manage calls to and from the PSTN without having to purchase traditional access lines dedicated to voice.

Local Inbound. Our local inbound service terminates traditional telephone network originated calls to Internet Protocol termination points. This one-way service is sold primarily to customers, such as call centers, conferencing providers, voice over IP service providers and enterprises to only receive calls at their locations. The customers can obtain telephone numbers from us or port-in local telephone numbers that the customer already controls. These local calls are then converted to IP and transported over our backbone to a customer’s IP voice application at a customer-selected IP voice end point.

Enterprise Long Distance. Our long distance service portfolio consists of local and long distance transport and termination services. Medium and large enterprises purchase our long distance services for their corporate calling or outbound contact center needs. All Level 3 long distance services are offered at the customer’s option over circuit switch or softswitch technologies.

Enterprise Toll Free. Our toll free service terminates toll free calls that are originated on the traditional telephone network. These toll free calls are carried over either a circuit switch or softswitch network and delivered to customers in Internet Protocol or traditional TDM format.
Collaboration Services. We offer a comprehensive suite of audio, web and video collaboration services, which include the following services:

Audio Conferencing. Ready-Access®, our on-demand/reservation less audio conferencing service, provides toll free access in key business markets worldwide. We also provide operator-assisted, full-service conference calls where participants can access our service by dialing in on either a toll or a toll-free number, or by being dialed out to by an operator.

Web Conferencing. Our Ready-Access Web Meeting is fully integrated with ReadyAccess audio conferencing for on-demand collaboration, allowing customers to manage their calls on-line, change account options, share presentations with participants and record entire meetings, including visuals. eMeeting is a full-featured Web conferencing application that allows customers to collaborate and share documents, presentations, applications, data and feedback with polling and instant messaging features. Live Meeting service uses technology licensed from Microsoft®

15

Table of Contents

to allow multiple attendees to participate in meetings using only their computer, a phone, and an Internet connection. We have integrated Ready-Access as an audio conferencing component into Live Meeting.

Videoconferencing Service. Our videoconferencing service provides video over IP and ISDN platforms, using multi-point bridging to connect multiple sites. Enhanced options available with our videoconferencing services include scheduling, recording and hybrid meetings that combine our audio and video services.

Colocation and Data Center Services. Colocation and Data Center services include data center facilities and services including cloud, hosting, and application management solutions. Our data center facilities offer high quality, data center space where customers can locate servers, content storage devices and communications network equipment in a safe and secure technical operating environment. In addition, we offer high-speed, reliable connectivity to our network and to other networks, including metro and intercity networks, the traditional public switched telephone network and the Internet. Our data center services range from dedicated hosting and cloud services to more complex managed solutions, including disaster recovery, business continuity, applications management support, and security services to manage mission critical applications.

Security Services. Also reported in this category, Level 3 Network-Based Security Solutions use our expansive view of the threat landscape to enable customers to address the escalating risk of cyber-attacks. The solutions allow customers to create a secure network, safeguard brand value, enable business continuity, and avoid complexity and cost. Our Security Services include: Adaptive Network Security, a fully managed and maintained cloud-based network security option to protect all layers of the enterprise including intrusion protection, data loss protection and Web content filtering; Adaptive Threat Intelligence, which provides actionable threat intelligence for a customer’s network, automatically identifying and prioritizing risks in a tailored portal or integrated into a customer security information and event management, or SIEM; network-based Distributed Denial of Service (DDoS) Mitigation, which protects against internet-based DDoS attacks; and Professional Security Services for governance, risk management, and compliance. Security Services are sold stand-alone or in conjunction with Data Services.

Wholesale Voice Services. Our Wholesale Voice Services include voice termination and toll free service. These services share many of the same features as the local and enterprise voice services described above.
Voice Termination. Our wholesale long distance offer include domestic and international voice termination services targeted to IXCs, wireless providers, local phone companies, cable companies, resellers and voice over IP providers.

Toll Free. As with Enterprise Toll Free, Level 3’s wholesale Toll Free service terminates toll free calls that are originated on the traditional telephone network. Customers for these services include call centers, conferencing providers, and voice over IP providers.

Our priority remains to protect the confidentiality of our customers’ data, and to protect and secure our network. In addition, it is our policy and our practice to comply with laws in every country where we operate, and to provide government agencies access to customer data only when we are compelled to do so by the laws in the country where the data is located. We will continue to operate our global network in this manner to comply with applicable laws and the regulatory requirements of the telecommunications industry.

16

Table of Contents

For a discussion of certain geographic information regarding our revenue from external customers and long-lived assets and a discussion of financial information and operating segments, please see the notes to our consolidated financial statements appearing elsewhere in this annual report on Form 10-K. For a discussion of our communications revenue, please see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing later in this Form 10-K.
Our management continues to review our existing lines of business and service offerings to determine how those lines of business and service offerings align with our strategy and our financial objectives. This exercise takes place in the ordinary course of our business. To the extent that certain lines of business or service offerings are not considered to be compatible with our strategy or with our financial objectives, we may exit those lines of business or stop offering those services in part or in whole.
Our Distribution Strategy
Our customers generally include the following types of customers: Enterprises (including Content and Government customers) and Wholesale. Our enterprise customers include:
large multinational customers;
larger enterprises that purchase communications services in a manner similar to carriers;
enterprises that purchase communications services on a regional or local basis;
portals and large search enterprises;
regional service providers;
systems integrators; and
software service providers.

Our Content customers comprise subgroups of customers including:
Digital Entertainment, such as providers of online gaming; social networking providers; technology companies that enable digital advertising and digital ad agencies; and companies that provide video over the Internet;

Media and Entertainment, such as media conglomerates; programmers; studios and production companies; and broadcast station ownership groups; and

Sports teams (professional and college); and stadiums and venues.

Our Government customers include U.S. Federal government departments and agencies, the government departments and agencies of other countries around the world, U.S. states and municipalities as well as research and educational consortia.
Our Wholesale customers include domestic and international carriers; voice service providers, which include calling card companies, conferencing providers, and contact centers that use VoIP technology to better manage costs and enable advanced applications; wireless providers; and broadband cable television operators.
To implement our strategy and reach our target large, multinational enterprise customers, we have a Global Account Management team, which operates across our regions. In North America we also

17

Table of Contents

have a General Manager sales model to target enterprises that are not Global Account Management accounts and government customers, where sales leaders manage sales, sales support, marketing, service delivery, service assurance, network planning and financial personnel. In North America, we also use an inside or call center based sales force, and indirect sales channels of third-party agents to reach our target customers.
In EMEA and Latin America, our sales teams use a combination of a direct sales force, an inside or call center based sales force, and indirect sales channels of third-party agents.
The specific elements that we use to reach our target customers depend upon the nature of the customers that are being targeted.
Our sales functions are supported by dedicated employees in sales and customer target marketing. These sales functions are also supported by centralized service or product management and development, general or corporate marketing, network services, engineering, information technology, and corporate functions including legal, finance, strategy and human resources.
For the year ended December 31, 2016, our top ten communications customers represented approximately 16% of our total revenue.
For a discussion of certain geographic information regarding how we manage our business, please see the discussion under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing later in this Form 10-K.
Our Communications Network
Our network is an advanced, international, facilities based communications network. We primarily provide services over our own facilities. As of December 31, 2016, our network encompasses:
approximately 106,000 intercity route miles in North America, Europe and Latin America;

metropolitan fiber networks in approximately 350 markets containing approximately 69,000 route miles;

approximately eight million square feet of Gateway and transmission facilities in North America, Europe and Latin America;

more than 360 colocation and data center facilities globally;

approximately 37,500 route miles of subsea optical fiber cable systems; and

more than 60 countries in service around the world.

Terrestrial Intercity Networks. Our intercity network covers approximately 70,000 route miles in North America, 26,000 route miles in Europe, and 10,000 route miles in Latin America as of December 31, 2016. We may eliminate specific routes or duplicate routes as we continue to look at opportunities to optimize our cost structure and remove unnecessary cost. Our intercity network generally includes the following characteristics:
Optical fiber strands designed to accommodate Dense Wave Division Multiplexing, or DWDM, transmission technology. Our optical fiber strands are designed to accommodate DWDM technology. We believe that the installation of newer optical fibers will allow a combination of greater wavelengths of light per strand, higher transmission speeds and longer physical spacing between network electronics. We

18

Table of Contents

also believe that each new generation of optical fiber will allow increases in the performance of these network design aspects and will therefore enable lower unit costs.
High speed intercity DWDM equipment. Our high speed intercity DWDM equipment provides high quality, reliable and cost effective transmission across our fiber backbone. We are continually evaluating advancements in technology that will enable us to scale, lower our cost and provide higher speed services over our intercity network. We believe that the market will continue to move toward Ethernet based services and higher speed interfaces. Through our technology evaluations we believe that we have positioned ourselves to be able to deliver these capabilities for both our own IP network needs as well as those of our customers.
Open, non-proprietary hardware and software interfaces. Our intercity network is designed to maximize the use of open, non-proprietary hardware and software interfaces to allow less costly upgrades as hardware and software technology improves.
Local Market Infrastructure. Our local facilities include fiber optic metropolitan networks connecting our intercity network and Gateways to buildings housing communications intensive end users, enterprise customers and traffic aggregation points-including ILEC and CLEC central offices, long distance carrier points-of-presence or POPs, cable head-ends, wireless providers’ facilities and Internet peering and transit facilities. Our high fiber count metropolitan networks allow us to extend our services directly to our customers’ locations at low costs, because the availability of this network infrastructure does not require extensive multiplexing equipment to reach a customer location, which is required in ordinary fiber constrained metropolitan networks. As of December 31, 2016, we had approximately 59,000, 3,200 and 6,800 route miles of metropolitan fiber networks in North America, Europe and Latin America, respectively, and had operational, facilities based, local metropolitan networks in 229, 59, 52 and 2 markets in North America, Europe, Latin America and Asia, respectively. We may eliminate specific and/or duplicate routes as we continue to look at opportunities to reduce and/or optimize our network cost structure.
We operate approximately eight million square feet of space for our Gateway and transmission facilities. Our initial Gateway facilities were designed to house local sales staff, operational staff, our transmission and Internet Protocol routing, Content Delivery Networks and voice switching facilities and technical space to accommodate colocation services that is, the colocation of equipment by high-volume Level 3 customers, in an environmentally controlled, secure site with direct access to Level 3’s network generally through dual, fault tolerant connections. As of December 31, 2016, we had more than 250 colocation facilities in North America, approximately 90 colocation facilities in Europe, and approximately 15 colocation facilities in Latin America.
Most of these facilities offer a complete set of data center services ranging from housing and hosting, to more complex managed solutions, including disaster recovery, applications management, business continuity, and security services to manage mission critical applications.
Transoceanic Networks. We own a number of subsea fiber optic cable systems, including Atlantic Crossing-1 (“AC-1”), Atlantic Crossing-2 (“AC-2”), Mid-Atlantic Crossing (“MAC”), South American Crossing (“SAC”), Pan American Crossing (“PAC”) and an approximately 300 route mile system connecting the U.K. and Ireland. AC-1 and AC-2 link our European network to our North American intercity network and each of AC-1 and Yellow (AC-2) consists of four fiber strand pairs. MAC provides a strategic gateway between the Eastern Seaboard of the U.S. and our Latin America assets, a route that is experiencing acute demand growth. SAC connects major markets throughout Latin America and is one of only two sub-sea systems currently in operation that circumnavigates the majority of South America including an extension into Colombia. PAC is integrated with a 2,300 mile terrestrial ring route (including associated backhaul) within Mexico, as well as an extension to Costa Rica.

19

Table of Contents

We also own capacity in the TAT-14 transatlantic cable system. In 2016 we purchased and lit a fiber pair on the Apollo South cable system. We also are an owner of the Japan-US cable system, (were an owner on the China-US cable system which retired in December 2016), an indefeasible right of use, or IRU, holder on the Southern Cross cable system extending from Australia to California, as well as an owner of the Americas II cable extending from Florida to Brazil, and an IRU holder on the Arcos system in the Caribbean. We also own a share in the Hawaiian Inter Island Fiber Network (HIFN). In addition, we own capacity on the Global Cloud Exchange transatlantic system Flag Atlantic-1 and capacity on the Hibernia transatlantic cable system and also the Apollo North cable system.
Content Acquisition and Distribution Services Architecture. Content distribution network, or CDN, describes a system of computers networked together across the Internet to provide content to users in the most efficient manner to enable an optimal user experience. In a CDN, nodes or groups of computers are deployed in multiple locations closer to the end user, also known as the “edge of the network” and cooperate with each other to satisfy requests for content by end users, transparently moving content behind the scenes to optimize the delivery process. Requests for content are directed intelligently through sophisticated software applications to nodes that provide optimal performance for end users.
The CDN platform directs network traffic across our existing physical network and infrastructure. The CDN platform is composed of the edge server or computer that provides caching and streaming functions, and the global server that provides load balancing-that is, a computer that directs the traffic to the most efficient edge server to meet the end user’s request. The edge server enables the storage of popular content in a location that is closer to the end user and thereby reduces bandwidth requirements and improves response times for that stored content.
The Vyvx platform transmits audio and video programming for our customers over our fiber optic network and via satellite. We use our network to carry many live traditional broadcast and cable television events from the site of the event to the network control centers of the broadcasters of the event.
Our Patent Portfolio
Through acquisitions and through our own research and development, as of December 31, 2016, we have more than 1,400 patents and patent applications in the United States and around the world. Our patent portfolio includes patents covering technologies ranging from data and voice services to content distribution to transmission and networking equipment.
In addition to the patents and patent applications we own, we have received licenses to patents held by others, including through a cross-license agreement with IBM entered into in December 2007, giving us access to technology covered by IBM’s approximately (at that time) 42,000 patents covering many technologies relevant to our business. While patents give us the right to prevent others, particularly competitors, from using our proprietary technologies, patent licenses give us the freedom to operate our business without the risk of interruption from the holder of the patent that has been licensed to us.
We use our patent portfolio in a number of ways. First, developing or acquiring technologies and receiving the legal right to preclude others from using them may give us a competitive advantage. Second, the breadth and depth of our patent portfolio may deter others, particularly telecommunications operators, from bringing patent infringement claims against us for fear of counter-claim by us. Most of the patent infringement suits brought against us to date have been initiated by patent-holding companies who do not operate telecommunications businesses and who are less likely to be subject to a counter-claim of infringement by us. Finally, the extensiveness of our patent portfolio gives us the option to cross-license with others having similarly broad portfolios on terms acceptable to us, mitigating the risk that others will wish to assert patent infringement claims against us.
We will continue to file new patent applications as we enhance and develop products and services, we will continue to seek opportunities to expand our patent portfolio through strategic

20

Table of Contents

acquisitions and licensing and we will continue to appropriately enforce our patents against infringement by others.
Business Support Systems
We believe that it is important to streamline and simplify our processes and systems. To pursue our business strategies, we have developed and are continuing to develop and implement a set of integrated software applications designed to automate our operational processes. These development activities also relate to the integration of the systems that were used by the companies that we have acquired. Through the development of our business support systems, we believe that we have the opportunity to obtain a competitive advantage relative to traditional telecommunications companies. In addition, we recognize that for the success of certain of our services that some of our business support systems will need to be easily accessible and usable directly by our customers.
We are currently developing and deploying a unified set of simplified processes and systems that have been designed to streamline and synchronize our service, sales and operational functions. These processes and systems have been designed to provide improved capability in service catalog management, sales opportunity management, customer management, quoting, order entry, order workflow, physical and logical network inventory management, service management, and financial management.
Key design aspects of the business support system development program are:
integrated modular applications to allow us to upgrade specific applications as new services are available;

a scalable architecture that allows our customers and third-party sales channel partners direct access to certain functions that would otherwise have to be performed by our employees;

phased completion of software releases designed to allow us to test functionality on an incremental basis;

“web-enabled” applications so that on-line access to order entry, network operations, billing, and customer care functions are available to all authorized users, including our customers;

use of a service-oriented architecture that is designed to separate data and applications, and is expected to allow reuse of software capabilities at minimum cost;

use of pre-developed, commercial “off-the-shelf” applications or Software as a Service (SaaS), where applicable, which will interface with our internally developed applications; and

creation of a mobility solution for use by sales and certain operational functions to improve productivity and customer experience.

Competition
The communications industry has been and remains highly competitive. In the late 1990s and the early 2000s, significant new capacity was deployed by both existing and new entrants. This oversupply led to a period of financial restructuring and industry consolidation. Given the significant economies of scale inherent in the communications industry, we believe further consolidation will occur such as CenturyLink’s acquisition of us and Verizon’s recently completed acquisition of XO.

21

Table of Contents

Our primary competitors are long distance carriers, ILECs, CLECs, Post Telephone and Telegraphs, or PTTs, companies that operate Content Delivery Networks, or CDNs, and other companies such as cable companies, that provide communications services. The following information identifies some key competitors for each of our service offerings.
Our key competitors for our IP and data services include Verizon, AT&T, NTT, Tata and Cogent in North America, and BT, Orange, TeliaSonera and Tata in Europe. In Latin America, our main competitors are Telefonica, Telmex and national incumbent telecommunications carriers.
For transport and fiber services, our key competitors in North America are other facilities based communications companies including AT&T, Verizon, CenturyLink, and Zayo. In Europe, our key competitors are other carriers such as PTT companies, BT, Orange, Vodafone, TeliaSonera, Colt, Interoute, KPN, Belgacom and Zayo. In Latin America, our main competitors are Telefonica, Telmex and national incumbent telecommunications carriers.
For voice services our key competitors are other providers of communications services including AT&T, Verizon, CenturyLink, CLECs and national incumbent telecommunications carriers.
For our colocation and datacenter services, our key competitors are other facilities based communications companies, and other colocation providers such as web hosting companies and third-party colocation companies. In North America, these companies include Equinix, Terremark (Verizon), and CoreSite. In Europe, competitors include Equinix, Global Switch, InterXion, and Telehouse Europe. In Latin America, our largest competitors include Telefonica, Telmex, and IBM.
For CDN services, our key competitors include Akamai Technologies, Limelight Networks, Amazon, Edgecast Networks (Verizon), Fastly and CDNetworks.
For security services, our key competitors include Akamai, Verizon, CenturyLink, AT&T and Cloudflare.
In the enterprise and government markets, our key competitors in North America include ILECs (such as AT&T, Verizon and CenturyLink) and CLECs. In Europe, they include BT, Vodafone, Deutsche Telekom and Orange. In Latin America, competitors include Telefonica and Telmex.
The communications industry is subject to rapid and significant changes in technology. For instance, periodic technological advances permit substantial increases in transmission capacity of both new and existing fiber, and the introduction of new products or emergence of new technologies may reduce the cost or increase the supply of certain services similar to those which we plan on providing. Accordingly, in the future our most significant competitors may be new entrants to the communications industry, such as content companies that have existing significant customer bases and substantial cash resources that are greater than ours, and, unlike the traditional incumbent carriers we also compete with, would not be burdened by an installed base of outmoded or legacy equipment.
Regulation
U.S. Regulation
Federal Regulation
The Federal Communications Commission (“FCC”) has jurisdiction over interstate and international communications services. We have obtained FCC approval to land our transoceanic cables in the United States. We have also obtained FCC authorization to provide international services on a facilities and resale basis, as well as via various wireless licenses. Under the

22

Table of Contents

Telecommunications Act of 1996 (the “1996 Act”), any entity, including cable television companies and electric and gas utilities, may enter any telecommunications market, subject to reasonable state regulation of safety, quality and consumer protection. The United States House of Representatives Energy and Commerce Committee continues to consider revising and updating the 1996 Act, including potential changes to the FCC, its jurisdiction, its operating procedures and its organizational structure. It is too early in this process for us to either predict any modifications that might be made to the 1996 Act as part of this process, their effects on us, or the pace at which this process may proceed.
The 1996 Act previously required certain tariffs to define the services, terms, and conditions under which said services were to be offered. Subsequent deregulatory measures have eliminated some tariff requirements for competitive services.
Accordingly, as of August 1, 2001, our tariffs for interstate end user services were eliminated and our tariffs for international interexchange services were eliminated on January 28, 2002. Our rates must still be “just and reasonable” and “nondiscriminatory” under the 1996 Act. Our state tariffs remain in place where required (some states do not have, or have eliminated, the requirement to file certain tariffs). We have historically relied primarily on our sales force and marketing activities to provide information to our customers regarding these matters and expect to continue to do so. Further, in accordance with certain FCC tariff filing requirements, we maintain a schedule of our rates, terms and conditions for our domestic and international private line services on our web site.
Special Access Regulation. Special access services are “lit” loop or transport facilities that support the transmission of data on a point-to-point basis, often referred to as “private lines.” Level 3 purchases a substantial amount of special access services from ILECs and other telecommunications carriers to reach customer premises and, less frequently, to support interoffice transport requirements. In addition, Level 3 provides special access services to end user customers and to other carriers via its own network and/or through the resale of other carriers’ special access services.
In January 2005, the FCC commenced an examination of the regulatory framework governing the rates, terms, and conditions under which ILECs subject to “price cap” regulation provide interstate special access services. In this rulemaking, the FCC is reviewing both the price cap regime by which ILEC special access rates are set in most areas, as well as the “pricing flexibility” regime under which ILECs have obtained, in so-called “phase I” areas, the ability to enter into more individualized relationships with customers and to lower prices, and in so-called “phase II” areas, the ability to raise prices based upon certain threshold showings of the presence of competitors in a specific geographic and product market. In August 2012, the FCC froze further grants of pricing flexibility. In December 2012, the FCC issued an order stating that it will gather additional data on a mandatory basis from both providers and purchases of special access services so that it can conduct a comprehensive evaluation of the state of competition in the special access market. Responses to these additional, mandatory data requests were made in early 2015, but we cannot predict when or whether the FCC will complete its review of the data submitted, or what the outcome of its review will be. In 2016, the FCC prospectively limited certain tariff terms of price cap ILECs, known in the industry as “demand lock-up” terms. We cannot predict, however, whether these rulings will be challenged given the new makeup of the FCC following the 2016 U.S. Presidential election, and if challenged, what the result will be.
Network Neutrality and Open Internet. On February 26, 2015, the FCC adopted its most recent Open Internet order, the Open Internet Remand Order. The 2015 Order prohibits broadband providers from: blocking access to lawful content; impairing or degrading (also known as throttling) Internet traffic; prioritizing some content over other content in exchange for payment or other consideration; or unreasonably interfering with or disadvantaging the ability of users to access lawful content. The 2015 Order also provides the Commission with authority to hear complaints regarding

23

Table of Contents

interconnection disputes with broadband providers. The 2015 Order was challenged in court and, in an initial ruling, was upheld, but the appeal process is still on-going. There have also been a variety of legislative efforts to water down the 2015 Order, and the 2015 Order may be revisited given the new makeup of the FCC following the 2016 U.S. Presidential election. We cannot predict the outcome of such initiatives.
IP Interconnection. We have noted IP interconnection and congestion disputes with last mile bottleneck broadband providers, some of which historically refused to augment (or add) bandwidth at congested interconnection links between our respective networks (which is known to degrade the quality of third party content) without the payment of tolls unilaterally dictated by the broadband supplier. During 2015 and 2016, we concluded improved IP Interconnection agreements with several large broadband providers, some of which were announced publicly. We cannot predict at this time whether these arrangements will in all cases provide us with sufficient last mile interconnection capacity to avoid Internet congestion as the Internet continues to grow and/or when these agreements expire. The FCC’s current Open Internet rules provide Level 3 a forum to lodge interconnection disputes with the FCC for resolution, but how such disputes would be resolved, as well as the future of these Open Internet Rules, is unclear (see “Network Neutrality and Open Internet” discussion immediately above).
Intercarrier Compensation. Telecommunications carriers compensate one another for traffic carried on each other’s networks. Interexchange carriers pay access charges to local telephone companies for long distance calls that originate and terminate on local networks. Local telephone companies typically charge one another for local and Internet-bound traffic terminating on each other’s networks. The methodology by which carriers compensate one another for exchanged traffic, whether it be for local, intrastate or interstate traffic, has been under review by the FCC for over a decade.
In November 2011, the FCC released its Universal Service Fund/Intercarrier Compensation Transformation Order (USF/ICC Transformation Order). Along with addressing other matters, the USF/ ICC Transformation Order established a prospective intercarrier compensation framework for terminating switched access and VoIP traffic. Under the USF/ICC Transformation Order and subsequent related FCC orders, most terminating switched access charges and all reciprocal compensation charges were capped at then-current levels, and will be reduced to zero over, as relevant to Level 3, generally a six year transition period that began July 1, 2012.
Level 3 maintains approximately 300 interconnection agreements with other telecommunications carriers. These agreements set out the terms and conditions under which the parties will exchange traffic. The largest agreements are with AT&T and Verizon. Most of Level 3’s agreements with AT&T and Verizon have expired terms, but remain effective in evergreen status. As these and other interconnection agreements expire, we will continue to evaluate simply allowing them to continue in evergreen status (so long as the counterparty allows it) or negotiating new agreements. Any renegotiation would involve uncertainty as to the final terms and conditions, including the compensation rates for various types of traffic. In addition, changes in law, including FCC orders, may allow or compel us to renegotiate current and successor interconnection agreements over the next year.
Intercarrier Compensation/VoIP. Pursuant to the USF/ICC Transformation Order, VoIP, while remaining unclassified as either an information or a telecommunications service, was prospectively categorized as either local or non-local traffic. If “local”, then VoIP traffic is subject to reciprocal compensation; if “non-local”, then it is subject to interstate rates, thus eliminating any intrastate access rate applicable to VoIP. The USF/ICC Transformation Order did not address the treatment of VoIP retroactively. Level 3 is involved in a number of intercarrier compensation disputes dealing with the rating of VoIP traffic. During 2015, the FCC issued clarifications concerning the rating of VoIP traffic that were favorable to Level 3. Those clarifications were appealed, with the Court ruling that

24

Table of Contents

additional action by the FCC is required to sustain its prior findings. This initial ruling has been further appealed. At this time, we cannot predict the outcome of these appeals.
Other VoIP Regulation. The FCC has imposed various regulatory requirements on VoIP providers that had previously been applicable only to traditional telecommunications providers, such as obligations to provide 911 functionality, contribute to the federal universal service fund, to comply with regulations relating to local number portability (including contributing to the costs of managing number portability requirements), to abide by the FCC’s service discontinuance rules, to contribute to the Telecommunications Relay Services fund, and to abide by the regulations concerning Customer Proprietary Network Information and the Communications Assistance for Law Enforcement Act. In addition, a number of state public utility commissions are conducting regulatory proceedings that could affect our rights and obligations with respect to IP-based voice applications. Specifically, some states have taken the position that the “local” component of VoIP service is subject to traditional regulations applicable to local telecommunications services, such as the obligation to pay intrastate universal service fees. We cannot predict whether the FCC or state public utility commissions will impose additional requirements, regulations or charges upon our provision of services related to IP communications.
Intercarrier Compensation/Wireless. There are currently a number of lawsuits ongoing in the United States concerning the intercarrier compensation charges applicable to certain wireless telephone calls, how to determine whether those calls were local or long distance under the applicable rules, and what statute of limitations applies to such claims. We are defendants in certain of these lawsuits, and are potential plaintiffs in others. As with any litigation, the outcome of this litigation is difficult to predict.
Universal Service. Level 3 is subject to federal and state regulations that implement universal service support for access to communications services in rural and high-cost areas and to low-income consumers at reasonable rates; and access to advanced communications services by schools, libraries and rural health care providers. The FCC assesses Level 3 a percentage of interstate and international revenue it receives from retail customers as its contribution to the Federal Universal Service Fund, which assessments are generally passed on to our customers. Additionally, the FCC has ruled that states may assess contributions to their state Universal Service Funds from VoIP providers. Any change in the assessment methodology may affect Level 3’s revenue and expenses, but at this time it is not possible to predict the extent we would be affected, if at all.
Network Security Agreement. In connection with the acquisition of Global Crossing, we entered into an agreement (the “Network Security Agreement”) with certain agencies of the U.S. Government to address the U.S. Government’s national security and law enforcement concerns. The Network Security Agreement is intended (i) to ensure our ability to carry out lawfully authorized U.S. Government electronic surveillance of communications that originate and/or terminate in the U.S.; (ii) to prevent and detect access to and use of U.S. communications; and (iii) to satisfy U.S. critical infrastructure protection requirements. Failure to comply with our obligations under the Network Security Agreement could result in the revocation of our telecommunications licenses by the FCC and other penalties. The Network Security Agreement also imposes significant requirements related to information storage and management, traffic routing and management, physical, logical and network security, personnel screening and training, audit, reporting and other matters.
State Regulation
The 1996 Act is intended to increase competition in the telecommunications industry, especially in the local exchange market. With respect to local services, ILECs are required to allow interconnection to their networks and to provide unbundled access to network facilities, as well as a number of other pro-competitive measures.

25

Table of Contents

State regulatory agencies have jurisdiction when our facilities and services are used to provide intrastate telecommunications services. A portion of our traffic may be classified as intrastate telecommunications and therefore subject to state regulation. We expect that we will offer more intrastate telecommunications services (including intrastate switched services) as our business and product lines expand. We are authorized to provide telecommunications services in all fifty states and the District of Columbia. In addition, we need to maintain interconnection agreements with ILECs where we wish to provide service. We expect that we should be able to negotiate or otherwise obtain renewals or successor agreements through adoption of others’ contracts or through arbitration proceedings, although the rates, terms, and conditions applicable to interconnection and the exchange of traffic with certain ILECs could change significantly in certain cases. The degree to which the rates, terms, and conditions may change will depend not only upon the negotiation and arbitration process and availability of other interconnection agreements, but will also depend in significant part upon state commission proceedings that either uphold or modify the current regimes governing interconnection and the exchange of certain kinds of traffic between carriers.
There are initiatives in several state legislatures to lower intrastate access rates, aligning them with interstate rates, some of which may be affected by the FCC Order on intercarrier compensation. While we believe that rate adjustment initiatives such as this are generally better considered holistically by the FCC as part of its overall intercarrier compensation reforms, some states have and may continue to determine otherwise. Depending on whether we are a net collector or a net payer of any adjusted rate, such rate adjustments could have a negative effect on us.
Some states also require prior approvals or notifications for certain transfers of assets, customers or ownership of certificated carriers and for issuances by certified carriers of equity or debt.
Local Regulation
Our networks are subject to numerous local regulations such as building/permitting/trenching codes and licensing/franchise fees. Such regulations vary on a city-by-city, county-by-county and state-by-state basis. To install our own fiber optic transmission facilities, we need to obtain rights-of-way over privately and publicly owned land. Rights-of-way that are not already secured, or which may expire and not be renewed, may not be available to us on economically reasonable or advantageous terms in the future.
European Regulation
Unlike the United States which has a federal-state regulatory scheme, the European Union, or EU, has adopted a more systematic approach to the convergence of networks and the regulation of telecommunications services. The European Commission oversees the implementation by its Member States of various directives developed to regulate electronic communications. In March 2002, the European Union adopted a new regulatory framework for electronic communications that is designed to address in a technologically neutral manner the convergence of communications across telecommunications, computer and broadcasting networks. The directives address: (1) framework, (2) interconnection and access, (3) authorization and licensing, (4) universal service, and (5) privacy. These directives along with an additional decision on radio spectrum set out the basis for regulation at the national level.
Pursuant to these measures, the licensing regime was replaced with one of general authorization, whereby all providers of electronic communication services, or ECS, are authorized by statute in all 28 EU countries to (1) build/maintain a network and (2) sell any form of ECS, other than mobile or broadcast services, without the need for an individual license. Accordingly, as for all communications providers, our existing licenses were canceled and replaced with statutory

26

Table of Contents

authorization, subject to various general conditions imposed by national regulatory authorities, or NRAs. NRAs continue to be responsible for issuing specific licenses in relation to radio spectrum.
The Framework requires NRAs, on a rolling basis, to analyze a set of markets for electronic communications which may require ex-ante regulation to function competitively.
This analysis contains three different elements:
Market definition - first the NRA must define the relevant geographic and product market.

SMP assessment - in a second step the NRA must analyze whether one or more undertaking active in that market possesses significant market power (conceptually similar to dominance), either individually or jointly with others.

Decision on remedies - if the NRA identifies a market with a lack of effective competition, it is required to impose certain regulatory obligations, so-called remedies.

The basis for this measure is the European Commission’s Recommendation on Relevant Markets, which contains a list of markets that should be subject to ex ante regulation. Whenever a NRA concludes that a given market shows failures that hamper competition, it must impose appropriate remedies on undertakings with a significant market power in accordance with the market Access Directive and Universal Service Directives.
In November 2009, the European Parliament and Council of Ministers agreed to implement a number of changes to the existing regime, comprising the “Better Regulation” Directive (Directive 2009/140/EC) and the “Citizens’ Rights” Directive (Directive 2009/136/EC), which adjust the existing regulations in order to remove areas of potential ambiguity and more clearly define user rights.

In 2010, the EU adopted a long term strategic policy known as the Digital Agenda for Europe 2010 - 2020, aimed at ensuring that the EU derives the maximum economic, industrial and social benefit from advanced communications services, including the extensive roll-out of ‘superfast broadband.’ The majority of Member States have each adopted their own national policies in support of this high level agenda.

In November 2015, the EU adopted Regulation EU 2015/2120 which, among other things set out new legislation in relation to open internet. The net neutrality provisions of this Regulation became effective at the beginning of the second quarter 2016. In 2015, the EU Commission also began a review of the entire suite of Directives and Regulations relating to the communications sector and proposals are currently under consideration with a view to agreeing any changes in sufficient time to have these transposed into Member State law by 2019.
Notwithstanding a synchronized approach to regulation in Europe, the implementation of the directives has not been uniform across the Member States of the European Union. Recognizing this concern, in November 2009, the EU also implemented one regulation establishing the Body of European Regulators for Electronic Communications (Regulation (EC) No 1211/2009), or BEREC. BEREC’s objective is to improve harmonization between national regulatory measures so as to ensure greater consistency of remedies and to anticipate emerging regulatory requirements. From 2012 through 2016, BEREC adopted a common position on several issues of relevance, including wholesale local and broadband access, wholesale leased lines and net neutrality. BEREC’s work program for 2017 published in January 2017, identifies four key areas of focus: (1) promoting competition and investment, with a particular focus on promoting investment in infrastructure and preparing for market developments relating to IP applications; (2) ensuring NRA support for activities that promote the EU internal market, including

27

Table of Contents

the ongoing review of the regulatory framework (3) empowering and protecting end-users; and (4) improving the quality and efficiency of regulatory decision making.
United Kingdom ‘Brexit’
In June 2016, following a national referendum, the UK decided to cease its membership in the EU. The European Treaty sets out the legal process that must be followed to accomplish this departure, but has not yet been triggered. It is generally expected that the UK will remain a member of the EU until at least 2019. While there is likely to be little immediate effect for the company or its customers, the longer term implications are presently unclear.

Middle East and African Regulation
In recent years, we have expanded our operations beyond the borders of the European Union. While a number of jurisdictions have adopted regulatory regimes broadly similar to the European model and promote full competition, many of the countries in this region have not yet committed to liberalizing their telecommunications regimes and opening their telecommunications markets to foreign investment as part of the 1998 World Trade Organization Agreement on Basic Telecommunications Services. We cannot be certain of how many regional countries may ultimately liberalize their national markets or how quickly change may take place and the effect on our business of future regulatory change cannot be accurately predicted.
Canadian Regulation
The Canadian Radio-television and Telecommunications Commission (“CRTC”) regulates telecommunications providers and their service offerings in Canada. Regulatory developments over the past several years have terminated the historic monopolies of the ILECs, bringing significant competition to this industry for both domestic and international long distance services. The provision of Canadian domestic and international transmission facilities based services is no longer restricted to “Canadian carriers”. Prior to June 2012, these carriers had to have majority ownership and control in-fact by Canadians. There are no such Canadian ownership and control requirements for companies that resell the services and facilities of a Canadian carrier. Accordingly, we have historically operated as a reseller of Canadian domestic and international transmission facilities-based services in Canada. Material ownership restrictions were repealed, thus allowing us to register with the CRTC as a facilities-based telecommunications common carrier, which we did and also obtained a Basic International Telecommunications Service license, allowing us to carry traffic that originates or terminates in points outside of Canada.
Latin American Regulation
The regulatory status of the telecommunications markets in Latin America varies to some degree. All of the countries in which we currently operate are members of the World Trade Organization, and most have committed to some deregulatory measures such as market competition and foreign ownership. Some countries now permit competition for all telecommunications facilities and services, while others allow less competition for some facilities and services, but restrict competition for other services. The telecommunications regulatory regimes of many Latin American countries are in the process of development. Many issues, such as regulation of incumbent providers, interconnection, unbundling of local loops, resale of telecommunications services, and pricing have not been addressed fully, or even at all. We cannot accurately predict whether and how these issues will be resolved, or their effect on our operations.

28

Table of Contents

Below is a summary of certain of the regulations currently applicable to our Latin American operations, by country. The regulations apply equally to all of our operating entities in a given country.
Argentina
The regulatory framework of the Argentine telecommunications sector is changing. The
Argentine telecommunications sector is subject to national Law “Argentina Digital” No. 27,078 of
December 16, 2014 (the “ICT Law”) which replaced (i) former Law No. 19,798 (the former Telecommunications Law), as amended, which had governed the operation of telecommunications companies in Argentina since August 1972; and (ii) Decree No. 764/2000, as amended, which opened the Argentine telecommunications market to competition in September 2000, established rules for the granting of licenses for telecommunications services, interconnection, the management and control of the radio spectrum and a Universal Service Fund regime.
The ICT Law established that Law No. 19,798 and Decree No. 764/2000, its supplementary laws and decrees, will remain in full force and effect as long as they do not contradict the ICT Law and until the regulatory authority enacts the required new supporting regulatory framework.
On January 4, 2016, a Necessity and Urgency Decree No. 267/2015 (“Decree 267”) was published which basically: (i) partially amended the ICT Law; (ii) created a new control authority called the ENACOM (Ente Nacional de Comunicaciones) to replace the former authority (AFTIC), an entity under the jurisdiction of the Argentine Communications Ministry, that is in charge of the telecommunications and audiovisual communications industry; and (iii) created a special committee for the purpose of drafting a unified and updated new law that will replace the ICT Law (the “New ICT Law”).
Most relevant aspects to our business (such as the licensing processes, USF regime, interconnection regime and spectrum regime) set forth under the former Law No. 19,798 and Decree No. 764/2000, and its supplementary laws, continue in full force until the enactment of the New ICT Law. The special committee created by Decree 267 is expected to submit a new a bill of the New ICT Law to Congress during 2017.

Brazil
Law No. 9,472, of 16 July 1997, known as the General Telecommunications Law (“LGT”), provides for the organization of telecommunications services in Brazil (which includes the regulation of the performance, provision and use of services, and the implementation and operation of telecommunications networks, as well as the use of orbit resources and radio-frequency spectrums) and creates the National Telecommunications Agency (“ANATEL”), the regulatory agency, which shall act independently, impartially, legally, impersonally and publicly.
ANATEL has generally pursued a policy of market liberalization and supported a competitive telecommunications environment. In order to foster effective competition and prohibit economic concentration in the market, the agency may establish restrictions, limits or conditions for companies, or groups of companies, regarding obtaining and transferring concessions, permits and authorizations to render telecommunications’ services.
The convergence of services, the rapid changes in technology, the poor quality of telecommunication services being delivered to most of the population in the consumer market and the economic crisis in Brazil, among other factors, are leading ANATEL to consider a variety of changes to the current telecommunications regulation framework. During 2017, we expect several measures with significant changes in the regulatory model, thus promoting the unification of private and public regimes, a certain level of deregulation and quality of service obligations.

29

Table of Contents

The Internet Civil Framework approved by Law 12.965/2014 provides for network neutrality and prohibits broadband providers from impairing or degrading (also known as throttling) Internet traffic to different Internet applications; prioritizing traffic or some content; or unreasonably interfering with or hindering the ability of users to access lawful content. The party responsible for the transmission, switching or routing has the duty to process, on an isonomic basis, any data packages, regardless of content, origin and destination, service, terminal or application and the legal discrimination or degradation of traffic, although still subject to further regulation, can only result from: (i) technical requirements essential to the adequate provision of services and applications; and (ii) prioritization of emergency services.

Chile

The telecommunications industry in Chile is regulated by the Undersecretariat of Telecommunications, a department under the Ministry of Transportation and Telecommunications.
In 1978, the National Policy on Telecommunications was issued which, in its most relevant aspects, called for the development of telecommunications services to be conducted by private institutions through authorizations granted by the government. However, it also endorsed a series of regulations aimed at establishing increased technical control over such investments and conferring certain discretionary powers upon the government. The policy was formalized through the General Law on Telecommunications approved in 1982, in which free, non-discriminatory access was granted to private firms in the development of the nation’s telecommunications services. This law established responsibilities with respect to telecommunication services, compulsory interconnection of facilities between public service licensees, and effectuated mandatory tariffing of services where existing market conditions were deemed insufficient to guarantee a free tariff system.
Chile amended its General Law on Telecommunications in 1985 to provide that concessions and permits may be granted without limit depending upon the quantity and type of service and geographic location. The law guarantees interconnection among telecommunications service concessionaires. Chile defines value added services as supplementary services. It is not necessary to have a telecommunications service license to offer supplementary services, although those who provide additional services must comply with the technical standards established by the Department of Telecommunications, and obtain authorization therefrom.
The General Law on Telecommunications has been amended on several occasions regarding such matters as network neutrality, the recent elimination of domestic long distance telephony, and full implementation of number portability, and establishing a national plan for critical telecommunications infrastructure to ensure continuity of services.
Colombia
The telecommunication industry in Colombia is subject to regulation by the Colombian Ministry of Communications. Since 1991, the Colombian Government has pursued a policy of liberalization and has encouraged joint ventures between public and private telecommunication companies to provide new and improved telecommunication services. In 2009, the Colombian government adopted a new regulatory regime (Law 1341, the “TIC law”) that was aimed at further deregulating the telecommunications market.
The telecommunication industry in Colombia is subject to regulation by the Communications Regulation Commission (CRC), the National Spectrum Agency (ANE) and the National Television Authority (ANTV).
The competition authority and consumer protection agency in Colombia is the Superintendence of Industry and Commerce (SIC), which is responsible for enforcing antitrust

30

Table of Contents

regulations, protecting consumers’ rights and promoting competition in all economic sectors, including telecommunications.
The Ministry of Information and Communications Technologies (“ICT”) is in charge of telecommunications policymaking, and the Minister is a member of the board of the regulatory bodies (CRC, ANTV and ANE).
The TIC Law created a new ICT register to facilitate market entry by telecommunications operators, as licenses were no longer tied to the provision of telecommunications services in Colombia. If services providers require spectrum the Ministry granted a spectrum use permit. During 2015, the CRC and the Ministry of Information and Communications Technologies (“MinICT”) issued regulations and policies to promote and improve competition in the telecommunications sector in Colombia, relating to, among other things, customer contracts, reporting, interconnection charges in the mobile market and certain local accounting rules.
The Colombian government issued the National Development Plan (NDP), which is intended to increase competition and the use of information technology and communications in the country. The NDP contains provisions to allow for the efficient deployment of infrastructure and services.
The Colombian government is interested in joining the Organization for Economic Cooperation and Development, or OECD, and this will require the adoption of some reforms in the telecommunication sector, such as measures to ensure the independence of the regulatory authorities, eliminate concentration in fixed and mobile markets and remove barriers to network infrastructure deployment, which would not affect our business in Colombia.
Costa Rica
Costa Rica was the last country in Central America to liberalize the telecommunications market. Following ratification of the free trade agreement between the US and Central American States, in 2007, through the enactment of the General Telecommunications Law in 2008, and the appointment of the Telecommunications Superintendence (“SUTEL”) as market regulator in 2009, Costa Rica consolidated the opening to competition of the telecommunications sector. SUTEL is an administrative body within the former Public Services Regulatory Authority (ARESEP) and as market regulator holds responsibilities such as: implementing policy and legislation, regulating the market entry by service providers and the services, imposing access and interconnection obligations, resolving intercarrier and unfair competition disputes, approving both retail tariffs (only if there are no effective competition conditions within the market) and adhesion contracts with end users, overseeing the universal service fund (FONATEL), and managing scarce resources, including numbers and radio spectrum. SUTEL also ensures compliance with consumer protections and promotes competition in the telecommunications sector.
The executive branch retains certain direct responsibilities in the telecom sector through the Ministry of Science, Technology and Telecommunications (“MICITT”), which is the main authority for the promotion and definition of national telecommunications policy, including the definition of a national plan for the development of telecommunications and granting spectrum licenses.
In 2014, SUTEL started to conduct market research on the prices of submarine cable access services in Costa Rica, to determine whether prices in that country are competitive in comparison with international prices. The final report on this research has not been released yet.
At the end of 2014, SUTEL announced that it expects to review the conditions for effective competition in the various telecommunications markets in Costa Rica (fixed, mobile, data, etc.), which could lead to the liberalization of the prices of telecommunication services in some markets or a review of new regulatory rulings to promote competition.

31

Table of Contents

In October 2015, MICITT released the National Telecommunications Plan 2015-2021. The plan addresses the main objectives for the growth of the telecommunications sector until 2021 and the telecommunications market milestones. These objectives are mandatory both to MICITT and SUTEL regarding the spectrum procurement proceedings and the procurement proceedings financed through FONATEL.
Since 2015, there has also been an important reform process to the regulatory framework, implemented through the enactment of new regulations concerning subjects such as infrastructure sharing, quality of services, end user rights, pricing and tariffs, privacy of communications, universal access and services, among others.
Following a public consultation on the studies reviewing the conditions for competition in various telecommunications markets in Costa Rica, in December 2016, SUTEL declared effective competition in four of the telecommunications markets: International Telephony, Fixed Internet, International Roaming, and Telecommunications Transit. These markets thereon will no longer have a tariff regulation. The government determined that the Origination, Termination in individual fixed networks, Termination in individual mobile networks, and Fixed telephony markets do not present conditions for effective competition, and will therefore remain under tariff regulation. Lastly, SUTEL postponed the decision concerning the ‘Mobile Telecommunications’, ‘Access and Origination in a Mobile Network’, and ’Loop Unbundling’ markets to the first quarter of 2017.
On December 2016, SUTEL also published the official invitation for the tendering of 70 MHz of spectrum in the 1800 MHz and 1900/2100 MHz bands, intended for the provision of mobile telephony and mobile internet services.
Ecuador

A Law of Telecommunications was enacted in February of 2015. As a result, the organizational structure of public entities in Ecuador will changed with the creation of the Agency for the Regulation and Control of Telecommunications (“ARCOTEL”), which will be responsible for the planning, regulation and control of telecommunications services as well as spectrum management.
The Ministry of Telecommunications will remain in charge of the development of information and communication technologies in Ecuador. It issues policies and general plans and monitors their implementation. The Ministry also evaluates, coordinates and promotes actions to ensure equal access to services and the effective and efficient use thereof.
Mexico
In June, 2013, the Mexican government performed an integral amendment of the regime, through the enactment of a Constitutional Decree. Such Decree included the modification of the Mexican Constitution and several legislative measures that have been requiring a series of further regulations amending the main regulatory framework of the telecommunications industry. Some of the most important aspects set forth in the amendment are the following: (i) the Federal Institution of Telecommunications (“IFT”) was created as a constitutionally autonomous entity, replacing the existing Federal Telecommunications Commission (“COFETEL”), as the sole telecommunications regulatory body; and (ii) foreign investment was allowed with up to 100% in telecommunications and satellite communication services (previously capped at 49%) and up to 49% in broadcasting services (previously prohibited).
A telecommunications law was approved by the Federal Congress of Mexico and became effective on August 13, 2014.

32

Table of Contents

The telecommunications sector in Mexico is regulated primarily by the IFT. Among other aspects, the IFT regulates the requirements for licensing public telecommunications networks, and the obligations of telecommunication companies in Mexico. Further, it manages licensing requirements for radioelectric spectrum, satellite geostationary orbits assigned to Mexico and its related spectrum, makes declarations of preponderant agents in the telecommunications and broadcasting sectors (more than 50% of the users, subscribers, audience, network traffic or used network capacity, measured on a national basis), analyzes the divestiture and restructuring plans submitted by Preponderant agents to reconsider their status and authorizations to commercialize telecommunications services.
Under the new telecommunications law, the provision of value-added services has been deregulated. Also, there is a new concession-granting regime, which establishes a unique concession for the provision of all telecommunication services. The unique concession may be granted by the IFT only to Mexican individuals or companies, but there will be no limitation on foreign investment. However, the concessions granted before the new law was enacted, will remain valid until they expire or the operator decides to apply for a master concession (transition regime).
On March 6 2014, the IFT declared America Movil SAB de CV, Telefonos de Mexico SAB de CV, and Grupo Carso, among other companies, to be preponderant agents in the telecommunications sector, and Grupo Televisa, among others, to be a preponderant agent in the open broadcast television sector. The divestiture plan submitted by America Movil is pending approval.
The IFT may impose additional asymmetric regulations and specific obligations upon preponderant agents such as rates, quality, shared-use of infrastructure, rights of way and disaggregation of the local telecommunication network.
Some important regulatory measures were issued by the IFT in 2015: (i) the application of no charge for the interconnection with networks of the preponderant agents and (ii) the modification of tariffs for national long distances telephony services due to the Mexican territory treatment as a local area.
While the IFT provides the main regulatory framework of the telecommunications industry, other relevant laws in the field are the Federal Antitrust Law, the Foreign Investment Law, the Law of Protection of Personal Information in Possession of Private Entities, and the Federal Consumers Protection Law, all of which play a part in the overall regulation of the sector, in addition to the general commerce and contractual laws. The above mentioned laws also shall be adjusted to the new telecommunication law.
The enactment of the new law and the initial measures taken by the IFT in 2014 have increased the dynamism of the Mexican telecommunications market, in which the main players are moving faster and new players are emerging.
In 2016 the IFT issued the Guidelines for Collaboration with Justice which came into force on January 1, 2016, and brought about several new obligations for the telecommunications concessionaires and authorization holders. However, the implementation of such Guidelines is still not completely clear, as the IFT’s criterion is that every concessionaire and authorization holder is responsible for complying with the Guidelines, even when its technical and operative capabilities do not allow them to gather the information required by the Guidelines.

Panama
In Panama the telecommunications market was privatized in 1997 and deregulated in 2003, and services have seen strong growth since that time. Due to the comparative advantages of the geographical location of Panama there is a significant supply of subsea connections.

33

Table of Contents

The telecommunications industry in Panama is regulated by Autoridad Nacional de los Servicios Públicos or ASEP (formerly Ente Regulador de los Servicios Públicos), an independent regulatory body. ASEP is a multi-sector regulator in charge of all Panama utilities including telecommunications.
Peru
The telecommunications industry in Peru is regulated by the Supervisory Authority for Private Investment in Telecommunications (“OSIPTEL”) and the Ministry of Transportation and Communications (“MTC”). OSIPTEL is an independent regulatory body attached to the Office of the President of the Council of Ministers.
Under Peruvian law, the provision of public telecommunications services requires a concession. The functions related to the issuance of concessions and market access registration and the assignment of the radio spectrum for public telecommunications services are managed by the MTC’s General Directorate of Concessions in Telecommunications. Since market liberalization became effective in August 1998, there has been no limitation on the issuance of concessions, except for services subject to natural limitations on grounds of scarce resources, as in the case of the radio spectrum.
During 2014, the National Congress submitted a General Telecommunication Bill which would modify the existing general regulatory regime. The bill remains under debate and has not yet been passed.
Uruguay
The telecom market in Uruguay is highly regulated. The Executive Branch, through the Ministry of Industry, Energy and Mining, is the final authority in regards with telecom matters, while the Telecom National Office (Dirección Nacional de Telecomunicaciones) works as a general advisory body and the Communication Services Regulatory Unit URSEC (Unidad Reguladora de Servicios de Comunicaciones) participates as a regulatory agency.
To provide telecommunications services, it is necessary to hold a license. Moreover, if the service also requires the assignment of spectrum, it is also necessary to have a concession. The Executive Branch grants licenses to broadcast and also grants assignments of spectrum with a fixed term. URSEC is entitled to grant licenses and concessions in all the remaining cases. The international long distance telephony is a closed market with approximately ten players operating in that market. Through our Uruguayan branch, we are licensed for data transmission services and as an international long distance service provider.
Venezuela
The Venezuelan telecommunications industry is regulated by the Comisión Nacional de Telecomunicaciones (“CONATEL of Venezuela”), which is ascribed to and under the purview of the Minister of People’s Power for Communication and Information. Venezuela opened its telecommunications market to competition on November 28, 2000. In 2007, the Venezuelan government nationalized the incumbent telecommunications operator, CANTV. In December 2010, the government issued a new law declaring that the provision of telecommunications services is an activity of the “public domain.” To date, the government has not indicated its intent to expand nationalization within the telecommunications sector.
The Venezuelan government restricts the setting of fees for telecommunication services, limiting the ability of service providers to adjust their fees in response to Venezuela’s high inflation rate
Asian Regulation

34

Table of Contents

The status of liberalization of the telecommunications regulatory regimes of the Asian countries in which we operate or may in the future operate varies. Some countries allow full competition in the telecommunications sector, while others limit competition for many or most services. Similarly, some countries in Asia maintain foreign ownership restrictions which limit the amount of foreign direct investment and require foreign companies to seek local joint venture partners.
Most of the countries in the region have committed to liberalizing their telecommunications regimes and opening their telecommunications markets to foreign investment as part of the World Trade Organization Agreement on Basic Telecommunications Services, which came into force in 1998. Additionally, the United States has entered into bilateral Free Trade Agreements with Singapore, Australia and South Korea that became effective in 2003, 2005 and 2012, respectively, and a Trans-Pacific Partnership agreement with Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam that was concluded in 2015. We cannot predict what effect, if any, these agreements will have on other countries in the region or whether the U.S. will pursue similar agreements with other countries. We also cannot be certain whether this liberalizing trend will continue or accurately predict the pace and scope of liberalization. It is possible that one or more of the countries in which we operate or may in the future operate will slow or halt the liberalization of its telecommunications markets. The effect on us of such an action cannot be accurately predicted.
The telecommunications regulatory regimes of many Asian countries are in the process of development. Many issues, such as regulation of incumbent providers, interconnection, unbundling of local loops, resale of telecommunications services, offering of voice services and pricing have not been addressed fully or at all. We cannot accurately predict whether or how these issues will be resolved and their effect on our operations in Asia.

Glossary of Terms
access
Telecommunications services that permit long distance carriers to use local exchange facilities to originate and/or terminate long distance service.
access charges
The fees paid by long distance carriers to LECs for originating and terminating long distance calls on the LECs’ local networks.
ATM
Asynchronous transfer mode. An information transfer standard that is one of a general class of packet technologies that relay traffic by way of an address cell. The ATM format can be used by many different information systems, including LANs, to deliver traffic at varying rates, permitting a mix of data, voice and video.
backbone
A high-speed network that interconnects smaller, independent networks. It is the through‑portion of a transmission network, as opposed to spurs which branch off the through‑portions
CAP
Competitive Access Provider. A company that provides its customers with an alternative to the local exchange company for local transport of private line and special access telecommunications services.
caching
A process by which a Web storage device or cache is located between Web servers (or origin servers) and a user, and watches requests for HTML pages and objects such as images, audio, and video, then saves a copy for itself. If there is another request for the same object, the cache will use its copy, instead of asking the origin server for it again.
capacity
The information carrying ability of a communications facility.
carrier
A provider of communications transmission services by fiber, wire or radio.

35

Table of Contents

CDN
Content Distribution Network or CDN describes a system of computers networked together across the Internet that cooperate transparently to deliver various types of content to end users. The delivery process is optimized generally for either performance or cost. When optimizing for performance, locations that can serve content quickly to the user are chosen. When optimizing for cost, locations that are less expensive to serve from may be chosen instead.
central office
Telephone company facility where subscribers’ lines are joined to switching equipment for connecting other subscribers to each other, locally and long distance.
CLEC
Competitive Local Exchange Carrier. A company that competes with ILECs in the local services market.
co-carrier
A relationship between a CLEC and an ILEC that affords each company the same access to and right on the other’s network and provides access and services on an equal basis.
common carrier
A government defined group of private companies offering telecommunications services or facilities to the general public on a non-discriminatory basis.
conduit
A pipe, usually made of metal, ceramic or plastic, that protects buried cables.
dark fiber
Fiber optic strands that are not connected to transmission equipment.
dedicated lines
Telecommunications lines reserved for use by particular customers.
facilities based carriers
Carriers that own and operate their own network and equipment.
fiber optics
A technology in which light is used to transport information from one point to another. Fiber optic cables are thin filaments of glass through which light beams are transmitted over long distances carrying enormous amounts of data. Modulating light on thin strands of glass produces major benefits including high bandwidth, relatively low cost, low power consumption, small space needs and total insensitivity to electromagnetic interference.
Gateway
Gateways are the primary technical facilities in the markets we serve. They are the endpoints of each long haul city-pair segment. Where we have metro rings, they are the locations most metro rings home to.
Gbps
Gigabits per second. A transmission rate. One gigabit equals 1.024 billion bits of information.
ISDN
Integrated Services Digital Network. An information transfer standard for transmitting digital voice and data over telephone lines at speeds up to 128 Kbps.
ILEC
Incumbent Local Exchange Carrier. A company historically providing local telephone service. Often refers to one of the Regional Bell Operating Companies (RBOCs). Often referred to as “LEC” (Local Exchange Carrier).
Interconnection
Interconnection of facilities between or among the networks of carriers, including potential physical colocation of one carrier’s equipment in the other carrier’s premises to facilitate such interconnection.
ISPs
Internet Service Providers. Companies formed to provide access to the Internet to consumers and business customers via local networks.
IXC
Interexchange Carrier. A telecommunications company that provides telecommunications services between local exchanges on an interstate or intrastate basis.
Kbps
Kilobits per second. A transmission rate. One kilobit equals 1,024 bits of information.
LATA
Local Access and Transport Area. A geographic area composed of contiguous local exchanges, usually but not always within a single state. There are approximately 200 LATAs in the United States.

36

Table of Contents

leased line
An amount of telecommunications capacity dedicated to a particular customer along predetermined routes.
LEC
Local Exchange Carrier. A telecommunications company that provides telecommunications services in a geographic area. LECs include both ILECs and CLECs.
local exchange
A geographic area determined by the appropriate state regulatory authority in which calls generally are transmitted without toll charges to the calling or called party.
local loop
A circuit that connects an end user to the LEC central office within a LATA.
long distance carriers
Long distance carriers provide services between local exchanges on an interstate or intrastate basis. A long distance carrier may offer services over its own or another carrier’s facilities.
Mbps
Megabits per second. A transmission rate. One megabit equals 1.024 million bits of information.
MPLS
MultiProtocol Label Switching. A standards approved technology for speeding up network traffic flow and making it easier to manage. MPLS involves setting up a specific path for a given sequence of packets, identified by a label put in each packet, thus saving the time needed for a router or switch to look up the address to the next node to forward the packet to.
multiplexing
An electronic or optical process that combines a large number of lower speed transmission lines into one high speed line by splitting the total available bandwidth into narrower bands (frequency division), or by allotting a common channel to several different transmitting devices, one at a time in sequence (time division).
PBX
Private Branch eXchange. A PBX, sometimes known as a phone switch or phone switching device, is a device that connects office telephones in a business with the PSTN. The functions of a PBX include routing incoming calls to the appropriate extension in an office, sharing phone lines between extensions, automated greetings for callers using recorded messages, dialing menus, connections to voicemail, automatic call distribution and teleconferencing.
peering
The commercial practice under which ISPs exchange traffic with each other. Although ISPs are free to make a private commercial arrangement, there are generally two types of peering. With a settlement free peering arrangement the ISPs do not need to pay each other for the exchange of traffic. With paid peering, the larger ISP receives payment from the smaller ISP to carry the traffic of that smaller ISP. Peering occurs at both public and private exchange points.
POP
Point of Presence. Telecommunications facility where a communications provider locates network equipment used to connect customers to its network backbone.
private line
A dedicated telecommunications connection between end user locations.
PSTN
Public Switched Telephone Network. That portion of a local exchange company’s network available to all users generally on a shared basis (i.e., not dedicated to a particular user). Traffic along the public switched network is generally switched at the local exchange company’s central offices.
RBOCs
Regional Bell Operating Companies. Originally, the seven local telephone companies established as a result of the divestitures of AT&T in connection with its settlement with the U.S. Department of Justice of an antitrust lawsuit.
reciprocal compensation
The compensation of a CLEC for termination of a local call by the ILEC on the CLEC’s network, which is the same as the compensation that the CLEC pays the ILEC for termination of local calls on the ILEC’s network.
 resale
Resale by a provider of telecommunications services (such as a LEC) of such services to other providers or carriers on a wholesale or a retail basis.

37

Table of Contents

router
Equipment placed between networks that relays data to those networks based upon a destination address contained in the data packets being routed.
selective router
Telephone switch or functional equivalent, controlled by the relevant local exchange carrier (LEC), which determines the public safety answering point to which a 911 call should be delivered based on the location of the 911 caller.
SONET
Synchronous Optical Network. An electronics and network architecture for variable bandwidth products which enables transmission of voice, data and video (multimedia) at very high speeds. SONET ring architecture provides for virtually instantaneous restoration of service in the event of a fiber cut or equipment failure by automatically rerouting traffic in the opposite direction around the ring.
special access services
The lease of private, dedicated telecommunications lines or “circuits” along the network of a local exchange company or a CAP, which lines or circuits run to or from the long distance carrier POPs. Examples of special access services are telecommunications lines running between POPs of a single long distance carrier, from one long distance carrier POP to the POP of another long distance carrier or from an end user to a long distance carrier POP.
streaming
Streaming is the delivery of media, such as movies and live presentations, over a network in real time. A computer (a streaming server) sends the media to another computer (a client computer), which plays the media as it is delivered.
switch
A device that selects the paths or circuits to be used for transmission of information and establishes a connection. Switching is the process of interconnecting circuits to form a transmission path between users and it also captures information for billing purposes.
Tbps
Terabits per second. A transmission rate. One terabit equals 1.024 trillion bits of information.
TDM
Time Division Multiplexing. A technology that transmits multiple signals simultaneously over a single transmission path.
unbundled
Services, programs, software and training sold separately from the hardware.
unbundled access
Access to unbundled elements of a telecommunications services provider’s network including network facilities, equipment, features, functions and capabilities, at any technically feasible point within such network.
VoIP
Voice over Internet Protocol.
ITEM 1A. RISK FACTORS
Forward Looking Statements
We, or our representatives, occasionally may make or may have made certain forward-looking statements, either orally or in writing, including without limitation statements made or to be made in this Form 10-K, our quarterly reports on Form 10-Q, information in other filings with the SEC, press releases and other public documents or statements. In addition, our representatives, occasionally, participate in speeches and calls with market analysts, conferences with investors or potential investors in our securities and other meetings and conferences. Some of the information presented at these speeches, calls, meetings and conferences may include forward-looking statements. We use words like “plan,” “estimate,” “expect,” “anticipate,” “believe,” “intend,” “goal,” “seek,” “project,” “strategy,” “future,” “likely,” “may,” “should,” “will” and similar references to future periods to identify forward-looking statements.
We wish to ensure that all forward-looking statements are accompanied by meaningful cautionary statements, to ensure to the fullest extent possible the protections of the safe harbor established in the U.S. Private Securities Litigation Reform Act of 1995. Accordingly, all forward-looking statements are qualified in their entirety by reference to, and are accompanied by, this discussion of certain important factors that could cause actual results to differ materially from those projected in these forward-looking

38

Table of Contents

statements. We caution the reader that this list of important factors may not be exhaustive. We operate in a rapidly changing business, and new risk factors emerge from time to time.
Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations, and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. We cannot predict every risk factor, nor can we assess the effect, if any, of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those projected in any forward-looking statements. Accordingly, forward-looking statements should not be relied upon as a prediction of actual results. Further, we undertake no obligation to update forward-looking statements that may be made occasionally, whether because of new information, future developments or otherwise, after the date they are made to conform the statements to actual results or changes in our expectations.
For more information about our results of operations and financial condition, see the discussion under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” appearing later in this Form 10-K.
Risks Related to our Pending Merger with CenturyLink
Our pending merger with CenturyLink may cause disruption to our business.
On October 31, 2016, we entered into an agreement and plan of merger with CenturyLink, pursuant to which we will, subject to the satisfaction or waiver of the stated closing conditions, merge with a wholly owned subsidiary of CenturyLink in a stock-and-cash transaction. The merger agreement generally requires us to operate our business in the ordinary course pending consummation of the proposed merger and restricts us, without CenturyLink’s consent, from taking certain specified actions until the merger is completed. These restrictions may affect our ability to execute our business strategies and attain our financial and other goals and may affect our financial condition, results of operations and cash flows. The pursuit of the merger and the preparation for the integration of our business with CenturyLink’s business may place a significant burden on management and internal resources. The diversion of management’s attention away from day-to-day business concerns could adversely affect our financial results.
We are also subject to litigation related to the CenturyLink merger, which may result in significant costs and expenses. In addition to potential litigation-related expenses, we have incurred and will continue to incur other significant costs, expenses and fees for professional services and other transaction costs in connection with the CenturyLink merger, and many of these fees and costs are payable regardless of whether or not the CenturyLink merger is consummated.
Uncertainty regarding the completion of the CenturyLink merger may cause customers to delay or defer decisions concerning us and may adversely affect our ability to attract and retain key employees.
The CenturyLink 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 CenturyLink’s proposed stock issuance in connection with the CenturyLink merger by CenturyLink’s shareholders and the receipt of regulatory approvals. Many of the conditions are beyond our control. As a result, there may be uncertainty regarding the completion of the CenturyLink merger. This uncertainty, along with potential customer uncertainty regarding the service to be provided by the combined company following the CenturyLink merger, may cause customers to delay or defer decisions concerning purchases from us or affect our customer retention initiatives, which could

39

Table of Contents

negatively affect our revenue, earnings and cash flow, regardless of whether the CenturyLink merger is ultimately completed.
Uncertainty regarding the completion of the CenturyLink merger may also foster uncertainty among employees about their future roles. Key employees may depart because of issues relating to the uncertainty and difficulty of integration or desire not to remain with the combined company following the combination. 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 revenue at anticipated levels prior to the completion of the CenturyLink merger.
Our pending merger with CenturyLink 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 CenturyLink merger and the transactions contemplated thereby could have material and adverse effects on us.
The completion of our pending merger with CenturyLink is subject to a number of conditions, including the receipt of required regulatory approvals, the approval and adoption of the Merger Agreement and the approval of the CenturyLink merger by our stockholders, and the approval of CenturyLink’s stock issuance in connection with the CenturyLink merger by CenturyLink’s shareholders, which make the completion and timing of the completion of the CenturyLink merger uncertain. Also, either we or CenturyLink may terminate the Merger Agreement if the CenturyLink merger has not been completed by October 31, 2017 (subject to extension to January 31, 2018 under certain circumstances) unless the failure of the CenturyLink merger to be completed has resulted from the failure of the party seeking to terminate the Merger Agreement to perform its obligations.
If the CenturyLink merger is not completed on a timely basis, or at all, our ongoing business may be adversely affected. Additionally, in the event the CenturyLink merger is not completed, we will be subject to a number of risks without realizing any of the benefits of having completed the CenturyLink merger, including the following:
We may be required to pay to CenturyLink a termination fee of $737.5 million (less any previously reimbursed expenses), and in some cases, expenses of CenturyLink up to $75 million if the CenturyLink merger is terminated under qualifying circumstances, as described in the Merger Agreement;
 
We will be required, subject to certain exceptions, to pay our costs relating to the CenturyLink merger, such as financial advisor, legal, accounting and printing fees, whether or not the CenturyLink merger is completed;

Time and resources committed by management to matters relating to the CenturyLink 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 CenturyLink merger will be completed; and

If the Merger Agreement is terminated and our Board of Directors subsequently 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 CenturyLink has agreed to in the CenturyLink merger.
 

40

Table of Contents

The merger agreement contains provisions that could discourage a potential competing acquirer.
The merger agreement contains “no shop” provisions that, subject to limited exceptions, restrict our ability to solicit, initiate, or knowingly encourage and facilitate competing third-party proposals for the acquisition of our stock or assets. In addition, before our board of directors withdraws, qualifies or modifies its recommendation of the proposed merger with CenturyLink or terminates the merger agreement to enter into a third-party acquisition proposal, CenturyLink generally has an opportunity to offer to modify the terms of the proposed merger. In some circumstances, upon termination of the merger agreement, we will be required to pay a termination fee of $737.5 million. These provisions could discourage a potential third-party acquirer that might have an interest in acquiring all or a significant portion of us from considering or proposing that acquisition, even if it were prepared to pay consideration with a higher per share cash or market value than the market value proposed to be received or realized in the merger, or might otherwise result in a potential third-party acquirer proposing to pay a lower price to our stockholders than it might otherwise have proposed to pay because of the added expense of the termination fee that may become payable in certain circumstances.

Risks Related to our Business Operations
We need to increase Core Network Services revenue from the services we offer to realize our targets for financial and operating performance.

We must increase Core Network Services revenue at acceptable margins to realize our targets for financial and operating performance, including free cash flow. If:

we do not avoid excessive customer churn or improve our current relationships with existing key customers;

we cannot expand the available capacity on our network to meet our customers’ demands promptly; or

our customers determine to obtain these services from either their own network or from one of our competitors,

we may not increase or maintain either or both of our Core Network Services revenue at acceptable margins and free cash flow, which would adversely affect our ability to become and/or remain profitable.
Our business requires the continued development of effective business support systems and uniform standards, controls and policies to implement customer orders and to provide and bill for services.
Our business depends on our ability to continue to develop and manage effective business support systems. In certain cases, developing these business support systems is required to realize anticipated benefits from both past and future acquisitions. The development and management of business support systems is a complicated undertaking requiring significant resources and expertise, developing uniform standards, controls, procedures and policies and the efficient consolidation and elimination of business support systems that are no longer useful in the business. This undertaking also requires support from third-party vendors. Following the development of the business support systems, the data migration regarding network and circuit inventory must be completed for the full benefit of the systems to be realized. Business support systems are needed for:
quoting, accepting and inputting customer orders for services;

provisioning, installing and delivering services;

41

Table of Contents


providing customers with direct access to our information systems so they can manage the services they purchase from us, generally through web-based customer portals; and

billing for services.

Because our business provides for continued rapid growth in the number of customers we serve, the volume of services offered and the integration of any acquired companies’ business support systems, there is a need to continually develop our business support systems on a schedule sufficient to meet proposed milestone dates. Failing to continue to develop effective unified business support systems or complete the data migration regarding network and circuit inventory into these systems could materially adversely affect our ability to implement our business plans and realize anticipated benefits from our acquisitions.
We may lose customers if we experience system failures that significantly disrupt the availability and quality of the services we provide. System failures may also cause interruptions to service delivery and the completion of other corporate functions.
Our operations depend on our ability to limit and mitigate interruptions or degradation in service for customers. Interruptions in service or performance problems for whatever reason, including integration related activities, could undermine confidence in our services and cause us to lose customers or make it more difficult to attract new ones. In addition, because many of our services are critical to the businesses of many of our customers, any significant interruption or degradation in service could cause lost profits or other losses to customers. Although we generally limit our liability for service failures in our service agreements to limited service credits (generally in the form of free service for a short period of time) and generally exclude any liability for “consequential” damages such as lost profits, a court might not enforce these limitations on liability in the manner contemplated, which could expose us to financial loss. In addition, we often provide our customers with committed service levels. If we cannot meet these service level commitments, we may have to provide service credits or other compensation to our customers. Because we offer emergency notification services called “911” services, any significant interruption or degradation in those services could create legal and financial exposure.
The failure of any equipment or facility on our network, including our network operations control centers and network data storage locations, could cause the interruption of customer service and other corporate functions until necessary repairs are effected or replacement equipment is installed. In addition, our business continuity plans may not be adequate to address a particular failure we experience. Delays, errors, network equipment or network facility failures, including with respect to our network operations control centers and network data storage locations, could also result from natural disasters (including natural disasters that may increase in frequency because of the effects of climate change), disease, accidents, terrorist acts, power losses, security breaches, vandalism or other illegal acts, computer viruses, or other causes. Our business could be significantly hurt from these delays, errors, failures or faults including as a result of:
service interruptions;
exposure to customer liability;
the inability to install new service;
the unavailability of employees necessary to provide services;

42

Table of Contents

the delay in completing other corporate functions such as issuing bills and preparing financial statements; or

the need for expensive modifications to our systems and infrastructure.

We have only recently generated net income for our three most recent full fiscal years and have generated substantial net losses in the past.
While we had net income of $677 million and $3.433 billion (which included a $3.3 billion income tax benefit due to the release of a valuation allowance against U.S. federal and state deferred tax assets) and $314 million for the year ended December 31, 2016, 2015 and 2014, respectively, we generated net losses of approximately $109 million and $422 million for the years ended December 31, 2013 and 2012, respectively. Although we anticipate that our operating results will continue to improve over time, there can be no assurance that the recent level of operating results and profitability will continue and that anticipated future operating improvements will be realized on schedule or that we can sustain profitability in the future. If we would incur net losses in the future they could limit our ability to fund expansions of our network, investments in our products and services, interest and principal payments on our debt, or other business needs.
If our security measures are breached, or if our services are subject to attacks that degrade or deny the ability of users to access our systems, products and services, we may experience significant legal and financial exposure, our products and services may be perceived as not being secure, users and customers may curtail or stop using our products and services, and our business may be disrupted.
Network and information systems and other technologies are critical to our business activities. Network and information systems-related events such as computer hackings, cyber-attacks, computer viruses, worms or other destructive or disruptive software, process breakdowns, denial of service attacks or other malicious activities, or any combination of the these items, could cause a degradation or disruption of our services, damage to our properties, equipment and data, or unauthorized disclosure of confidential information. We experience cyber-attacks against our network and information systems of varying degrees regularly, and as a result, unauthorized parties could obtain access to our data or our customers’ data. Our security measures may also be breached due to employee error, malfeasance, or otherwise. And outside parties may attempt to fraudulently induce our employees or customers to disclose sensitive information to gain access to our data or our customers’ data, including information subject to data protection laws and regulations both in the United States and elsewhere governing personally identifiable information, protected health information and Customer Proprietary Network Information. The risk of these systems-related events and security breaches occurring has intensified, in part because we maintain certain information necessary to conduct our businesses in digital form stored on servers connected to the Internet.
While we develop and maintain systems and processes designed to prevent systems-related events and security breaches from occurring, the development and maintenance of these systems and processes is costly and requires ongoing monitoring and updating as technologies change and efforts to overcome security measures become more sophisticated. Despite our efforts, there can be no assurance that unauthorized access and security breaches will not occur in the future. In addition, because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently and often are not recognized until launched against a target, we may not anticipate these techniques or to implement adequate preventive measures.
Any security breach or unauthorized access could cause significant legal and financial exposure, including regarding customer credits, lost revenue due to business interruption, increased expenditures on security measures, monetary damages, regulatory enforcement actions, fines and/or criminal

43

Table of Contents

prosecution. In addition, damage to our reputation and the market perception of the effectiveness of our security measures could cause us to lose customers. Moreover, the amount and scope of insurance we maintain against losses resulting from unauthorized access or security breaches may not be sufficient to cover our losses or otherwise adequately compensate us for any disruptions to our businesses that may result.
Failure to develop and introduce new services could affect our ability to compete in the industry.
We continuously develop, test and introduce new services delivered over our communications network. These new services are intended to allow us to address new segments of the communications marketplace, address the changing communications needs of our existing customers and compete for additional customers.
In certain instances, introducing new services requires the successful development of new technology. If upgrades of existing technology are required for introducing new services, the success of these upgrades may depend on reaching mutually acceptable terms with vendors and on vendors meeting their obligations promptly.
In addition, new service offerings may not be widely accepted by our customers. If our new service offerings are not widely accepted by our customers, we may terminate those service offerings and we may be required to impair any assets or technology used to develop or offer those services.
If we cannot complete the development and introduction of new services promptly, our business could be materially adversely affected.
Our future results will suffer if we do not effectively manage expansions to our operations.
We may continue to expand our operations through new product and service offerings and through additional strategic investments, acquisitions or joint ventures, some of which may involve complex technical and operational challenges. Our future success depends, in part, upon our ability to manage our expansion opportunities, which pose numerous risks and uncertainties, including the need to integrate new operations into our existing business in an efficient and timely manner, to combine accounting and data processing systems and management controls and to integrate relationships with customers, vendors and business partners. In addition, future acquisitions or joint ventures may involve the issuance of additional shares of our common stock, which may dilute our stockholders’ ownership.
Any future acquisitions of businesses or facilities could entail several risks, including:
problems with effectively integrating operations;
inability to maintain key pre-acquisition business relationships;
increased operating costs;
exposure to unanticipated liabilities; and
difficulties in realizing projected efficiencies, synergies and cost savings.

We continually evaluate potential investments and strategic opportunities to expand, enhance connectivity and add traffic to our network. In the future, we may seek additional investments, strategic alliances or similar arrangements, which may expose us to risks such as:

44

Table of Contents

the difficulty of identifying appropriate investments, strategic allies or opportunities on terms acceptable to us;

the possibility that senior management may have to spend considerable time negotiating agreements and monitoring these arrangements;

potential regulatory issues applicable to the telecommunications industry;

the loss or reduction in value of the capital investment;

our inability to capitalize on the opportunities presented by these arrangements; and

the possibility of insolvency of a strategic ally.

We cannot be certain that our future expansion or acquisition opportunities will succeed, or that we will realize expected operating efficiencies, cost savings, revenue enhancements, synergies or other benefits.
Our future growth depends upon the continued development and expansion of the Internet as a communications medium and marketplace for the distribution and consumption of data and video by businesses, consumers and governments.
Achieving the anticipated benefits of our business operations will depend in part upon the continued development and expansion of the Internet as a communications medium and marketplace for the distribution and consumption of data and video by businesses, consumers and governments. Using the Internet for these purposes may not grow and expand at the rate we anticipate or may be restricted by such things as:
actions by ISPs or the owners of access networks that restrict us from delivering our customers’ traffic to the users of those networks;

future regulation;

a lack of anticipated technology innovation and adoption; or

a lack of continued broadband penetration both in the United States and elsewhere.

Intellectual property and proprietary rights of others could prevent us from using necessary technology to provide our services or subject us to expensive intellectual property litigation.
If technology necessary for us to provide our services was determined by a court to infringe a patent held by another entity that is unwilling to grant us a license on terms acceptable to us, we could be precluded by a court order from using that technology and we would likely be required to pay a significant monetary damages award to the patent holder. The successful enforcement of these patents, or our inability to negotiate a license for these patents on acceptable terms, could force us to cease using the relevant technology and offering services incorporating the technology. If a claim of infringement was brought against us based on the use of our technology or against our customers based on their use of our services for which we must indemnify, we could be subject to litigation to determine whether such use or sale is, in fact, infringing. This litigation could be expensive and distracting, regardless of the outcome.
While our own patent portfolio may deter other operating companies from bringing such actions, patent infringement claims are increasingly being asserted by patent holding companies, which do not use technology and whose sole business is to enforce patents against operators, such as us, for

45

Table of Contents

monetary gain. Because such patent holding companies do not provide services or use technology, the assertion of our own patents by way of counterclaim would be largely ineffective. We have already been the subject of time-consuming and expensive patent litigation brought by certain patent holding companies and we can reasonably expect that we will face further claims in the future.
Continued uncertainty in the global financial markets and the global economy may negatively affect our financial results.
Continued uncertainty in the global financial markets and economy may negatively affect our financial results. A prolonged period of economic decline could have a material adverse effect on our results of operations and financial condition and exacerbate some of the other risk factors we describe herein. Our operating results and financial condition could be negatively affected if, because of economic conditions:
customers cancel, defer or forgo purchases of our services;

customers cannot make timely payments to us;
the demand for, and prices of, our services are reduced because of actions by our competitors or otherwise;

key suppliers upon which we rely are unwilling or unable to provide us with the materials we need for our network on a timely basis or on terms we find acceptable; or

our financial counterparties, insurance providers or other contractual counterparties cannot, or do not meet, their contractual commitments to us.

Future expansion or adaptation of our network will require substantial resources, which may not be available at the time.
We will need to continue to expand and adapt our network to remain competitive, which may require significant additional funding. Additional expansion and adaptations of our communications network’s electronic and software components will be necessary to respond to:
growing number of customers;

the development and launching of new services;

increased demands by customers to transmit larger amounts of data;

changes in customers’ service requirements;

technological advances by competitors; and

governmental regulations.

Future expansion or adaptation of our network will require substantial additional financial, operational and managerial resources, which may not be available at the time. We may be unable to expand or adapt our network to respond to these developments on a timely basis and at a commercially reasonable cost.

46

Table of Contents

The market prices for many of our services have decreased in the past and may decrease in the future, resulting in lower revenue and margins than we anticipate.
Over the past few years, the market prices for many of our services have decreased. These decreases resulted from downward market pressure and other factors including:
technological changes and network expansions which have resulted in increased transmission capacity available for sale by us and by our competitors;

some of our customer agreements contain volume based pricing; and

some of our competitors have been willing to accept smaller operating margins in the short term in an attempt to increase long-term revenue.

To retain customers and revenue, we often must reduce prices in response to market conditions and trends. As our prices for some of our services decrease, our operating results may suffer unless we can either reduce our operating expenses or increase traffic volume from which we can derive additional revenue.
The need to obtain additional capacity for our network from other providers increases our costs. In addition, the need to interconnect our network to networks controlled by others could increase our costs.
We use network resources owned by other companies for portions of our network. We obtain the right to use such network portions, including both telecommunications capacity and rights to use dark fiber, through operating leases and IRU agreements. In several of those agreements, the counter party is responsible for network maintenance and repair. If a counter party to a lease or IRU suffers financial distress or bankruptcy, we may not be able to enforce our rights to use these network assets or, even if we could continue to use these network assets, we could incur material expenses related to maintenance and repair. We could also incur material expenses if we had to locate alternative network assets. We may not succeed in obtaining reasonable alternative network assets if needed. Failure to obtain usage of alternative network assets, if necessary, could have a material adverse effect on our ability to carry on business operations. In addition, some of our agreements with other providers require the payment of amounts for services whether or not those services are used.
In the normal course of business, we must enter into interconnection agreements, including IP interconnection for voice and data services, with many domestic and foreign local telephone companies and the owners of networks that our customers desire to access to deliver their services. We are not always able to secure these interconnection agreements on favorable terms.
Costs of obtaining service from other communications carriers comprise a significant proportion of the operating expenses of long distance carriers. Similarly, a large proportion of the costs of providing international service consists of payments to other carriers. Changes in regulation, particularly the regulation of local and international telecommunication carriers and local access network owners, could indirectly, but significantly, affect our competitive position. These changes could increase or decrease the costs of providing our services.
Our operations are subject to regulation in each country in which we operate and require us to obtain and maintain several governmental licenses and permits. If we violate those regulatory requirements or to obtain and maintain those licenses and permits, including payment of related fees, if any, we may not be able to conduct our business in that jurisdiction. Moreover, those regulatory requirements could change in a manner that significantly increases our costs or otherwise adversely affects our operations.

47

Table of Contents

In the ordinary course of constructing our networks and providing our services, we must obtain and maintain a variety of telecommunications and other licenses and authorizations in the countries in which we operate, and rights-of-way from utilities, railroads, incumbent carriers and other persons. We also must comply with a variety of regulatory obligations. Due to the political and economic risks associated with the countries in which we operate, there can be no assurance we can maintain our licenses or that they will be renewed upon their expiration. Our failure to obtain or maintain necessary licenses, authorizations and rights-of-way, or to comply with the obligations imposed upon license holders including the payment of fees, in one or more countries, may cause sanctions or additional costs, including the revocation of authority to provide services in one or more countries.
In addition, our subsidiaries are defendants in several lawsuits that, among other things, challenge the subsidiaries’ use of rights-of-way. The plaintiffs have sought to have these lawsuits certified as class actions. It is possible that additional suits challenging use of our rights-of-way will be filed and those plaintiffs also may seek class certification. The outcome of such litigation may increase our costs and adversely affect our operating results.
Our operations around the world are subject to regulation at the regional level (for example, the European Union), the national level (for example, the FCC) and, often, at the state, provincial, and local levels. We also operate in some areas of the world without licenses, but only as permitted through relationships with locally licensed partners. Regulating telecommunications networks and services around the world varies widely. In some countries, the range of services we are legally permitted to provide may be limited, or may change. In other countries, existing telecommunications legislation is in development, is unclear or inconsistent, or is applied in an unequal or discriminatory fashion, or inadequate judicial, regulatory or other forums are available to address these inadequacies or disputes. Changes to existing regulations or rules, or the failure to regulate going forward in areas historically regulated on matters such as network neutrality, licensing fees, environmental, health and safety, privacy, intercarrier compensation, interconnection and other areas, in general or particular to our industry, may increase costs, restrict operations or decrease revenue. Our inability or failure to comply with the telecommunications and other laws and regulations of one or more countries in which we operate could cause the temporary or permanent suspension of operations in one or more countries. We also may be prohibited from entering certain countries at all or from providing all of our services in one or more countries. In addition, many countries in which we operate are conducting regulatory or other proceedings that will affect the implementation of their telecommunications legislation. We cannot be certain of the outcome of these proceedings. These proceedings may affect how we may provide our services in these countries and the level of fees and taxes payable to the government.
Termination of relationships with key suppliers could cause delay and additional costs.
Our business depends on third-party suppliers for fiber, computers, software, optronics, transmission electronics and related components and providers of network colocation facilities and right of way rights that are integrated into our network, some of which are critical to operating our business. If any of these critical relationships is terminated, a supplier either exits or curtails its business because of economic conditions, a supplier fails to provide critical rights of use, services or equipment, or the supplier is forced to stop providing services due to legal constraints, such as patent infringement, and we cannot reach suitable alternative arrangements quickly, we may experience significant additional costs or we may not be able to provide certain services to customers.
Our consolidated revenue is concentrated in a few customers.
Approximately 16% of our consolidated revenue is concentrated among our top ten customers at year end 2016. If we lost one or more of our major customers, or, if one or more of them significantly decreased or terminated orders for our services, our business could be materially and adversely affected.

48

Table of Contents

ILECs may not provide us local access services at prices that allow us to effectively compete.
We acquire a significant portion of our local access services, the connection between our owned network and the customer premises, from incumbent local exchange carriers or ILECs. The ILECs compete directly with our business and may have a tendency to favor themselves and their affiliates to our detriment. For instance, at the end of 2013, AT&T attempted to eliminate its longer term plans (and correspondingly larger discounts) used routinely by us to purchase certain local access services from AT&T. The price increases we would have seen as the result of losing these larger discounts, price increases we would have had little choice but to pass on to our customers, would have made competing with AT&T in its operating region more difficult. We and others objected to AT&T’s filings at the FCC, and following FCC intervention, AT&T withdrew these unilateral price increases. We cannot predict what AT&T may try next, and what other incumbent telephone companies may pursue.
Network access represents a very large portion of our total costs and if we face less favorable pricing and provisioning timeframes, we may be at a competitive disadvantage to the ILECs.
Sometimes it is expensive and difficult to switch new customers to our network, and lack of cooperation of incumbent carriers can slow the new customer connection process.
It is expensive, difficult and time-consuming for new customers to switch to our network if we require cooperation from the incumbent carrier where there is no direct connection between the customer and our network. Many of our principal competitors, the domestic and international incumbent carriers, are already established providers of local telephone services to all or virtually all telephone subscribers within their respective service areas. Their physical connections from their premises to those of their customers are expensive and difficult to duplicate. To complete the new customer provisioning process for a customer’s location not located on our network, we rely on the incumbent carrier to process certain information. The incumbent carriers have a financial interest in retaining their customers, which could reduce their willingness to cooperate with our new customer provisioning requests, thereby adversely affecting our ability to compete and increase revenue. Further consolidation of incumbent carriers with other telecommunications service providers may make these problems more acute.
We may be liable for the information that content owners or distributors distribute over our network.
The law relating to the liability of private network operators for information carried on or disseminated through their networks is still unsettled. While we disclaim any liability for third-party content in our services agreements, we may become subject to legal claims relating to the content disseminated on our network, even though such content is owned or distributed by our customers or a customer of our customers. For example, lawsuits may be brought against us claiming that material distributed using our network was inaccurate, offensive, or violated the law or the rights of others. Claims could also involve matters such as defamation, invasion of privacy and copyright infringement. In addition, the law remains unclear over whether content may be distributed from one jurisdiction, where the content is legal, into another jurisdiction, where it is not. Companies operating private networks have been sued in the past, sometimes successfully, based on the nature of material distributed, even if the content is not owned by the network operator and the network operator has no knowledge of the content or its legality. It is not practical for us to monitor all of the content distributed using our network. We may need to take costly measures to reduce our exposure to these risks or to defend ourselves against such claims.
We may not efficiently and effectively integrate future acquired operations and thus may not fully realize the anticipated benefits from those future acquisitions.
Achieving the anticipated benefits of any acquisitions depends in part upon whether we can integrate our businesses in an efficient and effective manner. We may acquire businesses in accordance

49

Table of Contents

with our business strategy. Integrating any acquired businesses involves several risks, including, but not limited to:
demands on management related to any significant increase in size after the acquisition;

the disruption of ongoing business and the diversion of management’s attention from the management of daily operations to management of integration activities;

failure to fully achieve expected synergies and costs savings;

unanticipated impediments in integrating departments, systems, including accounting systems, technologies, books and records, procedures and policies, and in maintaining uniform standards and controls, including internal control over financial reporting;

loss of customers or the failure of customers to order incremental services we expect them to order;

failure to provision services ordered by customers during the integration period;

higher integration costs than anticipated; and

difficulties in the assimilation and retention of highly qualified, experienced employees, many of whom may be geographically dispersed.

Successful integration of acquired businesses or operations depends on our ability to manage these operations, realize opportunities for revenue growth presented by strengthened service offerings and expanded geographic market coverage, obtain better terms from our vendors due to increased buying power, and eliminate redundant and excess costs to fully realize the expected synergies. Because of difficulties in combining geographically distant operations and systems which may not be fully compatible, we may not be able to achieve these objectives.
We cannot be certain that we will realize our anticipated benefits from our acquisitions, or that we can efficiently and effectively integrate acquired operations as planned.
Changes in regulations affecting commercial power providers may increase our costs.
In the normal course of business, we must contract with many providers of commercial power for our office, network, Gateway facilities, and colocation and data center facilities. Costs of obtaining commercial power comprise a significant component of our operating expenses. Changes in regulations that affect commercial power providers, particularly regulations related to the control of greenhouse gas emissions or other climate change related matters, could affect the costs of commercial power, which may increase the costs of providing our services.
Potential regulation of Internet service providers in the United States could adversely affect our operations.
In the United States, the FCC has, to date, treated Internet service providers as enhanced service providers. In addition, Congress has, to date, not sought to heavily regulate the provision of IP-based services. Both Congress and the FCC are considering proposals that involve greater regulation of IP-based service providers. Depending on the content and scope of any regulations, the imposition of such regulations could have a material adverse effect on our business and the profitability of our services.
The communications industry is highly competitive with participants with greater resources and a greater number of existing customers.

50

Table of Contents

The communications industry is highly competitive. Many of our existing and potential competitors have financial, personnel, marketing and other resources significantly greater than ours. Many have the added competitive advantage of a larger existing customer base. In addition, significant new or increased competition could arise because of:
the consolidation in the industry;

allowing foreign carriers to more extensively compete in the U.S. market;

further technological advances; and

further deregulation and other regulatory initiatives.

In addition, future significant competitors could include new entrants to the communications industry such as content companies that have existing significant customer bases and substantial cash resources that are greater than ours. If we cannot compete successfully, our business could be significantly affected.
Rapid technological changes can lead to further competition.
The communications industry is subject to rapid and significant changes in technology. In addition, the introduction of new services or technologies, and the further development of existing services and technologies, may reduce the cost or increase the supply of certain services similar to those that we provide. As a result, our most significant competitors in the future may be new entrants to the communications industry. These new entrants may not be burdened by an installed base of outdated equipment or obsolete technology. Our future success depends, in part, on our ability to anticipate and adapt in a timely manner to technological changes.
Our international operations and investments expose us to risks that could materially adversely affect the business.
We have operations and investments outside of the United States, and rights to undersea cable capacity extending to other countries, that expose us to risks inherent in international operations. These include:
general economic, social and political conditions;

the difficulty of enforcing agreements and collecting receivables through certain foreign legal systems;

tax rates in some countries may exceed those in the United States;

United States and other country tax laws may limit our ability to repatriate cash from non-U.S. affiliates without adverse tax consequences;

foreign currency exchange rates may fluctuate, which could adversely affect our results of operations and the value of our international assets and investments;

non-U.S. earnings may be subject to withholding requirements or the imposition of tariffs, exchange controls or other restrictions;

difficulties and costs of compliance with non-U.S. laws and regulations that impose restrictions on our investments and operations, with penalties for noncompliance, including loss of licenses and monetary fines;

51

Table of Contents


difficulties in obtaining licenses or interconnection arrangements on acceptable terms, if at all; and

changes in laws and regulations relating to non-U.S. trade and investment.

We are exposed to significant currency exchange rate risks and currency transfer restrictions and our results may suffer due to currency translations and remeasurements.
Certain of our current and prospective customers derive their revenue in currencies other than U.S. dollars but are invoiced by us in U.S. dollars. The obligations of customers with substantial revenue in foreign currencies may be subject to unpredictable and indeterminate increases if such currencies depreciate relative to the U.S. dollar. Furthermore, these customers may become subject to exchange control regulations restricting the conversion of their revenue currencies into U.S. dollars. In either event, the affected customers may not be able to pay us in U.S. dollars. Similarly, declines in the value of foreign currencies (such as the devaluation of the Brazilian real and the Argentine peso discussed below) relative to the U.S. dollar could adversely affect our ability to market our services to customers whose revenue is denominated in those currencies. In addition, where we issue invoices for our services in currencies other than U.S. dollars, our results of operations may suffer due to currency translations if such currencies depreciate relative to the U.S. dollar and we cannot or do not elect to enter into currency hedging arrangements regarding those payment obligations.
We conduct a portion of our business using the British pound, the euro and the Brazilian real. Appreciation of the U.S. dollar adversely affects our consolidated revenue. Since we tend to incur costs in the same currency in which those operations realize revenue, the effect on operating income and operating cash flow is largely mitigated. However, if the U.S. dollar appreciates significantly, future revenue, operating income and operating cash flows could be materially affected. In addition, the appreciation of the U.S. dollar relative to foreign currencies reduces the U.S. dollar value of cash balances held in those currencies.
Certain Latin American economies have experienced shortages in foreign currency reserves and have adopted restrictions on the use of certain mechanisms to expatriate local earnings and convert local currencies into U.S. dollars. Any of these shortages or restrictions may limit or impede our ability to transfer or to convert those currencies into U.S. dollars and to expatriate those funds. In addition, currency devaluations in one country may have adverse effects in another country.
Economic and political conditions in Latin America pose numerous risks to our operations.
Our business operations in the Latin American region constitute a significant portion of our business. As events in the Latin American region have demonstrated, negative economic or political developments in one country in the region can lead to or exacerbate economic or political instability elsewhere in the region. Furthermore, events in recent years in other developing markets have placed pressures on the stability of the currencies of several countries in Latin America in which we operate, including Argentina, Brazil and Colombia. While certain areas in the Latin American region have experienced economic growth, this recovery remains fragile. Pressures on local currencies are likely to have an adverse effect on our customers in this region. Volatility in regional currencies and capital markets could also have an adverse effect on our ability and that of our customers to gain access to international capital markets for necessary financing, refinancing and repatriation of earnings.
In addition, any changes to the political and economic conditions in certain Latin American countries could materially and adversely affect our business.

52

Table of Contents

Inflation and certain government measures to curb inflation in some Latin American countries may have adverse effects on their economies and our business and operations in those locations.
Some Latin American countries, including Brazil and Argentina, have historically experienced high rates of inflation. Inflation and some measures implemented to curb inflation have had significant negative effects on the economies of these countries. Governmental actions taken to curb inflation, coupled with speculation about possible future actions, have contributed to economic uncertainty at times in most Latin American countries. These countries may experience high levels of inflation in the future that could lead to further government intervention in the economy, including the introduction of government policies that could adversely affect our results of operations in those locations. In addition, if any of these countries experience high rates of inflation, we may not be able to adjust the price of our services sufficiently to offset the effects of inflation on our cost structures in those locations. A high inflation environment would also have negative effects on the level of economic activity and employment and adversely affect our business.
Our agreements with certain agencies of the U.S. Government impose significant requirements on us. Violating those agreements could have severe consequences.
We are a party to an agreement with the U.S. Departments of Homeland Security, Justice and Defense addressing the U.S. government’s national security and law enforcement concerns. This agreement imposes significant requirements on us related to information storage and management; traffic management; physical, logical, and network security arrangements; personnel screening and training; and other matters. We are also party to an agreement with the U.S. Department of Defense addressing the U.S. government’s national security concerns. This agreement imposes significant requirements on us related to the composition and qualifications of the Level 3 Communications, Inc. board of directors; the limitation of the influence or control over us of non-U.S. persons; physical, logical, and network security arrangements; and other matters.
While we expect to continue to comply fully with our obligations under both above-mentioned agreements, it is impossible to eliminate completely the risk of violating either. The consequences of violating these agreements could be severe, potentially including the revocation of our FCC licenses in the U.S., which would cause the cessation of our U.S. operations, and/or losing permissions required to do business with the U.S. Government.
We are subject to the U.S. Foreign Corrupt Practices Act (the “FCPA”) and other anticorruption laws, and our failure to comply therewith could cause penalties which could harm our reputation and have a material adverse effect on our business.
We are subject to the FCPA, which generally prohibits companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or keeping business and/or other benefits. Although we have policies and procedures designed to ensure that we, our employees and agents comply with the FCPA and other anticorruption laws, there can be no assurance that such policies or procedures will work effectively all of the time or protect us against liability for actions taken by our agents, employees and intermediaries regarding our business or any businesses we acquire.
We currently operate and in the future may operate in several jurisdictions that pose a high risk of potential anticorruption violations. If we do not comply with the FCPA and other laws governing the conduct of business with government entities (including local laws), we may be subject to criminal and civil penalties and other remedial measures. Any investigation of any potential violations of the FCPA or other anticorruption laws by U.S. or foreign authorities could have an adverse effect on our business.
The U.K. Bribery Act 2010 (the “Bribery Act”) reformed the United Kingdom (“U.K.”) law in relation to bribery and corruption. As well as containing provisions about bribery of public officials, the Bribery Act

53

Table of Contents

includes a criminal offense of failing to prevent bribery by relevant commercial organizations. This offense applies when any person associated with the organization offers or accepts bribery anywhere in the world intending to obtain or retain a business advantage for the organization or in the conduct of business. The Bribery Act has wide ranging implications in particular for business in the U.K., including our subsidiaries. However, it also has a wide-ranging extra-territorial effect. The Bribery Act is broader in scope than the FCPA because it directly addresses commercial bribery besides bribery of government officials and it does not recognize certain exceptions, notably facilitation payments permitted by the FCPA. Under the Bribery Act, it is a defense to the accusation of failure to prevent bribery for a commercial organization to show it had in place “adequate procedures” designed to prevent such acts.
As with the FCPA, if we do not comply with the Bribery Act and similar laws in the U.K. or elsewhere, such as The Federal Law n. 12.846/13, which is known as the “Brazilian Anti-corruption Law” that became effective on February 2, 2014, that apply to our business, we may be subject to criminal and civil penalties and other remedial measures.
Risks Related to Our Liquidity and Financial Resources
Disruptions in the financial markets could affect our ability to obtain debt or equity financing or refinance our existing indebtedness on reasonable terms (or at all), and have other adverse effects on us.
Disruptions in the commercial credit markets could cause a tightening of credit markets. The effects of recent credit market disruptions were widespread, and it is impossible to predict whether the improvement in the global credit markets will continue. Because of credit market turmoil, we may not obtain debt or equity financing or refinance our existing indebtedness on favorable terms (or at all), which could affect our strategic operations and our financial performance and force modifications to our operations.
If we cannot comply with the restrictions and covenants in our debt agreements, there would be a default under these agreements, and this could cause an acceleration of payment of funds borrowed.
If we were unable to comply with the restrictions and covenants in any of our debt agreements, there would be a default under those agreements. As a result, borrowings under other debt instruments that contain cross-acceleration or cross-default provisions may also be accelerated and become due and payable. If any of these events occur, there can be no assurance we could make necessary payments to the lenders or that we could find alternative financing. Even if we obtained alternative financing, there can be no assurance it would be on terms that are acceptable.
If we experience a change in control or certain other events, we may be unable to satisfy our obligations to repurchase our outstanding notes as required under our outstanding debt agreements.
Upon the occurrence of certain events defined in the various debt agreements relating to our outstanding debt, we are required to make an offer to purchase all of our outstanding notes at a purchase price generally equal to 101% of the principal amount of the notes, plus accrued and unpaid interest thereon (if any). In addition, if we must make an offer to purchase one of the outstanding issues of our notes, the debt agreements relating to our other issues of notes may require us to repurchase that other debt upon a change in control or termination of trading. We may not have or be able to borrow enough funds to pay the purchase price for all the notes tendered by holders seeking to accept the offer to purchase.
We have substantial debt, which may hinder our growth and put us at a competitive disadvantage.

54

Table of Contents

Our substantial debt may have important consequences, including:
the ability to obtain additional financing for acquisitions, working capital, investments and capital or other expenditures could be impaired or financing may not be available on acceptable terms;

a substantial portion of our cash flows will be used to make principal and interest payments on outstanding debt, reducing the funds otherwise available for operations and future business opportunities;

a substantial decrease in cash flows from operating activities or an increase in expenses could make it difficult to meet debt service requirements and force modifications to operations;
having more debt than certain of our competitors may place us at a competitive disadvantage; and

substantial debt may make us more vulnerable to a downturn in business or the economy generally.

We had a ratio of earnings to fixed charges of 2.3 for the year ended December 31, 2016, 1.4 for the year ended December 31, 2015 and 1.3 for the year ended December 31, 2014. We had substantial deficiencies of earnings to cover fixed charges of approximately $71 million and $374 million for the years ended December 31, 2013 and 2012, respectively.
We may not be able to repay our existing debt; failure to do so or refinance the debt could prevent us from implementing our strategy and realizing anticipated profits.
If we could not refinance our debt or to raise additional capital on acceptable terms, our ability to operate our business would be impaired. As of December 31, 2016, we had an aggregate of approximately $11.009 billion of current and long-term debt on a consolidated basis (excluding debt discounts and fair value adjustments), and approximately $10.917 billion of stockholders’ equity. Of the long-term debt, approximately $7 million is due to mature in 2017, $306 million is due to mature in 2018, $822 million is due to mature in 2019 and $1,804 million is due to mature in 2020, in each case excluding debt discounts and fair value adjustments. This information does not reflect the recent refinancing transaction completed by our wholly owned subsidiary, Level 3 Financing in the first quarter 2017.
Our ability to make interest and principal payments on our debt and borrow additional funds on favorable terms depends on the future performance of the business. If we do not have enough cash flow in the future to make interest or principal payments on our debt, we may have to refinance all or a part of our debt or to raise additional capital. We cannot be sure that we will be able to refinance our debt or raise additional capital on acceptable terms.
Restrictions and covenants in our debt agreements limit our ability to conduct our business and could prevent us from obtaining needed funds in the future.
Our debt and financing arrangements contain several significant limitations that restrict our ability to, among other things:
borrow additional money or issue guarantees;

pay dividends or other distributions to stockholders;

make investments;


55

Table of Contents

create liens on assets;

sell assets;

enter into sale-leaseback transactions;

enter into transactions with affiliates; and

engage in mergers or consolidations.
Risks Related to Our Common Stock
The unpredictability of our quarterly results may adversely affect the trading price of our common stock.
Our revenue and operating results will vary significantly from quarter to quarter due to several factors, many of which are outside of our control and any of which may cause the price of our common stock to fluctuate. The primary factors, among other things, that may affect our quarterly results include:
the timing of costs associated with operating our business and integration activities regarding any completed acquisitions;

demand for our services;

loss of customers or the ability to attract new customers;

changes in pricing policies or the pricing policies of our competitors;

costs related to acquisitions of technology or businesses;

changes in regulatory rulings; and

general economic conditions and those specific to the communications and related industries.

A delay in generating revenue or the timing of recognizing revenue and expenses could cause significant variations in our operating results from quarter to quarter. It is possible that in some future quarters our results may be below analysts’ and investors’ expectations. In these circumstances, the price of our common stock will likely decrease.
If certain transactions occur regarding our capital stock, we may be unable to fully utilize our net operating loss carry forwards, or NOLs, to reduce our U.S. federal income taxes.
As of December 31, 2016, we had NOLs of approximately $9 billion for U.S. federal income tax purposes (after taking into account the effects of Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”)). If certain transactions occur regarding our capital stock that result in a cumulative ownership change of more than 50 percentage points by 5% stockholders over a three-year period as determined under rules prescribed by the Code and applicable regulations, annual limitations would be imposed regarding our ability to utilize our NOLs and certain current deductions against any taxable income we achieve in future periods.
We have entered into transactions over the applicable three-year period that, when combined with other changes in ownership that are outside of our control, have resulted in cumulative changes in the ownership of our capital stock. Additional transactions we enter into, and transactions by existing 5% stockholders and transactions by holders that become new 5% stockholders that we do not participate in, could cause us to incur a 50 percentage point ownership change by 5% stockholders and, if we trigger

56

Table of Contents

the above noted Code imposed limitations, such transactions would prevent us from fully utilizing NOLs and certain current deductions to reduce our U.S. federal income taxes and could result in a substantial income tax expense to our consolidated statement of operations. In addition, these limitations could cause us not to pursue otherwise favorable acquisitions and other transactions involving our capital stock, or could reduce the net benefits to be realized from any such transactions.
In April 2011, we entered into the rights agreement to deter acquisitions of our common stock that might reduce our ability to use our NOLs. Under the rights agreement, from and after the record date of April 21, 2011, each share of our common stock carries with it one preferred share purchase right that could discourage a third-party from proposing a change of control or other strategic transaction concerning Level 3 or otherwise have the effect of delaying or preventing a change of control of Level 3 that other stockholders may view as beneficial.
In July 2014, the rights agreement was amended to provide that the rights issued under the rights agreement will expire at or prior to the earliest of:
October 31, 2017;

the time at which the rights are redeemed;

the time at which the rights are exchanged;

the time at which our board of directors determines that the NOLs are utilized in all material respects or that an ownership change under Section 382 of the Internal Revenue Code of 1986, as amended, would not adversely effect in any material respect the time period in which we could use the NOLs, or materially impair the amount of the NOLs we could use in any particular time period, for applicable tax purposes; or

a determination by our board of directors, prior to the date that the rights are distributed, that the rights agreement and the rights are no longer in our and our stockholders’ best interests.

Under our certificate of incorporation, we can issue more shares of our common stock than are currently outstanding. Such future issuances of our common stock may have a dilutive effect on the earnings per share and voting power of our stockholders.
Our certificate of incorporation, as currently in effect, authorizes us to issue to up to 433,333,333 shares of our common stock, which is a greater number of shares of common stock than are outstanding. If our Board of Directors elects to issue additional shares of common stock in the future, whether in public offerings, for mergers and acquisitions or otherwise, these additional issuances may dilute the earnings per share and voting power of our stockholders. Depending on the number of shares being issued and the particular circumstances, the Board of Directors may be able to complete a particular issuance without further stockholder action.
Anti-takeover provisions in our charter and by-laws could limit the share price and delay a change of management.
Our restated certificate of incorporation and by-laws contain provisions that could make it more difficult or even prevent a third-party from acquiring us without the approval of our incumbent Board of Directors. These provisions, among other things:
prohibit stockholder action by written consent in place of a meeting;

limit the right of stockholders to call special meetings of stockholders;


57

Table of Contents

limit the right of stockholders to present proposals or nominate directors for election at annual meetings of stockholders; and

authorize our board of directors to issue preferred stock in one or more series without any action on the part of stockholders.

In addition, the terms of most of our long-term debt require that upon a “change in control,” as defined in the agreements that contain the terms and conditions of the long-term debt, we make an offer to purchase the outstanding long term debt at either 100% or 101% of the aggregate principal amount of that long term debt.
These provisions could limit the price that investors might pay in the future for shares of our common stock and significantly impede the ability of the holders of our common stock to change management. Provisions and agreements that inhibit or discourage takeover attempts could reduce the market value of our common stock.
If a large number of shares of our common stock is sold in the public market, the sales could reduce the trading price of our common stock and impede our ability to raise future capital.
We cannot predict what effect, if any, future issuances by us of our common stock will have on the market price of our common stock. In addition, shares of our common stock we issue in connection with an acquisition may not be subject to resale restrictions. The market price of our common stock could drop significantly if certain large holders of our common stock, or recipients of our common stock in connection with an acquisition, sell all or a significant portion of their shares of common stock or are perceived by the market as intending to sell these shares other than in an orderly manner. In addition, these sales could impair our ability to raise capital through the sale of additional common stock in the capital markets.
The market price of our common stock has been volatile and, in the future, the market price of our common stock may fluctuate substantially due to many factors.
The market price of our common stock has been subject to volatility and, in the future, the market price of our common stock may fluctuate substantially due to many factors, including:
the depth and liquidity of the trading market for our common stock;

variations in actual or anticipated operating results;

changes in estimated results by securities analysts;

market conditions in the communications and information services industries;

announcement and performance by competitors;

regulatory actions; and

general economic conditions.

In addition, market fluctuations could have a material adverse effect on the market price or liquidity of our common stock.

58

Table of Contents

Other Risks
We have environmental liabilities from our historical operations.
There could be environmental liabilities arising from historical operations of our predecessors, for which we may be liable. Our operations and properties are subject to a wide variety of laws and regulations relating to environmental protection, human health and safety. These laws and regulations include those about the use and management of hazardous and non-hazardous substances and wastes. We have made and will continue to make significant expenditures relating to our environmental compliance obligations. Despite our best efforts, we may not at all times comply with all of these requirements.
In connection with certain historical operations, as of February 1, 2017, we have responded to or been notified of potential environmental liability at approximately 173 properties. We are engaged in addressing or have liquidated environmental liabilities at 89 of those properties. Of these: (a) we have formal commitments or other potential future costs at 23 sites; (b) there are nine sites with unknown future costs; and (c) there are 57 sites with no likely future costs. The remaining properties have been dormant for several years. We could potentially be held liable, jointly or severally, and without regard to fault, for the costs of investigation and remediation of these sites. The discovery of additional environmental liabilities related to historical operations or changes in existing environmental requirements could have a material adverse effect on our business.
We are exposed to legal proceedings and contingent liabilities that could result in material losses we have not reserved against.
We are party to various legal proceedings and are subject to certain important contingent liabilities described more fully in Note 15, “Commitments, Contingencies and Other Items,” to our consolidated financial statements included in this Form 10-K. If one or more of these legal proceedings or contingent liabilities were to be resolved in a manner adverse to us, we could suffer material losses. Certain of these contingent liabilities could have a material adverse effect on our business besides the effect of any potential monetary judgment or sanction against us. Furthermore, any legal proceedings, regardless of the outcome, could cause substantial costs and diversion of resources. Assets and entities we have acquired may be subject to unknown or contingent liabilities for which we may have no recourse, or only limited recourse to the entity from which the business was acquired (or its stakeholders).
Terrorist attacks and other acts of violence or war may adversely affect the financial markets and our business.
There can be no assurance there will not be future terrorist attacks. These attacks or armed conflicts may directly affect our physical facilities or those of our customers. These events could cause consumer confidence and spending to decrease or result in increased volatility in the U.S. and world financial markets and economy. Any of these occurrences could materially adversely affect our business.
The pension plans previously maintained by Global Crossing and regarding our operations before 1997 may require additional funding and negatively affects cash flows.
Certain North American and European hourly and salaried employees of Global Crossing are covered by defined benefit pension plans. On December 31, 1996, the North American plan was frozen and all employees hired thereafter are not eligible to participate in the plan. The U.K. plans were closed to new employees on December 31, 1999. The pension expense and required contributions to these pension plans are directly affected by the value of plan assets, the projected rate of return on plan assets, the actual rate of return on plan assets and the actuarial assumptions used to measure the defined benefit pension plan obligations. As of December 31, 2016, the projected benefit obligation under these pension plans and the pension plans regarding non-Global Crossing operations prior to 1997 was

59

Table of Contents

approximately $158 million ($69 million for U.S. plans and $89 million for U.K. plans) and the value of plan assets was approximately $136 million (approximately $67 million for U.S. plans and $69 million for U.K. plans), resulting in these pension plans being underfunded by $22 million. If plan assets perform below expectations, future pension expense and funding obligations will increase, which would have a negative effect on our cash flows from operations.
ITEM 1B.    UNRESOLVED STAFF COMMENTS
None.

ITEM 2. PROPERTIES
Our headquarters are located on 46 acres in the Interlocken Advanced Technology Environment within the City and County of Broomfield, Colorado. The campus facility, which we own, encompasses approximately 850,000 square feet of office space.
We also lease or own significant corporate office space in the following cities and lease smaller sales, administrative, and support offices around the world:
North America: Atlanta, Georgia; Littleton, Colorado; Miami, Florida; Montreal, Canada; New York, New York; Phoenix, Arizona; Pittsburgh, Pennsylvania; Southfield, Michigan; and Tulsa, Oklahoma

Europe: Basingstoke, England; Crewe, England; Dublin, Ireland; London, England; Amsterdam, The Netherlands; and Paris, France

Latin America: Bogota, Colombia; Buenos Aires, Argentina; Caracas, Venezuela; Lima, Peru; Quito, Ecuador; Santiago, Chile; and Sao Paulo, Brazil

Asia/Pacific: Hong Kong, China; Singapore and Tokyo, Japan

We own or lease numerous cable landing stations and telehouses throughout the world related to undersea and terrestrial cable systems. Furthermore, we own or lease properties to house and operate our fiber optic backbone and distribution network facilities, our point-to-point distribution capacity, as well as our switching equipment and connecting lines between other carriers’ equipment and facilities and the equipment and facilities of our customers. Our Gateway facilities are designed to house local sales staff, operational staff, our transmission and IP routing/switching facilities and technical space to accommodate colocation of equipment by high-volume Level 3 customers. We operate approximately 15.5 million square feet of space for our Gateway and technical or transmission facilities. Our Gateway space is either owned by and other properties relating to our network operations, see Item 1, “Business -- Our Communications Network.”
We have entered into various agreements regarding our unused office and technical space to reduce our ongoing operating expenses regarding such space.
Our existing properties are in good condition and are suitable for the conduct of our business.


60

Table of Contents

ITEM 3. LEGAL PROCEEDINGS
For information regarding legal proceedings in which we are involved, see Note 15, "Commitments, Contingencies and Other Items," to our Consolidated Financial Statements included in this Form 10-K.


ITEM 4. MINING SAFETY DISCLOSURES
Not applicable.

61

Table of Contents


Part II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information.

Our common stock is traded on the New York Stock Exchange under the symbol "LVLT." As of February 22, 2017, there were approximately 5,373 holders of record of our common stock, par value $.01 per share. The table below sets forth, for the calendar quarters indicated, the high and low per share closing sales prices of our common stock as reported by the NYSE Composite Tape for the quarters and the years indicated.

Year Ended December 31, 2016
 
High
 
Low
First Quarter
 
$
53.74

 
$
42.74

Second Quarter
 
54.21

 
47.43

Third Quarter
 
57.18

 
46.38

Fourth Quarter
 
57.20

 
45.09


Year Ended December 31, 2015
 
High
 
Low
First Quarter
 
$
55.46

 
$
47.02

Second Quarter
 
56.90

 
52.11

Third Quarter
 
54.16

 
41.57

Fourth Quarter
 
54.45

 
43.00


Equity Compensation Plan Information.

We have one equity compensation plan under which we may issue shares of our common stock to employees, officers, directors and consultants, which is called The Level 3 Communications, Inc. Stock Incentive Plan. In addition, in connection with our acquisition of Global Crossing, we assumed sponsorship of the 2003 Global Crossing Limited Stock Incentive Plan. Options outstanding under the 2003 Global Crossing Limited Stock Incentive Plan at the closing of the acquisition were automatically exchanged for options to purchase shares of our common stock. Since this plan’s term has expired, no shares remain for future issuances under this plan, but shares do remain for awards outstanding as of the expiration of the term. The following table provides information about the shares of our common stock that may be issued upon exercise of awards under the Level 3 Communications, Inc. Stock Incentive Plan (in the ‘‘Equity compensation plans approved by stockholders’’ category) and the 2003 Global Crossing Limited Stock Incentive Plan (in the ‘‘Equity compensation plans not approved by stockholders’’ category) as of December 31, 2016.


62

Table of Contents

Plan Category
 
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
 
 
 
Weighted-average
exercise price of
outstanding options,
warrants and rights
 
 
 
Number of securities
remaining available for
future issuance under
equity compensation plans
 
 
Equity compensation plans approved by stockholders
 
6,096,699

 
(1)
 
$

 
(3)
 
13,659,866

 
(1)
Equity compensation plans not approved by stockholders
 
85,523

 
(2)
 
$

 
(3)
 

 
 

(1) Includes restricted stock units and performance restricted stock units (‘‘PRSUs’’). For purposes of this table, each PRSU was assumed to be included at the maximum possible issuance of our common stock (which would be maximum target performance) from the total number of shares reserved for issuance under the Level 3 Communications, Inc. Stock Incentive Plan.

(2) The 2003 Global Crossing Limited Stock Incentive Plan provided for the granting of (i) stock options, (ii) stock appreciation rights and (iii) other stock based awards, including, without limitation, restricted stock units, to eligible participants. Amounts shown indicate the number of awards outstanding under the 2003 Global Crossing Limited Stock Incentive Plan at December 31, 2016.

(3) At December 31, 2016, there were no outstanding awards that included an ‘‘exercise price’’.


Dividend Policy.

Our current dividend policy, in effect since April 1, 1998, is to retain future earnings for use in our business. As a result, our directors and management do not anticipate paying any cash dividends on shares of our common stock in the foreseeable future. In addition, under certain of our debt covenants we may be restricted from paying cash dividends on shares of our common stock. We would also need to address any restrictions contained in the CenturyLink Merger agreement or obtain a waiver.

Performance Graph.

The following performance graph shall not be deemed to be incorporated by reference by means of any general statement incorporating by reference this annual report on Form 10-K into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent that we specifically incorporate such information by reference, and shall not otherwise be deemed filed under such acts.

The performance graph compares the cumulative total return of our common stock for the five year period from 2012 through 2016 with the S&P® 500 Index and the Nasdaq Telecommunications Index. The performance graph assumes that the value of the investment was $100 on December 31, 2011, and that all dividends and other distributions were reinvested.


63

Table of Contents

Comparison of Five Year Cumulative Total Return
Among Our Common Stock, the S&P® 500 Index
and the Nasdaq Telecommunications Index

lvlt12311610kcharta01a04.jpg


 
12/11
 
12/12
 
12/13
 
12/14
 
12/15
 
12/16
Level 3 common stock
$
100.00

 
$
136.02

 
$
195.23

 
$
290.64

 
$
319.95

 
$
331.72

S&P 500® Index
100.00

 
113.41

 
146.98

 
163.72

 
162.53

 
178.02

NASDAQ Telecommunications
100.00

 
102.00

 
126.50

 
137.77

 
127.44

 
146.39





64

Table of Contents

ITEM 6. SELECTED FINANCIAL DATA

The Selected Financial Data of Level 3 Communications, Inc. and its subsidiaries appear below.

 
Year Ended December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
(dollars in millions, except per share amounts)
Results of Operations:
 
 
 
 
 
 
 
 
 
Revenue (1)
$
8,172

 
$
8,229

 
$
6,777

 
$
6,313

 
$
6,376

Net Income (Loss) (2)
677

 
3,433

 
314

 
(109
)
 
(422
)
Per Common Share:
 
 
 
 
 
 
 
 
 
Net Income (Loss) - Basic (2)
1.89

 
9.71

 
1.23

 
(0.49
)
 
(1.96
)
Net Income (Loss) - Diluted (2)
1.87

 
9.58

 
1.21

 
(0.49
)
 
(1.96
)
Dividends declared (3)

 

 

 

 

 
 
 
 
 
 
 
 
 
 
Financial Position:
 
 
 
 
 
 
 
 
 
Total Assets (6)
$
24,888

 
$
24,017

 
$
20,802

 
$
12,754

 
$
13,174

Current portion of long-term debt (4)
7

 
15

 
349

 
31

 
216

Long-Term Debt, less current portion (4) (6)
10,877

 
10,866

 
10,839

 
8,211

 
8,383

Stockholders' Equity (5)
10,917

 
10,126

 
6,363

 
1,411

 
1,171


(1)
On October 31, 2014, we completed the acquisition of tw telecom inc. ("tw telecom"). During 2014, we recorded revenue attributable to tw telecom of approximately $285 million.

(2)
In 2012, we recognized a $160 million loss on modification and extinguishment of debt as a result of the refinancing of the $650 million Tranche B II Term Loan and $550 million Tranche B III Term Loan in October 2012, the refinancing of the $1.4 billion Tranche A Term Loan in August 2012 and the repayment of existing vendor financing obligations, the redemption of the 8.75% Senior Notes due 2017 in August 2012, the redemption of the 9.25% Senior Notes due 2014 in February 2012 and the exchange of a portion of the 15% Convertible Senior Notes due 2013 in March 2012. We also recognized $34 million of restructuring charges. We completed an updated analysis and revised our estimated future cash flows of our asset retirement obligations as a result of a strategic review of our real estate portfolio in the fourth quarter of 2012. As a result, we reduced our asset retirement obligations liability by $73 million with an offsetting reduction to property, plant and equipment of $24 million, selling, general and administrative expenses of $47 million and depreciation and amortization of $2 million. In addition, as a result of the refinancing of the Tranche A Term Loan in 2012, two interest rate swap agreements maturing in early 2014 that had effectively hedged changes in the interest rate on a portion of the Tranche A Term Loan were deemed "ineffective" under GAAP. We recognized a non-cash loss on the agreements of approximately $60 million (excluding accrued interest), which represented the cumulative loss recorded in Accumulated Other Comprehensive Income (Loss) ("AOCI") at the date the instruments ceased to qualify as hedges.

In 2013, we recognized an $84 million loss on modification and extinguishment of debt as a result of refinancing our $815 million Tranche B 2019 Term Loan and $595.5 million Tranche B 2016 Term Loan in August 2013, our $1.2 billion Tranche B-II 2019 Term Loan in October 2013 and our $640 million 10% Senior Notes due 2018 and $300 million Floating Rate Senior Notes due 2015 in December 2013. Additionally, we incurred $47 million of restructuring charges.


65

Table of Contents

In 2014, we issued $600 million aggregate principal amount of our 5.75% Senior Notes due 2022. The net proceeds from the offering of the notes, together with cash on hand, were used to redeem the $605 million aggregate principal amount outstanding of our 11.875% Senior Notes due 2019. We recognized a debt extinguishment loss of $53 million associated with this transaction during the fourth quarter of 2014.

In 2014, we also recognized a $100 million income tax benefit primarily related to the release of a foreign deferred tax valuation allowance.

In 2015, we redeemed Level 3 Financing's 9.375% Senior Notes due 2019 together with cash on hand, from the issuance on January 29, 2015 of its 5.625% Senior Notes due 2023. We recognized a loss on extinguishment of debt of $36 million associated with this transaction in the second quarter of 2015. Level 3 Financing also issued $700 million aggregate principal amount of its 5.125% Senior Notes due 2023 and $800 million aggregate principal amount of its 5.375% Senior Notes due 2025. The net proceeds from the offering of these notes together with cash on hand, were used to redeem all $1.2 billion aggregate principal amount of Level 3 Financing's 8.125% Senior Notes due 2019 and all $300 million aggregate principal amount of our 8.875% Senior Notes due 2019. In the second quarter 2015, we recognized a loss on extinguishment of debt of $100 million as a result of these redemptions. Level 3 Financing completed the refinancing of its $2 billion senior secured Tranche B Term Loan due 2022 with an aggregate $2 billion principal amount of a new senior secured Tranche B-II 2022 Term Loan. In the second quarter of 2015, we recognized a loss on modification and extinguishment of debt of $27 million as a result of this refinancing. In the fourth quarter 2015, Level 3 Financing issued $900 million aggregate principal amount of its 5.375% Senior Notes due 2024. The net proceeds from the offering of the 5.375% Senior Notes due 2024, together with cash on hand, were used to redeem all $900 million aggregate principal amount of our 8.625% Senior Notes due 2020. We recognized a loss on modification and extinguishment of debt of approximately $55 million associated with this transaction during the fourth quarter of 2015.

Effective September 30, 2015, we deconsolidated our Venezuelan subsidiary from our consolidated financial statements. This change resulted in a one-time charge of $171 million, which includes $83 million of bolivar denominated cash and $40 million of intercompany receivables from our Venezuelan subsidiary during the third quarter 2015.

In the fourth quarter of 2015, with the continued expectation of generating income before taxes in the United States, we released a significant portion of our valuation allowance against our net U.S. federal and state deferred tax asset position. The release of the valuation allowance benefited income tax expense and net income by approximately $3.3 billion.

On April 21, 2016, all of the outstanding principal amount of the 7% Senior Notes Due 2020 was redeemed at a redemption price equal to 104.138% of the principal amount, along with accrued and unpaid interest to but excluding the redemption date. To fund the redemption of these notes, Level 3 Financing used the net proceeds, along with cash on hand, from the March 22, 2016, issuance of its 5.25% Senior Notes due 2026. We recognized a loss on modification and extinguishment of debt of approximately $40 million in Other Expense in the second quarter of 2016 as a result of the redemption of the 7% Senior Notes due 2020.

In 2016, we recognized a $22 million income tax benefit from the vesting of stock based compensation due to the adoption of ASU 2016-09, Improvements to Employee Share-Based Payment Accounting.

In 2016, we recognized an estimated one-time $110 million income tax benefit related to the issuance of new regulations under Internal Revenue Code Section 987 addressing the taxation of foreign currency translation gains and losses arising from foreign branches.


66

Table of Contents

In 2016, we recognized an $82 million income tax benefit related to the release of deferred tax valuation allowances primarily in Germany, Brazil, and Mexico.

In 2016 we recognized a $24 million income tax expense related to income tax rate changes.

(3)
Our current dividend policy, in effect since April 1998, is to retain future earnings for use in our business. As a result, management does not anticipate paying cash dividends on shares of common stock in the foreseeable future. In addition, we are restricted under certain debt-related covenants from paying cash dividends on shares of our common stock. We would also need to address any restrictions contained in the CenturyLink Merger agreement or obtain a waiver of those restrictions.

(4)
In 2012, we refinanced our existing $650 million Tranche B II Term Loan and $550 million Tranche B III Term Loan under our existing senior secured credit facility through the creation of a new term loan in the aggregate principal amount of $1.2 billion (the "Tranche B-II 2019 Term Loan") along with cash on hand. We also fully repaid the outstanding principal amount of our Commercial Mortgage due 2015 along with accrued interest which was approximately $63 million. Also in 2012, we completed the offering of $300 million aggregate principal amount of our 8.875% Senior Notes due 2019 in a private offering. The net proceeds from that offering were used for general corporate purposes, including the repurchase, redemption, repayment or refinancing of our and our subsidiaries' existing indebtedness. Additionally in 2012, we completed the offering of $775 million aggregate principal amount of our 7% Senior Notes due 2020 in a private offering. The net proceeds from the offering of the notes, along with cash on hand, were used to redeem all of our outstanding 8.75% Senior Notes due 2017, including the payment of accrued and unpaid interest and applicable premiums. We refinanced our existing $1.4 billion Tranche A Term Loan under our existing senior secured credit facility through the creation of new term loans in the aggregate principal amount of $1.415 billion (the "New Term Loans") along with cash on hand and used the remaining net proceeds to repay $15 million in principal amount plus a premium for existing vendor financing obligations. Further in 2012, we exchanged approximately $100 million aggregate principal amount of our outstanding 15% Convertible Senior Notes due 2013 for approximately 5.4 million shares of our common stock, including an inducement premium. Also in 2012, We issued $900 million aggregate principal amount of our 8.625% Senior Notes due 2020. A portion of the net proceeds from the offering were used to redeem all of our outstanding 9.25% Senior Notes due 2014 in aggregate principal amount of $807 million.

In 2013, we repaid at maturity approximately $172 million of our 15% Convertible Senior Notes due 2013. We also refinanced our existing $815 million Tranche B 2019 Term Loan through the creation of the $815 million Tranche B-III 2019 Term loan. We also refinanced our $595.5 million Tranche B 2016 Term Loan and $1.2 billion Tranche B-II 2019 Term Loan through the creation of a new term loan in the aggregate principal amount of $1.796 billion (the "Tranche B 2020 Term Loan"). Additionally, we completed the offering of $640 million aggregate principal amount of our 6.125% Senior Notes due 2021. The proceeds from the offering, together with cash on hand, were used to redeem all of the outstanding 10% Senior Notes due 2018. Also in 2013, we completed the offering of $300 million aggregate principal amount of our Floating Rate Senior Notes due 2018. The net proceeds of these notes, together with cash on hand, were used to redeem all of the outstanding Floating Rate Notes due 2015. Finally in 2013, the holders of approximately $200 million aggregate principal amount of our outstanding 6.5% Convertible Senior Notes due 2016 converted these notes for approximately 10.8 million shares of our common stock. The remaining $1 million principal amount of our 6.5% Convertible Senior Notes due 2016 was redeemed with cash on hand.

In 2014, Level 3 Escrow II, Inc. issued $1.0 billion in aggregate principal amount of its 5.375% Senior Notes due 2022 (the “5.375% Senior Notes due 2022”). The 5.375% Senior Notes due 2022 were assumed by Level 3 Financing, Inc., our direct wholly owned subsidiary, and the proceeds were used to refinance certain existing indebtedness of tw telecom. Additionally, we entered into a ninth amendment agreement to the Existing Credit Agreement to incur $2.0 billion in aggregate

67

Table of Contents

borrowings under the Existing Credit Agreement through the creation of a new Tranche B 2022 Term Loan (the "Tranche B 2022 Term Loan"). The net proceeds from both the 5.375% Senior Notes due 2022 and the Tranche B 2022 Term Loan were used to finance the cash portion of the consideration payable to tw telecom stockholders and to refinance certain existing indebtedness of tw telecom, including fees and premiums, in connection with the closing of the tw telecom acquisition. Further, in 2014, we issued a total of $600 million aggregate principal amount of our 5.75% Senior Notes due 2022 (the “5.75% Senior Notes”). The net proceeds from the offering of the 5.75% Senior Notes, together with cash on hand were used to redeem all of our outstanding 11.875% Senior Notes due 2019. In 2014, we issued approximately 5 million shares of common stock when holders of approximately $142 million of our 7% Convertible Senior Notes due 2015 converted these notes.

Refer to Note 10 - Long-Term Debt in the notes to the Consolidated Financial Statements for our offerings and refinancings in 2016 and 2015.

Long-term debt, less current portion includes capital lease obligations. Refer to "Contractual Obligations" within Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations for further discussion of our total obligations.

(5)
In 2012, we issued approximately 5.4 million shares of common stock, including an inducement premium, in exchange for approximately $100 million aggregate principal amount of our outstanding 15% Convertible Senior Notes due 2013.

In 2013, we issued approximately 10.8 million shares of common stock when holders of approximately $200 million of our 6.5% Convertible Senior Notes due 2016 converted these notes.

In 2014, we issued approximately 5 million shares of common stock when holders of approximately $142 million of our 7% Convertible Senior Notes due 2015 converted these notes.

In 2014, as a result of the tw telecom acquisition, we issued approximately 96.9 million shares of our common stock to former holders of tw telecom common shares, stock options, restricted stock unit awards and restricted stock units.

In 2015, we issued approximately 12 million shares of common stock when holders of the remaining $333 million of our 7% Convertible Senior Notes due 2015 converted these notes.

In 2016, we adopted ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which required adjustments to be reflected as of January 1, 2016. Upon adoption, we recognized previously unrecognized excess tax benefits using the modified retrospective transition method, which resulted in a cumulative-effect adjustment of $42 million recorded to accumulated deficit as of January 1, 2016.

(6)
Reflects retrospective application of the requirements of ASU 2015-03 “Simplifying the Presentation of Debt Issuance Costs”.


68

Table of Contents

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our Consolidated Financial Statements (including the notes thereto) included elsewhere herein and the description of our business in Item 1, "Business".


Executive Summary

Overview

We are a facilities-based provider of a broad range of communications services. Revenue for communications services is generally recognized on a monthly basis as these services are provided. For contracts involving private line, wavelength and dark fiber services, we may receive upfront payments for services to be delivered for a period of generally up to 25 years. In these situations, we defer the revenue and amortize it on a straight-line basis to earnings over the term of the contract. At December 31, 2016, for contracts where upfront payments were received for services to be delivered in the future, our weighted average remaining contract period was approximately 12 years.

On October 31, 2016, we entered into an agreement and plan of merger (the "Merger Agreement") with CenturyLink, Inc., a Louisiana corporation ("CenturyLink"), Wildcat Merger Sub 1 LLC, a Delaware limited liability company and an indirect wholly owned subsidiary of CenturyLink ("Merger Sub 1"), and WWG Merger Sub LLC, a Delaware limited liability company and an indirect wholly owned subsidiary of CenturyLink ("Merger Sub 2"), pursuant to which, subject to the satisfaction or waiver of the conditions set forth in the Merger Agreement, we will be acquired by CenturyLink in a cash and stock transaction, including the assumption of our debt (the "CenturyLink Merger").

As of September 30, 2015, we deconsolidated our Venezuelan subsidiary and began accounting for our investment in that subsidiary using the cost method of accounting in the fourth quarter of 2015. This change resulted in a one-time charge of $171 million to adjust the Venezuelan subsidiary's assets and liabilities to estimated fair value in the third quarter of 2015. Our financial results do not include the operating results of our Venezuelan subsidiary subsequent to September 30, 2015. Any dividends from our Venezuelan subsidiary are recorded as other income upon receipt of the cash. Please see Note 1 to the accompanying Consolidated Financial Statements and additional discussion in this Management's Discussion and Analysis of Financial Condition and Results of Operations under "Venezuela Effects" in Results of Operations.

On October 31, 2014, we completed the acquisition of tw telecom inc. (“tw telecom”) and tw telecom became our indirect, wholly owned subsidiary through a tax-free, stock and cash reorganization.

We pursue the strategies discussed in Item 1. Business, "Business Overview and Strategy." In particular, with respect to strategic financial objectives, we focus our attention on the following:

growing revenue by increasing sales generated by our Core Network Services;

focusing on our Enterprise customers, as this customer group has the largest potential for growth;

continually improving the customer experience to increase customer retention and reduce customer churn;

launching new products and services to meet customer needs, in particular for enterprise customers;


69

Table of Contents

improving profitability by reducing network costs and operating expenses;

achieving and maintaining sustainable generation of positive cash flows from operations;

continuing to show improvement in Adjusted EBITDA (as defined in this Item below) as a percentage of revenue;

localizing certain decision-making and interaction with our mid-market enterprise customers, including leveraging our existing network assets;

concentrating our capital expenditures on those technologies and assets that enable us to develop our Core Network Services;

managing Wholesale Voice Services for profit contribution; and

refinancing our future debt maturities.

Our management continues to review all existing lines of business and service offerings to determine how they enhance our focus on the delivery of communications services and meeting our financial objectives. To the extent that certain lines of business or service offerings are not considered to be compatible with the delivery of our services or with meeting our financial objectives, we may exit those lines of business or stop offering those services in part or in whole.

We have also been focused on improving our liquidity and financial condition, and extending the maturity dates of certain debt. See Note 10 - Long-Term Debt in the notes to the Consolidated Financial Statements.

We will continue to look for opportunities to improve our financial position and focus our resources on growing revenue and managing costs for the business.

Our management reporting structure reflects the way in which we allocate resources and assess performance. Our reportable segments consist of: 1) North America; 2) EMEA; and 3) Latin America.

Total Revenue consists of:

Core Network Services revenue from Internet Protocol ("IP") and data services; transport and fiber; local and enterprise voice services; colocation and data center services; and security services.

Wholesale Voice Services revenue from sales of long distance voice services to wholesale customers.

Core Network Services revenue represents higher profit services and Wholesale Voice Services revenue represents lower profit services. Core Network Services revenue requires different levels of investment and focus and provides different contributions to our operating results than Wholesale Voice Services revenue. Management believes that growth in revenue from our Core Network Services is critical to the long-term success of our business. We also believe we must continue to effectively manage the profitability of the Wholesale Voice Services revenue. We believe performance in our communications business is best gauged by analyzing revenue changes in Core Network Services.


70

Table of Contents

Core Network Services

IP and data services primarily include our Internet services, Virtual Private Network ("VPN"), Content Delivery Network ("CDN"), media delivery, Vyvx broadcast and Managed Services. Our IP and high speed IP service is high quality and is offered in a variety of capacities. Our VPN service permits businesses of any size to replace multiple networks with a single, cost-effective solution that greatly simplifies the converged transmission of voice, video, and data. This convergence to a single platform can be obtained without sacrificing the quality of service or security levels of traditional ATM and frame relay offerings. VPN service also permits customers to prioritize network application traffic so that high priority applications, such as voice and video, are not compromised in performance by the flow of low priority applications such as email.

Growth in transport (such as private line and wavelengths) and fiber revenue is largely dependent on increased demand for bandwidth services and available capital of companies requiring communications capacity for their own use or in providing capacity as a service provider to their customers. These expenditures may be in the form of monthly payments or, in the case of private line, wavelength or dark fiber services, either monthly payments or upfront payments. We are focused on providing end-to-end transport and fiber services to our customers to directly connect customer locations with a private network.

Voice services comprise a broad range of local and enterprise voice services using Voice over Internet Protocol ("VoIP") and traditional circuit-switch based technologies, including VoIP enhanced local service, SIP Trunking, local inbound service, Primary Rate Interface service, long distance service and toll-free service. Our voice services also include our comprehensive suite of audio, Web and video collaboration services.

Colocation and data center services allow customers to place their network equipment and servers in suitable environments maintained by us with high-speed links providing on-net access to more than 60 countries. These services are secure, redundant and flexible to fit the varying needs of our customers. Services, which vary by location, include hosting network equipment used to transport high speed data and voice over our global network; providing managed IT services, installation, maintenance, storage and monitoring of enterprise services; and providing comprehensive IT outsource solutions.

Security Services can be used to enable customers to address the growing threat of cyber-attack and allow customers to create a secure network, safeguard brand value, enable business continuity, and avoid complexity and cost. Our Security Services include: Secure Access which provides secure and encrypted connectivity for mobile users or remote offices; Cloud and Premises based Managed Firewall and Unified Threat Management Services including Intrusion Prevention and Detection service and Web Content filtering; network-based Distributed Denial of Service (DDoS) Mitigation, which protects against Internet based DDoS attacks; and Security Consulting services for Governance, Risk Management and Compliance. Security Services are sold stand-alone or in conjunction with Data Services.

We believe a source of future incremental demand for our Core Network Services will be from customers that are seeking to distribute their feature rich content or video over the Internet. Revenue growth in this area is dependent on the continued increase in demand from customers and the pricing environment. An increase in the reliability and security of information transmitted over the Internet and declines in the cost to transmit data have resulted in increased utilization of e-commerce or Web-based services by businesses. Although the pricing for data services is currently relatively stable, the IP market is generally characterized by price compression and high unit growth rates depending upon the type of service. We have continued to experience price compression in the high-speed IP and voice services markets.


71

Table of Contents

The following provides a discussion of our Core Network Services revenue in terms of the enterprise and wholesale channels.

The enterprise channel includes large, multi-national enterprises requiring large amounts of bandwidth to support their business operations, such as financial services companies, healthcare companies, content providers, and portal and search engine companies. It also includes medium-sized enterprises, regional service providers, as well as government markets, the U.S. federal government, the systems integrators supporting the U.S. federal government, U.S. state and local governments, academic consortia, and certain academic institutions.

The wholesale channel includes revenue from incumbent and alternative carriers in each of the regions, global carriers, wireless carriers, cable companies, satellite companies and voice service providers.

We believe the alignment of Core Network Services around channels should allow us to drive growth while enabling us to better focus on the needs of our customers. Each of these channels is supported by dedicated employees in sales. Each of these channels is also supported by non-dedicated, centralized service delivery and management, product management and development, corporate marketing, global network services, engineering, information technology, and corporate functions, including legal, finance, strategy and human resources.

Wholesale Voice Services

We offer wholesale voice services that target large and existing markets. The revenue potential for wholesale voice services is large; however, pricing is expected to continue to decline over time as a result of the new low-cost IP and optical-based technologies. In addition, the market for wholesale voice services is being targeted by many competitors, several of which are larger and have more financial resources than us.

Seasonality and Fluctuations

We continue to expect business fluctuations to affect sequential quarterly trends in revenue, costs and cash flow. This includes the timing, as well as any seasonality of sales and service installations, usage, rate changes and repricing for contract renewals. Historically, our revenue and expense in the first quarter has been affected by the slowing of our customers' purchasing activities during the holidays and the resetting of payroll taxes in the new year. We conduct a portion of our business in currencies other than the U.S. dollar, the currency in which our Consolidated Financial Statements are reported. Accordingly, our operating results could also be adversely affected by foreign currency exchange rate volatility relative to the U.S. dollar. Our historical experience with quarterly fluctuations may not necessarily be indicative of future results.
 
Because revenue subject to billing disputes where collection is uncertain is not recognized 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 disconnection may also affect our results in a particular quarter, with disconnection early in the quarter generally having a greater effect. The timing of capital and other expenditures may affect our costs or cash flow. The convergence of any of these or other factors such as fluctuations in usage, increases or decreases in certain taxes and fees or pricing declines upon contract renewals in a particular quarter may result in our revenue growing more or less than previous trends, may affect our profitability and other financial results and may not be indicative of future financial performance. We also establish appropriate reserves for disputes of incorrect network access cost billings from our suppliers of network services, which may include disputes for circuits that are not disconnected by the supplier on a timely basis, charges from suppliers for circuits that were not timely installed and incorrect rate or other inadequate information needed to determine the appropriate billing from the supplier. The network access cost reserves for disputed supplier billings are based on an analysis of our

72

Table of Contents

historical experience in resolving disputes with our suppliers and regulatory analysis regarding certain specific supplier billing matters. The timing and ultimate outcome of the dispute resolution process could differ from our initial estimates and these differences could be material.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, equity, revenue, expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We evaluate these estimates on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.

While we have other accounting policies that involve estimates such as the allowance for doubtful accounts and unfavorable contracts recognized in acquisition accounting, management has identified the policies below, which require the most significant judgments and estimates to be made in the preparation of the Consolidated Financial Statements, as critical to our business operations and the understanding of our results of operations.

Revenue

Revenue is recognized monthly as the services are provided based on contractual amounts expected to be collected. Communications services are provided either on a usage basis, which can vary period to period, or at a contractually committed amount.

For certain sale and long-term indefeasible right of use ("IRU") contracts involving private line, wavelengths and dark fiber services, we may receive upfront payments for services to be delivered for a period of up to 25 years. In these situations, we defer the revenue and amortize it on a straight-line basis to earnings over the term of the contract.

Termination revenue is recognized when a customer disconnects service prior to the end of the contract period and for which we had previously received consideration and for which revenue recognition was deferred. Termination revenue is also recognized when customers make termination penalty payments to us to settle contractually committed purchase amounts that the customer no longer expects to meet or when a customer renegotiates a contract with us under which we are no longer obligated to provide product or services for consideration previously received and for which revenue recognition has been deferred. Termination revenue is reported in the same manner as the original product or service provided.

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers, which amended the existing accounting standards for revenue recognition and requires an entity to recognize the amount of revenue it expects to be entitled to for the transfer of promised goods or services to customers. The ASU and subsequent amendments have been codified as ASC 606, Revenue from Contracts with Customers (“ASC 606”). In July 2015, the FASB deferred the effective date to annual reporting periods beginning after December 15, 2017, and interim reporting periods within those periods. Early adoption is permitted using the original effective date of annual reporting periods beginning after December 15, 2016, and interim reporting periods within those periods. The new guidance may be applied retrospectively to each prior period presented or prospectively with the cumulative effect recognized as of the date of initial adoption. We will not adopt ASC 606 early.


73

Table of Contents

We are performing a comprehensive analysis of our revenue streams and contractual arrangements to identify the effects of ASC 606 on our consolidated financial statements and are developing new accounting and reporting policies, business and internal control processes and procedures to facilitate adoption of the standard. Because we currently have service contracts that contain a significant financing component that are not currently separately accounted for, we will be required to estimate and record incremental revenue and interest cost associated with these contractual terms. In addition, we will be required to capitalize, and subsequently amortize, commission costs associated with obtaining or fulfilling our customer contracts, which we do not currently defer and amortize. We will also have to comply with new revenue disclosure requirements. We are continuing to review and evaluate underlying contract information that will be used to support new accounting and disclosure requirements under ASC 606 and evaluate other matters that may result from adoption of the standard. We have not yet selected a transition method, as our method of transition may be affected by the CenturyLink Merger, which we expect will be completed in the third quarter of 2017, and subsequent integration activities completed prior to the January 1, 2018 ASC 606 adoption date.

Revenue Reserves

We establish appropriate revenue reserves at the time services are rendered based on an analysis of historical credit activity to address, where significant, situations in which collection is not reasonably assured as a result of credit risk, potential billing disputes or other reasons. Our significant estimates are based on assumptions and other considerations, including payment history, credit ratings, customer financial performance and history of billing disputes.

Network Access Cost Reserves

We dispute incorrect billings from our suppliers of network services. The most prevalent types of disputes include disputes for circuits that are not disconnected by the supplier on a timely basis, charges from suppliers for circuits that were not timely installed and incorrect rate or other inadequate information needed to determine the appropriate billing from the supplier. Depending on the type and complexity of the issues involved, it may and often does take several quarters to resolve the disputes. We establish appropriate network access cost reserves for disputed supplier billings based on an analysis of our historical experience in resolving disputes with our suppliers and regulatory analysis regarding certain supplier billing matters. Judgment is required in estimating the ultimate outcome of the dispute resolution process, as well as any other amounts that may be incurred to conclude the negotiations or settle any litigation. Actual results may differ from these estimates under different assumptions or conditions and such differences could be material.

Valuation of Long-Lived Assets

We perform an assessment of our long-lived assets, including finite-lived intangible assets, for impairment when events or changes in circumstances indicate that the carrying value of assets or asset groupings may not be recoverable. This review requires the identification of the lowest level of identifiable cash flows for purposes of grouping assets subject to review. The estimate of undiscounted cash flows includes long-term forecasts of revenue growth and operating expenses. All of these items require significant judgment and assumptions. An impairment loss may exist when the estimated undiscounted cash flows attributable to the assets are less than their carrying amount. If an asset is deemed to be impaired, the amount of the impairment loss recognized represents the excess of the long-lived asset's carrying value as compared to its estimated fair value, based on management's assumptions and projections.

We conducted a long-lived asset impairment analysis in the fourth quarter of 2016 and 2015 and in each case concluded that our long-lived assets, including our finite-lived intangible assets, were not impaired. To the extent that future changes in assumptions and estimates cause a change in estimates of future cash flows that indicate the carrying amount of our long-lived assets, including finite-lived intangible

74

Table of Contents

assets, may not be recoverable, we may incur impairment charges in the future to write-down the carrying amount of our long-lived assets to their estimated fair value.

Useful Lives of Long-Lived Assets

We perform internal reviews to evaluate the depreciable lives of our property, plant and equipment annually or more frequently if new facts and circumstances arise that may affect management's original estimates. Due to the rapid changes in technology and the competitive environment, selecting the estimated economic life of telecommunications property, plant, and equipment requires a significant amount of judgment. Our internal reviews take into account input from our global engineering and network services personnel, actual usage, the physical condition of our property, plant, and equipment, industry data, and other relevant factors.

Goodwill and Indefinite-Lived Intangible Assets

We perform an annual impairment assessment of our goodwill and intangible assets with indefinite useful lives during the fourth quarter, or more frequently if we determine that indicators of impairment exist. Our impairment review process considers the fair value of each reporting unit relative to its carrying value. We assess the fair value of each of our reporting units using an income approach (also known as a discounted cash flow) and a market multiple approach. The income approach utilizes cash flow projections discounted using an appropriate Weighted Average Cost of Capital (WACC) rate for each reporting unit. The market multiple approach uses a multiple of a company’s Earnings Before Interest, Taxes, and Depreciation and Amortization expenses (EBITDA).

If the fair value of the reporting unit exceeds its carrying value, goodwill is not impaired and no further testing is performed. If the carrying value of the reporting unit exceeds its fair value, then a second step must be performed, and the implied fair value of the reporting unit's goodwill must be determined and compared to the carrying value of the reporting unit's goodwill. If the carrying value of a reporting unit's goodwill exceeds its implied fair value, then an impairment loss equal to the difference will be recorded. In accordance with applicable accounting guidance, prior to performing the two step evaluation, an assessment of qualitative factors may be performed to determine whether it is more likely than not that the fair value of a reporting unit exceeds the carrying value. If it is determined that it is unlikely that the carrying value exceeds the fair value, we are not required to complete the two step goodwill impairment evaluation. The selection and assessment of qualitative factors used to determine whether it is more likely than not that the fair value of a reporting unit exceeds the carrying value involves significant judgment.

In 2016, our reporting units consisted of our three regional operating units in: North America; Europe, the Middle East and Africa ("EMEA"); and Latin America. Goodwill assigned to the North America, EMEA and Latin America reporting units at December 31, 2016 totaled $7.729 billion and was $7.024 billion, $109 million and $596 million, respectively. Goodwill assigned to the North America, EMEA and Latin America reporting units at December 31, 2015 totaled $7.749 billion and was $7.024 billion, $129 million and $596 million, respectively.

In 2016, we conducted our qualitative goodwill impairment analysis and determined that it was more likely than not that the fair value of our reporting units exceeded the carrying value and concluded that goodwill was not impaired. As a result, we did not perform the two step goodwill impairment evaluation. In 2015, as a result of the deconsolidation of our Venezuelan subsidiary, we completed an assessment of the Latin American and other reporting units' goodwill as of September 30, 2015 and concluded there was no impairment in 2015.

To the extent that future changes in our assumptions and estimates cause a change in the related fair value estimates that indicate the carrying amount of our goodwill may exceed its fair value, we may incur impairment charges in the future to write-down the carrying amount of our goodwill to its estimated fair value.

75

Table of Contents


Our indefinite-lived intangible assets impairment review process compares the estimated fair value of the indefinite-lived intangible assets to their respective carrying values. If the fair value of the indefinite-lived intangible assets exceeds their carrying values, then the indefinite-lived intangible assets are not impaired. If the carrying value of the indefinite-lived intangible assets exceeds their fair value, then an impairment loss equal to the difference will be recorded. In accordance with applicable accounting standards, an entity may assess qualitative factors to determine whether it is more likely than not that the fair value exceeds the carrying value prior to performing the evaluation. If it is determined that it is unlikely the carrying value exceeds the fair value, then the entity is not required to perform the indefinite-lived intangible assets impairment evaluation.

During the fourth quarter of 2016 and 2015, we conducted our indefinite-lived intangible assets impairment analysis and concluded that there was no impairment in 2016 and 2015.

Assessment of Loss Contingencies

We have legal, tax and other contingencies that could result in significant losses upon the ultimate resolution of such contingencies. We have provided for losses in situations where we have concluded that it is probable that a loss has been incurred and the amount of the loss is reasonably estimable. Further, with respect to loss contingencies, where it is probable that a liability has been incurred and there is a range in the expected loss and no amount in the range is more likely than any other amount, we accrue at the low end of the range. A significant amount of judgment is involved in determining whether a loss is probable and reasonably estimable due to the uncertainty involved in predicting the likelihood of future events and estimating the financial impact of such events. Accordingly, it is possible that upon the further development or resolution of a contingent matter, a significant charge could be recorded in a future period related to an existing contingent matter. For additional information, see Note 15 - Commitments, Contingencies And Other Items in the notes to the Consolidated Financial Statements.

Business Combinations

The accounting guidance for business combinations requires an acquiring entity to recognize all of the assets acquired and liabilities assumed at the acquisition date fair value. The allocation of the purchase price to the assets acquired and liabilities assumed from an acquisition, and the related estimated lives of depreciable and amortizable tangible and identifiable intangible assets, require a significant amount of judgment and is considered a critical estimate. Such allocation of certain aspects of the purchase price to items that are more complex to value is performed by management, taking into consideration information provided to management by an independent valuation firm.


76

Table of Contents

Income Taxes

We recognize deferred tax assets and liabilities for our United States and non-U.S. operations, for operating loss and other credit carry forwards and the expected tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts using enacted tax rates in effect for the year the differences are expected to reverse. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible.

The evaluation of deferred tax assets requires judgment in assessing the likely future tax consequences of events that have been recognized in our financial statements or tax returns, and future profitability by tax jurisdiction. We have historically provided a valuation allowance to reduce our U.S. federal, state and non-U.S. deferred tax assets to the amount that is more likely than not to be realized; however, in the fourth quarter 2015, we released the majority of our valuation allowance against our U.S. federal and state deferred tax assets, resulting in a non-cash benefit to income tax expense of approximately $3.3 billion, $3.1 billion of which was related to future taxable earnings.

Given our current level of pre-tax income, and assuming we maintain into the future this current level of pre-tax income at a minimum, we expect to generate income before taxes in the United States in future periods at a level that would fully utilize our U.S. federal and the majority of our state net operating loss carryforward balances. We continue to maintain a valuation allowance of approximately $0.9 billion as of December 31, 2016, against net deferred tax assets, primarily in non-U.S. and certain of our state jurisdictions where we do not currently believe the realization of our deferred tax assets is more likely than not.

We evaluate our deferred tax assets quarterly to determine whether adjustments to the valuation allowance are appropriate in light of changes in facts or circumstances, such as changes in expected future pre-tax earnings, tax law, interactions with taxing authorities and developments in case law. In making this evaluation, we rely on our recent history of pre-tax earnings. Our material assumptions are our forecasts of future pre-tax earnings and the nature and timing of future deductions and income represented by the deferred tax assets and liabilities, all of which involve the exercise of significant judgment.

We had a valuation allowance on many of our non-U.S. jurisdictions as of December 31, 2016. We monitor our cumulative loss position in these non-U.S. jurisdictions and other evidence each quarter to determine the appropriateness of our valuation allowance. In 2016 we had an $82 million income tax benefit related to the release of deferred tax valuation allowances primarily in Germany, Brazil, and Mexico. The determinations to release the foreign valuation allowances were driven by our projection of future profitability for each legal entity due to the recapitalization of our German subsidiary, the planned action to restructure our Brazilian business, and the merger of our Mexican subsidiaries.

With respect to our foreign branches, we had historically established deferred tax liabilities for foreign branches with an overall cumulative translation gain, but had not established deferred tax assets for those with an overall translation loss as we had no plans to trigger realization of the losses in the foreseeable future.  On December 7, 2016, the Internal Revenue Service issued new regulations under Internal Revenue Code Section 987 addressing the taxation of foreign currency translation gains and losses arising from foreign branches. The new regulations require a “fresh start” recalculation of the unrealized gains and losses as of the adoption date.  The regulations provide that the tax bases of specified assets, such as fixed assets, will be translated at historic foreign exchange rates.  As a result, the deferred taxes related to such foreign currency translation are expected to reverse through the operations of the branch thereby allowing the recognition of deferred tax assets arising from translation losses as well. The issuance of the regulations resulted in us recognizing an estimated one-time income tax benefit of $110 million during the fourth quarter 2016.


77

Table of Contents


Although we believe our estimates are reasonable, the ultimate determination of the appropriate amount of valuation allowance, as well as the effect of recently issued tax regulations addressing the complex area of foreign currency translation involves significant judgment.


Results of Operations 2016 vs. 2015 and 2015 vs. 2014

Year Ended December 31,
 
 
 
 
 
 
(dollars in millions)
 
2016
 
2015
 
2014
Revenue
 
$
8,172

 
$
8,229

 
$
6,777

Network access costs
 
2,725

 
2,833

 
2,529

Network related expenses
 
1,346

 
1,432

 
1,246

Depreciation and amortization
 
1,250

 
1,166

 
808

Selling, general and administrative expenses
 
1,407

 
1,467

 
1,181

Total Costs and Expenses
 
6,728

 
6,898

 
5,764

Operating Income
 
1,444

 
1,331

 
1,013

Other Income (Expense):
 
 
 
 
 
 
Interest income
 
4

 
1

 
1

Interest expense
 
(546
)
 
(642
)
 
(654
)
Loss on modification and extinguishment of debt
 
(40
)
 
(218
)
 
(53
)
Venezuela deconsolidation charge
 

 
(171
)
 

Other, net
 
(20
)
 
(18
)
 
(69
)
Total Other Expense
 
(602
)
 
(1,048
)
 
(775
)
Income Before Income Taxes
 
842

 
283

 
238

Income Tax (Expense) Benefit
 
(165
)
 
3,150

 
76

Net Income
 
$
677

 
$
3,433

 
$
314




Discussion of all significant variances:

Revenue by Channel:

Year Ended December 31,
 
 
 
 
(dollars in millions)
 
2016
 
2015
 
2014
Core Network Services Revenue:
 
 
 
 
 
 
North America - Wholesale Channel
 
$
1,694

 
$
1,746

 
$
1,472

North America - Enterprise Channel
 
4,668

 
4,461

 
3,048

EMEA - Wholesale Channel
 
247

 
278

 
334

EMEA - Enterprise Channel
 
497

 
557

 
570

Latin America - Wholesale Channel
 
147

 
182

 
217

Latin America - Enterprise Channel
 
514

 
533

 
567

Total Core Network Services Revenue
 
7,767

 
7,757

 
6,208

Wholesale Voice Services
 
405

 
472

 
569

Total Revenue
 
$
8,172

 
$
8,229

 
$
6,777



78

Table of Contents

Revenue by Service Offering:

Year Ended December 31,
 
 
 
 
 
 
(dollars in millions)
 
2016
 
2015
 
2014
Core Network Services Revenue:
 
 
 
 
 
 
Colocation and Datacenter Services
 
$
604

 
$
606

 
$
590

Transport and Fiber
 
2,308

 
2,350

 
2,087

IP and Data Services
 
3,659

 
3,589

 
2,530

Voice Services (Local and Enterprise)
 
1,196

 
1,212

 
988

Total Core Network Services Revenue
 
7,767

 
7,757

 
6,195

Wholesale Voice Services
 
405

 
472

 
582

Total Revenue
 
$
8,172

 
$
8,229

 
$
6,777


Revenue decreased 1% in 2016 compared to 2015 and increased 21% in 2015 compared to 2014. Core Network Services revenue remained essentially flat at $7.767 billion in 2016 compared to $7.757 billion in 2015, although enterprise channel revenue increased $128 million, partially offset by a $118 million decrease in wholesale channel revenue.

Enterprise channel revenue increased $207 million in North America in 2016 compared to 2015, primarily due to growth in VPN services and wavelengths services provided to enterprise customers. This growth was partially offset by Latin America, where enterprise channel revenue declined $19 million, primarily due to the effect of the September 30, 2015 deconsolidation of our Venezuelan subsidiary with $57 million of enterprise channel revenue and the strengthening of the U.S. dollar against Latin American currencies in 2016 compared to the exchange rates in 2015, partially offset by an increase in enterprise channel revenue of $37 million, due largely to growth in IP, wavelengths, and VPN services to enterprise customers. Enterprise channel revenue in EMEA decreased $60 million compared to 2015, primarily due to the effect of the stronger U.S. dollar against European currencies and decreased U.K. Government revenue.

Wholesale channel revenue decreased $52 million in North America in 2016 compared to 2015 primarily due to a decline in private line and IP services, partially offset by VPN, dark fiber and wavelengths services growth. Latin America wholesale channel revenue decreased $35 million in 2016, primarily due to the effect of the September 30, 2015 deconsolidation of our Venezuelan subsidiary of $15 million, in addition to a decrease in IP and data services, VPN, and private line services. EMEA wholesale channel revenue decreased $31 million primarily due to certain large disconnects and the strengthening of the U.S. dollar against local currencies in 2016 compared to exchange rates in 2015. Wholesale channel revenue continued to be affected by industry consolidation across all regions.

From a service and product offering perspective, we continued to grow our IP and data services by $70 million in 2016 compared to 2015, driven primarily by an increase in VPN services of $118 million, CDN services of $18 million and managed services of $13 million. These increases were partially offset by the effect of the September 30, 2015 deconsolidation of our Venezuelan subsidiary of $47 million and the strengthening of the U.S. dollar against local currencies in 2016 compared to the exchange rates in 2015 of $34 million. Transport and fiber decreased by $42 million, primarily due to a decrease in private line of $123 million, the effect of the September 30, 2015 deconsolidation of our Venezuelan subsidiary of $14 million, and the strengthening of the U.S. dollar against local currencies in 2016 compared to the exchange rates in 2015 of $12 million, partially offset by increases in wavelengths services of $76 million and dark fiber services of $30 million. Voice services decreased by $16 million, primarily due to the decrease of intercarrier compensation for voice services of $14 million, the strengthening of the U.S. dollar against local currencies in 2016 compared to the exchange rates in 2015 of $11 million, the

79

Table of Contents

decrease of collaboration services of $7 million, partially offset by the increase in voice services by $16 million. Colocation and datacenter services decreased by $2 million, primarily due to the effect of the September 30, 2015 deconsolidation of our Venezuelan subsidiary of $11 million and the strengthening of the U.S. dollar against local currencies in 2016 compared to the exchange rates in 2015 of $8 million, partially offset by growth in managed security services, data center, and colocation services.

Wholesale Voice Services revenue decreased in all regions in 2016 compared to 2015, primarily due to competitive pressures caused by industry consolidation and our focus on maintaining or growing Wholesale Voice Services profitability.

 The increase in total revenue in 2015 compared to 2014 was primarily driven by a full year of additional revenue in 2015 associated with acquisition of tw telecom in the fourth quarter of 2014, compared to $285 million representing two months of revenue from the tw telecom acquisition included in the 2014 results.  Assuming the tw telecom revenue was included for the full year of 2014, the total revenue would have increased from $8.123 billion in 2014 to $8.229 billion in 2015, or a 1% increase (see Note 3 - Events Associated with the Acquisition of tw telecom inc. in the Notes to the Consolidated Financial Statements). This increase was primarily driven by enterprise channel growth of $313 million in North America, offset by declines in Latin America revenue of $69 million and EMEA revenue of $69 million primarily due to the strengthening of the U.S. dollar against local currencies in 2015, declines of $99 million in Wholesale Voice Services revenue and the effect of the deconsolidation of our Venezuelan subsidiary as of September 30, 2015.

We experienced continued growth in our IP and data services of $1.056 billion, transport and fiber services of $258 million and voice services of $233 million during 2015 compared to 2014 driven primarily by the acquisition of tw telecom and end user customer demand for VPN and bandwidth in the enterprise channel. The increase in IP and data services was predominantly driven by our VPN and managed services and revenue from the tw telecom acquisition.  We also experienced increases in transport and fiber driven by dark fiber, wavelengths and professional services and in colocation and datacenter services and voice services, which also benefited from the tw telecom acquisition, offset by the adverse effect of weakening currencies in EMEA and Latin America against the U.S. dollar.

Core Network Services revenue increased in the North America region in 2015 compared to 2014 as a result of the full year of results from the tw telecom acquisition and growth in services provided to the existing enterprise customer base. These increases were partially offset by decreases in EMEA and Latin America for 2015 due to the appreciation of the U.S. dollar against currencies in EMEA and Latin America.

Wholesale Voice Services revenue decreased in all regions in 2015 compared to 2014. In 2015 compared to 2014, Wholesales Voice Services revenue decreased in North America and EMEA and remained flat in Latin America. The changes during the periods are primarily due to competitive pressures and our focus on maintaining Wholesale Voice Services profitability.

Network Access Costs include leased capacity, right-of-way costs, access charges, satellite transponder lease costs and other third party costs directly attributable to providing access to customer locations from our network, but excludes Network Related Expenses, and depreciation and amortization. Network Access Costs do not include any employee expenses or impairment expenses; these expenses are allocated to Network Related Expenses or Selling, General and Administrative Expenses.

Network Access Costs as a percentage of total revenue was 33% in 2016 compared to 34% in 2015 and 37% in 2014. The decrease is primarily due to an improving mix of higher profit on-net Core Network Services and a decline in lower profit Wholesale Voice Services. Additionally, we continue to implement initiatives to reduce both fixed and variable network access costs, which resulted in a decrease in Network Access Costs.


80

Table of Contents

Network Related Expenses include certain expenses associated with the delivery of services to customers and the operation and maintenance of our network, such as facility rent, utilities, maintenance and other costs, each related to the operation of our communications network, as well as salaries, wages and related benefits (including non-cash stock-based compensation expenses) associated with personnel who are responsible for the delivery of services, operation and maintenance of our communications network, and accretion expense on asset retirement obligations, but excludes depreciation and amortization.

Network Related Expenses decreased 6% in 2016 from 2015 and increased 15% in 2015 from 2014. The decrease in 2016 compared to 2015 was primarily related to decreased employee related expense of $46 million and a decrease in facilities and network based expenses of $27 million as we continued to optimize our workforce and facilities. Additionally, in the third quarter of 2015, we implemented certain workforce reductions, resulting in approximately $8 million of restructuring charges recorded in Network Related Expenses.

The increase in 2015 compared to 2014 was primarily related to an increase in employee related expense of $106 million and an increase in facilities and rent expense of $62 million resulting from the acquisition of tw telecom. Additionally, in the third quarter of 2015, we implemented certain workforce reductions, resulting in approximately $8 million of restructuring charges recorded in Network Related Expenses.

Depreciation and Amortization expense increased 7% in 2016 from 2015 and increased 44% in 2015 from 2014. The increase in 2016 compared to 2015 is primarily related to $101 million of depreciation and amortization charges associated with additional capital expenditures, net of fully depreciated assets, partially offset by $17 million of foreign currency exchange rate changes in EMEA and Latin America. The increase in 2015 compared to 2014 is primarily attributable to $312 million of depreciation and amortization charges associated with the assets acquired from tw telecom and increased capital expenditures, partially offset by the impact of foreign currency exchange rate changes in EMEA and Latin America of $17 million.

Selling, General and Administrative Expenses ("SG&A Expenses") includes the salaries, wages and related benefits (including non-cash stock-based compensation expenses) and the related costs of corporate and sales personnel, travel, insurance, non-network related rent, advertising, and other administrative expenses.

SG&A Expenses decreased 4% in 2016 compared to 2015 and increased 24% in 2015 compared to 2014. The decrease in 2016 was primarily related to decreased employee-related expenses of $24 million as we continued to drive greater operational efficiencies, as well as lower other tax of $7 million and a decrease in bad debt expense of $5 million. In 2016 we also released an accrual for an assessment of $12 million and associated interest of $14 million corresponding to certain Peruvian tax litigation. See Note 15 — Commitments, Contingencies and Other Items in the notes to Consolidated Financial Statements for additional information. Additionally, in the third quarter of 2015, we implemented certain workforce reductions, resulting in approximately $16 million of restructuring charges recorded in SG&A expenses. These decreases were partially offset by an increase in non-cash stock-based compensation of $13 million in 2016 compared to 2015. The increase in 2015 compared to 2014 was primarily related to $199 million of additional employee related expenses and an increase in professional services and non-network rent of $51 million, primarily associated with the acquisition of tw telecom, partially offset by a decrease of $18 million in restructuring charges from $34 million in 2014. We incurred $32 million and $81 million in expenses related to the acquisition of tw telecom in 2015 and 2014, respectively.

Non-cash, stock-based compensation expense of $156 million, $141 million and $73 million was recorded in 2016, 2015 and 2014, respectively, related to outperform stock appreciation rights, performance restricted stock units ("PRSUs"), restricted stock units, incentive and retention plans and shares issued for our matching contribution to the 401(k) plan. Approximately $134 million, $121 million

81

Table of Contents

and $64 million of non-cash stock-based compensation expense was recorded in SG&A Expenses in 2016, 2015 and 2014, respectively, and $22 million, $20 million and $9 million was recorded in Network Related Expenses in 2016, 2015 and 2014, respectively. The increase in 2016 compared to 2015 was primarily due to additional grants of restricted stock units and performance stock units, partially offset by decreased expense due to a 2015 change in retirement eligibility, which accelerated the expensing of awards for certain retirement eligible personnel in 2015, and outperform stock appreciation right awards reaching full amortization by the third quarter of 2016. The increase in 2015 compared to 2014 was primarily related to additional grants of restricted stock units, PRSUs, and increased matching contributions for our 401(k) plan due to the additional headcount from the tw telecom acquisition.

Adjusted EBITDA, as defined by us, is net income (loss) from the Consolidated Statements of Income before (1) income tax benefit (expense), (2) total other income (expense), (3) non-cash impairment charges included within selling, general and administrative expenses and network related expenses, (4) depreciation and amortization expense and (5) non-cash stock-based compensation expense included within selling, general and administrative expenses and network related expenses and (6) discontinued operations.

Adjusted EBITDA is not a measurement under generally accepted accounting principles ("GAAP") and may not be used in the same way by other companies. We believe that Adjusted EBITDA is an important part of our internal reporting and is a key measure used by us to evaluate our profitability and operating performance and to make resource allocation decisions. We believe such measurement is especially important in a capital-intensive industry such as telecommunications. We also use Adjusted EBITDA to compare our performance to that of our competitors and to eliminate certain non-cash and non-operating items in order to consistently measure from period to period our ability to fund capital expenditures, fund growth, service debt and determine bonuses.

Adjusted EBITDA excludes non-cash impairment charges and non-cash stock-based compensation expense because of the non-cash nature of these items. Adjusted EBITDA also excludes interest income, interest expense and income tax benefit (expense) because these items are associated with our capitalization and tax structures. Adjusted EBITDA also excludes depreciation and amortization expense because these non-cash expenses reflect the effect of capital investments which we believe are better evaluated through cash flow measures. Adjusted EBITDA excludes net other income (expense) because these items are not related to our primary operations.

There are limitations to using non-GAAP financial measures such as Adjusted EBITDA, including the difficulty associated with comparing companies that use similar performance measures whose calculations may differ from our calculations. Additionally, this financial measure does not include certain significant items such as interest income, interest expense, income tax benefit (expense), depreciation and amortization expense, non-cash impairment charges, non-cash stock-based compensation expense and net other income (expense). Adjusted EBITDA should not be considered a substitute for other measures of financial performance reported in accordance with GAAP.


82

Table of Contents

The following information provides a reconciliation of Net Income to Adjusted EBITDA as defined by us along with Adjusted EBITDA by reportable segment:

 
 
Year Ended December 31,
(dollars in millions)
 
2016
 
2015
 
2014
Net Income
 
$
677

 
$
3,433

 
$
314

Income Tax Expense (Benefit)
 
165

 
(3,150
)
 
(76
)
Total Other Expense
 
602

 
1,048

 
775

Depreciation and amortization
 
1,250

 
1,166

 
808

Non-Cash Stock Compensation Attributable to Stock Awards
 
156

 
141

 
73

Non-Cash Impairment
 

 

 
1

Adjusted EBITDA
 
$
2,850

 
$
2,638

 
$
1,895

 
 
 
 
 
 
 
North America
 
$
3,220

 
$
3,048

 
$
2,065

EMEA
 
215

 
235

 
214

Latin America
 
293

 
302

 
348

Unallocated Corporate Expenses
 
(878
)
 
(947
)
 
(732
)
Adjusted EBITDA
 
$
2,850

 
$
2,638

 
$
1,895


Adjusted EBITDA was $2.850 billion in 2016 compared with $2.638 billion in 2015 and $1.895 billion in 2014. The increase in Adjusted EBITDA is attributable to growth in our higher incremental profit Core Network Services revenue and continued improvements in network access costs as a percentage of revenue and lower network related and SG&A Expenses, partially offset by lower wholesale voice revenue and the September 30, 2015 deconsolidation of our Venezuelan subsidiary, which had Adjusted EBITDA of $46 million for the nine months ended September 30, 2015. See Note 14 — Segment Information in the notes to Consolidated Financial Statements for additional information on Adjusted EBITDA by region.

Adjusted EBITDA increased $172 million in the North America region in 2016 compared to 2015, primarily due to increased Core Network Services revenue of $155 million partially offset by Wholesale Voice Services revenue, as discussed further above, and initiatives resulting in reduced fixed and variable network access costs. Network access costs decreased $53 million in 2016 compared to 2015.

Adjusted EBITDA decreased $20 million in the EMEA region in 2016 compared to 2015 as a result of the $91 million decrease in Core Network Services revenue in 2016, partially offset by reduced employee related expenses of $7 million and a $25 million reduction in network related expenses, as discussed further above. EMEA Adjusted EBITDA was favorably affected by initiatives that reduced fixed and variable network access costs. Network access costs in EMEA decreased $39 million in 2016 compared to 2015.

Adjusted EBITDA decreased $9 million in the Latin American region in 2016 compared to 2015, primarily as a result of the $46 million decrease from the deconsolidation of our Venezuelan subsidiary on September 30, 2015, partially offset by reduced employee related expenses and other SG&A expenses of $29 million, reduced network access costs of $4 million, and reduced network related expenses of $4 million, as discussed further above. Adjusted EBITDA was favorably affected by initiatives that reduced fixed and variable network access costs.

83

Table of Contents

Adjusted EBITDA increased in the North America region in 2015 compared to 2014 primarily as a result of the tw telecom acquisition, growth in Core Network Services revenue and initiatives resulting in reduced network access costs.

Adjusted EBITDA increased in the EMEA region in 2015 compared to 2014 as a result of initiatives that reduced network access costs, which were partially offset by the effect of the stronger U.S. dollar against European currencies. Adjusted EBITDA for 2015 was negatively affected by approximately 1% versus the comparable prior period as a result of the changes in foreign currency rates.
Adjusted EBITDA decreased in the Latin American region in 2015 compared to 2014 primarily as a result of the effect of the stronger U.S. dollar against Latin American currencies. Adjusted EBITDA for 2015 was negatively affected by approximately 2% versus the comparable prior period, as a result of the changes in foreign currency rates. The decrease was partially offset by initiatives resulting in reduced network access costs.

Interest Expense decreased $96 million in 2016 from 2015 and decreased $12 million in 2015 from 2014. The decrease in 2016 compared to 2015 is due to a lower weighted average interest cost of debt of 4.7% at December 31, 2016 compared to 4.9% at December 31, 2015 due to refinancing activities. Interest expense decreased in 2015 compared to 2014 by $72 million due to a lower weighted average interest cost of debt of 4.9% at December 31, 2015 compared to 5.9% at December 31, 2014 due to refinancing activities and a $30 million reduction in interest expense as a result of the conversion of the 7% Convertible Senior Notes due 2015 and 7% Convertible Senior Notes due 2015, Series B into common stock, partially offset by $89 million of interest expense on additional borrowings used to fund the tw telecom acquisition.

Approximately 55% of our long-term debt is subject to variable interest rates and therefore subject to market risks arising from changes in interest rates. As of December 31, 2016 we expect annual interest expense in 2017 to approximate $570 million based on current interest rates on our debt outstanding as of December 31, 2016. See Note 10 - Long-Term Debt in the notes to Consolidated Financial Statements for additional information on our financing activities.

Loss on Modification and Extinguishment of Debt was $40 million in 2016 compared to a loss of $218 million in 2015 and a loss of $53 million in 2014. See Note 10 - Long-Term Debt in the notes to the Consolidated Financial Statements for more details regarding our financing activities.

In the second quarter of 2016, we recorded a charge of approximately $40 million related to the April 2016 redemption of the 7% Senior Notes due 2020.

The loss recorded during 2015 was related to a charge of approximately $36 million related to the redemption of the 9.375% Senior Notes due 2019 in April 2015, $100 million related to the redemptions of the 8.125% Senior Notes due 2019 and 8.875% Senior Notes due 2019 in April 2015, $27 million related to the refinancing of the $2 billion senior secured Tranche B Team Loan due 2022 in May 2015 and $55 million related to the redemption of the 8.625% Senior Notes due 2020.

The loss recorded during 2014 was related to the refinancing of the 11.875% Senior Notes due 2019.


84

Table of Contents

Other, net is primarily comprised of gains and losses on the sale of non-operating assets, foreign currency gains and losses and other income and expense.
 
 
Year Ended December 31,
(dollars in millions)
 
2016
 
2015
 
2014
(Gain) Loss on Sale of Property, Plant, and Equipment and Other Assets
 
$
(2
)
 
$
1

 
$
(3
)
Foreign Currency Loss related to Venezuela
 

 
11

 
43

Other Foreign Currency Loss
 
31

 
18

 
18

Impairment
 

 

 
17

Other Income
 
(9
)
 
(12
)
 
(6
)
Other, net
 
$
20

 
$
18

 
$
69


The Other, net expense in 2016 and 2015 was incurred primarily due to foreign currency losses attributable to the appreciation of the U.S. dollar for certain intercompany balances denominated in the local currency of foreign subsidiaries in North America, EMEA and Latin America that are not considered to be long-term in nature.

Other, net expense in 2014 is primarily due to foreign currency fluctuations of local currencies relative to the U.S. dollar, including foreign currency losses attributable to the devaluation of the Venezuelan bolivar as discussed below, and the partial impairment of our indefinite-lived intangible asset, partially offset by net foreign currency gains.

During the first quarter of 2014, the Venezuelan government enacted additional changes to the country's foreign exchange system. The government expanded the types of transactions that may be allowed via the weekly auctions under the Complementary System of Foreign Currency Acquirement ("SICAD 1"). The Venezuelan government also announced the replacement of its existing foreign currency administration with the National Center for Foreign Commerce ("CENCOEX"). At that time, entities could seek approval to transact through CENCOEX at the official rate of 6.30 Venezuelan bolivars to the U.S. dollar; however, certain transactions could be approved at the latest SICAD 1 rate, depending on the entity's facts and circumstances.

During the second quarter of 2014, based on additional experience with the new foreign exchange mechanisms, we concluded that the most appropriate rate was SICAD 1. Accordingly, we recognized a loss of approximately $34 million in 2014, resulting from the devaluation of Venezuelan bolivar denominated monetary assets and liabilities from the official rate of 6.3 to the SICAD 1 rate. Based upon the further deterioration of the SICAD rate from 10.6 as of June 30, 2014 to 12.0 as of September 30, 2014, we recognized an additional loss of approximately $7 million in the third quarter of 2014. As of December 31, 2014, SICAD 1 was 12.0 Venezuelan bolivars to the U.S. dollar.

During the second quarter of 2015, we recognized a charge of $6 million related to the devaluation of the Venezuelan SICAD I exchange rate from 12.0 bolivars to the U.S. dollar to 12.8 bolivars to the U.S. dollar at June 30, 2015.

During the third quarter of 2015 prior to deconsolidation, we recognized a charge of $5 million related to the devaluation of the Venezuelan SICAD I exchange rate from 12.8 bolivars to the U.S. dollar to 13.5 bolivars to the U.S. dollar effective September 1, 2015.

Income Tax (Expense) Benefit was $165 million of expense in 2016 compared to $3.150 billion of benefit in 2015 and $76 million of benefit in 2014. Income tax expense for the year ended December 31, 2016 includes an estimated one-time $110 million income tax benefit related to the issuance of new regulations under Internal Revenue Code Section 987 addressing the taxation of foreign currency

85

Table of Contents

translation gains and losses arising from foreign branches, an $82 million income tax benefit related to the release of deferred tax valuation allowances primarily in Germany, Brazil, and Mexico, and a $22 million benefit from the vesting of stock based compensation due to the adoption of ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, offset by income tax expense associated with current year taxable earnings and $24 million income tax expense related to income tax rate changes. The determinations to release the foreign valuation allowances were driven by our projection of future profitability for each legal entity due to the recapitalization of our German subsidiary, the planned action to restructure our Brazilian business, and the merger of our Mexican subsidiaries. Our effective tax rate is lower than the statutory rate primarily due to the benefit related to the issuance of new regulations under Internal Revenue Code Section 987, the income tax benefit on the foreign valuation allowance releases, and the adoption of ASU 2016-09, partially offset by limitations on certain deductions, the inability to recognize tax benefits on losses incurred in certain jurisdictions due to maintenance of valuation allowances against deferred taxes in those jurisdictions, as well as, other discrete items such as enacted tax rate changes.

During the fourth quarter of 2015, we released approximately $3.3 billion of our deferred tax valuation allowance related to our business in the United States. Income tax expense in prior periods was primarily related to taxes in foreign jurisdictions. In making the determination to release the valuation allowance against U.S. federal and state deferred tax assets, we took into consideration our movement into a cumulative income position for the most recent three-year period, including pro forma adjustments for acquired entities, our eight out of nine consecutive quarters of pre-tax operating income, and forecasts of future earnings for our U.S. business. The release was reflected as an income tax benefit in 2015.

During the fourth quarter of 2014, we released approximately $100 million of deferred tax valuation allowance primarily related to our business in the United Kingdom due to a recapitalization and consolidation of legal entities whereby one U.K. entity with a full valuation allowance was merged with an entity that had no valuation allowance against its deferred tax assets, as we had an expectation of future taxable income for the combined entities. The release was reflected as an income tax benefit in 2014.

We incur tax expense attributable to income in the U.S. and in various subsidiaries that are required to file state or foreign income tax returns on a separate legal entity basis. We also recognize accrued interest and penalties in income tax expense related to uncertain tax benefits. Our tax rate is volatile and may move up or down with changes in, among other things, the amount and source of income or loss, our ability to utilize foreign tax credits, changes in tax laws, our deferred tax valuation allowance, and the movement of liabilities established for uncertain tax positions as statutes of limitations expire or positions are otherwise effectively settled.

Venezuela Effects

Effective September 30, 2015, we deconsolidated our Venezuelan subsidiary from our consolidated financial statements. Despite the deconsolidation of our Venezuelan subsidiary, we continue to wholly own our Venezuelan subsidiary, operate in the region and remain committed to serving our Venezuelan customers. We deem it appropriate to continue to deconsolidate Venezuela.

There are a number of currency and other operating controls and restrictions in Venezuela, which have evolved over time and may continue to evolve in the future. These evolving conditions have resulted in an other-than-temporary lack of exchangeability between the Venezuelan bolivar and U.S. dollar, and have restricted our Venezuelan operations’ ability to pay dividends and settle intercompany obligations in U.S. dollars. The severe currency controls imposed by the Venezuelan government have significantly limited the ability to realize the benefits from earnings of our Venezuelan operations and access the resulting liquidity provided by those earnings in U.S. dollars. We expect that this condition will continue for the foreseeable future. Additionally, government regulations affecting our ability to manage our Venezuelan subsidiary’s capital structure, purchasing, product pricing, customer invoicing and collections, and labor relations; and the current political and economic situation within Venezuela have resulted in an

86

Table of Contents

acute degradation in the ability to make key operational decisions. This lack of exchangeability and degradation in our ability to control key operational decisions has resulted in a lack of control over our Venezuelan subsidiary for U.S. accounting purposes. Therefore, we concluded we no longer met the accounting criteria for consolidation and deconsolidated our Venezuelan subsidiary effective as of September 30, 2015 and began accounting for the investment in our Venezuelan subsidiary using the cost method of accounting. This change resulted in a one-time charge of $171 million, which includes $83 million of bolivar denominated cash and $40 million of intercompany receivables from our Venezuelan subsidiary. The factors that led to the deconsolidation of our Venezuelan subsidiary at the end of the third quarter of 2015 continued to exist through the end of 2016. Any dividends from our Venezuelan subsidiaries will be recorded as other income upon receipt of the cash in U.S. dollars. While we do not expect to enter into material transactions with our subsidiary in Venezuela that would result in the creation of additional intercompany receivable balances, if any such transactions were completed, we would evaluate collectability of the intercompany receivable balance at that time which could result in a charge negatively affecting our results of operations. Please see Note 1 to the accompanying unaudited Consolidated Financial Statements. Prior to the deconsolidation, our operations in Venezuela accounted for approximately 1% of consolidated total revenue for the nine months ended September 30, 2015 and for the twelve months ended December 31, 2014, and approximately 3% and 4% of consolidated operating income for the same periods, respectively.

Financial Condition—December 31, 2016

Cash flows provided by operating activities, investing activities and financing activities for the years ended December 31, 2016 and 2015, respectively, are summarized as follows:
 
 
Year Ended December 31,
(dollars in millions)
 
2016
 
2015
 
Change
Net Cash Provided by Operating Activities
 
$
2,343

 
$
1,855

 
$
488

Net Cash Used in Investing Activities
 
(1,319
)
 
(1,344
)
 
25

Net Cash Used in Financing Activities
 
(56
)
 
(219
)
 
163

Effect of Exchange Rates on Cash and Cash Equivalents
 
(3
)
 
(18
)
 
15

Net Change in Cash and Cash Equivalents
 
$
965

 
$
274

 
$
691


Operating Activities

Cash provided by operating activities increased to $2.343 billion in 2016 compared to $1.855 billion in 2015. The increase in cash provided by operating activities was primarily due to growth in earnings before income tax driven by continued optimization of Network Access Costs, and an increase in cash provided by working capital. Cash provided by operating activities is subject to variability period over period as a result of the timing of the collection of receivables and payments related to interest expense, accounts payable, bonuses and capital expenditures.

Investing Activities

Cash used in investing activities decreased to $1.319 billion in 2016 compared to $1.344 billion in 2015, primarily as a result of an $83 million write-down in 2015 of our Venezuelan bolivar denominated cash balance, which was deconsolidated as of September 30, 2015. This decrease was partially offset by an increase in capital expenditures, which totaled $1.334 billion in 2016 and $1.229 billion in 2015.


87

Table of Contents

Financing Activities

Cash used in financing activities of $56 million in 2016 decreased compared to $219 million used in financing activities in 2015. See Note 10 - Long-Term Debt in the notes to the Consolidated Financial Statements for more details regarding our debt transactions during 2016 and 2015.
 
Effect of Exchange Rates on Cash and Cash Equivalents

The effect of exchange rates on cash and cash equivalents in 2016 and 2015 was a reduction in cash of $3 million and $18 million, respectively, and was primarily due to the fluctuations of the U.S. dollar against currencies in EMEA and Latin America, including Venezuela prior to its deconsolidation.

Liquidity and Capital Resources

We had $1.819 billion of cash and cash equivalents on hand at December 31, 2016. We also had $38 million of current and non-current restricted cash and securities used to collateralize outstanding letters of credit and certain performance and operating obligations and other deposits at December 31, 2016.

Free Cash Flow is defined by us as net cash provided by (used in) operating activities less capital expenditures as disclosed in the Consolidated Statements of Cash Flows. Management believes that Free Cash Flow is a relevant metric to provide to investors, as it is an indicator of our ability to generate cash to service our debt. Free Cash Flow excludes cash used for acquisitions, principal repayments and the impact of exchange rate changes on cash and cash equivalents balances.

There are material limitations to using Free Cash Flow to measure our performance as it excludes certain material items such as principal payments on and repurchases of long-term debt and cash used to fund acquisitions. Comparisons of our Free Cash Flow to that of some of our competitors may be of limited usefulness since we do not currently pay a significant amount of income taxes due to net operating losses, and therefore, generate higher cash flow than a comparable business that does pay income taxes. Additionally, this financial measure is subject to variability quarter over quarter as a result of the timing of payments related to interest expense, accounts receivable and accounts payable and capital expenditures. Free Cash Flow should not be used as a substitute for net change in cash and cash equivalents on the Consolidated Statements of Cash Flows.

The following information provides a reconciliation of Net Cash Provided by Operating Activities to Free Cash Flow as defined by us:

 
 
Year Ended December 31,
(dollars in millions)
 
2016
 
2015
 
2014
Net Cash Provided by Operating Activities
 
$
2,343

 
$
1,855

 
$
1,161

Capital Expenditures
 
(1,334
)
 
(1,229
)
 
(910
)
Free Cash Flow
 
$
1,009

 
$
626

 
$
251


Free Cash Flow was $1.009 billion in 2016 compared to $626 million in 2015, reflecting a $383 million improvement driven by $488 million of higher cash provided by operating activities offset by $105 million of higher spending on capital expenditures in 2016. For the full year 2017, we expect to generate Free Cash Flow of $1.10 to $1.16 billion excluding any CenturyLink merger related expenses.

Capital expenditures for 2017 are expected to be approximately 16% of revenue, consistent with 16% of revenue in 2016 as we invest in base capital expenditures (estimated capital required to keep the network operating efficiently and support new service development) with the remaining capital expenditures expected to be partly success-based, which is tied to a specific customer revenue opportunity, and partly project-based where capital is used to expand the network based on our expectation that the project will eventually lead to incremental revenue.

Net cash interest payments are expected to increase to approximately $520 million in 2017 from $508 million in 2016 based on forecasted interest rates on our variable rate debt outstanding as of December 31, 2016. As of December 31, 2016, we had contractual debt obligations, including capital lease obligations, but excluding interest and discounts on debt issuance, of $7 million that mature in 2017, $306 million in 2018, and $822 million in 2019.

88

Table of Contents


We currently have the ability to repatriate cash and cash equivalents into the United States without paying or accruing U.S. taxes. We do not currently intend to repatriate to the United States any of our foreign cash and cash equivalents from operating entities outside of Latin America. We have no material restrictions on our ability to repatriate to the United States foreign cash and cash equivalents. We had approximately $49 million of non-U.S. denominated cash and cash equivalents at December 31, 2016.

We believe our current liquidity and anticipated future cash flows from operations will be sufficient to fund our business for at least the next twelve months.

We may need to refinance all or a portion of our indebtedness at or before maturity and cannot provide assurances that we will be able to refinance any such indebtedness on commercially reasonable terms or at all. In addition, we may elect to secure additional capital in the future, at acceptable terms, to improve our liquidity or fund acquisitions. In addition, in an effort to reduce future cash interest payments as well as future amounts due at maturity or to extend debt maturities, we may, from time to time, issue new debt, enter into debt for debt, debt for equity or cash transactions to purchase our outstanding debt securities in the open market or through privately negotiated transactions. In addition, we may consider other uses of capital or opportunities to return cash to stockholders. We will evaluate any such transactions in light of the existing market conditions and the possible dilutive effect to stockholders. The amounts involved in any such transaction, individually or in the aggregate, may be material.

In addition to raising capital through the debt and equity markets, we may sell or dispose of existing businesses, investments or other non-core assets.

Consolidation of the communications industry may continue. We will continue to evaluate consolidation opportunities and could make additional acquisitions in the future.

In pursuing any of these various actions, we would also need to address any restrictions contained in the CenturyLink Merger agreement or obtain a waiver of those restrictions.

Off-Balance Sheet Arrangements

We have not entered into off-balance sheet arrangements.

Contractual Obligations

The following table summarizes our contractual obligations and other commercial commitments at December 31, 2016, as further described in the Notes to Consolidated Financial Statements.

89

Table of Contents


Payments Due by Period

 
 
Total
 
Less than
1 Year
 
2 - 3
Years
 
4 - 5
Years
 
After 5
Years
(dollars in millions)
Contractual Obligations
 
 
 
 
 
 
 
 
 
 
Long-Term Debt, including current portion
 
$
11,009

 
$
7

 
$
1,128

 
$
2,454

 
$
7,420

Interest Obligations
 
2,990

 
523

 
1,013

 
796

 
658

Asset Retirement Obligations
 
89

 
13

 
10

 
3

 
63

Operating Leases
 
1,537

 
282

 
466

 
288

 
501

Right of Way Agreements
 
743

 
162

 
151

 
105

 
325

Purchase and Other Obligations
 
1,276

 
941

 
212

 
51

 
72

Other Commercial Commitments
 
 
 
 
 
 
 
 
 
 
Letters of Credit
 
39

 
5

 
4

 
1

 
29



Our debt instruments contain certain covenants which, among other things, limit additional indebtedness, dividend payments, certain investments and transactions with affiliates. If we should fail to comply with these covenants, amounts due under the instruments may be accelerated at the debt holder's discretion after the declaration of an event of default. Our debt instruments do not have covenants that require us or our subsidiaries to maintain certain levels of financial performance or other financial measures such as total leverage or minimum revenue. These types of covenants are commonly referred to as "maintenance covenants."

Interest obligations assume interest rates on $4.9 billion of variable rate debt do not change from December 31, 2016. In addition, interest is calculated based on debt outstanding as of December 31, 2016.

Our asset retirement obligations consist of legal requirements to remove certain of our network infrastructure at the expiration of the underlying right-of-way ("ROW") term and restoration requirements for leased facilities. The initial and subsequent measurement of our asset retirement obligations require us to make estimates regarding the eventual costs and probability or likelihood that we will be required to remove certain of our network infrastructure and restore certain of our leased properties.

Certain right of way agreements include provisions for increases in payments in future periods based on the rate of inflation as measured by various price indexes. We have not included estimates for these increases in future periods in the amounts included above.

Certain non-cancelable right of way agreements provide for automatic renewal on a periodic basis. We include payments due during these automatic renewal periods given the significant cost to relocate our network and other facilities.

Certain other right of way agreements are currently cancelable or can be terminated under certain conditions by us. We include the payments under such cancelable right of way agreements in the table above for a period of 1 year from January 1, 2017, if we do not consider it likely that we will cancel the right of way agreement within the next year.

Purchase and other obligations represent all our outstanding purchase order amounts as of December 31, 2016 ($616 million), contractual commitments with third parties to purchase network access services ($425 million) and fixed maintenance payments for portions of our network ($235 million).


90

Table of Contents

The table above does not include other long-term liabilities, such as liabilities recorded for legal matters that are not contractual obligations by nature. We cannot determine with any degree of certainty the years in which these liabilities might ultimately be paid.

Due to uncertainty regarding the completion of tax audits and possible outcomes, the remaining estimate of the timing of payments related to uncertain tax positions and interest cannot be made. See Note 13 - Income Taxes and Note 15 - Commitments, Contingencies and Other Items in the notes to Consolidated Financial Statements for additional information regarding our uncertain tax positions.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

We are subject to market risks arising from changes in interest rates. As of December 31, 2016, Level 3 Financing had borrowed a total of approximately $4.9 billion primarily under term loans pursuant to a senior secured credit facility (excluding discounts) and Floating Rate Senior Notes due 2018 that bear interest at LIBOR rates plus an applicable margin. As the LIBOR rates fluctuate, so too will the interest expense on amounts borrowed under the debt instruments, unless LIBOR rates are below the minimum LIBOR rate for a particular Senior Secured Term Loan. The weighted average interest rate on these variable rate instruments at December 31, 2016, was approximately 3.8%.

At December 31, 2016, the senior secured credit facility's variable interest rate is based on a fixed rate of 3.0% plus LIBOR, with a fixed minimum LIBOR rate of 1.0% for both the $815 million Tranche B-III 2019 and the $1.796 billion Tranche B 2020 Term Loans and the interest rate is based on a fixed rate of 2.75% plus LIBOR, with a minimum fixed LIBOR of 0.75% for the $2 billion Tranche B-II 2022 Term Loan. The effective market LIBOR rate for the senior secured credit facility was approximately 0.68% for the Tranche B-II 2022 Term Loan, and 0.85% for the Tranche B-III 2019 Term Loan and the Tranche B 2020 Term Loan at December 31, 2016, respectively, which were below the fixed minimum rate. Declines in LIBOR below the fixed minimum rate or increases up to the fixed minimum rate do not affect our annual interest expense. A hypothetical increase in LIBOR by 1% point would increase our annual interest expense on all of our variable rate instruments by approximately $44 million as of December 31, 2016.

At December 31, 2016, we had $6.1 billion (excluding discounts) of fixed rate debt bearing a weighted average interest rate of 5.5%. A decline in interest rates in the future will not generally benefit us with respect to the fixed rate debt due to the terms and conditions of the indentures relating to that debt that would require us to repurchase the debt at specified premiums if redeemed early. Indicated changes in interest rates are based on hypothetical movements and are not necessarily indicative of the actual results that may occur.

Foreign Currency Exchange Rate Risk

We conduct a portion of our business in currencies other than the U.S. dollar, the