S-1 1 d715611ds1.htm S-1 S-1
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As filed with the Securities and Exchange Commission on July 2, 2014

Registration No. 333-            

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

Zayo Group Holdings, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware   4813   26-1398293

(State or other
jurisdiction of

incorporation or
organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

1805 29th Street, Suite 2050

Boulder, CO 80301

(303) 381-4683

(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

Scott E. Beer, Esq.

General Counsel

Zayo Group Holdings, Inc.

1805 29th Street, Suite 2050

Boulder, CO 80301

(303) 381-4683

(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agents For Service)

 

With a copy to:

Brian J. Lane, Esq.

Andrew Fabens, Esq.

Robyn E. Zolman, Esq.

Gibson, Dunn & Crutcher LLP

1801 California Street, Suite 4200

Denver, Colorado 80202-2642

(303) 298-5700

 

James S. Scott, Sr. Esq.

Shearman & Sterling LLP

599 Lexington Avenue

New York, New York 10022-6069

(212) 848-4000

Approximate date of commencement of proposed sale to the public: As soon as practicable after this registration statement becomes effective.

If the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box.    ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

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

 

Large accelerated filer    ¨       Accelerated filer    ¨  
Non-accelerated filer    x       Smaller reporting company    ¨  
(Do not check if a smaller reporting company)        

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of

Securities to be Registered

 

Proposed Maximum Aggregate

Offering Price(1)(2)

 

Amount of

Registration Fee

Common stock, par value $0.001 per share

  $100,000,000   $12,880

 

 

(1) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.
(2) Includes offering price of additional shares that the underwriters have the option to purchase.

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, or until the registration statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.


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The information in this preliminary prospectus is not complete and may be changed. We and the selling stockholders may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities, and we are not soliciting offers to buy these securities in any state where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED JULY 2, 2014

PROSPECTUS

            Shares

Zayo Group Holdings, Inc.

 

LOGO

Common Stock

 

 

This is Zayo Group Holdings, Inc.’s initial public offering. We are selling            shares of our common stock, and the selling stockholders identified in this prospectus, including certain members of our senior management, are selling            shares of our common stock. We will not receive any of the proceeds from the sale of shares to be offered by the selling stockholders. We expect the public offering price to be between $        and $        . Prior to this offering, there has been no public market for the shares.

We expect to apply to list our common stock on the            under the symbol            .

Investing in our common stock involves risks. See “Risk Factors” beginning on page 15 to read about factors you should consider before buying our common stock.

 

    

Price to Public

   Underwriting
Discounts and

Commissions(1)
    

Proceeds, before
expenses to Zayo

     Proceeds, before
expenses to the
Selling Stockholders
 

Per Share

   $                  $                     $                     $               

Total

   $                  $                     $                     $               

 

(1) The underwriters will receive compensation in addition to the underwriting discount. See “Underwriting.”

The underwriters have the option to purchase up to an additional             shares from the selling stockholders, at the initial public offering price, less the underwriting discount.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or the accuracy of this prospectus. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the shares of common stock to purchasers on or about                     , 2014.

 

 

 

Morgan Stanley   Barclays   Goldman, Sachs & Co.

 

RBC Capital Markets   Citigroup   SunTrust Robinson Humphrey

 

Cowen and Company   D.A. Davidson & Co.     Oppenheimer & Co.   Raymond James   Stephens Inc.   Wells Fargo Securities   William Blair

Prospectus dated                     , 2014


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TABLE OF CONTENTS

 

    

Page

 

PROSPECTUS SUMMARY

     1   

CORPORATE INFORMATION

     8   

THE OFFERING

     10   

RISK FACTORS

     15   

FORWARD LOOKING STATEMENTS

     30   

USE OF PROCEEDS

     31   

DIVIDEND POLICY

     32   

CAPITALIZATION

     33   

DILUTION

     35   

SELECTED HISTORICAL CONSOLIDATED FINANCIAL INFORMATION

     36   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     38   

BUSINESS

     78   

MANAGEMENT

     96   

EXECUTIVE COMPENSATION

     103   

PRINCIPAL AND SELLING STOCKHOLDERS

     111   

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

     114   

DESCRIPTION OF CERTAIN INDEBTEDNESS

     116   

DESCRIPTION OF CAPITAL STOCK

     117   

SHARES ELIGIBLE FOR FUTURE SALE

     120   

MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES TO NON-U.S. HOLDERS OF OUR COMMON STOCK

     122   

UNDERWRITING

     126   

LEGAL MATTERS

     132   

EXPERTS

     133   

WHERE YOU CAN FIND MORE INFORMATION

     134   

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

     F-1   

GLOSSARY OF TERMS

     G-1   

 

 

You should rely only upon the information contained in this prospectus or in any free writing prospectus prepared by or on behalf of us. None of us, the underwriters, or the selling stockholders have authorized anyone to provide you with additional or different information. If anyone provides you with additional, different or inconsistent information, you should not rely on it. If you are in a jurisdiction where offers to sell, or solicitations of offers to purchase, shares of our common stock are unlawful, or if you are a person to whom it is unlawful to direct these types of activities, then the offer presented in this document does not extend to you. You should assume the information appearing in this prospectus is accurate only as of the respective dates of such information. Our business, financial condition, results of operations, and prospects may have changed since those dates.

Market, Industry, and Other Data

In this prospectus, we rely on and refer to information and statistics regarding our industry, including papers produced by: Cisco Systems, Inc., entitled “Visual Networking Index (VNI) Global Mobile Data Traffic Forecast Update Feb-2014” and “VNI Global IP Traffic Forecast, 2013-2018;” Gartner, Inc., entitled “Forecast: The Internet of Things, Worldwide, 2013;” Nielsen, entitled “The Cross-Platform Report;” RightScale® Inc., entitled “State of the Cloud Report;” Sandvine, entitled “Global Internet Phenomena Report” (available at www.sandvine.com/trends/global-internet-phenomena); and Vertical Systems Group’s ENS (Emerging Networks Service) Research. We obtained this market data from independent industry publications or other publicly available information. Although we believe that these sources are reliable, we have not independently verified

 

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and do not guarantee the accuracy and completeness of this information. Industry surveys, publications, consultant surveys, and forecasts generally state that the information contained therein has been obtained from sources believed to be reliable, but completeness of such information is not guaranteed. We take responsibility for compiling and extracting, but we have not independently verified any of the data from third-party sources, nor have we ascertained the underlying economic assumptions relied upon therein. Forecasts are particularly likely to be inaccurate, especially over long periods of time. While we are not aware of any misstatements regarding market data, industry data, and forecasts presented herein, estimates in such information involve risks and uncertainties and are subject to change based on various factors, including those discussed under “Risk Factors” in this prospectus. We cannot guarantee the accuracy or completeness of any such information contained in this prospectus.

The Gartner Report described herein (the “Gartner Report”) represents data, research opinion or viewpoints published as part of a syndicated subscription service by Gartner, Inc. (“Gartner”), and are not representations of fact. The Gartner Report speaks as of its original publication date (and not as of the date of this prospectus) and the opinions expressed in the Gartner Report are subject to change without notice. The Gartner Report consists of “Forecast: The Internet of Things, Worldwide, 2013” published November 18, 2013 by Peter Middleton, Peter Kjeldsen, and Jim Tully.

Non-GAAP Financial Measures

We have included certain financial measures in this prospectus that are not defined under generally accepted accounting principles in the United States, or GAAP, including Adjusted EBITDA, Adjusted EBITDA Margin, levered free cash flow, and annualized revenue and annualized Adjusted EBITDA.

Adjusted EBITDA is defined as earnings from continuing operations before interest, income taxes, depreciation, and amortization (“EBITDA”), adjusted to exclude acquisition-related transaction costs, losses on extinguishment of debt, stock-based compensation, unrealized foreign currency translation gains on an intercompany loan, and impairment of cost method investment. Adjusted EBITDA Margin is defined as Adjusted EBITDA divided by revenue. Levered free cash flow is defined as net cash flows provided by operating activities minus purchases of property and equipment, net of stimulus grant. These measures are not measurements of our financial performance under GAAP and should not be considered in isolation or as alternatives to net income, net cash flows provided by operating activities, total net cash flows or any other performance measures derived in accordance with GAAP or as alternatives to net cash flows from operating activities or total net cash flows as measures of our liquidity.

We use these measures to evaluate our operating performance and liquidity, and they are among the primary measures used by management for planning and forecasting future periods. We believe the presentation of these measures is relevant and useful for investors because they allow investors to view results in a manner similar to the method used by management and make it easier to compare 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 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 the quantitative and qualitative information, are also utilized by management and our Compensation Committee for purposes of determining bonus payments to employees.

 

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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 of operations and operating cash flows 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;

 

   

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.

Levered free cash flow 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, while it does include cash interest, levered free cash flow:

 

   

does not reflect principal payments on debt;

 

   

does not reflect principal payments on capital lease obligations;

 

   

does not reflect any dividend payments, if any; and

 

   

does not reflect the cost of acquisitions.

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

Because we have acquired numerous entities since our inception and incurred transaction costs in connection with each acquisition, borrowed money in order to finance our operations and acquisitions, and used capital and intangible assets in our business, and because the payment of income taxes is necessary if we generate taxable income after the utilization of our net operating loss carryforwards, any measure that excludes these items has material limitations. As a result of these limitations, these measures should not be considered as a measure of discretionary cash available to us to invest in the growth of our business or as a measure of our liquidity. See “Summary Consolidated Financial Information and Other Data” for a quantitative reconciliation of Adjusted EBITDA to net income/(loss) and for a quantitative reconciliation of levered free cash flow to net cash flows provided by operating activities.

Annualized revenue and annualized Adjusted EBITDA are derived by multiplying the total revenue and Adjusted EBITDA, respectively, for the most recent quarterly period by four. Our computations of annualized revenue and annualized Adjusted EBITDA may not be representative of our actual annual results.

 

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PROSPECTUS SUMMARY

This summary highlights some of the information contained in this prospectus. This summary may not contain all of the information that may be important to you. For a more complete understanding of our business and this offering, we encourage you to read this entire prospectus, including “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the more detailed information regarding our Company and the common stock being sold in this offering, as well as our consolidated financial statements and the related notes appearing elsewhere in this prospectus, before deciding to invest in our common stock. Some of the statements in this prospectus constitute forward-looking statements. See “Forward-Looking Statements.”

A chart summarizing our corporate structure is on page 8 of this prospectus. Prior to the Restructuring (as described below under “—Restructuring”) and the consummation of this offering, Zayo Group Holdings, Inc. was a direct, wholly owned subsidiary of Communications Infrastructure Investments, LLC (“CII”). Unless the context otherwise requires, “we,” “us,” “our” and the “Company” refers to Zayo Group Holdings, Inc. and its consolidated subsidiaries, including Zayo Group, LLC (“ZGL”).

Our industry uses many terms and acronyms that may not be familiar to you. To assist you in reading this prospectus, we have provided definitions of some of these terms in the “Glossary of Terms” beginning on page G-1 of this prospectus.

OVERVIEW

We are one of the largest providers of bandwidth infrastructure in the United States and Europe. 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 and IP connectivity 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 datacenter facilities. Our fiber networks and datacenter 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. As of March 31, 2014, we had more than $4.3 billion in revenue under contract with a weighted average remaining contract term of 42 months. We operate our business with a unique focus on capital allocation and financial performance with the ultimate goal of maximizing equity value for our stockholders. Our core values center on partnership, alignment, and transparency with our three primary constituent groups—employees, customers, and stockholders. For the quarter ended March 31, 2014, we generated annualized revenue of $1,139 million and annualized Adjusted EBITDA of $662 million. See “Non-GAAP Financial Measures” and “Summary Consolidated Financial Information and Other Data” for a reconciliation of Adjusted EBITDA to net income (loss).

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 demand for bandwidth infrastructure, and to be an active participant in the consolidation of the industry. The growth of cloud-based computing, video, mobile and social media applications, machine-to-machine connectivity, and other bandwidth-intensive applications continues to drive rapidly increasing consumption of bandwidth on a global basis. Cisco estimates that, from 2013 to 2018, mobile data traffic will grow at an annual rate of 50% and that metro IP traffic will grow at an annual rate of 28% through 2017. Additionally, according to Gartner in its November 18, 2013 report, Forecast: The Internet of Things, Worldwide, 2013, “[t]he installed base of ‘things,’ excluding PCs,

 

 

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tablets and smartphones, will grow to 26 billion units in 2020, which is almost a 30-fold increase from 0.9 billion units in 2009.” As an early believer in the enduring nature of these trends, we assembled our asset base and built a business model specifically to provide high-bandwidth connectivity to customers whose businesses depend most on the continuous and growing demand for bandwidth. As a core tenet of our strategy for capitalizing on these industry trends, we have been a leading consolidator in the industry and have acquired 30 bandwidth infrastructure businesses and assets through June 30, 2014. Our owned, secure, and redundant fiber network and datacenters serve as the foundation for our bandwidth solutions and allow us to offer customers both physical infrastructure and lit services. We believe the continuous demand for additional bandwidth from service providers, enterprises and consumers, combined with our unique and dense metro, regional, and long-haul networks, position us as a mission-critical infrastructure supplier to the largest users of bandwidth.

Our network footprint includes both large and small metro geographies, the extended suburban regions of many cities, and the large rural, national and international links that connect our metro networks. We believe that our network assets would be difficult to replicate given the geographic reach, network density, and capital investment required. As of March 31, 2014, our fiber networks spanned over 77,000 route miles and 5,700,000 fiber miles (representing an average of 74 fibers per route), served 297 geographic markets in the United States and Europe, and connected to 14,490 buildings, including 3,838 cellular towers and 527 datacenters. We own fiber networks in almost 300 metro markets, including large metro areas, such as New York, Chicago, San Francisco, and London, as well as smaller metro areas, such as Allentown, Pennsylvania, Fargo, North Dakota, and Spokane, Washington. Our networks allow us to provide our high-bandwidth infrastructure services to our customers over redundant fiber facilities between key customer locations. As of March 31, 2014, we owned over 93% of our fiber miles, the remainder of which were operated by us under long-term IRU contracts with an average remaining contract term of 9 years. We believe our ownership and the location and density of our expansive network footprint allow us to more competitively service our target customers’ bandwidth infrastructure needs at the local, regional, national, and international level relative to other regional bandwidth infrastructure service providers or long-haul carriers. We also provide our network-neutral colocation and interconnection services utilizing our own datacenters located within major carrier hotels and other strategic buildings in 27 locations throughout the United States and, as of March 31, 2014, operate more than 200,000 square feet of billable colocation space.

The density and geographic reach of our network footprint allow us to provide tailored bandwidth infrastructure solutions on our own network (“on-net”) that address the current and future bandwidth needs of our customers. Our dense metro and regional networks have high fiber counts that enable us to provide both our physical infrastructure services (e.g., dark fiber) and our lit services (e.g., wavelengths and Ethernet). Our networks are deep and scalable, meaning we have spare fiber, conduit access and/or aerial overlash rights that allow us to continue to add capacity to our network as our existing and new customers’ demand for our services increases. In addition, many of our core network technologies provide capacity through which we can continue to add wavelengths to our network without consuming additional fiber. We also believe the density and diversity of our networks provide a strong and growing competitive barrier to protect our existing revenue base. We believe our networks provide significant opportunity to organically connect to new customer locations, datacenters, towers, or small cell locations to help us achieve an attractive return on our capital deployed. Since our founding, we have assembled a large portfolio of fiber networks and colocation assets through both acquisitions and customer demand-driven investments in property and equipment. From our inception through June 30, 2014, we have completed acquisitions with an aggregate purchase consideration, net of cash acquired, totaling approximately $3.7 billion. For the period from July 1, 2012 through March 31, 2014, we also invested an additional $598 million in capital expenditures primarily to expand the reach and capacity of our networks.

Our business model focuses on providing on-net bandwidth infrastructure solutions to our customers, which results in what we refer to as “infrastructure economics.” Infrastructure economics are characterized by attractive revenue visibility, strong Adjusted EBITDA margins coupled with operating leverage for new revenue, success-based capital investments with low maintenance capital needs, and the ability to generate significant cash flow

 

 

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over time. For the nine month period ended March 31, 2014, over 98% of our revenue was recurring in nature with a weighted average remaining contract term of over 42 months. Our Adjusted EBITDA margin for the quarter ended March 31, 2014 was 58% due to our infrastructure-based, on-net strategy. Additionally, our Adjusted EBITDA margin on incremental revenue is approximately 70%, highlighting the operating leverage we achieve through our asset base and on-net focus. See “Non-GAAP Financial Measures.” Our capital expenditure program is predominantly success-based, meaning that before we commit resources to expand our network, we have a signed customer contract that will provide us with an attractive return on the required capital. For the nine month period ended March 31, 2014, 77% of our total capital expenditures of $266 million were success-based, with customers providing up-front cash payments of $113 million, largely used to finance our network expansion. After committing capital to connect additional customer sites, our goal is to sell additional high-bandwidth connectivity on these new routes at a relatively low incremental cost, which further enhances the return we extract from our asset base. Finally, the combination of our scale and infrastructure economics results in the ability to generate meaningful free cash flow over time. For the nine month period ended March 31, 2014, we generated $135 million of levered free cash flow. See “Non-GAAP Financial Measures” and “Summary Consolidated Financial Information and Other Data” for a reconciliation of levered free cash flow to net cash flows provided by operating activities.

Our management is intensely focused on creating equity value for our stockholders. Our equity value creation philosophy includes regular and rigorous financial and operational measurement, financial transparency (both internally and externally), and clear alignment of interests among employees, management, and stockholders. Our real-time measurement and reporting system serves as the foundation for our decision making and our extensive financial and operational disclosure. We also believe in fostering an entrepreneurial culture that aligns the interests of our employees, management, and stockholders. Following this offering, assuming an initial public offering price at the midpoint of the estimated price range set forth on the cover of this prospectus, our management and employees are expected to own     % of our shares. Additionally, following our initial public offering, most employees are expected to have a significant portion of their performance-based compensation paid in restricted stock that will be tied directly to the level of equity value created.

OUR COMPANY

We provide high-bandwidth infrastructure services over our extensive metro, regional, and long-haul fiber networks and through our interconnect-oriented datacenter facilities. We focus on customers who are very large consumers of bandwidth, including wireless and wireline carriers, media companies, Internet companies, governments, and very large enterprises. We provide two major types of products and services, which form the basis for our primary operating segments: Physical Infrastructure and Lit Services. Across our Physical Infrastructure and Lit Services units, we operate seven individual Strategic Product Groups. Each Strategic Product Group has financial accountability and decision-making authority, which promotes agility in the fast-moving markets we serve.

Physical Infrastructure.    Through our Physical Infrastructure segment, we provide raw bandwidth infrastructure to customers that require more control of their internal networks. These services include dark fiber, mobile infrastructure (fiber-to-the-tower and small cell), and colocation and interconnection. 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. Our datacenters offer colocation and interconnection services to our customers, who then house and power their computing and networking equipment for the purpose of aggregating and distributing data, voice, Internet, and video traffic. The contract terms in our Physical Infrastructure segment tend to range from three to twenty years.

Lit Services.    Our Lit Services segment provides bandwidth infrastructure solutions over our metro, regional, and long-haul fiber networks where we use optronics to light the fiber and our customers pay us for access based

 

 

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on the amount and type of bandwidth they purchase. Our lit services include wavelength, Ethernet, IP, and SONET services. We target customers who require a minimum of 10G of bandwidth across their networks. The contract terms in this segment typically range from two to five years.

We also have an Other segment currently comprised of our eighth Strategic Product Group, Zayo Professional Services (“ZPS”). ZPS is our professional services business that provides network management and technical resources to our customers.

Our sales force of approximately 120 quota bearing representatives serves all of our Strategic Product Groups and is organized by customer. Our average sales representative generated approximately $15,000 of new monthly recurring revenue per month during the quarter ended March 31, 2014. Our sales force compensation includes both a base salary and a commission component. The commission plan is based on the net present value (“NPV”) of the total contract value sold less the required capital and certain operating expenses, which we believe aligns our sales force with the corporate objective of maximizing equity value created. We have recently launched a new on-line portal, “Tranzact,” which is designed to provide our sales people and customers the opportunity to evaluate and purchase bandwidth infrastructure services on demand using an integrated platform.

We utilize an integrated, custom-built cloud-based operating and reporting platform that is used universally across our Company. This system provides management the ability to monitor business activities, including quoting new business, order processing, installation planning, billing, and customer service. We believe our platform provides us a competitive advantage as it enables us to spot emerging trends in our business, constantly monitor the underlying economics of our contracts and capital plan, and provide our customers with commercial solutions and high-quality, responsive customer service. Each of the companies we acquire is rapidly integrated into our platform, which improves efficiency and helps drive the realization of cost synergies.

OUR MISSION STATEMENT

Our mission is to be the premier provider of bandwidth infrastructure services in the United States, Europe, and beyond for years and decades to come. We seek to accomplish this goal through our steadfast commitment to:

 

   

Our Employees:    Provide an environment where we are the employer of choice for highly skilled, entrepreneurial employees who want to build their careers in the transformational technology space while being key contributors to a winning organization.

 

   

Our Customers:    Provide exceptional performance for customers, starting with the best purchasing and solution design experience and continuing through service activation, billing, and service management, thereby earning the role of trusted advisor and strategic partner.

 

   

Our Services:    Offer innovative physical infrastructure (fiber, space and power, and mobile infrastructure) and lit services (Wavelengths, Ethernet, IP, and SONET) to customers who most depend on bandwidth for their business activities.

 

   

Our Network:    Develop and manage network and colocation assets, the strategic underpinnings of our service offerings, through investments and acquisitions.

 

   

Our Stockholders:    Deliver exceptional results to our stockholders supported by transparent and consistent measurement and disclosure of business performance, and a compensation philosophy that aligns the interests of management and employees with those of stockholders.

 

 

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OUR BUSINESS STRATEGY

In pursuit of our mission, our Business Strategy includes the following key elements:

 

   

Focus on Bandwidth Infrastructure.    We expect that bandwidth needs for mobile applications, cloud-based computing, and machine-to-machine connectivity will continue to grow with the continued adoption of bandwidth-intensive devices, as well as the escalating demand for Internet-delivered video. We focus on providing high-bandwidth infrastructure solutions, which we see as essential in the consumption and delivery of bandwidth-intensive applications and services by enterprise customers and communications service providers. We believe our disciplined approach to providing these critical services to our targeted customers enables us to offer a high level of customer service, while at the same time being responsive to changes in the marketplace.

 

   

Target Large Consumers of Bandwidth.    Our asset base and product suite are geared for large consumers of bandwidth with high connectivity requirements. The majority of our customers require more than 10G of bandwidth; many of our customers require multiple terabytes of bandwidth. Our revenue base is generally characterized by customers with a high bandwidth spend, consisting of a large number of individual services and increasing bandwidth infrastructure service demand. Tailoring our operations around these products, services and customers allows us to operate efficiently and meet these large consumers’ requirements for mission-critical infrastructure.

 

   

Leverage Our Extensive Asset Base by Selling Services on Our Network.    Targeting our sales efforts on services that utilize our existing fiber networks and datacenters enables us to limit our reliance on third-party service providers. We believe this in turn produces high incremental margins, which helps us expand consolidated margins, achieve attractive returns on the capital we invest, and realize significant levered free cash flow. We also believe this enables us to provide our customers with a superior level of customer service due to the relative ease in responding to customer service inquiries over one contiguous fiber network. Our existing networks enable us to sell additional bandwidth to our existing customers as their capacity needs grow.

 

   

Continue to Expand Our Infrastructure Assets.    Our ability to rapidly add network capacity to meet the growing requirements of our customers is an important component of our value proposition. We will continue to seek opportunities to expand our network footprint where supporting customer contracts provide an attractive return on our investment. The expansion of our network footprint also provides the ancillary benefit of bringing other potential customer locations within reach. We design our networks with additional capacity so that increasing bandwidth capacity can be deployed economically and efficiently. A significant portion of our capital expenditures are success-based.

 

   

Leverage our Existing Relationships and Assets to Innovate.    We believe we possess a unique set of assets and management systems designed to deliver customer solutions tailored to specific trends we observe in the marketplace. Our high-energy, entrepreneurial culture fosters employee innovation on an ongoing basis in response to specific customer requirements. Furthermore, we plan to continue to commit capital to new lines of infrastructure businesses that leverage our existing assets. For example, we are expanding into small cell infrastructure services provided to wireless services providers. These services entail Zayo providing dark fiber and related services from a small cell location back to a mobile switching center. We provide the fiber-based transport over our existing and/or newly constructed fiber networks. In addition, we provide network-neutral space and power for wireless service providers to co-locate their small cell antennas and ancillary equipment.

 

   

Intelligently Expand Through Acquisitions.    We have made 30 acquisitions through June 30, 2014 for an aggregate purchase price, net of cash, of $3.7 billion, and associated with these acquisitions, we have

 

 

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acquired approximately $385 million of Adjusted EBITDA based on the quarter prior to each acquisition’s close annualized. See “Business—Business Strategy” for an explanation of acquired Adjusted EBITDA. We believe we have consistently demonstrated an ability to acquire and effectively integrate companies, realize cost synergies, and organically grow revenue and Adjusted EBITDA post-acquisition. Acquisitions have the ability to increase the scale of our operations, which in turn affords us the ability to expand our operating leverage, extend our network reach, and broaden our customer base. Through June 30, 2014, we have identified and planned, although not fully realized, cost synergies representing over $155 million in annual recurring cost savings. We believe our ability to realize significant cost synergies through acquisitions provides us with a competitive advantage in future consolidation opportunities within our industry. See “Business—Business Strategy” for an explanation of planned cost synergies. We will continue to evaluate potential acquisition opportunities and are regularly involved in acquisition discussions. We will evaluate these opportunities based on a number of criteria, including the quality of the infrastructure assets, the fit within our existing businesses, the opportunity to expand our network, and the opportunity to create value through the realization of cost synergies.

OUR COMPETITIVE STRENGTHS

We believe the following are among our core competitive strengths and enable us to differentiate ourselves in the markets we serve:

 

   

Unique Bandwidth Infrastructure Assets.    We believe replicating our extensive metro, regional, and long-haul fiber assets would be difficult given the significant capital, time, permitting, and expertise required. As of March 31, 2014, our fiber spanned over 77,000 route miles and 5,700,000 fiber miles (representing an average of 74 fibers per route), served 297 geographic markets in the United States and Europe, and connected to 14,490 buildings. The majority of the markets that we serve and buildings to which we connect have few other networks capable of providing similar high-bandwidth infrastructure and connectivity solutions, which we believe provides us with a sustainable competitive advantage in these markets, and positions us as a mission-critical infrastructure supplier to the largest users of bandwidth. We believe that the vast majority of customers using our network, including our lit bandwidth, fiber-to-the-tower, and dark fiber customers, choose our services due to the quality and reach of our network, and the ability our network gives us to innovate and scale with their growing bandwidth needs. Additionally, we operate 27 datacenter facilities, including in eight of the most important carrier hotels in the U.S. This collective presence, combined with our high network density, creates a network effect that helps us retain existing customers and attract new customers. We believe the uniqueness of our network and our focus on investment in infrastructure assets provides us with the ability to enhance our high Adjusted EBITDA margin profile. From July 1, 2012 through March 31, 2014, exclusive of acquisitions, we have invested $598 million of capital in our networks, including expansion and maintenance expenditures.

 

   

Strong Revenue Growth, Visibility, and Durability.    We have consistently grown our revenue, as gross installed revenue have exceeded churn processed in every quarter since we began reporting in March 2010. We believe our exposure to the enduring trend of increasing bandwidth consumption combined with our focused execution have allowed us to achieve this consistent growth. We typically provide our bandwidth infrastructure services for a fixed monthly recurring fee under multi-year contracts. Our contract terms range from one year to twenty years with a weighted average contract term of approximately 72 months for contracts entered into during the twelve months ended March 31, 2014. As of March 31, 2014, we had more than $4.3 billion in revenue under contract with a weighted average remaining contract life of 42 months. Our customers use our bandwidth infrastructure to support their mission-critical networks and applications. The switching costs and effort required to replace our services can be high, particularly for the services within our Physical Infrastructure segment, given the criticality of our services and the potential cost and disruption. We believe that increasing bandwidth needs combined with the mission-critical nature of our services provided under multi-year contracts create

 

 

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strong revenue growth, visibility, and durability, which support our decision-making abilities and financial stability.

 

   

Customer Service and Ability to Innovate for Our Customers.    Our sales and product professionals work closely with potential and existing customers to design tailored high-bandwidth connectivity solutions across our eight Strategic Product Groups, spanning physical infrastructure and lit and professional service solutions, to meet specific, varying, and evolving customer needs. We are focused on delivering high-quality, reliable service to our customers. We do this by leveraging our contiguous network to expand with our customers as they seek to build scale, coverage, and/or performance. Additionally, our focus on serving the largest and most sophisticated users of bandwidth keeps our sales, engineering, and service organizations attuned to the latest technologies, architectures, and solutions that our customers may seek to implement. We believe our willingness to innovate for our customers and our dedication to customer service help establish our position as an important infrastructure supplier and help us attract new customers and businesses, sell an increasing amount of services to our existing customers, and reduce customer turnover. From March 31, 2013 through March 31, 2014, existing customers accounted for over 85% of newly installed monthly recurring revenue.

 

   

Strategic, Operational and Financial Transparency Excellence.    As part of our strategy to serve the largest users of bandwidth, we have completed and integrated 30 acquisitions through June 30, 2014. Our acquired assets have been combined to create a contiguous network with the ability to provision and maintain local, regional, national, or international high-bandwidth connections across our eight Strategic Product Groups. Our entire network, sales and churn activity, installation pipeline, NPV commission plans, and all customer contracts are managed through an integrated operating and reporting platform, which gives management strong visibility into the business and improves our ability to drive return-maximizing decisions throughout the organization. We believe this approach creates efficiency, as evidenced by identified and planned, though not fully realized to date, cost synergies representing over $155 million in annual recurring cost savings from our 30 acquisitions through June 30, 2014. We also believe this approach allows for the integration of additional network assets whether through new builds or acquisitions. Our focus on operational and financial transparency not only allows us to be very nimble in attacking various market opportunities, but also provides us the ability to deliver disclosure that our stockholders and other stakeholders can use to accurately judge management’s performance from a capital allocation, financial, and operational perspective.

 

   

Financially Focused and Entrepreneurial Culture.    Virtually all operational and financial decisions we make are driven by the standard of maximizing the value of our enterprise. Our sales commission plans use an NPV-based approach with the goal of encouraging the proper behavior within our sales force, and our eight Strategic Product Groups are held to group level equity internal rate of return (“IRR”) targets set by management. Additionally, to align individual behaviors with stockholder objectives, equity compensation is used throughout the Company, and our compensation plans include a larger equity component than we believe is standard in our industry. We expect that our employees will own     % of our outstanding shares following this offering, assuming an initial public offering price at the midpoint of the estimated price range set forth on the cover of this prospectus, which we believe is a significantly higher percentage than other public peers. In addition to striving for industry-leading operational and growth outcomes to drive value creation, we are prepared to use debt capacity to enhance stockholder returns, but not at the expense of other stakeholders and only at levels we believe are in the long-term interests of the Company, our customers, and our stockholders. Finally, our owners’ manual, mission statement, and investor transparency all serve to enhance cultural alignment across the Company and our stockholders.

 

   

Experienced Management with Unique Leadership Approach.    We have assembled an experienced management team that we believe is well-qualified to lead our company and execute our strategy. Our

 

 

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management team has substantial industry experience in managing and designing fiber networks and network-neutral colocation and interconnection facilities and in selling and marketing bandwidth infrastructure services. In addition, our management team has significant experience in acquiring and integrating bandwidth infrastructure and assets. Our management team is a cohesive unit with a common history that in many cases precedes the Company’s founding. We also believe that our approach to leadership—operationally, financially, culturally—is unique in our industry and differentiates us from our competitors.

RESTRUCTURING

Prior to this offering, we will engage in a reorganization involving our parent company, CII, as a result of which                  shares of our common stock (after giving effect to a             :1 stock split) will be distributed to the members of CII in accordance with their distribution rights under the existing operating agreement of CII, and              shares of our common stock will be retained to be subsequently distributed to the members of CII following resolution of contingent distributions among the members of CII. We refer to these transactions as our “Restructuring.”

CORPORATE INFORMATION

Our principal executive office is located at 1805 29th Street, Suite 2050, Boulder, Colorado 80301. Our telephone number at that address is (303) 381-4683. Our website address is www.zayo.com. Information on our website is deemed not to be a part of this prospectus.

A simplified summary of our corporate structure following this offering appears below.

 

LOGO

We are a Delaware corporation formed in 2007, and as of March 31, 2014, we had 1,421 employees. Our fiscal year ends June 30 each year, and we refer to the fiscal year ending June 30, 2014 as “Fiscal 2014,” the fiscal year ended June 30, 2013 as “Fiscal 2013,” the fiscal year ended June 30, 2012 as “Fiscal 2012,” and the fiscal year ended June 30, 2011 as “Fiscal 2011.”

RISKS TO CONSIDER

We are subject to a number of risks, including risks that may prevent us from achieving our business objectives or that may adversely affect our business, financial condition, results of operations, cash flows, and prospects. You should carefully consider the following risks, including the risks discussed in the section entitled “Risk Factors,” before investing in our common stock:

 

   

We have consistently generated net losses since our inception and expect such losses to continue for at least several years.

 

 

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Since our inception, we have used more cash than we have generated from operations, and we may continue to do so.

 

   

We are highly dependent on our management team and other key employees, many of whom own equity that has been illiquid but will become liquid as a result of this offering.

 

   

Our revenue is relatively concentrated among a small number of customers, and the loss of any of these customers could significantly harm our business, financial condition, results of operations, and cash flows.

 

   

Future acquisitions are a component of our strategic plan, and will include integration and other risks that could harm our business.

 

   

We are growing rapidly and might not efficiently manage our growth.

 

   

Any failure of our physical infrastructure or services could lead to significant costs and disruptions.

 

   

We use franchises, licenses, permits, rights-of-way, conduit leases, fiber agreements, and property leases, which could be canceled or not renewed.

 

   

We are required to maintain, repair, upgrade, and replace our network and our facilities, the cost of which could materially impact our results and our failure to do so could irreparably harm our business.

 

   

Our debt level could negatively impact our financial condition, results of operations, cash flows, and business prospects and could prevent us from fulfilling our obligations under our outstanding indebtedness. In the future, we may incur substantially more indebtedness, which could further increase the risks associated with our leverage.

 

   

Our debt agreements contain restrictions on our ability to operate our business and to pursue our business strategies, and our failure to comply with these covenants could result in an acceleration of our indebtedness.

 

   

Our future tax liabilities are not predictable or controllable. If we become subject to increased levels of taxation, our financial condition and operations could be negatively impacted.

 

   

The international operations of our business expose us to risks that could materially and adversely affect the business.

 

   

We may be vulnerable to security breaches that could disrupt our operations and adversely affect our business and operations.

 

 

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THE OFFERING

 

Total common stock offered

            shares

 

Common stock offered by us

            shares

 

Common stock offered by the selling stockholders

            shares

 

Option to purchase additional shares

            shares

 

Common stock to be outstanding immediately after this offering

            shares

 

Use of proceeds

We estimate that the net proceeds to us from this offering, after deducting the underwriting discount and estimated offering expenses payable by us, will be approximately $         million, assuming the shares are offered at $         per share (the midpoint of the estimated price range set forth on the cover of this prospectus).

 

  We will not receive any proceeds from the sale of shares by the selling stockholders.

 

  We intend to use the net proceeds from the sale of common stock by us in this offering for general corporate purposes, which may include some or all of the following: repayment of certain existing indebtedness, acquisitions, working capital, and capital expenditures, and to pay other fees and expenses incurred in connection with this offering. See “Use of Proceeds.”

 

Principal stockholders

Following the Restructuring and the completion of this offering, our five largest stockholders are expected to be: GTCR LLC, which will beneficially own approximately              shares, or     %, of our outstanding common stock, Oak Investment Partners XII, Limited Partnership, which will beneficially own approximately              shares, or     %, of our outstanding common stock, Columbia Capital, which will beneficially own approximately              shares, or     %, of our outstanding common stock, M/C Partners, which will beneficially own approximately              shares, or     %, of our outstanding common stock, and Charlesbank Capital Partners, which will beneficially own approximately             shares, or     %, of our outstanding common stock.

 

  It is expected that after this offering, CII will own approximately              shares, or     %, of our outstanding common stock, which will be distributed to the unitholders of CII subsequent to this offering. See “Restructuring.”

 

Dividend policy

We currently intend to retain all available funds and any future earnings for use in the operation of our business, and therefore we do

 

 

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not anticipate paying any cash dividends in the foreseeable future. Any future determination to pay dividends will be at the discretion of our board of directors and will depend upon our financial condition, results of operations, cash flows, capital requirements, and other factors that our board of directors deems relevant. We are a holding company, and substantially all of our operations are carried out by our subsidiary, ZGL, and its subsidiaries. ZGL’s ability to pay dividends to us is limited by its credit agreement and the indentures governing its outstanding notes, which may in turn limit our ability to pay dividends on our common stock. Our ability to pay dividends may also be restricted by the terms of any future credit agreement or any future debt or preferred securities of ours or of our subsidiaries. See “Dividend Policy.”

 

Risk factors

Investing in our common stock involves a high degree of risk. See “Risk Factors” beginning on page 15 of this prospectus for a discussion of factors you should carefully consider before deciding to invest in our common stock.

Proposed symbol for trading on

Unless otherwise indicated, all information in this prospectus relating to the number of shares of our common stock to be outstanding immediately after this offering:

 

   

excludes              shares reserved for future grants under our equity compensation plans;

 

   

assumes an initial public offering price of $         per share (the midpoint of the estimated price range set forth on the cover of this prospectus); and

 

   

assumes no exercise by the underwriters of their option to purchase up to                      additional shares from the selling stockholders.

 

 

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SUMMARY CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA

The following table summarizes our historical consolidated financial information for the periods and as of the dates indicated. The selected historical consolidated financial information as of June 30, 2012 and 2013 and for the years ended June 30, 2011, 2012 and 2013 is derived from, and qualified by reference to, our audited consolidated financial statements included elsewhere in this prospectus. The selected historical consolidated financial information as of June 30, 2011 is derived from our audited consolidated financial statements not included in this prospectus. The selected historical consolidated financial information as of March 31, 2014 and for the nine months ended March 31, 2013 and 2014 is derived from, and qualified by reference to, our unaudited consolidated financial statements included elsewhere in this prospectus. The selected historical consolidated financial information as of March 31, 2013 is derived from our unaudited consolidated financial statements not included in this prospectus. Our unaudited consolidated financial statements have been prepared on the same basis as our audited consolidated financial statements and, in our opinion, reflect all adjustments, consisting only of normal and recurring adjustments, necessary for a fair presentation of such financial statements in all material respects.

The financial data set forth in the following tables should be read in conjunction with our historical consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” each included elsewhere in this prospectus. The results for any interim period are not necessarily indicative of the results that may be expected for a full year or any future period.

 

     Year Ended June 30,     Nine Months Ended
March 31,
 
     2011     2012     2013     2013     2014  
                       (unaudited)     (unaudited)  

Consolidated Statements of Operations Data (in thousands):

          

Revenue

   $ 282,143      $ 375,526      $ 1,004,354      $ 742,647      $ 826,537   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating costs and expenses

          

Operating costs, excluding depreciation and amortization

     70,978        82,083        145,877        110,032        110,634   

Selling, general and administrative expenses, excluding stock-based compensation expenses

     88,414        112,410        318,523        233,393        234,395   

Stock-based compensation

     24,310        26,253        105,849        67,913        165,134   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selling, general and administrative expenses

     112,724        138,663        424,372        301,306        399,529   

Depreciation and amortization

     60,463        84,961        324,532        243,880        246,922   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating costs and expenses

     244,165        305,707        894,781        655,218        757,085   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     37,978        69,819        109,573        87,429        69,452   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

     (33,414     (50,720     (202,464     (164,807     (150,905

Impairment of cost method investment

            (2,248                     

Other income/(expense), net

     (126     123        326        302        1,266   

Loss on extinguishment of debt

                   (77,253     (77,253     (1,911 )  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other expenses, net

     (33,540     (52,845     (279,391     (241,758     (151,550
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings/(loss) from continuing operations before income taxes

     4,438        16,974        (169,818     (154,329     (82,098

Provision/(benefit) for income taxes

     11,329        26,871        (24,205     (33,549     27,202   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations

     (6,891     (9,897     (145,613     (120,780     (109,300

Earnings/(loss) from discontinued operations, net of income taxes

     5,331        8,673        8,396        7,488        3,655   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (1,560   $ (1,224   $ (137,217   $ (113,292   $ (105,645
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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     Year Ended June 30,     Nine Months Ended
March 31,
 
     2011     2012     2013     2013     2014  
                       (unaudited)     (unaudited)  

Consolidated Balance Sheet Data (at period end) (in thousands):

          

Cash and cash equivalents

   $ 25,394      $ 150,693      $ 91,313      $ 70,177      $ 254,607   

Property and equipment, net

     518,513        754,738        2,437,707        2,363,339        2,533,256   

Total assets

     849,396        1,442,055        4,251,240        4,166,825        4,561,816   

Long-term debt and capital lease obligations, including current portion

     365,588        701,339        2,843,872        2,850,919        2,990,241   

Total stockholder’s equity

     258,083        410,314        606,253        632,766        517,319   

Selected cash flow data (in thousands):

          

Net cash flows provided by operating
activities from continuing operations

   $ 99,502      $ 167,630      $ 404,883      $ 268,265      $ 401,321   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Purchases of property and equipment, net of stimulus grants(1)

   $ (112,524   $ (124,137   $ (323,232   $ (221,328   $ (265,872

Acquisitions

   $ (183,666   $ (351,273   $ (2,480,738   $ (2,473,675   $ (101,009

Net cash flows used in investing activities from continuing operations

   $ (296,162   $ (475,410   $ (2,803,970   $ (2,695,003   $ (366,881

Net cash flows provided by financing
activities from continuing operations

   $ 134,190      $ 433,079      $ 2,340,029      $ 2,346,803      $ 128,396   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other Financial Data and Operating Data:

          

Adjusted EBITDA (in thousands)(2)

   $ 123,490      $ 187,786      $ 554,429      $ 412,571      $ 482,619   

Levered free cash flow (in thousands)(3)

             135,449   

Customers

     986        1,292        4,091        3,910        4,276   

Total revenue under contract ($ in millions)(4)

   $ 1,098      $ 1,874      $ 3,521      $ 3,388      $ 4,363   

Weighted average remaining contract term (in months)(5)

     38        46        37        36        42   

Route miles

     24,251        46,504        75,839        74,325        77,113   

Fiber miles

     1,008,205        2,054,118        5,442,780        5,404,310        5,723,984   

On-net buildings

     4,393        6,055        12,222        11,740        14,490   

Reconciliation of Adjusted EBITDA:

          

Net loss

   $ (1,560   $ (1,224   $ (137,217   $ (113,292   $ (105,645

Earnings from discontinued operations, net of income taxes

     5,331        8,673        8,396        7,488        3,655   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss from continuing operations

     (6,891     (9,897     (145,613     (120,780     (109,300

Add back non-adjusted EBITDA items included in loss from continuing operations:

          

Depreciation and amortization

     60,463        84,961        324,532        243,880        246,922   

Interest expense

     33,414        50,720        202,464        164,807        150,905   

Provision/(benefit) for income taxes

     11,329        26,871        (24,205     (33,549     27,202   

Stock-based compensation

     24,310        26,253        105,849        67,913        165,134   

Loss on extinguishment of debt

                   77,253        77,253        1,911   

Impairment of cost method investment

            2,248                        

Unrealized foreign currency translation gains(6)

                   (55     (42     (944

Transaction costs(7)

     865        6,630        14,204        13,089        789   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

   $ 123,490      $ 187,786      $ 554,429      $ 412,571      $ 482,619   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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     Nine Months
Ended
March 31,
 
     2014  

Reconciliation of Levered Free Cash Flow (in thousands):

  

Net cash flows provided by operating activities from continuing operations

   $ 401,321   

Purchase of property and equipment, net of stimulus grant

     (265,872
  

 

 

 

Levered Free Cash Flow

   $ 135,449   
  

 

 

 

 

 

(1)    See Note 2—Basis of Presentation and Significant Accounting Policies—n. Government Grants to our audited consolidated financial statements for an explanation of our stimulus grants.

(2)    Adjusted EBITDA is not a financial measurement prepared in accordance with GAAP. We define Adjusted EBITDA as earnings from continuing operations before interest, income taxes, depreciation and amortization (“EBITDA”) adjusted to exclude acquisition-related transaction costs, losses on extinguishment of debt, stock-based compensation, unrealized foreign currency translation gains on an intercompany loan, and impairment of cost method investment. See “Non-GAAP Financial Measures.” The table above sets forth, for the periods indicated, a reconciliation of net loss to Adjusted EBITDA, as net loss is calculated in accordance with GAAP.

(3)    Levered free cash flow is not a financial measurement prepared in accordance with GAAP. We define levered free cash flow as net cash flows provided by operating activities minus purchases of property and equipment, net of stimulus grants received. See “Non-GAAP Financial Measures.” The table sets forth, for the periods indicated, a reconciliation of net cash flows provided by operating activities to levered free cash flow.

(4)    Monthly recurring revenue (“MRR”) and monthly amortized revenue (“MAR”) under contract multiplied by the remaining contract term in months as of the reporting date, with a deemed maximum original contract term of twenty years.

(5)    The weighted average remaining contract term is equal to revenue under contract divided by the sum of MRR and MAR on last day of quarter and MRR and MAR associated with cumulative gross new sales (bookings) that have not yet become gross installed revenue (have not been activated or installed), excluding intercompany sales.

(6)    Unrealized foreign currency translation gains result from the translation of an intercompany loan to a foreign subsidiary denominated in U.S. dollars to British pounds, the functional currency of the subsidiary.

(7)    Transaction costs include expenses associated with professional services (i.e., legal, accounting, regulatory, etc.) rendered in connection with signed and/or closed acquisitions, travel expense, severance expense incurred on the date of acquisition, and other direct expenses incurred that are associated with such acquisitions.

 

 

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RISK FACTORS

This offering and an investment in our common stock involve a high degree of risk. You should carefully consider the risks and uncertainties described below, together with the risks and uncertainties described elsewhere in this prospectus, including our consolidated financial statements and the related notes contained elsewhere in this prospectus, before you decide to purchase shares of our common stock. If any of the following risks or uncertainties actually occurs, our business, financial condition, results of operations, cash flow and prospects could be materially and adversely affected. As a result, the price of our common stock could decline and you could lose all or part of your investment in our common stock.

Risks Related to our Business

We have consistently generated net losses since our inception and expect such losses to continue for at least several years.

We have consistently generated net losses since our inception and expect such losses to continue for at least several years. These net losses primarily have been driven by significant depreciation, amortization, interest expense, and stock-based compensation. During the nine months ended March 31, 2014, we had depreciation and amortization expense of $246.9 million and interest expense of $150.9 million. At March 31, 2014, we had $2,990.2 million of total debt (including capital leases). We cannot assure you that we will generate net income in the future.

Since our inception, we have used more cash than we have generated from operations, and we may continue to do so.

Since our inception, we have consistently consumed our entire positive cash flow generated from operating activities with our investing activities. Our investing activities have consisted principally of the acquisition of businesses as well as material additions to property and equipment. We have funded the excess of cash used in investing activities over cash provided by operating activities with proceeds from equity contributions and debt issuances.

We intend to continue to invest in expanding our fiber network and our business and pursuing acquisitions that we believe provide an attractive return on our capital. These investments may continue to exceed the amount of capital available from operations after debt service requirements. To the extent that our investments exceed our cash flow from operations, we plan to rely on potential future debt or equity issuances, which could increase interest expense or dilute your interest as a stockholder, as well as cash on hand and borrowings under our revolving credit facility. We cannot assure you, however, that we will be able to obtain or continue to have access to sufficient capital to successfully grow our business.

We are highly dependent on our management team and other key employees, many of whom own equity that has been illiquid but will become liquid as a result of this offering.

We expect that our continued success will largely depend upon the efforts and abilities of members of our management team and other key employees. Our success also depends upon our ability to identify, attract, develop, and retain qualified employees. None of the executive management team except for Mr. Caruso is bound by an employment agreement with us. If we lost members of our management team or other key employees, it would likely have a material adverse effect on our business.

All of our officers and many of our key management and employees have had a significant portion of their compensation paid in equity. Our employees, including members of our senior management, will offer a total of            shares for sale in this offering. While subject to the underwriters’ lock-up agreement and other restrictions on trading (including continued vesting), a substantial portion of management and employee equity will be vested at the time of this offering and is expected to become tradable after the expiration of the 180-day

 

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lock-up agreement with the underwriters. This liquidity will in many cases represent material wealth of our officers and key management employees that may impact retention and focus of existing key employees.

Our revenue is relatively concentrated among a small number of customers, and the loss of any of these customers could significantly harm our business, financial condition, results of operations, and cash flows.

Our largest single customer accounted for approximately 7% of our revenue during the year ended June 30, 2013, and total revenues from our top ten customers accounted for approximately 30% of our revenue during the year ended June 30, 2013. We currently depend, and expect to continue to depend, upon a relatively small number of customers for a significant percentage of our revenue. Many of these customers are also competitors for some or all of our service offerings. Our customer contracts typically have terms of one to twenty years. Our customers may elect not to renew these contracts. Furthermore, our customer contracts are terminable for cause if we breach a material provision of the contract. We may face increased competition and pricing pressure as our customer contracts become subject to renewal. Our customers may negotiate renewal of their contracts at lower rates, for fewer services or for shorter terms. If we are unable to successfully renew our customer contracts on commercially acceptable terms, or if our customer contracts are terminated, our business could suffer.

We are also subject to credit risk associated with the concentration of our accounts receivable from our key customers. If one or more of these customers were to become bankrupt, insolvent or otherwise were unable to pay for the services provided by us, we may incur significant write-offs of accounts receivable or incur impairment charges.

We have numerous customer orders for connections, including contracts with multiple national wireless carriers to build out additional towers. If we are unable to satisfy new orders or build our network according to contractually specified deadlines, we may incur penalties or suffer the loss of revenue.

Future acquisitions are a component of our strategic plan, and will include integration and other risks that could harm our business.

We intend to continue to acquire complementary businesses and assets, and some of these acquisitions may be large or in new geographic areas where we do not currently operate. This exposes us to the risk that when we evaluate a potential acquisition target we over-estimate the target’s value and, as a result, pay too much for it. We also cannot be certain that we will be able to successfully integrate acquired assets or the operations of the acquired entity with our existing operations. We may engage in large acquisitions, which could be much more difficult to integrate. Difficulties with integration could cause material customer disruption and dissatisfaction, which could in turn increase churn and reduce new sales. Additionally, we may not be able to integrate acquired businesses in a manner that permits us to realize the cost synergies we anticipate in the time, manner, or amount we currently expect, or at all. Our actual cost synergies, cost savings, growth opportunities, and efficiency and operational benefits resulting from any acquisition may be lower and may take longer to realize than we currently expect.

We may incur additional debt or issue additional equity to assist in the funding of these potential transactions, which may increase our leverage and/or dilute your interest as a stockholder. Further, additional transactions could cause disruption of our ongoing business and divert management’s attention from the management of daily operations to the closing and integration of the acquired business. Acquisitions also involve other operational and financial risks such as:

 

   

increased demand on our existing employees and management related to the increase in the size of the business and the possible distraction from our existing business due to the acquisition;

 

   

loss of key employees and salespeople of the acquired business;

 

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liabilities of the acquired business, both unknown and known at the time of the consummation of the acquisition;

 

   

discovery that the financial statements we relied on to buy a business were incorrect;

 

   

expenses associated with the integration of the operations of the acquired business;

 

   

the possibility of future impairment, write-downs of goodwill and other intangibles associated with the acquired business;

 

   

finding that the services and operations of the acquired business do not meet the level of quality of those of our existing services and operations; and

 

   

recognizing that the internal controls of the acquired business were inadequate.

We are growing rapidly and might not efficiently manage our growth.

We have rapidly grown our company through acquisitions of companies and assets as well as expansion of our own network and the acquisition of new customers through our own sales efforts. We intend to continue to rapidly grow our company, including through acquisitions, some of which may be large. Our expansion may place strains on our management and our operational and financial infrastructure. Our ability to manage our growth will be particularly dependent upon our ability to:

 

   

expand, develop, and retain an effective sales force and other qualified personnel;

 

   

maintain the quality of our operations and our service offerings;

 

   

maintain and enhance our system of internal controls to ensure timely and accurate reporting; and

 

   

expand our operational information systems in order to support our growth.

Service level agreements in our customer agreements could subject us to liability or the loss of revenue.

Our contracts with customers typically contain service guarantees (including network availability) and service delivery date targets, which could enable customers to claim credits and, under certain conditions, terminate their agreements. Our inability to meet our service level guarantees could adversely affect our revenue. While we typically have carve-outs for force majeure events, many events, such as fiber cuts, equipment failure and third-party vendors being unable to meet their underlying commitments with us, could impact our ability to meet our service level agreements.

Any failure of our physical infrastructure or services could lead to significant costs and disruptions.

Our business depends on providing customers with highly reliable service. The services we provide are subject to failure resulting from numerous factors, including:

 

   

human error;

 

   

power loss;

 

   

improper building maintenance by the landlords of the buildings in which our datacenters are located;

 

   

physical or electronic security breaches;

 

   

fire, earthquake, hurricane, flood, and other natural disasters;

 

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water damage;

 

   

the effect of war, terrorism, and any related conflicts or similar events worldwide; and

 

   

sabotage and vandalism.

Problems within our network or our datacenters, whether within our control or the control of our landlords or other third-party providers, could result in service interruptions or equipment damage. In the past, we have experienced disruptions in our network attributed to equipment failure and power outages. Although such disruptions have been remedied and the network has been stabilized, there can be no assurance that similar disruptions will not occur in the future. Given the service level agreement obligations we typically have in our customer contracts, such disruptions could result in customer credits; however, we cannot assume that our customers will accept these credits as compensation in the future, and we may face additional liability.

We use franchises, licenses, permits, rights-of-way, conduit leases, fiber agreements, and property leases, which could be canceled or not renewed.

We must maintain rights-of-way, franchises, and other permits from railroads, utilities, state highway authorities, local governments, transit authorities, and others to operate our owned fiber network. We cannot be certain that we will be successful in maintaining these rights-of-way agreements or obtaining future agreements on acceptable terms. Some of these agreements are short-term or revocable at will, and we cannot assure you that we will continue to have access to existing rights-of-way after they have expired or terminated. If a material portion of these agreements are terminated or are not renewed, we might be forced to abandon our networks. In order to operate our networks, we must also maintain fiber leases and IRU agreements that we have with public and private entities. There is no assurance that we will be able to renew those fiber routes on favorable terms, or at all. If we are unable to renew those fiber routes on favorable terms, we may fact increased costs or reduced revenues.

In order to expand our network to new locations, we often need to obtain additional rights-of-way, franchises, and other permits. Our failure to obtain these rights in a prompt and cost-effective manner may prevent us from expanding our network, which may be necessary to meet our contractual obligations to our customers and could expose us to liabilities.

If we lose or are unable to renew key real property leases where we have located our POPs, it could adversely affect our services and increase our costs, as we would be required to restructure our network and move our POPs.

We are required to maintain, repair, upgrade, and replace our network and our facilities, the cost of which could materially impact our results and our failure to do so could irreparably harm our business.

Our business requires that we maintain, repair, upgrade, and periodically replace our facilities and networks. This requires management time and capital expenditures. In the event that we fail to maintain, repair, upgrade, or replace essential portions of our network or facilities, it could lead to a material degradation in the level of service that we provide to our customers. Our networks can be damaged in a number of ways, including by other parties engaged in construction close to our network facilities. In the event of such damage, we will be required to incur expenses to repair the network. We could be subject to significant network repair and replacement expenses in the event a terrorist attack or a natural disaster damages our network. Further, the operation of our network requires the coordination and integration of sophisticated and highly specialized hardware and software. Our failure to maintain or properly operate this can lead to degradations or interruptions in customer service. Our failure to provide proper customer service could result in claims from our customers, early termination of contracts, and damage our reputation.

 

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Our debt level could negatively impact our financial condition, results of operations, cash flows, and business prospects and could prevent us from fulfilling our obligations under our outstanding indebtedness. In the future, we may incur substantially more indebtedness, which could further increase the risks associated with our leverage.

As of March 31, 2014, our total debt (including capital lease obligations) was $2,990.2 million, primarily consisting of ZGL’s $750.0 million of 8.125% Senior Secured Notes due 2020 (the “Senior Secured Notes”) and $500.0 million of 10.125% Senior Unsecured Notes due 2020 (together with the Senior Secured Notes, the “Notes”), its $1,720.7 million senior secured term loan facility (the “Term Loan Facility”) and $19.5 million in capital lease obligations. In addition, ZGL has a $250.0 million senior secured revolving credit facility (the “Revolver,” and collectively with the Term Loan Facility, the “Credit Facilities”), of which $243.6 million was available at such date. Subject to the limitations set forth in the indentures (the “Indentures”) governing the Notes and the agreement governing the Credit Facilities (the “Credit Agreement”), ZGL may incur additional indebtedness (including additional first lien obligations) in the future.

Our level of debt could have important consequences, including the following:

 

   

making it more difficult for us to satisfy our obligations under our debt agreements;

 

   

requiring us to dedicate a substantial portion of our cash flow from operations to required payments on debt, thereby reducing the availability of cash flow for working capital, capital expenditures, and other general business activities;

 

   

limiting our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, and general corporate and other activities;

 

   

limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

 

   

increasing our vulnerability to both general and industry-specific adverse economic conditions;

 

   

placing us at a competitive disadvantage relative to less leveraged competitors; and

 

   

preventing us from raising the funds necessary to repurchase the Notes tendered to ZGL upon the occurrence of certain changes of control, which would constitute a default under the Indentures.

We may not be able to generate enough cash flow to meet our debt obligations.

Our future cash flow may be insufficient to meet our debt obligations and commitments. Any insufficiency could negatively impact our business. A range of economic, competitive, business, regulatory, and industry factors will affect our future financial performance, and, as a result, our ability to generate cash flow from operations and to pay our debt. Many of these factors, such as economic and financial conditions in our industry and the global economy, or competitive initiatives of our competitors, are beyond our control.

If we do not generate enough cash flow from operations to satisfy our debt obligations, we may have to undertake alternative financing plans, such as:

 

   

reducing or delaying capital investments;

 

   

raising additional capital;

 

   

refinancing or restructuring our debt; and

 

   

selling assets.

 

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We cannot assure you that we would be able to implement alternative financing plans, if necessary, on commercially reasonable terms, or at all, or that implementing any such alternative financing plans would allow us to meet our debt obligations.

If ZGL is unable to meet its debt service obligations, it would be in default under the terms of the Indentures and the Credit Agreement, permitting acceleration of the amounts due on the Notes and under the Credit Agreement and eliminating our ability to draw on the Revolver. If the amounts outstanding under the Credit Facilities, the Notes, or other future indebtedness were to be accelerated, we could be forced to file for bankruptcy.

Our debt agreements contain restrictions on our ability to operate our business and to pursue our business strategies, and our failure to comply with these covenants could result in an acceleration of our indebtedness.

The Indentures and the Credit Facilities each contain, and agreements governing future debt issuances may contain, covenants that restrict ZGL’s ability to, among other things:

 

   

incur additional indebtedness and issue preferred stock;

 

   

pay dividends or make other distributions with respect to any equity interests or make certain investments or other restricted payments;

 

   

create liens;

 

   

sell or otherwise dispose of assets, including capital stock of subsidiaries;

 

   

incur restrictions on the ability of its restricted subsidiaries to pay dividends or make other payments to it;

 

   

consolidate or merge with or into other companies or transfer all, or substantially all, of its assets;

 

   

engage in transactions with affiliates;

 

   

engage in business other than telecommunications; and

 

   

enter into sale and leaseback transactions.

As a result of these covenants, we are limited in the manner in which we may conduct our business, and as a result we may be unable to engage in favorable business activities or finance future operations or capital needs. The ability to comply with some of the covenants and restrictions contained in the Credit Agreement and the Indentures may be affected by events beyond our control. If market or other economic conditions deteriorate, our ability to comply with these covenants may be impaired. A failure to comply with the covenants, ratios, or tests in the Credit Agreement, the Indentures, or any future indebtedness could result in an event of default under the Credit Facilities, the Indentures or our future indebtedness.

In addition, the Credit Facilities require ZGL to comply with specified financial ratios, including ratios regarding total leverage, secured leverage and fixed charge coverage. Our ability to comply with these ratios may be affected by events beyond our control. These restrictions limit our ability to plan for or react to market conditions, meet capital needs, or otherwise constrain our activities or business plans. They also may adversely affect our ability to finance our operations, enter into acquisitions, or engage in other business activities that would be in our interest.

A breach of any of the covenants contained in the Credit Agreement, in any future credit agreement or the Indentures or our inability to comply with the financial ratios could result in an event of default, which would allow the lenders to declare all borrowings outstanding to be due and payable or to terminate the ability to borrow under the Revolver. If the amounts outstanding under the Credit Facilities, the Notes or other future indebtedness were to be accelerated, we cannot assure that our assets would be sufficient to repay in full the money owed, including the Notes. In such a situation, we could be forced to file for bankruptcy.

 

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Our future tax liabilities are not predictable or controllable. If we become subject to increased levels of taxation, our financial condition and operations could be negatively impacted.

We provide telecommunication and other services in multiple jurisdictions across the United States and Europe and are, therefore, subject to multiple sets of complex and varying tax laws and rules. We cannot predict the amount of future tax liabilities to which we may become subject. Any increase in the amount of taxation incurred as a result of our operations or due to legislative or regulatory changes would be adverse to us. In addition, we may become subject to income tax audits by many tax jurisdictions throughout the world. It is possible that certain tax positions taken by us could result in tax liabilities for us. While we believe that our current provisions for taxes are reasonable and appropriate, we cannot assure you that these items will be settled for the amounts accrued or that we will not identify additional exposures in the future.

We cannot assure you whether, when or in what amounts we will be able to use our net operating losses, or when they will be depleted.

At March 31, 2014, we had approximately $1,376.3 million of federal net operating losses (“NOLs”), which relate primarily to prior acquisitions. Under certain circumstances, these NOLs can be used to offset our future federal and certain taxable income. If we experience an “ownership change,” as defined in Section 382 of the Internal Revenue Code and related Treasury regulations at a time when our market capitalization is below a certain level, our ability to use the NOLs could be substantially limited. This limit could impact the timing of the usage of the NOLs, thus accelerating cash tax payments or causing NOLs to expire prior to their use, which could affect the ultimate realization of the NOLs.

Furthermore, transactions that we enter into, as well as transactions by existing or future 5% stockholders that we do not participate in, could cause us to incur an “ownership change,” which could prevent us from fully utilizing our NOLs to reduce our federal income taxes. These limitations could cause us not to pursue otherwise favorable acquisitions and other transactions involving our capital stock, or could reduce the net benefits to be realized from any such transactions. Despite this, we expect to use substantially all of these NOLs and certain other deferred tax attributes as an offset to our federal future taxable income, although the timing of that use will depend upon our future earnings and future tax circumstances. If and when our NOLs are fully utilized, we expect that the amount of our cash flow dedicated to the payment of federal taxes will increase substantially.

We may be subject to interest rate risk and increasing interest rates may increase our interest expense.

Borrowings under each of the Credit Facilities bear, and our future indebtedness may bear, interest at variable rates and expose us to interest rate risk. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same, and our net income and cash available for servicing our indebtedness would decrease.

The international operations of our business expose us to risks that could materially and adversely affect the business.

We have operations and investments outside of the United States, as well as rights to undersea cable capacity extending to other countries, that expose us to risks inherent in international operations. These include:

 

   

general economic, social and political conditions;

 

   

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

 

   

tax rates in some foreign countries may exceed those in the U.S.;

 

   

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

 

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foreign earnings may be subject to withholding requirements or the imposition of tariffs, exchange controls or other restrictions;

 

   

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

 

   

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

 

   

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

We may as part of our expansion strategy increase our exposure to international investments and operations.

Our international operations are subject to the laws and regulations of the U.S. and many foreign countries, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act.

We are subject to a variety of laws regarding our international operations, including the U.S. Foreign Corrupt Practices Act and the U.K Bribery Act of 2010, and regulations issued by U.S. Customs and Border Protection, the U.S. Bureau of Industry and Security, the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”) and various foreign governmental agencies. We cannot predict the nature, scope or effect of future regulatory requirements to which our international operations might be subject or the manner in which existing laws might be administered or interpreted. Actual or alleged violations of these laws could lead to enforcement actions and financial penalties that could result in substantial costs.

The U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments for the purpose of obtaining or retaining business. Recent years have seen a substantial increase in anti-bribery law enforcement activity with more frequent and aggressive investigations and enforcement proceedings by both the Department of Justice and the U.S. Securities and Exchange Commission, increased enforcement activity by non-U.S. regulators and increases in criminal and civil proceedings brought against companies and individuals. We are in the process of creating and implementing a program for compliance with anti-bribery laws. Because our anti-bribery internal control policies and procedures have been recently implemented, we may have increased exposure to reckless or criminal acts committed by our employees or third-party intermediaries. Violations of these anti-bribery laws may result in criminal or civil sanctions, which could have a material adverse effect on our business, financial condition, and results of operations.

Our international operations expose us to currency risk.

We conduct a portion of our business using the British Pound Sterling and the Euro. Appreciation of the U.S. Dollar adversely affects our consolidated revenue. Since we tend to incur costs in the same currency in which those operations realize revenue, the effect on operating income and operating cash flow is largely mitigated. However, if the U.S. Dollar appreciates significantly, future revenues, operating income and operating cash flows could be materially affected.

We may be vulnerable to security breaches that could disrupt our operations and adversely affect our business and operations.

Despite security measures and business continuity plans, our information technology networks and infrastructure may be vulnerable to damage, disruptions, or shutdowns due to unauthorized access, computer viruses, cyber-attacks, distributed denial of service, and other security breaches. An attack on or security breach of our network could result in interruption or cessation of services, our inability to meet our service level commitments, and potentially compromise customer data transmitted over our network. We cannot guarantee that our security measures will not be circumvented, resulting in network failures or interruptions that could

 

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impact our network availability and have a material adverse effect on our business, financial condition, and operational results. We may be required to expend significant resources to protect against such threats. If an actual or perceived breach of our security occurs, the market perception of the effectiveness of our security measures could be harmed, and we could lose customers. Any such events could result in legal claims or penalties, disruption in operations, misappropriation of sensitive data, damage to our reputation, and/or costly response measures, which could adversely affect the our business.

Risks Related to Our Industry

We could face increased competition from companies in the telecommunications industry that currently do not focus on bandwidth infrastructure.

Many of our competitors in the bandwidth infrastructure space are other focused bandwidth infrastructure providers that operate on a regional or local basis. In some cases we also compete with communications service providers who also own certain infrastructure assets and make them available to customers as an infrastructure service. These communication service providers include ILECs, such as AT&T and Verizon, and cable television companies, such as Comcast.

Some of these competitors have greater financial, managerial, sales and marketing, and research and development resources than we do and are able to promote their brands with significantly larger budgets. Most of them are also our customers. If ILECs and cable television companies focus on providing bandwidth infrastructure, it could have a material adverse effect on us. A few of these competitors also have significant fiber assets that they principally employ in the provision of their communications services. If any of these competitors with greater resources and/or significant fiber assets chose to focus those resources on bandwidth infrastructure, our ability to compete in the bandwidth infrastructure industry could be negatively impacted.

Consolidation among companies in the telecommunications and cable television industries could adversely impact our business.

The telecommunications and cable television industries are intensely competitive and continue to undergo significant consolidation. There are many reasons for consolidation in these industries, including the desire for communications and cable television companies to acquire network assets in regions where they currently have no or insufficient amounts of owned network infrastructure. The consolidation within the industry may cause customers to disconnect services to move them to their own networks, or consolidate buying with other bandwidth infrastructure providers.

Certain of our services are subject to regulation that could change or otherwise impact us in an adverse manner.

Communications services are subject to domestic and international regulation at the federal, state, and local levels. These regulations affect our business and our existing and potential competitors. In addition, in the United States, both the Federal Communications Commission (“FCC”) and the state public utility commissions or similar regulatory authorities (the “State PUCs”) typically require us to file periodic reports, pay various regulatory fees and assessments, and to comply with their regulations. Such compliance can be costly and burdensome and may affect the way we conduct our business. Delays in receiving required regulatory approvals (including approvals relating to acquisitions or financing activities or for interconnection agreements with other carriers), the enactment of new and adverse international or domestic legislation or regulations (including those pertaining to broadband initiatives and net-neutrality), or the denial, modification or termination by a regulator of any approval or authorization, could have a material adverse effect on our business. Further, the current regulatory landscape is subject to change through judicial review of current legislation and rulemaking by the FCC and other domestic and international rulemaking bodies. These bodies regularly consider changes to their regulatory framework and fee obligations. Changes in current regulation may make it more difficult to obtain the

 

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approvals necessary to operate our business, significantly increase the regulatory fees to which we are subject, or have other adverse effects on our future operations in the United States and Europe.

Unfavorable general economic conditions in the United States and Europe could negatively impact our operating results and financial condition.

Unfavorable general global economic conditions could negatively affect our business. Although it is difficult to predict the impact of general economic conditions on our business, these conditions could adversely affect the affordability of, and customer demand for, our services, and could cause customers to delay or forgo purchases of our services. One or more of these circumstances could cause our revenue to decline. Also, our customers may not be able to obtain adequate access to credit, which could affect their ability to purchase our services or make timely payments to us. The current economic conditions, including federal fiscal and monetary policy actions, may lead to inflationary conditions in our cost base, particularly in our lease and personnel related expenses. This could harm our margins and profitability if we are unable to increase prices or reduce costs sufficiently to offset the effects of inflation in our cost base. For these reasons, among others, if challenging economic conditions persist or worsen, our operating results and financial condition could be adversely affected.

Disruptions in the financial markets could affect our ability to obtain debt or equity financing or to refinance our existing indebtedness on reasonable terms (or at all).

Disruptions in the financial markets could impact our ability to obtain debt or equity financing, or lines of credit, in the future as well as impact our ability to refinance our existing indebtedness on reasonable terms (or at all), which could affect our strategic operations and our financial performance and force modifications to our operations.

Changes in our traffic patterns or industry practice could result in increasing peering costs for our IP network.

Peering agreements with other ISPs have allowed us to access the Internet and exchange traffic with these providers. In most cases, we peer with these ISPs on a payment-free basis, referred to as settlement-free peering. We plan to continue to leverage this settlement-free peering. If other providers change the terms upon which they allow settlement-free peering or if changes in Internet traffic patterns, including the ratio of inbound to outbound traffic, cause us to fall below the criteria that these providers use in allowing settlement-free peering, the costs of operating our Internet backbone will likely increase. Any increases in costs could have an adverse effect on our margins and our ability to compete in the IP market.

Terrorism and natural disasters could adversely impact our business.

The ongoing threat of terrorist activity and other acts of war or hostility have had, and may continue to have, an adverse effect on business, financial and general economic conditions. Effects from these events and any future terrorist activity, including cyber terrorism, may, in turn, increase our costs due to the need to provide enhanced security, which would adversely affect our business and results of operations. Terrorist activity could damage or destroy our Internet infrastructure and may adversely affect our ability to attract and retain customers, raise capital, and operate and maintain our network access points. We are particularly vulnerable to acts of terrorism because of our large datacenter presence in New York. We are also susceptible to other catastrophic events such as major natural disasters, extreme weather, fires, or similar events that could affect our headquarters, other offices, our network, infrastructure, or equipment, all of which could adversely affect our business.

 

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Risks Related to this Offering and Ownership of Our Common Stock

There is no existing market for our common stock, and we do not know if one will develop. Even if a market does develop, the stock prices in the market may not exceed the offering price.

Prior to this offering, there has not been a public market for our common stock or any of our equity interests. We cannot predict the extent to which investor interest in our company will lead to the development of an active trading market on the            , or how liquid that market may become. An active public market for our common stock may not develop or be sustained after the offering. If an active trading market does not develop or is not sustained, you may have difficulty selling any shares that you buy.

The initial public offering price for the common stock will be determined by negotiations among us and the representatives of the underwriters and may not be indicative of prices that will prevail in the open market following this offering. Consequently, you may not be able to sell shares of our common stock at prices equal to or greater than the price you pay in this offering.

Our stock price may be volatile or may decline regardless of our operating performance and you may not be able to resell your shares at or above the initial public offering price, if at all.

The market price of our common stock may fluctuate significantly in response to numerous factors, many of which are beyond our control. In addition to the other risk factors described herein, these factors include:

 

   

actual or anticipated fluctuations in our revenue and other operating results;

 

   

announcements by us or our competitors of significant technical innovations, acquisitions, strategic partnerships, joint ventures or capital commitments;

 

   

changes in operating performance and stock market valuations of other companies in our industry;

 

   

the addition or loss of significant customers;

 

   

fluctuations in the trading volume of our common stock or the size of our public float;

 

   

announcements by us with regard to the effectiveness of our internal controls and our ability to accurately report our financial results;

 

   

price and volume fluctuations in the overall stock market, including as a result of trends in the economy as a whole;

 

   

general economic, legal, regulatory and market conditions unrelated to our performance;

 

   

lawsuits threatened or filed against us; and

 

   

other events or factors, including those resulting from war, incidents of terrorism or responses to these events.

If the market price of our common stock after this offering does not exceed the initial public offering price, you may not realize any return on your investment in our common stock and may lose some or all of your investment. In addition, the stock markets have experienced extreme fluctuations in price and trading volume that have caused and will likely continue to cause the stock prices of many telecommunications companies to fluctuate in a manner unrelated or disproportionate to the operating performance of those companies. In the past, stockholders have instituted securities class action litigation following periods of declining stock prices. If we were to become involved in securities litigation, we could face substantial costs and be forced to divert resources and the attention of management from our business, which could adversely affect our business.

 

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If securities or industry analysts do not publish, continue to publish, or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.

The trading market for our common stock depends on the research and reports that securities or industry analysts publish about us or our business. Certain securities and industry analysts currently publish research reports with respect to certain of our debt securities; however, they are currently not publishing reports on our equity securities. If they fail to pick up coverage of our equity securities, fail to publish reports about us or our securities regularly, or otherwise cease to cover our Company, demand for our stock could decrease and the trading price of our stock could decline. A downgrade of our stock or the publication of inaccurate or unfavorable research about our business would likely cause our stock price to decline.

Sales of substantial amounts of our common stock in the public market, or the perception that they might occur, could reduce the price that our common stock might otherwise attain.

The price of our common stock could decline if there are substantial sales of our common stock, particularly sales by our directors, executive officers and significant stockholders, or if there is a large number of shares of our common stock available for sale. After this offering, we will have a small public float relative to the total number of shares of our common stock issued and outstanding, and a substantial majority of our issued and outstanding shares will be restricted as a result of securities laws, lock-up agreements or other contractual provisions that restrict transfers.

After this offering, there will be outstanding            shares of our common stock. This includes the             shares that we or the selling stockholders are selling in this offering, which may be resold in the public market immediately. Certain of the remaining            outstanding shares after this offering are subject to lock-up agreements, as more fully described in “Underwriting.” These lock-up restrictions will expire 180 days after the date of this prospectus, subject to extension in some circumstances. Shares held by directors, executive officers and other affiliates will be subject to volume limitations under Rule 144 under the Securities Act of 1933 (the “Securities Act”) and various vesting agreements in some cases.

After this offering, the holders of an aggregate of            shares of our common stock outstanding will have rights, subject to some conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or our stockholders. For a more detailed description of these registration rights, see “Description of Capital Stock—Registration Rights.” All of these shares are subject to market standoff or lock-up agreements restricting their sale for 180 days after the date of this prospectus, subject to extension in some circumstances. We also intend to file registration statements covering the shares of common stock that we have issued and may issue under our employee equity incentive plans. Once these registration statements are filed, these shares will be able to be sold freely in the public market upon issuance, subject to existing market standoff or lock-up agreements. Morgan Stanley & Co. LLC and Barclays Capital Inc. acting together may, in their sole discretion, permit our officers, directors, employees and current stockholders who are subject to the contractual lock up to sell shares prior to the expiration of the lock-up agreements. See “Underwriting” for more information.

Following this offering, there will be            shares available for issuance under our stock incentive plan, and we could also make equity compensation grants outside of our stock incentive plan. The shares issuable under our stock incentive plan will be registered pursuant to a registration statement on Form S-8.

We may issue shares of our common stock or securities convertible into our common stock from time to time in connection with financings, acquisitions, investments, or otherwise. Any such issuance could result in ownership dilution to you as a stockholder, and cause the trading price of our common stock to decline.

 

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Delaware law and our amended and restated certificate of incorporation and bylaws contain provisions that could delay or discourage takeover attempts that our stockholders may consider favorable.

Provisions in our amended and restated certificate of incorporation and amended and restated bylaws may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following:

 

   

our board of directors is divided into three classes serving staggered three-year terms;

 

   

our board of directors has the right to elect a director to fill a vacancy created by the expansion of the board of directors or due to the resignation or departure of an existing board member;

 

   

our directors are not elected by cumulative voting, which would allow less than a majority of stockholders to elect director candidates;

 

   

advance notice of nominations for election to the board of directors or for proposing matters that can be acted upon at a stockholders meeting is required;

 

   

our board of directors may alter our bylaws without obtaining stockholder approval;

 

   

our board of directors may issue, without stockholder approval, up to            shares of preferred stock with terms set by the board of directors, certain rights of which could be senior to those of our common stock;

 

   

stockholders do not have the right to call a special meeting of stockholders and to take action by written consent in lieu of a meeting;

 

   

approval of at least two thirds of the shares entitled to vote at an election of directors is required to amend or repeal, or adopt any provision inconsistent with, our amended and restated bylaws or the provisions of our amended and restated certificate of incorporation regarding, among other items, the election and removal of directors; and

 

   

directors may be removed from office for only for cause.

In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law (the “DGCL”). In general, Section 203 prohibits a publicly-held Delaware corporation from engaging in a “business combination” with an “interested stockholder” for three years following the time that such stockholder becomes an interested stockholder, unless the business combination is approved in a prescribed manner. A “business combination” includes, among other things, a merger, asset or stock sale or other transaction resulting in a financial benefit to the interested stockholder. An “interested stockholder” is a person who, together with affiliates and associates, owns, or did own, within three years prior to the determination of interested stockholder status, 15% or more of a corporation’s voting stock.

These provisions may prohibit large stockholders, particularly those owning 15% or more of our outstanding voting stock, from merging or combining with us. These provisions in our amended and restated certificate of incorporation and our amended and restated bylaws and the DGCL could discourage potential takeover attempts, could reduce the price that investors are willing to pay for shares of our common stock in the future and could potentially result in the market price of our common stock being lower than it otherwise would be.

In addition, our debt agreements may require very significant payments if we have a change of control, which reduces the possibility that such an event will occur.

 

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Our directors, executive officers, and principal stockholders will collectively own approximately     % of our outstanding common stock after this offering and will continue to have substantial control over the company.

Upon completion of this offering, assuming an initial public offering price at the midpoint of the estimated price range set forth on the cover of this prospectus, our directors, executive officers, and holders of more than 5% of our common stock, together with their affiliates, will beneficially own, in the aggregate, approximately     % of our outstanding common stock. As a result, these stockholders, acting together, would have the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation or sale of all or substantially all of our assets. In addition, these stockholders, acting together, would have the ability to control our management and affairs. Accordingly, this concentration of ownership might harm the market price of our common stock by:

 

   

delaying, deferring or preventing a change in control;

 

   

impeding a merger, consolidation, takeover or other business combination involving us; or

 

   

discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control.

We do not intend to pay dividends for the foreseeable future.

We have never declared or paid cash dividends on our common stock. ZGL’s ability to pay dividends to us is limited by its Credit Agreement and its Indentures, which may in turn limit our ability to pay dividends on our common stock. Our ability to pay dividends may also be restricted by the terms of any future credit agreement or any future debt or preferred securities of ours or of our subsidiaries. We currently intend to retain any future earnings to finance the operation and expansion of our business, and we do not expect to declare or pay any dividends in the foreseeable future. As a result, you may only receive a return on your investment in our common stock if the market price of our common stock increases.

If you purchase shares of our common stock in this offering, you will experience substantial and immediate dilution.

The initial public offering price of our common stock will be substantially higher than the pro forma net tangible book value per share of our outstanding common stock following this offering. Therefore, if you purchase shares of our common stock in this offering, you will experience immediate dilution of $        per share, the difference between the price per share you pay for our common stock and the pro forma net tangible book value per share as of March 31, 2014, after giving effect to the issuance of            shares of our common stock in this offering. See “Dilution.” This dilution is due in large part to the fact that our earlier investors paid substantially less than the initial public offering price when they purchased their shares of our capital stock.

We will incur increased costs as a result of being a publicly-traded company.

After the completion of this offering, we will be subject to the reporting requirements of the Securities Exchange Act of 1934 (the “Exchange Act”), the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the rules and regulations of the stock market on which our common stock is traded. Being subject to these rules and regulations will result in legal, accounting and financial compliance costs, will make some activities more difficult, time-consuming and costly and may also place significant strain on our personnel, systems and resources.

If we do not timely satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, the trading price of our common stock could be adversely affected.

The Sarbanes-Oxley Act requires, among other things, that we test the effectiveness of our internal control over financial reporting in accordance with an established internal control framework and report on our conclusion as to the effectiveness of our internal control over financial reporting. Any delays or difficulty in

 

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satisfying the requirements of the Sarbanes-Oxley Act could, among other things, cause investors to lose confidence in, or otherwise be unable to rely on, the accuracy of our reported financial information, which could adversely affect the trading price of our common stock.

As a public company, we will be required to maintain internal control over financial reporting and to report any material weaknesses in such internal control. We are in the process of designing, implementing, and testing our internal control over financial reporting required to comply with this obligation, which is a time-consuming, costly, and complicated process.

 

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FORWARD-LOOKING STATEMENTS

Information contained in this prospectus that is not historical by nature constitutes “forward-looking statements,” which 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 management’s 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:

 

   

We have consistently generated net losses since our inception and expect such losses to continue for at least several years.

 

   

Since our inception, we have used more cash than we have generated from operations, and we may continue to do so.

 

   

We are highly dependent on our management team and other key employees, many of whom own equity that has been illiquid but will become liquid as a result of this offering.

 

   

Our revenue is relatively concentrated among a small number of customers, and the loss of any of these customers could significantly harm our business, financial condition, results of operations, and cash flows.

 

   

Future acquisitions are a component of our strategic plan, and will include integration and other risks that could harm our business.

 

   

We are growing rapidly and might not efficiently manage our growth.

 

   

Any failure of our physical infrastructure or services could lead to significant costs and disruptions.

 

   

We use franchises, licenses, permits, rights-of-way, conduit leases, fiber agreements, and property leases, which could be canceled or not renewed.

 

   

We are required to maintain, repair, upgrade, and replace our network and our facilities, the cost of which could materially impact our results and our failure to do so could irreparably harm our business.

 

   

Our debt level could negatively impact our financial condition, results of operations, cash flows, and business prospects and could prevent us from fulfilling our obligations under our outstanding indebtedness. In the future, we may incur substantially more indebtedness, which could further increase the risks associated with our leverage.

 

   

Our debt agreements contain restrictions on our ability to operate our business and to pursue our business strategies, and our failure to comply with these covenants could result in an acceleration of our indebtedness.

 

   

Our future tax liabilities are not predictable or controllable. If we become subject to increased levels of taxation, our financial condition and operations could be negatively impacted.

 

   

The international operations of our business expose us to risks that could materially and adversely affect the business.

 

   

We may be vulnerable to security breaches that could disrupt our operations and adversely affect our business and operations.

 

   

The other risks described above in “Risk Factors.”

 

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USE OF PROCEEDS

We estimate that the net proceeds to us from this offering, after deducting the underwriting discount and estimated offering expenses payable by us, will be approximately $         million, assuming the shares are offered at $         per share (the midpoint of the estimated price range set forth on the cover of this prospectus). We will not receive any proceeds from the sale of shares by the selling stockholders.

Each $1.00 increase or decrease in the assumed initial public offering price of $         per share (the midpoint of the estimated price range set forth on the cover of this prospectus) would increase or decrease, as applicable, the net proceeds we receive from this offering by approximately $         million, assuming the number of shares offered by us, as set forth on the cover of this prospectus, remains the same and after deducting the underwriting discount and estimated offering expenses.

We intend to use the net proceeds from the sale of common stock by us in this offering for general corporate purposes, which may include some or all of the following: repayment of certain existing indebtedness, acquisitions, working capital, and capital expenditures, and to pay other fees and expenses incurred in connection with this offering of approximately $        .

Pending use of the net proceeds from this offering described above, we intend to invest the net proceeds in short-term, investment-grade instruments, such as U.S. Treasury bonds or money market securities.

 

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DIVIDEND POLICY

We currently intend to retain all available funds and any future earnings for use in the operation of our business, and therefore we do not anticipate paying any cash dividends in the foreseeable future. Any future determination to pay dividends will be at the discretion of our board of directors and will depend upon our financial condition, results of operations, cash flows, capital requirements, and other factors that our board of directors deems relevant. We are a holding company, and substantially all of our operations are carried out by our subsidiary, ZGL, and its subsidiaries. ZGL’s ability to pay dividends to us is limited by the Credit Agreement and Indentures, which may in turn limit our ability to pay dividends on our common stock. Our ability to pay dividends may also be restricted by the terms of any future credit agreement or any future debt or preferred securities.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and capitalization as of March 31, 2014:

 

   

on an actual basis from continuing operations; and

 

   

on a pro forma, as adjusted basis to give effect to the following transactions as if they occurred on March 31, 2014:

 

  ¡    

the Restructuring;

 

  ¡    

the sale of             shares of our common stock in this offering by us at an assumed initial public offering price of $         per share (the midpoint of the estimated price range set forth on the cover of this prospectus) after deducting the underwriting discount and estimated offering expenses payable by us and the intended application of the net proceeds therefrom as described in “Use of Proceeds”;

 

  ¡    

the effectiveness of our amended and restated certificate of incorporation included as an exhibit to the registration statement of which this prospectus forms a part, which we will adopt prior to the completion of this offering;

 

  ¡    

no exercise by the underwriters of their option to purchase up to             additional shares from the selling stockholders; and

 

  ¡    

the use of $         million of the estimated net proceeds of this offering to pay other fees and expenses incurred in connection with this offering.

You should read the following table in conjunction with the sections entitled “Use of Proceeds,” “Selected Historical Consolidated Financial Information” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

     As of March 31, 2014  
     Actual
(unaudited)
     Pro Forma
as  Adjusted
(unaudited)
 
    

(in thousands, except share

and per share data)

 

Cash and cash equivalents

   $ 254,607       $                
  

 

 

    

 

 

 

Long-term debt and capital lease obligations:

     

Revolving credit facility

   $       $     

Term loan facility

     1,720,711      

Senior secured notes

     750,000      

Senior unsecured notes

     500,000      

Capital lease obligations

     19,531      
  

 

 

    

 

 

 

Total debt

     2,990,242      
  

 

 

    

 

 

 

 

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     As of March 31, 2014  
     Actual
(unaudited)
     Pro Forma
as  Adjusted
(unaudited)
 
    

(in thousands, except share

and per share data)

 

Stockholders’ Equity:

     

Common stock, $0.001 par value per share, 1,000 shares authorized, 1,000 shares issued and outstanding, actual; $0.001 par value per share,             shares authorized,             shares issued and outstanding, pro forma as adjusted

     

Preferred stock, $0.001 par value per share, no shares authorized, issued or outstanding, actual; $0.001 par value per share,             shares authorized, no shares issued or outstanding, pro forma as adjusted

     

Additional paid-in capital

     778,431      
  

 

 

    

 

 

 

Total stockholders’ equity

     517,319      
  

 

 

    

 

 

 

Total capitalization

   $ 3,762,168       $                
  

 

 

    

 

 

 

 

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DILUTION

If you invest in our common stock, your interest will be immediately diluted to the extent of the difference between the initial public offering price per share of our common stock and the pro forma as adjusted net tangible book value per share of our common stock immediately after this offering.

Historical net tangible book value (deficit) per share is our historical net tangible book value, divided by the number of outstanding shares. The historical net tangible book deficit of our common stock as of March 31, 2014 was $881.1 million, or $881,140 per share. Historical net tangible book value (deficit) is the amount of our total tangible assets less our total liabilities.

The pro forma net tangible book deficit of our common stock as of March 31, 2014 was $881.1 million, or $             per share. Pro forma net tangible book value (deficit) and pro forma net tangible book value (deficit) per share give effect to the Restructuring.

Pro forma as adjusted net tangible book value (deficit) gives effect to (i) the Restructuring, (ii) the sale of              shares of common stock in this offering at the initial public offering price of $             per share, the midpoint of the estimated price range set forth on the cover of this prospectus, and after deducting the underwriting discount and estimated offering expenses payable by us, and (iii) the application of the net proceeds received by us as described under “Use of Proceeds.” As of March 31, 2014, our pro forma as adjusted net tangible book deficit would have been $         million, or $             per share. This represents an immediate decrease in pro forma net tangible book deficit of $             per share to our existing stockholders and an immediate dilution of $             per share to investors purchasing common stock in this offering.

The following table illustrates this dilution on a per share basis to new investors:

 

Initial public offering price per share

   $                    

Pro forma net tangible book deficit per share as of March 31, 2014, before giving effect to this offering

   $                    

Decrease in pro forma net tangible book deficit per share attributable to new investors in this offering

     

Pro forma as adjusted net tangible book deficit per share after giving effect to this offering

     

Dilution per share to new investors purchasing shares in this offering

     

If the underwriters exercise their option to purchase additional shares of our common stock in full, the pro forma as adjusted net tangible book deficit per share will be $             per share, the decrease in pro forma net tangible book deficit per share to existing stockholders will be $             per share and the dilution per share to new investors purchasing shares in this offering will be $             per share.

The table below summarizes as of March 31, 2014, on a pro forma as adjusted basis described above, the number of shares of our common stock, the total consideration, and the average price per share (i) paid to us by our existing stockholders and (ii) to be paid by new investors purchasing our common stock in this offering (assuming no exercise of the underwriters’ option to purchase additional shares), before deducting the underwriting discount and estimated offering expenses payable by us.

 

     Shares Purchased     Total Cash Consideration     Average
Price  Per
Share
 
     Number    Percent     Amount      Percent    

Existing stockholders

                       $                                     $                

New investors

                               
  

 

  

 

 

   

 

 

    

 

 

   

 

 

 

Total

                       $                                     $                
  

 

  

 

 

   

 

 

    

 

 

   

 

 

 

If the underwriters’ option to purchase additional shares in this offering is exercised in full, the percentage of shares of our common stock held by existing stockholders will be reduced to     % of the total number of shares of our common stock outstanding after this offering, and the number of shares held by new investors will increase to              shares, or     % of the total number of shares of our common stock outstanding after this offering.

 

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SELECTED HISTORICAL CONSOLIDATED FINANCIAL INFORMATION

The following tables present selected historical consolidated financial information of the Company for the periods and as of the dates indicated. The selected historical consolidated financial information as of June 30, 2012 and 2013 and for the years ended June 30, 2011, 2012 and 2013 is derived from, and qualified by reference to, our audited consolidated financial statements included elsewhere in this prospectus. The selected historical consolidated financial information as of June 30, 2011 is derived from our audited consolidated financial statements not included in this prospectus. The selected historical consolidated financial information as of June 30, 2009 and 2010 and for the years ended June 30, 2009 and 2010 is derived from our unaudited consolidated financial statements not included in this prospectus. The selected historical consolidated financial information as of March 31, 2014 and for the nine months ended March 31, 2013 and 2014 is derived from, and qualified by reference to, our unaudited consolidated financial statements included elsewhere in this prospectus. The selected historical consolidated financial information as of March 31, 2013 is derived from our unaudited consolidated financial statements not included in this prospectus. Our unaudited consolidated financial statements have been prepared on the same basis as our audited consolidated financial statements and, in our opinion, reflect all adjustments, consisting only of normal and recurring adjustments, necessary for a fair presentation of such financial statements in all material respects.

The financial data set forth in the following tables should be read in conjunction with our historical consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” each included elsewhere in this prospectus. The results for any interim period are not necessarily indicative of the results that may be expected for a full year or any future period.

 

    Year Ended June 30,     Nine Months Ended
March 31
 
    2009     2010     2011     2012     2013     2013     2014  
    (unaudited)     (unaudited)                       (unaudited)     (unaudited)  

Consolidated Statements of Operations Data (in thousands, except for share data):

             

Revenue

  $ 125,339      $ 197,889      $ 282,143      $ 375,526      $ 1,004,354      $ 742,647      $ 826,537   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating costs and expenses

             

Operating costs, excluding depreciation and amortization

    37,792        62,513        70,978        82,083        145,877        110,032        110,634   

Selling, general and administrative expenses, excluding stock-based compensation expenses

    51,493        65,347        88,414        112,410        318,523        233,393        234,395   

Stock-based compensation

    6,412        18,168        24,310        26,253        105,849        67,913        165,134   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selling, general and administrative expenses

    57,905        83,515        112,724        138,663        424,372        301,306        399,529   

Depreciation and amortization

    26,554        38,738        60,463        84,961        324,532        243,880        246,922   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating costs and expenses

    122,251        184,766        244,165        305,707        894,781        655,218        757,085   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    3,088        13,123        37,978        69,819        109,573        87,429        69,452   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

    (15,245     (18,692     (33,414     (50,720     (202,464     (164,807     (150,905

Impairment of cost method investment

                         (2,248                     

Other income/(expense), net

    234        1,526        (126     123        326        302        1,266   

Loss on extinguishment of debt

           (5,881                   (77,253     (77,253     (1,911
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other expenses, net

    (15,011     (23,047     (33,540     (52,845     (279,391     (241,758     (151,550
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings/(loss) from continuing operations before income taxes

    (11,923     (9,924     4,438        16,974        (169,818     (154,329     (82,098

Provision/(benefit) for income taxes

    (2,321     4,549        11,329        26,871        (24,205     (33,549     27,202   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations

    (9,602     (14,473     (6,891     (9,897     (145,613     (120,780     (109,300

Earnings/(loss) from discontinued operations, net of income taxes

    7,355        6,761        5,331        8,673        8,396        7,488        3,655   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

  $ (2,247   $ (7,712   $ (1,560   $ (1,224   $ (137,217   $ (113,292   $ (105,645
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average shares used to compute net loss per share:

             

Basic and diluted

    1,000        1,000        1,000        1,000        1,000        1,000        1,000   

Loss from continuing operations per share:

             

Basic and diluted

  $ (9,602   $ (14,473   $ (6,891   $ (9,897   $ (145,613   $ (120,780   $ (109,300

Income from discontinued operations per share:

             

Basic and diluted

    7,355        6,761        5,331        8,673        8,396        7,488        3,655   

Pro forma net loss per share (unaudited)(1):

             

Basic and diluted

             

 

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    Year Ended June 30,     Nine Months Ended
March 31
 
    2009     2010     2011     2012     2013     2013     2014  
    (unaudited)     (unaudited)                       (unaudited)     (unaudited)  

Consolidated Balance Sheet Data (at period end) (in thousands):

             

Cash and cash equivalents

  $ 38,019      $ 87,864      $ 25,394      $ 150,693      $ 91,313      $ 70,177      $ 254,607   

Property and equipment, net

    211,864        297,889        518,513        754,738        2,437,707        2,363,339        2,533,256   

Total assets

    415,333        605,474        849,396        1,442,055        4,251,240        4,166,825        4,561,816   

Long-term debt and capital lease obligations, including current portion

    151,487        259,786        365,588        701,339        2,843,872        2,850,919        2,990,241   

Total stockholder’s equity

    213,076        243,323        258,083        410,314        606,253        632,766        517,319   

Selected cash flow data (in thousands):

             

Net cash flows provided by operating activities from continuing operations

  $ 24,667      $ 58,200      $ 99,502      $ 167,630      $ 404,883      $ 268,265      $ 401,321   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Purchases of property and equipment, net of stimulus grants(2)

  $ (61,614   $ (58,751   $ (112,524   $ (124,137   $ (323,232   $ (221,328   $ (265,872

Acquisitions

  $ (11,508   $ (96,571   $ (183,666   $ (351,273   $ (2,480,738   $ (2,473,675   $ (101,009

Net cash flows used in investing activities from continuing operations

  $ (73,122   $ (155,322   $ (296,162   $ (475,410   $ (2,803,970   $ (2,695,003   $ (366,881

Net cash flows provided by financing activities from continuing operations

  $ 67,921      $ 135,446      $ 134,190      $ 433,079      $ 2,340,029      $ 2,346,803      $ 128,396   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other Financial Data:

             

Adjusted EBITDA (in thousands)(3)

  $ 37,007      $ 72,854      $ 123,490      $ 187,786      $ 554,429      $ 412,571      $ 482,619   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reconciliation of Adjusted EBITDA (in thousands):

             

Net loss

  $ (2,247   $ (7,712   $ (1,560   $ (1,224   $ (137,217   $ (113,292   $ (105,645

Earnings from discontinued operations, net of income taxes

    7,355        6,761        5,331        8,673        8,396        7,488        3,655   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations

    (9,602     (14,473     (6,891     (9,897     (145,613     (120,780     (109,300

Add back non-adjusted EBITDA items included in loss from continuing operations:

             

Depreciation and amortization

    26,554        38,738        60,463        84,961        324,532        243,880        246,922   

Interest expense

    15,245        18,692        33,414        50,720        202,464        164,807        150,905   

Provision/(benefit) for income taxes

    (2,321     4,549        11,329        26,871        (24,205     (33,549     27,202   

Stock-based compensation

    6,412        18,168        24,310        26,253        105,849        67,913        165,134   

Loss on extinguishment of debt

           5,881                      77,253        77,253        1,911   

Impairment of cost method investment

                         2,248                        

Unrealized foreign currency translation gains(4)

                                (55     (42     (944

Transaction costs(5)

    719        1,299        865        6,630        14,204        13,089        789   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

  $ 37,007      $ 72,854      $ 123,490      $ 187,786      $ 554,429      $ 412,571      $ 482,619   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(1)    Pro forma basic and diluted net loss per share were computed to give effect to (i) the Restructuring and (ii) the issuance of                      shares of common stock by us in this offering as if they had occurred on July 1, 2013.

(2)    See Note 2—Basis of Presentation and Significant Accounting Policies—n. Government Grants to our audited consolidated financial statements for an explanation of our stimulus grants.

(3)     Adjusted EBITDA is not a financial measurement prepared in accordance with GAAP. We define Adjusted EBITDA as earnings from continuing operations before interest, income taxes, depreciation and amortization (“EBITDA”) adjusted to exclude acquisition-related transaction costs, losses on extinguishment of debt, stock-based compensation, unrealized foreign currency translation gains on an intercompany loan, and impairment of cost method investment. See “Non-GAAP Financial Measures.” The table above sets forth, for the periods indicated, a reconciliation of net loss to Adjusted EBITDA, as net loss is calculated in accordance with GAAP.

(4)     Unrealized foreign currency gain results from the translation of an intercompany loan to a foreign subsidiary denominated in U.S. dollars to British pounds, the functional currency of the subsidiary.

(5)     Transaction costs include expenses associated with professional services (i.e., legal, accounting, regulatory, etc.) rendered in connection with signed and/or closed acquisitions, travel expense, severance expense incurred on the date of acquisition, and other direct expenses incurred that are associated with such acquisitions.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

The following discussion and analysis should be read together with our audited consolidated financial statements and the related notes appearing elsewhere in this prospectus. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this prospectus, particularly in “Risk Factors.” Unless the context otherwise requires, “we,” “us,” “our,” and the “Company” refer to Zayo Group Holdings, Inc. and its consolidated subsidiaries, including Zayo Group, LLC (“ZGL”).

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

Overview

We are one of the largest providers of bandwidth infrastructure in the United States and Europe. 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 and IP connectivity 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 datacenter facilities. Our fiber networks and datacenter 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. As of March 31, 2014, we had more than $4.3 billion in revenue under contract with a weighted average remaining contract term of 42 months. We operate our business with a unique focus on capital allocation and financial performance with the ultimate goal of maximizing equity value for our stockholders. Our core values center on partnership, alignment, and transparency with our three primary constituent groups—employees, customers, and stockholders.

Prior to the Restructuring and consummation of this offering, Zayo Group Holdings, Inc. was a direct, wholly owned subsidiary of Communications Infrastructure Investments, LLC (“CII”). Our fiscal year ends June 30 each year, and we refer to the fiscal year ending June 30, 2014 as “Fiscal 2014,” the fiscal year ended June 30, 2013 as “Fiscal 2013,” the fiscal year ended June 30, 2012 as “Fiscal 2012” and the fiscal year ended June 30, 2011 as “Fiscal 2011.”

Our Segments

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. As of March 31, 2014, we have three reportable segments as described below:

 

   

Physical Infrastructure.    Through our Physical Infrastructure segment, we provide raw bandwidth infrastructure to customers that require more control of their internal networks. These services include dark fiber, mobile infrastructure (fiber-to-the-tower and small cell), and colocation and interconnection. 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. Our datacenters offer colocation and interconnection services to our

 

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customers, who then house and power our computing and networking equipment for the purpose of aggregating and distributing data, voice, Internet, and video traffic. The contract terms in our Physical Infrastructure segment typically range from three to twenty years.

 

   

Lit Services.    Our Lit Services segment provides bandwidth infrastructure solutions over our metro, regional, and long-haul fiber networks where we use optronics to light the fiber and our customers pay us for access based on the amount and type of bandwidth they purchase. Our lit services include wavelength, Ethernet, IP, and SONET services. We target customers who require a minimum of 10G of bandwidth across their networks. The contract terms in this segment typically range from two to five years.

 

   

Other.    Our Other segment currently consists of our eighth Strategic Product Group, Zayo Professional Services (“ZPS”). ZPS is our professional services business that provides network management and technical resources to our customers.

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 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 30 acquisitions through June 30, 2014.

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.

Significant Acquisitions

AboveNet, Inc. (“AboveNet”)

On July 2, 2012, we acquired 100% of the outstanding capital stock of AboveNet, a public company listed on the New York Stock Exchange, for total consideration of approximately $2,210.0 million in cash, net of cash acquired. At the closing, each outstanding share of AboveNet common stock was converted into the right to receive $84 in cash.

AboveNet was a provider of bandwidth infrastructure and network-neutral colocation and interconnection services, primarily to large corporate enterprise clients and communication carriers, including Fortune 1000 and FTSE 500 companies in the United States and Europe. AboveNet’s commercial strategy was consistent with ours, which was to focus on leveraging its infrastructure assets to provide bandwidth infrastructure services to a select set of customers with high-bandwidth demands. AboveNet provided physical infrastructure and lit services over its dense metropolitan, regional, national, and international fiber networks. It also operated a Tier 1 IP network with direct and indirect (through peering arrangements) connectivity in many of the most important bandwidth centers and peering exchanges in the U.S. and Europe. Its product set was highly aligned with our own, consisting primarily of dark fiber, wavelengths, Ethernet, IP, and colocation services. AboveNet had also built a very strong base of business with enterprise clients, particularly within the financial services sector.

The acquisition of AboveNet added approximately 20,600 new route miles and approximately 2,500,000 fiber miles to our network and added connections to approximately 4,000 on-net buildings, including more than 2,600 enterprise locations, many of which housed some of the largest corporate users of network services in the world. AboveNet’s metropolitan networks typically contained 432, and in some cases 864, fiber strands in each cable. This high fiber count allowed AboveNet to add new customers in a timely and cost-effective manner by focusing

 

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incremental construction and capital expenditures on the laterals that connect to the customer premises. AboveNet’s metropolitan networks served 17 markets in the U.S., with strong network footprints in a number of the largest metro markets, including Boston, Chicago, Los Angeles, New York, Philadelphia, San Francisco, Seattle, and Washington, D.C. It also served four metro markets in Europe: London, Amsterdam, Frankfurt, and Paris. These locations also included many private datacenters and hub locations that were important for AboveNet’s customers. AboveNet used under-sea capacity on the Trans-Atlantic undersea telecommunications network and other trans-Atlantic cables to provide connectivity from the U.S. to Europe.

The results of the acquired AboveNet business are included in our operating results beginning July 2, 2012.

360networks Holdings (USA) Inc. (“360networks”)

On December 1, 2011, we acquired 100% of the equity of 360networks. We paid the purchase price of approximately $317.9 million, net of approximately $0.7 million in cash acquired and net of an assumed working capital deficiency of approximately $26.4 million.

The acquired 360networks business operated 19,789 route miles of intercity and metropolitan fiber network across 21 states and British Columbia. 360networks’ intercity network interconnected over 70 markets across the central and western United States. In addition to its intercity network, 360networks operated over 800 route miles of metropolitan fiber networks across 25 markets, including Seattle, Denver, Colorado Springs, Omaha, Sacramento, and Salt Lake City.

The results of the acquired 360networks business are included in our operating results beginning December 1, 2011.

Geo Networks Limited (“Geo”)

On May 16, 2014, we acquired all of the outstanding shares of Geo, a London-based dark fiber provider. The purchase price of £175 million ($294.3 million based on the foreign currency exchange rate on that date) was paid with a combination of cash on hand and available funds drawn on our $250 million revolving credit facility.

Geo owns and operates a high capacity fiber network in the United Kingdom, providing dark fiber and co-location services to a variety of high-bandwidth sectors including media companies, service providers, financial services, datacenters, and gaming organizations. The acquisition added over 2,100 route miles to our European network and connectivity to 587 on-net buildings.

The results of the acquired Geo business are not included in our operating results presented herein, as the acquisition closed on May 16, 2014.

 

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Summary of Business Acquisitions

The table below summarizes the dates and purchase prices (which are net of cash acquired and includes assumption of debt and capital leases) of all acquisitions and asset purchases through June 30, 2014.

 

Acquisition

  Date      Acquisition Cost  
           (In thousands)  

Memphis Networx

    July 31, 2007       $ 9,173   

PPL Telecom

    August 24, 2007         46,301   

Indiana Fiber Works

    September 28, 2007         22,601   

Onvoy

    November 7, 2007         69,962   

Voicepipe

    November 7, 2007         2,800   

Citynet Fiber Networks

    February 15, 2008         99,238   

Northwest Telephone

    May 30, 2008         5,181   

CenturyTel Tri-State Markets

    July 22, 2008         2,700   

Columbia Fiber Solutions

    September 30, 2008         12,091   

CityNet Holdings Assets

    September 30, 2008         3,350   

Adesta Assets

    September 30, 2008         6,430   

Northwest Telephone California

    May 26, 2009         15   

FiberNet

    September 9, 2009         96,571   

AGL Networks

    July 1, 2010         73,666   

Dolphini Assets

    September 20, 2010         235   

American Fiber Systems

    October 1, 2010         114,141   

360networks

    December 1, 2011         317,891   

MarquisNet

    December 31, 2011         13,581   

Arialink

    May 1, 2012         17,129   

AboveNet

    July 2, 2012         2,210,043   

FiberGate

    August 31, 2012         118,335   

USCarrier

    October 1, 2012         16,092   

FTS

    December 14, 2012         109,700   

Litecast

    December 31, 2012         22,160   

Core NAP

    May 31, 2013         7,080   

Corelink

    August 1, 2013         1,889   

Access

    October 1, 2013         40,068   

FiberLink

    October 2, 2013         43,137   

CoreXchange

    March 4, 2014         17,503   

Geo

    May 16, 2014         294,228   

Less portion of acquisition costs allocated to the discontinued operations of Onvoy

       (62,823
    

 

 

 

Total

     $ 3,730,468   
    

 

 

 

We completed each of the acquisitions described above, with the exception of Voicepipe and Corelink, with cash raised through combinations of equity issuances and the incurrence of debt. We acquired Voicepipe from certain existing CII equity holders in exchange for CII preferred units, and we acquired Corelink with a combination of cash and CII preferred units.

Recently Closed Acquisitions

On July 1, 2014, we acquired Neo Telecoms (“Neo”), a Paris-based bandwidth infrastructure company, for a purchase price of €58 million ($79.3 million based on the foreign currency exchange rate on that date). The purchase price was funded with cash on hand available from the proceeds of the Sixth Amendment to our Term Loan Facility. The acquisition of Neo added over 300 route miles of owned Paris metro fiber and approximately 540 on-net buildings to our network. Neo also operates nine colocation centers across France, offering more than 36,000 square feet of datacenter space. The Paris and regional network throughout France will be integrated into our existing European network connecting London, Frankfurt, and Amsterdam and the U.S.

 

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The results of the acquired Neo business are not included in our operating results presented herein, as the acquisition closed July 1, 2014.

On July 1, 2014, we acquired Colo Facilities Atlanta (“AtlantaNAP”), a data center and managed services provider in Atlanta, for a purchase price of $52.5 million. The purchase price was paid with cash on hand. The acquisition of AtlantaNAP added over 72,000 square feet of total data center space, including 42,000 square feet of conditioned colocation space.

The results of the acquired AtlantaNAP business are not included in our operating results presented herein, as the acquisition closed July 1, 2014.

Spin-Off of Business

In connection with certain business combinations, we have acquired assets and liabilities that support products outside of our primary focus of providing bandwidth infrastructure services. On June 13, 2014, we spun off all of our equity interest in Onvoy, LLC (“Onvoy”), a business that provides voice and managed services, to CII. The results of operations of Onvoy are presented as discontinued operations. See Note 4—Spin-off of Business to our audited consolidated financial statements.

Substantial Indebtedness

We had total indebtedness (excluding capital lease obligations) of $2,970.7 million and $2,830.7 million as of March 31, 2014 and June 30, 2013, respectively. As of March 31, 2014, our indebtedness consisted of $750.0 million aggregate principal amount of 8.125% senior secured first-priority notes due 2020 issued by ZGL (the “Senior Secured Notes”), $500.0 million of 10.125% senior unsecured notes due 2020 issued by ZGL (the “Senior Unsecured Notes,” and together with the Senior Secured Notes, the “Notes”), and a $1,720.7 million senior secured term loan facility of ZGL (the “Term Loan Facility”). The interest rate on the Term Loan Facility is floating based on LIBOR (subject to a floor of 1.0%) and was 4.00% as of March 31, 2014 and 4.50% as of June 30, 2013. ZGL also has a $250 million senior secured revolving credit facility (the “Revolver”), which was undrawn as of March 31, 2014. On May 16, 2014, we entered into a Sixth Amendment (the “Sixth Amendment”) to the credit agreement governing the Term Loan Facility and Revolver (the “Credit Agreement”). The Sixth Amendment increased the Company’s Term Loan Facility by $275.0 million. Term Loan Facility borrowings bear interest at the existing rate of LIBOR plus 3.0%, with a minimum LIBOR rate of 1.0%. The $275 million add-on was priced at 99.5%. No other terms of the Credit Agreement were amended.

In August 2012, we entered into interest rate swap agreements with an aggregate notional value of $750.0 million and a maturity date of June 30, 2017. The contracts state that we pay a 1.67% fixed rate of interest for the term of the agreement beginning June 30, 2013. The counterparties pay to us the greater of actual LIBOR or 1.25%. We entered into the swap arrangements to reduce the risk of increased interest costs associated with potential future increases in LIBOR rates.

Substantial Capital Expenditures

During Fiscal 2013, 2012, and 2011, we invested, net of stimulus grant reimbursements, $323.2 million, $124.1 million and $112.5 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.

Debt and Equity Financings

In connection with the AboveNet acquisition, on July 2, 2012, ZGL issued the Notes and entered into the Credit Agreement. In addition, CII concluded the sale of preferred units of CII pursuant to certain securities purchase agreements with new private investment funds, as well as certain existing owners of CII and other investors. The total value of the preferred units issued pursuant to the securities purchase agreements was

 

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approximately $470.3 million, net of $2.0 million in costs associated with raising the additional capital. $133.2 million of the net proceeds from the equity raised were contributed to us in June 2012, and the remaining $337.1 million was contributed to us in July 2012.

A portion of the proceeds from the equity contribution, together with (i) the net proceeds from the Notes and the Term Loan Facility and (ii) cash on hand, were used to refinance ZGL’s then-existing indebtedness and to pay the cash consideration for the AboveNet acquisition and associated fees and expenses. In connection with the Notes offering and the Term Loan Facility, we recorded an original issue discount of $30.0 million and incurred debt issuance costs of $85.2 million.

On October 5, 2012 and February 27, 2013, we amended the Credit Agreement to reduce the interest rate on the Term Loan Facility and Revolver and removed the senior secured and total leverage maintenance covenants and increased the total leverage ratio required to be met in order to incur certain additional indebtedness.

In connection with the Fiscal 2013 refinancing transactions discussed above, we recognized an expense of $77.3 million during the year ended June 30, 2013, associated with debt extinguishment costs. The loss on extinguishment of debt associated with these transactions includes a portion of early call premiums paid to non-consenting creditors, non-cash expense associated with the write-off of unamortized debt issuance costs and issuance discounts on the debt balances accounted for as an extinguishment and certain fees paid to third parties involved in the debt refinancing transactions.

On November 26, 2013, we entered into a Fifth Amendment (the “Fifth Amendment”) to the Credit Agreement that increased the Term Loan Facility by $150.0 million to $1,749.8 million, and reduced the interest rate on the Term Loan Facility to LIBOR plus 3.0%, with a minimum LIBOR rate of 1.0%. The interest rate on the Revolver was also amended to LIBOR plus 2.75% (based on the current leverage ratio of ZGL). We recognized debt extinguishment expense in November 2013 of $1.9 million related to the Fifth Amendment and incurred an additional $1.5 million in debt issuance costs. We did not incur a re-pricing premium.

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 amortized (non-cash) portion of previously collected upfront charges to customers. Upfront charges are typically related to 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 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.    Bookings are the dollar amount of orders recorded as MRR and MAR 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).

 

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Gross Installed Revenue.    Installs are the amount of MRR and MAR for services that have been installed, tested, accepted by the customer, and entered into the billing system in 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. 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 by adding an estimate of the acquired companies’ revenue for the reporting period prior to the date of inclusion in our results of operations, and then calculating the growth rate between the two reported periods. The estimate of acquired annual revenue is based on the acquired companies’ revenues for the most recent quarter prior to close (including estimated purchase accounting adjustments) multiplied by four, except in the case of AboveNet, which is based upon publicly reported revenue for the full period from June 30, 2011 to June 30, 2012. If, in calculating our estimated organic growth rates, we were to use the actual revenue results for the four quarters preceding the closing of each of our acquisitions, including AboveNet, our estimated organic growth rates would be higher than the estimated organic growth rates presented below. If we were to use acquired annual revenue, calculated by taking each acquired company’s revenues for the most recent quarter prior to the closing of such acquisition and multiplying by four, including for AboveNet, our estimated organic growth rates would be lower than the estimated organic growth rates presented below.

Operating Costs

Our operating costs consist primarily of third-party network service costs and colocation facility costs. Third-party network service costs result 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. Our colocation facility costs include rent and license fees paid to the landlords of the buildings in which our zColo 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. We have excluded depreciation and amortization expense from our operating costs.

Selling, General, and Administrative Expenses

Our selling, general, and administrative (“SG&A”) expenses include compensation and benefits expenses, network operations expenses, other SG&A expenses, transaction costs and stock-based compensation.

Compensation and benefits expenses include salaries, wages, incentive compensation (bonus and commissions) and benefits. Employee-related costs that are directly associated with network construction, service installations and development of business support systems are capitalized rather than expensed in SG&A.

After compensation and benefits and stock-based compensation, network operations expenses are the largest components of our SG&A expenses. Network operations expenses include all of the non-personnel related expenses of 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.

Other SG&A expenses include expenses such as property tax, franchise fees, travel, office expense, and maintenance expense on colocation facilities.

 

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Transaction costs include expenses associated with professional services (i.e., legal, accounting, regulatory, etc.) rendered in connection with acquisitions, travel expense, severance expense incurred on the date of acquisition, and other direct expenses incurred that are associated with signed and/or closed acquisitions.

Our stock-based compensation expense contains two components, common unit awards classified as liabilities and, to a lesser extent, preferred unit awards classified as equity. For the CII common units granted to employees and directors, we recognize an expense equal to the fair value of all of those common units that vest during the period plus the change in fair value of previously vested units, and record a liability in respect of those amounts. When the CII preferred units are initially granted, we recognize no expense. We use the straight line method, over the vesting period, to amortize the fair value of those units, as determined on the date of grant. Subsequent changes in the fair value of the preferred units granted to members of management and directors do not affect the amount of expense we recognize.

Refer to “Selected Historical Consolidated Financial Information” for additional financial information for the indicated periods.

Nine Months Ended March 31, 2014 Compared to the Nine Months Ended March 31, 2013

Revenue

 

      Nine Months ended March 31,  
     2014     2013     $ Variance     % Variance  
     (in thousands)  
Segment and consolidated revenue:         

Physical Infrastructure

   $ 361,691      $ 304,894      $ 56,797        19

Lit Services

     454,292        425,021        29,271        7

Other

     19,705        21,020        (1,315     (6 )% 

Corp/eliminations

     (9,151     (8,288     (863     10
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated

   $ 826,537      $ 742,647      $ 83,890        11
  

 

 

   

 

 

   

 

 

   

 

 

 

Our total revenue increased by $83.9 million, or 11%, from $742.6 million for the nine months ended March 31, 2013 to $826.5 million for the nine months ended March 31, 2014. The increase in revenue was driven by our organic growth as well as Fiscal 2013 and 2014 acquisitions.

We estimate that the period-over-period organic growth was approximately 6%. Our organic growth was driven by installs that exceeded churn over the course of both periods, resulting from continued strong demand for bandwidth infrastructure services broadly across our service territory and customer verticals. Further underlying revenue drivers included:

 

   

Bookings grew significantly, increasing from $12.8 million to $15.7 million in combined MRR and MAR. This growth was driven by increased customer demand for our services, our growing fiber and datacenter footprint (from both organic investments and acquisitions), and our salesforce’s improved effectiveness in selling on this base of assets. The total contract value associated with this period’s bookings was approximately $1.2 billion.

 

   

Installs grew by approximately $0.8 million between the two periods, but lagged the increase in bookings, which included more infrastructure-related services with longer booking to install time intervals. Examples included several FTT sales and a large dark fiber sale to tw telecom.

 

   

Monthly churn percentage increased slightly between the two periods, from 1.3% to 1.4%, representing an increase in total churn from $9.8 million to $11.1 million.

 

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Multiple Fiscal 2013 and Fiscal 2014 acquisitions impacted revenue growth between the two periods. The six Fiscal 2013 acquisitions were completed at various times throughout the year, although the largest (AboveNet) closed on July 2, 2012 and was fully included in the nine month results for the period ended March 31, 2013 and therefore was not a contributor to the period-over-period acquisition growth. The others had partial impacts on the nine months ended March 31, 2013 compared to a full impact for the nine months ended March 31, 2014. The four Fiscal 2014 acquisitions were completed on August 1, 2013, October 1, 2013, October 2, 2013 and March 4, 2014 and were included in our nine months ended March 31, 2014 results for approximately eight, six, six and one month(s), respectively. The Fiscal 2014 acquisitions represented smaller acquisitions of dark fiber and colocation-only providers.

Physical Infrastructure.    Revenue from our Physical Infrastructure segment increased by $56.8 million, or 19%, from $304.9 million to $361.7 million for the nine months ended March 31, 2013 and 2014, respectively.

We estimate that organic revenue growth for the Physical Infrastructure segment between the two comparative nine month periods was approximately 7%. Dark fiber is the largest Strategic Product Group within the segment and benefited from continuing growth in infrastructure demand. Our FTT and zColo products also contributed to the segment’s growth. Bookings of MRR and MAR for the nine months ended March 31, 2014 were $7.7 million (with a total contract value of approximately $930 million), nearly double the $4.6 million in bookings for the comparative prior nine month period. Installs were $6.1 million, an increase from $4.8 million from the comparative prior nine month period. The monthly churn percentage remained consistent between the two periods at 0.9%, while total churn was $2.8 million and $3.2 million for the nine month periods ended March 31, 2013 and 2014, respectively. All of the Fiscal 2014 acquisitions impacted the Physical Infrastructure segment revenues, with FiberLink (dark fiber) and CoreLink and CoreXchange (both colocation) being Physical Infrastructure-only businesses.

Lit Services.    Revenue from our Lit Services segment increased by $29.3 million, or 7%, from $425.0 million to $454.3 million for the nine months ended March 31, 2013 and 2014, respectively.

We estimate that organic revenue growth for the Lit Services segment between the two comparative nine month periods was approximately 5%. Growth was strongest in the segment’s Ethernet and IP Strategic Product Groups, driven by customer demand and increased effectiveness in marketing these products. Wavelength revenue growth was dampened by churn, including price concessions we proactively offered in exchange for customer contract extensions. SONET is a legacy product; its revenue declined between the two periods, consistent with our expectations. Bookings of MRR and MAR decreased slightly from $8.2 million to $8.0 million between the two periods, with a total contract value of approximately $270 million, for the nine month period ended March 31, 2014. Installs were $8.4 million for the nine months ended March 31, 2014, compared to $8.9 million for the comparative prior year period. The monthly churn percentage increased slightly from 1.6% to 1.7% over the two periods, with total churn increasing from $6.9 million to $7.6 million. The Lit Services period-over-period revenue results were only influenced by the carryover impacts from the Fiscal 2013 acquisitions as the Fiscal 2014 acquisitions all related only to Physical Infrastructure.

Other.    Revenue from our Other segment, consisting of Zayo Professional Services, declined by 6% ($1.3 million) for the nine months ended March 31, 2014 versus the comparative prior year period. The decline was largely attributable to lower sales. The Other segment represented approximately 2% of our total revenue.

 

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The following table reflects the stratification of our revenue during these periods. While MRR continued to represent the vast majority of our revenue, MAR increased as a percentage of total revenue as a result of Physical Infrastructure installs with large upfront payments to offset capital expenditures and two Fiscal 2014 acquisitions with significant deferred revenue balances.

 

     Nine months ended March 31,  
     2014     2013  
     (in thousands)  

Monthly recurring revenue

   $ 771,962         93   $ 701,640         94

Monthly amortized revenue

     40,605         5     31,186         4

Other revenue

     13,970         2     9,821         1
  

 

 

    

 

 

   

 

 

    

 

 

 

Total revenue

   $ 826,537         100   $ 742,647         100
  

 

 

    

 

 

   

 

 

    

 

 

 

Operating Costs, Excluding Depreciation and Amortization

 

      Nine Months ended March 31,  
     2014     2013     $ Variance     % Variance  
     (in thousands)  
Segment and consolidated operating costs, excluding depreciation and amortization:         

Physical Infrastructure

   $ 32,456      $ 27,986      $ 4,470        16

Lit Services

     72,811        74,743        (1,932     (3 )% 

Other

     9,813        10,755        (942     9

Corp/eliminations

     (4,446     (3,452     (994     29
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated

   $ 110,634      $ 110,032      $ 602        1
  

 

 

   

 

 

   

 

 

   

 

 

 

As a percentage of revenue

     13     15    

Our operating costs, which exclude depreciation and amortization, increased by $0.1 million, or 1%, from $110.0 million for the nine months ended March 31, 2013 to $110.6 million for the nine months ended March 31, 2014. The increase in consolidated operating costs was due to increased facility costs related to the zColo acquisitions offset by cost savings, as planned network related synergies were realized. Operating costs as a percentage of total revenue decreased from 15% to 13% as a result of cost reductions and because our incremental revenue typically has less third-party network service costs associated with it than the existing base of revenue.

Physical Infrastructure.    Our Physical Infrastructure operating costs increased by $4.5 million, or 16%, from $28.0 million to $32.5 million for the nine months ended March 31, 2013 and 2014, respectively. The increase in operating costs was primarily a result of zColo’s acquisitions in Fiscal 2013 and during the nine months ended March 31, 2014.

Lit Services.    Our Lit Services operating costs decreased by $1.9 million, or 3%, from $74.7 million to $72.8 million for the nine months ended March 31, 2013 and 2014, respectively. The 3% decrease in operating costs was primarily due to realized network-related cost synergies related to our acquisitions, and, to a lesser extent, ongoing off-net circuit cost reduction projects.

Other.    Our Other operating costs decreased by $1.0 million, or 9%, from $10.8 million to $9.8 million for the nine months ended March 31, 2013 and 2014, respectively. The reduction in other operating costs was primarily attributable to the reduction in equipment sales and corresponding decrease in equipment costs.

 

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Selling, General, and Administrative Expenses

The table below sets forth the components of our selling, general, and administrative (“SG&A”) expenses during the nine months ended March 31, 2014 and 2013.

 

     Nine months ended March 31,  
           2014                 2013           $ Variance     % Variance  
     (in thousands)              

Compensation and benefits expenses

   $ 74,914      $ 78,783      $ (3,869     (5 %) 

Network operations expenses

     96,508        83,019        13,489        16

Other SG&A expenses

     62,184        58,502        3,682        6

Transaction costs

     789        13,089        (12,300     (94 %) 

Stock-based compensation

     165,134        67,913        97,221        143
  

 

 

   

 

 

   

 

 

   

 

 

 

Total SG&A expenses

   $ 399,529      $ 301,306      $ 98,223        33
  

 

 

   

 

 

   

 

 

   

 

 

 

As a percentage of revenue

     48     41    

As a percentage of revenue (excluding stock-based compensation)

     28     31    

Compensation and Benefits Expenses.    Compensation and benefits expenses decreased by $3.9 million, or 5%, from $78.8 million to $74.9 million for the nine months ended March 31, 2013 and 2014, respectively.

The decrease reflected a reduction in bonus payout as the average payout in the nine months ended March 31, 2013 was approximately 140% of target as compared to approximately 100% of target in the nine months ended March 31, 2014. The nine months ended March 31, 2013 also included elevated compensation and benefits costs related to the acquisition and integration of AboveNet, including elevated severance and commission costs. Offsetting the reduction in compensation and benefits costs was the increase in headcount during the fourth quarter of Fiscal 2013 and the first three quarters of Fiscal 2014 to support our growing business, including certain employees retained from businesses acquired since March 31, 2013.

Headcount as of the end of the respective periods was:

 

     March 31,
2014
     March 31,
2013
 

Physical Infrastructure

     821         510   

Lit Services

     571         553   

Other

     29         26   
  

 

 

    

 

 

 

Total

     1,421         1,089   
  

 

 

    

 

 

 

Network Operations Expenses.    Network operations expenses increased by $13.5 million, or 16%, from $83.0 million to $96.5 million for the nine months ended March 31, 2013 and 2014, respectively. Contributing to the increase was a $2.5 million expense associated with a third party imposed relocation of our network infrastructure during the nine months ended March 31, 2014. The increase also reflected the growth of our network assets and the related expenses of operating that expanded network.

Other SG&A.    Other SG&A expenses increased by $3.7 million, or 6%, from $58.5 million to $62.2 million for the nine months ended March 31, 2013 and 2014, respectively. The increase was principally a result of additional expenses attributable to our Fiscal 2013 and Fiscal 2014 acquisitions, which were partially offset by the receipt of $3.8 million in connection with an escrow settlement reached relating to the 360networks acquisition during the second quarter of Fiscal 2014.

Transaction Costs.    Transaction costs decreased by $12.3 million, or 94%, from $13.1 million to $0.8 million for the nine months ended March 31, 2013 and 2014, respectively. The decrease was due to higher transaction-related costs in the first quarter of Fiscal 2013 associated with the AboveNet acquisition.

 

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Stock-Based Compensation.    Stock-based compensation expenses increased by $97.2 million, or 143%, from $67.9 million to $165.1 million during the nine months ended March 31, 2013 and 2014, respectively. The stock-based compensation expense associated with the common units is impacted by both the estimated value of the common units and the number of common units vesting during the period. The following table reflects the estimated fair value of the common units during the relevant periods impacting the stock-based compensation expense for the nine months ended March 31, 2014 and 2013.

 

     Estimated fair value as of  

Common Units

   March 31,
2014
     June 30,
2013
     March 31,
2013
     June 30,
2012
 
            (estimated value per unit)         

Class A

   $ 2.17       $ 1.50       $ 1.32       $ 0.92   

Class B

     1.93         1.34         1.16         0.81   

Class C

     1.65         1.14         0.96         0.68   

Class D

     1.60         1.10         0.93         0.65   

Class E

     1.38         0.95         0.78         0.55   

Class F

     1.22         0.75         0.68         0.49   

Class G

     0.65         0.46         0.31         n/a   

Class H

     0.53         0.38         0.24         n/a   

Class I

     0.31         n/a         n/a         n/a   

Class J

     0.22         n/a         n/a         n/a   

ZPS Class A

     0.20         0.20         n/a         n/a   

The increase in the estimated value of the common units in the current period is primarily a result of our organic growth since March 31, 2013 and cost synergies realized (and expected to be realized) from our prior acquisitions.

Depreciation and Amortization

Depreciation and amortization expense increased by $3.0 million, or 1%, from $243.9 million for the nine months ended March 31, 2013 to $246.9 million for the nine months ended March 31, 2014. The increase was primarily the result of depreciation related to capital expenditures since March 31, 2013 and acquisition-related growth.

Total Other Expenses, Net

The table below sets forth the components of our total other expenses, net for the nine months ended March 31, 2014 and 2013.

 

     Nine months ended March 31,  
             2014                     2013          
     (in thousands)  

Interest expense

   $ (150,905   $ (164,807

Loss on extinguishment of debt

     (1,911     (77,253

Other income, net

     1,266        302   
  

 

 

   

 

 

 

Total other expenses, net

   $ (151,550   $ (241,758
  

 

 

   

 

 

 

Interest Expense.    Interest expense decreased by $13.9 million, or 8%, from $164.8 million to $150.9 million for the nine months ended March 31, 2013 and 2014, respectively. The decrease in interest expense was primarily the result of the amendment of our Credit Agreement during the second and third quarters of Fiscal 2013 to lower the interest rates on our Term Loan Facility and Revolver, in addition to quarterly principal payments on our Term Loan Facility, which reduced our outstanding debt obligations. Also contributing to the decrease in interest expense was the impact of changes in market value of our interest rate swap during the nine months ended March 31, 2014 as compared

 

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to the comparable period. We recorded additional interest expense of $1.9 million during the nine months ended March 31, 2014, as compared to additional $5.1 million of additional interest expense during the nine months ended March 31, 2013 to reflect the change in the fair value of our interest rate swaps, representing a change in interest expense of $3.2 million. The decrease was partially offset by additional interest expense related to the $150.0 million add-on to our Term Loan Facility during the second quarter of Fiscal 2014.

Loss on Extinguishment of Debt.    In connection with the debt refinancing activities during the second quarter of Fiscal 2014, we recognized an expense of $1.9 million associated with debt extinguishment costs, including a cash expense of $0.9 million associated with the payment of third party costs and non-cash expenses of $1.0 million, consisting of $0.7 million associated with the write-off of unamortized debt issuance costs and $0.3 million associated with the write-off of the net unamortized discount on the extinguished debt balances.

In connection with the debt refinancing activities during the nine months ended March 31, 2013, we recognized an expense of $77.3 million associated with debt extinguishment costs, including a cash expense of $43.1 million associated with the payment of early redemption fees and other third party expenses on our previous indebtedness and non-cash expenses, including $34.2 million associated with the write-off of unamortized debt issuance costs and unamortized discounts.

Other Income, net.    Other income, net during the nine months ended March 31, 2014 primarily related to an unrealized foreign currency translation gain on an intercompany loan. Our domestic subsidiaries have an intercompany loan denominated in U.S. dollars with our U.K. foreign subsidiary. The intercompany loan balance is eliminated in consolidation; however, the weakening of the British pound over the U.S. dollar during the nine months ended March 31, 2014 resulted in an unrealized foreign currency translation gain on the intercompany loan of $0.9 million at our foreign subsidiary.

Provision for Income Taxes

We recorded a provision for income taxes of $27.2 million during the nine months ended March 31, 2014 as compared to a benefit of $33.5 million during the nine months ended March 31, 2013. 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. We were unable to combine our NOLs for application to the income of our subsidiaries in some states and thus our state income tax expense was higher than the expected blended rate. In addition, as a result of our stock-based compensation and certain transaction costs not being deductible for income tax purposes, our effective tax rate was higher than the statutory rate.

Our foreign operations have historically incurred operating losses. In the event that we have future positive earnings in foreign jurisdictions and repatriate these funds, we would be required to accrue and pay the appropriate income tax in the U.S. It is our intent that any current or future profits from foreign operations will be reinvested in those foreign jurisdictions.

 

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The following table reconciles an expected tax provision based on the statutory federal tax rate applied to our earnings before income taxes to our actual provision/(benefit) for income taxes:

 

     Nine months ended March 31,  
             2014                     2013          
     (in thousands)  

Expected benefit at statutory rate

   $ (28,559   $ (54,021

Increase/(decrease) due to:

    

Non-deductible stock-based compensation

     62,554        22,968   

State income taxes (benefit), net of federal benefit

     (3,928     (4,942

Transactions costs not deductible for tax purposes

     201        970   

Foreign tax rate differential

     (62     (1,096

Provision to return adjustment

     (514       

Release of accrual for uncertain tax position

     (2,600       

Other, net

     110        2,572   
  

 

 

   

 

 

 

Provision/(benefit) for income taxes

   $ 27,202      $ (33,549
  

 

 

   

 

 

 

Year Ended June 30, 2013 Compared to the Year Ended June 30, 2012

Revenue

 

     Year ended June 30,  
     2013     2012     $ Variance     % Variance  
     (in thousands)  
Segment and consolidated revenue:         

Physical Infrastructure

   $ 415,454      $ 157,419      $ 258,035        164

Lit Services

     572,631        224,624        348,007        155

Other

     27,775               27,775          

Corp/eliminations

     (11,506     (6,517     (4,989     77
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated

   $ 1,004,354      $ 375,526      $ 628,828        167
  

 

 

   

 

 

   

 

 

   

 

 

 

Our total revenue increased by $628.8 million, or 167%, from $375.5 million for Fiscal 2012 to $1,004.4 million for Fiscal 2013. The increase in revenue was driven by our organic growth and Fiscal 2012 and 2013 acquisitions.

We estimate that we achieved an organic growth rate from Fiscal 2012 to Fiscal 2013 of approximately 6%. Our organic growth was driven by installs that exceeded churn in both periods, resulting from strong demand for bandwidth infrastructure services broadly across our geographic markets and customer verticals. Further underlying organic activity drivers during the period included:

 

   

Bookings approximately doubled, increasing from $8.5 million to $17.7 million in combined MRR and MAR. This growth was primarily driven by the addition of the AboveNet fiber assets, select salespeople and customer relationships used to market our services across a broader set of assets. Our bookings grew over the course of Fiscal 2013, with each quarter’s results exceeding the prior. The total contract value associated with Fiscal 2013 bookings was approximately $1 billion.

 

   

Installs more than doubled between the two periods from $7.4 million to $18.4 million, and were the primary driver of our organic revenue growth. This install activity was directly correlated to our bookings; however,

 

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there was a natural time lag between the booking and the associated install. We believe our ability to install bookings on a timely basis improved throughout the year as we completed the integration activities associated with the Fiscal 2012 acquisitions and substantially integrated the AboveNet acquisition.

 

   

The monthly churn percentage increased slightly from 1.3% to 1.4% between the two periods, with total churn increasing from $4.9 million to $13.6 million. This Fiscal 2013 churn percentage remained within our expected range. However, following our acquisition of AboveNet, we made a conscious and active effort to re-term former AboveNet customers in order to significantly extend the average remaining contract life of our services and revenue. These actions often required some price concession to our customers (which had a resulting churn impact) in exchange for a longer term.

The three Fiscal 2012 acquisitions were completed on December 1, 2011, December 31, 2011 and May 1, 2012 and therefore were included in our results of operations for seven, six and two months, respectively, in Fiscal 2012 compared to a full twelve months in Fiscal 2013. The most significant acquisition in Fiscal 2012 was 360networks. The acquisition of 360networks added substantial metro and regional network assets in the Western U.S. The six Fiscal 2013 acquisitions were completed at various times throughout the year with the largest, AboveNet, closing on July 2, 2012 and being included in our Fiscal 2013 results of operations for the entire twelve month period. The AboveNet acquisition significantly expanded our metro fiber assets in some of largest U.S. metro markets plus London, and provided important new customer relationships and product capabilities that we applied across our combined networks. The acquisition of AboveNet had the impact of more than doubling our previous revenue run rate.

Physical Infrastructure.    Revenues from our Physical Infrastructure segment increased by $258.0 million, or 164%, from $157.4 million to $415.5 million for Fiscal 2012 and Fiscal 2013, respectively.

We estimate that organic revenue growth for the Physical Infrastructure segment was approximately 12%. This was influenced by the increasing importance of bandwidth for our customers (in volume and criticality), and, in select cases, reflects a shift from lit services to physical infrastructure products. This is evidenced by strong bookings and install activity on large FTT projects for many of the major wireless carriers. Bookings of MRR and MAR during Fiscal 2013 totaled $6.3 million (with a total contract value of $610 million), compared to $5.3 million in Fiscal 2012. Installs were $6.5 million in Fiscal 2013, an increase from $3.5 million in the prior year. The monthly churn percentage improved from 1.1% to 0.9% between the two years; however, total churn grew from $1.7 million to $3.8 million in Fiscal 2013 as a result of the larger base of revenue. The six Fiscal 2013 acquisitions were disproportionately weighted towards Physical Infrastructure products, and therefore acquisitions had a larger impact on this segment. Each of our Fiscal 2012 acquisitions were heavily weighted towards dark fiber and colocation services.

Lit Services.    Our revenues from our Lit Services segment increased by $348.0 million, or 155%, from $224.6 million to $572.6 million for Fiscal 2012 and Fiscal 2013, respectively.

We estimate that organic revenue growth for the Lit Services segment was approximately 3%. This performance reflected higher churn related to proactively re-terming select Lit Services customer contracts in exchange for certain price concessions. Additionally, we experienced migration of select wavelength customers to dark fiber. Demand for Lit Services remained strong, as evidenced by $11.3 million of Fiscal 2013 bookings (totaling approximately $375 million in total contract value), versus $3.2 million in Fiscal 2012. This growth was supported by new geographies and routes, as well as enhanced Ethernet and IP capabilities that were acquired through the AboveNet acquisition. Installs were in line with bookings in Fiscal 2013, totaling $11.8 million of MRR and MAR. The monthly churn percentage increased from 1.5% to 1.7% between the two periods, resulting in total churn processed of $9.6 million, compared to $3.2 million in the prior fiscal year. AboveNet’s large base of wavelength and Ethernet customers was the primary contributor to the Lit Services inorganic growth.

 

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Other.    Our Other segment, consisting of Zayo Professional Services, was a new addition in Fiscal 2013 through the acquisition of AboveNet. The Other segment represented approximately 3% of our total revenue in Fiscal 2013.

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 (MRR).

 

     Year ended June 30,  
     2013     2012  
     (in thousands)  

Monthly recurring revenue

   $ 941,076         94   $ 350,900         93

Monthly amortized revenue

     43,140         4     13,785         4

Other revenue

     20,138         2     10,841         3
  

 

 

    

 

 

   

 

 

    

 

 

 

Total revenue

   $ 1,004,354         100   $ 375,526         100
  

 

 

    

 

 

   

 

 

    

 

 

 

Operating Costs, Excluding Depreciation and Amortization

 

     Year ended June 30,  
     2013     2012     $ Variance     % Variance  
     (in thousands)  
Segment and consolidated operating costs, excluding depreciation and amortization:         

Physical Infrastructure

   $ 37,146      $ 21,677      $ 15,469        71

Lit Services

     99,443        60,899        38,544        63

Other

     14,377               14,377        100

Corp/eliminations

     (5,089     (493     (6,140     1245
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated

   $ 145,877      $ 82,083      $ 63,794        78
  

 

 

   

 

 

   

 

 

   

 

 

 

As a percentage of revenue

     15     22    

Our operating costs, excluding depreciation and amortization, increased by $63.8 million, or 78%, from $82.1 million for Fiscal 2012 to $145.9 million for Fiscal 2013. The increase in consolidated operating costs primarily related to our Fiscal 2012 and Fiscal 2013 acquisitions, and additional network costs incurred in order to support new customer contracts entered into subsequent to June 30, 2012. Operating costs as a percentage of total revenue decreased from 22% to 15% principally due to the shift in product mix (namely the increased percentage of dark fiber) associated with the July 2, 2012 acquisition of AboveNet. Also, as a result of the acquisition of AboveNet and its status as a Tier 1 settlement-free peering partner, we were able to eliminate IP transit costs that we previously incurred by the Company.

Physical Infrastructure.    Our Physical Infrastructure operating costs increased by $15.5 million, or 71%, from $21.7 million to $37.1 million for Fiscal 2012 and Fiscal 2013, respectively. As a percentage of revenue physical infrastructure operating costs decreased materially reflecting the higher proportion of acquired dark fiber with little to no associated network costs.

Lit Services.    Our Lit Services operating costs increased by $38.5 million, or 63%, from $60.9 million to $99.4 million for Fiscal 2012 and Fiscal 2013, respectively. As a percentage of revenue Lit Services operating costs also decreased significantly. While the acquired AboveNet Lit Services did have associated network expenses, the proportion of those expenses to revenue was lower for AboveNet than the Company.

Other.    Our Other operating costs increased by $14.4 million, from $0.0 million to $14.4 million for Fiscal 2012 and Fiscal 2013, respectively. The increase was entirely the result of acquiring the ZPS strategic product group through the acquisition of AboveNet.

 

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Selling, General, and Administrative Expenses

The table below sets forth the components of our selling, general, and administrative (“SG&A”) expenses during the years ended June 30, 2013 and 2012.

 

     Year ended June 30,  
     2013     2012     $ Variance      % Variance  
     (in thousands)               

Compensation and benefits expenses

   $ 101,955      $ 42,635      $ 59,320         139

Network operations expenses

     119,850        37,097        82,753         223

Other SG&A expenses

     82,514        26,048        56,466         217

Transaction costs

     14,204        6,630        7,574         114

Stock-based compensation

     105,849        26,253        79,596         303
  

 

 

   

 

 

   

 

 

    

 

 

 

Total SG&A expenses

   $ 424,372      $ 138,663      $ 285,709         206
  

 

 

   

 

 

   

 

 

    

 

 

 

As a percentage of revenue

     42     37     

As a percentage of revenue, excluding stock-based compensation

     32     30     

Compensation and Benefits Expenses.    Compensation and benefits expenses increased by $59.3 million, or 139%, from $42.6 million to $102.0 million for Fiscal 2012 and Fiscal 2013, respectively.

The compensation and benefits increase reflects the increased number of employees resulting from the AboveNet acquisition and to a lesser extent employees hired during the year to support our growing business as well as employees retained from other Fiscal 2013 acquisitions. A majority of the increase to our headcount occurred on July 2, 2012 as a result of hiring certain former employees of AboveNet.

Head count as of the end of the respective periods was:

 

     June 30,
2013
     June 30,
2012
 

Physical Infrastructure

     584         225   

Lit Services

     546         275   

Other

     30           
  

 

 

    

 

 

 

Total

     1,160         500   
  

 

 

    

 

 

 

Network Operations Expenses.    Network operations expenses increased by $82.8 million, or 223%, from $37.1 million to $119.9 million for Fiscal 2012 and Fiscal 2013, respectively. The increase principally reflected the growth of our network assets and the related expenses of operating that expanded network. Our total network route miles increased approximately 63% from 46,504 miles at June 30, 2012 to 75,839 miles at June 30, 2013 (largely related to the acquisition of AboveNet). Also contributing to the increase was a one-time charge of $6.6 million related to lease termination costs associated with exit activities initiated for unutilized technical facilities space recognized during the fourth quarter of Fiscal 2013.

Other SG&A.    Other SG&A expenses increased by $56.5 million, or 217%, from $26.0 million to $82.5 million for the Fiscal 2012 and Fiscal 2013, respectively. The increase was principally a result of additional expenses attributable to our Fiscal 2013 and Fiscal 2012 acquisitions. In addition, during the fourth quarter of Fiscal 2013, we recognized a one-time charge of $3.6 million related to lease termination costs associated with exit activities initiated for unutilized office space.

Transaction Costs.    Transaction costs increased by $7.6 million, or 114%, from $6.6 million to $14.2 million for Fiscal 2012 and Fiscal 2013, respectively. This increase was primarily due to the AboveNet acquisition.

 

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Stock-Based Compensation.    Stock-based compensation expenses increased by $79.6 million, or 303%, from $26.3 million to $105.8 million for Fiscal 2012 and Fiscal 2013, respectively. The stock-based compensation expense associated with the common units was impacted by both the estimated value of the common units and the number of common units vesting during the period. The following table reflects the estimated fair value of the common units during the relevant periods impacting the stock-based compensation expense for the years ended June 30, 2013 and 2012.

 

     Estimated fair value as of June 30,  

Common Units

   2013      2012      2011  

Class A

   $ 1.50       $ 0.92       $ 0.81   

Class B

     1.34         0.81         0.58   

Class C

     1.14         0.68         0.33   

Class D

     1.10         0.65         0.31   

Class E

     0.95         0.55         0.23   

Class F

     0.75         0.49         n/a   

Class G

     0.46         n/a         n/a   

Class H

     0.38         n/a         n/a   

ZPS Class A

     0.20         n/a         n/a   

The increase in the value of the common units in the current period was primarily a result of our organic growth since June 30, 2012, cost synergies realized and expected to be realized from our prior acquisitions and a reduction to the discount rate utilized in the Company’s valuation of the common units resulting from our reduced financing costs.

We recognize changes in the fair value of the common units through increases or decreases in stock-based compensation expense and adjustments to the related stock-based compensation liability. The stock-based compensation liability associated with the common units was $159.3 million and $54.4 million as of June 30, 2013 and June 30, 2012, respectively. The liability was impacted by changes in the estimated value of the common units, number of vested common units, and distributions made to holders of the common units.

In December 2011, CII and the preferred unit holders of CII authorized a non-liquidating distribution to common unit holders of up to $10.0 million. The eligibility for receiving proceeds from the distribution was determined by the liquidation preference of the unit holder. Receiving proceeds from the authorized distribution was at the election of the common unit holder. As a condition of the early distribution, common unit holders electing to receive an early distribution received 85% of the amount that they would otherwise be entitled to receive if the distribution were in connection with a liquidating distribution. The common unit holders electing to receive the early distribution retained all of their common units and are entitled to receive future distributions only to the extent such future distributions are in excess of the non-liquidating distribution, excluding the 15% discount. During the year ended June 30, 2012, $8.8 million was distributed to CII’s common unit holders. Common unit holders electing to receive the early distribution forfeited $1.6 million in previously recognized stock-based compensation, which was recorded as a reduction to the stock-based compensation liability during the year ended June 30, 2012.

Depreciation and Amortization

Depreciation and amortization expense increased by $239.6 million, or 282%, from $85.0 million for Fiscal 2012 to $324.5 million for Fiscal 2013. The increase was a result of the substantial increase to our property and equipment and intangible assets since June 30, 2012, principally a result of our Fiscal 2012 and Fiscal 2013 acquisitions and capital expenditures since June 30, 2012.

 

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Total Other Expenses, Net

The table below sets forth the components of our total other expenses, net for the years ended June 30, 2013 and 2012.

 

     Year ended June 30,  
     2013     2012  
     (in thousands)  

Interest expense

   $ (202,464   $ (50,720

Loss on extinguishment of debt

     (77,253       

Impairment of cost method investment

            (2,248

Other income, net

     326        123   
  

 

 

   

 

 

 

Total other expenses, net

   $ (279,391   $ (52,845
  

 

 

   

 

 

 

Interest expense.    Interest expense increased by $151.7 million, or 299%, from $50.7 million to $202.5 million for Fiscal 2012 and Fiscal 2013, respectively. The increase was a result of our increased indebtedness during Fiscal 2013 as compared to Fiscal 2012, partially offset by a decrease in our weighted-average interest rate from Fiscal 2012 to Fiscal 2013.

Loss on extinguishment of debt.    In connection with the repayment of our previously existing term loan and revolver and redemption of our $350.0 million outstanding aggregate principal amount of previously issued notes in July 2012 (the “Debt Refinancing Activities”) and the subsequent re-pricing transactions completed during the second and third quarters of Fiscal 2013 related to our Term Loan Facility and Revolver (the “Second and Fourth Amendments”), we recorded a loss on extinguishment of debt totaling $77.3 million during the year ended June 30, 2013. In connection with the Debt Refinancing Activities, discussed above, we recognized an expense of $65.0 million associated with debt extinguishment costs, including a cash expense of $39.8 million associated with the payment of early redemption fees on our previous indebtedness and non-cash expenses of $17.0 million associated with the write-off of our unamortized debt issuance costs and $8.1 million associated with the write off of the net unamortized discount on the extinguished debt balances. In connection with the Second and Fourth Amendments, we recognized a loss on extinguishment of debt of $12.3 million. The loss consisted of a cash expense of $3.3 million associated with the payment of an early call premium paid to certain creditors and other third party expenses and $9.0 million associated with the write-off of unamortized debt issuance costs and discounts.

Impairment of cost method investment.    In connection with the October 1, 2010 acquisition of American Fiber Systems, we acquired an ownership interest in USCarrier. As of June 30, 2012, we owned 55% of the outstanding Class A membership units and 34% of the outstanding Class B membership units. On August 15, 2012, we entered into an agreement to acquire the remaining equity interest in USCarrier. As a result of certain disputes with the board of managers of USCarrier, we were unable to exercise control or significant influence over USCarrier’s operating and financial policies and as a result we accounted for this investment utilizing the cost method of accounting. Based upon the agreed upon purchase price of the remaining equity interests, we determined the fair value of our ownership interest in USCarrier as of June 30, 2012 to be $12.8 million and recognized an impairment of $2.2 million during the quarter ended June 30, 2012.

Provision for Income Taxes

We recorded a benefit for income taxes of $24.2 million during Fiscal 2013 as compared to a provision for income taxes of $26.9 million during Fiscal 2012. Our provision for income taxes included both the current and deferred provision for income tax expense resulting from timing differences between tax and financial reporting accounting bases. We were unable to combine our net operating losses (“NOLs”) for application to the income of our subsidiaries in some states and thus our state income tax expense was higher than the expected blended rate. During the year ended June 30, 2013, we dissolved certain acquired legal entities, which resulted in the loss of state NOLs that were generated by those entities. The loss of these NOLs resulted in an increase to the provision

 

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for income taxes of $2.8 million during the year ended June 30, 2013. In addition, as a result of our stock-based compensation and certain transaction costs not being deductible for income tax purposes, our effective tax rate was higher than the statutory rate. The following table reconciles our expected tax provision based on the statutory federal tax rate applied to our earnings before income taxes to our actual provision/(benefit) for income taxes:

 

     Year ended June 30,  
     2013     2012  
     (in thousands)  

Expected provision at statutory rate

   $ (59,469   $ 5,941   

Increase due to:

    

Non-deductible stock-based compensation

     35,879        8,685   

State income taxes, net of federal benefit

     (2,243     4,855   

Transactions costs not deductible for tax purposes

     1,257        1,416   

Foreign tax rate differential

     (2,264       

Change in uncertain tax positions

            5,808   

Change in effective tax rate

            459   

State NOL adjustment

     2,788          

Other, net

     (153     (293
  

 

 

   

 

 

 

Provision/(benefit) for income taxes

   $ (24,205   $ 26,871   
  

 

 

   

 

 

 

Year Ended June 30, 2012 Compared to the Year Ended June 30, 2011

Revenue

 

     Year ended June 30,  
     2012     2011     $ Variance     % Variance  
     (in thousands)  
Segment and consolidated revenue:         

Physical Infrastructure

   $ 157,419      $ 110,868      $ 46,551        42

Lit Services

     224,624        176,367        48,257        27

Corp/eliminations

     (6,517     (5,092     (1,425     28
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated

   $ 375,526      $ 282,143      $ 93,383        33
  

 

 

   

 

 

   

 

 

   

 

 

 

Our total revenue increased by $93.4 million, or 33%, from $282.1 million for Fiscal 2011 to $375.5 million for Fiscal 2012. The increase in revenue was driven by our organic growth as well as our Fiscal 2011 and Fiscal 2012 acquisitions.

We estimate that we achieved an organic growth rate from Fiscal 2011 to Fiscal 2012 of approximately 9%. Our organic growth was driven by installs exceeding churn in both periods, resulting from strong demand for bandwidth infrastructure services across our growing geographic coverage area. Further underlying revenue drivers during the period included:

 

   

Bookings increased from $6.3 million to $8.5 million in MRR and MAR. This growth was driven by our expansion from a regional to national provider of bandwidth infrastructure, as well as from expanding into two new product areas – dark fiber and IP services. The total contract value associated with Fiscal 2012 bookings was approximately $650 million.

 

   

Installs also grew, increasing from $5.8 million to $7.4 million between the two periods.

 

   

The monthly churn percentage increased slightly between the two periods, from 1.2% to 1.3%, resulting in total churn increasing from $3.5 million to $4.9 million.

 

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We completed two acquisitions in Fiscal 2011. The first, AGL, was completed on July 1, 2010, and was included in our results of operations for all of Fiscal 2011 and Fiscal 2012 and therefore was not a contributor to the year-over-year revenue growth. AGL was notable in that it represented the Company’s first substantive move into providing dark fiber as a product and was the catalyst for forming our Dark Fiber Strategic Product Group. American Fiber Systems was completed on October 1, 2010 and was included in our results of operations for nine months of Fiscal 2011. American Fiber Systems contributed many of the Western U.S. metro markets that the 360networks acquisition later connected. Of the three Fiscal 2012 acquisitions, the most significant contributor to revenue growth was the acquisition of 360networks on December 1, 2011. The acquisition of 360networks added substantial metro and regional network assets in the Western U.S.

Physical Infrastructure.    Revenues from our Physical Infrastructure segment increased by $46.6 million, or 42%, from $110.9 million to $157.4 million for Fiscal 2011 and Fiscal 2012, respectively.

We estimate that organic revenue growth for the Physical Infrastructure segment was approximately 21%, highlighting our focus on the business and customers’ growing need for infrastructure solutions. Our dark fiber product experienced growth in Fiscal 2012, its second fiscal year after its launch following the AGL acquisition, and benefited from the increasing customer demand and the additional American Fiber Systems and 360networks fiber assets. Our FTT product was a contributor to organic growth as well, as we were awarded and delivered on multiple large FTT deployments. Our colocation product grew as a result of our MarquisNet acquisition in Las Vegas. Bookings of MRR and MAR in Fiscal 2012 were $5.3 million (with a total contract value of approximately $540 million), compared to $2.9 million in Fiscal 2011. Installs were $3.5 million in Fiscal 2012, an increase from $2.7 million in the prior year. The monthly churn percentage was constant at 1.1% during the two periods, as total churn grew from $1.2 million to $1.7 million, in line with revenue growth. All of the Fiscal 2011 and Fiscal 2012 acquisitions impacted the Physical Infrastructure business, with AGL (dark fiber) and MarquisNet (colocation) being exclusively Physical Infrastructure transactions.

Lit Services.    Our revenues from our Lit Services segment increased by $48.3 million, or 27%, from $176.4 million to $224.6 million for Fiscal 2011 and Fiscal 2012, respectively.

We estimate that organic revenue growth for the Lit Services segment was approximately 3%. Demand for Lit Services continued to grow, supported by new metro and regional networks and routes as well as enhanced Ethernet and IP capabilities that were acquired through the 360networks transaction. Our wavelengths product performed strongly as customers increasingly sought out higher bandwidth solutions. Bookings in Fiscal 2012 were $3.2 million (with approximately $110 million in total contract value) versus $3.4 million in the prior fiscal year (boosted by a large individual sale). Installs were $3.9 million in Fiscal 2012, compared to $3.1 million in the prior fiscal year. The monthly churn percentage increased from 1.3% to 1.5% over the two periods, resulting in total churn of $3.3 million, compared to $2.4 million in the prior fiscal year. 360networks was the most significant acquisition in Fiscal 2012, contributing a material amount of wavelength, Ethernet and IP services revenue to the Lit Services segment.

Other.    We did not operate any businesses or have any financial results in our Other segment during these periods.

 

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Other revenue increased as a percentage of total revenue over the two years primarily as a result of an increase in early termination related revenue. 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 (MRR).

 

     Year ended June 30,  
     2012     2011  
     (in thousands)  

Monthly recurring revenue

   $ 350,900         93   $ 269,170         95

Monthly amortized revenue

     13,785         4     8,976         3

Other revenue

     10,841         3     3,997         2
  

 

 

    

 

 

   

 

 

    

 

 

 

Total revenue

   $ 375,526         100   $ 282,143         100
  

 

 

    

 

 

   

 

 

    

 

 

 

Operating Costs, Excluding Depreciation and Amortization

 

     Year ended June 30,  
     2012     2011     $ Variance     % Variance  
     (in thousands)  
Segment and consolidated operating costs, excluding depreciation and amortization:         

Physical Infrastructure

   $ 21,677      $ 18,002      $ 3,675        20

Lit Services

     60,899        49,920        10,979        22

Other

        

Corp/eliminations

     (493     3,056        (3,549     (116 %) 
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated

   $ 82,083      $ 70,978      $ 11,105        16
  

 

 

   

 

 

   

 

 

   

 

 

 

As a percentage of revenue

     22     25    

Our operating costs, excluding depreciation and amortization, increased by $11.1 million, or 16% from $71.0 million for Fiscal 2011 to $82.1 million for Fiscal 2012. The increase in consolidated operating costs primarily related to additional network costs incurred in order to support new customer contracts entered into subsequent to June 30, 2011 and additional costs assumed from our Fiscal 2011 and Fiscal 2012 acquisitions. Operating costs as a percentage of total revenue decreased from 25% to 22% as incremental revenue typically had less third-party network service cost associated with it than the existing base of revenue. We also benefited from operating cost savings as planned network-related cost synergies from prior acquisitions were realized.

Physical Infrastructure.    Our Physical Infrastructure operating costs increased by $3.7 million, or 20%, from $18.0 million to $21.7 million for the years ended June 30, 2011 and 2012, respectively.

Lit Services.    Our Lit Services operating costs increased by $11.0 million, or 22%, from $49.9 million to $60.9 million for the years ended June 30, 2011 and 2012, respectively.

 

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Selling, General and Administrative Expenses

The table below sets forth the components of our SG&A expenses during the years ended June 30, 2012 and 2011.

 

     Year ended June 30,  
     2012     2011     $ Variance      % Variance  
     (in thousands)               

Compensation and benefits expenses

   $ 47,102      $ 39,640      $ 7,462         19

Network operations expenses

     37,097        27,560        9,537         35

Other SG&A expenses

     21,581        20,349        1,232         6

Transaction costs

     6,630        865        5,765         666

Stock-based compensation

     26,253        24,310        1,943         8
  

 

 

   

 

 

   

 

 

    

 

 

 

Total SG&A expenses

   $ 138,663      $ 112,724      $ 25,939         23
  

 

 

   

 

 

   

 

 

    

 

 

 

As a percentage of revenue

     37     40     

As a percentage of revenue, excluding stock-based compensation

     30     31     

Compensation and Benefits Expenses.    Compensation and benefits expenses increased by $7.5 million, or 19%, from $39.6 million to $47.1 million for Fiscal 2011 and Fiscal 2012, respectively.

The increase in compensation and benefits reflected the increased number of employees, the largest component of which resulted from our acquisition of 360networks. Also contributing to the increase in compensation and benefits expenses was the increase in bonus payouts from approximately 100% of target in Fiscal 2011 to approximately 140% of target in Fiscal 2012.

Headcount as of the end of the respective periods was:

 

     June 30,
2012
     June 30,
2011
 

Physical Infrastructure

     225         158   

Lit Services

     275         238   

Other

               
  

 

 

    

 

 

 

Total

     500         396   
  

 

 

    

 

 

 

Network Operations Expenses.    Network operations expenses increased by $9.5 million, or 35%, from $27.6 million to $37.1 million for Fiscal 2011 and Fiscal 2012, respectively. The increase principally reflected the growth of our network assets and the related expenses of operating that expanded network. Our total network route miles increased approximately 92% from 24,251 miles at June 30, 2011 to 46,504 miles at June 30, 2012.

Other SG&A.    Other SG&A expenses increased by $1.2 million, or 6%, from $20.3 million to $21.6 million for Fiscal 2011 and Fiscal 2012, respectively. The increase in other SG&A was primarily due to additional expenses associated with our acquisitions of 360networks and MarquisNet.

Transaction Costs.    Transaction costs increased during Fiscal 2012 by $5.8 million as a result of costs associated with our acquisitions of 360networks, MarquisNet, Arialink, AboveNet, FiberGate, and USCarrier.

Stock-Based Compensation.    Stock-based compensation expense increased by $1.9 million, or 8%, from $24.3 million to $26.3 million for Fiscal 2011 and Fiscal 2012, respectively.

 

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The stock-based compensation expense associated with the common units is impacted by both the estimated value of the common units and the number of common units vesting during the period. During the year ended June 30, 2012, an additional 9.4 million units vested as compared to the year ended June 30, 2011. The following table reflects the estimated fair value of the common units during the relevant periods impacting the stock-based compensation expense for the years ended June 30, 2012 and 2011.

 

     Estimated fair value as of June 30,  

Common Units of CII

   2012      2011      2010  

Class A

   $ 0.92       $ 0.81       $ 0.49   

Class B

     0.81         0.58         0.28   

Class C

     0.68         0.33         0.03   

Class D

     0.65         0.31         n/a   

Class E

     0.55         0.23         n/a   

Class F

     0.49         n/a         n/a   

Depreciation and Amortization

Depreciation and amortization expense increased by $24.5 million, or 41%, from $60.5 million for Fiscal 2011 to $85.0 million for Fiscal 2012. The increase was a result of the substantial increase to our property and equipment and intangible assets since June 30, 2011, principally a result of capital expenditures since June 30, 2011 and the increase to our property and equipment and intangible asset balance due to the American Fiber Systems acquisition on October 1, 2010, the 360networks acquisition on December 1, 2011, the Marquisnet acquisition on December 31, 2011, and the Arialink acquisition on May 1, 2012.

Total Other Expenses, Net

The table below sets forth the components of our total other expenses, net for the years ended June 30, 2012 and 2011.

 

     Year ended June 30,  
     2012     2011  
     (in thousands)  

Interest expense

   $ (50,720   $ (33,414

Impairment of cost method investment

     (2,248       

Other income (expense), net

     123        (126
  

 

 

   

 

 

 

Total other expenses, net

   $ (52,845   $ (33,540
  

 

 

   

 

 

 

Interest Expense.    Interest expense increased by $17.3 million, or 52%, from $33.4 million to $50.7 million for Fiscal 2011 and Fiscal 2012, respectively. The increase was a result of our increased indebtedness during the year ended June 30, 2012 as compared to the year ended June 30, 2011. In connection with the 360networks acquisition, we entered into a $315.0 million term loan agreement on December 1, 2011, which accrued interest during the period at 7.0%. During the quarter ended March 31, 2012, we borrowed an additional $30.0 million against our then-existing revolving credit facility, which accrued interest at a floating rate ranging from 4.0% to 4.75% during the period.

Impairment of cost method investment.    In connection with the American Fiber Systems acquisition, we acquired an ownership interest in USCarrier. As of June 30, 2012, we owned 55% of the outstanding Class A membership units and 34% of the outstanding Class B membership units. On August 15, 2012, we entered into an agreement to acquire the remaining equity interest in USCarrier. As a result of certain disputes with the board of managers of USCarrier, we were unable to exercise control or significant influence over USCarrier’s operating and financial policies and so we accounted for this investment utilizing the cost method of accounting. Based upon the agreed upon purchase price of the remaining equity interests, we determined the fair value of our ownership interest in USCarrier as of June 30, 2012 to be $12.8 million, and recognized an impairment of $2.2 million during the quarter ended June 30, 2012.

 

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Provision for Income Taxes

Income tax expense increased over the prior year by $15.6 million, from $11.3 million for Fiscal 2011 to $26.9 million for Fiscal 2012. 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. We were unable to combine our net operating losses (“NOLs”) for application to the income of our subsidiaries in some states and thus our state income tax expense was higher than the expected blended rate. In addition, as a result of our stock-based compensation and certain transaction costs not being deductible for income tax purposes, our effective tax rate was higher than the statutory rate.

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.

 

      Year ended June 30,  
      2012     2011  

Expected provision at statutory rate

   $ 5,941      $ 1,505   

Increase due to:

    

Non-deductible stock-based compensation

     8,685        7,824   

State income taxes, net of federal benefit

     4,855        1,412   

Transactions costs not deductible for tax purposes

     1,416        294   

Provision for uncertain tax provisions, net

     5,808          

Change in effective tax rate

     459          

Other, net

     (293     294   
  

 

 

   

 

 

 

Provision for income taxes

   $ 26,871      $ 11,329   
  

 

 

   

 

 

 

Adjusted EBITDA

We define Adjusted EBITDA as earnings from continuing operations before interest, income taxes, depreciation and amortization (“EBITDA”) adjusted to exclude acquisition-related transaction costs, losses on extinguishment of debt, stock-based compensation, unrealized foreign currency translation gains on an intercompany loan, and impairment of cost method investment. 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 Indenture. 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 from operations and operating cash flows 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;

 

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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 net earnings/(loss) from continuing operations to Adjusted EBITDA are as follows:

Reconciliation from net earnings/(loss) to Adjusted EBITDA

 

     Nine months ended March 31, 2014  
     Physical
Infrastructure
    Lit Services      Other      Corp/
eliminations
    Total  

Net earnings/(loss)

   $ (119.4   $ 38.0       $ 3.0       $ (27.4   $ (105.6

Earnings from discontinued operations, net of income taxes

                            (3.7     (3.7

Interest expense

     90.2        60.7                        150.9   

Provision for income taxes

                            27.2        27.2   

Depreciation and amortization expense

     149.3        95.9         1.7                246.9   

Transaction costs

     0.6        0.1                        0.8   

Stock-based compensation

     115.3        49.1