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EX-32 - EX-32 - Zayo Group Holdings, Inc.zayo-20160930xex32.htm
EX-31.2 - EX-31.2 - Zayo Group Holdings, Inc.zayo-20160930ex312ff3159.htm
EX-31.1 - EX-31.1 - Zayo Group Holdings, Inc.zayo-20160930ex311c21917.htm
EX-10.6 - EX-10.6 - Zayo Group Holdings, Inc.zayo-20160930ex1065442aa.htm
EX-10.5 - EX-10.5 - Zayo Group Holdings, Inc.zayo-20160930ex1051b7d0d.htm
EX-10.4 - EX-10.4 - Zayo Group Holdings, Inc.zayo-20160930ex1042cec21.htm
EX-10.3 - EX-10.3 - Zayo Group Holdings, Inc.zayo-20160930ex103fc18d0.htm
EX-10.2 - EX-10.2 - Zayo Group Holdings, Inc.zayo-20160930ex102cf0a51.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-Q


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

For the quarterly period ended September 30, 2016

OR

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

Commission File Number: 001-36690


Zayo Group Holdings, Inc.

(Exact Name of Registrant as Specified in Its Charter)


 

 

 

 

DELAWARE

 

26-1398293

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

1805 29th Street, Suite 2050,

Boulder, CO 80301

(Address of Principal Executive Offices)

(303) 381-4683

(Registrant’s Telephone Number, Including Area Code)


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  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§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  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

 

 

 

 

 

Large accelerated filer

 

 

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

☐  (Do not check if a smaller reporting company)

 

Smaller reporting company

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No   ☒

The number of outstanding shares of common stock of Zayo Group Holdings, Inc. as of November 4, 2016, was 243,119,508 shares.

 

 


 

 

ZAYO GROUP HOLDINGS, INC. AND SUBSIDIARIES

INDEX 

 

 

 

 

 

 

Page

Part I. FINANCIAL INFORMATION 

 

 

Item 1. Financial Statements (Unaudited) 

 

Condensed Consolidated Balance Sheets as of September 30, 2016 and June 30, 2016 

 

Condensed Consolidated Statements of Operations for the Three Months Ended September 30, 2016 and 2015 

 

Condensed Consolidated Statements of Comprehensive Income/(Loss) for the Three Months Ended September 30, 2016 and 2015 

 

Condensed Consolidated Statement of Stockholders’ Equity for the Three Months Ended September 30, 2016 

 

Condensed Consolidated Statements of Cash Flows for the Three Months Ended September 30, 2016 and 2015 

 

Notes to Condensed Consolidated Financial Statements 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 

 

25 

Item 3. Quantitative and Qualitative Disclosures about Market Risk 

 

40 

Item 4. Controls and Procedures 

 

41 

Part II. OTHER INFORMATION 

 

 

Item 1. Legal Proceedings 

 

44 

Item 1A. Risk Factors 

 

44 

Item 6. Exhibits 

 

45 

Signatures 

 

46 

 

 

 


 

ZAYO GROUP HOLDINGS, INC. AND SUBSIDIARIES

 

PART I. FINANCIAL INFORMATION

 

ITEM 1.FINANCIAL STATEMENTS (UNAUDITED)

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(in millions, except share amounts)

 

 

 

 

 

 

 

 

    

September 30,

    

June 30,

 

 

2016

    

2016

Assets

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

Cash and cash equivalents

 

$

193.0

 

$

170.7

Trade receivables, net of allowance of $8.0 and $7.5 as of September 30, 2016 and June 30, 2016, respectively

 

 

148.4

 

 

148.4

Prepaid expenses

 

 

62.7

 

 

68.8

Other assets

 

 

7.3

 

 

9.2

Total current assets

 

 

411.4

 

 

397.1

Property and equipment, net

 

 

4,169.1

 

 

4,079.5

Intangible assets, net

 

 

921.3

 

 

934.9

Goodwill

 

 

1,210.6

 

 

1,214.5

Deferred income taxes, net

 

 

7.0

 

 

7.0

Other assets

 

 

114.6

 

 

94.5

Total assets

 

$

6,834.0

 

$

6,727.5

Liabilities and stockholders' equity

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

Accounts payable

 

 

56.1

 

 

97.0

Accrued liabilities

 

 

255.4

 

 

225.7

Accrued interest

 

 

64.6

 

 

28.6

Capital lease obligations, current

 

 

5.9

 

 

5.8

Deferred revenue, current

 

 

126.8

 

 

129.4

Total current liabilities

 

 

508.8

 

 

486.5

Long-term debt, non-current

 

 

4,088.1

 

 

4,085.3

Capital lease obligation, non-current

 

 

46.0

 

 

44.9

Deferred revenue, non-current

 

 

823.1

 

 

793.3

Deferred income taxes, net

 

 

44.9

 

 

41.3

Other long-term liabilities

 

 

67.2

 

 

57.0

Total liabilities

 

 

5,578.1

 

 

5,508.3

Commitments and contingencies (Note 10)

 

 

 

 

 

 

Stockholders' equity

 

 

 

 

 

 

Preferred stock, $0.001 par value - 50,000,000 shares authorized; no shares issued and outstanding as of September 30, 2016 and June 30, 2016, respectively

 

 

 —

 

 

 —

Common stock, $0.001 par value - 850,000,000 shares authorized; 243,119,508 and 242,649,498 shares issued and outstanding as of September 30, 2016 and June 30, 2016, respectively

 

 

0.2

 

 

0.2

Additional paid-in capital

 

 

1,803.6

 

 

1,777.6

Accumulated other comprehensive income

 

 

1.2

 

 

4.5

Accumulated deficit

 

 

(549.1)

 

 

(563.1)

Total stockholders' equity

 

 

1,255.9

 

 

1,219.2

Total liabilities and stockholders' equity

 

$

6,834.0

 

$

6,727.5

The accompanying notes are an integral part of these condensed consolidated financial statements.

1


 

ZAYO GROUP HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(in millions, except per share data)  

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

    

2016

    

2015

Revenue

 

$

504.9

 

$

366.8

Operating costs and expenses

 

 

 

 

 

 

Operating costs (excluding depreciation and amortization and including stock-based compensation—Note 8)

 

 

173.8

 

 

113.0

Selling, general and administrative expenses (including stock-based compensation—Note 8)

 

 

105.6

 

 

84.6

Depreciation and amortization

 

 

138.5

 

 

117.1

Total operating costs and expenses

 

 

417.9

 

 

314.7

Operating income

 

 

87.0

 

 

52.1

Other expenses

 

 

 

 

 

 

Interest expense

 

 

(53.3)

 

 

(53.8)

Foreign currency loss on intercompany loans

 

 

(11.2)

 

 

(10.7)

Other expense, net

 

 

(0.2)

 

 

(0.1)

Total other expenses, net

 

 

(64.7)

 

 

(64.6)

Income/(loss) from operations before income taxes

 

 

22.3

 

 

(12.5)

Provision for income taxes

 

 

6.6

 

 

2.7

Net income/(loss)

 

$

15.7

 

$

(15.2)

Weighted-average shares used to compute net income/(loss) per share:

 

 

 

 

 

 

Basic

 

 

242.6

 

 

243.0

Diluted

 

 

244.0

 

 

243.0

Net income/(loss) per share:

 

 

 

 

 

 

Basic

 

$

0.06

 

$

(0.06)

Diluted

 

$

0.06

 

$

(0.06)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

2


 

ZAYO GROUP HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS) (UNAUDITED)

(in millions)

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

    

2016

    

2015

Net income/(loss)

 

$

15.7

 

$

(15.2)

Foreign currency translation adjustments

 

 

(2.1)

 

 

(4.0)

Defined benefit pension plan adjustments

 

 

(1.2)

 

 

 —

Comprehensive income/(loss)

 

$

12.4

 

$

(19.2)

The accompanying notes are an integral part of these condensed consolidated financial statements.

3


 

ZAYO GROUP HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)

THREE MONTHS ENDED SEPTEMBER 30, 2016

(in millions, except share data)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common
Shares

    

Common
Stock

    

Additional
paid-in
Capital

    

Accumulated
Other
Comprehensive
(Loss)/Income

    

Accumulated
Deficit

    

Total
Stockholders'
Equity

Balance at June 30, 2016

 

242,649,498

 

$

0.2

 

$

1,777.6

 

$

4.5

 

$

(563.1)

 

$

1,219.2

Stock-based compensation

 

470,010

 

 

 —

 

 

24.3

 

 

 —

 

 

 —

 

 

24.3

Cumulative effect adjustment resulting from adoption of ASU 2016-09

(Note 1)

 

 —

 

 

 —

 

 

1.7

 

 

 —

 

 

(1.7)

 

 

 —

Foreign currency translation adjustment

 

 —

 

 

 —

 

 

 —

 

 

(2.1)

 

 

 —

 

 

(2.1)

Defined benefit pension plan adjustments

 

 —

 

 

 —

 

 

 —

 

 

(1.2)

 

 

 —

 

 

(1.2)

Net income

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

15.7

 

 

15.7

Balance at September 30, 2016

 

243,119,508

 

$

0.2

 

$

1,803.6

 

$

1.2

 

$

(549.1)

 

$

1,255.9

The accompanying notes are an integral part of these condensed consolidated financial statements.

4


 

ZAYO GROUP HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in millions)

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

    

2016

    

2015

Cash flows from operating activities

 

 

 

    

 

 

Net income/(loss)

 

$

15.7

 

$

(15.2)

Adjustments to reconcile net income/(loss) to net cash provided by operating activities

 

 

 

 

 

 

Depreciation and amortization

 

 

138.5

 

 

117.1

Non-cash interest expense

 

 

2.6

 

 

3.5

Stock-based compensation

 

 

32.0

 

 

46.1

Amortization of deferred revenue

 

 

(27.5)

 

 

(20.4)

Additions to deferred revenue

 

 

40.9

 

 

49.7

Foreign currency loss on intercompany loans

 

 

11.2

 

 

10.7

Excess tax benefit from stock-based compensation

 

 

 —

 

 

(7.9)

Deferred income taxes

 

 

4.8

 

 

2.0

Provision for bad debts

 

 

0.9

 

 

0.6

Non-cash loss on investments

 

 

0.3

 

 

0.2

Changes in operating assets and liabilities, net of acquisitions

 

 

 

 

 

 

Trade receivables

 

 

(1.9)

 

 

(5.6)

Accounts payable and accrued liabilities

 

 

5.6

 

 

24.5

Other assets and liabilities

 

 

9.7

 

 

(10.1)

Net cash provided by operating activities

 

 

232.8

 

 

195.2

Cash flows from investing activities

 

 

 

 

 

 

Purchases of property and equipment

 

 

(208.3)

 

 

(159.2)

Other

 

 

1.5

 

 

(0.3)

Net cash used in investing activities

 

 

(206.8)

 

 

(159.5)

Cash flows from financing activities

 

 

 

 

 

 

Principal payments on long-term debt

 

 

 —

 

 

(4.1)

Principal payments on capital lease obligations

 

 

(1.0)

 

 

(1.2)

Payment of debt issue costs

 

 

(0.7)

 

 

 —

Excess tax benefit from stock-based compensation

 

 

 —

 

 

7.9

Net cash (used in)/provided by financing activities

 

 

(1.7)

 

 

2.6

Net cash flows

 

 

24.3

 

 

38.3

Effect of changes in foreign exchange rates on cash

 

 

(2.0)

 

 

(1.2)

Net increase in cash and cash equivalents

 

 

22.3

 

 

37.1

Cash and cash equivalents, beginning of year

 

 

170.7

 

 

308.6

Cash and cash equivalents, end of period

 

$

193.0

 

$

345.7

Supplemental disclosure of non-cash investing and financing activities:

 

 

 

 

 

 

Cash paid for interest, net of capitalized interest

 

$

13.2

 

$

29.3

Cash paid for income taxes

 

 

1.9

 

 

4.7

Non-cash purchases of equipment through capital leasing

 

 

3.3

 

 

5.3

Increase in accounts payable and accrued expenses for purchases of property and equipment

 

 

11.4

 

 

11.0

 

Refer to Note 2 — Acquisitions for details regarding the Company’s recent acquisitions.

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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ZAYO GROUP HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

(1) BUSINESS AND BASIS OF PRESENTATION

Business

Zayo Group Holdings, Inc., a Delaware corporation, was formed on November 13, 2007, and is the parent company of a number of subsidiaries engaged in bandwidth infrastructure services. Zayo Group Holdings, Inc. and its subsidiaries are collectively referred to as “Zayo Group Holdings” or the “Company.” The Company’s primary operating subsidiary is Zayo Group, LLC (“ZGL”). Headquartered in Boulder, Colorado, the Company operates bandwidth infrastructure assets, including fiber networks and data centers, in the United States, Canada and Europe to offer:

·

Dark Fiber Solutions, including dark fiber and mobile infrastructure services.

·

Colocation and Cloud Infrastructure, including cloud and colocation services.

·

Network Connectivity, wavelengths, Ethernet, IP and SONET services.

·

Other services, including Zayo Professional Services (“ZPS”), voice and unified communications.

The Company’s shares are listed on the New York Stock Exchange (NYSE) under the ticker symbol “ZAYO”.

Basis of Presentation

The accompanying condensed consolidated financial statements include all the accounts of the Company and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated in consolidation. The accompanying consolidated financial statements and related notes are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial reporting and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for quarterly reports on Form 10-Q, and do not include all of the note disclosures required by GAAP for complete financial statements. These consolidated financial statements should, therefore, be read in conjunction with the consolidated financial statements and notes thereto for the year ended June 30, 2016 included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2016. In the opinion of management, all adjustments considered necessary for a fair presentation of financial position, results of operations and cash flows of the Company have been included herein. Certain amounts in the prior period financial statements have been condensed to conform to the current period presentation and had no impact on reported net income or losses. The results of operations for the three months ended September 30, 2016 are not necessarily indicative of the operating results for any future interim period or the full year.

The Company’s fiscal year ends June 30 each year, and we refer to the fiscal year ended June 30, 2016 as “Fiscal 2016” and the fiscal year ending June 30, 2017 as “Fiscal 2017.”

Earnings or Loss per Share

Basic earnings or loss per share attributable to the Company’s common shareholders is computed by dividing net earnings or loss attributable to common shareholders by the weighted average number of common shares outstanding for the period.   Diluted earnings or loss per share attributable to common shareholders presents the dilutive effect, if any, on a per share basis of potential common shares (such as restricted stock units) as if they had been vested or converted during the periods presented. No such items were included in the computation of diluted loss per share for the three months ended September 30, 2015 as the Company incurred a loss from operations in that period and the effect of inclusion would have been anti-dilutive. 

The effect of 1.4 million incremental shares attributable to the release of Part A and Part B units upon vesting (treasury method) were included in the computation of diluted income per share for the three months ended September 30, 2016.

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ZAYO GROUP HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Significant Accounting Policies

Upon early adoption of ASU 2016-09 (as described below), the Company elected to change its accounting policy to account for forfeitures as they occur versus estimating forfeitures. The Company recognizes all stock-based awards to employees and independent directors based on their grant-date fair values, with no estimated forfeiture consideration. The Company recognizes the fair value of outstanding awards as a charge to operations over the vesting period.

There have been no other changes to the Company’s significant accounting policies described in its Annual Report on Form 10-K for the year ended June 30, 2016.

Use of Estimates

The preparation of the Company’s condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. Significant estimates are used when establishing allowances for doubtful accounts and accruals for billing disputes, determining useful lives for depreciation and amortization and accruals for exit activities associated with real estate leases, assessing the need for impairment charges (including those related to intangible assets and goodwill), determining the fair values of assets acquired and liabilities assumed in business combinations, accounting for income taxes and related valuation allowances against deferred tax assets, determining the defined benefit costs and defined benefit obligations related to post-employment benefits and estimating the restricted stock unit grant fair values used to compute the stock-based compensation liability and expense. Management evaluates these estimates and judgments on an ongoing basis and makes estimates based on historical experience, current conditions, and various other assumptions that are believed to be reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities as well as identifying and assessing the accounting treatment with respect to commitments and contingencies. Actual results may differ from these estimates under different assumptions or conditions.

Recently Issued Accounting Pronouncements

In August 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-15, "Statement of Cash Flows (Topic 230): Classifications of Certain Cash Receipts and Cash Payments." The new standard provides guidance for eight changes with respect to how cash receipts and cash payments are classified in the statement of cash flows, with the objective of reducing diversity in practice. The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 31, 2017, with early adoption permitted. The Company does not plan to early adopt, nor does it expect the adoption of this new standard to have a material impact on its condensed consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases. The new guidance supersedes existing guidance on accounting for leases in Topic 840 and is intended to increase the transparency and comparability of accounting for lease transactions. ASU 2016-02 requires most leases to be recognized on the balance sheet. Lessees will need to recognize a right-of-use asset and a lease liability for virtually all leases. The liability will be equal to the present value of lease payments. The asset will be based on the liability, subject to adjustment, such as for initial direct costs. For income statement purposes, the FASB retained a dual model, requiring leases to be classified as either operating or finance. Lessor accounting remains similar to the current model, but updated to align with certain changes to the lessee model and the new revenue recognition standard (ASU 2014-09). The ASU will require both quantitative and qualitative disclosures regarding key information about leasing arrangements. The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. The new standard must be adopted using a modified retrospective transition, and provides for certain practical expedients. Transition will require application of the new guidance at the beginning of the earliest comparative period presented. The Company is

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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

evaluating the effect that ASU 2016-02 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

 

On March 30, 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which is intended to improve the accounting for share-based payment transactions as part of the FASB’s simplification initiative. The ASU changes five aspects of the accounting for share-based payment award transactions that will affect public companies, including: (1) accounting for income taxes; (2) classification of excess tax benefits on the statement of cash flows; (3) forfeitures; (4) minimum statutory tax withholding requirements; and (5) classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax-withholding purposes. The Company early-adopted ASU 2016-09 effective July 1, 2016. Excess tax benefits for share-based payments are now recognized against income tax expense rather than additional paid-in capital and are included in operating cash flows rather than financing cash flows. The recognition of excess tax benefits have been applied prospectively and prior periods have not been adjusted. The Company did not have any excess tax benefits for the three months ended September 30, 2016.  In addition, the Company elected to change its accounting policy to account for forfeitures as they occur. The change was applied on a modified retrospective basis with a cumulative effect adjustment to accumulated deficit of $1.7 million as of July 1, 2016. Amendments related to minimum statutory tax withholding requirements and the classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax-withholding purposes have been adopted prospectively and did not have a material impact on the condensed consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in GAAP when it becomes effective. In July 2015, the FASB deferred the effective date to annual reporting periods and interim reporting periods within annual reporting periods beginning after December 15, 2017.  Early adoption is permitted as of the original effective date or annual reporting periods and interim reporting periods within annual reporting periods beginning after December 15, 2016. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU 2014-09 will have on the Company and its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

(2) ACQUISITIONS

Since inception, the Company has consummated 38 transactions accounted for as business combinations. The acquisitions were executed as part of the Company’s business strategy of expanding through acquisitions. The acquisitions of these businesses have allowed the Company to increase the scale at which it operates, which in turn affords the Company the ability to increase its operating leverage, extend its network reach, and broaden its customer base.

The accompanying condensed consolidated financial statements include the operations of the acquired entities from their respective acquisition dates. The Company has not completed any transactions accounted for as a business combination during the three months ended September 30, 2016.

Acquisitions Completed During Fiscal 2016

Clearview

On April 1, 2016, the Company acquired 100% of the equity interest in Clearview International, LLC (“Clearview”), a Texas based colocation and cloud infrastructure services provider for cash consideration of $18.3 million, subject to certain post-closing adjustments. $1.7 million of the purchase consideration is currently held in

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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

escrow pending the expiration of the indemnification adjustment period. The acquisition was funded with cash on hand and was considered an asset purchase for tax purposes.

The acquisition consisted of two Texas data centers. The data centers, located at 6606 LBJ Freeway in Dallas, Texas and 700 Austin Avenue in Waco, Texas, added approximately 30,000 square feet of colocation space, as well as a set of hybrid cloud infrastructure services that complement the Company’s global cloud capabilities.   

Allstream

On January 15, 2016, the Company acquired 100% of the equity interest in Allstream, Inc. and Allstream Fiber U.S. Inc. (together “Allstream”) from Manitoba Telecom Services Inc. (“MTS”) for cash consideration of CAD $422.9 million (or $297.6 million), net of cash acquired, subject to certain post-closing adjustments. The consideration paid is net of CAD $42.1 million (or $29.6 million) of working capital and other liabilities assumed by the Company in the acquisition. The acquisition was funded with Term Loan Proceeds (as defined in Note 5 – Long-Term Debt). CAD $4.2 million (or $3.2 million) is currently held in escrow pending the expiration of the indemnification adjustment period. The acquisition was considered a stock purchase for tax purposes.

The acquisition added more than 18,000 route miles to the Company’s fiber network, including 12,500 miles of long-haul fiber connecting all major Canadian markets and 5,500 route miles of metro fiber network connecting approximately 3,300 on-net buildings concentrated in Canada’s top five metropolitan markets.

As part of the Allstream acquisition, MTS agreed to retain Allstream’s former defined benefit pension obligations, and related pension plan assets, of retirees and other former employees of Allstream and also agreed to reimburse Allstream for certain solvency funding payments related to the pension obligations of active Allstream employees as of January 15, 2016.  MTS will transfer assets from Allstream’s former defined benefit pension plans related to pre-closing service obligations for active employees to a new Allstream defined benefit pension plans created by the Company, subject to regulatory approval. In addition, if the pre-closing benefit obligation for the January 15, 2016 active employees exceeds the fair value of assets transferred to the new Allstream pension plans, MTS agreed to fund the funding deficiency at the later of the asset transfer date or the date at which it is determined that no further solvency deficit exists. Any required funding of the pension benefit obligation subsequent to January 15, 2016, will be the responsibility of the Company. The amount of the funding deficiency was not material to the financial statements as of September 30, 2016.

Also as part of the Allstream acquisition, the Company assumed the liabilities related to Allstream’s other non-pension unfunded post retirement benefits plans. The liability assumed on January 15, 2016 was approximately CAD $12.8 million (or $8.3 million). The balance of this liability as of September 30, 2016 was approximately CAD $13.0 million (or $9.9 million). This liability is currently included in “Other long-term liabilities” on the consolidated balance sheet.

Viatel

On December 31, 2015, the Company completed the acquisition of a 100% interest in Viatel Infrastructure Europe Ltd., Viatel (UK) Limited, Viatel France SAS, Viatel Deutschland GmbH and Viatel Nederland BV (collectively, “Viatel”) for cash consideration of €92.9 million (or $101.2 million), net of cash acquired. The acquisition was funded with cash on hand. The acquisition was considered a stock purchase for tax purposes. During the three months ended September 30, 2016, the Company received a refund of the purchase price from escrow of  €1.3 million (or $1.5 million). The refund is reflected as a cash inflow from investing activities on the condensed consolidated statement of cash flows for the three months ended September 30, 2016 within the Other caption.

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Dallas Data Center Acquisition (“Dallas Data Center”)

On December 31, 2015, the Company acquired a 36,000 square foot data center located in Dallas, Texas for cash consideration of $16.6 million. The acquisition was funded with cash on hand and was considered an asset purchase for tax purposes.

Acquisition Method Accounting Estimates

The Company initially recognizes the assets and liabilities acquired from the aforementioned acquisitions based on its preliminary estimates of their acquisition date fair values. As additional information becomes known concerning the acquired assets and assumed liabilities, management may make adjustments to the opening balance sheet of the acquired company up to the end of the measurement period, which is no longer than a one year period following the acquisition date. The determination of the fair values of the acquired assets and liabilities assumed (and the related determination of estimated lives of depreciable tangible and identifiable intangible assets) requires significant judgment. As of September 30, 2016, the Company has not completed its fair value analysis and calculations in sufficient detail necessary to arrive at the final estimates of the fair value of certain working capital and non-working capital acquired assets and assumed liabilities, including the allocations to goodwill and intangible assets, deferred revenue and resulting deferred taxes related to its acquisitions of Clearview, Allstream, Viatel and Dallas Data Center. All information presented with respect to certain working capital and non-working capital acquired assets and liabilities assumed as it relates to these acquisitions is preliminary and subject to revision pending the final fair value analysis.

 

The table below reflects the Company's estimates of the acquisition date fair values of the assets and liabilities assumed from its Fiscal 2016 acquisitions:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Clearview

 

Allstream

 

Viatel

 

Dallas Data
Center

Acquisition date

    

April 1, 2016

    

January 15, 2016

    

December 31, 2015

    

December 31, 2015

 

 

 

(in millions)

Cash

 

$

 —

 

$

2.9

 

$

3.5

 

$

 —

Other current assets

 

 

0.6

 

 

102.2

 

 

12.0

 

 

 —

Property and equipment

 

 

15.4

 

 

262.3

 

 

162.3

 

 

14.8

Deferred tax assets, net

 

 

0.2

 

 

2.4

 

 

 —

 

 

 —

Intangibles

 

 

9.8

 

 

64.5

 

 

 —

 

 

1.8

Goodwill

 

 

3.9

 

 

 —

 

 

13.0

 

 

 —

Other assets

 

 

0.2

 

 

4.5

 

 

2.1

 

 

 —

Total assets acquired

 

 

30.1

 

 

438.8

 

 

192.9

 

 

16.6

Current liabilities

 

 

1.1

 

 

64.6

 

 

17.6

 

 

 —

Deferred revenue

 

 

0.4

 

 

46.2

 

 

57.8

 

 

 —

Deferred tax liability, net

 

 

 —

 

 

 —

 

 

5.7

 

 

 —

Other liabilities

 

 

10.3

 

 

27.5

 

 

7.1

 

 

 —

Total liabilities assumed

 

 

11.8

 

 

138.3

 

 

88.2

 

 

 —

Net assets acquired

 

 

18.3

 

 

300.5

 

 

104.7

 

 

16.6

Less cash acquired

 

 

 —

 

 

(2.9)

 

 

(3.5)

 

 

 —

Net consideration paid

 

$

18.3

 

$

297.6

 

$

101.2

 

$

16.6

 

The goodwill arising from the Company’s acquisitions results from synergies, anticipated incremental sales to the acquired company customer base and economies-of-scale expected from the acquisitions. The Company has allocated the goodwill to the reporting units (in existence on the respective acquisition dates) that were expected to benefit from the acquired goodwill. The allocation was determined based on the excess of the estimated fair value of the reporting unit

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over the estimated fair value of the individual assets acquired and liabilities assumed that were assigned to the reporting units. Note 3 - Goodwill, displays the allocation of the Company's acquired goodwill to each of its reporting units.

 

In the Company’s acquisitions, the Company acquired certain customer relationships. These relationships represent a valuable intangible asset, as the Company anticipates continued business from the acquired customer bases. The Company’s estimate of the fair value of the acquired customer relationships is based on a multi-period excess earnings valuation technique that utilizes Level 3 inputs.

Transaction Costs

Transaction costs include expenses associated with professional services (i.e., legal, accounting, regulatory, etc.) rendered in connection with signed and/or closed acquisitions or disposals (including spin-offs), travel expense, severance expense incurred on the date of acquisition or disposal, and other direct expenses incurred that are associated with such acquisitions or disposals. The Company incurred transaction costs of $3.0 million and nil for the three months ended September 30, 2016 and 2015, respectively. Transaction costs have been included in selling, general and administrative expenses in the condensed consolidated statements of operations and in cash flows from operating activities in the condensed consolidated statements of cash flows during these periods. 

(3) GOODWILL

The Company’s goodwill balance was $1,210.6 million and $1,214.5 million as of September 30, 2016 and June 30, 2016, respectively.

The Company’s reporting units are comprised of its strategic product groups (“SPGs”): Zayo Dark Fiber (“Dark Fiber”), Zayo Wavelength Services (“Waves”), Zayo SONET Services (“SONET”), Zayo Ethernet Services (“Ethernet”), Zayo IP Services (“IP”), Zayo Mobile Infrastructure Group (“MIG”), Zayo Colocation (“zColo"), Zayo Cloud Services (“Cloud”), Allstream business (“Zayo Canada”) and Other (primarily ZPS).

The following reflects the changes in the carrying amount of goodwill during the three months ended September 30, 2016:

 

 

 

 

 

 

 

 

 

 

Product Group

    

As of June 30, 2016

    

Foreign Currency
Translation and
Other

    

As of September 30, 2016

 

 

(in millions)

Dark Fiber

 

$

295.1

 

$

(2.6)

 

$

292.5

Waves

 

 

258.3

 

 

(1.2)

 

 

257.1

Sonet

 

 

51.3

 

 

 —

 

 

51.3

Ethernet

 

 

104.3

 

 

 —

 

 

104.3

IP

 

 

87.5

 

 

 —

 

 

87.5

MIG

 

 

73.6

 

 

 —

 

 

73.6

zColo

 

 

268.8

 

 

 —

 

 

268.8

Cloud

 

 

60.0

 

 

 —

 

 

60.0

Other

 

 

15.6

 

 

(0.1)

 

 

15.5

Total

 

$

1,214.5

 

$

(3.9)

 

$

1,210.6

 

 

 

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(4) INTANGIBLE ASSETS

Identifiable intangible assets as of September 30, 2016 and June 30, 2016 were as follows:

 

 

 

 

 

 

 

 

 

 

 

    

Gross Carrying Amount

    

Accumulated
Amortization

    

Net

 

 

(in millions)

September 30, 2016

 

 

 

 

 

 

 

 

 

Finite-Lived Intangible Assets

 

 

 

 

 

 

 

 

 

Customer relationships

 

$

1,149.0

 

$

(247.3)

 

$

901.7

Trade names

 

 

0.2

 

 

(0.2)

 

 

 —

Underlying rights

 

 

1.6

 

 

(0.3)

 

 

1.3

Total

 

 

1,150.8

 

 

(247.8)

 

 

903.0

Indefinite-Lived Intangible Assets

 

 

 

 

 

 

 

 

 

Certifications

 

 

3.5

 

 

 —

 

 

3.5

Underlying Rights

 

 

14.8

 

 

 —

 

 

14.8

Total

 

$

1,169.1

 

$

(247.8)

 

$

921.3

June 30, 2016

 

 

 

 

 

 

 

 

 

Finite-Lived Intangible Assets

 

 

 

 

 

 

 

 

 

Customer relationships

 

$

1,143.6

 

$

(228.8)

 

$

914.8

Trade names

 

 

0.2

 

 

(0.2)

 

 

 —

Underlying rights

 

 

1.6

 

 

(0.3)

 

 

1.3

Total

 

 

1,145.4

 

 

(229.3)

 

 

916.1

Indefinite-Lived Intangible Assets

 

 

 

 

 

 

 

 

 

Certifications

 

 

3.5

 

 

 —

 

 

3.5

Underlying Rights

 

 

15.3

 

 

 —

 

 

15.3

Total

 

$

1,164.2

 

$

(229.3)

 

$

934.9

 

(5) LONG-TERM DEBT

As of September 30, 2016 and June 30, 2016, long-term debt was as follows:

 

 

 

 

 

 

 

 

 

 

September 30,

 

June 30,

 

 

    

2016

    

2016

 

 

 

(in millions)

Term Loan Facility due 2021

 

$

1,837.4

 

$

1,837.4

 

6.00% Senior Unsecured Notes due 2023

 

 

1,430.0

 

 

1,430.0

 

6.375% Senior Unsecured Notes due 2025

 

 

900.0

 

 

900.0

 

Total debt obligations

 

 

4,167.4

 

 

4,167.4

 

Unamortized discount on Term Loan Facility

 

 

(18.0)

 

 

(19.0)

 

Unamortized premium on 6.00% Senior Unsecured Notes due 2023

 

 

6.1

 

 

6.3

 

Unamortized discount on 6.375% Senior Unsecured Notes due 2025

 

 

(15.3)

 

 

(15.6)

 

Unamortized debt issuance costs

 

 

(52.1)

 

 

(53.8)

 

Carrying value of debt

 

$

4,088.1

 

$

4,085.3

 

Term Loan Facility due 2021 and Revolving Credit Facility

On May 6, 2015, ZGL and Zayo Capital, Inc. (“Zayo Capital”) entered into an Amendment and Restatement Agreement whereby the Credit Agreement (the “Credit Agreement”) governing their senior secured term loan facility (the “Term Loan Facility”) and $450.0 million senior secured revolving credit facility (the “Revolver”) was amended and restated in its entirety. The amended and restated Credit Agreement extended the maturity date of the outstanding term loans under the Term Loan Facility to May 6, 2021. The interest rate margins applicable to the Term Loan Facility were decreased by 25 basis points to LIBOR plus 2.75% with a minimum LIBOR of 1.0%. In addition, the amended and

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restated Credit Agreement removed the fixed charge coverage ratio covenant and replaced such covenant with a springing senior secured leverage ratio maintenance requirement applicable only to the Revolver, increased certain lien and debt baskets, and removed certain covenants related to collateral. The terms of the Term Loan Facility require the Company to make quarterly principal payments of $5.1 million plus an annual payment of up to 50% of excess cash flow, as determined in accordance with the Credit Agreement (no such payment was required during the three months ended September 30, 2016 or 2015).

The Revolver matures at the earliest of (i) April 17, 2020 and (ii) six months prior to the maturity date of the Term Loan Facility, subject to amendment thereof.  The Credit Agreement also allows for letter of credit commitments of up to $50.0 million.  The Revolver is subject to a fee per annum of 0.25% to 0.375% (based on ZGL’s current leverage ratio) of the weighted-average unused capacity, and the undrawn amount of outstanding letters of credit backed by the Revolver are subject to a 0.25% fee per annum. Outstanding letters of credit backed by the Revolver accrue interest at a rate ranging from LIBOR plus 2.0% to LIBOR plus 3.0% per annum based upon ZGL’s leverage ratio.

On January 15, 2016, ZGL and Zayo Capital entered into an Incremental Amendment (the “Amendment”) to the Credit Agreement. Under the terms of the Amendment, the Term Loan Facility was increased by $400.0 million (the “Incremental Term Loan”). The additional amounts borrowed bear interest at LIBOR plus 3.5% with a minimum LIBOR rate of 1.0%. The $400.0 million add-on was priced at 99.0% (the “Term Loan Proceeds”). The issue discount of $4.8 million on the Amendment is being accreted to interest expense over the term of the Term Loan Facility under the effective interest method. No other terms of the Credit Agreement were amended.  The Term Loan Proceeds were used to fund the Allstream acquisition (see Note 2 – Acquisitions) and for general corporate purposes.

On July 22, 2016, ZGL and Zayo Capital entered into a Repricing Amendment (the “Repricing Amendment”) to the Credit Agreement.  Per the terms of the Amendment, the Incremental Term Loan was repriced to bear interest at a rate of LIBOR plus 2.75%, with a minimum LIBOR rate of 1.0%, which represented a downward adjustment of 75 basis points. No other terms of the Credit Agreement were amended.

The weighted average interest rates (including margins) on the Term Loan Facility were approximately 3.75% and 3.9% at September 30, 2016 and June 30, 2016, respectively. Interest rates on the Revolver as of September 30, 2016 and June 30, 2016 were approximately 3.6% and 3.4%, respectively.

As of September 30, 2016, no amounts were outstanding under the Revolver. Standby letters of credit were outstanding in the amount of $7.9 million as of September 30, 2016, leaving $442.1 million available under the Revolver.

6.00% Senior Unsecured Notes Due 2023 and 6.375% Senior Unsecured Notes due 2025

On April 14, 2016, ZGL and Zayo Capital completed a private offering of $550.0 million aggregate principal amount of additional 2025 Unsecured Notes (the “New 2025 Notes”). The New 2025 Notes were an additional issuance of the existing 6.375% senior unsecured notes due in 2025 (the “2025 Unsecured Notes”) and were priced at 97.1%. The issue discount of $15.9 million of the New 2025 Notes is being accreted to interest expense over the term of the New 2025 Notes using the effective interest method. The net proceeds from the offering plus cash on hand (i) were used to redeem the then outstanding $325.6 million 10.125% senior unsecured notes due 2020, including the required $20.3 million make-whole premium and accrued interest, and (ii) were used to repay $196.0 million of borrowings under its secured Term Loan Facility. Per the terms of the Credit Agreement, the $196.0 million prepayment on the Term Loan Facility relieves the Company of its obligation to make quarterly principal payments on the Term Loan Facility until the cumulative amount of such relieved payments exceeds $196.0 million. The Company recorded a $2.1 million loss on extinguishment of debt associated with the write-off of unamortized debt discount on the Term Loan Facility accounted for as an extinguishment during the fourth quarter of Fiscal 2016. Following the offering of the New 2025 Notes, $900.0 million aggregate principal amount of the 2025 Unsecured Notes is outstanding.

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Debt covenants

The indentures (the “Indentures”) governing the 6.00% senior unsecured notes due 2023 (the “2023 Unsecured Notes”) and the 2025 Unsecured Notes (collectively the “Notes”) contain covenants that, among other things, restrict the ability of ZGL and its subsidiaries to incur additional indebtedness and issue preferred stock; pay dividends or make other distributions with respect to any equity interests, make certain investments or other restricted payments, create liens, sell assets, incur restrictions on the ability of the ZGL’s restricted subsidiaries to pay dividends or make other payments to ZGL, consolidate or merge with or into other companies or transfer all or substantially all of their assets, engage in transactions with affiliates, and enter into sale and leaseback transactions.  The terms of the Indentures include customary events of default.

The Credit Agreement contains customary events of default, including among others, non-payment of principal, interest, or other amounts when due, inaccuracy of representations and warranties, breach of covenants, cross default to certain other indebtedness, insolvency or inability to pay debts, bankruptcy, or a change of control. The Credit Agreement also contains a covenant, applicable only to the Revolver, that ZGL maintain a senior secured leverage ratio below 5.25:1.00 at any time when the aggregate principal amount of loans outstanding under the Revolver is greater than 35% of the commitments under the Revolver. The Credit Agreement also requires ZGL and its subsidiaries to comply with customary affirmative and negative covenants, including covenants restricting the ability of ZGL and its subsidiaries, subject to specified exceptions, to incur additional indebtedness, make additional guaranties, incur additional liens on assets, or dispose of assets, pay dividends, or make other distributions, voluntarily prepay certain other indebtedness, enter into transactions with affiliated persons, make investments and amend the terms of certain other indebtedness.

The Indentures limit any increase in ZGL’s secured indebtedness (other than certain forms of secured indebtedness expressly permitted under such indentures) to a pro forma secured debt ratio of 4.50 times ZGL’s previous quarter’s annualized modified EBITDA (as defined in the indentures), and limit ZGL’s incurrence of additional indebtedness to a total indebtedness ratio of 6.00 times the previous quarter’s annualized modified EBITDA.

The Company was in compliance with all covenants associated with its debt agreements as of September 30, 2016.

Guarantees

The Notes are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by all of ZGL’s current and future domestic restricted subsidiaries. The Notes were co-issued with Zayo Capital, which does not have independent assets or operations.

Debt issuance costs

In connection with the Credit Agreement (and subsequent amendments thereto), and the various Notes offerings, the Company incurred debt issuance costs of $90.1 million (net of extinguishments). These costs are being amortized to interest expense over the respective terms of the underlying debt instruments using the effective interest method, unless extinguished earlier, at which time the related unamortized costs are to be immediately expensed.

Unamortized debt issuance costs of $11.4 million associated with the Company’s previous indebtedness were recorded as part of the loss on extinguishment of debt during the fourth quarter of Fiscal 2016. 

The balance of debt issuance costs as of September 30, 2016 and June 30, 2016 was $52.1 million and $53.8 million, net of accumulated amortization of $38.0 million and $35.8 million, respectively. The amortization of debt issuance costs is included on the condensed consolidated statements of cash flows within the caption “Non-cash interest

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expense” along with the amortization or accretion of the premium and discount on the Company’s indebtedness and changes in the fair value of the Company’s interest rate derivatives.  Interest expense associated with the amortization of debt issuance costs was $2.2 million and $2.5 million for the three months ended September 30, 2016 and 2015, respectively.

Debt issuance costs are presented in the condensed consolidated balance sheets as a reduction to “Long-term debt, non-current”.

Interest rate derivatives

On August 13, 2012, the Company entered into forward-starting interest rate swap agreements with an aggregate notional value of $750.0 million, a maturity date of June 30, 2017, and a start date of June 30, 2013. There were no up-front fees for these agreements. The contract states that the Company shall pay a 1.67% fixed rate of interest for the term of the agreement beginning on the start date. The counter-party will pay to the Company the greater of actual LIBOR or 1.25%. The Company entered in to the forward-starting swap arrangements to reduce the risk of increased interest costs associated with potential changes in LIBOR rates.

Changes in the fair value of interest rate swaps are recorded in interest expense in the condensed consolidated statements of operations for the applicable period. The fair value of the interest rate swaps of $2.3 million and $3.0 million are included in “Other long term liabilities” in the Company’s condensed consolidated balance sheets as of September 30, 2016 and June 30, 2016, respectively. During the three months ended September 30, 2016 and 2015, $(0.7) million and $0.4 million was recorded as a (decrease)/increase in interest expense for the change in fair value of the interest rate swaps.

(6) INCOME TAXES

The Company’s effective tax rates on pre-tax income/(loss) for the three months ended September 30, 2016 and September 30, 2015 was 29.8% and 21.6%, respectively.

 

The interim period effective tax rate is derived from anticipated pre-tax book income for the full fiscal year adjusted for anticipated items that are deductible/non-deductible for tax purposes only (i.e., permanent items). Additionally, the tax expense or benefit related to discrete permanent differences in an interim period are recorded in the period they occur.

 

The interim effective tax rate for the three months ended September 30, 2016 was positively impacted by the United Kingdom (“UK”) tax rate decrease (described further below) as well as non-US tax expense not recognized due to full valuation allowances recorded on certain foreign entities. The effective tax continues to be negatively impacted by stock-based compensation expense related to the common units of Communications Infrastructure Investments, LLC (“CII”), which is not deductible for income tax purposes. The interim effective tax rate was further negatively impacted by an excess of GAAP stock compensation expense for the current quarter, related to the Company’s Restricted Stock Unit plan, over what is deductible for income tax purposes.

 

In the UK, the main rate of corporation tax was reduced during the current quarter from 18% to 17%, applicable from April 1, 2020. The Company, in accordance with ASC 740-270-25, is recording the effect of this tax rate change on its deferred tax assets and liabilities as a discrete item in the current interim period. The impact of the change in the UK tax rate in the three months ended September 30, 2016 was a reduction in the Company’s tax effective tax rate of 7.4%.

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(7) EQUITY

During the three months ended September 30, 2016, the Company recorded a $24.3 million increase in additional paid-in capital associated with stock-based compensation expense related to the Company’s equity classified stock-based compensation awards (See Note 8 –Stock-based Compensation). 

(8) STOCK-BASED COMPENSATION

The following tables summarize the Company’s stock-based compensation expense for liability and equity classified awards included in the condensed consolidated statements of operations.

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

    

2016

    

2015

 

 

(in millions)

Included in:

 

 

 

 

 

 

Operating costs

 

$

3.3

 

$

6.7

Selling, general and administrative expenses

 

 

28.7

 

 

39.4

Total stock-based compensation expense

 

$

32.0

 

$

46.1

 

 

 

 

 

 

 

CII common units

 

$

4.2

 

$

19.5

Part A restricted stock units

 

 

21.3

 

 

10.0

Part B restricted stock units

 

 

6.2

 

 

16.4

Part C restricted stock units

 

 

0.3

 

 

0.2

Total stock-based compensation expense

 

$

32.0

 

$

46.1

CII Common Units

During the three months ended September 30, 2016 and 2015, the Company recognized $4.2 million and $19.5 million, respectively, of stock-based compensation expense related to vesting of CII common and preferred units. As of September 30, 2016, the unrecognized compensation associated with the Company component of unvested CII common units was $5.9 million.

Performance Incentive Compensation Plan (“PCIP”)

During October 2014, the Company adopted the 2014 Performance Compensation Incentive Plan (“PCIP”).  The PCIP includes incentive cash compensation (ICC) and equity (in the form of restricted stock units or “RSUs”).  Grants under the PCIP RSU plans are made quarterly for all participants. The PCIP was effective on October 16, 2014 and will remain in effect for a period of 10 years (or through October 16, 2024) unless it is earlier terminated by the Company’s Board of Directors.

The PCIP has the following components:

Part A

Under Part A of the PCIP, all full-time employees, including the Company’s executives, are eligible to earn quarterly awards of RSUs. Each participant in Part A of the PCIP will have a RSU annual award target value, which will be allocated to each fiscal quarter. The final Part A value awarded to a participant for any fiscal quarter is determined by the Compensation Committee subsequent to the end of the respective performance period taking into account the Company’s measured value creation for the quarter, as well as such other subjective factors that it deems relevant

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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

(including group and individual level performance factors). The number of Part A RSUs granted will be calculated based on the final award value determined by the Compensation Committee divided by the average closing price of the Company’s common stock over the last ten trading days of the respective performance period. Part A RSUs will vest assuming continuous employment fifteen months subsequent to the end of the performance period. Upon vesting, the RSUs convert to an equal number of shares of the Company’s common stock.

During the three months ended September 30, 2016 and 2015, the Company recognized $21.3 million and $10.0 million, respectively, of compensation expense associated with the vested portion of the Part A awards. The September 2016 and June 2016 quarterly awards were recorded as liabilities totaling $3.3 million and $2.0 million, as of September 30, 2016 and June 30, 2016, respectively, as the awards represent an obligation denominated in a fixed dollar amount to be settled in a variable number of shares during the subsequent quarter.  The quarterly stock-based compensation liability is included in “Other long-term liabilities” in the accompanying condensed consolidated balance sheets. Upon the issuance of the RSUs, the liability is re-measured and then reclassified to additional paid-in capital, with a corresponding charge (or credit) to stock based compensation expense. The value of the remaining unvested RSUs is expensed ratably through the vesting date. At September 30, 2016, the remaining unrecognized compensation cost to be expensed over the remaining vesting period for Part A awards is $29.7 million.

The following table summarizes the Company’s Part A RSU activity for the three months ended September 30, 2016:

 

 

 

 

 

 

 

 

 

 

 

    

 

Number of Part A
RSUs

    

Weighted average
grant-date fair
value per share

    

 

Weighted average
remaining contractual
term in months

Outstanding at July 1, 2016

 

 

2,169,901

 

$

26.04

 

 

7.9

Granted

 

 

788,471

 

 

29.01

 

 

 

Vested

 

 

(419,217)

 

 

28.62

 

 

 

Forfeited

 

 

(126,280)

 

 

n/a

 

 

 

Outstanding at September 30, 2016

 

 

2,412,875

 

$

26.56

 

 

8.0

Part B

Under Part B of the PCIP, participants, including the Company’s executives, are awarded quarterly grants of RSUs. The number of the RSUs earned by the participants is based on the Company’s stock price performance over a performance period of one year with the starting price being the average closing price over the last ten trading days of the quarter immediately prior to the grant and vest assuming continuous employment through the end of the measurement period. The existence of a vesting provision that is associated with the performance of the Company’s stock price is a market condition, which affects the determination of the grant date fair value.  Upon vesting, RSUs earned convert to an equal number of shares of the Company’s common stock.

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The following table summarizes the Company’s Part B RSU activity for the three months ended September 30, 2016:

 

 

 

 

 

 

 

 

 

 

 

    

 

Number of Part B
RSUs

    

Weighted average
grant-date fair
value per unit

    

 

Weighted average
remaining contractual
term in months

Outstanding at July 1, 2016

 

 

860,936

 

$

29.50

 

 

6.2

Granted

 

 

200,425

 

 

47.00

 

 

 

Vested

 

 

(202,696)

 

 

25.26

 

 

 

Forfeited

 

 

(200,920)

 

 

n/a

 

 

 

Outstanding at September 30, 2016

 

 

657,745

 

$

36.12

 

 

5.9

The table below reflects the total Part B RSUs granted during Fiscal 2017 and 2016, the maximum eligible shares of the Company’s stock that the respective Part B RSU grant could be converted into shares of the Company’s common stock, and the grant date fair value per Part B RSU:

 

 

 

 

 

 

During the three months ended

 

    

September 30,
2016

Part B RSUs granted

 

 

200,425

Maximum eligible shares of the Company's common stock

 

 

1,030,185

Grant date fair value per Part B RSU

 

$

47.00

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

During the three months ended

 

    

June 30,
2016

    

March 31,
2016

    

December 31,
2015

    

September 30,
2015

Part B RSUs granted

 

 

312,516

 

 

284,773

 

 

282,074

 

 

272,813

Maximum eligible shares of the Company's common stock

 

 

1,606,332

 

 

1,463,733

 

 

1,449,860

 

 

1,426,812

Grant date fair value per Part B RSU

 

$

37.03

 

$

25.12

 

$

25.26

 

$

17.83

Units converted to Company's common stock at vesting date

 

 

n/a

 

 

n/a

 

 

n/a

 

 

40,182

 

The Company recognized stock-based compensation expense of $6.2 million and $16.4 million related to Part B awards for the three months ended September 30, 2016 and 2015, respectively.

The grant date fair value of Part B RSU grants is estimated utilizing a Monte Carlo simulation.  This simulation estimates the ten-day average closing stock price ending on the vesting date, the stock price performance over the performance period, and the number of common shares to be issued at the vesting date. Various assumptions are utilized in the valuation method, including the target stock price performance ranges and respective share payout percentages, the Company’s historical stock price performance and volatility, peer companies’ historical volatility and an appropriate risk-free rate. The aggregate future value of the grant under each simulation is calculated using the estimated per share value of the common stock at the end of the vesting period multiplied by the number of common shares projected to be granted at the vesting date. The present value of the aggregate grant is then calculated under each of the simulations, resulting in a distribution of potential present values. The fair value of the grant is then calculated based on the average of the potential present values. The remaining unrecognized compensation cost associated with Part B RSU grants is $14.4 million at September 30, 2016.

Part C

Under Part C of the PCIP, independent directors of the Company are eligible to receive quarterly awards of RSUs.  Independent directors electing to receive a portion of their annual director fees in the form of RSUs are granted a set dollar amount of Part C RSUs each quarter.  The quantity of Part C RSUs granted is based on the average closing price of the Company’s common stock over the last ten trading days of the quarter ended immediately prior to the grant date

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and vest at the end of each quarter for which the grant was made.  During the three months ended September 30, 2016, the Company’s independent directors were granted 10,611 Part C RSUs. Part C RSUs vest in the same quarter that they are issued. During the three months ended September 30, 2016 and 2015 the Company recognized $0.3 million and $0.2 million, respectively, of compensation expense associated with the Part C RSUs.

(9) FAIR VALUE MEASUREMENTS

The Company’s financial instruments consist of cash and cash equivalents, restricted cash, trade receivables, accounts payable, interest rate swaps, long-term debt, certain post-employment plans and stock-based compensation liability. The carrying values of cash and cash equivalents, restricted cash, trade receivables and accounts payable approximated their fair values at September 30, 2016 and June 30, 2016 due to the short maturity of these instruments.

The carrying value of the Company’s Notes, excluding debt issuance costs, reflects the original amounts borrowed, inclusive of net unamortized discount, and was $2,320.8 million and $2,320.7 million as of September 30, 2016 and June 30, 2016, respectively. Based on market interest rates for debt of similar terms and average maturities, the fair value of the Company's Notes as of September 30, 2016 and June 30, 2016 was estimated to be $2,460.0 million and $2,338.1 million, respectively. The Company’s fair value estimates associated with its Note obligations were derived utilizing Level 2 inputs – quoted prices for similar instruments in active markets.

The carrying value of the Company’s Term Loan Facility, excluding debt issuance costs, reflects the original amounts borrowed, inclusive of unamortized discounts, and was $1,819.4 million and $1,818.4 million as of September 30, 2016 and June 30, 2016, respectively. The Company’s Term Loan Facility accrues interest at variable rates based upon the one month, three month or six month LIBOR (with a LIBOR floor of 1.00%) plus a spread of 2.75%. Since management does not believe that the Company’s credit quality has changed significantly since the date when the Term Loan Facility was last amended on May 6, 2015, its carrying amount approximates fair value. Excluding any offsetting effect of the Company’s interest rate swaps, a hypothetical increase in the applicable interest rate on the Company’s Term Loan Facility of one percentage point above the 1.0% LIBOR floor would increase the Company’s annual interest expense by approximately $18.4 million.

The Company’s interest rate swaps are valued using discounted cash flow techniques that use observable market inputs, such as LIBOR-based yield curves, forward rates, and credit ratings. Changes in the fair value of the interest rate swaps of $(0.7) million and $0.4 million were recorded as a (decrease)/increase to interest expense during the three months ended September 30, 2016 and 2015, respectively.  A hypothetical increase in LIBOR rates of 100 basis points would favorably increase the fair value of the interest rate swaps by approximately $3.9 million.

As of September 30, 2016 and June 30, 2016, there was no balance outstanding under the Company's Revolver.

Financial instruments measured at fair value on a recurring basis are summarized below:

 

 

 

 

 

 

 

 

 

 

    

Level

    

September 30, 2016

    

June 30, 2016

Liabilities Recorded at Fair Value in the Financial Statements:

 

 

 

 

(in millions)

Interest rate swap

 

Level 2

 

$

2.3

 

$

3.0

 

(10) COMMITMENTS AND CONTINGENCIES

Purchase commitments

At September 30, 2016, the Company was contractually committed for $296.0 million of capital expenditures for construction materials and purchases of property and equipment. A majority of these purchase commitments are expected to be satisfied in the next twelve months. These purchase commitments are primarily success based; that is, the Company has executed customer contracts that support the future capital expenditures.

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Contingencies

In the normal course of business, the Company is party to various outstanding legal proceedings, asserted and unasserted claims, and carrier disputes. In the opinion of management, the ultimate disposition of these matters, both asserted and unasserted, will not have a material adverse effect on the Company’s financial condition, results of operations, or cash flows.

(11) RELATED PARTY TRANSACTIONS

In May 2016, CII sold Onvoy, LLC and its subsidiaries (“OVS”) to an entity that has a material ownership interest in the Company. The Company continues to have ongoing contractual relationships with OVS, whereby the Company provides OVS and its subsidiaries with bandwidth capacity and OVS provides the Company and its subsidiaries with voice services. The contractual relationships are based on agreements that were entered into at estimated market rates.

The following table represents the revenue and expense transactions the Company recorded with OVS for the periods presented:

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

    

2016

    

2015

 

 

(in millions)

Revenues

 

$

1.6

 

$

1.7

Operating costs

 

$

0.1

 

$

0.1

 

 

As of September 30, 2016 and June 30, 2016, the Company had no outstanding balances due from OVS.

Dan Caruso, the Company’s Chief Executive Officer and Chairman of the Board, is a party to an aircraft charter (or membership) agreement through his affiliate, Bear Equity LLC, for business and personal travel.  Under the terms of the charter agreement, all fees for the use of the aircraft are effectively variable in nature. For his business travel on behalf of the Company, Mr. Caruso is reimbursed for his use of the aircraft subject to an annual maximum reimbursement threshold approved by the Company's Nominating and Governance Committee. During the three months ended September 30, 2016 and 2015 the Company reimbursed Mr. Caruso $0.2 million and $0.1 million, respectively, for his business use of the aircraft.

(12) SEGMENT REPORTING

The Company uses the management approach to determine the segment financial information that should be disaggregated and presented separately in the Company's notes to its financial statements. The management approach is based on the manner by which management has organized the segments within the Company for making operating decisions, allocating resources, and assessing performance.

 

As the Company has increased in scope and scale, it has developed its management and reporting structure to support this growth. The Company’s dark fiber solutions, network connectivity, colocation and cloud infrastructure, Zayo Canada and other services are comprised of various related product groups generally defined around the type of service the customer is buying, referred to as Strategic Product Groups ("SPG" or "SPGs"). Each SPG is responsible for the revenue, costs and associated capital expenditures of their respective services. The SPGs enable sales, make pricing and product decisions, engineer networks and deliver services to customers, and support customers for their specific telecom and Internet infrastructure services.

 

With the continued increase in the Company’s scope and scale, effective October 1, 2015 the Company's chief operating decision maker ("CODM"), the Company's Chief Executive Officer, implemented certain organizational

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changes to the management and operation of the business that directly impacts how the CODM makes resource allocation decisions and manages the Company. The change in structure had the impact of establishing a new reportable segment and re-aligning the Company’s existing SPGs to the revised reportable segments.  Prior to this change, the operating segments were reported as Physical Infrastructure, which included the Company’s Dark Fiber, MIG and zColo SPGs, Cloud and Connectivity, which included the Company’s Waves, SONET, Ethernet, IP and Cloud SPGs, and Other, which primarily included ZPS.  The new structure has moved the zColo and Cloud SPGs out of the Physical Infrastructure and Cloud and Connectivity reporting segments, respectively, creating a new reportable segment named Colocation and Cloud Infrastructure. The Dark Fiber and MIG SPGs are now reported in the Dark Fiber Solutions operating segment, and Ethernet, IP, Waves, and SONET SPGs, are now reported in the Network Connectivity operating segment. SPGs report directly to the reportable segment managers who are responsible for the operations and financial results for the Dark Fiber Solutions, Network Connectivity, Colocation and Cloud Infrastructure, and Other reportable segments (collectively, the “Revised Segments”). The segment managers report directly to the CODM, and it is the financial results of those segments that are evaluated and drive the resource allocation decisions made by the CODM.

The Company’s segments are further described below:

Dark Fiber Solutions. Through the Dark Fiber Solutions segment, the Company provides raw bandwidth infrastructure to customers that require more control of their internal networks. These services include dark fiber and mobile infrastructure (fiber-to-the-tower and small cell). Dark fiber is a physically separate and secure, private platform for dedicated bandwidth. The Company leases dark fiber pairs (usually 2 to 12 total fibers) to its customers, who “light” the fiber using their own optronics. The Company’s mobile infrastructure services provide direct fiber connections to cell towers, small cells, hub sites, and mobile switching centers. Dark Fiber Solutions customers include carriers and other communication service providers, Internet service providers, wireless service providers, major media and content companies, large enterprises, and other companies that have the expertise to run their own fiber optic networks or require interconnected technical space. The contract terms in the Dark Fiber Solutions segment tend to range from three to twenty years.

Network Connectivity. The Network Connectivity segment provides bandwidth infrastructure solutions over the Company’s metro, regional, and long-haul fiber networks where it uses optronics to light the fiber and the Company’s customers pay for access based on the amount and type of bandwidth they purchase. The Company’s services within this segment include wavelength, Ethernet, IP and SONET. The Company targets customers who require a minimum of 10G of bandwidth across their networks. Network Connectivity customers include carriers, financial services companies, healthcare, government institutions, education institutions and other enterprises. The contract terms in this segment tend to range from two to five years.

Colocation and Cloud Infrastructure. The Colocation and Cloud Infrastructure segment provides data center infrastructure solutions to a broad range of enterprise, carrier, content and cloud customers. The Company’s services within this segment include colocation, interconnection, cloud, hosting and managed services, such as security and remote hands offerings. Solutions range in size from single cabinet and server support to comprehensive international outsourced IT infrastructure environments. The Company’s data centers also support a large component of the Company’s networking equipment for the purpose of aggregating and distributing data, voice, Internet, and video traffic. The contract terms in this segment tend to range from two to five years

Zayo Canada. The Zayo Canada segment is comprised of the recently acquired business of Allstream (see Note 2 – Acquisitions). The services provided by this segment include legacy dark fiber, network connectivity, cloud and colocation infrastructure, voice, unified communications, managed security services and small and medium businesses (“SMB”) of Allstream.  Voice provides a full range of local voice services allowing business customers to complete telephone calls in their local exchange, as well as make long distance, toll-free and related calls. Unified communications is the integration of real-time communication services such as telephony (including IP telephony), instant messaging and video conferencing with non-

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real-time communication services, such as integrated voicemail and e-mail.  Unified communications provides a set of products that give users the ability to work and communicate across multiple devices, media types and geographies. Managed security services provide proactive services and solutions designed to enable organizations to operate in an environment of constantly evolving threats from organized cyber-crime. The service provides real-time threat analysis and correlation of information security threats, response and mitigations services, secure access to the internet and the cloud, information risk and compliance services, and management of the IT security envelope.  Zayo Canada provides services to over 26,000 customers in the SMB market while leveraging its extensive network and product offerings. These include IP, internet, voice, IP trunking, cloud private branch exchange, collaboration services and unified communications.


Other. The Other segment is primarily comprised of ZPS. ZPS provides network and technical resources to customers who wish to leverage our expertise in designing, acquiring and maintaining networks. Services are typically provided for a term of one year for a fixed recurring monthly fee in the case of network and on an hourly basis for technical resources (usage revenue).

Revenues for all of the Company’s products are included in one of the Company’s segments. The segment presentation has been recast for all prior periods presented for comparability. The results of operations for each segment include an allocation of certain indirect costs and corporate related costs, including overhead and third party-financed debt. The allocation is based on a percentage that represents management’s estimate of the relative burden each segment bears of indirect and corporate costs. Management has evaluated the allocation methods utilized to allocate these costs and determined they are systematic, rational and consistently applied. Identifiable assets for each reportable segment are reconciled to total consolidated assets including unallocated corporate assets and intersegment eliminations. Unallocated corporate assets consist primarily of cash and deferred taxes.

Segment Adjusted EBITDA

Segment Adjusted EBITDA is the primary measure used by the Company’s CODM to evaluate segment operating performance.

The Company defines Segment Adjusted EBITDA as earnings/(loss) from operations before interest, income taxes, depreciation and amortization (“EBITDA”) adjusted to exclude acquisition or disposal-related transaction costs, losses on extinguishment of debt, stock-based compensation, unrealized foreign currency gains/(losses) on intercompany loans, and non-cash income/(loss) on equity and cost method investments. The Company uses Segment Adjusted EBITDA to evaluate operating performance, and this financial measure is among the primary measures used by management for planning and forecasting of future periods. The Company believes that the presentation of Segment Adjusted EBITDA is relevant and useful for investors because it allows investors to view results in a manner similar to the method used by management and facilitates comparison of the Company’s results with the results of other companies that have different financing and capital structures.

Segment Adjusted EBITDA results, along with other quantitative and qualitative information, are also utilized by the Company and its Compensation Committee for purposes of determining bonus payouts to employees.

Segment Adjusted EBITDA has limitations as an analytical tool and should not be considered in isolation from, or as a substitute for, analysis of the Company’s results from operations and operating cash flows as reported under GAAP. For example, Segment Adjusted EBITDA:

·

does not reflect capital expenditures, or future requirements for capital and major maintenance expenditures or contractual commitments;

·

does not reflect changes in, or cash requirements for, working capital needs;

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·

does not reflect the significant interest expense, or the cash requirements necessary to service the interest payments, on the Company’s debt; and

·

does not reflect cash required to pay income taxes.

The Company’s computation of Segment Adjusted EBITDA may not be comparable to other similarly titled measures computed by other companies because all companies do not calculate segment Adjusted EBITDA in the same fashion.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of and for the three months ended September 30, 2016

 

    

Dark Fiber
Solutions

    

Network
Connectivity

    

Colocation and Cloud
Infrastructure

 

Zayo
Canada

    

Other

    

Corp/
Eliminations

    

Total

 

 

(in millions)

Revenue from external customers

  

$

148.4

 

$

175.6

 

$

64.1

 

$

112.2

 

$

4.6

 

$

 —

 

$

504.9

Segment Adjusted EBITDA

  

 

108.2

 

 

91.6

 

 

32.2

 

 

27.5

 

 

1.1

 

 

 —

 

 

260.6

Total assets

  

 

3,237.8

 

 

1,898.1

 

 

1,090.5

 

 

475.7

 

 

32.3

 

 

99.6

 

 

6,834.0

Capital expenditures

  

 

128.1

 

 

48.9

 

 

28.0

 

 

3.3

 

 

 —

 

 

 —

 

 

208.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of and for the three months ended September 30, 2015

 

    

Dark Fiber
Solutions

    

Network
Connectivity

    

Colocation and Cloud
Infrastructure

 

Zayo
Canada

    

Other

    

Corp/
Eliminations

    

Total

 

 

(in millions)

Revenue from external customers

  

$

135.0

 

$

167.0