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EX-10.1 - EX-10.1 - ZAYO GROUP LLCzgl-20170930ex10137efea.htm
EX-31.1 - EX-31.1 - ZAYO GROUP LLCzgl-20170930ex311a78ff0.htm
EX-31.2 - EX-31.2 - ZAYO GROUP LLCzgl-20170930ex312daee7c.htm
EX-32 - EX-32 - ZAYO GROUP LLCzgl-20170930xex32.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, 2017

OR

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

Commission File Number: 333-169979


Zayo Group, LLC

(Exact Name of Registrant as Specified in Its Charter)


 

 

 

 

DELAWARE

 

26-2012549

(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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth 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

 

 

 

 

 

Emerging growth company

 

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

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

 

 

 

 


 

 

ZAYO GROUP, LLC AND SUBSIDIARIES

INDEX 

 

 

 

 

 

Page

Part I. FINANCIAL INFORMATION 

 

 

Item 1. Financial Statements (Unaudited) 

 

1

Condensed Consolidated Balance Sheets as of September 30, 2017 and June 30, 2017 

 

1

Condensed Consolidated Statements of Operations for the Three Months Ended September 30, 2017 and 2016 

 

2

Condensed Consolidated Statements of Comprehensive Income for the Three Months Ended September 30, 2017 and 2016 

 

3

Condensed Consolidated Statement of Member's Equity for the Three Months Ended September 30, 2017 

 

4

Condensed Consolidated Statements of Cash Flows for the Three Months Ended September 30, 2017 and 2016 

 

5

Notes to Condensed Consolidated Financial Statements 

 

6

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

 

32

Item 3. Quantitative and Qualitative Disclosures about Market Risk 

 

47

Item 4. Controls and Procedures 

 

48

Part II. OTHER INFORMATION 

 

 

Item 1. Legal Proceedings 

 

48

Item 1A. Risk Factors 

 

48

Item 6. Exhibits 

 

49

Signatures 

 

50

 

 

 


 

ZAYO GROUP, LLC AND SUBSIDIARIES

 

PART I. FINANCIAL INFORMATION

 

ITEM 1.   FINANCIAL STATEMENTS (UNAUDITED)

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(in millions)  

 

 

 

 

 

 

 

 

    

 

 

    

 

 

 

    

September 30,
2017

    

June 30,
2017

Assets

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

Cash and cash equivalents

 

$

290.5

 

$

220.0

Trade receivables, net of allowance of $9.5 as of each of September 30, 2017 and June 30, 2017

 

 

225.7

 

 

191.6

Prepaid expenses

 

 

67.1

 

 

68.3

Other assets

 

 

26.3

 

 

34.1

Total current assets

 

 

609.6

 

 

514.0

Property and equipment, net

 

 

5,053.6

 

 

5,016.0

Intangible assets, net

 

 

1,170.8

 

 

1,188.6

Goodwill

 

 

1,844.1

 

 

1,840.2

Deferred income taxes, net

 

 

25.1

 

 

27.3

Other assets

 

 

147.6

 

 

141.7

Total assets

 

$

8,850.8

 

$

8,727.8

Liabilities and stockholders' equity

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

Current portion of long-term debt

 

$

5.0

 

$

5.0

Accounts payable

 

 

65.2

 

 

72.4

Accrued liabilities

 

 

361.7

 

 

329.2

Accrued interest

 

 

86.0

 

 

63.5

Capital lease obligations, current

 

 

7.8

 

 

8.0

Deferred revenue, current

 

 

149.6

 

 

146.0

Total current liabilities

 

 

675.3

 

 

624.1

Long-term debt, non-current

 

 

5,537.5

 

 

5,532.7

Capital lease obligation, non-current

 

 

92.3

 

 

93.6

Deferred revenue, non-current

 

 

995.3

 

 

989.7

Deferred income taxes, net

 

 

40.5

 

 

40.2

Other long-term liabilities

 

 

45.8

 

 

52.4

Total liabilities

 

 

7,386.7

 

 

7,332.7

Commitments and contingencies (Note 10)

 

 

 

 

 

 

Member's equity

 

 

 

 

 

 

Member's interest

 

 

1,902.7

 

 

1,879.0

Accumulated other comprehensive income

 

 

27.5

 

 

5.4

Accumulated deficit

 

 

(466.1)

 

 

(489.3)

Total member's equity

 

 

1,464.1

 

 

1,395.1

Total liabilities and member's  equity

 

$

8,850.8

 

$

8,727.8

 

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

1


 

ZAYO GROUP, LLC AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) 

(in millions)  

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

 

2017

    

2016

Revenue

 

$

643.5

 

$

504.9

Operating costs and expenses

 

 

 

 

 

 

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

 

 

235.7

 

 

173.8

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

 

 

128.3

 

 

105.6

Depreciation and amortization

 

 

184.1

 

 

138.5

Total operating costs and expenses

 

 

548.1

 

 

417.9

Operating income

 

 

95.4

 

 

87.0

Other expenses

 

 

 

 

 

 

Interest expense

 

 

(73.6)

 

 

(53.3)

Loss on extinguishment of debt

 

 

(4.9)

 

 

 —

Foreign currency gain/(loss) on intercompany loans

 

 

10.8

 

 

(11.2)

Other income/(expense), net

 

 

0.9

 

 

(0.2)

Total other expenses, net

 

 

(66.8)

 

 

(64.7)

Income from operations before income taxes

 

 

28.6

 

 

22.3

Provision for income taxes

 

 

5.4

 

 

6.6

Net income

 

$

23.2

 

$

15.7

 

 

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

2


 

ZAYO GROUP, LLC AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(in millions)

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

    

2017

    

2016

Net income

 

$

23.2

 

$

15.7

Foreign currency translation adjustments

 

 

22.1

 

 

(2.1)

Defined benefit pension plan adjustments

 

 

 —

 

 

(1.2)

Comprehensive income

 

$

45.3

 

$

12.4

 

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

3


 

ZAYO GROUP, LLC AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF MEMBER’S EQUITY (UNAUDITED)

THREE MONTHS ENDED SEPTEMBER 30, 2017

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Member's
Interest

    

Accumulated
Other
Comprehensive
Income

    

Accumulated
Deficit

    

Total
Member's
Equity

Balance at June 30, 2017

 

$

1,879.0

 

$

5.4

 

$

(489.3)

 

$

1,395.1

Stock-based compensation

 

 

23.7

 

 

 —

 

 

 —

 

 

23.7

Foreign currency translation adjustment

 

 

 —

 

 

22.1

 

 

 —

 

 

22.1

Net income

 

 

 —

 

 

 —

 

 

23.2

 

 

23.2

Balance at September 30, 2017

 

$

1,902.7

 

$

27.5

 

$

(466.1)

 

$

1,464.1

 

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

 

 

4


 

ZAYO GROUP, LLC AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in millions)

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

 

2017

 

2016

Cash flows from operating activities

 

 

 

    

 

 

Net income

 

$

23.2

 

$

15.7

Adjustments to reconcile net income to net cash provided by operating activities

 

 

 

 

 

 

Depreciation and amortization

 

 

184.1

 

 

138.5

Loss on extinguishment of debt

 

 

4.9

 

 

 —

Non-cash interest expense

 

 

2.4

 

 

2.6

Stock-based compensation

 

 

27.8

 

 

32.0

Amortization of deferred revenue

 

 

(32.8)

 

 

(27.5)

Foreign currency (gain)/loss on intercompany loans

 

 

(10.8)

 

 

11.2

Deferred income taxes

 

 

2.7

 

 

4.8

Provision for bad debts

 

 

0.8

 

 

0.9

Non-cash loss on investments

 

 

0.1

 

 

0.3

Changes in operating assets and liabilities, net of acquisitions

 

 

 

 

 

 

Trade receivables

 

 

(32.0)

 

 

(1.9)

Accounts payable and accrued liabilities

 

 

53.4

 

 

5.6

Additions to deferred revenue

 

 

40.5

 

 

40.9

Other assets and liabilities

 

 

4.5

 

 

9.6

Net cash provided by operating activities

 

 

268.8

 

 

232.7

Cash flows from investing activities

 

 

 

 

 

 

Purchases of property and equipment

 

 

(193.4)

 

 

(208.3)

Other

 

 

 —

 

 

1.5

Net cash used in investing activities

 

 

(193.4)

 

 

(206.8)

Cash flows from financing activities

 

 

 

 

 

 

Proceeds from debt

 

 

312.8

 

 

 —

Principal payments on long-term debt

 

 

(311.9)

 

 

 —

Principal payments on capital lease obligations

 

 

(1.7)

 

 

(1.0)

Payment of debt issue costs

 

 

(3.4)

 

 

(0.7)

Cash paid for Santa Clara acquisition financing arrangement

 

 

(1.3)

 

 

 —

Net cash used in financing activities

 

 

(5.5)

 

 

(1.7)

Net cash flows

 

 

69.9

 

 

24.2

Effect of changes in foreign exchange rates on cash

 

 

0.6

 

 

(2.0)

Net increase in cash and cash equivalents

 

 

70.5

 

 

22.2

Cash and cash equivalents, beginning of year

 

 

220.0

 

 

170.1

Cash and cash equivalents, end of period

 

$

290.5

 

$

192.3

Supplemental disclosure of non-cash investing and financing activities:

 

 

 

 

 

 

Cash paid for interest, net of capitalized interest

 

$

54.3

 

$

13.2

Cash paid for income taxes

 

$

1.4

 

$

1.9

Non-cash purchases of equipment through capital leasing

 

$

0.1

 

$

3.3

Increase/(decrease) in accounts payable and accrued expenses for purchases of property and equipment

 

$

(18.0)

 

$

11.4

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.

 

 

5


 

Table of Contents

ZAYO GROUP, LLC AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

(1) BUSINESS AND BASIS OF PRESENTATION 

Business

Zayo Group, LLC, a Delaware limited liability company, was formed on May 4, 2007, and is the operating parent company of a number of subsidiaries engaged in bandwidth infrastructure services. Zayo Group LLC and its subsidiaries are collectively referred to as “Zayo Group” or the “Company.” 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:

·

Fiber Solutions, including dark fiber and mobile infrastructure services.

·

Transport services, including wavelength, wholesale IP and SONET services.

·

Enterprise Networks, including Ethernet, private lines, dedicated Internet and cloud services.

·

Colocation, including provision of colocation space and power and interconnection services.

·

Voice, unified communications and services dedicated to small and medium sized businesses.

·

Other services, including Zayo Professional Services (“ZPS”).

Zayo Group is wholly owned by Zayo Group Holdings, Inc. (“Holdings” or “ZGH”).

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 condensed 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 condensed consolidated financial statements should, therefore, be read in conjunction with the consolidated financial statements and notes thereto for the year ended June 30, 2017 included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2017. 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. The results of operations for the three months ended September 30, 2017 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 ending June 30, 2018 as “Fiscal 2018” and the fiscal year ended June 30, 2017 as “Fiscal 2017.”

Significant Accounting Policies

There have been no changes to the Company’s significant accounting policies described in its Annual Report on Form 10-K for the year ended June 30, 2017.

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

6


 

Table of Contents

ZAYO GROUP, LLC AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

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 certain 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 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 established a project team and commenced an initial impact assessment process. To date, the Company has reviewed a sample of lessee and lessor arrangements and made preliminary assessments of the impact this standard will have on the consolidated financial statements. Although it is still assessing the impact of this standard, the Company expects the new guidance to significantly increase the reported assets and liabilities on the consolidated balance sheets. There are currently no plans to early adopt this ASU.

 

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.

In Fiscal 2017, the Company established a project team and commenced an initial impact assessment process based on a review of a sample of contracts with its customers. Lease revenue is not included in the scope of ASU 2014-09 and as a result the revenue to which the Company must apply the new guidance is generally limited to service revenue, certain maintenance revenue not covered by lease arrangements and other fees charged to customers. Although the Company is still assessing the impact of this standard on its consolidated financial statements, it has preliminarily determined that due to changes in the timing of recognition of certain installation services, discounts and promotional credits given to customers, there may be additional contract assets and liabilities recorded in the consolidated balance

7


 

Table of Contents

ZAYO GROUP, LLC AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

sheets upon adoption. Additionally, the requirement to defer incremental costs incurred to acquire a contract including sales commissions, and recognize such costs over the contract period or expected customer life may result in additional deferred charges recognized in the consolidated balance sheets and could have the impact of deferring operating expenses. The assessment of the impact of this standard on the Company’s consolidated financial statements also includes developing new accounting policies, internal controls and procedures and possible changes to our systems to facilitate the adoption of this accounting policy. The Company plans to adopt this new standard as of July 1, 2018 and based on its initial assessment expects to apply the modified retrospective method, which may result in a cumulative effect adjustment as of the date of adoption. The Company's initial assessment of changes to the reporting of its revenue and expenses and anticipated adoption method may change depending on the results of the Company’s ongoing and final assessment of this ASU. Until the Company is further along in its assessment, it does not anticipate being able to provide reasonably accurate estimates of the impact of ASU 2014-09.

(2) ACQUISITIONS

Since inception, the Company has consummated 41 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.

Acquisitions Completed During Fiscal 2017

KIO Networks US Data Centers

 

On May 1, 2017, the Company completed the $11.9 million cash acquisition of Castle Access, Inc.’s (d/b/a “KIO Networks US”) San Diego data centers.   The two data centers, located at 12270 World Trade Drive and 9606 Aero Drive, total more than 100,000 square feet of space and 2 megawatts of critical, IT power, with additional power available. As of September 30, 2017, $1.2 million of the purchase consideration is being held in escrow pending the expiration of the indemnification adjustment period. The acquisition was funded with cash on hand and was considered a stock purchase for tax purposes.

Electric Lightwave Parent, Inc.

On March 1, 2017, the Company acquired Electric Lightwave Parent, Inc. (“Electric Lightwave”), an infrastructure and telecom services provider serving 35 markets in the western U.S., for net purchase consideration of $1,426.6 million, net of cash acquired, subject to certain post-closing adjustments.  As of September 30, 2017, $7.0 million of the purchase consideration is being held in escrow pending the expiration of the indemnification adjustment period.  The acquisition was funded through debt (see Note 5 – Long-Term Debt) and cash on hand.  As of September 30, 2017, $0.2 million of the net purchase consideration remains payable by the Company.  The acquisition was considered a stock purchase for tax purposes.

The acquisition added 8,100 route miles of long haul fiber and 4,000 miles of dense metro fiber across Denver, Minneapolis, Phoenix, Portland, Seattle, Sacramento, San Francisco, San Jose, Salt Lake City, Spokane and Boise, with on-net connectivity to more than 3,100 enterprise buildings and 100 data centers.

Santa Clara Data Center Acquisition

On October 3, 2016, the Company acquired a data center in Santa Clara, California (the “Santa Clara Data Center”), for net purchase consideration of $11.3 million. The net purchase consideration represents the net present value of ten quarterly payments of approximately $1.3 million beginning in the December 2016 quarter. As of September 30,

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Table of Contents

ZAYO GROUP, LLC AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

2017, the remaining cash consideration to be paid was $7.7 million. The acquisition was considered an asset purchase for tax purposes and a business combination for accounting purposes.  Payments made to the previous owners of the Santa Clara Data Center during the three months ended September 30, 2017 of $1.3 million, representing the principal portion of the financing arrangement, are included in the consolidated statement of cash flows within financing activities.

The Santa Clara Data Center, located at 5101 Lafayette Street, includes 26,900 total square feet and three megawatts (MW) of critical power. The facility also includes high-efficiency power and cooling infrastructure, seismic reinforcement and proximity to Zayo’s long haul dark fiber routes between San Francisco and Los Angeles.

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, 2017, for the KIO Networks US Data Centers and Electric Lightwave acquisitions, 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, property and equipment, deferred revenue and resulting deferred taxes. 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 2017 acquisitions:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

KIO Networks US Data Centers

 

Electric Lightwave

 

Santa Clara Data
Center

Acquisition date

    

 

 

 

May 1, 2017

 

March 1, 2017

 

October 3, 2016

 

 

 

 

 

 

 

 

(in millions)

Cash

 

 

 

 

$

 0.1

 

$

 12.6

 

$

 —

Other current assets

 

 

 

 

 

0.1

 

 

55.0

 

 

 —

Property and equipment

 

 

 

 

 

 2.4

 

 

 520.6

 

 

 31.9

Deferred tax assets, net

 

 

 

 

 

1.8

 

 

45.0

 

 

 —

Intangibles

 

 

 

 

 

6.4

 

 

312.2

 

 

6.0

Goodwill

 

 

 

 

 

2.9

 

 

631.2

 

 

 —

Other assets

 

 

 

 

 

0.5

 

 

1.7

 

 

 —

Total assets acquired

 

 

 

 

 

14.2

 

 

1,578.3

 

 

37.9

Current liabilities

 

 

 

 

 

1.7

 

 

57.9

 

 

 —

Deferred tax liabilities, net

 

 

 

 

 

 —

 

 

 —

 

 

 —

Capital lease obligations

 

 

 

 

 

 —

 

 

 —

 

 

26.6

Deferred revenue

 

 

 

 

 

0.5

 

 

80.0

 

 

 —

Other liabilities

 

 

 

 

 

 —

 

 

1.2

 

 

 —

Total liabilities assumed

 

 

 

 

 

2.2

 

 

139.1

 

 

26.6

Net assets acquired

 

 

 

 

 

12.0

 

 

1,439.2

 

 

11.3

Less cash acquired

 

 

 

 

 

(0.1)

 

 

(12.6)

 

 

 —

Total consideration paid/payable

 

 

 

 

$

11.9

 

$

1,426.6

 

$

11.3

 

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

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the acquired goodwill. The allocation was determined based on the excess of the estimated fair value of the reporting unit over the estimated fair value of the individual assets acquired and liabilities assumed that were assigned to the reporting units. See Note 3 – Goodwill for 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 generally 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, travel expense, severance expense incurred associated with acquisitions or disposals, and other direct expenses incurred that are associated with signed and/or closed acquisitions or disposals and unsuccessful acquisitions. The Company incurred transaction costs of $8.3 million and $3.0 million for the three months ended September 30, 2017 and 2016, 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 $1,844.1 million and $1,840.2 million as of September 30, 2017 and June 30, 2017, respectively.

The Company’s reporting units are comprised of its strategic product groups (“SPG” or “SPGs”). Effective January 1, 2017, the Company implemented organizational changes which had an impact on the composition of the Company’s SPGs. The change in structure had the impact of consolidating and/or regrouping existing SPGs, disaggregating the legacy Zayo Canada SPG among the existing SPGs and a creating a new Allstream and IP Transit SPG (See Note 12 – Segment Reporting). In connection with the organizational change, goodwill was re-allocated to the Company’s SPG’s on a relative fair value basis. The Company completed an assessment immediately prior to and after the organizational change at the SPG level and determined that it is more likely than not that the fair value of the Company’s reporting units is greater than their carrying amounts. 

As of September 30, 2017, the Company’s SPGs were comprised of the following: Fiber Solutions, Zayo Wavelength Services (“Waves”), Zayo IP Transit Services (“IP Transit”), Zayo SONET Services (“SONET”), Zayo Ethernet Services (“Ethernet”), Enterprise Private and Connectivity (“EPIC”), Zayo Cloud Services (“Cloud”),  Zayo Colocation (“zColo"), Allstream and Other (primarily Zayo Professional Services).

The following reflects the changes in the carrying amount of goodwill during the three months ended September 30, 2017:

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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product Group

    

As of June 30, 2017

    

Adjustments to Fiscal 2017
Acquisitions

    

Foreign Currency
Translation and
Other

    

As of September 30, 2017

 

 

(in millions)

Fiber Solutions

 

$

633.9

 

$

0.2

 

$

2.5

 

$

636.6

Waves

 

 

247.4

 

 

 —

 

 

1.3

 

 

248.7

Sonet

 

 

52.0

 

 

 —

 

 

 —

 

 

52.0

Ethernet

 

 

359.5

 

 

 —

 

 

0.2

 

 

359.7

EPIC

 

 

89.5

 

 

 —

 

 

0.2

 

 

89.7

zColo

 

 

256.3

 

 

(3.1)

 

 

0.9

 

 

254.1

Cloud

 

 

69.5

 

 

 —

 

 

—  

 

 

69.5

Allstream

 

 

116.5

 

 

 —

 

 

 —

 

 

116.5

Other

 

 

15.6

 

 

1.7

 

 

 —

 

 

17.3

Total

 

$

1,840.2

 

$

(1.2)

 

$

5.1

 

$

1,844.1

 

(4) INTANGIBLE ASSETS

Identifiable intangible assets as of September 30, 2017 and June 30, 2017 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

    

Gross Carrying Amount

    

Accumulated
Amortization

    

Net

 

 

(in millions)

September 30, 2017

 

 

 

 

 

 

 

 

 

Finite-Lived Intangible Assets

 

 

 

 

 

 

 

 

 

Customer relationships

 

$

1,483.2

 

$

(332.3)

 

$

1,150.9

Underlying rights

 

 

1.6

 

 

(0.5)

 

 

1.1

Total

 

 

1,484.8

 

 

(332.8)

 

 

1,152.0

Indefinite-Lived Intangible Assets

 

 

 

 

 

 

 

 

 

Certifications

 

 

3.5

 

 

 —

 

 

3.5

Underlying Rights

 

 

15.3

 

 

 —

 

 

15.3

Total

 

$

1,503.6

 

$

(332.8)

 

$

1,170.8

June 30, 2017

 

 

 

 

 

 

 

 

 

Finite-Lived Intangible Assets

 

 

 

 

 

 

 

 

 

Customer relationships

 

$

1,477.7

 

$

(308.6)

 

$

1,169.1

Underlying rights

 

 

1.6

 

 

(0.4)

 

 

1.2

Total

 

 

1,479.3

 

 

(309.0)

 

 

1,170.3

Indefinite-Lived Intangible Assets

 

 

 

 

 

 

 

 

 

Certifications

 

 

3.5

 

 

 —

 

 

3.5

Underlying Rights

 

 

14.8

 

 

 —

 

 

14.8

Total

 

$

1,497.6

 

$

(309.0)

 

$

1,188.6

 

 

 

 

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(5) LONG-TERM DEBT

As of September 30, 2017 and June 30, 2017, long-term debt was as follows:

 

 

 

 

 

 

 

 

 

 

 

September 30,

 

June 30,

 

 

    

2017

    

2017

 

 

 

(in millions)

Term Loan Facility due 2021

 

$

497.5

 

$

498.8

 

Term Loan Facility due 2024

 

 

1,119.3

 

 

1,429.9

 

6.00% Senior Unsecured Notes due 2023

 

 

1,430.0

 

 

1,430.0

 

6.375% Senior Unsecured Notes due 2025

 

 

900.0

 

 

900.0

 

5.75% Senior Unsecured Notes due 2027

 

 

1,650.0

 

 

1,350.0

 

Total debt obligations

 

 

5,596.8

 

 

5,608.7

 

Unamortized discount on Term Loan Facility

 

 

(13.6)

 

 

(16.0)

 

Unamortized premium on 6.00% Senior Unsecured Notes due 2023

 

 

5.3

 

 

5.5

 

Unamortized discount on 6.375% Senior Unsecured Notes due 2025

 

 

(13.9)

 

 

(14.3)

 

Unamortized premium on 5.75% Senior Unsecured Notes due 2027

 

 

33.6

 

 

21.6

 

Unamortized debt issuance costs

 

 

(65.7)

 

 

(67.8)

 

Carrying value of debt

 

 

5,542.5

 

 

5,537.7

 

Less current portion

 

 

(5.0)

 

 

(5.0)

 

Long-term debt, less current portion

 

$

5,537.5

 

$

5,532.7

 

Term Loan Facility and Revolving Credit Facility

On May 6, 2015, the Company and Zayo Capital, Inc. (“Zayo Capital”) entered into an Amendment and Restatement Agreement whereby its Credit Agreement (the “Credit Agreement”) governing its 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 a portion of the outstanding term loans under the Term Loan Facility from July 2, 2019 to May 6, 2021. The interest rate margins applicable to the portion of the Term Loan Facility due in 2021 were decreased by 25 basis points to LIBOR plus 2.75% with a minimum LIBOR of 1.0%. The terms of the Term Loan Facility required 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 annual payment was required during Fiscal 2017 or Fiscal 2016).    

Under the amended and restated Credit Agreement, the Revolver matures at the earliest of (i) April 17, 2020, and (ii) six months prior to the earliest 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 its 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 its leverage ratio.

On January 15, 2016, the Company and Zayo Capital entered into an Incremental Amendment (the “Amendment”) to its Credit Agreement. Under the terms of the Amendment, the portion of the Term Loan Facility due 2021 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%. No other terms of the Credit Agreement were amended. The Incremental Term Loan proceeds were used to fund the Allstream acquisition and for general corporate purposes.

On July 22, 2016, the Company and Zayo Capital entered into a Repricing Amendment (the “Repricing Amendment”) to the Credit Agreement.  Per the terms of the Repricing Amendment, the Incremental Term Loan was

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repriced at par and will 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.

On January 19, 2017, the Company and Zayo Capital entered into an Incremental Amendment No. 2 (the “Incremental Amendment”) to the Company’s Credit Agreement. Per the terms of the Incremental Amendment, the existing $1.85 billion of term loans under the Credit Agreement were repriced at 99.75% with one $500.0 million tranche that bears interest at a rate of LIBOR plus 2.0%, with a minimum LIBOR rate of 0.0% and a maturity date of four years from incurrence, which represents a downward adjustment of 75 basis points along with the lowering of the previous LIBOR floor, and a second $1.35 billion tranche (the “B-2 Term Loan” and along with the $500.0 million tranche, the “Refinancing Term Loans”) that bears interest at a rate of LIBOR plus 2.5%, with a minimum LIBOR rate of 1.0% and a maturity of seven years from incurrence, which represents a downward adjustment of 25 basis points.  In addition, per the terms of the Incremental Amendment, the Company and Zayo Capital added a new $650.0 million term loan tranche under the Credit Agreement (the “Electric Lightwave Incremental Term Loan”) that bears interest at LIBOR plus 2.5%, with a minimum LIBOR rate of 1.0%, with a maturity of seven years from the closing date of the Incremental Amendment. In connection with the Incremental Amendment the full $2,500.0 million Term Loan Facility, including the Refinancing Term Loans and the Electric Lightwave Incremental Term Loan, was re-issued at a price of 99.75%. Per the terms of the Incremental Amendment, the Revolver matures on April 17, 2020. No other material terms of the Credit Agreement were amended. On April 10, 2017, $570.1 million of the B-2 Term Loan and the Electric Lightwave Incremental Term Loan was repaid from proceeds of issuance of senior unsecured notes as further discussed below.

On July 20, 2017, the Company and Zayo Capital entered into a second repricing (the “Repricing Amendment No. 2”) to the Credit Agreement. Per the terms of the Repricing Amendment No. 2, the outstanding balances of the B-2 Term Loan and Electric Lightwave Incremental Term Loan were repriced at par and will bear interest at a rate of LIBOR plus 2.25%, with a minimum LIBOR rate of 1.0%, which represented a downward adjustment of 25 basis points. No other terms of the Credit Agreement were amended. 

In connection with the Repricing Amendment No. 2, the Company recognized an expense of $4.9 million during the three months ended September 30, 2017 associated with debt extinguishment costs.  The $4.9 million loss on extinguishment of debt primarily represents non-cash expenses associated with the write-off of unamortized debt issuance costs and the issuance discounts on the portion of the Credit Agreement, as further amended.  The loss on extinguishment of debt also includes certain fees paid to third parties involved in the Repricing Amendment No. 2.

Additionally, in April 2017, $310.7 million of the B-2 Term Loan was repaid from the proceeds of issuance of senior unsecured notes as further discussed below.

The weighted average interest rate (including margin) on the Term Loan Facility was approximately 3.4% at each of September 30, 2017 and June 30, 2017. Interest rates on the Revolver as of September 30, 2017 and June 30, 2017 were approximately 4.0% and 3.8%, respectively.

As of September 30, 2017, no amounts were outstanding under the Revolver and $1,616.8 million in aggregate principal amount was outstanding under the Term Loan Facility. Standby letters of credit were outstanding in the amount of $7.8 million as of September 30, 2017, leaving $442.2 million available under the Revolver.

Senior Unsecured Notes

6.00% Senior Unsecured Notes due 2023

On January 23, 2015 and March 9, 2015, the Company and Zayo Capital completed private offerings of aggregate principal amounts of $700.0 million and $730.0 million, respectively, of 6.00% senior unsecured notes due in 2023 (the

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“2023 Unsecured Notes”).  The 2023 Unsecured Notes bear interest at the rate of 6.00% per year, which is payable on April 1 and October 1 of each year. The 2023 Unsecured Notes will mature on April 1, 2023.  

6.375% Senior Unsecured Notes due 2025

On April 14, 2016, the Company and Zayo Capital completed a private offering of $550.0 million aggregate principal amount of 2025 Unsecured Notes (the “Incremental 2025 Notes”). The Incremental 2025 Notes were priced at 97.76% and were an additional issuance of the $350.0 million 6.375% senior unsecured notes due in 2025 that were originally issued on May 6, 2015 (the “2025 Notes” and together with the Incremental 2025 Notes, the “2025 Unsecured Notes”). The net proceeds from the Incremental 2025 Notes, plus cash on hand, were used to (i) 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) repay $196.0 million of borrowings under the then outstanding secured Term Loan Facility. The 2025 Unsecured Notes bear interest at the rate of 6.375% per year, which is payable on May 15 and November 15 of each year. The 2025 Unsecured Notes will mature on May 15, 2025.

5.75% Senior Unsecured Notes due 2027

On January 27, 2017, the Company and Zayo Capital completed a private offering of $800.0 million aggregate principal amount of 5.75% senior unsecured notes due 2027 (the “January 2027 Notes”), which were issued at par. The net proceeds from the offering, along with the Electric Lightwave Incremental Term Loan discussed above, were used to fund the Electric Lightwave acquisition (see Note 2 – Acquisitions), which closed on March 1, 2017.

On April 10, 2017, the Company completed a private offering of $550.0 million aggregate principal amount of 5.75% senior unsecured notes due 2027 (the “Incremental 2027 Notes”). The Incremental 2027 Notes were an additional issuance of the January 2027 Notes and were priced at 104.0%. The net proceeds from the Incremental 2027 Notes were used to repay certain outstanding balances on the Company’s B-2 Term Loan.

On July 5, 2017, the Company completed a private offering of $300.0 million aggregate principal amount of 5.75% senior notes due 2027 (the “July Incremental 2027 Notes” and together with the Incremental 2027 Notes and the January 2027 Notes, the “2027 Unsecured Notes”). The July Incremental 2027 Notes were an additional issuance of the January 2027 Notes and Incremental 2027 Notes and were priced at 104.25%. The net proceeds of $310.7 million from the offering were used to further repay certain outstanding balances on the Company’s B-2 Term Loan. The 2027 Unsecured Notes bear interest at the rate of 5.75% per year, which is payable on January 15 and July 15 of each year. The 2027 Unsecured Notes will mature on January 15, 2027. 

Debt covenants

The indentures (the “Indentures”) governing the 2023 Unsecured Notes,  the 2025 Unsecured Notes and the 2027 Unsecured Notes (collectively the “Notes”) contain covenants that, among other things, restrict the ability of the Company 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 Company’s restricted subsidiaries to pay dividends or make other payments to the Company, 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 the Company 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 the Company and its subsidiaries to comply with customary affirmative and negative covenants, including covenants restricting the ability of

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the Company 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 the Company’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 the Company’s previous quarter’s annualized modified EBITDA (as defined in the indentures), and limit the Company’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, 2017.

Guarantees

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

The Term Loan Facility and Revolver are fully and unconditionally guaranteed, jointly and severally, on a senior secured basis by all of the Company’s current and future domestic restricted subsidiaries.

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 $113.1 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.

The balance of debt issuance costs as of September 30, 2017 and June 30, 2017 was $65.7 million and $67.8 million, net of accumulated amortization of $47.4 million and $45.1 million, respectively. The amortization of debt issuance costs is included on the condensed consolidated statements of cash flows within the caption “Non-cash interest expense” along with the amortization or accretion of the premium and discount on the Company’s indebtedness.  Interest expense associated with the amortization of debt issuance costs was $2.3 million and $2.2 million for the three months ended September 30, 2017 and 2016, respectively.

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

(6) INCOME TAXES

 

A reconciliation of the actual income tax provision and the tax computed by applying the U.S. federal rate to the earnings before income taxes during the three month periods ended September 30, 2017 and 2016 is as follows: 

 

 

 

 

 

 

 

 

 

 

For the three months ended September 30,

 

 

2017

    

2016

 

 

 

(in millions)

Expected provision at the statutory rate

 

$

10.0

 

$

7.8

Increase/(decrease) due to:

 

 

 

 

 

 

Stock-based compensation

 

 

1.5

 

 

3.3

State income taxes benefit, net of federal benefit

 

 

0.6

 

 

0.7

Transaction costs not deductible for tax purposes

 

 

0.1

 

 

 —

Change in statutory tax rate

 

 

 —

 

 

(1.7)

Foreign tax rate differential

 

 

(2.2)

 

 

(0.7)

Change in valuation allowance

 

 

(5.7)

 

 

(2.4)

Other, net

 

 

1.1

 

 

(0.4)

Provision for income taxes

 

$

5.4

 

$

6.6

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The interim period effective tax rate is driven from year-to-date and 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 in which they occur.

 

The interim effective tax rate for the three months ended September 30, 2017 was positively impacted by lower tax rates on foreign earnings and foreign tax expense not recognized due to full valuation allowances recorded on certain foreign entities as well as reversing valuation allowances on deferred tax assets that are expected to be realized. The effective tax rate was negatively impacted by the smaller allowable deduction for stock-based compensation for tax purposes as compared to the book expense related to the Company’s Restricted Stock Unit plan (See Note 8 – Stock-based Compensation).

 

The interim effective tax rate for the three months ended September 30, 2016 was positively impacted by the United Kingdom (“UK”) tax rate decrease as well as foreign tax expense not recognized due to full valuation allowances recorded on certain foreign entities. The effective tax rate was negatively impacted by pre-IPO non-deductible stock-based compensation and the excess of GAAP stock compensation expense, related to the Company’s Restricted Stock Unit plan, over what is deductible for income tax purposes.

 

The Company files income tax returns in various federal, state, and local jurisdictions including the United States, Canada, United Kingdom and France. In the normal course of business, the Company is subject to examination by taxing authorities throughout the world. With few exceptions, the Company is no longer subject to income tax examinations by tax authorities in major tax jurisdictions for years before 2012.

 

As of September 30, 2017, the Company has a $0.2 million current liability for uncertain tax positions related to state taxing jurisdictions, including $0.1 million of accrued interest and penalties. The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. The entire balance is expected to be settled within the next year and would impact the effective tax rate if recognized.

 

As of September 30, 2017, the Company has removed the indefinite reinvestment assertion on several newly-operational foreign entities because it intends to remit the earnings. The Company has recorded an immaterial deferred tax liability in the quarterly tax provision. The indefinite reinvestment assertion remains for all other foreign subsidiaries.

(7) EQUITY

During the three months ended September 30, 2017, the Company recorded a $23.7 million increase in member’s interest associated with stock-based compensation expense related to the Company’s equity classified stock-based compensation awards (See Note 8 – Stock-based Compensation).

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(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,

 

 

2017

    

2016

 

 

(in millions)

Included in:

 

 

 

 

 

 

Operating costs

 

$

3.2

 

$

3.3

Selling, general and administrative expenses

 

 

24.6

 

 

28.7

Total stock-based compensation expense

 

$

27.8

 

$

32.0

 

 

 

 

 

 

 

CII common units

 

$

 —

 

$

4.2

Part A restricted stock units

 

 

22.2

 

 

21.3

Part B restricted stock units

 

 

5.1

 

 

6.2

Part C restricted stock units

 

 

0.5

 

 

0.3

Total stock-based compensation expense

 

$

27.8

 

$

32.0

CII Common Units

During the three months ended September 30, 2016, the Company recognized $4.2 million of stock-based compensation expense related to vesting of common units of Communications Infrastructure Investments, LLC (“CII”).  On December 31, 2016, the CII common units became fully vested and as such there is no unrecognized compensation cost associated with CII common units for the three months ended September 30, 2017.

Performance Compensation Incentive Program

During October 2014, ZGH adopted the 2014 Performance Compensation Incentive Program (“PCIP”).  The PCIP includes incentive cash compensation 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 ZGH’s Board of Directors.

The PCIP has the following components:

Part A

Under Part A of the PCIP, certain 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 ZGH’s measured value creation for the quarter, as well as such other subjective factors that it deems relevant (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 ZGH’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 ZGH’s common stock. Additionally, under Part A of the PCIP, awards may be granted to certain employees upon commencement of their employment with the Company.

During the three months ended September 30, 2017 and 2016, the Company recognized $22.2 million and $21.3 million, respectively, of compensation expense associated with the vested portion of the Part A awards. The September 2017 and June 2017 quarterly awards were recorded as liabilities totaling $6.9 million and $5.5 million, as of September

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30, 2017 and June 30, 2017, 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 “Accrued liabilities” in the accompanying condensed consolidated balance sheets. Upon the issuance of the RSUs, the liability is re-measured and then reclassified to member’s interest, 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, 2017, the remaining unrecognized compensation cost to be expensed over the remaining vesting period for Part A awards is $30.8 million.

The following table summarizes the Company’s Part A RSU activity for the three months ended September 30, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

    

 

Number of Part A
RSUs

    

Weighted average
grant-date fair
value per share

    

 

Weighted average
remaining contractual
term in months

Outstanding at July 1, 2017

 

 

2,364,386

 

$

31.63

 

 

7.1

Granted

 

 

579,601

 

 

34.23

 

 

 

Vested

 

 

(771,519)

 

 

29.01

 

 

 

Forfeited

 

 

(142,880)

 

 

n/a

 

 

 

Outstanding at September 30, 2017

 

 

2,029,588

 

$

32.72

 

 

7.4

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 ZGH’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. The RSU’s vest assuming continuous employment through the end of the measurement period. The existence of a vesting provision that is associated with the performance of ZGH’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 ZGH’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, 2017:

 

 

 

 

 

 

 

 

 

 

 

    

 

Number of Part B
RSUs

    

Weighted average
grant-date fair
value per unit

    

 

Weighted average
remaining contractual
term in months

Outstanding at July 1, 2017

 

 

411,973

 

$

42.86

 

 

6.1

Granted

 

 

163,960

 

 

19.06

 

 

 

Vested

 

 

(131,575)

 

 

75.56

 

 

 

Forfeited

 

 

(6,636)

 

 

n/a

 

 

 

Outstanding at September 30, 2017

 

 

437,722

 

$

23.97

 

 

6.3

The table below reflects the total Part B RSUs granted during Fiscal 2018 and 2017, the maximum eligible shares of ZGH’s stock that the respective Part B RSU grant could be converted into shares of ZGH’s common stock, and the grant date fair value per Part B RSU during the period indicated. The table below also reflects the units converted to the ZGH’s common stock at a vesting date that is subsequent to the period indicated for those RSUs granted during the period indicated:

 

 

 

 

 

 

 

During the three months ended

 

 

September 30,
2017

Part B RSUs granted

 

 

163,960

Maximum eligible shares of the Company's common stock

 

 

590,256

Grant date fair value per Part B RSU

 

$

19.06

Units converted to Company's common stock at vesting date

 

 

n/a

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

During the three months ended

 

 

June 30,

2017

    

March 31,

2017

    

December 31,

2016

    

September 30,

2016

Part B RSUs granted

    

 

152,808

 

 

171,316

 

 

191,015

 

 

200,425

Maximum eligible shares of the Company's common stock

 

 

550,109

 

 

880,564

 

 

981,817

 

 

1,030,185

Grant date fair value per Part B RSU

 

$

26.52

 

$

27.39

 

$

75.56

 

$

47.00

Units converted to Company's common stock at vesting date

 

 

n/a

 

 

n/a

 

 

102,511

 

 

99,508

During the three months ended September 30, 2017 and 2016, the Company recognized stock-based compensation expense of $5.1 million and $6.2 million, respectively, related to Part B awards.

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 $5.6 million at September 30, 2017.

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Part C

Under Part C of the PCIP, independent directors of ZGH 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 ZGH’s common stock over the last ten trading days of the quarter ended immediately prior to the grant date and vest at the end of each quarter for which the grant was made. During the three months ended September 30, 2017 and 2016, the Company’s independent directors were granted 15,686 and 10,611 Part C RSUs, respectively. During the three months ended September 30, 2017 and 2016, the Company recognized $0.5 million and $0.3 million, respectively, of stock-based compensation expense associated with the Part C awards.

(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, 2017 and June 30, 2017 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 premium, and was $4,005.0 million and $3,692.8 million as of September 30, 2017 and June 30, 2017, 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, 2017 and June 30, 2017 was estimated to be $4,221.3 million and $3,895.7 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 $1,603.2 million and $1,912.7 million as of September 30, 2017 and June 30, 2017, respectively. The Company’s Term Loan Facility accrues interest at variable rates based upon the one month, three month or nine month LIBOR plus i) a spread of 2.0% on the Company’s $500.0 million tranche (which has a LIBOR floor of 0.0%) and ii) a spread of 2.25% on its B-2 Term Loan tranche (which has a LIBOR floor of 1.00%).  Since management does not believe that the Company’s credit quality has changed significantly since the date when the Term Loan Facility was amended on July 20, 2017, its carrying amount approximates fair value. A hypothetical increase in the applicable interest rate on the Company’s Term Loan Facility of one percentage point above a 1.0% LIBOR floor would increase the Company’s annual interest expense by approximately  $16.2 million.

As of September 30, 2017 and June 30, 2017, there was no balance outstanding under the Company's Revolver.

 

 

 

 

(10) COMMITMENTS AND CONTINGENCIES

Purchase commitments

As of September 30, 2017, the Company was contractually committed for $356.0 million of capital expenditures for construction materials and purchases of property and equipment,  as well as energy and network expenditures. 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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Outstanding Letters of Credit

As of September 30, 2017, the Company had $7.8 million in outstanding letters of credit, which were primarily entered into in connection with various lease agreements. Additionally, as of September 30, 2017, Zayo Canada, Inc., a subsidiary of the Company, had CAD $3.5 million (or $2.8 million) in letters of credit, under a CAD $5.0 million (or $4.0 million) unsecured credit letter agreement.

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”), a company that provided voice and managed services that the Company spun off during the year ended June 30, 2014, to an entity that has a material ownership interest in the Company. The Company continues to have ongoing contractual relationships with Inteliquent, Inc., successor by merger to OVS (“Inteliquent”), whereby the Company provides Inteliquent and its subsidiaries with bandwidth capacity and Inteliquent 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 Inteliquent for the periods presented:

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

 

2017

    

2016

 

 

(in millions)

Revenues

 

$

1.9

 

$

1.6

Operating costs

 

$

0.6

 

$

0.1

 

As of September 30, 2017 and June 30, 2017, the Company had $0.3 million and $0.5 million, respectively, due from Inteliquent.

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, 2017 and 2016, the Company reimbursed Mr. Caruso $0.1 million and $0.2 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 bandwidth infrastructure, colocation and connectivity services are comprised of

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various related product groups generally defined around the type of service the customer is buying, referred to as SPGs. Each SPG is responsible for the revenue, costs and associated capital expenditures of its 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.

 

In connection with the Company’s continued increase in scope and scale, effective January 1, 2017, and contemplation of the Company’s acquisition of Electric Lightwave which was completed March 1, 2017, the Company's chief operating decision maker ("CODM"), the Company's Chief Executive Officer, implemented certain organizational changes to the management and operation of the business that directly impact how the CODM makes resource allocation decisions and manages the Company. Under the new structure, the Company’s reportable segments include: Fiber Solutions, Transport, Enterprise Networks, Zayo Colocation, Allstream and Other.  The change in structure had the impact of consolidating and/or regrouping existing SPGs and product offerings among the Company’s reportable segments and disaggregating the legacy Zayo Canada segment among the existing SPGs and a new Allstream reportable segment.  The change in structure also resulted in adjustments to intercompany pricing which more closely align to third party pricing on the services which are provided between the Company’s SPGs.

 

The Company’s legacy SPGs included Dark Fiber and Mobile Infrastructure Group (“MIG”).  Effective January 1, 2017, the Dark Fiber and MIG SPGs were merged together and are now reported as part of the Fiber Solutions reporting segment.  Waves and Ethernet services that are provided on dedicated dark fiber strands and colocation facilities that support only dark fiber customers which were historically reported as part of the Waves, Ethernet or zColo SPGs were transferred to the Fiber Solutions reportable segment effective January 1, 2017 (the “Dedicated Services Transfers”).

 

The Company’s legacy Waves, IP and Sonet SPGs, after giving effect to the Dedicated Services Transfers, are now reported under the Company’s Transport reportable segment.

 

The Company’s legacy Ethernet and Cloud SPGs, after giving effect to the Dedicated Services Transfers, are now reported under the Company’s Enterprise Networks segment.

 

The Company’s legacy Zayo Canada reporting segment was disaggregated based upon the products offered by the legacy Zayo Canada segment to the Company’s existing SPGs and two new SPGs were established: Voice and Small and Medium Business (“SMB”).

The Company’s segments are further described below:

Fiber Solutions. Through the Fiber Solutions segment, the Company provides raw bandwidth infrastructure to customers that require more control of their internal networks. These services include dark fiber, dedicated lit networks 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. 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 Fiber Solutions segment tend to range from three to twenty years.

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

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Enterprise Networks. The Enterprise Networks segment provides communication solutions to medium and large enterprises. The Company’s services within this segment include Ethernet, enterprise private and connectivity services, managed services and cloud based compute and storage products. Solutions range from point-to-point data connections to multi-site managed networks to international outsourced IT infrastructure environments.

Zayo Colocation (zColo).  The Colocation segment provides data center infrastructure solutions to a broad range of enterprise, carrier, cloud, and content customers. The Company’s services within this segment include the provision of colocation space, power and interconnection services in North America and Western Europe.  Solutions range in size from single cabinet solutions to 1MW+ data center 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.

Allstream.  The Allstream segment provides Voice, SIP Trunking, Unified Communications and scalable data services using a variety of technologies for businesses.  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 Cloud-based IP telephony), instant messaging and video conferencing with non-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. Allstream also offers a range of data services that help small and medium business (“SMB”) customers implement the right data and networking solutions for their business. Those scalable data services make use of technologies including Ethernet services, IP/MPLS VPN Solutions, and wavelength services.  Allstream provides services to approximately 70,000 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). ZPS also generates revenue via telecommunication equipment sales.

Effective January 1, 2017, revenues for all of the Company’s products are included in one of the Company’s six segments. This segment presentation has been recast for all 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

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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;

·

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, 2017

 

    

Fiber
Solutions

  

Transport

  

Enterprise
Networks

  

zColo

  

Allstream

  

Other

  

Corp/
Eliminations

  

Total

 

 

(in millions)

Revenue from external customers

  

$

195.5

 

$

119.1

 

$

137.7

 

$

58.4

 

$

127.7

 

$

5.1

 

$

 —

 

$

643.5

Segment Adjusted EBITDA

  

 

154.2

 

 

51.6

 

 

49.5

 

 

29.4

 

 

30.8

 

 

1.1

 

 

 —

 

 

316.6

Total assets

 

 

4,517.9

 

 

1,256.5

 

 

1,394.6

 

 

1,005.5

 

 

424.3

 

 

32.2

 

 

219.8

 

 

8,850.8

Capital expenditures

  

 

107.3

 

 

33.7

 

 

21.0

 

 

27.9

 

 

3.5

 

 

 —

 

 

 —

 

 

193.4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

    

Fiber
Solutions

    

Transport

    

Enterprise Networks

 

zColo

 

Allstream

    

Other

    

Corp/
Eliminations

    

Total

 

 

(in millions)

Revenue from external customers

  

$

174.1

 

$

106.1

 

$

114.4

 

$

51.2

 

$

54.5

 

$

4.6

 

$

 —

 

$

504.9

Segment Adjusted EBITDA

  

 

138.3

 

 

44.6

 

 

40.6

 

 

26.3

 

 

9.7

 

 

1.1

 

 

 —

 

 

260.6

Capital expenditures

  

 

130.8

 

 

33.5

 

 

20.9

 

 

22.9

 

 

0.2

 

 

 —

 

 

 —

 

 

208.3

 

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As of June 30, 2017

 

    

Fiber
Solutions

    

Transport

    

Enterprise

Networks

 

zColo

 

Allstream

    

Other

    

Corp/
Eliminations

    

Total

 

 

(in millions)

Total assets

  

$

4,504.6

 

$

1,230.0

 

$

1,385.7

 

$

994.4

 

$

406.2

 

$

33.2

 

$

173.7

 

$

8,727.8

 

Reconciliation from Total Segment Adjusted EBITDA to income from operations before taxes:

 

 

 

 

 

 

 

 

 

 

For the three months ended September 30,

 

 

2017

    

2016

 

 

 

(in millions)

Total Segment Adjusted EBITDA

  

$

316.6

 

$

260.6

Interest expense

  

 

(73.6)

 

 

(53.3)

Depreciation and amortization expense

  

 

(184.1)

 

 

(138.5)

Transaction costs

  

 

(8.3)

 

 

(3.0)

Stock-based compensation

  

 

(27.8)

 

 

(32.0)

Loss on extinguishment of debt

 

 

(4.9)

 

 

 —

Foreign currency gain/(loss) on intercompany loans

  

 

10.8

 

 

(11.2)

Non-cash loss on investments

 

 

(0.1)

 

 

(0.3)

Income from operations before income taxes

 

$

28.6

 

$

22.3

 

 

 

 

(13) CONDENSED CONSOLIDATING FINANCIAL INFORMATION

As discussed Note 5 – Long-Term Debt, as of September 30, 2017, the Company has outstanding $1,430.0 million 2023 Unsecured Notes, $900.0 million 2025 Unsecured Notes and $1,650.0 million of 2027 Unsecured Notes. The Notes are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by all of the Company’s current and future domestic restricted subsidiaries. Zayo Capital does not have independent assets or operations. The non-guarantor subsidiaries consist of the foreign subsidiaries that were acquired in conjunction with the Company's acquisitions.

The accompanying condensed consolidating financial information has been prepared and is presented to display the components of the Company’s balance sheets, statements of operations and statements of cash flows in a manner that allows an existing or future holder of the Company’s Notes to review and analyze the current financial position and recent operating results of the legal subsidiaries that guarantee the Company’s debt obligations.

The operating activities of the separate legal entities included in the Company’s consolidated financial statements are interdependent. The accompanying condensed consolidating financial information presents the results of operations, financial position and cash flows of each legal entity. Zayo Group and its guarantors provide services to each other during the normal course of business. These transactions are eliminated in the consolidated results of operations of the Company. Activity related to income taxes is included at the issuer, or Zayo Group level, and the Company's non-guarantor subsidiaries and is not allocated to the Company's guarantor subsidiaries in the condensed consolidated financial information presented below.

 

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Condensed Consolidating Balance Sheets (Unaudited)

September 30, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Zayo Group,

    

 

 

    

 

 

    

 

 

    

 

 

 

 

LLC

 

Guarantor

 

Non-Guarantor

 

 

 

 

 

 

 

 

(Issuer)

 

Subsidiaries

 

Subsidiaries

 

Eliminations

 

Total

 

 

(in millions)

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

129.6

 

$

4.6

 

$

156.3

 

$

 —

 

 

290.5

Trade receivables, net of allowance

 

 

130.7

 

 

1.5

 

 

93.5

 

 

 —

 

 

225.7

Prepaid expenses

 

 

45.1

 

 

0.3

 

 

21.7

 

 

 —

 

 

67.1

Other assets

 

 

17.2

 

 

 —

 

 

9.1

 

 

 —

 

 

26.3

Total current assets

 

 

322.6

 

 

6.4

 

 

280.6

 

 

 —

 

 

609.6

Property and equipment, net

 

 

4,334.6

 

 

 —

 

 

719.0

 

 

 —

 

 

5,053.6

Intangible assets, net

 

 

1,013.4

 

 

10.6

 

 

146.8

 

 

 —

 

 

1,170.8

Goodwill

 

 

1,659.6

 

 

14.6

 

 

169.9

 

 

 —

 

 

1,844.1

Deferred income taxes, net

 

 

25.0

 

 

 —

 

 

0.1

 

 

 —

 

 

25.1

Other assets

 

 

121.4

 

 

 —

 

 

26.2

 

 

 —

 

 

147.6

Related party receivable

 

 

352.0

 

 

 —

 

 

 —

 

 

(352.0)

 

 

 —

Investment in subsidiary

 

 

664.8

 

 

 —

 

 

 —

 

 

(664.8)

 

 

 —

Total assets

 

$

8,493.4

 

$

31.6

 

$

1,342.6

 

$

(1,016.8)

 

$

8,850.8

Liabilities and member's equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current portion of long-term debt

 

$

5.0

 

$

 —

 

$

 —

 

$

 —

 

$

5.0

Accounts payable

 

 

50.2

 

 

 —

 

 

15.0

 

 

 —

 

 

65.2

Accrued liabilities

 

 

231.1

 

 

0.5

 

 

130.1

 

 

 —

 

 

361.7

Accrued interest

 

 

86.0

 

 

 —

 

 

 —

 

 

 —

 

 

86.0

Capital lease obligations, current

 

 

6.3

 

 

 —

 

 

1.5

 

 

 —

 

 

7.8

Deferred revenue, current

 

 

111.5

 

 

0.3

 

 

37.8

 

 

 —

 

 

149.6

Total current liabilities

 

 

490.1

 

 

0.8

 

 

184.4

 

 

 —

 

 

675.3

Long-term debt, non-current

 

 

5,537.5

 

 

 —

 

 

 —

 

 

 —

 

 

5,537.5

Related party debt, long-term

 

 

 —

 

 

 —

 

 

352.0

 

 

(352.0)

 

 

 —

Capital lease obligation, non-current

 

 

81.4

 

 

 —

 

 

10.9

 

 

 —

 

 

92.3

Deferred revenue, non-current

 

 

895.8

 

 

 —

 

 

99.5

 

 

 —

 

 

995.3

Deferred income taxes, net

 

 

(0.8)

 

 

 —

 

 

41.3

 

 

 —

 

 

40.5

Other long-term liabilities

 

 

25.3

 

 

 —

 

 

20.5

 

 

 —

 

 

45.8

Total liabilities

 

 

7,029.3

 

 

0.8

 

 

708.6

 

 

(352.0)

 

 

7,386.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Member's equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Member's interest

 

 

1,934.0

 

 

17.9

 

 

582.3

 

 

(631.5)

 

 

1,902.7

Accumulated other comprehensive loss

 

 

5.3

 

 

 —

 

 

22.2

 

 

 —

 

 

27.5

Accumulated deficit

 

 

(475.2)

 

 

12.9

 

 

29.5

 

 

(33.3)

 

 

(466.1)

Total member's equity

 

 

1,464.1

 

 

30.8

 

 

634.0

 

 

(664.8)

 

 

1,464.1

Total liabilities and member's equity

 

$

8,493.4

 

$

31.6

 

$

1,342.6

 

$

(1,016.8)

 

$

8,850.8

 

 

26


 

Table of Contents

ZAYO GROUP, LLC AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Condensed Consolidating Balance Sheets (Unaudited)

June 30, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Zayo Group,

    

 

 

    

 

 

    

 

 

    

 

 

 

 

LLC

 

Guarantor

 

Non-Guarantor

 

 

 

 

 

 

 

 

(Issuer)

 

Subsidiaries

 

Subsidiaries

 

Eliminations

 

Total

 

 

(in millions)

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

96.6

 

$

2.1

 

$

121.3

 

$

 —

 

 

220.0

Trade receivables, net of allowance

 

 

117.9

 

 

4.5

 

 

69.2

 

 

 —

 

 

191.6

Prepaid expenses

 

 

42.6

 

 

0.3

 

 

25.4

 

 

 —

 

 

68.3

Other assets

 

 

25.1

 

 

 —

 

 

9.0

 

 

 —

 

 

34.1

Total current assets

 

 

282.2

 

 

6.9

 

 

224.9

 

 

 —

 

 

514.0

Property and equipment, net

 

 

4,306.3

 

 

 —

 

 

709.7

 

 

 —

 

 

5,016.0

Intangible assets, net

 

 

1,033.6

 

 

11.0

 

 

144.0

 

 

 —

 

 

1,188.6

Goodwill

 

 

1,660.8

 

 

14.6

 

 

164.8

 

 

 —

 

 

1,840.2

Deferred income taxes, net

 

 

27.2

 

 

 —

 

 

0.1

 

 

 —

 

 

27.3

Other assets

 

 

115.6

 

 

 —

 

 

26.1

 

 

 —

 

 

141.7

Related party receivable

 

 

341.5

 

 

 —

 

 

 —

 

 

(341.5)

 

 

 —

Investment in subsidiary

 

 

624.6

 

 

 —

 

 

 —

 

 

(624.6)

 

 

 —

Total assets

 

$

8,391.8

 

$

32.5

 

$

1,269.6

 

$

(966.1)

 

$

8,727.8

Liabilities and member's equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current portion of long-term debt

 

$

5.0

 

$

 —

 

$

 —

 

$

 —

 

$

5.0

Accounts payable

 

 

57.0

 

 

 —

 

 

15.4

 

 

 —

 

 

72.4

Accrued liabilities

 

 

217.5

 

 

1.4

 

 

110.3

 

 

 —

 

 

329.2

Accrued interest

 

 

63.5

 

 

 —

 

 

 —

 

 

 —

 

 

63.5

Capital lease obligations, current

 

 

6.6

 

 

 —

 

 

1.4

 

 

 —

 

 

8.0

Deferred revenue, current

 

 

113.1

 

 

0.2

 

 

32.7

 

 

 —

 

 

146.0

Total current liabilities

 

 

462.7

 

 

1.6

 

 

159.8

 

 

 —

 

 

624.1

Long-term debt, non-current

 

 

5,532.7

 

 

 —

 

 

 —

 

 

 —

 

 

5,532.7

Related party debt, long-term

 

 

 —

 

 

 —

 

 

341.5

 

 

(341.5)

 

 

 —

Capital lease obligation, non-current

 

 

82.6

 

 

 —

 

 

11.0

 

 

 —

 

 

93.6

Deferred revenue, non-current

 

 

884.8

 

 

 —

 

 

104.9

 

 

 —

 

 

989.7

Deferred income taxes, net

 

 

 —

 

 

 —

 

 

40.2

 

 

 —

 

 

40.2

Other long-term liabilities

 

 

33.9

 

 

 —

 

 

18.5

 

 

 —

 

 

52.4

Total liabilities

 

 

6,996.7

 

 

1.6

 

 

675.9

 

 

(341.5)

 

 

7,332.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Member's equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Member's interest

 

 

1,893.5

 

 

18.5

 

 

574.2

 

 

(607.2)

 

 

1,879.0

Accumulated other comprehensive loss

 

 

 —

 

 

 —

 

 

5.4

 

 

 —

 

 

5.4

Accumulated deficit

 

 

(498.4)

 

 

12.4

 

 

14.1

 

 

(17.4)

 

 

(489.3)

Total member's equity

 

 

1,395.1

 

 

30.9

 

 

593.7

 

 

(624.6)

 

 

1,395.1

Total liabilities and member's equity

 

$

8,391.8

 

$

32.5

 

$

1,269.6

 

$

(966.1)

 

$

8,727.8

 

27


 

Table of Contents

ZAYO GROUP, LLC AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Condensed Consolidating Statements of Comprehensive Income

For the three months ended September 30, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Zayo Group,

    

 

 

    

 

 

    

 

 

    

 

 

 

 

LLC

 

Guarantor

 

Non-Guarantor

 

 

 

 

 

 

 

 

(Issuer)

 

Subsidiaries

 

Subsidiaries

 

Eliminations

 

Total

 

 

(in millions)

Revenue

 

$

488.2

 

$

5.1

 

$

150.2

 

$

 —

 

$

643.5

Operating costs and expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

161.1

 

 

3.8

 

 

70.8

 

 

 —

 

 

235.7

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

 

 

91.9

 

 

0.3

 

 

36.1

 

 

 —

 

 

128.3

Depreciation and amortization

 

 

154.9

 

 

0.5

 

 

28.7

 

 

 —

 

 

184.1

Total operating costs and expenses

 

 

407.9

 

 

4.6

 

 

135.6

 

 

 —

 

 

548.1

Operating income

 

 

80.3

 

 

0.5

 

 

14.6

 

 

 —

 

 

95.4

Other expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

(68.0)

 

 

 —

 

 

(5.6)

 

 

 —

 

 

(73.6)

Loss on extinguishment of debt

 

 

(4.9)

 

 

 —

 

 

 —

 

 

 —

 

 

(4.9)

Foreign currency gain on intercompany loans

 

 

5.3

 

 

 —

 

 

5.5

 

 

 —

 

 

10.8

Other income

 

 

0.2

 

 

 —

 

 

0.7

 

 

 —

 

 

0.9

Equity in net earnings of subsidiaries

 

 

15.9

 

 

 —

 

 

 —

 

 

(15.9)

 

 

 —

Total other expense, net

 

 

(51.5)

 

 

 —

 

 

0.6

 

 

(15.9)

 

 

(66.8)

Income from operations before income taxes

 

 

28.8

 

 

0.5

 

 

15.2

 

 

(15.9)

 

 

28.6

Provision for income taxes

 

 

5.6

 

 

 —

 

 

(0.2)

 

 

 —

 

 

5.4

Net income

 

 

23.2

 

 

0.5

 

 

15.4

 

 

(15.9)

 

 

23.2

Other comprehensive income, net of income taxes

 

 

22.1

 

 

 —

 

 

22.1

 

 

(22.1)

 

 

22.1

Comprehensive income

 

$

45.3

 

$

0.5

 

$

37.5

 

$

(38.0)

 

$

45.3

28


 

Table of Contents

ZAYO GROUP, LLC AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Condensed Consolidating Statements of Comprehensive Income

For the three months ended September 30, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Zayo Group,

    

 

 

    

 

 

    

 

 

    

 

 

 

 

LLC

 

Guarantor

 

Non-Guarantor

 

 

 

 

 

 

 

 

(Issuer)

 

Subsidiaries

 

Subsidiaries

 

Eliminations

 

Total

 

 

(in millions)

Revenue

 

$

342.0

 

$

4.6

 

$

158.3

 

$

 —

 

$

504.9

Operating costs and expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

97.8

 

 

3.3

 

 

72.7

 

 

 —

 

 

173.8

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

 

 

65.0

 

 

0.3

 

 

40.3

 

 

 —

 

 

105.6

Depreciation and amortization

 

 

110.6

 

 

0.5

 

 

27.4

 

 

 —

 

 

138.5

Total operating costs and expenses

 

 

273.4

 

 

4.1

 

 

140.4

 

 

 —

 

 

417.9

Operating income

 

 

68.6

 

 

0.5

 

 

17.9

 

 

 —

 

 

87.0

Other expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

(47.8)

 

 

 —

 

 

(5.5)

 

 

 —

 

 

(53.3)

Foreign currency loss on intercompany loans

 

 

(5.1)

 

 

 —

 

 

(6.1)

 

 

 —

 

 

(11.2)

Other expense

 

 

(0.1)

 

 

 —

 

 

(0.1)

 

 

 —

 

 

(0.2)

Equity in net earnings of subsidiaries

 

 

8.4

 

 

 —

 

 

 —

 

 

(8.4)

 

 

 —

Total other expense, net

 

 

(44.6)

 

 

 —

 

 

(11.7)

 

 

(8.4)

 

 

(64.7)

Income/(loss) from operations before income taxes

 

 

24.0

 

 

0.5

 

 

6.2

 

 

(8.4)

 

 

22.3

Provision/(benefit) for income taxes

 

 

8.3

 

 

 —

 

 

(1.7)

 

 

 —

 

 

6.6

Net income/(loss)

 

 

15.7

 

 

0.5

 

 

7.9

 

 

(8.4)

 

 

15.7

Other comprehensive loss, net of income taxes

 

 

(3.3)

 

 

 —

 

 

(3.3)

 

 

3.3

 

 

(3.3)

Comprehensive income

 

$

12.4

 

$

0.5

 

$

4.6

 

$

(5.1)

 

$

12.4

29


 

Table of Contents

ZAYO GROUP, LLC AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Condensed Consolidating Statements of Cash Flows

For the three months ended September 30, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Zayo Group,

    

 

 

    

 

 

    

 

 

 

 

LLC

 

Guarantor

 

Non-Guarantor

 

 

 

 

 

(Issuer)

 

Subsidiaries

 

Subsidiaries

 

Total

 

 

(in millions)

Net cash provided by operating activities

 

$

213.6

 

$

3.6

 

$

51.6

 

$

268.8

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(176.3)

 

 

 —

 

 

(17.1)

 

 

(193.4)

Net cash used in investing activities

 

 

(176.3)

 

 

 —

 

 

(17.1)

 

 

(193.4)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

 

 

 

 

Proceeds from debt

 

 

312.8

 

 

 —

 

 

 —

 

 

312.8

Principal payments on long-term debt

 

 

(311.9)

 

 

 —

 

 

 —

 

 

(311.9)

Principal repayments on capital lease obligations

 

 

(1.6)

 

 

 —

 

 

(0.1)

 

 

(1.7)

Payment of debt issuance costs

 

 

(3.4)

 

 

 —

 

 

 —

 

 

(3.4)

Contributions to parent

 

 

1.1

 

 

(1.1)

 

 

 —

 

 

 —

Cash paid for Santa Clara acquisition

 

 

(1.3)

 

 

 —

 

 

 —

 

 

(1.3)

Net cash used in financing activities

 

 

(4.3)

 

 

(1.1)

 

 

(0.1)

 

 

(5.5)

Effect of changes in foreign exchange rates on cash

 

 

 —

 

 

 —

 

 

0.6

 

 

0.6

Net increase in cash and cash equivalents

 

 

33.0

 

 

2.5

 

 

35.0

 

 

70.5

Cash and cash equivalents, beginning of period

 

 

96.6

 

 

2.1

 

 

121.3

 

 

220.0

Cash and cash equivalents, end of period

 

$

129.6

 

$

4.6

 

$

156.3

 

$

290.5

30


 

Table of Contents

ZAYO GROUP, LLC AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Condensed Consolidating Statements of Cash Flows

For the three months ended September 30, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Zayo Group,

    

 

 

    

 

 

    

 

 

 

 

LLC

 

Guarantor

 

Non-Guarantor

 

 

 

 

 

(Issuer)

 

Subsidiaries

 

Subsidiaries

 

Total

 

 

(in millions)

Net cash provided by operating activities

 

$

189.8

 

$

1.7

 

$

41.2

 

$

232.7

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(190.2)

 

 

 —

 

 

(18.1)

 

 

(208.3)

Acquisitions, net of cash acquired

 

 

 —

 

 

 —

 

 

1.5

 

 

1.5

Net cash used in investing activities

 

 

(190.2)

 

 

 —

 

 

(16.6)

 

 

(206.8)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

 

 

 

 

Principal repayments on capital lease obligations

 

 

(0.5)

 

 

 —

 

 

(0.5)

 

 

(1.0)

Payment of debt issuance costs

 

 

(0.7)

 

 

 —

 

 

 —

 

 

(0.7)

Contributions to parent

 

 

1.7

 

 

(1.7)

 

 

 —

 

 

 —

Net cash provided by/(used in) financing activities

 

 

0.5

 

 

(1.7)

 

 

(0.5)

 

 

(1.7)

Effect of changes in foreign exchange rates on cash

 

 

 —

 

 

 —

 

 

(2.0)

 

 

(2.0)

Net increase in cash and cash equivalents

 

 

0.1

 

 

 —

 

 

22.1

 

 

22.2

Cash and cash equivalents, beginning of period

 

 

91.3

 

 

3.0

 

 

75.8

 

 

170.1

Cash and cash equivalents, end of period

 

$

91.4

 

$

3.0

 

$

97.9

 

$

192.3

 

(14) SUBSEQUENT EVENTS

In connection with the Company’s acquisition of 100% of the equity interest in Allstream, Inc. and Allstream Fiber U.S. Inc. (together “Allstream Acquisition”) on January 15, 2016 from Manitoba Telecom Services Inc. (now known as “Bell MTS” as a result of their acquisition by BCE Inc.), Bell MTS agreed to retain Allstream Acquisition’s former defined benefit pension obligations, and related pension plan assets, of retirees and other former employees of Allstream Acquisition and also agreed to reimburse Allstream Acquisition for certain solvency funding payments related to the pension obligations of active Allstream Acquisition employees as of January 15, 2016. On October 31, 2017, Bell MTS transferred assets of  CAD $117.9 million (or $91.6 million) from Allstream Acquisition’s former defined benefit pension plans related to pre-closing service obligations for active employees to a  new Allstream Acquisition defined benefit pension plans created by the Company. Accordingly, the Company has recognized a pension asset and liability of CAD $117.9 million (or $91.6 million) subsequent to September 30, 2017, which is subject to review and adjustment by Bell MTS and the Company in November 2017.

 

 

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ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Certain Factors That May Affect Future Results

Information contained or incorporated by reference in this Quarterly Report on Form 10-Q (this “Report”) and in other filings by Zayo Group, LLC (“we” or “us”) with the Securities and Exchange Commission (the “SEC”) that is not historical by nature constitutes “forward-looking statements,” and can be identified by the use of forward-looking terminology such as “believes,” “expects,” “plans,” “intends,” “estimates,” “projects,” “could,” “may,” “will,” “should,” or “anticipates,” or the negatives thereof, other variations thereon or comparable terminology, or by discussions of strategy. No assurance can be given that future results expressed or implied by the forward-looking statements will be achieved, and actual results may differ materially from those contemplated by the forward-looking statements. Such statements are based on our current expectations and beliefs and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied by the forward-looking statements. These risks and uncertainties include, but are not limited to, those relating to our financial and operating prospects, current economic trends, future opportunities, ability to retain existing customers and attract new ones, our acquisition strategy and ability to integrate acquired companies and assets, outlook of customers, reception of new products and technologies, and strength of competition and pricing. Other factors and risks that may affect our business and future financial results are detailed in our SEC filings, including, but not limited to, those described under “Risk Factors” in our Annual Report on Form 10-K (our “Annual Report”) filed with the SEC on August 22, 2017 and in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We caution you not to place undue reliance on these forward-looking statements, which speak only as of their respective dates. We undertake no obligation to publicly update or revise forward-looking statements to reflect events or circumstances after the date of this Report or to reflect the occurrence of unanticipated events, except as may be required by law.

The following discussion and analysis should be read together with our unaudited condensed consolidated financial statements and the related notes appearing in this Report and in our audited annual consolidated financial statements as of and for the year ended June 30, 2017, included in our Annual Report. 

Amounts presented in this Item 2 are rounded. As such, rounding differences could occur in period-over-period changes and percentages reported throughout this Item 2.

Overview

We are a large and fast growing provider of bandwidth infrastructure in the United States, Europe and Canada. Our products and services enable mission-critical, high-bandwidth applications, such as cloud-based computing, video, mobile, social media, machine-to-machine connectivity, and other bandwidth-intensive applications. Key products include leased dark fiber, fiber to cellular towers and small cell sites, dedicated wavelength connections, Ethernet, IP connectivity, cloud services and other high-bandwidth offerings. We provide our services over a unique set of dense metro, regional, and long-haul fiber networks and through our interconnect-oriented data center facilities. Our fiber networks and data center facilities are critical components of the overall physical network architecture of the Internet and private networks. Our customer base includes some of the largest and most sophisticated consumers of bandwidth infrastructure services, such as wireless service providers; telecommunications service providers; financial services companies; social networking, media, and web content companies; education, research, and healthcare institutions; and governmental agencies. We typically provide our bandwidth infrastructure services for a fixed monthly recurring fee under contracts that vary between one and twenty years in length. We operate our business with a unique focus on capital allocation and financial performance with the ultimate goal of maximizing equity value for Zayo Group Holdings, Inc. (“ZGH”) stockholders. Our core values center on partnership, alignment, and transparency with our three primary constituent groups – employees, customers, and ZGH stockholders.

We are a wholly-owned subsidiary of Zayo Group Holdings, Inc., a Delaware corporation, which prior to October 16, 2014, was wholly owned by Communications Infrastructure Investments, LLC, a Delaware limited liability company (“CII”).

Our fiscal year ends June 30 each year, and we refer to the fiscal year ending June 30, 2018 as “Fiscal 2018” and the fiscal year ended June 30, 2017 as “Fiscal 2017.”

32


 

We are headquartered in Boulder, Colorado.

Reportable Segments and our Strategic Product Groups

We use the management approach to determine the segment financial information that should be disaggregated and presented. 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. With the continued increase in our scope and scale, effective January 1, 2017, our chief operating decision maker ("CODM"), who is our Chief Executive Officer, implemented certain organizational changes to the management and operation of the business that directly impact how the CODM makes resource allocation decisions and manages the Company. The change in structure had the impact of revising our reportable segments and re-aligning our existing Strategic Product Groups (“SPGs”) within these segments. We have six reportable segments as described below:

Fiber Solutions. Through the Fiber Solutions segment, we provide raw bandwidth infrastructure to customers that require more control of their internal networks. These services include dark fiber, dedicated lit networks and mobile infrastructure (fiber-to-the-tower and small cell). Dark fiber is a physically separate and secure, private platform for dedicated bandwidth. We lease dark fiber pairs (usually 2 to 12 total fibers) to our customers, who “light” the fiber using their own optronics. Our mobile infrastructure services provide direct fiber connections to cell towers, small cells, hub sites, and mobile switching centers. 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 Fiber Solutions segment tend to range from three to twenty years.

Transport. The Transport segment provides lit bandwidth infrastructure solutions over our metro, regional, and long-haul fiber networks. The segment uses optronics to light the fiber, and our customers pay for service based on the amount and type of bandwidth they purchase. The services within this segment include wavelengths, wholesale IP services and SONET. We target customers who require a minimum of 10G of bandwidth across their networks. Transport customers include carriers, content providers, financial services companies, healthcare, government entities, education institutions and other medium and large enterprises. The contract terms in this segment tend to range from two to five years.

Enterprise Networks. The Enterprise Networks segment provides communication solutions to medium and large enterprises. Our services within this segment include Ethernet, enterprise private and connectivity services, managed services and cloud based compute and storage products. Solutions range from point-to-point data connections to multi-site managed networks to international outsourced IT infrastructure environments.

Zayo Colocation (zColo). The Colocation segment provides data center infrastructure solutions to a broad range of enterprise, carrier, cloud, and content customers. Our services within this segment include the provision of colocation space, power and interconnection services in North America and Western Europe.  Solutions range in size from single cabinet solutions to 1MW+ data center infrastructure environments. Our data centers also support a large component of our 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.

Allstream. The Allstream segment provides Voice, SIP Trunking, Unified Communications and scalable data services using a variety of technologies for businesses.  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 Cloud-based IP telephony), instant messaging and video conferencing with non-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. Allstream also offers a range of data services that help small and medium business (“SMB”) customers implement the right data and networking solutions for their business. Those scalable data services make use of technologies including Ethernet services, IP/MPLS VPN Solutions, and wavelength services.  Allstream provides services to approximately 70,000 customers in the

33


 

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. Our Other segment is primarily comprised of Zayo Professional Services (“ZPS”). We provide 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). ZPS also generates revenue via telecommunications equipment sales.

 

Factors Affecting Our Results of Operations

Business Acquisitions

We were founded in 2007 with the investment thesis of building a bandwidth infrastructure platform to take advantage of the favorable Internet, data, and wireless growth trends driving the ongoing demand for bandwidth infrastructure, and to be an active participant in the consolidation of the industry. These trends have continued in the years since our founding, despite volatile economic conditions, and we believe that we are well positioned to continue to capitalize on those trends. We have built a significant portion of our network and service offerings through 41 acquisitions through September 30, 2017.

As a result of the growth of our business from these acquisitions, and capital expenditures and the increased debt used to fund those investing activities, our results of operations for the respective periods presented and discussed herein are not comparable.

Recent Significant Acquisitions

KIO Networks US Data Centers

 

On May 1, 2017, the Company completed the $11.9 million cash acquisition of Castle Access, Inc.’s (d/b/a “KIO Networks US”) San Diego data centers.  The two data centers, located at 12270 World Trade Drive and 9606 Aero Drive, total more than 100,000 square feet of space and 2 megawatts of critical, IT power, with additional power available.  As of September 30, 2017, $1.2 million of the purchase consideration is being held in escrow pending the expiration of the indemnification adjustment period. The acquisition was funded with cash on hand and was considered a stock purchase for tax purposes.

The results of the acquired KIO Networks US business are included in our operating results beginning May 1, 2017.

Electric Lightwave Parent, Inc.

On March 1, 2017, we acquired Electric Lightwave Parent, Inc. (“Electric Lightwave”), an infrastructure and telecom services provider serving 35 markets in the western U.S., for net purchase consideration of $1,426.6 million, net of cash acquired, subject to certain post-closing adjustments. As of September 30, 2017, $7.0 million of the purchase price consideration is being held in escrow pending the expiration of the indemnification adjustment period. The acquisition was funded through debt and cash on hand. 

The acquisition added 8,100 route miles of long haul fiber and 4,000 miles of dense metro fiber across Denver, Minneapolis, Phoenix, Portland, Seattle, Sacramento, San Francisco, San Jose, Salt Lake City, Spokane and Boise, with on-net connectivity to more than 3,100 enterprise buildings and 100 data centers.

The results of the acquired Electric Lightwave business are included in our operating results beginning March 1, 2017.

Santa Clara Data Center

On October 3, 2016, we acquired a data center in Santa Clara, California (the “Santa Clara Data Center”), for net purchase consideration of $11.3 million. The net purchase consideration, which was valued using a discounted cash flow

34


 

method, will be paid in ten quarterly payments of $1.3 million, beginning in the December 2016 quarter. As of September 30, 2017, the remaining consideration to be paid was $7.7 million.

The Santa Clara Data Center, located at 5101 Lafayette Street, includes 26,900 total square feet and three megawatts of critical power. The facility also includes high-efficiency power and cooling infrastructure, seismic reinforcement and proximity to our long haul dark fiber routes between San Francisco and Los Angeles.

The results of the acquired Santa Clara Data Center business are included in our operating results beginning October 3, 2016.

Substantial Indebtedness

Term Loan Facility and Revolving Credit Facility

On May 6, 2015, we and Zayo Capital, Inc. (“Zayo Capital”) entered into an Amendment and Restatement Agreement whereby the Credit Agreement (the “Credit Agreement”) governing our 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 a portion of the then outstanding term loans under the Term Loan Facility from July 2, 2019 to May 6, 2021. The interest rate margins applicable to the portion of the Term Loan Facility due in 2021 were decreased by 25 basis points to LIBOR plus 2.75% with a minimum LIBOR of 1.0%. The terms of the Term Loan Facility required us 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 annual payment was required during Fiscal 2017 and Fiscal 2016).

Under the amended and restated Credit Agreement, the Revolver matures at the earliest of (i) April 17, 2020, and (ii) six months prior to the earliest 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 our 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 our leverage ratio.

On January 15, 2016, we and Zayo Capital entered into an Incremental Amendment (the “Amendment”) to the Credit Agreement. Under the terms of the Amendment, the portion of the Term Loan Facility due 2021 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%. No other terms of the Credit Agreement were amended.  The Incremental Term Loan proceeds were used to fund the Allstream acquisition and for general corporate purposes.

On July 22, 2016, we and Zayo Capital entered into a Repricing Amendment (the “Repricing Amendment”) to the Credit Agreement.  Per the terms of the Repricing Amendment, the Incremental Term Loan was repriced at par and will 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.

On January 19, 2017, we and Zayo Capital entered into an Incremental Amendment No. 2 (the “Incremental Amendment”) to the Credit Agreement. Per the terms of the Incremental Amendment, the existing $1.85 billion of term loans under the Credit Agreement were repriced at 99.75% with one $500.0 million tranche that bears interest at a rate of LIBOR plus 2.0%, with a minimum LIBOR rate of 0.0% and a maturity date of four years from incurrence, which represents a downward adjustment of 75 basis points along with the lowering of the previous LIBOR floor, and a second $1.35 billion tranche (the “B-2 Term Loan” and along with the $500.0 million tranche, the “Refinancing Term Loans”) that bears interest at a rate of LIBOR plus 2.5%, with a minimum LIBOR rate of 1.0% and a maturity of seven years from incurrence, which represents a downward adjustment of 25 basis points.  In addition, per the terms of the Incremental Amendment, we and Zayo Capital added a new $650.0 million term loan tranche under the Credit Agreement (the “Electric Lightwave Incremental Term Loan”) that bears interest at LIBOR plus 2.5%, with a minimum LIBOR rate of 1.0%, with a maturity of seven years from the closing date of the Incremental Amendment. In connection with the Incremental Amendment the full $2,500.0 million Term Loan Facility including the Refinancing Term Loans and the Electric Lightwave Incremental Term Loan, was issued at a price of 99.75%. Per the terms of the Incremental Amendment, the Revolver matures on April 17, 2020. No other material terms of the Credit Agreement were amended.

35


 

On April 10, 2017, $570.1 million of the B-2 Term Loan and the Electric Lightwave Incremental Term Loan was repaid from proceeds of issuance of senior unsecured notes as further discussed below.

On July 20, 2017, we and Zayo Capital entered into a second repricing amendment (the “Repricing Amendment No. 2”) to the Credit Agreement. Per the terms of the Repricing Amendment No. 2, the outstanding balances of the B-2 Term Loan and Electric Lightwave Incremental Term Loan were repriced at par and will bear interest at a rate of LIBOR plus 2.25%, with a minimum LIBOR rate of 1.0%, which represented a downward adjustment of 25 basis points. No other terms of the Credit Agreement were amended.

Additionally, in April 2017, $310.7 million of the B-2 Term Loan was repaid from the proceeds of the issuance of senior unsecured notes as further discussed below.

The weighted average interest rate (including margin) on the Term Loan Facility was approximately 3.4% at each of September 30, 2017 and June 30, 2017. Interest rates on the Revolver as of September 30, 2017 and June 30, 2017 were approximately 4.0% and 3.8%, respectively.

As of September 30, 2017, no amounts were outstanding under the Revolver and $1,616.8 million in aggregate principal amount was outstanding under the Term Loan Facility. Standby letters of credit were outstanding in the amount of $7.8 million as of September 30, 2017, leaving $442.2 million available under the Revolver, subject to certain conditions.

Senior Unsecured Notes

6.00% Senior Unsecured Notes due 2023

On January 23, 2015 and March 9, 2015, we and Zayo Capital completed private offerings of aggregate principal amounts of $700.0 million and $730.0 million, respectively, of 6.00% senior unsecured notes due in 2023 (the “2023 Unsecured Notes”). The 2023 Unsecured Notes bear interest at the rate of 6.00% per year, which is payable on April 1 and October 1 of each year. The 2023 Unsecured Notes will mature on April 1, 2023.  

6.375% Senior Unsecured Notes due 2025

On April 14, 2016, we and Zayo Capital completed a private offering of $550.0 million aggregate principal amount of 2025 Unsecured Notes (the “Incremental 2025 Notes”). The Incremental 2025 Notes were priced at 97.76% and were an additional issuance of the existing 6.375% senior unsecured notes due in 2025 that were originally issued on May 6, 2015 (the “2025 Notes” and together with the Incremental 2025 Notes, the “2025 Unsecured Notes”). The net proceeds from the Incremental 2025 Notes, plus cash on hand, were used to (i) 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) repay $196.0 million of borrowings under the then outstanding secured Term Loan Facility. The 2025 Unsecured Notes bear interest at the rate of 6.375% per year, which is payable on May 15 and November 15 of each year. The 2025 Unsecured Notes will mature on November 15, 2025.

5.75% Senior Unsecured Notes due 2027

On January 27, 2017, we and Zayo Capital completed a private offering of $800.0 million aggregate principal amount of 5.75% senior unsecured notes due 2027 (the “January 2027 Notes”).  The net proceeds from the offering, along with the Electric Lightwave Incremental Term Loan discussed above, were used to fund the Electric Lightwave acquisition, which closed on March 1, 2017.

On April 10, 2017, we and Zayo Capital  completed a private offering of $550.0 million aggregate principal amount of 5.75% senior unsecured notes due 2027 (the “Incremental 2027 Notes”). The Incremental 2027 notes were an additional issuance of the January 2027 Notes and were priced at 104.0%. The net proceeds from the Incremental 2027 Notes were used to repay certain outstanding balances on our B-2 Term Loan. 

36


 

On July 5, 2017, we and Zayo Capital  completed a private offering of $300.0 million aggregate principal amount of 5.75% senior unsecured notes due 2027 (the “July Incremental 2027 Notes” and together with the Incremental 2027 Notes and the January 2027 Notes, the “2027 Unsecured Notes”). The July Incremental 2027 Notes were an additional issuance of the January 2027 Notes and Incremental 2027 Notes and were priced at 104.25%. The net proceeds of $310.7 million from the July Incremental 2027 Notes were used to further repay certain outstanding balances on our B-2 Term Loan. The 2027 Unsecured Notes bear interest at the rate of 5.75% per year, which is payable on January 15 and July 15 of each year. The 2027 Unsecured Notes will mature on January 15, 2027.

Capital Expenditures

During the three months ended September 30, 2017 and 2016, we invested $193.4 million and $208.3 million, respectively, in capital expenditures primarily to expand our fiber network to support new customer contracts. We expect to continue to make significant capital expenditures in future periods.

Critical Accounting Policies and Estimates

For a description of our critical accounting policies and estimates, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report for the year ended June 30, 2017.

Background for Review of Our Results of Operations

Revenue

Our revenue is comprised predominately of monthly recurring revenue (“MRR”). MRR is related to an ongoing service that is generally fixed in price and paid by the customer on a monthly basis. We also report monthly amortized revenue (“MAR”), which represents the amortization of previously collected upfront charges to customers. Upfront charges are typically related to indefeasible rights of use (“IRUs”) structured as pre-payments rather than monthly recurring payments (though we structure IRUs as both prepaid and recurring, largely dependent on the customers’ preference) and installation fees. The last category of revenue we report is other revenue. Other revenue primarily includes credits and adjustments, termination revenue, construction services, and equipment sales.

Our consolidated reported revenue in any given period is a function of our beginning revenue under contract and the impact of organic growth and acquisition activity. Our organic activity is driven by net new sales (“bookings”), gross installed revenue (“installs”) and churn processed (“churn”) as further described below.

Net New Sales.   Net new sales (“bookings”) represent the dollar amount of orders, to be recorded as MRR and MAR upon installation, in a period that have been signed by the customer and accepted by our service delivery organization. The dollar value of bookings is equal to the monthly recurring price that the customer will pay for the services and/or the monthly amortized amount of the revenue that we will recognize for those services. To the extent a booking is cancelled by the customer prior to it being installed, it is subtracted from the total bookings number in the period that it is cancelled. Bookings do not immediately impact revenue until they are installed (gross installed revenue).

Gross Installed Revenue.   Installs are the amount of MRR and MAR for services that have been installed, tested, accepted by the customer, and have been recognized in revenue during a given period.   Installs include new services, price increases, and upgrades.

Churn Processed.   Churn is any negative change to MRR and MAR. Churn includes disconnects, negative price changes, and disconnects associated with upgrades or replacement services. For each period presented, disconnects associated with attrition and upgrades or replacement services are the drivers of churn, accounting for more than 75% of negative changes in MRR and MAR while price changes account for less than 25%. Monthly churn is also presented as a percentage of MRR and MAR (“churn percentage”).

Given the size and amount of acquisitions we have completed, we have estimated the revenue growth rate associated with our organic activity in each period reported. Our estimated organic growth rate is calculated as if acquisitions closed during the periods presented were closed on the first day of the earliest period presented within this Quarterly Report.   In calculating this pro-forma growth figure we add the revenue recorded by the  acquired companies’ (including estimated purchase accounting adjustments) for the reporting periods prior to the date of inclusion in our

37


 

results of operations, and then calculate the growth rate between the two reported periods.    The estimated pro-forma revenue growth rates are not necessarily indicative of either future results of operations or results that might have been achieved had the acquisitions been consummated on the first day of the earliest period presented.  As we conduct operations outside of the United States of America and have historically acquired companies with functional currencies other than the United States Dollar (“USD”), the estimated pro-forma revenue growth rates may not adequately reflect operational performance as a result of changes in foreign currency exchange rates. 

We have foreign subsidiaries that enter into contracts with customers and vendors in currencies other than the USD – principally the British Pound Sterling (“GBP”) and Canadian Dollar (“CAD”) and to a lesser extent the Euro. Changes in foreign currency exchange rates impact our revenue and expenses each period. The comparisons excluding the impact of foreign currency exchange rates assume exchange rates remained constant at the comparative period rate.

Operating Costs and Expenses

Our operating costs and expenses consist of network expense (“Netex”), compensation and benefits, network operations expense (“Netops”), stock-based compensation expense, other expenses, and depreciation and amortization.

Netex consists of third-party network service costs resulting from our leasing of certain network facilities, primarily leases of circuits and dark fiber, from carriers to augment our owned infrastructure, for which we are generally billed a fixed monthly fee. Netex also includes colocation facility costs for rent and license fees paid to the landlords of the buildings in which our colocation business operates, along with the utility costs to power those facilities. While increases in demand for our services will drive additional operating costs in our business, consistent with our strategy of leveraging our owned infrastructure assets, we expect to primarily utilize our existing network infrastructure or build new network infrastructure to meet the demand. In limited circumstances, we will augment our network with additional circuits or services from third-party providers. Third-party network service costs include the upfront cost of the initial installation of such circuits. Such costs are included in operating costs in our condensed consolidated statements of operations over the respective service period.

Compensation and benefits expenses include salaries, wages, incentive compensation and benefits. Employee-related costs that are directly associated with network construction, service installations (and development of business support systems) are capitalized and amortized to operating costs and expenses. Compensation and benefits expenses related to the departments attributed to generating revenue are included in our operating costs line item while compensation and benefits expenses related to the sales, product, and corporate departments are included in our selling, general and administrative expenses line item of our condensed consolidated statements of operations.

Netops expense includes all of the non-personnel related expenses of operating and maintaining our network infrastructure, including contracted maintenance fees, right-of-way costs, rent for cellular towers and other places where fiber is located, pole attachment fees, and relocation expenses. Such costs are included in operating costs in our condensed consolidated statements of operations.

Stock-based compensation expense is included, based on the responsibilities of the awarded recipient, in either our operating costs or selling, general and administrative expenses in our condensed consolidated statements of operations.

Other expenses include expenses such as property tax, franchise fees, colocation facility maintenance, travel, office expense and other administrative costs. Other expenses are included in both operating costs and selling, general and administrative expenses depending on their relationship to generating revenue or association with sales and administration.

Transaction costs include expenses associated with professional services (i.e. legal, accounting, regulatory, etc.) rendered in connection with acquisitions or disposals (including spin-offs), travel expense, severance expense incurred that are associated with acquisitions or disposals, and other direct expenses incurred that are associated with signed and/or closed acquisitions or disposals and unsuccessful acquisitions. Transaction costs are included in selling, general and administrative expenses in our condensed consolidated statements of operations.

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Three Months Ended September 30, 2017 Compared to the Three Months Ended September 30, 2016

Revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended September 30,

 

 

    

2017

    

2016

    

 

$ Variance

    

% Variance

 

 

 

 

(in millions)

 

Segment and consolidated revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiber Solutions

 

$

195.5

 

$

174.1

 

 

$

21.4

 

12

%

Transport

 

 

119.1

 

 

106.1

 

 

 

13.0

 

12

%

Enterprise Networks

 

 

137.7

 

 

114.4

 

 

 

23.3

 

20

%

zColo

 

 

58.4

 

 

51.2

 

 

 

7.2

 

14

%

Allstream

 

 

127.7

 

 

54.5

 

 

 

73.2

 

134

%

Other

 

 

5.1

 

 

4.6

 

 

 

0.5

 

11

%

Consolidated

 

$

643.5

 

$

504.9

 

 

$

138.6

 

27

%

 

Our total revenue increased by $138.6 million, or 27%, to $643.5 million for the three months ended September 30, 2017 from $504.9 million for the three months ended September 30, 2016. The increase in revenue was driven by our Fiscal 2017 acquisitions as well as organic growth.

We estimate that the period-over-period pro-forma organic revenue declined by 0.1%. Our pro-forma revenue decline was primarily driven by declining revenue from the voice businesses acquired in our Fiscal 2017 acquisitions. Partially offsetting this pro-forma decline was organic growth resulting from installs that exceeded churn over the course of both periods as a result of the continued strong demand for bandwidth infrastructure services broadly across our service territory and customer verticals.

Changes in exchange rates also partially offset the pro-forma revenue decline. The average exchange rate of the GBP against the USD weakened by 0.3%, the average exchange rate of the Euro against the USD strengthened by 5.3% and the average exchange rate of the CAD against the USD strengthened by 4.0% during the three months ended September 30, 2017 as compared to the three months ended September 30, 2016. Normalizing our estimated pro-forma revenue decline to exclude the impact of foreign currency exchange rate fluctuations, we estimate that pro-forma revenue would have decreased between the three months ended September 30, 2017 and September 31, 2016 by an additional $6.5 million for a total period-over-period pro-forma revenue decline of 1.1%.

Additional underlying revenue drivers included:

·

MRR and MAR associated with new bookings during the three months ended September 30, 2017 and 2016 decreased period-over-period to $7.6 million from $8.2 million, excluding Allstream. The total contract value associated with bookings for the three months ended September 30, 2017 was approximately $395.0 million, excluding Allstream.

·

During the three months ended September 30, 2017 and 2016, we recognized net installs of $1.2 million and $2.1 million, respectively, excluding Allstream.

·

Monthly churn percentage increased to 1.2% for the three months ended September 30, 2017 from 1.1% for the three months ended September 30, 2016, excluding Allstream.

Fiber Solutions.  Revenue from our Fiber Solutions segment increased by $21.4 million, or 12%, to $195.5 million for the three months ended September 30, 2017 from $174.1 million for the three months ended September 30, 2016. The increase was a result of both organic and acquisition related growth.

Transport.   Revenue from our Transport segment increased by $13.0 million, or 12%, to $119.1 million for the three months ended September 30, 2017 from $106.1 million for the three months ended September 30, 2016. The increase was a result of both organic and acquisition related growth.

Enterprise Networks.   Revenue from our Enterprise Networks segment increased by $23.3 million, or 20%, to $137.7 million for the three months ended September 30, 2017 from $114.4 million for the three months ended September 30, 2016.  The increase was a result of both organic and acquisition related growth.

39


 

zColo.   Revenue from our zColo segment increased by $7.2 million, or 14%, to $58.4 million for the three months ended September 30, 2017 from $51.2 million for the three months ended September 30, 2016. The increase was a result of both organic and acquisition related growth.

Allstream.   Revenue from our Allstream segment increased by $73.2 million, or 134%, to $127.7 million for the three months ended September 30, 2017 from $54.5 million for the three months ended September 30, 2016. The increase was a result of acquiring Electric Lightwave on March 1, 2017.

Other.   Revenue from our Other segment increased by $0.5 million, or 11%, to $5.1 million for the three months ended September 30, 2017 from $4.6 million for the three months ended September 30, 2016. The Other segment represented less than 1% of our total revenue during the three months ended September 30, 2017.

The following table reflects the stratification of our revenues during these periods. The substantial majority of our revenue continued to come from recurring payments from customers under contractual arrangements.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended September 30,

 

 

 

2017

    

 

2016

 

 

 

 

(in millions)

 

Monthly recurring revenue

    

$

577.6

    

 

90

%  

 

$

451.8

    

90

%

Amortization of deferred revenue

 

 

32.8

 

 

5

%  

 

 

27.5

 

5

%

Usage revenue

 

 

19.5

 

 

3

%  

 

 

17.7

 

3

%

Other revenue

 

 

13.6

 

 

2

%  

 

 

7.9

 

2

%

Total Revenue

 

$

643.5

 

 

100

%  

 

$

504.9

 

100

%

Operating Costs and Expenses 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended September 30,

 

 

    

2017

    

2016

    

$ Variance

    

% Variance

 

 

 

 

(in millions)

 

Segment and consolidated operating costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Fiber Solutions

 

$

151.4

 

$

130.3

 

$

21.1

 

16

%

Transport

 

 

105.8

 

 

90.2

 

 

15.6

 

17

%

Enterprise Networks

 

 

118.2

 

 

99.1

 

 

19.1

 

19

%

zColo

 

 

55.8

 

 

47.0

 

 

8.8

 

19

%

Allstream

 

 

112.3

 

 

47.2

 

 

65.1

 

138

%

Other

 

 

4.6

 

 

4.1

 

 

0.5

 

12

%

Consolidated

 

$

548.1

 

$

417.9

 

$

130.2

 

31

%

 

 

Our operating costs increased by $130.2 million, or 31%, to $548.1 million for the three months ended September 30, 2017 from $417.9 million for the three months ended September 30, 2016. The increase in consolidated operating costs was primarily due to our Fiscal 2017 acquisitions and the organic growth of our network footprint.

Fiber Solutions.    Fiber Solutions operating costs increased by $21.1 million, or 16%, to $151.4 million for the three months ended September 30, 2017 from $130.3 million for the three months ended September 30, 2016. The increase in operating costs and expenses was primarily a result of a $13.1 million increase in depreciation and amortization as a result of Fiscal 2017 acquisitions and organic growth of our network. Additionally, compensation and benefits expense increased $6.8 million as a result of increased headcount to support our growing business.

Transport.    Transport operating costs increased by $15.6 million, or 17%, to $105.8 million for the three months ended September 30, 2017 from $90.2 million for the three months ended September 30, 2016. The increase in operating costs and expenses was primarily a result of an $11.1 million increase in depreciation and amortization and a $6.1 million increase in Netex, Netops and other operating expenses as a result of Fiscal 2017 acquisitions and organic growth of our network, partially offset by a $2.1 million decrease in stock-based compensation.

Enterprise Networks.    Enterprise Networks operating costs increased by $19.1 million, or 19%, to $118.2 million for the three months ended September 30, 2017 from $99.1 million for the three months ended September 30, 2016. The increase in operating costs and expenses was primarily a result of a $13.8 million increase in Netex, Netops and other

40


 

operating costs and a $4.7 million increase in depreciation and amortization as a result of Fiscal 2017 acquisitions and organic growth of our network, partially offset by a $1.0 million decrease in stock-based compensation.

zColo.    zColo operating costs increased by $8.8 million, or 19%, to $55.8 million for the three months ended September 30, 2017 from $47.0 million for the three months ended September 30, 2016. The increase in operating costs and expenses was primarily a result of a $4.8 million increase in depreciation and amortization expense, $1.4 million in Netex and $1.9 million in other expenses as a result of Fiscal 2017 acquisitions and organic growth of our network, partially offset by a $0.5 million decrease in stock-based compensation.

Allstream.    Allstream operating costs increased by $65.1 million, or 138%, to $112.3  million for the three months ended September 30, 2017 from $47.2 million for the three months ended September 30, 2016. The increase in operating costs and expenses was primarily a result of acquiring Electric Lightwave on March 1, 2017.

Other.    Other operating costs were $4.6 million for the three months ended September 30, 2017, as compared to $4.1 million for the three months ended September 30, 2016. The increase was directly attributed to an increase in revenue associated with equipment sales.

The table below sets forth the components of our operating costs and expenses during the three months ended September 30, 2017 and 2016.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended September 30,

 

 

 

2017

    

2016

    

$ Variance

    

% Variance

 

 

 

 

(in millions)

 

Netex

 

$

131.5

 

$

93.3

 

$

38.2

 

41

%

Compensation and benefits expenses

 

 

82.0

 

 

63.9

 

 

18.1

 

28

%

Network operations expense

 

 

71.6

 

 

56.0

 

 

15.6

 

28

%

Other expenses

 

 

42.8

 

 

31.2

 

 

11.6

 

37

%

Transaction costs

 

 

8.3

 

 

3.0

 

 

5.3

 

177

%

Stock-based compensation

 

 

27.8

 

 

32.0

 

 

(4.2)

 

(13)

%

Depreciation and amortization

 

 

184.1

 

 

138.5

 

 

45.6

 

33

%

Total operating costs and expenses

 

$

548.1

 

$

417.9

 

$

130.2

 

31

%

 

Netex.    Our Netex increased by $38.2 million, or 41%, to $131.5 million for the three months ended September 30, 2017 from $93.3 million for the three months ended September 30, 2016. The increase in Netex was primarily due to our Fiscal 2017 acquisitions, partially offset by cost savings, as planned network related synergies were realized.

 

Compensation and Benefits Expenses.    Compensation and benefits expenses increased by $18.1 million to $82.0 million for the three months ended September 30, 2017 from $63.9 million for the three months ended September 30, 2016.

The increase in compensation and benefits expenses was primarily due to an increase in headcount from 3,126 for the three months ended September 30, 2016 to 3,647 for the three months ended September 30, 2017 to support our growing business, including employees retained from businesses acquired during Fiscal 2017.

 

Network Operations Expenses.    Network operations expenses increased by $15.6 million, or 28%, to $71.6 million for the three months ended September 30, 2017 from $56.0 million for the three months ended September 30, 2016. The increase principally reflected the organic and inorganic growth of our network assets and the related expenses of operating that expanded network. Our total network route miles increased approximately 10% to 126,065 miles at September 30, 2017 from 114,492 miles at September 30, 2016.

Other Expenses.    Other expenses increased by $11.6 million, or 37%, to $42.8 million for the three months ended September 30, 2017 from $31.2 million for the three months ended September 30, 2016. The increase was primarily the result of additional expenses attributable to our Fiscal 2017 acquisitions.

Transaction Costs. Transaction costs increased by $5.3 million, or 177%, to $8.3 million for the three months ended September 30, 2017 from $3.0 million for the three months ended September 30, 2016.  The increase was due

41


 

primarily to greater transaction costs incurred associated with our second half Fiscal 2017 acquisitions of KIO Networks US Data Centers and Electric Lightwave.

Stock-Based Compensation.    Stock-based compensation expense decreased by $4.2 million, or 13%, to $27.8 million for the three months ended September 30, 2017 from $32.0 million for the three months ended September 30, 2016.  The decrease in stock-based compensation expense was primarily driven by the remaining tranches of our pre-IPO common unit grants becoming fully vested in the quarter ended December 31, 2016.

Depreciation and Amortization

Depreciation and amortization expense increased by $45.6 million, or 33%, to $184.1 million for the three months ended September 30, 2017 from $138.5 million for the three months ended September 30, 2016.  The increase was primarily a result of depreciation related to increased capital expenditures and increased depreciation and amortization expense associated with our Fiscal 2017 acquisitions.   

Total Other Expense, Net

The table below sets forth the components of our total other expense, net for the three months ended September 30, 2017 and 2016, respectively.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended September 30,

 

 

    

2017

    

2016

    

$ Variance

    

% Variance

 

 

 

 

(in millions)

 

Interest expense

 

$

(73.6)

 

$

(53.3)

 

$

(20.3)

 

(38)

%

Loss on extinguishment of debt

 

 

(4.9)

 

 

 —

 

 

(4.9)

 

 

*

Foreign currency gain/(loss) on intercompany loans

 

 

10.8

 

 

(11.2)

 

 

22.0

 

 

*

Other income/(expense), net

 

 

0.9

 

 

(0.2)

 

 

1.1

 

 

*

Total other expenses, net

 

$

(66.8)

 

$

(64.7)

 

$

(2.1)

 

(3)

%


* not meaningful

Interest expense.   Interest expense increased by $20.3 million, or 38%, to $73.6 million for the three months ended September 30, 2017 from $53.3 million for the three months ended September 30, 2016. The increase was primarily a result of an increase in debt from the comparative period resulting from incremental debt raised to fund our acquisition of Electric Lightwave.

Loss on extinguishment of debt.   Loss on extinguishment of debt was $4.9 million for the three months ended September 30, 2017. The $4.9 million loss on extinguishment of debt includes a non-cash expense associated with the write-off of unamortized debt issuance costs and the issuance discounts on the portion of the Credit Agreement, as amended, that was deemed to have been extinguished as well as the portion extinguished through early prepayment.  The loss on extinguishment of debt also includes certain fees paid to third parties involved in the Repricing Amendment No.2. 

Foreign currency gain/(loss) on intercompany loans.   We recorded a foreign currency gain on intercompany loans of $10.8 million for the three months ended September 30, 2017,  compared to a loss of $11.2 million for the three months ended September 30, 2016.  We have intercompany loans between our United States (“US”) and United Kingdom (“UK”) legal entities which were established to fund our international acquisitions. As the loans are recorded as an intercompany receivable at our US entities, strengthening of the USD over the GBP results in a foreign currency loss on intercompany loans and the weakening of the USD over the GBP results in a gain on intercompany loans. This non-cash gain was driven by the weakening of the USD over the GBP period-over-period and the related impact on intercompany loans entered into by foreign subsidiaries with functional currency in GBP.

42


 

Provision for Income Taxes

 

Our provision for income taxes decreased by $1.2 million to $5.4 million for the three months ended September 30, 2017 from $6.6 million for the three months ended September 30, 2016. Our provision for income taxes included both the current provision and a provision for deferred income tax expense resulting from timing differences between tax and financial reporting accounting bases.  Our stock-based compensation plan has a material impact on the comparison of our effective tax rate and the expected income tax expense at the statutory rate. During the three months ended September 30, 2017, our effective tax rate was negatively impacted by the smaller allowable deduction for stock-based compensation for tax purposes as compared to the book expense related to our Restricted Stock Unit plan. Additionally, we are subject to lower tax rates on foreign earnings, and we record valuation allowances against foreign deferred tax assets, which are contributing drivers of our effective tax rate being lower than the expected tax provision at the statutory rate. During the quarter, the Company also reversed the valuation allowance on certain deferred tax assets that are expected to be realized. It is reasonably possible that the Company may reverse the valuation allowance recorded on certain foreign subsidiaries’ deferred tax assets in the near future.

The following table reconciles an expected tax provision based on a statutory federal tax rate applied to our earnings before income tax to our actual provision for income taxes:

 

 

 

 

 

 

 

 

 

For the three months ended September 30,

 

 

2017

    

2016

 

 

 

(in millions)

Expected provision at the statutory rate

 

$

10.0

 

$

7.8

Increase/(decrease) due to:

 

 

 

 

 

 

Stock-based compensation

 

 

1.5

 

 

3.3

State income taxes benefit, net of federal benefit

 

 

0.6

 

 

0.7

Transaction costs not deductible for tax purposes

 

 

0.1

 

 

 —

Change in statutory tax rate

 

 

 —

 

 

(1.7)

Foreign tax rate differential

 

 

(2.2)

 

 

(0.7)

Change in valuation allowance

 

 

(5.7)

 

 

(2.4)

Other, net

 

 

1.1

 

 

(0.4)

Provision for income taxes

 

$

5.4

 

$

6.6

Adjusted EBITDA

We define 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. We use Adjusted EBITDA to evaluate operating performance, and this financial measure is among the primary measures used by management for planning and forecasting for future periods. We believe that the presentation of 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 our results with the results of other companies that have different financing and capital structures.

We also monitor Adjusted EBITDA because our subsidiaries have debt covenants that restrict their borrowing capacity that are based on a leverage ratio, which utilizes a modified EBITDA, as defined in our Credit Agreement and the indentures governing our outstanding Notes. The modified EBITDA is consistent with our definition of Adjusted EBITDA; however, it includes the pro forma Adjusted EBITDA of and expected cost synergies from the companies acquired by us during the quarter for which the debt compliance certification is due.

Adjusted EBITDA results, along with other quantitative and qualitative information, are also utilized by management and our compensation committee for purposes of determining bonus payouts to employees.

Adjusted EBITDA has limitations as an analytical tool and should not be considered in isolation from, or as a substitute for, analysis of our results as reported under GAAP. For example, Adjusted EBITDA:

·

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

43


 

·

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

·

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

·

does not reflect cash required to pay income taxes.

Our computation of Adjusted EBITDA may not be comparable to other similarly titled measures computed by other companies because all companies do not calculate Adjusted EBITDA in the same fashion.

Reconciliations from segment and consolidated Adjusted EBITDA to net income/(loss) are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended September 30, 2017

 

    

Fiber Solutions

    

Transport

    

Enterprise
Networks

    

zColo

    

Allstream

    

Other

    

Corp/
Eliminations

    

Total

 

 

 

(in millions)

Segment and consolidated Adjusted EBITDA

 

$

154.2

 

$

51.6

 

$

49.5

 

$

29.4

 

$

30.8

 

$

1.1

 

$

 —

 

$

316.6

Interest expense

 

 

(40.1)

 

 

(9.0)

 

 

(10.8)

 

 

(9.8)

 

 

(3.9)

 

 

 —

 

 

 —

 

 

(73.6)

Provision for income taxes

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(5.4)

 

 

(5.4)

Depreciation and amortization expense

 

 

(95.3)

 

 

(32.3)

 

 

(20.1)

 

 

(23.3)

 

 

(12.6)

 

 

(0.5)

 

 

 —

 

 

(184.1)

Transaction costs

 

 

(2.3)

 

 

(1.0)

 

 

(2.5)

 

 

(0.4)

 

 

(2.1)

 

 

 —

 

 

 —

 

 

(8.3)

Stock-based compensation

 

 

(11.8)

 

 

(4.8)

 

 

(7.4)

 

 

(3.1)

 

 

(0.5)

 

 

(0.2)

 

 

 —

 

 

(27.8)

Loss on extinguishment of debt

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(4.9)

 

 

(4.9)

Foreign currency gain on intercompany loans

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

10.8

 

 

10.8

Non-cash loss on investments

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(0.1)

 

 

(0.1)

Net income/(loss)

 

$

4.7

 

 

4.5

 

 

8.7

 

 

(7.2)

 

 

11.7

 

 

0.4

 

 

0.4

 

 

23.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended September 30, 2016

 

    

Fiber Solutions

    

Transport

    

Enterprise
Networks

    

zColo

    

Allstream

    

Other

    

Corp/
Eliminations

    

Total

 

 

(in millions)

Segment and consolidated Adjusted EBITDA

 

$

138.3

 

$

44.6

 

$

40.6

 

$

26.3

 

$

9.7

 

$

1.1

 

$

 —

 

$

260.6

Interest expense

 

 

(30.7)

 

 

(7.0)

 

 

(8.5)

 

 

(7.1)

 

 

 —

 

 

 —

 

 

 —

 

 

(53.3)

Provision for income taxes

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(6.6)

 

 

(6.6)

Depreciation and amortization expense

 

 

(82.2)

 

 

(21.2)

 

 

(15.4)

 

 

(18.5)

 

 

(0.6)

 

 

(0.6)

 

 

 —

 

 

(138.5)

Transaction costs

 

 

(0.2)

 

 

(0.3)

 

 

(1.5)

 

 

 —

 

 

(1.0)

 

 

 —

 

 

 —

 

 

(3.0)

Stock-based compensation

 

 

(12.0)

 

 

(6.9)

 

 

(8.4)

 

 

(3.6)

 

 

(0.9)

 

 

(0.2)

 

 

 —

 

 

(32.0)

Foreign currency loss on intercompany loans

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(11.2)

 

 

(11.2)

Non-cash loss on investments

 

 

(0.1)

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(0.2)

 

 

(0.3)

Net income/(loss)

 

$

13.1

 

$

9.2

 

$

6.8

 

$

(2.9)

 

$

7.2

 

$

0.3

 

$

(18.0)

 

$

15.7

 

44


 

Liquidity and Capital Resources

Our primary sources of liquidity have been cash provided by operations, equity contributions, and incurrence of debt. Our principal uses of cash have been for acquisitions, capital expenditures, and debt service requirements. We anticipate that our principal uses of cash in the future will be for acquisitions, capital expenditures, working capital, and debt service.

We have financial covenants under the Indentures governing the 2023 Unsecured Notes, the 2025 Unsecured Notes and the 2027 Unsecured Notes (collectively, the “Notes”) and our Credit Agreement that, under certain circumstances, restrict our ability to incur additional indebtedness. The indentures governing the Notes limit any increase in our 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 our previous quarter’s annualized modified EBITDA (as defined in the indentures), and limit our incurrence of additional indebtedness to a total indebtedness ratio of 6.00 times the previous quarter’s annualized modified EBITDA.  The Credit Agreement also contains a covenant, applicable only to the Revolver, that we 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 us and our subsidiaries to comply with customary affirmative and negative covenants, including covenants restricting the ability of us and our 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 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.

As of September 30, 2017, we had $290.5 million in cash and cash equivalents and a working capital deficit of $65.7 million. Cash and cash equivalents consist of amounts held in bank accounts and highly-liquid U.S. treasury money market funds.  Although we had a working capital deficit at September 30, 2017, a substantial portion of the deficit is a result of a current deferred revenue balance of $149.6 million that we will be recognizing as revenue over the next twelve months. The actual cash outflows associated with fulfilling this deferred revenue obligation during the next twelve months will be significantly less than the September 30, 2017 current deferred revenue balance. Additionally, as of September 30, 2017, we had $442.2 million available under our Revolver, subject to certain conditions. Accordingly, we believe that we have sufficient resources to fund our obligations and foreseeable liquidity requirements in the near term and for the foreseeable future.

Our capital expenditures decreased by $14.9 million, or 7%, to $193.4 million during the three months ended September 30, 2017, as compared to $208.3 million for the three months ended September 30, 2016. Although we had a decrease in the period, we expect to continue to invest in our network for the foreseeable future. As of September 30, 2017, we were contractually committed for $356.0 million of capital expenditures for construction materials and purchases of property and equipment, as well as energy and network expenditures. A majority of these purchase commitments are expected to be satisfied in the next twelve months. These capital expenditures, however, are expected to primarily be success-based; that is, in most situations, we will not invest the capital until we have an executed customer contract that supports the investment. 

As part of our corporate strategy, we continue to be regularly involved in discussions regarding potential acquisitions of companies and assets, some of which may be quite large. We expect to fund such acquisitions with cash from operations, debt issuances (including available borrowings under our $450.0 million Revolver), contributions from Zayo Group Holdings, Inc., and available cash on hand. We regularly assess our projected capital requirements to fund future growth in our business, repay our debt obligations, and support our other general corporate and operational needs, and we regularly evaluate our opportunities to raise additional capital. As market conditions permit, we may refinance existing debt, issue new debt through the capital markets, or obtain additional bank financing to fund our projected capital requirements or provide additional liquidity.

Cash Flows

We believe that our cash flows from operating activities, in addition to cash and cash equivalents currently on-hand, will be sufficient to fund our operating activities and capital expenditures for the foreseeable future, and in any

45


 

event for at least the next 12 to 18 months. Given the generally volatile global economic climate, no assurance can be given that this will be the case.

We regularly consider acquisitions and additional strategic opportunities, including large acquisitions, which may require additional debt or equity financing.

The following table sets forth components of our cash flow for the three months ended September 30, 2017 and 2016.

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

    

2017

    

2016

 

 

(in millions)

Net cash provided by operating activities

 

$

268.8

 

$

232.7

Net cash used in investing activities

 

$

(193.4)

 

$

(206.8)

Net cash used in financing activities

 

$

(5.5)

 

$

(1.7)

Net Cash Flows from Operating Activities

 

Net cash flows from operating activities increased by $36.1 million, or 16%, to $268.8 million during the three months ended September 30, 2017 from $232.7 million during the three months ended September 30, 2016. Net cash flows from operating activities during the three months ended September 30, 2017 include our net income of $23.2 million, plus the add backs of non-cash items deducted in the determination of net income, principally depreciation and amortization of $184.1 million, stock-based compensation expense of $27.8 million, loss on extinguishment of debt of $4.9 million and non-cash interest expense of $2.4 million, partially offset by foreign currency gain on intercompany loans of $10.8 million. Also contributing to the cash provided by operating activities were additions to deferred revenue of $40.5 million, partially offset by amortization of deferred revenue of $32.8 million.  Cash flow during the period was increased by the net change in other working capital components of $25.9 million.

Net cash flows from operating activities during the three months ended September 30, 2016 include our net income of $15.7 million, plus the add backs of non-cash items deducted in the determination of net income, principally depreciation and amortization of $138.5 million, stock-based compensation expense of $32.0 million, foreign currency loss on intercompany loans of $11.2 million, non-cash interest expense of $2.6 million and deferred income taxes of $4.8 million. Also contributing to the cash provided by operating activities were additions to deferred revenue of $40.9 million, partially offset by amortization of deferred revenue of $27.5 million.  Cash flow during the period was increased by the net change in other working capital components of $13.3 million.  

The increase in net cash flows from operating activities during the three months ended September 30, 2017 as compared to the three months ended September 30, 2016 is primarily a result of additional earnings and synergies realized from our Fiscal 2017 acquisitions  as well as timing of cash receipts from customers and payments to vendors and for interest.

Cash Flows used in Investing Activities

We used cash in investing activities of $193.4 million and $206.8 million during the three months ended September 30, 2017 and 2016, respectively. During the three months ended September 30, 2017, our principal use of cash for investing activities was for additions to property and equipment.

During the three months ended September 30, 2016, our uses of cash for investing activities were primarily related to additions to property and equipment.

Cash Flows used in Financing Activities

Our net cash used in financing activities was $5.5 million and $1.7 million during the three months ended September 30, 2017 and 2016, respectively.

Our cash flows used in financing activities during the three months ended September 30, 2017 were primarily comprised of $311.9 million in principal payments on long-term debt, $1.7 million in principal payments on capital lease obligations, and $3.4 million in payments of debt issuance costs, partially offset by $312.8 million in debt proceeds.

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Our cash flows used in financing activities during the three months ended September 30, 2016 were primarily comprised of $1.0 million in principal payments on capital lease obligations and a $0.7 million payment of debt issuance costs.

Off-Balance Sheet Arrangements

We do not have any special purpose or limited purpose entities that provide off-balance sheet financing, liquidity, or market or credit risk support and we do not engage in leasing, hedging, or other similar activities that expose us to any significant liabilities that are not (i) reflected on the face of the condensed consolidated financial statements, (ii) disclosed in Note 10 – Commitments and Contingencies to the condensed consolidated financial statements, or in the Future Contractual Obligations table included in Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report or (iii) discussed under “Item 3: Quantitative and Qualitative Disclosures About Market Risk” below.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to market risk consists of changes in interest rates from time to time and market risk arising from changes in foreign currency exchange rates that could impact our cash flows and earnings.

As of September 30, 2017, we had outstanding $1,430.0 million of 2023 Unsecured Notes, $900.0 million of 2025 Unsecured Notes, $1,650.0 million of 2027 Unsecured Notes (collectively, the “Notes”), a balance of $497.5 million on our Term Loan Facility due 2021, a balance of $1,119.3 million on our Term Loan Facility due 2024, and $100.1 million of capital lease obligations. As of September 30, 2017, we had $442.2 million available for borrowing under our Revolver, subject to certain conditions.

Based on current market interest rates for debt of similar terms and average maturities and based on recent transactions, we estimate the fair value of our Notes to be $4,221.3 million as of September 30, 2017. Our 2023 Unsecured Notes, 2025 Unsecured Notes, and 2027 Unsecured Notes accrue interest at fixed rates of 6.00%, 6.375%, and 5.75% respectively.

 

Both our Revolver and our Term Loan Facility accrue interest at floating rates subject to certain conditions. The Company’s Term Loan Facility accrues interest at variable rates based upon the one month, three month or nine month LIBOR plus i) a spread of 2.0% on the Company’s $500.0 million tranche (which has a LIBOR floor of 0.0%) and ii) a spread of 2.25% on its B-2 Term Loan tranche (which has a LIBOR floor of 1.00%).  As of September 30, 2017, the weighted average interest rates (including margin) on the Term Loan Facility and our Revolver was approximately 3.4% and 4.0%, respectively. A hypothetical increase in the applicable interest rate on our Term Loan Facility of one percentage point would increase our annualized interest expense by approximately 27% or $16.2 million, based on the applicable interest rate as of September 30, 2017. Historically, this impact was limited as a result of the applicable interest rate being below the minimum 1.0% LIBOR floor on our Term Loan Facility tranche that matures on January 19, 2024. 

We are exposed to the risk of changes in interest rates if it is necessary to seek additional funding to support the expansion of our business and to support acquisitions. The interest rate that we may be able to obtain on future debt financings will be dependent on market conditions.

We have exposure to market risk arising from foreign currency exchange rates. During the three months ended September 30, 2017, our foreign activities accounted for approximately 23% of our consolidated revenue. We monitor foreign markets and our commitments in such markets to assess currency and other risks. A one percent change in foreign exchange rates would change consolidated revenue by approximately $1.5 million for the quarter ended September 30, 2017. To date, we have not entered into any hedging arrangement designed to limit exposure to foreign currencies. As a result of past European expansion through acquisitions as well as our acquisitions of Viatel and Allstream during the Fiscal Year ended June 30, 2016, our level of foreign activities is expected to increase and if it does, we may determine that such hedging arrangements would be appropriate and will consider such arrangements to minimize our exposure to foreign exchange risk.

We do not have any material commodity price risk.

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ITEM 4.CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Management has established and maintained disclosure controls and procedures that are designed to ensure that material information relating to the Company and our subsidiaries required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Our management, including our Chief Executive Officer and Chief Financial Officer, have conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Our Chief Executive Officer and Chief Financial Officer concluded that as of September 30, 2017, our disclosure controls and procedures were effective.

Changes in Internal Controls over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.    

PART II. OTHER INFORMATION

ITEM 1.        LEGAL PROCEEDINGS

In the ordinary course of business, we are from time to time party to various litigation matters that we believe are incidental to the operation of our business. We record an appropriate provision when the occurrence of loss is probable and can be reasonably estimated. We cannot estimate with certainty our ultimate legal and financial liability with respect to any such pending litigation matters and it is possible one or more of them could have a material adverse effect on us. However, we believe that the outcome of such pending litigation matters will not have a material adverse effect upon our results of operations, our consolidated financial condition or our liquidity.

ITEM 1A.        RISK FACTORS 

Item 1A of our Annual Report on Form 10-K for the year ended June 30, 2017 set forth information relating to other important risks and uncertainties that could materially adversely affect our business, financial condition or operating results. Those risk factors, in addition to the other information set forth in this report, continue to be relevant to an understanding of our business, financial condition and operating results for the quarter ended September 30, 2017.

There have been no material changes in our risk factors from those disclosed in our Annual Report.

 

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ITEM 6. EXHIBITS

 

 

 

Exhibit No.

    

Description of Exhibit

4.1**

 

Indenture, dated as of January 23, 2015, among Zayo Group, LLC, Zayo Capital, Inc., the guarantors party thereto and The Bank of New York Mellon Trust Company N.A., as trustee (incorporated by reference to Exhibit 4.1 of our Current Report on Form 8-K filed with the SEC on January 23, 2015, File No. 333‑169979).

 

 

 

4.2**

 

Indenture, dated as of May 6, 2015, between Zayo Group, LLC, Zayo Capital, Inc., the guarantors party thereto and The Bank of New York Mellon Trust Company N.A., as trustee (incorporated by reference to Exhibit 4.1 of our Current Report on Form 8-K filed with the SEC on May 7, 2015, File No. 333-169979).

 

 

 

4.3**

 

Indenture, dated as of January 27, 2017, among Zayo Group, LLC, Zayo Capital, Inc., the guarantors party thereto and The Bank of New York Mellon Trust Company, N.A., as trustee (incorporated by reference to Exhibit 4.1 of our Current Report on Form 8-K filed with the SEC on April 11, 2017, File No. 333-169979).

 

 

 

10.1*+

 

Employment Agreement, dated as of September 11, 2017, by and between Zayo Group, LLC and Matt Steinfort.

 

 

 

10.2**

 

Repricing Amendment No. 2 to Amended and Restated Credit Agreement, dated as of July 20, 2017, by and among Zayo Group, LLC, Zayo Capital, Inc., Morgan Stanley Senior Funding, Inc., as term facility administrative agent, SunTrust Bank, as revolving facility administrative agent, and the other lenders signatory thereto (incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K filed with the SEC on July 21, 2017, File No. 333-169979).

 

 

 

31.1*

 

Certification of Chief Executive Officer of the Registrant, pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

 

 

 

31.2*

 

Certification of Chief Financial Officer of the Registrant, pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

 

 

 

32*

 

Certification of the Registrant, pursuant to 18 U.S.C. Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

101 *

 

Financial Statements from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2017, formatted in XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income/(Loss), (iv) Consolidated Statement of Member’s Equity, (v) Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements.

 

 

 


*        Filed/furnished herewith.

**      Previously filed and incorporated herein by reference.

+Management contract and/or compensatory plan or arrangement.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

 

 

 

 

 

Zayo Group, LLC

 

 

 

Date: November 6, 2017

 

By:

 

/s/ Dan Caruso

 

 

 

 

Dan Caruso

 

 

 

 

Chief Executive Officer

 

 

 

 

 

 

 

Date: November 6, 2017

 

By:

 

/s/ Matt Steinfort

 

 

 

 

Matt Steinfort

 

 

 

 

Chief Financial Officer

 

 

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