#
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number:
(Exact Name of Registrant as Specified in Its Charter)
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
(Address of Principal Executive Offices)
(
(Registrant’s Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
Not applicable | Not applicable | Not applicable |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer |
| ◻ |
| Accelerated filer |
| ◻ |
⌧ | Smaller reporting company | |||||
Emerging growth company | ||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻
Indicate by check mark whether the registrant is a shell company (as defined in Rule b-2 of the Exchange Act). Yes
ZAYO GROUP, LLC AND SUBSIDIARIES
INDEX
ZAYO GROUP, LLC AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in millions)
| December 31, 2019 |
| June 30, | |||
Assets | ||||||
Current assets | ||||||
Cash and cash equivalents | $ | | $ | | ||
Trade receivables, net of allowance of $ | | | ||||
Prepaid expenses | | | ||||
Other current assets | | | ||||
Total current assets | | | ||||
Property and equipment, net | | | ||||
Intangible assets, net | | | ||||
Goodwill | | | ||||
Right-of-use operating lease assets | | — | ||||
Deferred income taxes, net | | | ||||
Other assets | | | ||||
Total assets | $ | | $ | | ||
Liabilities and stockholders' equity | ||||||
Current liabilities | ||||||
Accounts payable | $ | | $ | | ||
Accrued liabilities | | | ||||
Accrued interest | | | ||||
Current portion of long-term debt | | | ||||
Operating lease obligations, current | | — | ||||
Finance lease obligations, current | | | ||||
Deferred revenue, current | | | ||||
Total current liabilities | | | ||||
Long-term debt, non-current | | | ||||
Operating lease liabilities, non-current | | — | ||||
Finance lease obligation, non-current | | | ||||
Deferred revenue, non-current | | | ||||
Deferred income taxes, net | | | ||||
Other long-term liabilities | | | ||||
Total liabilities | | | ||||
Commitments and contingencies (Note 11) | ||||||
Member's equity | ||||||
Member's interest | | | ||||
Accumulated other comprehensive loss | ( | ( | ||||
Accumulated deficit | ( | ( | ||||
Total member's equity | | | ||||
Total liabilities and member's equity | $ | | $ | | ||
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
ZAYO GROUP, LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(in millions)
Three Months Ended December 31, | Six Months Ended December 31, | |||||||||||
2019 |
| 2018 | 2019 |
| 2018 | |||||||
Revenue |
| $ | | $ | | $ | | $ | | |||
Operating costs and expenses | ||||||||||||
Operating costs (excluding depreciation and amortization and including stock-based compensation—Note 8) | | | | | ||||||||
Selling, general and administrative expenses (including stock-based compensation—Note 8) | | | | | ||||||||
Depreciation and amortization | | | | | ||||||||
Total operating costs and expenses | | | | | ||||||||
Operating income | | | | | ||||||||
Other expenses | ||||||||||||
Interest expense | ( | ( | ( | ( | ||||||||
Foreign currency gain/(loss) on intercompany loans | | ( | | ( | ||||||||
Other income, net | | | | | ||||||||
Total other expenses, net | ( | ( | ( | ( | ||||||||
Income from operations before income taxes | | | | | ||||||||
Provision for income taxes | | | | | ||||||||
Net income | $ | | $ | | $ | | $ | | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
ZAYO GROUP, LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(in millions)
Three Months Ended December 31, | Six Months Ended December 31, | |||||||||||
| 2019 |
| 2018 | 2019 |
| 2018 | ||||||
Net income | $ | | $ | | $ | | $ | | ||||
Foreign currency translation adjustments, net of tax | | ( | | ( | ||||||||
Defined benefit pension plan adjustments, net of tax | — | | | | ||||||||
Comprehensive income | $ | | $ | | $ | | $ | | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
ZAYO GROUP, LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF MEMBER’S EQUITY (UNAUDITED)
(in millions)
For the Three Months Ended December 31, 2019 | ||||||||||||
| Member's |
| Accumulated |
| Accumulated |
| Total | |||||
Balance at September 30, 2019 | $ | | $ | ( | $ | ( | $ | | ||||
Stock-based compensation | | — | — | | ||||||||
Foreign currency translation adjustment | — | | — | | ||||||||
Net income | — | — | | | ||||||||
Balance at December 31, 2019 | $ | | $ | ( | $ | ( | $ | | ||||
For the Three Months Ended December 31, 2018 | ||||||||||||
Member's | Accumulated | Accumulated | Total | |||||||||
September 30, 2018 | $ | | $ | ( | $ | ( | $ | | ||||
Stock-based compensation | | — | — | | ||||||||
Foreign currency translation adjustment | — | ( | — | ( | ||||||||
Capital distribution to parent | ( | — | — | ( | ||||||||
Defined benefit pension plan adjustments | — | | — | | ||||||||
Net income | — | — | | | ||||||||
Balance at December 31, 2018 | $ | | $ | ( | $ | ( | $ | | ||||
For the Six Months Ended December 31, 2019 | ||||||||||||
| Member's |
| Accumulated |
| Accumulated |
| Total | |||||
Balance at June 30, 2019 | $ | | $ | ( | $ | ( | $ | | ||||
Stock-based compensation | | — | — | | ||||||||
Foreign currency translation adjustment | — | | — | | ||||||||
Defined benefit pension plan adjustments | — | | — | | ||||||||
Net income | — | — | | | ||||||||
Balance at December 31, 2019 | $ | | $ | ( | $ | ( | $ | | ||||
For the Six Months Ended December 31, 2018 | ||||||||||||
| Member's |
| Accumulated |
| Accumulated |
| Total | |||||
Balance at June 30, 2018 | $ | | $ | ( | $ | ( | $ | | ||||
Stock-based compensation | | — | — | | ||||||||
Foreign currency translation adjustment | — | ( | — | ( | ||||||||
Capital distribution to parent | ( | — | — | ( | ||||||||
Defined benefit pension plan adjustments | — | | — | | ||||||||
Net income | — | — | | | ||||||||
Balance at December 31, 2018 | $ | | $ | ( | $ | ( | $ | | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
6
ZAYO GROUP, LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in millions)
Six Months Ended December 31, | ||||||
| 2019 |
| 2018 | |||
Cash flows from operating activities |
| |||||
Net income | $ | | $ | | ||
Adjustments to reconcile net income to net cash provided by operating activities | ||||||
Depreciation and amortization | | | ||||
Gain on sale of SRT | — | ( | ||||
Non-cash interest expense | | | ||||
Stock-based compensation | | | ||||
Amortization of deferred revenue | ( | ( | ||||
Foreign currency (gain)/loss on intercompany loans | ( | | ||||
Deferred income taxes | | | ||||
Provision for bad debts | | | ||||
Non-cash loss on investments | — | | ||||
Changes in operating assets and liabilities | ||||||
Trade receivables | | | ||||
Accounts payable and accrued liabilities | | ( | ||||
Additions to deferred revenue | | | ||||
Other assets and liabilities | ( | | ||||
Net cash provided by operating activities | | | ||||
Cash flows from investing activities | ||||||
Purchases of property and equipment | ( | ( | ||||
Proceeds from sale of SRT, net of cash held in escrow | — | | ||||
Net cash used in investing activities | ( | ( | ||||
Cash flows from financing activities | ||||||
Proceeds from debt | — | | ||||
Principal payments on debt | ( | ( | ||||
Principal payments on finance lease obligations | ( | ( | ||||
Repayments to purchase ZGH common stock | — | ( | ||||
Cash paid for Santa Clara acquisition financing arrangement and other | — | ( | ||||
Net cash used in financing activities | ( | ( | ||||
Net cash flows | ( | ( | ||||
Effect of changes in foreign exchange rates on cash | | ( | ||||
Net decrease in cash, cash equivalents and restricted cash | ( | ( | ||||
Cash, cash equivalents and restricted cash, beginning of period | | | ||||
Cash, cash equivalents and restricted cash, end of period | | $ | | |||
Supplemental disclosure of non-cash investing and financing activities: | ||||||
Cash paid for interest, net of capitalized interest | $ | | $ | | ||
Cash paid for income taxes | $ | | $ | | ||
Non-cash purchases of equipment through finance leasing | $ | | $ | | ||
Non-cash purchases of equipment and other assets through nonmonetary exchange | $ | | $ | | ||
Change in accounts payable and accrued expenses for purchases of property and equipment | $ | | $ | ( | ||
Reconciliation of cash, cash equivalents, and restricted cash: |
| December 31, 2019 |
| June 30, 2019 |
| December 31, 2018 |
| June 30, 2018 | ||||
Cash and cash equivalents | $ | $ | $ | $ | ||||||||
Restricted cash included in other assets | ||||||||||||
Total cash, cash equivalents and restricted cash | $ | $ | $ | $ | ||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
7
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(1) | BUSINESS AND BASIS OF PRESENTATION |
Business
Zayo Group, LLC, a Delaware limited liability company, was formed on May 4, 2007, and is the operating parent company of a number of subsidiaries engaged in providing access to bandwidth infrastructure. Zayo Group LLC and its subsidiaries are collectively referred to as “Zayo Group” or the “Company.” The Company is a wholly-owned subsidiary of Zayo Group Holdings, Inc. (“ZGH”). Headquartered in Boulder, Colorado, the Company provides communication infrastructure solutions, including fiber and bandwidth connectivity, colocation and cloud infrastructure, to businesses primarily in the United States (“U.S.”), Canada and Europe. The Company provides its products and offerings through
| ● | Zayo Networks, including dark fiber, mobile infrastructure solutions, ethernet, wavelength, wholesale IP, SONET solutions, private lines and dedicated internet. |
| ● | Zayo Colocation (“zColo”), including provision of colocation space and power and interconnection offerings and cloud-based computing offerings. |
| ● | Allstream, including Cloud, VoIP and Data Solutions. |
| ● | Other offerings, including Zayo Professional Services (“ZPS”). |
Significant Merger Development
On May 8, 2019, ZGH, Front Range TopCo, Inc. (“Parent”), a Delaware corporation and Front Range BidCo, Inc., a Delaware corporation and a wholly owned subsidiary of Parent (“Merger Sub”), entered into an Agreement and Plan of Merger (the “Merger Agreement”) to be acquired by a consortium of private equity funds including affiliates of EQT Infrastructure IV, Digital Colony Partners, LP, DC Front Range Holdings I, LP and FMR LLC (the “Consortium”). Upon the close of the Merger (defined below), ZGH will operate as a privately-held company. Parent and Merger Sub were formed by the Consortium.
The Merger Agreement provides, among other things and upon the terms and subject to the conditions of the Merger Agreement, that (i) Merger Sub will be merged with and into ZGH (the “Merger”), with ZGH surviving and continuing as the surviving corporation in the Merger and a wholly owned subsidiary of Parent, and (ii) at the effective time of the Merger, each outstanding share of ZGH common stock, par value $
The closing of the Merger is subject to customary closing conditions, including (i) the adoption of the Merger Agreement by the holders of not less than a majority of the outstanding shares of ZGH Common Stock, (ii) the receipt of specified required regulatory approvals, (iii) the absence of any law or order enjoining or prohibiting the Merger or making it illegal, (iv) the accuracy of the representations and warranties contained in the Merger Agreement (subject to “material adverse effect” and materiality qualifications) and (v) compliance with covenants in the Merger Agreement in all material respects.
ZGH’s board of directors and the board of directors of Parent have each unanimously approved the Merger and the Merger Agreement. On July 26, 2019, ZGH held a special meeting of stockholders where ZGH stockholders approved the adoption of the Merger Agreement. On July 31, 2019, ZGH announced the early termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, satisfying one of the conditions to the closing of the pending transaction. The closing of the deal continues to be subject to customary conditions, including regulatory approvals relating to review and clearance by the Committee on Foreign Investment in the United States (which have been obtained) and the receipt of certain foreign antitrust approvals (which have been obtained), certain other foreign direct investment review approvals (which have been obtained), and the approval of multiple U.S. states
8
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(all of which have been obtained except for approval from the California public utility commission), and the receipt of FCC approval. We expect to receive all remaining approvals in the first calendar quarter of 2020, but cannot guarantee that such approvals will be timely provided.
In addition, the Merger Agreement may be terminated under specified circumstances. The closing of the Merger is not subject to a financing condition. The Merger is expected to close by late first calendar quarter or early second calendar quarter of 2020. Until the closing, we will continue to operate as an independent company. The Company has incurred ongoing Merger-related costs of $
Basis of Presentation
The accompanying condensed consolidated financial statements include all the accounts of the Company and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated in consolidation. The accompanying condensed consolidated financial statements and related notes are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial reporting and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for quarterly reports on Form 10-Q, and do not include all of the note disclosures required by GAAP for complete financial statements. These condensed consolidated financial statements should, therefore, be read in conjunction with the consolidated financial statements and notes thereto for the year ended June 30, 2019 included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2019. In the opinion of management, all adjustments considered necessary for a fair presentation of financial position, results of operations and cash flows of the Company have been included herein. The results of operations for the three and six months ended December 31, 2019 are not necessarily indicative of the operating results for any future interim period or the full year. Unless otherwise noted, dollar amounts and disclosures throughout the notes to the condensed consolidated financial statements are presented in millions of dollars.
The Company’s fiscal year ends June 30 each year, and we refer to the fiscal year ending June 30, 2020 as “Fiscal 2020” and the fiscal year ended June 30, 2019 as “Fiscal 2019.”
Use of Estimates
The preparation of the Company’s condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. Estimates are used when establishing allowances for doubtful accounts and accruals for billing disputes, determining useful lives for depreciation and amortization and accruals for exit activities associated with real estate leases, assessing the need for impairment charges (including those related to intangible assets and goodwill), determining the fair values of assets acquired and liabilities assumed in business combinations, accounting for income taxes and related valuation allowances against deferred tax assets, determining the defined benefit costs and defined benefit obligations related to post-employment benefits, selection of the discount rate used to value lease liabilities, determining the fair value of nonmonetary exchanges, determining the fair value of plan assets related to post-employment benefits and estimating certain restricted stock unit grant fair values used to compute the stock-based compensation liability and expense. Management evaluates these estimates and judgments on an ongoing basis and makes estimates based on historical experience, current conditions, and various other assumptions that are believed to be reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities as well as identifying and assessing the accounting treatment with respect to commitments and contingencies. Actual results may differ from these estimates under different assumptions or conditions.
9
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Significant Accounting Policies
On July 1, 2019, the Company adopted the requirements of Accounting Standards Update (“ASU”) 2016-02, Leases (“ASC 842”). See Recently Adopted Accounting Pronouncements below and Note 13 – Leases for additional disclosure on the Company’s adoption of ASC 842 and its impact on the condensed consolidated financial statements.
There have been no other changes to the Company’s significant accounting policies as described in its Annual Report on Form 10-K for the year ended June 30, 2019.
Recently Issued Accounting Pronouncements
In June 2016, the FASB issued ASU 2016-13, "Measurement of Credit Losses on Financial Instruments." The primary impact of ASU 2016-13 for us is a change in the model for the recognition of credit losses related to our financial instruments from an incurred loss model, which recognized credit losses only if it was probable a loss had been incurred, to an expected loss model, which requires our management team to estimate the total credit losses expected on the portfolio of financial instruments. We are currently reviewing the requirements of the standard and evaluating the impact on our consolidated financial statements. We are required to adopt the provisions of ASU 2016-13 no later than July 1, 2020.
In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.” ASU 2019-12 introduced a number of simplification initiatives by removing certain exceptions to the general principles in Topic 740. We are currently reviewing the requirements of the standard and evaluating the impact on our consolidated financial statements. We are required to adopt the provisions of ASU 2016-13 no later than July 1, 2021.
Recently Adopted Accounting Pronouncements
In February 2016, the FASB issued ASU 2016-02, Leases. The new guidance supersedes existing guidance on accounting for leases in Topic 840 and is intended to increase the transparency and comparability of accounting for lease transactions. ASU 2016-02 requires most leases to be recognized on the balance sheet. Lessees are required to recognize a right-of-use asset and a lease liability for virtually all leases. The liability is equal to the present value of lease payments. The asset is based on the liability, subject to certain adjustments. For income statement purposes, the FASB retained a dual model, requiring leases to be classified as either operating or finance. Lessor accounting remains similar to the current model but updated to align with certain changes to the lessee model and the new revenue recognition standard (ASC 606). ASU 2016-02 requires both quantitative and qualitative disclosures regarding key information about leasing arrangements. Under the standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases.
The Company adopted ASC 842 effective July 1, 2019 using the modified retrospective transition method. Under this method, the Company recognized a cumulative effect adjustment in the first quarter of Fiscal 2020, rather than restating any prior periods. Comparative information for prior periods has not been restated and continues to be reported in accordance with Topic 840.
The Company elected the package of practical expedients permitted under the transition guidance, which does not require reassessment of prior conclusions related to contracts containing a lease, lease classification and initial direct lease costs. As an accounting policy election, the Company will exclude short-term leases (term of 12 months or less) from the balance sheet presentation and will account for non-lease and lease components in a contract as a single lease component for certain asset classes. The Company also elected the land easements practical expedient, which permits the Company to carry forward the historical accounting treatment for agreements entered into prior to the adoption date.
The adoption of ASC 842 impacted the Company’s condensed consolidated balance sheet with the recognition of existing operating leases as lessee resulting in $
10
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
As lessor, accounting for the Company’s leases remains largely unchanged from ASC 840. The Company leases dark fiber and circuits (within the Zayo Networks segment) and provides leases of colocation space (within the zColo segment) which have contract terms that are accounted for as operating leases and are further described in Note 15 – Segment Reporting. The new lease standard more narrowly defines initial direct costs as only costs that are incremental to origination of a lease (i.e. costs that would not have been incurred had the lease not been obtained). The Company did not historically capitalize non-incremental costs; therefore, this change will not have an impact on the accounting for initial direct costs in the condensed consolidated financial statements on a prospective basis.
(2) ACQUISITIONS AND DISPOSITIONS
Since inception through December 31, 2019, the Company has consummated
The accompanying condensed consolidated financial statements include the operations of the acquired entities from their respective acquisition dates.
In the Company’s acquisitions, the Company acquired certain customer relationships. These relationships represent a valuable intangible asset, as the Company anticipates continued business from the acquired customer bases. The Company’s estimate of the fair value of the acquired customer relationships is generally based on a multi-period excess earnings valuation technique utilizing Level 3 inputs.
Transaction Costs
Transaction costs include expenses associated with professional services (i.e. legal, accounting, regulatory, etc.) rendered in connection with acquisitions or disposals, travel expenses and severance expenses incurred that are associated with acquisitions or disposals, and other direct expenses incurred that are associated with signed and/or closed acquisitions or disposals and unsuccessful acquisitions or disposals. The Company incurred transaction costs of $
Scott-Rice Telephone Co.
On July 31, 2018, the Company completed the sale of Scott-Rice Telephone Co. (“SRT”), a Minnesota incumbent local exchange carrier, for $
The Company concluded SRT was not a significant disposal group and did not represent a strategic shift, and therefore was not classified as discontinued operations.
11
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(3) GOODWILL
During the fourth quarter of Fiscal 2019, the Company implemented organizational changes resulting in changes to its reportable segments. In connection with the organizational change, the Company’s reporting units changed and goodwill was re-allocated to the new reporting units on a relative fair value basis. The Company completed an assessment immediately prior to and after the organizational change and determined it is more likely than not the fair value of the Company’s reporting units is greater than their carrying amounts.
The following reflects the changes in the carrying amount of goodwill during the six months ended December 31, 2019:
Product Group |
| As of June 30, 2019 |
| Foreign Currency |
| As of December 31, 2019 | |||
(in millions) | |||||||||
Fiber Solutions | $ | | $ | | $ | | |||
Layer 2/3 | | | | ||||||
Transport | | | | ||||||
zColo | | ( | | ||||||
Cloud | | — | | ||||||
Allstream | | — | | ||||||
Other | | — | | ||||||
Total | $ | | $ | | $ | | |||
(4) INTANGIBLE ASSETS
Identifiable intangible assets as of December 31, 2019 and June 30, 2019 were as follows:
| Gross Carrying Amount |
| Accumulated |
| Net | ||||
(in millions) | |||||||||
December 31, 2019 | |||||||||
Finite-Lived Intangible Assets | |||||||||
Customer relationships | $ | | $ | ( | $ | | |||
Underlying rights and other | | ( | | ||||||
Total | | ( | | ||||||
Indefinite-Lived Intangible Assets | |||||||||
Certifications | | — | | ||||||
Underlying rights and other | | — | | ||||||
Total | $ | | $ | ( | $ | | |||
June 30, 2019 | |||||||||
Finite-Lived Intangible Assets | |||||||||
Customer relationships | $ | | $ | ( | $ | | |||
Underlying rights and other | | ( | | ||||||
Total | | ( | | ||||||
Indefinite-Lived Intangible Assets | |||||||||
Certifications | | — | | ||||||
Underlying rights and other | | — | | ||||||
Total | $ | | $ | ( | $ | | |||
12
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(5) LONG-TERM DEBT
As of December 31, 2019 and June 30, 2019, long-term debt was as follows:
Date of | Outstanding as of | ||||||||||||||
Issuance or most |
| Maturity |
| Interest |
| Interest Rate |
| December 31, 2019 |
| June 30, 2019 | |||||
(in millions) | |||||||||||||||
Term Loan Facility due 2021 | Jan 2017 | Jan 2021 | Monthly | LIBOR +2.00% | $ | | $ | | |||||||
B-2 Term Loan Facility | Feb 2018 | Jan 2024 | Monthly | LIBOR +2.25% | | | |||||||||
Jan & Mar 2015 | Apr 2023 | Apr/Oct | | | |||||||||||
May 2015 & Apr 2016 | May 2025 | May/Nov | | | |||||||||||
Jan, Apr & Jul 2017 | Jan 2027 | Jan/Jul | | | |||||||||||
Revolving Loan Facility | Jan/Apr 2019 (1) | Jul 2020 (2) | Monthly | LIBOR +1.75% | | | |||||||||
Total obligations | | | |||||||||||||
Unamortized premium, net | | | |||||||||||||
Unamortized debt issuance costs | ( | ( | |||||||||||||
Carrying value of debt | | | |||||||||||||
Less current portion (2) | ( | ( | |||||||||||||
Total long-term debt, less current portion | $ | | $ | | |||||||||||
| (1) | The most recent borrowings under the Revolving Loan Facility occurred in January 2019 and the most recent amendment on the Revolving Loan Facility was April 2019. |
| (2) | The earliest possible maturity under the Extension Amendment No. 1 entered into on April 3, 2019 is July 2020 and as a result, the Revolving Loan Facility is classified as current. See below for further details. |
Term Loan Facility and Revolving Credit Facility
On May 6, 2015, the Company and Zayo Capital, Inc. (“Zayo Capital”) entered into an Amendment and Restatement Agreement whereby the Credit Agreement (the “Credit Agreement”) governing the senior secured term loan facility (the “Term Loan Facility”) and $
On January 19, 2017, the Company and Zayo Capital entered into an Incremental Amendment No. 2 (the “Incremental Amendment”) to the Company’s Credit Agreement. Per the terms of the Incremental Amendment, the existing $
13
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
unsecured notes as further discussed below. Additionally, in July 2017, $
On July 20, 2017, the Company and Zayo Capital entered into a second repricing (the “Repricing Amendment No. 2”) to the Credit Agreement. Per the terms of the Repricing Amendment No. 2, the outstanding balances of the B-2 Term Loan and Electric Lightwave Incremental Term Loan were repriced at par to bear interest at a rate of LIBOR plus
On December 22, 2017, the Company and Zayo Capital entered into a third repricing amendment (the “Repricing Amendment No. 3”) to the Credit Agreement. Per the terms of the Repricing Amendment No. 3, the Revolver under the Credit Agreement was repriced to bear interest at a rate of LIBOR plus
On February 26, 2018, the Company and Zayo Capital entered into an amendment to the Credit Agreement and the Company added a new $
On April 3, 2019, the Company and Zayo Capital entered into Extension Amendment No. 1 to the Credit Agreement (the “Extension Amendment”) with respect to the Revolver. Under the terms of the Extension Amendment, the maturity date of the revolving credit facility was extended from April 17, 2020 to the earliest of (i) April 17, 2023, (ii) six months prior to the maturity date of the $
The weighted average interest rates (including margin) on the Term Loan Facility were approximately
The Company had
Senior Unsecured Notes
On January 23, 2015 and March 9, 2015, the Company and Zayo Capital completed private offerings of aggregate principal amounts of $
14
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
On April 14, 2016, the Company and Zayo Capital completed a private offering of $
On January 27, 2017, the Company and Zayo Capital completed a private offering of $
On April 10, 2017, the Company completed a private offering of $
On July 5, 2017, the Company completed a private offering of $
In connection with the Merger, on January 17, 2020, BidCo commenced cash tender offers for any and all of the Company’s outstanding 2023 Unsecured Notes, 2025 Unsecured Notes and 2027 Unsecured Notes (together with the 2023 Unsecured Notes and the 2025 Unsecured Notes, the “Notes”). On January 31, 2020, BidCo announced that it had received tenders and related consents from the requisite number of holders of each such series of the Notes in order to authorize the amendments proposed as part of its offering. See Note 17—Subsequent Events.
Debt covenants
The indentures (the “Indentures”) governing the 2023 Unsecured Notes, the 2025 Unsecured Notes and the 2027 Unsecured Notes (collectively the “Notes”) contain covenants that, among other things, restrict the ability of the Company and its subsidiaries to incur additional indebtedness and issue preferred stock, pay dividends or make other distributions with respect to any equity interests, make certain investments or other restricted payments, create liens, sell assets, incur restrictions on the ability of the Company’s restricted subsidiaries to pay dividends or make other payments to the Company, consolidate or merge with or into other companies or transfer all or substantially all of their assets, engage in transactions with affiliates, and enter into sale and leaseback transactions. The terms of the Indentures include customary events of default.
The Credit Agreement contains customary events of default, including among others, non-payment of principal, interest, or other amounts when due, inaccuracy of representations and warranties, breach of covenants, cross default to certain other indebtedness, insolvency or inability to pay debts, bankruptcy, or a change of control. The Credit Agreement also contains a covenant, applicable only to the Revolver, that the Company maintain a senior secured leverage ratio below or equal to
15
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
other distributions, voluntarily prepay certain other indebtedness, enter into transactions with affiliated persons, make investments and amend the terms of certain other indebtedness.
The Indentures limit any increase in the Company’s secured indebtedness (other than certain forms of secured indebtedness expressly permitted under the Indentures) to a pro forma secured debt ratio of
The Company was in compliance with all covenants associated with its debt agreements as of December 31, 2019.
Guarantees
The Notes are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by all of the Company’s current and future domestic restricted subsidiaries. The Notes were co-issued with Zayo Capital, which does not have independent assets or operations.
The Term Loan Facility and Revolver are fully and unconditionally guaranteed, jointly and severally, on a senior secured basis by all of the Company’s current and future domestic restricted subsidiaries.
Debt issuance costs
In connection with the Credit Agreement (and subsequent amendments thereto), and the various Notes offerings, the Company incurred debt issuance costs of $
The balance of debt issuance costs as of December 31, 2019 and June 30, 2019 was $
Debt issuance costs are presented in the condensed consolidated balance sheets as a reduction to long-term debt, non-current.
16
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(6) INCOME TAXES
A reconciliation of the actual income tax provision and the tax computed by applying the U.S. federal rate to the earnings before income taxes during the three and six month periods ended December 31, 2019 and 2018, respectively, is as follows:
Three Months Ended December 31, | Six Months Ended December 31, | |||||||||||
| 2019 |
| 2018 |
| 2019 |
| 2018 | |||||
(in millions) | ||||||||||||
Expected provision at the statutory rate | $ | | $ | | $ | | $ | | ||||
Increase/(decrease) due to: | ||||||||||||
Stock-based compensation | ( | | | | ||||||||
State income tax expense, net of federal benefit | | | | | ||||||||
Change in statutory tax rates outside U.S. | — | — | — | ( | ||||||||
Changes in uncertain tax benefits | — | | | | ||||||||
Foreign tax rate differential | | | | | ||||||||
State NOL expirations | — | — | | — | ||||||||
Adjustments to taxes recorded in a prior year | | — | | — | ||||||||
U.S. Tax Reform | — | ( | — | | ||||||||
Change in valuation allowance | ( | ( | ( | ( | ||||||||
Other, net | | ( | | | ||||||||
Provision for income taxes | $ | | $ | | $ | | $ | | ||||
The Company’s interim income tax provision reflects an estimate of the effective tax rate for the full fiscal year, applied to the year-to-date book income, adjusted for any discrete events, which are recorded in the period in which they occur. The estimates are re-evaluated each quarter based on estimated tax expense for the full fiscal year.
On December 22, 2017, the U.S. federal government enacted a tax bill, H.R.1, An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018, previously known as Tax Cuts and Jobs Act of 2017 (“U.S. Tax Reform”). U.S. Tax Reform reduced the U.S. corporate tax rate from
The Company files income tax returns in various federal, state, and local jurisdictions including the United States, Canada, United Kingdom and France. In the normal course of business, the Company is subject to examination by taxing authorities throughout the world. With few exceptions, the Company is no longer subject to income tax examinations by tax authorities in major tax jurisdictions for years before 2014.
The Company had gross unrecognized tax benefits of $
(7) EQUITY
On May 7, 2018, the Board of Directors of ZGH authorized the repurchase of up to $
17
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
2018 with ZGH having repurchased $
During the three and six months ended December 31, 2019, the Company recorded an increase of $
(8) STOCK-BASED COMPENSATION
The following tables summarize the Company’s stock-based compensation expense for liability and equity classified awards included in the condensed consolidated statements of operations.
Three Months Ended December 31, | Six Months Ended December 31, | ||||||||||||
2019 |
| 2018 |
| 2019 |
| 2018 | |||||||
(in millions) | |||||||||||||
Included in: | |||||||||||||
Operating costs | $ | | $ | | $ | | $ | | |||||
Selling, general and administrative expenses | | | | | |||||||||
Total stock-based compensation expense | $ | | $ | | $ | | $ | | |||||
| |||||||||||||
Part A restricted stock units | $ | | $ | | $ | | $ | | |||||
Part B restricted stock units | | | | | |||||||||
Part C restricted stock units | | | | | |||||||||
Total stock-based compensation expense | $ | | $ | | $ | | $ | | |||||
Performance Compensation Incentive Program
During October 2014, the Company adopted the 2014 Performance Compensation Incentive Program (“PCIP”). The PCIP includes incentive cash compensation and equity in the form of restricted stock units (“RSUs”). Grants under the PCIP RSU plans are made quarterly for all participants. The PCIP was effective on October 16, 2014 and will remain in effect for a period of
The PCIP has the following components:
Part A
Under Part A of the PCIP, certain full-time employees, including the Company’s executives, are eligible to earn quarterly awards of RSUs. Each participant in Part A of the PCIP will have an RSU annual award target value, which will be allocated to each fiscal quarter. The final Part A value awarded to a participant for any fiscal quarter is determined by the Compensation Committee of the Board of Directors subsequent to the end of the respective performance period taking into account ZGH’s measured value creation for the quarter, as well as such other subjective factors that it deems relevant (including group and individual level performance factors). The number of Part A RSUs granted will be calculated based on the final award value determined by the Compensation Committee divided by the average closing price of ZGH’s common stock over the last trading days of the respective performance period. Part A RSUs will vest assuming continuous employment for
The December 2019 and June 2019 quarterly awards were recorded as liabilities totaling $
18
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
a fixed dollar amount to be settled in a variable number of shares during the subsequent quarter. The quarterly stock-based compensation liability is included in accrued liabilities in the accompanying condensed consolidated balance sheets. Upon the issuance of the RSUs, the liability is re-measured and then reclassified to additional paid-in capital, with a corresponding charge (or credit) to stock based compensation expense. The value of the remaining unvested RSUs is expensed ratably through the vesting date. At December 31, 2019, the remaining unrecognized compensation cost to be expensed over the remaining vesting period for Part A awards is $
The following table summarizes the Company’s Part A RSU activity for the six months ended December 31, 2019:
| Number of Part A |
| Weighted average |
| Weighted average | |||||
Outstanding at July 1, 2019 | | $ | | |||||||
Granted | | | ||||||||
Vested | ( | | ||||||||
Forfeited | ( | n/a | ||||||||
Outstanding at December 31, 2019 | | $ | | |||||||
Part B
Under Part B of the PCIP, participants, including the Company’s executives, are awarded quarterly grants of RSUs. The number of the RSUs earned by the participants is based on ZGH’s stock price performance over a performance period of
The Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) are also awarded quarterly grants of RSUs under the same provisions as other Part B participants outlined above. However, beginning with the grant during the three months ended December 31, 2018, in the case of the CEO, and beginning with the grant during the three months ended March 31, 2019, in the case of the CFO, awards are subject to additional vesting criteria that are based on ZGH’s stock performance subsequent to the end of the measurement period. In order for the CEO and CFO to receive the maximum award ZGH’s stock price must remain at or above the ending measurement period price for the six months subsequent to the end of the performance period.
The following table summarizes the Company’s Part B RSU activity for the six months ended December 31, 2019:
| Number of Part B |
| Weighted average |
| Weighted average | |||||
Outstanding at July 1, 2019 | | $ | | |||||||
Granted | | | ||||||||
Vested | ( | | ||||||||
Forfeited | — | n/a | ||||||||
Outstanding at December 31, 2019 | | $ | | |||||||
The table below reflects the total Part B RSUs granted during each period presented, the maximum eligible shares of ZGH’s common stock that the respective Part B RSU grant could be converted into shares of ZGH’s common stock, and the grant date fair value per Part B RSU during the period indicated. The table below also reflects the units
19
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
converted to the ZGH’s common stock at a vesting date that is subsequent to the period indicated for those RSUs granted during the period indicated:
| During the Three Months Ended | |||||
December 31, 2019 | September 30, 2019 | |||||
Part B RSUs granted | | | ||||
Maximum eligible shares of ZGH's common stock | | | ||||
Average grant date fair value per Part B RSU | $ | $ | ||||
Units converted to ZGH's common stock at vesting date |
| n/a | n/a | |||
| During the Three Months Ended | |||||||||||
| June 30, 2019 |
| March 31, 2019 |
| December 31, 2018 |
| September 30, 2018 | |||||
Part B RSUs granted |
| | |
| | | ||||||
Maximum eligible shares of ZGH's common stock |
| | |
| | | ||||||
Average grant date fair value per Part B RSU |
| $ | | $ | |
| $ | | $ | | ||
Units converted to ZGH's common stock at vesting date |
| n/a | n/a | — | — | |||||||
The grant date fair value of Part B RSU grants is estimated utilizing a Monte Carlo simulation. This simulation estimates the
Part C
Under Part C of the PCIP, independent directors of the Company are eligible to receive quarterly awards of RSUs. Independent directors electing to receive a portion of their annual director fees in the form of RSUs are granted a set dollar amount of Part C RSUs each quarter. The quantity of Part C RSUs granted is based on the average closing price of ZGH’s common stock over the last trading days of the quarter ended immediately prior to the grant date and vest at the end of each quarter for which the grant was made. During the three and six months ended December 31, 2019, the Company’s independent directors were granted
20
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(9) EMPLOYEE BENEFITS
In connection with the Company’s acquisition of Allstream, Inc. in January 2016, the Company assumed sponsorship for a defined pension plan for certain employees of Allstream, Inc. The Company also assumed sponsorship of a post-retirement benefit (“ OPEB”) for certain employees of Allstream, Inc., which provides health care and life insurance benefits for certain eligible retirees. The OPEB plan is not funded. Benefits are paid directly to the participants in the plan.
The service cost component of the defined benefit pension and OPEB plans is included within selling, general and administrative expenses and all other components are recognized in other income, net in the accompanying condensed consolidated statements of operations.
Pension Plan | |||||||||||||
Three Months Ended December 31, | Six Months Ended December 31, | ||||||||||||
| 2019 |
| 2018 |
|
| 2019 |
| 2018 | |||||
( in millions) | |||||||||||||
Service cost | $ | | $ | | $ | | $ | | |||||
Interest cost | | | | | |||||||||
Expected return on plan assets | ( | ( | ( | ( | |||||||||
Amortization of service cost from earlier periods | | | | | |||||||||
Gain on curtailment(1) | — | — | — | ( | |||||||||
Net periodic pension benefit cost | $ | | $ | | $ | | $ | | |||||
| (1) | During the six months ended December 31, 2018, the Company approved an amendment to the defined benefit pension plan freezing benefit accruals for certain members of the pension plan as of September 30, 2018. The plan freeze had an immaterial impact to the financial statements for the period ended September 30, 2018. |
OPEB Plan | |||||||||||||
Three Months Ended December 31, | Six Months Ended December 31, | ||||||||||||
| 2019 |
| 2018 |
|
| 2019 |
| 2018 | |||||
( in millions) | |||||||||||||
Service cost | $ | — | $ | | $ | — | $ | | |||||
Interest cost | | | | | |||||||||
Amortization of loss from earlier periods | | — | | — | |||||||||
Net periodic OPEB benefit cost | $ | | $ | | $ | | $ | | |||||
(10) FAIR VALUE MEASUREMENTS
The Company’s financial instruments consist of cash and cash equivalents, restricted cash, trade receivables, accounts payable, long-term debt, certain post-employment plans and stock-based compensation liability. The carrying values of cash and cash equivalents, restricted cash, trade receivables and accounts payable approximated their fair values at December 31, 2019 and June 30, 2019 due to the short maturity of these instruments.
The carrying value of the Company’s Notes, excluding debt issuance costs, reflects the original amounts borrowed, inclusive of net unamortized premium, and was $
The carrying value of the Company’s Term Loan Facility, excluding debt issuance costs, reflects the original amounts borrowed, inclusive of unamortized discounts, and was $
21
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
floor of
As of December 31, 2019 and June 30, 2019, the outstanding balance under the Company’s Revolver was $
A hypothetical increase in the applicable interest rate on the Company’s Term Loan Facility and Revolver of
(11) COMMITMENTS AND CONTINGENCIES
Purchase Commitments
As of December 31, 2019, the Company was contractually committed for $
During the year ended June 30, 2019, the Company entered into a CAD $
Also, during the year ended June 30, 2019, the Company entered into a CAD $
Outstanding Letters of Credit
As of December 31, 2019, the Company had $
Contingencies
In the normal course of business, the Company is party to various outstanding legal proceedings, asserted and unasserted claims, and disputes. In the opinion of management, the ultimate disposition of these matters, both asserted and unasserted, will not have a material adverse effect on the Company’s financial condition, results of operations, or cash flows.
The Company accrues for losses related to contingencies when a loss from such claims is probable and the amount of loss can be reasonably estimated. In determining whether a loss from a claim is probable and the loss can be reasonably estimated, the Company reviews and evaluates its litigation and regulatory matters in light of potentially relevant factual and legal developments. If the Company determines an unfavorable outcome is not probable or the amount of loss cannot be reasonably estimated, the Company does not accrue for a potential litigation loss. In those situations, the Company discloses an estimate or range of the reasonably possible losses, if such estimates can be made. At this time, the Company does not believe that it is possible to estimate the reasonably possible losses or a range of reasonably possible losses related to the matters described below.
Following the filing of the preliminary proxy statement on June 3, 2019, several complaints were filed against ZGH and its Board of Directors challenging the Merger. Four actions were filed in the United States District Court for the District of Delaware captioned Scarantino v. Zayo Group Holdings, Inc., et al., Case No. 1:19-cv-01068-RGA (D. Del.), Klein v. Zayo Group Holdings, Inc., et al., Case No. 1:19-cv-01085-RGA (D. Del.), Duggan v. Zayo Group
22
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Holdings, Inc., et al., Case No. 1:19-cv-01112-RGA (D. Del.), and Dixon v. Zayo Group Holdings, Inc., et al., Case No. 1:19-cv-01123-RGA (D. Del.); one action was filed in the United States District Court for the District of Colorado captioned Graves v. Zayo Group Holdings, Inc., et al., Case No. 1:19-cv-01747-LTB (D. Colo.); and one action was filed in the District Court of Boulder County, Colorado captioned Saroop v. Zayo Group Holdings, Inc., et al., Case No. 2019CV30601. The complaints generally alleged, among other things, that ZGH and its directors disseminated an allegedly false and materially misleading proxy statement or that ZGH’s Board of Directors breached their fiduciary duties in connection with the merger. The complaints sought, among other things, to enjoin the merger, a declaration that the proxy statement violated federal securities laws, unspecified damages, and an award of attorneys’ and experts’ fees.
ZGH issued supplemental disclosures in the definitive proxy statement dated June 26, 2019. In light of those supplemental disclosures during the six months ended December 31, 2019, each of the above-referenced complaints was voluntarily dismissed as moot. Plaintiffs in those actions have reserved the right to seek an award for attorneys’ fees for causing the filing of the supplemental disclosures.
Three ZGH stockholders also filed complaints in the Delaware Court of Chancery pursuant to 8 Del. C. §220 seeking corporate books and records, captioned Teamsters Local 237 Additional Security Benefit Fund, et al. v. Zayo, C.A. No. 2019-0572-TMR (July 25, 2019); Massachusetts Laborers' Annuity Fund v. Zayo Group Holdings, Inc., C.A. No. 2019-0573-TMR; and Waterhouse v. Zayo Group Holdings, Inc., C.A. No. 2019-0589-TMR (July 31, 2019). Three complaints were treated as one consolidated action, and on October 8, 2019, the parties executed a Settlement and Confidentiality Agreement whereby ZGH agreed to produce certain books and records to the plaintiffs in full satisfaction and dismissal of the consolidated action. The parties are meeting and conferring to resolve any outstanding questions regarding production, and plaintiffs are obligated to dismiss their cases once that process concludes.
(12) REVENUE AND CONTRACT COSTS
Nature of the Company’s Products and Offerings
Refer to the Revenue Recognition section of Note 2 – Basis of Presentation and Significant Accounting Policies and Note 15 – Revenue and Contract Costs in our annual report on Form 10-K for the year ended June 30, 2019 for further information regarding our application of ASC 606, including practical expedients and judgments applied in determining the amounts and timing of revenue from contracts with customers.
Reconciliation of Total Revenue to Revenue from Contracts with Customers
The following table provides the amount of revenue that is not subject to ASC 606, but is instead governed by other accounting standards:
Three Months Ended December 31, | Six Months Ended December 31, | ||||||||||||
| 2019 |
| 2018 |
| 2019 |
| 2018 | ||||||
(in millions) | |||||||||||||
Revenue from Contracts with Customers - ASC 606 | $ | | | $ | | | |||||||
Lease Revenue - ASC 842 (1) | | | | | |||||||||
Total revenue | $ | | $ | | $ | | $ | | |||||
(1) Includes revenue from use of long-term Fiber Contracts and Colocation solutions, which are not within the scope of ASC 606. See Note 13 – Leases.
Remaining Performance Obligation Associated with Non-Lease Arrangements
A majority of the Company’s revenue is provided over a contract term. When allocating the total contract transaction price to identified performance obligations, a portion of the total transaction price relates to performance obligations that are yet to be satisfied or are partially satisfied as of the end of the reporting period.
Remaining performance obligations associated with the Company’s contracts reflect recurring charges billed, adjusted to reflect estimates for sales incentives and revenue adjustments. At December 31, 2019, the aggregate amount
23
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
of the transaction price allocated to remaining performance obligations was approximately $
Contract Assets and Liabilities
The timing of revenue recognition may differ from the time of billing to the Company’s customers. Customer receivables represent an unconditional right to consideration net of an estimated allowance for doubtful accounts. Contract balances represent amounts from an arrangement when either the Company has performed, by transferring a solution to the customer in advance of receiving all or partial consideration for such goods and offerings from the customer, or the customer has made payment to the Company in advance of obtaining control of the goods and/or offerings promised to the customer in the contract.
Contract liabilities arise when the Company bills its customers and receives consideration in advance of providing the goods or offerings promised in the contract. Contract liabilities are recognized as revenue when product offerings are provided to the customer. Contract liabilities are presented in the Company’s condensed consolidated balance sheet as deferred revenue.
The following table presents information about the Company’s customer receivables, contract assets and contract liabilities as of December 31, 2019 and June 30, 2019:
| December 31, 2019 |
| June 30, 2019 | |||
(in millions) | ||||||
Customer receivable, net(1) | $ | | $ | | ||
Contract liabilities(1) | $ | | $ | | ||
During the three and six months ended December 31, 2019, the Company recognized $
Contract Costs
The Company recognizes an asset for incremental commission and bonus expenses paid to internal sales personnel and third party agents in conjunction with obtaining certain customer contracts. These costs are only deferred when the commissions are incremental and would not have been incurred absent the customer contract. Costs to obtain a contract are amortized and recorded ratably within selling, general and administrative expenses on the Company’s condensed consolidated statements of operations over the estimated contract term.
The Company also defers costs incurred to fulfill contracts that relate directly to the contract, are expected to generate resources that will be used to satisfy the Company’s performance obligation under the contract and are expected to be recovered through revenue generated under the contract. Contract fulfillment costs are expensed to cost of service as the Company satisfies its performance obligations. These costs principally relate to direct costs associated with activating new customer solutions.
The Company estimates the amortization period for its costs incurred to obtain and fulfill customer contracts at a portfolio level due to the similarities within its customer contract portfolios.
Other costs, such as general costs or costs related to past performance obligations, are expensed as incurred.
As of December 31, 2019 and June 30, 2019, the Company had $
24
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
three and six months ended December 31, 2019, the Company recorded $
(13) LEASES
As previously discussed in Note 1 - Business and Basis of Presentation, the Company adopted ASC 842 effective July 1, 2019 using the modified retrospective transition method at the adoption date. In addition, the Company elected the package of permitted under the transition guidance, which permits companies to carry forward the historical lease classification. Adoption of the new standard resulted in $
Leases as Lessee
The Company determines if an arrangement is a lease at inception and whether that lease meets the classification criteria of a finance or operating lease in accordance with U.S. GAAP. The Company leases office space, warehouse space, network assets, switching and transport sites, points of presence, components and equipment under non-cancelable operating leases. For leases with an initial term of 12 months or less, the Company recognizes lease expense on a straight-line basis over the lease term but does not recognize a ROU asset or lease liability.
Operating lease assets have been included as right-of-use operating lease assets on the condensed consolidated balance sheets. The associated lease liabilities have been included as operating lease obligations, current or operating lease liabilities, non-current on the condensed consolidated balance sheets. ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. Variable lease payments consist of non-lease services related to the lease. Variable lease payments are excluded from the ROU assets and lease liabilities and are recognized in the period in which the obligation for those payments is incurred. As the Company’s leases as lessee typically do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. The Company assessed multiple variables when determining the incremental borrowing rate, such as lease term, payment terms, collateral, economic conditions, and creditworthiness. ROU assets also include any lease payments made and exclude lease incentives. Rental expense for lease payments related to operating leases is recognized on a straight-line basis over the lease term.
Some of the Company’s lease arrangements contain lease components and non-lease components. The Company generally accounts for each component separately based on the estimated standalone price of each component. For colocation leases, the Company accounts for the lease and non-lease components as a single lease component.
Many of the Company’s lease agreements contain renewal options; however, the Company does not recognize ROU assets or lease liabilities for renewal periods unless it is determined the Company is reasonably certain of renewing the lease at inception or when a triggering event occurs. The depreciable life of assets and leasehold improvements are limited by the expected lease term, unless there is a transfer of title or purchase option reasonably certain to be exercised. The Company’s lease agreements do not contain any material purchase option, material residual value guarantees or material restrictive covenants.
25
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Lease expense consisted of the following:
Three Months Ended | Six Months Ended | ||||||
(in millions) | |||||||
Operating and short-term lease cost | $ | | $ | | |||
Finance lease cost: | |||||||
Amortization of right-of-use assets | | | |||||
Interest on lease liability | | | |||||
Total finance lease cost | | | |||||
Total lease cost | $ | | $ | | |||
Supplemental unaudited condensed consolidated balance sheet information and other information related to leases (in millions unless otherwise stated):
Leases | Classification on the Balance Sheet | As of December 31, 2019 | |||
(in millions) | |||||
Assets | |||||
Operating lease assets | $ | | |||
Finance lease assets | | ||||
Total leased assets | $ | | |||
Liabilities | |||||
Current | |||||
Operating | $ | | |||
Finance | | ||||
Noncurrent | |||||
Operating | | ||||
Finance | | ||||
Total lease liabilities | $ | | |||
Weighted-average remaining lease term (years) | |||||
Operating leases | |||||
Finance leases | |||||
Weighted-average discount rate | |||||
Operating leases | |||||
Finance leases | |||||
26
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Supplemental unaudited condensed consolidated cash flow statement information related to leases:
Three Months Ended | Six Months Ended | ||||||
(in millions) | (in millions) | ||||||
Cash paid for amounts included in the measurement of lease liabilities: | |||||||
Operating cash flows from operating leases | $ | | $ | | |||
Operating cash flows from finance leases | | | |||||
Finance cash flows from finance leases | | | |||||
Total lease cost | $ | | $ | | |||
As of December 31, 2019, maturities of lease liabilities were as follows:
| Operating Leases |
| Finance Leases | ||||
Year Ended June 30, | (in millions) | ||||||
2020 (remaining six months) | $ | | $ | | |||
2021 | | | |||||
2022 | | | |||||
2023 | | | |||||
2024 | | | |||||
Thereafter | | | |||||
Total lease payments | | | |||||
Less: interest | ( | ( | |||||
Total | | | |||||
Less: current portion | ( | ( | |||||
Long-term portion | $ | | $ | | |||
As of December 31, 2019, the Company had
Year Ended June 30, |
| (in millions) | ||
2020 | $ | | ||
2021 | | |||
2022 | | |||
2023 | | |||
2024 | | |||
Thereafter | | |||
Total minimum lease payments | | |||
Less amounts representing interest | ( | |||
Less current portion | ( | |||
Finance lease obligations, non-current | $ | | ||
27
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Minimum contractual lease payments due under the Company’s long-term operating leases as of June 30, 2019 are as follows:
Year Ended June 30, | (in millions) | |||
2020 | $ | | ||
2021 | | |||
2022 | | |||
2023 | | |||
2024 | | |||
Thereafter | | |||
$ | | |||
Leases as Lessor
As of December 31, 2019, maturities of non-cancellable leases were as follows:
Year Ended June 30, | (in millions) | |||
2020 (remaining six months) | $ | | ||
2021 | | |||
2022 | | |||
2023 | | |||
2024 | | |||
Thereafter | | |||
Total lease payments | $ | | ||
The Company leases dark fiber and circuits (within the Zayo Networks segment) and zColo segments have contract terms that are accounted for as operating leases and are further described in Note 15 – Segment Reporting. Lease income is included in operating revenue in the condensed consolidated statements of operations. The Company’s lease revenue contains both minimum lease payments as well as variable lease payments. See Note 12 – Revenue and Contract Costs for further details on the Company’s disaggregated revenue streams and associated accounting treatment.
(14) RELATED PARTY TRANSACTIONS
Dan Caruso, the Company’s Chief Executive Officer and Chairman of the Board, is a party to an aircraft charter (or membership) agreement through his affiliate, Bear Equity LLC, for business and personal travel. Under the terms of the charter agreement, all fees for the use of the aircraft are effectively variable in nature. For his business travel on behalf of the Company, Mr. Caruso is reimbursed for his use of the aircraft subject to an annual maximum reimbursement threshold approved by the Company's Nominating and Governance Committee. In each of the three and six months ended December 31, 2019, the Company reimbursed Mr. Caruso $
(15) SEGMENT REPORTING
The Company uses the management approach to determine the segment financial information that should be disaggregated and presented separately in the Company's notes to its condensed consolidated financial statements. The management approach is based on the manner by which management has organized the segments within the Company for making operating decisions, allocating resources, and assessing performance.
As the Company has increased in scope and scale, it has developed its management and reporting structure to support this growth. The Company’s bandwidth infrastructure, colocation and connectivity offerings are comprised of various related product groups generally defined around the type of offering to which the customer is licensing access, referred to as SPGs. Each SPG is responsible for the revenue, costs and associated capital expenditures of its respective
28
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
solutions. The SPGs enable licensing and sales, make pricing and product decisions, engineer networks and deliver solutions to customers, and support customers for specific telecom and internet infrastructure requirements.
During the fourth quarter of Fiscal 2019, with the continued increase in our scope and scale, our chief operating decision maker ("CODM"), who is our Chief Executive Officer, implemented certain organizational changes to the management and operation of the business that directly impact how the CODM makes resource allocation decisions and manages the Company. The changes in structure had the impact of combining our legacy Fiber Solutions, Transport and Enterprise segments into a single new segment, Zayo Networks and re-aligning our Cloud and Cybersecurity SPG from our legacy Enterprise segment to our zColo segment. These changes to our existing reportable segments have been recast for all prior periods. The Company’s segments are further described below:
Zayo Networks. Our Zayo Networks segment provides access to bandwidth infrastructure. This includes our Fiber, Layer 2/3 and Transport solutions. Within the Fiber business, Zayo provides access to mobile infrastructure (fiber-to-the-tower and small cell). Our mobile infrastructure solutions permit direct fiber connections to cell towers, small cells, hub sites and mobile switching centers. Fiber solutions customers include carriers and other communication service providers, internet service providers, wireless service providers, major media and content companies, large enterprises and other companies that have the expertise to run their own fiber optic networks or require interconnected technical space. The contract terms for fiber solutions customers tend to range from to or more years. Our Layer 2/3 line of business provides connectivity and telecommunications solutions to medium and large enterprises. Our offerings within Layer 2/3 include Ethernet, internet offerings, Wide Area Networking products and CloudLink. Solutions range from point-to-point data connections to multi-site managed networks to international outsourced IT infrastructure environments. The contract terms for Layer 2/3 solutions tend to range from to
Zayo Colocation (“zColo”). The zColo segment provides data center and cloud infrastructure solutions to a broad range of enterprise, carrier, cloud and content customers. Our offerings within this segment include the provision of colocation space, power and interconnection offerings in North America and Western Europe. Solutions range in size from single cabinet solutions to 1MW+ data center infrastructure environments. Our data centers also support a large component of networking components for the purpose of aggregating and accommodating customers’ data, voice, internet and video traffic. The contract terms in this segment tend to range from to
Allstream. The Allstream segment provides Cloud VoIP and Data Solutions. This includes a full range of local voice offerings allowing business customers to complete telephone calls in their local exchange, as well as make long distance, toll-free and related calls. Unified Communications is the integration of real-time communication services such as telephony (including Cloud-based IP telephony), instant messaging and video conferencing with non-real-time communication services, such as integrated voicemail and e-mail. Allstream also provides customers with comprehensive telecommunications services including Ethernet, and IP/MPLS VPN Solutions.
Other. The Other segment is primarily comprised of Zayo Professional Services (“ZPS”). ZPS provides network and technical resources to customers who wish to leverage the Company’s expertise in designing, acquiring and maintaining a network. The contract terms typically run for
29
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
monthly fee in the case of network and on an hourly basis for technical resources (usage revenue). ZPS also generates revenue via telecommunication equipment sales.
The results of operations for each segment include an allocation of certain indirect costs and corporate-related costs, including overhead and third-party financed debt. The allocation is based on a percentage that represents management’s estimate of the relative burden each segment bears of indirect and corporate costs. Management has evaluated the allocation methods utilized to allocate these costs and determined they are systematic, rational and consistently applied. Identifiable assets for each reportable segment are reconciled to total consolidated assets including unallocated corporate assets and intersegment eliminations. Unallocated corporate assets consist primarily of cash and deferred taxes.
Segment Adjusted EBITDA
Segment Adjusted EBITDA is the primary measure used by the Company’s CODM to evaluate segment operating performance.
The Company defines Segment Adjusted EBITDA as earnings from operations before interest, income taxes, depreciation and amortization (“EBITDA”) adjusted to exclude acquisition or disposal-related transaction costs, losses on extinguishment of debt, stock-based compensation, unrealized foreign currency gains/(losses) on intercompany loans, gains/(losses) on business dispositions and non-cash income/(loss) on equity and cost method investments. The Company uses Segment Adjusted EBITDA to evaluate operating performance, and this financial measure is among the primary measures used by management for planning and forecasting of future periods. The Company believes the presentation of Segment Adjusted EBITDA is relevant and useful for investors because it allows investors to view results in a manner similar to the method used by management and facilitates comparison of the Company’s results with the results of other companies that have different financing and capital structures.
Segment Adjusted EBITDA results, along with other quantitative and qualitative information, are also utilized by the Company and its Compensation Committee for purposes of determining bonus payouts to employees.
Segment Adjusted EBITDA has limitations as an analytical tool and should not be considered in isolation from, or as a substitute for, analysis of the Company’s results from operations and operating cash flows as reported under GAAP. For example, Segment Adjusted EBITDA:
The Company’s computation of Segment Adjusted EBITDA may not be comparable to other similarly titled measures computed by other companies because all companies do not calculate segment Adjusted EBITDA in the same manner.
For the Three Months Ended December 31, 2019 | ||||||||||||||||||
| Zayo Networks |
| zColo |
| Allstream |
| Other |
| Corp/ |
| Total | |||||||
(in millions) | ||||||||||||||||||
Revenue from external customers |
| $ | | $ | | $ | | $ | | $ | — | $ | | |||||
Segment Adjusted EBITDA |
| | | | | — | | |||||||||||
Capital expenditures |
| | | | — | — | | |||||||||||
30
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
As of and for the Six Months Ended December 31, 2019 | ||||||||||||||||||
| Zayo Networks |
| zColo |
| Allstream |
| Other |
| Corp/ |
| Total | |||||||
(in millions) | ||||||||||||||||||
Revenue from external customers |
| $ | | $ | | $ | | $ | | $ | — | $ | | |||||
Segment Adjusted EBITDA |
| | | | | — | | |||||||||||
Total assets |
| | | | | | | |||||||||||
Capital expenditures |
| | | | — | — | | |||||||||||
For the Three Months Ended December 31, 2018 | ||||||||||||||||||
| Zayo Networks |
| zColo |
| Allstream |
| Other |
| Corp/ |
| Total | |||||||
(in millions) | ||||||||||||||||||
Revenue from external customers |
| $ | | $ | | $ | | $ | | $ | — | $ | | |||||
Segment Adjusted EBITDA |
| | | | | — | | |||||||||||
Capital expenditures | | | | — | — | | ||||||||||||
For the Six Months Ended December 31, 2018 | ||||||||||||||||||
| Zayo Networks |
| zColo |
| Allstream |
| Other |
| Corp/ |
| Total | |||||||
(in millions) | ||||||||||||||||||
Revenue from external customers |
| $ | | $ | | $ | | $ | | $ | — | $ | | |||||
Segment Adjusted EBITDA |
| | | | | — | | |||||||||||
Capital expenditures |
| | | | — | — | | |||||||||||
As of June 30, 2019 | ||||||||||||||||||
| Zayo Networks |
| zColo |
| Allstream |
| Other |
| Corp/ |
| Total | |||||||
(in millions) | ||||||||||||||||||
Total assets |
| $ | | $ | | $ | | $ | | $ | | $ | | |||||
Reconciliation from Total Segment Adjusted EBITDA to income from operations before taxes:
For the Three Months Ended December 31, | ||||||
2019 |
| 2018 | ||||
(in millions) | ||||||
Total Segment Adjusted EBITDA |
| $ | | $ | | |
Interest expense |
| ( | ( | |||
Depreciation and amortization expense |
| ( | ( | |||
Transaction costs |
| ( | ( | |||
Stock-based compensation |
| ( | ( | |||
Foreign currency gain/(loss) on intercompany loans |
| | ( | |||
Non-cash loss on investments | — | ( | ||||
Income from operations before income taxes | $ | | $ | | ||
31
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
For the Six Months Ended December 31, | ||||||
| 2019 |
| 2018 | |||
| (in millions) | |||||
Total Segment Adjusted EBITDA |
| $ | | $ | | |
Interest expense |
| ( | ( | |||
Depreciation and amortization expense |
| ( | ( | |||
Transaction costs |
| ( | ( | |||
Stock-based compensation | ( | ( | ||||
Foreign currency gain/(loss) on intercompany loans | | ( | ||||
Gain on business disposition | — | | ||||
Non-cash loss on investments | — | ( | ||||
Income from operations before income taxes | $ | | $ | | ||
(16) CONDENSED CONSOLIDATING FINANCIAL INFORMATION
As discussed Note 5 – Long-term Debt, as of December 31, 2019, the Company has outstanding $
The accompanying condensed consolidating financial information has been prepared and is presented to display the components of the Company’s balance sheets, statements of operations and statements of cash flows in a manner that allows an existing or future holder of the Company’s Notes to review and analyze the current financial position and recent operating results of the legal subsidiaries that guarantee the Company’s debt obligations.
The operating activities of the separate legal entities included in the Company’s consolidated financial statements are interdependent. The accompanying condensed consolidating financial information presents the results of operations, financial position and cash flows of each legal entity. Zayo Group and its guarantors provide services to each other during the normal course of business. These transactions are eliminated in the consolidated results of operations of the Company. Activity related to income taxes is included at the issuer, or Zayo Group level, and the Company's non-guarantor subsidiaries and is not allocated to the Company's guarantor subsidiaries in the condensed consolidated financial information presented below.
32
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidating Balance Sheets (Unaudited)
December 31, 2019
|
|
|
|
| |||||||||||
Zayo Group, LLC | Guarantor | Non-Guarantor | |||||||||||||
(Issuer) | Subsidiaries | Subsidiaries | Eliminations | Total | |||||||||||
(in millions) | |||||||||||||||
Assets | |||||||||||||||
Current assets | |||||||||||||||
Cash and cash equivalents | $ | | $ | | $ | | $ | — |
| $ | | ||||
Trade receivables, net of allowance |
| |
| |
| |
| — |
|
| | ||||
Prepaid expenses |
| |
| |
| |
| — |
|
| | ||||
Other current assets |
| |
| |
| ( |
| — |
|
| | ||||
Total current assets |
| |
| |
| |
| — |
|
| | ||||
Property and equipment, net |
| |
| — |
| |
| — |
|
| | ||||
Intangible assets, net |
| |
| |
| |
| — |
|
| | ||||
Goodwill | | | | — | | ||||||||||
Right-of-use operating lease assets |
| |
| |
| |
| — |
|
| | ||||
Deferred income taxes, net |
| — |
| — |
| |
| — |
|
| | ||||
Other assets |
| |
| — |
| |
| — |
|
| | ||||
Related party receivable | | — | — | ( |
| — | |||||||||
Investment in subsidiary | | — | — | ( | — | ||||||||||
Total assets | $ | | $ | | $ | | $ | ( | $ | | |||||
Liabilities and member's equity |
|
|
|
|
| ||||||||||
Current liabilities | |||||||||||||||
Accounts payable | $ | | $ | | $ | | $ | — | $ | | |||||
Accrued liabilities |
| |
| |
| |
| — |
| | |||||
Accrued interest |
| |
| — |
| — |
| — |
| | |||||
Current portion of long-term debt | | — | — | — | | ||||||||||
Operating lease obligations, current | | | | — | | ||||||||||
Finance lease obligations, current | | — | | — | | ||||||||||
Deferred revenue, current |
| |
| |
| |
| — |
| | |||||
Total current liabilities |
| |
| |
| |
| — |
| | |||||
Long-term debt, non-current | | — | — | — | | ||||||||||
Operating lease obligation, non-current | | — | | — | | ||||||||||
Related party debt, non-current | — | — | | ( | — | ||||||||||
Finance lease obligation, non-current |
| |
| — |
| |
| — |
| | |||||
Deferred revenue, non-current |
| |
| — |
| |
| — |
| | |||||
Deferred income taxes, net |
| |
| — |
| |
| — |
| | |||||
Other long-term liabilities |
| |
| — |
| |
| — |
| | |||||
Total liabilities |
| |
| |
| |
| ( |
| | |||||
Member's equity |
|
|
|
|
| ||||||||||
Member's interest |
| |
| |
| |
| ( |
| | |||||
Accumulated other comprehensive loss |
| ( |
| — |
| ( |
| |
| ( | |||||
Accumulated (deficit)/earnings |
| ( |
| |
| |
| ( |
| ( | |||||
Total member's equity |
| |
| |
| |
| ( |
| | |||||
Total liabilities and member's equity | $ | | $ | | $ | | $ | ( | $ | | |||||
33
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidating Balance Sheets
June 30, 2019
|
|
|
|
| |||||||||||
Zayo Group, LLC | Guarantor | Non-Guarantor | |||||||||||||
(Issuer) | Subsidiaries | Subsidiaries | Eliminations | Total | |||||||||||
(in millions) | |||||||||||||||
Assets | |||||||||||||||
Current assets | |||||||||||||||
Cash and cash equivalents | $ | | $ | | $ | | $ | — |
| $ | | ||||
Trade receivables, net of allowance |
| |
| |
| |
| — |
|
| | ||||
Prepaid expenses |
| |
| |
| |
| — |
|
| | ||||
Other current assets |
| |
| — |
| ( |
| — |
|
| | ||||
Total current assets |
| |
| |
| |
| — |
|
| | ||||
Property and equipment, net |
| |
| — |
| |
| — |
|
| | ||||
Intangible assets, net |
| |
| |
| |
| — |
|
| | ||||
Goodwill |
| |
| |
| |
| — |
| | |||||
Deferred income taxes, net |
| |
| — |
| |
| — |
|
| | ||||
Other assets |
| |
| — |
| |
| — |
|
| | ||||
Related party receivable |
| |
| — |
| — |
| ( |
|
| — | ||||
Investment in subsidiary | | — | — | ( | — | ||||||||||
Total assets | $ | | $ | | $ | | $ | ( | $ | | |||||
Liabilities and member's equity |
|
|
|
|
| ||||||||||
Current liabilities | |||||||||||||||
Accounts payable | $ | | $ | | $ | | $ | — | $ | | |||||
Accrued liabilities |
| |
| |
| |
| — |
| | |||||
Accrued interest |
| |
| — |
| — |
| — |
| | |||||
Current portion of long-term debt | | — | — | — | | ||||||||||
Finance lease obligations, current | | — | | — | | ||||||||||
Deferred revenue, current |
| |
| |
| |
| — |
| | |||||
Total current liabilities |
| |
| |
| |
| — |
| | |||||
Long-term debt, non-current |
| |
| — |
| — |
| — |
| | |||||
Related party debt, non-current |
| — |
| — |
| |
| ( |
| — | |||||
Finance lease obligation, non-current |
| |
| — |
| |
| — |
| | |||||
Deferred revenue, non-current |
| |
| — |
| |
| — |
| | |||||
Deferred income taxes, net |
| |
| — |
| |
| — |
| | |||||
Other long-term liabilities |
| |
| — |
| |
| — |
| | |||||
Total liabilities |
| |
| |
| |
| ( |
| | |||||
Member's equity | |||||||||||||||
Member's interest |
| |
| |
| |
| ( |
| | |||||
Accumulated other comprehensive loss |
| ( |
| — |
| ( |
| |
| ( | |||||
Accumulated (deficit)/earnings |
| ( |
| |
| |
| ( |
| ( | |||||
Total member's equity |
| |
| |
| |
| ( |
| | |||||
Total liabilities and member's equity | $ | | $ | | $ | | $ | ( | $ | | |||||
34
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidating Statements of Operations (Unaudited)
For the Three Months Ended December 31, 2019
|
|
|
|
| |||||||||||
Zayo Group, LLC | Guarantor | Non-Guarantor | |||||||||||||
(Issuer) | Subsidiaries | Subsidiaries | Eliminations | Total | |||||||||||
(in millions) | |||||||||||||||
Revenue | $ | | $ | | $ | | $ | — | $ | | |||||
Operating costs and expenses | |||||||||||||||
Operating costs (excluding depreciation amortization and including stock-based compensation) |
| |
| |
| |
| — |
| | |||||
Selling, general and administrative expenses (including stock-based compensation) |
| |
| |
| |
| — |
| | |||||
Depreciation and amortization |
| |
| |
| |
| — |
| | |||||
Total operating costs and expenses |
| |
| |
| |
| — |
| | |||||
Operating income |
| |
| |
| |
| — |
| | |||||
Other expenses |
|
|
| ||||||||||||
Interest expense |
| ( |
| — |
| |
| — |
| ( | |||||
Foreign currency gain on intercompany loans |
| |
| — |
| |
| — |
| | |||||
Other income, net |
| |
| — |
| |
| — |
| | |||||
Equity in net earnings of subsidiaries |
| |
| — |
| — |
| ( |
| — | |||||
Total other expense, net |
| ( |
| — |
| |
| ( |
| ( | |||||
Income from operations before income taxes |
| |
| |
| |
| ( |
| | |||||
Provision for income taxes |
| |
| — |
| |
| — |
| | |||||
Net income | | | | ( | | ||||||||||
Other comprehensive income, net of income taxes | | — | | ( | | ||||||||||
Comprehensive income | $ | | $ | | $ | | $ | ( | $ | | |||||
35
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidating Statements of Operations (Unaudited)
For the Six Months Ended December 31, 2019
|
|
|
|
| |||||||||||
Zayo Group, LLC | Guarantor | Non-Guarantor | |||||||||||||
(Issuer) | Subsidiaries | Subsidiaries | Eliminations | Total | |||||||||||
(in millions) | |||||||||||||||
Revenue | $ | | $ | | $ | | $ | — | $ | | |||||
Operating costs and expenses | |||||||||||||||
Operating costs (excluding depreciation amortization and including stock-based compensation) |
| |
| |
| |
| — |
| | |||||
Selling, general and administrative expenses (including stock-based compensation) |
| |
| |
| |
| — |
| | |||||
Depreciation and amortization |
| |
| |
| |
| — |
| | |||||
Total operating costs and expenses |
| |
| |
| |
| — |
| | |||||
Operating income |
| |
| |
| |
| — |
| | |||||
Other expenses |
|
|
|
| |||||||||||
Interest expense |
| ( |
| — |
| — |
| — |
| ( | |||||
Foreign currency gain/(loss) on intercompany loans |
| |
| — |
| ( |
| — |
| | |||||
Other income, net |
| |
| — |
| |
| — |
| | |||||
Equity in net earnings of subsidiaries |
| |
| — |
| — |
| ( |
| — | |||||
Total other expense, net |
| ( |
| — |
| — |
| ( |
| ( | |||||
Income from operations before income taxes |
| |
| |
| |
| ( |
| | |||||
Provision for income taxes |
| |
| — |
| |
| — |
| | |||||
Net income | | | | ( | | ||||||||||
Other comprehensive income, net of income taxes | | — | | ( | | ||||||||||
Comprehensive income | $ | | $ | | $ | | $ | ( | $ | | |||||
36
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidating Statements of Operations (Unaudited)
For the Three Months Ended December 31, 2018
|
|
|
|
| |||||||||||
Zayo Group, LLC | Guarantor | Non-Guarantor | |||||||||||||
Issuer | Subsidiaries | Subsidiaries | Eliminations | Total | |||||||||||
(in millions) | |||||||||||||||
Revenue | $ | | $ | | $ | | $ | — | $ | | |||||
Operating costs and expenses | |||||||||||||||
Operating costs (excluding depreciation amortization and including stock-based compensation) |
| |
| |
| |
| — |
| | |||||
Selling, general and administrative expenses (including stock-based compensation) |
| |
| |
| |
| — |
| | |||||
Depreciation and amortization |
| |
| |
| |
| — |
| | |||||
Total operating costs and expenses |
| |
| |
| |
| — |
| | |||||
Operating income |
| |
| |
| |
| — |
| | |||||
Other expenses |
|
|
|
|
| ||||||||||
Interest expense |
| ( |
| — |
| ( |
| — |
| ( | |||||
Foreign currency loss on intercompany loans |
| ( |
| — |
| ( |
| — |
| ( | |||||
Other income, net |
| |
| — |
| |
| — |
| | |||||
Equity in net earnings of subsidiaries |
| |
| — |
| — |
| ( |
| — | |||||
Total other expense, net |
| ( |
| — |
| ( |
| ( |
| ( | |||||
Income from operations before income taxes |
| |
| |
| |
| ( |
| | |||||
Provision for income taxes |
| |
| — |
| |
| — |
| | |||||
Net income | | | | ( | | ||||||||||
Other comprehensive loss, net of income taxes | ( | — | ( | | ( | ||||||||||
Comprehensive income/(loss) | $ | | $ | | $ | ( | $ | | $ | | |||||
37
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidating Statements of Operations (Unaudited)
For the Six Months Ended December 31, 2018
|
|
|
|
| |||||||||||
Zayo Group, LLC | Guarantor | Non-Guarantor | |||||||||||||
Issuer | Subsidiaries | Subsidiaries | Eliminations | Total | |||||||||||
(in millions) | |||||||||||||||
Revenue | $ | | $ | | $ | | $ | — | $ | | |||||
Operating costs and expenses | |||||||||||||||
Operating costs (excluding depreciation amortization and including stock-based compensation) |
| |
| |
| |
| — |
| | |||||
Selling, general and administrative expenses (including stock-based compensation) |
| |
| |
| |
| — |
| | |||||
Depreciation and amortization |
| |
| |
| |
| — |
| | |||||
Total operating costs and expenses |
| |
| |
| |
| — |
| | |||||
Operating income |
| |
| |
| |
| — |
| | |||||
Other expenses |
|
|
| ||||||||||||
Interest expense |
| ( |
| — |
| ( |
| — |
| ( | |||||
Foreign currency loss on intercompany loans |
| ( |
| — |
| ( |
| — |
| ( | |||||
Other income, net |
| |
| — |
| |
| — |
| | |||||
Equity in net earnings of subsidiaries |
| |
| — |
| — |
| ( |
| — | |||||
Total other expense, net |
| ( |
| — |
| ( |
| ( |
| ( | |||||
Income from operations before income taxes |
| |
| |
| |
| ( |
| | |||||
Provision for income taxes |
| |
| — |
| |
| — |
| | |||||
Net income | | | | ( | | ||||||||||
Other comprehensive loss, net of income taxes | ( | — | ( | | ( | ||||||||||
Comprehensive income |
| $ | | $ | | $ | | $ | ( | $ | | ||||
38
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidating Statements of Cash Flows (Unaudited)
Six Months Ended December 31, 2019
|
|
|
| |||||||||
Zayo Group, LLC | Guarantor | Non-Guarantor | ||||||||||
(Issuer) | Subsidiaries | Subsidiaries | Total | |||||||||
(in millions) | ||||||||||||
Net cash provided by operating activities | $ | |
| $ | |
| $ | | $ | | ||
| ||||||||||||
Cash flows from investing activities: | ||||||||||||
Purchases of property and equipment |
| ( |
| — |
| ( |
| ( | ||||
Net cash used in investing activities |
| ( |
| — |
| ( | ( | |||||
Cash flows from financing activities: | ||||||||||||
Principal payments on long-term debt | ( | — | — | ( | ||||||||
Principal repayments on finance lease obligations | ( | — | — | ( | ||||||||
Contributions to/from parent | ( | ( | | — | ||||||||
Net cash (used in)/provided by financing activities |
| ( |
| ( |
| |
| ( | ||||
Effect of changes in foreign exchange rates on cash |
| — |
| — |
| |
| | ||||
Net (decrease)/increase in cash, cash equivalents and restricted cash |
| ( |
| ( |
| |
| ( | ||||
Cash, cash equivalents and restricted cash, beginning of period |
| |
| |
| |
| | ||||
Cash, cash equivalents and restricted cash, end of period | $ | | $ | | $ | | $ | | ||||
39
ZAYO GROUP, LLC AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidating Statements of Cash Flows (Unaudited)
Six Months Ended December 31, 2018
|
|
| ||||||||||
Zayo Group, LLC | Guarantor | Non-Guarantor | ||||||||||
(Issuer) | Subsidiaries | Subsidiaries | Total | |||||||||
(in millions) | ||||||||||||
Net cash provided by operating activities | $ | |
| $ | |
| $ | | $ | | ||
| ||||||||||||
Cash flows from investing activities: | ||||||||||||
Purchases of property and equipment |
| ( |
| — |
| ( |
| ( | ||||
Proceeds from sale of SRT, net of cash held in escrow | |
| — |
| — |
| | |||||
Net cash used in investing activities |
| ( |
| — |
| ( | ( | |||||
Cash flows from financing activities: |
| |||||||||||
Proceeds from debt | | — | — | | ||||||||
Principal payments on long-term debt | ( | — | — | ( | ||||||||
Principal repayments on finance lease obligations |
| ( | — | ( | ( | |||||||
Payments to repurchase ZGH common stock | ( | — | — | ( | ||||||||
Contributions to/from parent | | ( | — | — | ||||||||
Cash paid for Santa Clara acquisition | ( | — | — | ( | ||||||||
Net cash provided by financing activities |
| ( |
| ( |
| ( |
| ( | ||||
Effect of changes in foreign exchange rates on cash |
| — |
| — |
| ( |
| ( | ||||
Net decrease in cash, cash equivalents and restricted cash |
| ( |
| ( |
| ( |
| ( | ||||
Cash, cash equivalents and restricted cash, beginning of period |
| |
| |
| |
| | ||||
Cash, cash equivalents and restricted cash, end of period | $ | | $ | | $ | | $ | | ||||
(17) SUBSEQUENT EVENTS
In connection with the Merger Agreement, on January 17, 2020, BidCo commenced cash tender offers for any and all of the Company’s Notes. In connection with the tender offers, BidCo is soliciting consents of holders of each series of Notes to authorize the elimination of substantially all of the restrictive covenants and certain reporting obligations and the elimination or modification of certain of the events of default and related provisions contained in the applicable indenture governing such Notes (the “Proposed Amendments”). The early tender deadline for each tender offer was 5:00 p.m., New York City time, on January 31, 2020, and each tender offer will expire at 12:00 midnight, New York City time, at the end of the day on February 14, 2020, unless extended or earlier terminated by BidCo with respect to such tender offer.
On January 31, 2020, BidCo announced that the requisite consents had been received from holders of each series of Notes to authorize adopting the Proposed Amendments to the indentures governing the Company’s notes (the “Indentures”). Also on January 31, 2020, the Company, Zayo Capital, Inc., the guarantors party thereto and the trustee under each Indenture executed supplemental indentures with respect to all of the Company’s Notes, in each case to effect the Proposed Amendments to the Indentures. The Proposed Amendments relating to each applicable series of Notes, however, will not become operative until BidCo has accepted for purchase Notes that have been validly tendered representing at least a majority of the aggregate principal amount of such series of Notes then outstanding pursuant to the applicable tender offer.
BidCo’s obligation to consummate the tender offers is subject to the satisfaction or waiver of certain conditions, including, among others, the substantially concurrent consummation of the Merger on the terms and conditions set forth in the Merger Agreement and the consummation of certain debt financing.
40
ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Certain Factors That May Affect Future Results
Information contained or incorporated by reference in this Quarterly Report on Form 10-Q (this “Report”) and in other filings by Zayo Group, LLC (the “Company,” “we” or “us”) with the Securities and Exchange Commission (the “SEC”) that is not historical by nature constitutes “forward-looking statements,” within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, and can be identified by the use of forward-looking terminology such as “believes,” “expects,” “plans,” “intends,” “estimates,” “projects,” “could,” “may,” “will,” “should,” or “anticipates,” or the negatives thereof, other variations thereon or comparable terminology, or by discussions of strategy. No assurance can be given that future results expressed or implied by the forward-looking statements will be achieved, and actual results may differ materially from those contemplated by the forward-looking statements. Such statements are based on our current expectations and beliefs and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied by the forward-looking statements. These risks and uncertainties include, but are not limited to, those relating to our financial and operating prospects, current economic trends, future opportunities, ability to retain existing customers and attract new ones, our acquisition strategy and ability to integrate acquired companies and assets, outlook of customers, reception of new products and technologies, strength of competition and pricing, completion of the Merger (defined below) and uncertainty among customers and employees regarding the Merger, and potential organizational strategies that we may opt to pursue in the future, such as our potential REIT conversion including our ability to successfully combine our divisions and the feasibility and timing of any REIT conversion. Other factors and risks that may affect our business and future financial results are detailed in our SEC filings, including, but not limited to, those described under “Risk Factors” in our Annual Report on Form 10-K filed with the SEC on September 4, 2019, (our “Annual Report”) and in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We caution you not to place undue reliance on these forward-looking statements, which speak only as of their respective dates. We undertake no obligation to publicly update or revise forward-looking statements to reflect events or circumstances after the date of this Report or to reflect the occurrence of unanticipated events, except as may be required by law.
The following discussion and analysis should be read together with our unaudited condensed consolidated financial statements and the related notes appearing elsewhere in this Report and in our audited annual consolidated financial statements as of and for the year ended June 30, 2019, included in our Annual Report.
Amounts presented in this Item 2 are rounded. As such, rounding differences could occur in period-over-period changes and percentages reported throughout this Item 2.
In May 2018, ZGH announced the completion of the first phase of their investigation on the advisability and feasibility of a conversion to a real estate investment trust for U.S. federal income tax purposes (a “REIT”). Please see “Evaluation and Preparation for Potential REIT Conversion” in the below “Overview.”
On May 8, 2019, ZGH, Front Range TopCo, Inc. (“Parent”), a Delaware corporation, and Front Range BidCo, Inc., a Delaware corporation and a wholly owned subsidiary of Parent (“Merger Sub”), entered into an Agreement and Plan of Merger (the “Merger Agreement”) to be acquired by a consortium of private equity funds including affiliates of EQT Infrastructure IV, Digital Colony Partners, LP, DC Front Range Holdings I, LP and FMR LLC (the “Consortium”). Upon the close of the Merger, ZGH will operate as a privately-held company. Parent and Merger Sub were formed by the Consortium. Capitalized terms used herein not otherwise defined have the meanings set forth in the Merger Agreement. Please see “Significant Merger Development” in the below “Overview”.
Overview
We are a large and growing provider of access to bandwidth infrastructure in the United States (“U.S.”), Europe and Canada. Our products and offerings enable our customers’ mission-critical, high-bandwidth applications, such as cloud-based computing, video, mobile, social media, machine-to-machine connectivity, and other bandwidth-intensive applications. Our key products and offerings include leased dark fiber, fiber to cellular towers and small cell sites, dedicated wavelength connections, ethernet, IP connectivity, cloud-based computing and storage products and other high-bandwidth offerings. We provide access to our bandwidth infrastructure and other offerings over a unique set of dense metro, regional, and long-haul fiber network sections and through our interconnect-oriented data center facilities.
41
Our fiber network sections and data center facilities are critical components of the overall physical network architecture of the internet and private networks. Our customer base includes some of the largest and most sophisticated users of bandwidth infrastructure, such as wireless service carriers; telecommunications service carriers; financial services companies; social networking, media, and web content companies; education, research, and healthcare institutions; and governmental agencies. We typically provide customers with access to our bandwidth infrastructure solutions for a fixed monthly recurring fee under contracts that vary between one and twenty years in length. We operate our business with a unique focus on capital allocation and financial performance with the ultimate goal of maximizing equity value for our stockholders. Our core values center on partnership, alignment, and transparency with our three primary constituent groups – employees, customers, and ZGH stockholders.
We are a Delaware limited liability company formed in 2007. We are headquartered in Boulder, Colorado.
Our fiscal year ends June 30 each year, and we refer to the fiscal year ended June 30, 2020 as “Fiscal 2020” and the fiscal year ended June 30, 2019 as “Fiscal 2019.”
Reportable Segments and our Strategic Product Groups (“SPG”)
We use the management approach to determine the segment financial information that should be disaggregated and presented. The management approach is based on the manner by which management has organized the segments within the Company for making operating decisions, allocating resources, and assessing performance. With the continued increase in our scope and scale, during the fourth quarter of Fiscal 2019, our chief operating decision maker (“CODM”), who is our Chief Executive Officer, implemented certain organizational changes to the management and operation of the business that directly impact how the CODM makes resource allocation decisions and manages the Company. The changes in structure had the impact of combining our legacy Fiber Solutions, Transport, and Enterprise Networks segments into a single new segment, Zayo Networks, and re-aligning our Cloud and Cybersecurity SPG from our legacy Enterprise Networks segment to our zColo segment. These changes to our existing reportable segments have been recast for all prior period financial and operating metrics presented in this Annual Report for comparability. Our four reportable segments are described below.
Zayo Networks. Our Zayo Networks segment provides access to bandwidth infrastructure. This includes our Fiber, Layer 2/3 and Transport solutions. Within the Fiber business, Zayo provides access to mobile infrastructure (fiber-to-the-tower and small cell). Our mobile infrastructure solutions permit direct fiber connections to cell towers, small cells, hub sites and mobile switching centers. Fiber Solutions customers include carriers and other communication service providers, internet service providers, wireless service providers, major media and content companies, large enterprises and other companies that have the expertise to run their own fiber optic networks or require interconnected technical space. The contract terms for Fiber Solutions customers tend to range from three to twenty or more years. Our Layer 2/3 line of business provides connectivity and telecommunications solutions to medium and large enterprises. Our offerings within Layer 2/3 include Ethernet, internet offerings, Wide Area Networking products and CloudLink. Solutions range from point-to-point data connections to multi-site managed networks to international outsourced IT infrastructure environments. The contract terms for Layer 2/3 solutions tend to range from one to five years. Our Transport line of business provide access to lit communications bandwidth infrastructure using customer-accessed optronics to light the fiber, and our customers pay for access based on the amount and type of bandwidth they require. We target customers who require a significant amount of bandwidth across their networks. Transport customers include carriers, content providers, financial services companies, healthcare, government entities, education institutions and other medium and large enterprises. The contract terms in this segment tend to range from two to five years.
Zayo Colocation (“zColo”). The zColo segment provides data center and cloud infrastructure solutions to a broad range of enterprise, carrier, cloud and content customers. Our offerings within this segment include the provision of colocation space, power and interconnection offerings in North America and Western Europe. Solutions range in size from single cabinet solutions to 1MW+ data center infrastructure environments. Our data centers also support networking components for the purpose of aggregating and accommodating customers’ data, voice, internet and video traffic. The contract terms in this segment tend to range from two to five years. Our Cloud and Cybersecurity SPG is included in the zColo segment. The
42
Cloud and Cybersecurity SPG combines private cloud, public cloud and managed offerings in order to provide its customers secure infrastructure as a service (IaaS), which enables on-demand scaling and virtual computing in hybrid environments.
Allstream. The Allstream segment provides Cloud VoIP and Data Solutions. This includes a full range of local voice offerings allowing business customers to complete telephone calls in their local exchange, as well as make long distance, toll-free and related calls. Unified Communications is the integration of real-time communication services such as telephony (including Cloud-based IP telephony), instant messaging and video conferencing with non-real-time communication services, such as integrated voicemail and e-mail. Allstream also provides customers with comprehensive telecommunications services including ethernet, and IP/MPLS VPN Solutions.
Other. The Other segment is primarily comprised of Zayo Professional Services (“ZPS”). ZPS provides network and technical resources to customers who wish to leverage our expertise in designing, acquiring and maintaining a network. The contract terms typically run for one year for a fixed recurring monthly fee in the case of network and on an hourly basis for technical resources (usage revenue). ZPS also generates revenue via telecommunication equipment sales.
Evaluation and Preparation for Potential REIT Conversion
On May 3, 2018, ZGH announced the completion of the first phase of their investigation on the advisability and feasibility of a conversion of ZGH to a REIT. As part of the current phase of their evaluation and preparation for a potential conversion to a REIT. ZGH began a direct dialogue with the U.S. Internal Revenue Service (“IRS”) in an effort to obtain clarity and support for their position, and ZGH is seeking a private letter ruling (“PLR”) from the IRS that addresses among other things, whether revenues from dark and lit fiber satisfy applicable REIT income tests. ZGH submitted the PLR request to the IRS in July 2018, but the IRS may not provide a response until later in 2020 or beyond or may not respond at all. ZGH’s ultimate decision to convert to a REIT may depend upon a favorable PLR from the IRS.
Also, we have begun to execute various organizational changes that are required for ZGH to operate as a REIT, including the adoption of amendments to our organizational documents that, among other things, impose certain stock ownership limitations and transfer restrictions, the realignment of our business segments to clearly delineate the leasing of network assets from ancillary services and, in particular, the separation and potential divestiture or deconsolidation of our Allstream business segment. These organizational changes are not expected to result in any changes to our reportable segments.
If, following the current phase of evaluation and preparation, ZGH decides to convert to a REIT and are successful in qualifying ZGH for taxation as a REIT, then we will generally be permitted to deduct from federal income taxes the dividends that ZGH pays to its stockholders. The income represented by such dividends would not be subject to federal income taxation at the entity level but would be taxed, if at all, at the stockholder level. Nevertheless, the income of ZGH’s domestic taxable REIT subsidiaries (each a “TRS”), which will hold our U.S. operations that may not be REIT-compliant, will be subject, as applicable, to federal and state corporate income tax. Likewise, our foreign subsidiaries will continue to be subject to foreign income taxes in jurisdictions in which they hold assets or conduct operations, regardless of whether held or conducted through TRSs or through entities that are disregarded from us for U.S. federal income tax purposes. Also, we will be subject to a separate corporate income tax on any gains recognized during a specified period (generally five years) following the REIT conversion that are attributable to “built-in” gains with respect to the assets that we own on the date ZGH converts to a REIT.
ZGH’s ability to qualify for taxation as a REIT will depend upon our compliance with various requirements following our REIT conversion, including requirements related to the nature of our assets, the sources of our income and the distributions to ZGH’s stockholders. If ZGH fails to qualify for taxation as a REIT, we will be subject to federal and state income tax at regular corporate income tax rates in the same manner as we are currently taxed. Even if ZGH qualifies for taxation as a REIT, we may be subject to certain federal, state, local and foreign taxes on our income and property. In particular, while state income tax regimes often parallel the federal income tax regime for REITs described above, many states do not completely follow federal rules and some may not follow them at all.
43
At this stage of our evaluation and preparation for a potential conversion of ZGH to a REIT, we cannot accurately estimate the costs required to support any potential conversion, but we anticipate that our costs would include various administrative costs in addition to certain related tax liabilities.
Significant Merger Development
On May 8, 2019, ZGH, Parent and Merger Sub entered into a Merger Agreement to be acquired by the Consortium. Upon the close of the Merger, ZGH will operate as a privately-held company. Parent and Merger Sub were formed by the Consortium.
The Merger Agreement provides that, among other things and upon the terms and subject to the conditions of the Merger Agreement, (i) Merger Sub will be merged with and into ZGH (the “Merger”), with ZGH as the surviving and continuing corporation in the Merger and a wholly owned subsidiary of Parent, and (ii) at the effective time of the Merger, each of our outstanding shares of ZGH Common Stock (other than Common Stock owned by Parent, Merger Sub or any wholly owned subsidiary of Parent or Merger Sub or held in our treasury, all of which shall be canceled without any consideration being exchanged therefor, or shares of ZGH Common Stock held by holders who have made a valid demand for appraisal in accordance with Section 262 of the Delaware General Corporation Law) will be converted into the right to receive an amount equal to $35.00 per share in cash.
The closing of the Merger is subject to customary closing conditions, including (i) the adoption of the Merger Agreement by the holders of not less than a majority of the outstanding shares of ZGH Common Stock, (ii) the receipt of specified required regulatory approvals, (iii) the absence of any law or order enjoining or prohibiting the Merger or making it illegal, (iv) the accuracy of the representations and warranties contained in the Merger Agreement (subject to “material adverse effect” and materiality qualifications) and (v) compliance with covenants in the Merger Agreement in all material respects. The closing of the Merger is not subject to a financing condition.
ZGH’s board of directors and the board of directors of Parent have each unanimously approved the Merger and the Merger Agreement. On July 26, 2019, ZGH held a special meeting of stockholders where their stockholders approved the adoption of the Merger Agreement. On July 31, 2019, ZGH announced the early termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, satisfying one of the conditions to the closing of the pending transaction. The closing of the deal continues to be subject to customary conditions, including regulatory approvals relating to review and clearance by the Committee on Foreign Investment in the United States (which have been obtained) and the receipt of certain foreign antitrust approvals (which have been obtained), certain other foreign direct investment review approvals (which have been obtained), and the approval of multiple U.S. states (all of which have been obtained except for approval from the California public utility commission), and the receipt of FCC approval. ZGH expects to receive all remaining approvals in the first calendar quarter of 2020, but cannot guarantee that such approvals will be timely provided. The Merger is expected to close by late first calendar quarter or early second calendar quarter of 2020. Until the closing, we will continue to operate as an independent company.
The foregoing description of the Merger Agreement is qualified in its entirety by reference to the full text of the Merger Agreement, which has been filed as Exhibit 2.1 to ZGH’s Current Report on Form 8-K filed with the SEC on May 9, 2019.
Factors Affecting Our Results of Operations
Business Acquisitions
We were founded in 2007 with the investment thesis of building a bandwidth infrastructure platform to take advantage of the favorable internet, data, and wireless growth trends driving the ongoing demand for access to 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 we are well positioned to continue to capitalize on those trends. We have built a significant portion of our network and product offerings through 45 acquisitions through December 31, 2019.
44
Disposition
Scott-Rice Telephone Co.
On July 31, 2018, we completed the sale of Scott-Rice Telephone Co. (“SRT”), a Minnesota incumbent local exchange carrier, for $42.2 million to Nuvera Communications, Inc. (formerly New Ulm Telecom, Inc.). As of December 31, 2019, $3.2 million of purchase consideration was held in escrow. We recognized a pre-tax gain of $5.5 million on the sale, which is included in other income, net in the condensed consolidated statements of operations. We acquired SRT as part of our March 1, 2017 purchase of Electric Lightwave Parent, Inc. and it was included as part of the Allstream segment. SRT had a pre-tax net loss of $1.6 million for the year ended June 30, 2018 and pre-tax net income of $2.9 million from when it was acquired on March 1, 2017 through June 30, 2017.
Substantial Indebtedness
As of December 31, 2019 and June 30, 2019, long-term debt was as follows:
Date of | Outstanding as of | ||||||||||||||
Issuance or most |
| Maturity |
| Interest |
| Interest Rate |
| December 31, 2019 |
| June 30, 2019 | |||||
(in millions) | |||||||||||||||
Term Loan Facility due 2021 | Jan 2017 | Jan 2021 | Monthly | LIBOR +2.00% | $ | 486.2 | $ | 488.7 | |||||||
B-2 Term Loan Facility | Feb 2018 | Jan 2024 | Monthly | LIBOR +2.25% | 1,269.3 | 1,269.3 | |||||||||
6.00% Senior Unsecured Notes | Jan & Mar 2015 | Apr 2023 | Apr/Oct | 6.00% | 1,430.0 | 1,430.0 | |||||||||
6.375% Senior Unsecured Notes | May 2015 & Apr 2016 | May 2025 | May/Nov | 6.375% | 900.0 | 900.0 | |||||||||
5.75% Senior Unsecured Notes | Jan, Apr & Jul 2017 | Jan 2027 | Jan/Jul | 5.75% | 1,650.0 | 1,650.0 | |||||||||
Revolving Loan Facility | Jan/Apr 2019 (1) | Jul 2020 (2) | Monthly | LIBOR +1.75% | 50.0 | 145.0 | |||||||||
Total obligations | 5,785.5 | 5,883.0 | |||||||||||||
Unamortized premium, net | 12.0 | 11.9 | |||||||||||||
Unamortized debt issuance costs | (44.9) | (50.2) | |||||||||||||
Carrying value of debt | 5,752.6 | 5,844.7 | |||||||||||||
Less current portion (2) | (55.0) | (5.0) | |||||||||||||
Total long-term debt, less current portion | $ | 5,697.6 | $ | 5,839.7 | |||||||||||
| (1) | The most recent borrowings under the Revolving Loan Facility occurred in January 2019 and the most recent amendment on the Revolving Loan Facility was April 2019. |
| (2) | The earliest possible maturity under the Extension Amendment No. 1 entered into on April 3, 2019 is July 2020 and as a result, the Revolving Loan Facility is classified as current. See Note 5 – Long-term Debt to the condensed consolidated financial statements for further details. |
The weighted average interest rates (including margins) on the Term Loan Facility were approximately 4.0% and 4.6% at December 31, 2019 and June 30, 2019, respectively. Interest rates on the Company’s senior secured revolving credit facility (“the Revolver”) at December 31, 2019 and June 30, 2019 were approximately 3.5% and 4.2%, respectively. As of December 31, 2019, $50.0 million was outstanding under the Revolver. Standby letters of credit were outstanding in the amount of $8.8 million as of December 31, 2019, leaving $391.2 million available under the Revolver, subject to certain conditions. In connection with the Merger, on January 17, 2020, BidCo commenced cash tender offers for any and all of the Company’s outstanding Notes. On January 31, 2020, BidCo announced that it had received tenders and related consents from the requisite number of holders of each such series of the Notes in order to authorize the amendments proposed as part of its offering. See Note 17—Subsequent Events.
Substantial Capital Expenditures
During the six months ended December 31, 2019 and 2018, we invested $471.7 million and $384.7 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.
45
Critical Accounting Policies and Estimates
For a description of our critical accounting policies and estimates, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report for the year ended June 30, 2019.
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 offering that is generally fixed in price and paid by the customer on a monthly basis. We also report monthly amortized revenue (“MAR”), which represents the amortization of previously collected upfront charges to customers. Upfront charges are typically related to indefeasible rights of use (“IRUs”) structured as pre-payments rather than monthly recurring payments (though we structure IRUs as both prepaid and recurring, largely dependent on the customers’ preference) and installation fees. The last category of revenue we report is other revenue. Usage revenue represents charges to customers for variable contracts. Other revenue primarily includes credits and adjustments, termination revenue, construction contribution payments, and component sales.
Our consolidated reported revenue in any given period is a function of our beginning revenue under contract and the impact of organic growth and acquisition activity. Our organic activity is driven by net new sales (“bookings”), gross installed revenue (“installs”) and churn processed (“churn”) as further described below.
Net New Sales. Net new sales (“bookings”) represent the dollar amount of orders, to be recorded as MRR and MAR upon installation, in a period that have been signed by the customer and accepted by our product offering delivery organization. The dollar value of bookings is equal to the monthly recurring price the customer will pay for the offerings and/or the monthly amortized amount of the revenue we will recognize for those offerings. To the extent a booking is cancelled by the customer prior to the offerings being originated, it is subtracted from the total bookings number in the period that it is cancelled. Bookings do not immediately impact revenue until the solutions are installed (gross installed revenue).
Gross Installed Revenue. Installs are the amount of MRR and MAR for offerings that have been installed, tested, accepted by the customer, and have been recognized in revenue during a given period. Installs include new offerings, 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 offerings. For each period presented, disconnects associated with attrition and upgrades or replacement offerings are the drivers of churn, accounting for more than 75% of negative changes in MRR and MAR, while price changes account for less than 25%. Monthly churn is also presented as a percentage of MRR and MAR (“churn percentage”).
As we conduct operations outside of the U.S. and have historically acquired companies with functional currencies other than the U.S. dollar (“USD”), the estimated revenue growth rates may not adequately reflect operational performance as a result of changes in foreign currency exchange rates. The estimated revenue growth rates are not necessarily indicative of either future results of operations or results that might have been achieved had the acquisitions been consummated on the first day of the earliest period presented.
We have foreign subsidiaries that enter into contracts with customers and vendors in currencies other than the USD—principally the British pound sterling (“GBP”) and Canadian dollar (“CAD”) and to a lesser extent the Euro. Changes in foreign currency exchange rates impact our revenue and expenses each period. The comparisons excluding the impact of foreign currency exchange rates assume exchange rates remained constant at the comparative period rate.
Operating Costs and Expenses
Our operating costs and expenses consist of network expense (“Netex”), compensation and benefits expenses, network operations expense (“Netops”), stock-based compensation expense, other expenses, and depreciation and amortization.
46
Netex consists of third-party network costs resulting from our leasing of certain network facilities, primarily leases of circuits and dark fiber, from third parties to augment our owned infrastructure, for which we are generally billed a fixed monthly fee. Netex also includes colocation facility costs for rent and license fees paid to the landlords of the buildings in which our colocation business operates, along with the utility costs to power those facilities. While increases in demand for our offerings 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 infrastructure or offerings from third-party providers. Third-party network costs include the upfront cost of the initial installation of such infrastructure. Such costs are included in operating costs in our condensed consolidated statements of operations over the respective contract period.
Compensation and benefits expenses include salaries, wages, incentive compensation and benefits. Employee-related costs that are directly associated with network construction and location installations (and development of business support systems) are capitalized and amortized to operating costs and expenses. Compensation and benefits expenses related to the departments attributed to generating revenue are included in our operating costs line item while compensation and benefits expenses related to the sales, product, and corporate departments are included in our selling, general and administrative expenses line item of our condensed consolidated statements of operations.
Netops expense includes all of the non-personnel expenses of operating and maintaining our network infrastructure, including contracted maintenance fees, right-of-way costs, rent for cellular towers and other places where fiber is located, pole attachment fees, and relocation expenses. Such costs are included in operating costs in our condensed consolidated statements of operations.
Stock-based compensation expense is included, based on the responsibilities of the awarded recipient, in either our operating costs or selling, general and administrative expenses in our condensed consolidated statements of operations.
Other expenses include expenses such as property tax, franchise fees, colocation facility maintenance, travel, office expense and other administrative costs. Other expenses are included in both operating costs and selling, general and administrative expenses depending on their relationship to generating revenue or association with sales and administration.
Transaction costs include expenses associated with professional services (i.e. legal, accounting, regulatory, etc.) rendered in connection with acquisitions or disposals, travel expenses and severance expenses incurred that are associated with acquisitions or disposals, and other direct expenses incurred that are associated with signed and/or closed acquisitions or disposals and unsuccessful acquisitions or disposals. Transaction costs are included in selling, general and administrative expenses in the condensed consolidated statements of operations.
Three Months Ended December 31, 2019 Compared to the Three Months Ended December 31, 2018
Revenue
For the Three Months Ended December 31, | |||||||||||||
| 2019 |
| 2018 |
| $ Variance |
| % Variance |
| |||||
(in millions) | |||||||||||||
Segment and consolidated revenue: | |||||||||||||
Zayo Networks | $ | 502.5 | $ | 469.9 | $ | 32.6 | 7 | % | |||||
zColo | 64.1 | 67.7 | (3.6) | (5) | % | ||||||||
Allstream | 82.3 | 96.7 | (14.4) | (15) | % | ||||||||
Other | 4.8 | 4.8 | — | * | |||||||||
Consolidated | $ | 653.7 | $ | 639.1 | $ | 14.6 | 2 | % | |||||
_______________________
* not meaningful
47
Our total revenue increased by $14.6 million to $653.7 million for the three months ended December 31, 2019 from $639.1 million for the three months ended December 31, 2018.
The revenue increase was primarily driven by organic growth and the restructuring of a customer’s contract in our Zayo Networks segment offset by changes in exchange rates and churn associated with our Allstream segment. The average exchange rate of the GBP against the USD strengthened by 1.1%, the average exchange rate of the Euro against the USD strengthened by 3.0%, and the average exchange rate of the CAD against the USD weakened by 0.1% during the three months ended December 31, 2019 as compared to the three months ended December 31, 2018. Normalizing our estimated revenue to exclude the impact of foreign currency exchange rate fluctuations, we estimate revenue was negatively impacted by fluctuations in foreign currency rates between the three months ended December 31, 2019 and December 31, 2018 by $0.9 million, or approximately 0.1%.
Zayo Networks. Revenue from our Zayo Networks segment increased by $32.6 million, or 7%, to $502.5 million for the three months ended December 31, 2019 from $469.9 million for the three months ended December 31, 2018. The increase was due to organic growth and the restructuring of a customer’s contract.
zColo. Revenue from our zColo segment decreased by $3.6 million, or 5%, to $64.1 million for the three months ended December 31, 2019 from $67.7 million for the three months ended December 31, 2018. The decrease was due to increased churn.
Allstream. Revenue from our Allstream segment decreased by $14.4 million, or 15%, to $82.3 million for the three months ended December 31, 2019 from $96.7 million for the three months ended December 31, 2018. The decrease was due to churn.
Other. Revenue from our Other segment was $4.8 million for the three months ended December 31, 2019 and December 31, 2018. The Other segment represented less than 1% of our total revenue during the three months ended December 31, 2019.
The following table reflects the stratification of our revenues during these periods. The substantial majority of our revenue continued to come from recurring payments from customers under contractual arrangements.
For the Three Months Ended December 31, | |||||||||||||
2019 |
| 2018 | |||||||||||
(in millions) | |||||||||||||
Monthly recurring revenue |
| $ | 573.0 |
| 88 | % | $ | 576.0 |
| 90 | % | ||
Amortization of deferred revenue | 41.4 | 6 | % | 37.3 | 6 | % | |||||||
Usage revenue | 13.4 | 2 | % | 15.0 | 2 | % | |||||||
Other revenue | 25.9 | 4 | % | 10.8 | 2 | % | |||||||
Total Revenue | $ | 653.7 | 100 | % | $ | 639.1 | 100 | % | |||||
Operating Costs and Expenses
For the Three Months Ended December 31, | ||||||||||||
| 2019 |
| 2018 |
| $ Variance |
| % Variance |
| ||||
(in millions) | ||||||||||||
Segment and consolidated operating costs and expenses: | ||||||||||||
Zayo Networks | $ | 347.2 | $ | 325.0 | $ | 22.2 | 7 | % | ||||
zColo | 72.7 | 67.1 | 5.6 | 8 | % | |||||||
Allstream | 88.9 | 98.0 | (9.1) | (9) | % | |||||||
Other | 4.4 | 4.3 | 0.1 | * | ||||||||
Consolidated | $ | 513.2 | $ | 494.4 | $ | 18.8 | 4 | % | ||||
_______________________
* not meaningful
Our operating costs increased by $18.8 million, or 4%, to $513.2 million for the three months ended December 31, 2019 from $494.4 million for the three months ended December 31, 2018. The increase in consolidated operating
48
costs was primarily due to increases of $11.0 million in depreciation and amortization, $9.4 million in Netops, $3.6 million in other expenses, and $0.8 million in stock-based compensation, partially offset by decreases of $3.8 million in Netex, $1.9 million in compensation and benefits expenses and $0.3 million in transaction costs.
Zayo Networks. Zayo Networks operating costs increased by $22.2 million, or 7%, to $347.2 million for the three months ended December 31, 2019 from $325.0 million for the three months ended December 31, 2018. The increase in operating costs and expenses was primarily a result of increases of $14.4 million in depreciation and amortization as a result of additional assets, $9.5 million increase in Netex and Netops costs, net and $2.1 million in other expenses, partially offset by decreases of $2.3 million in stock-based compensation, $1.2 million in compensation and benefits expenses and $0.3 million in transaction costs.
zColo. zColo operating costs increased by $5.6 million, or 8%, to $72.7 million for the three months ended December 31, 2019 from $67.1 million for the three months ended December 31, 2018. The increase in operating costs and expenses was primarily a result of increases of $3.7 million in depreciation and amortization expense, $2.4 million in stock-based compensation, $2.1 million in other expenses and $0.2 million in transaction costs, partially offset by decreases of $2.4 million in Netex and Netops costs, net and $0.4 million in compensation and benefits expenses.
Allstream. Allstream operating costs decreased by $9.1 million, or 9%, to $88.9 million for the three months ended December 31, 2019 from $98.0 million for the three months ended December 31, 2018. The decrease in operating costs and expenses was primarily a result of decreases of $6.9 million in depreciation and amortization expense, $2.5 million in Netex and Netops costs, net, other expenses of $0.5 million and $0.2 million in transaction costs, partially offset by increases of $0.5 million in compensation and benefits expenses and $0.5 million in stock-based compensation.
Other. Other operating costs and expenses were $4.4 million for the three months ended December 31, 2019, as compared to $4.3 million for the three months ended December 31, 2018.
The table below sets forth the components of our operating costs and expenses during the three months ended December 31, 2019 and 2018.
For the Three Months Ended December 31, | ||||||||||||
2019 |
| 2018 |
| $ Variance |
| % Variance | ||||||
(in millions) | ||||||||||||
Netex | $ | 117.3 | $ | 121.1 | $ | (3.8) | (3) | % | ||||
Compensation and benefits expenses | 79.4 | 81.3 | (1.9) | (2) | % | |||||||
Network operations expense | 80.3 | 70.9 | 9.4 | 13 | % | |||||||
Other expenses | 48.8 | 45.2 | 3.6 | 8 | % | |||||||
Transaction costs | 2.5 | 2.8 | (0.3) | (11) | % | |||||||
Stock-based compensation | 27.0 | 26.2 | 0.8 | 3 | % | |||||||
Depreciation and amortization | 157.9 | 146.9 | 11.0 | 7 | % | |||||||
Total operating costs and expenses | $ | 513.2 | $ | 494.4 | $ | 18.8 | 4 | % | ||||
Netex. Our Netex decreased by $3.8 million, or 3%, to $117.3 million for the three months ended December 31, 2019 from $121.1 million for the three months ended December 31, 2018. The decrease in Netex was primarily due to our rationalization of available footprint for sale in our zColo segment.
Compensation and Benefits Expenses. Compensation and benefits expenses decreased by $1.9 million, or 2%, to $79.4 million for the three months ended December 31, 2019 from $81.3 million for the three months ended December 31, 2018. The decrease was primarily due to a decrease in incentive compensation.
Network Operations Expenses. Network operations expenses increased by $9.4 million, or 13%, to $80.3 million for the three months ended December 31, 2019 from $70.9 million for the three months ended December 31, 2018. The increase principally reflected the growth of our network assets and the related expenses of operating that
49
expanded network. Our total network route miles increased approximately 2% to 133,000 miles at December 31, 2019 from 131,000 miles at December 31, 2018.
Other Expenses. Other expenses increased by $3.6 million, or 8%, to $48.8 million for the three months ended December 31, 2019 from $45.2 million for the three months ended December 31, 2018. The increase was primarily due to foreign currency movements.
Transaction Costs. Transaction costs decreased by $0.3 million to $2.5 million for the three months ended December 31, 2019 from $2.8 million for the three months ended December 31, 2018. The decrease in transaction costs was primarily driven by costs related to our former plan to spin-off portions of our business in the three months ended December 31, 2018. These costs were partially offset by increased Merger-related transaction costs in the three months ended December 31, 2019.
Stock-Based Compensation. Stock-based compensation expense increased by $0.8 million, or 3%, to $27.0 million for the three months ended December 31, 2019 from $26.2 million for the three months ended December 31, 2018. The increase was driven by an increase in the expense associated with Part B awards due to a higher weighted average grant date value per share.
Depreciation and Amortization. Depreciation and amortization expense increased by $11.0 million, or 7%, to $157.9 million for the three months ended December 31, 2019 from $146.9 million for the three months ended December 31, 2018 as a result of depreciation adjustments and an increase in depreciable assets.
Total Other Expense, Net
The table below sets forth the components of our total other expense, net for the three months ended December 31, 2019 and 2018, respectively.
For the Three Months Ended December 31, | ||||||||||||
| 2019 |
| 2018 |
| $ Variance |
| % Variance |
| ||||
(in millions) | ||||||||||||
Interest expense | $ | (82.0) | $ | (84.0) | $ | 2.0 | 2 | % | ||||
Foreign currency gain/(loss) on intercompany loans | 27.4 | (8.3) | 35.7 | * | ||||||||
Other income, net | 0.6 | 0.3 | 0.3 | * | ||||||||
Total other expenses, net | $ | (54.0) | $ | (92.0) | $ | 38.0 | 41 | % | ||||
* not meaningful
Interest expense. Interest expense decreased by $2.0 million, or 2%, to $82.0 million for the three months ended December 31, 2019 from $84.0 million for the three months ended December 31, 2018. The decrease was primarily a result of fluctuations in LIBOR interest rates and the timing of our borrowings under the Revolver.
Foreign currency gain/(loss) on intercompany loans. We recorded a foreign currency gain on intercompany loans of $27.4 million for the three months ended December 31, 2019, compared to an $8.3 million loss for the three months ended December 31, 2018. We have intercompany loans primarily between our U.S. and UK entities, which were established to fund our international acquisitions. As the loans are recorded as an intercompany receivable by our U.S. entities, strengthening of the USD over a foreign currency results in a foreign currency loss on intercompany loans and the weakening of the USD over a foreign currency results in a gain on intercompany loans. This non-cash gain was driven by the weakening of the USD over the GBP period-over-period and the related impact on intercompany loans entered into with foreign subsidiaries whose functional currency is in GBP.
Provision for Income Taxes
Our provision for income taxes increased over the same quarter in the prior year by $2.6 million to $25.1 million for the current quarter ended December 31, 2019 from $22.5 million for the three months ended December 31, 2018. 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. The following table
50
reconciles an expected tax provision based on a statutory federal tax rate applied to our earnings before income tax to our actual provision for income taxes:
For the Three Months Ended December 31, | ||||||
| 2019 |
| 2018 | |||
(in millions) | ||||||
Expected provision at the statutory rate | $ | 18.2 | $ | 11.1 | ||
Increase/(decrease) due to: | ||||||
Stock-based compensation | (0.6) | 2.5 | ||||
State income tax expense, net of federal benefit | 2.8 | 2.5 | ||||
Changes in uncertain tax benefits | — | 6.4 | ||||
Foreign tax rate differential | 0.4 | 1.3 | ||||
Adjustments to taxes recorded in a prior year | 2.8 | — | ||||
U.S. Tax Reform | — | (0.4) | ||||
Change in valuation allowance | (1.3) | (0.5) | ||||
Other, net | 2.8 | (0.4) | ||||
Provision for income taxes | $ | 25.1 | $ | 22.5 | ||
During the three months ended December 31, 2019, a $1.0 million valuation allowance was released on the deferred tax assets of our German subsidiary.
On December 22, 2017, the U.S. federal government enacted a tax bill, H.R.1, An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018, previously known as Tax Cuts and Jobs Act of 2017 (“U.S. Tax Reform”). U.S. Tax Reform reduced the U.S. corporate tax rate from 35% to 21%, created a territorial tax system with a one-time mandatory repatriation tax on previously deferred foreign earnings, and changed business-related deductions and credits. Provisional impacts of U.S. Tax Reform were recorded in the six months ended June 30, 2018 and further adjusted during the three months ended September 30, 2018. In accordance with SAB 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act, the Company recorded the final impacts of U.S. Reform prior to the end of the provisional measurement period on December 31, 2018.
Six Months Ended December 31, 2019 Compared to the Six Months Ended December 31, 2018
For the Six Months Ended December 31, | |||||||||||||
| 2019 |
| 2018 |
|
| $ Variance |
| % Variance |
| ||||
(in millions) | |||||||||||||
Segment and consolidated revenue: | |||||||||||||
Zayo Networks | $ | 985.7 | $ | 931.5 | $ | 54.2 | 6 | % | |||||
zColo | 127.8 | 137.0 | (9.2) | (7) | % | ||||||||
Allstream | 168.9 | 201.7 | (32.8) | (16) | % | ||||||||
Other | 9.9 | 10.0 | (0.1) | (1) | % | ||||||||
Consolidated | $ | 1,292.3 | $ | 1,280.2 | $ | 12.1 | 1 | % | |||||
Our total revenue increased by $12.1 million to $1,292.3 million, or 1% for the six months ended December 31, 2019, from $1,280.2 million for the six months ended December 31, 2018.
The revenue increase was primarily driven by organic growth and the restructuring of a customer’s contract in our Zayo Networks segment offset by changes in exchange rates and churn associated with our Allstream and zColo segments. The average exchange rate of the GBP against the USD strengthened by 2.6%, the average exchange rate of the Euro against the USD strengthened by 3.7%, and the average exchange rate of the CAD against the USD strengthened by 0.4% during the six months ended December 31, 2019 as compared to the six months ended December 31, 2018. Normalizing our estimated revenue to exclude the impact of foreign currency exchange rate fluctuations, we
51
estimate revenue was negatively impacted by foreign currency exchange fluctuations between the six months ended December 31, 2019 and December 31, 2018 by $3.7 million or approximately 0.3%.
Zayo Networks. Revenue from our Zayo Networks segment increased by $54.2 million, or 6%, to $985.7 million for the six months ended December 31, 2019 from $931.5 million for the six months ended December 31, 2018. The increase was due to organic growth and the restructuring of a customer’s contract.
zColo. Revenue from our zColo segment decreased by $9.2 million, or 7%, to $127.8 million for the six months ended December 31, 2019 from $137.0 million for the six months ended December 31, 2018. The decrease was due to increased churn.
Allstream. Revenue from our Allstream segment decreased by $32.8 million, or 16%, to $168.9 million for the six months ended December 31, 2019 from $201.7 million for the six months ended December 31, 2018. The decrease was due to churn.
Other. Revenue from our Other segment decreased by $0.1 million, or 1%, to $9.9 million for the six months ended December 31, 2019 from $10.0 million for the six months ended December 31, 2018. The Other segment represented less than 1% of our total revenue during the six months ended December 31, 2019.
The following table reflects the stratification of our revenues during these periods. The substantial majority of our revenue continued to come from recurring payments from customers under contractual arrangements.
For the Six Months Ended December 31, | |||||||||||||
2019 |
| 2018 | |||||||||||
(in millions) | |||||||||||||
Monthly recurring revenue | $ | 1,145.2 | 89 | % | $ | 1,154.7 | 90 | % | |||||
Amortization of deferred revenue | 81.7 | 6 | % | 74.3 | 6 | % | |||||||
Usage revenue | 29.1 | 2 | % | 31.6 | 2 | % | |||||||
Other revenue | 36.3 | 3 | % | 19.6 | 2 | % | |||||||
Total Revenue | $ | 1,292.3 | 100 | % | $ | 1,280.2 | 100 | % | |||||
Operating Costs and Expenses
For the Six Months Ended December 31, | ||||||||||||
| 2019 |
| 2018 |
| $ Variance |
| % Variance |
| ||||
(in millions) | ||||||||||||
Segment and consolidated operating costs and expenses: | ||||||||||||
Zayo Networks | $ | 688.2 | $ | 662.4 | $ | 25.8 | 4 | % | ||||
zColo | 147.2 | 140.0 | 7.2 | 5 | % | |||||||
Allstream | 178.9 | 201.2 | (22.3) | (11) | % | |||||||
Other | 8.6 | 9.1 | (0.5) | (5) | % | |||||||
Consolidated | $ | 1,022.9 | $ | 1,012.7 | $ | 10.2 | 1 | % | ||||
Our operating costs increased by $10.2 million, or 1%, to $1,022.9 million for the six months ended December 31, 2019 from $1,012.7 million for the six months ended December 31, 2018. The increase in consolidated operating costs was primarily due to increases of $11.9 million in Netops costs, $5.7 million in other expenses, $1.3 million in stock-based compensation, and $1.0 million in transaction costs, partially offset by decreases of $5.8 million in Netex, $3.2 million in compensation and benefits expenses and $0.7 million in depreciation and amortization.
Zayo Networks. Zayo Networks operating costs increased by $25.8 million, or 4%, to $688.2 million for the six months ended December 31, 2019 from $662.4 million for the six months ended December 31, 2018. The increase in operating costs and expenses was primarily a result of increases of $15.4 million in Netex and Netops costs, net, $9.4 million in depreciation and amortization, $4.9 million in other expenses, $1.2 million in transaction costs and $0.1
52
million in compensation and benefits expenses, partially offset by a decrease of $5.2 million in stock-based compensation.
zColo. zColo operating costs increased by $7.2 million, or 5%, to $147.2 million for the six months ended December 31, 2019 from $140.0 million for the six months ended December 31, 2018. The increase in operating costs and expenses was primarily a result of increases of $5.0 million in stock-based compensation, $3.8 million in depreciation and amortization expense, $2.9 million in other expenses, and $0.2 million in transaction costs, partially offset by decreases of $4.3 million in Netex and Netops costs, net, and $0.4 million in compensation and benefits.
Allstream. Allstream operating costs decreased by $22.3 million, or 11%, to $178.9 million for the six months ended December 31, 2019 from $201.2 million for the six months ended December 31, 2018. The decrease in operating costs and expenses was primarily a result of decreases of $13.7 million in depreciation and amortization, $7.5 million in Netex and Netops costs, net, $1.6 million in other expenses, $0.4 million in compensation and benefits expenses and $0.4 million in transaction costs, partially offset by an increase of $1.3 million in stock-based compensation.
Other. Operating costs from our Other segment decreased by $0.5 million, or 5%, to $8.6 million for the six months ended December 31, 2019 from $9.1 million for the six months ended December 31, 2018. The decrease was primarily related to a decrease in compensation and benefits expense.
The table below sets forth the components of our operating costs and expenses during the six months ended December 31, 2019 and 2018.
For the Six Months Ended December 31, | ||||||||||||
| 2019 |
| 2018 |
| $ Variance |
| % Variance | |||||
(in millions) | ||||||||||||
Netex | $ | 238.0 | $ | 243.8 | $ | (5.8) | (2) | % | ||||
Compensation and benefits expenses | 158.8 | 162.0 | (3.2) | (2) | % | |||||||
Network operations expense | 157.8 | 145.9 | 11.9 | 8 | % | |||||||
Other expenses | 95.6 | 89.9 | 5.7 | 6 | % | |||||||
Transaction costs | 4.5 | 3.5 | 1.0 | 29 | % | |||||||
Stock-based compensation | 54.2 | 52.9 | 1.3 | 2 | % | |||||||
Depreciation and amortization | 314.0 | 314.7 | (0.7) | * | ||||||||
Total operating costs and expenses | $ | 1,022.9 | $ | 1,012.7 | $ | 10.2 | 1 | % | ||||
* not meaningful
Netex. Our Netex decreased by $5.8 million, or 2%, to $238.0 million for the six months ended December 31, 2019 from $243.8 million for the six months ended December 31, 2018. The decrease in Netex was primarily due to our rationalization of available footprint for sale in our zColo segment.
Compensation and Benefits Expenses. Compensation and benefits expenses decreased by $3.2 million, or 2%, to $158.8 million for the six months ended December 31, 2019 from $162.0 million for the six months ended December 31, 2018. The decrease was primarily due to a decrease in incentive compensation.
Network Operations Expenses. Network operations expenses increased by $11.9 million, or 8%, to $157.8 million for the six months ended December 31, 2019 from $145.9 million for the six months ended December 31, 2018. 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 2% to 133,000 miles at December 31, 2019 from 131,000 miles at December 31, 2018.
53
Other Expenses. Other expenses increased by $5.7 million, or 6%, to $95.6 million for the six months ended December 31, 2019, from $89.9 million for the six months ended December 31, 2018. The increase was primarily due to increases in our property tax expenses.
Transaction Costs. Transaction costs increased by $1.0 million, or 29%, to $4.5 million for the six months ended December 31, 2019 from $3.5 million for the six months ended December 31, 2018. The increase was the result of Merger-related transaction costs.
Stock-Based Compensation. Stock-based compensation expense increased by $1.3 million, or 2%, to $54.2 million for the six months ended December 31, 2019 from $52.9 million for the six months ended December 31, 2018. The increase in stock-based compensation expense was primarily driven by an increase in the number of Part A awards granted as compared to the six months ended December 31, 2018.
Depreciation and Amortization. Depreciation and amortization expense decreased by $0.7 million to $314.0 million for the six months ended December 31, 2019 from $314.7 million for the six months ended December 31, 2018 as a result of adjustments in depreciation.
Total Other Expense, Net
The table below sets forth the components of our total other expense, net for the six months ended December 31, 2019 and 2018, respectively.
For the Six Months Ended December 31, | ||||||||||||
| 2019 |
| 2018 |
| $ Variance |
| % Variance |
| ||||
(in millions) | ||||||||||||
Interest expense | $ | (166.7) | $ | (166.2) | $ | (0.5) | * | |||||
Foreign currency gain/(loss) on intercompany loans | 14.5 | (12.9) | 27.4 | * | ||||||||
Other income, net | 1.2 | 6.9 | (5.7) | * | ||||||||
Total other expenses, net | $ | (151.0) | $ | (172.2) | $ | 21.2 | 12 | % | ||||
* not meaningful
Interest expense. Interest expense increased by $0.5 million to $166.7 million for the six months ended December 31, 2019 from $166.2 million for the six months ended December 31, 2018. The increase was primarily a result of timing of borrowings and payments under the Revolver and fluctuations in LIBOR rates.
Foreign currency gain/(loss) on intercompany loans. We recorded a foreign currency gain on intercompany loans of $14.5 million for the six months ended December 31, 2019, compared to a loss of $12.9 million for the six months ended December 31, 2018. We have intercompany loans between our U.S. and UK entities, which were established to fund our international acquisitions. As the loans are recorded as an intercompany receivable by our U.S. entities, strengthening of the USD over a foreign currency results in a foreign currency loss on intercompany loans and the weakening of the USD over a foreign currency results in a gain on intercompany loans. This non-cash gain was driven by the weakening of the USD over the GBP period-over-period and the related impact on intercompany loans entered into by foreign subsidiaries with functional currency in GBP.
Other income, net. Other income, net decreased by $5.7 million to $1.2 million for the six months ended December 31, 2019 from $6.9 million for the six months ended December 31, 2018. The decrease was primarily a result of the pre-tax gain of $5.5 million on the sale of Scott-Rice Telephone Co. for the six months ended December 31, 2018.
Provision for Income Taxes
Our provision for income taxes decreased over the same period in the prior year by $3.9 million to $39.1 million for the six months ended December 31, 2019 from $43.0 million for the six months ended December 31, 2018. 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. The following table reconciles
54
an expected tax provision based on a statutory federal tax rate applied to our earnings before income tax to our actual provision for income taxes:
For the Six Months Ended December 31, | ||||||
| 2019 |
| 2018 | |||
(in millions) | ||||||
Expected provision at the statutory rate | $ | 24.9 | $ | 20.0 | ||
Increase/(decrease) due to: | ||||||
Stock-based compensation | 0.1 | 3.6 | ||||
State income tax expense, net of federal benefit | 4.7 | 4.0 | ||||
Change in statutory tax rates outside U.S. | — | (0.1) | ||||
Changes in uncertain tax benefits | 1.0 | 6.4 | ||||
Foreign tax rate differential | 1.6 | 1.5 | ||||
State NOL expirations | 1.6 | — | ||||
Adjustments to taxes recorded in a prior year | 2.8 | — | ||||
U.S. Tax Reform | — | 7.2 | ||||
Change in valuation allowance | (1.3) | (0.8) | ||||
Other, net | 3.7 | 1.2 | ||||
Provision for income taxes | $ | 39.1 | $ | 43.0 | ||
During the six months ended December 31, 2019, a $1.0 million valuation allowance was released on the deferred tax assets of our German subsidiary.
On December 22, 2017, the U.S. federal government enacted a tax bill, H.R.1, An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018, previously known as Tax Cuts and Jobs Act of 2017 (“U.S. Tax Reform”). U.S. Tax Reform reduced the U.S. corporate tax rate from 35% to 21%, created a territorial tax system with a one-time mandatory repatriation tax on previously deferred foreign earnings, and changed business-related deductions and credits. Provisional impacts of U.S. Tax Reform were recorded in the six months ended June 30, 2018 and further adjusted during the three months ended September 30, 2018. In accordance with SAB 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act, the Company recorded the final impacts of U.S. Reform prior to the end of the provisional measurement period on December 31, 2018.
Adjusted EBITDA
We define Adjusted EBITDA as earnings/(loss) from operations before interest, income taxes, depreciation and amortization (“EBITDA”) adjusted to exclude acquisition or disposal-related transaction costs, losses on extinguishment of debt, stock-based compensation, unrealized foreign currency gains/(losses) on intercompany loans, gains/(losses) on business dispositions and non-cash income/(loss) on equity and cost method investments. We use Adjusted EBITDA to evaluate operating performance, and this financial measure is among the primary measures used by management for planning and forecasting for future periods. We believe that the presentation of Adjusted EBITDA is relevant and useful for investors because it allows investors to view results in a manner similar to the method used by management and facilitates comparison of our results with the results of other companies that have different financing and capital structures.
We also monitor Adjusted EBITDA because our subsidiaries have debt covenants that restrict their borrowing capacity that are based on a leverage ratio, which utilizes a modified EBITDA, as defined in our Credit Agreement and the indentures governing our outstanding Notes. The modified EBITDA is consistent with our definition of Adjusted EBITDA; however, it includes the pro forma Adjusted EBITDA of and expected cost synergies from the companies acquired by us during the quarter for which the debt compliance certification is due.
Adjusted EBITDA results, along with other quantitative and qualitative information, are also utilized by management and our compensation committee for purposes of determining bonus payouts to employees.
55
Adjusted EBITDA has limitations as an analytical tool and should not be considered in isolation from, or as a substitute for, analysis of our results as reported under accounting principles generally accepted in the United States (“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. |
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 manner.
Reconciliations from segment and consolidated Adjusted EBITDA to net income/(loss) are as follows:
For the Three Months Ended December 31, 2019 | ||||||||||||||||||
| Zayo Networks |
| zColo |
| Allstream |
| Other |
| Corp/ |
| Total | |||||||
(in millions) | ||||||||||||||||||
Segment and consolidated Adjusted EBITDA | $ | 291.9 | $ | 29.7 | $ | 5.7 | $ | 1.2 | $ | — | $ | 328.5 | ||||||
Interest expense | (71.7) | (10.3) | — | — | — | (82.0) | ||||||||||||
Provision for income taxes | — | — | 3.2 | — | (28.3) | (25.1) | ||||||||||||
Depreciation and amortization expense | (114.7) | (31.1) | (11.7) | (0.4) | — | (157.9) | ||||||||||||
Transaction costs | (1.8) | (0.7) | — | — | — | (2.5) | ||||||||||||
Stock-based compensation | (19.8) | (6.4) | (0.5) | (0.3) | — | (27.0) | ||||||||||||
Foreign currency gain on intercompany loans | — | — | — | — | 27.4 | 27.4 | ||||||||||||
Net income/(loss) | $ | 83.9 | $ | (18.8) | $ | (3.3) | $ | 0.5 | $ | (0.9) | $ | 61.4 | ||||||
For the Three Months Ended December 31, 2018 | ||||||||||||||||||
| Zayo Networks |
| zColo |
| Allstream |
| Other |
| Corp/ |
| Total | |||||||
(in millions) | ||||||||||||||||||
Segment and consolidated Adjusted EBITDA | $ | 269.7 | $ | 32.7 | $ | 17.6 | $ | 1.2 | $ | — | $ | 321.2 | ||||||
Interest expense | (69.3) | (10.6) | (4.1) | — | — | (84.0) | ||||||||||||
Provision for income taxes | — | — | (0.6) | — | (21.9) | (22.5) | ||||||||||||
Depreciation and amortization expense | (100.3) | (27.4) | (18.6) | (0.5) | (0.1) | (146.9) | ||||||||||||
Transaction costs | (2.1) | (0.5) | (0.2) | — | — | (2.8) | ||||||||||||
Stock-based compensation | (22.1) | (4.0) | — | (0.1) | — | (26.2) | ||||||||||||
Foreign currency loss on intercompany loans | — | — | — | — | (8.3) | (8.3) | ||||||||||||
Non-cash (loss)/gain on investments | (0.4) | — | — | — | 0.1 | (0.3) | ||||||||||||
Net income/(loss) | $ | 75.5 | $ | (9.8) | $ | (5.9) | $ | 0.6 | $ | (30.2) | $ | 30.2 | ||||||
56
For the Six Months Ended December 31, 2019 | ||||||||||||||||||
| Zayo Networks |
| zColo |
| Allstream |
| Other |
| Corp/ |
| Total | |||||||
(in millions) | ||||||||||||||||||
Segment and consolidated Adjusted EBITDA | $ | 569.4 | $ | 56.3 | $ | 15.0 | $ | 2.6 | $ | — | $ | 643.3 | ||||||
Interest expense | (142.6) | (21.2) | (2.8) | — | (0.1) | (166.7) | ||||||||||||
Provision for income taxes | — | — | 4.9 | — | (44.0) | (39.1) | ||||||||||||
Depreciation and amortization expense | (228.2) | (61.6) | (23.3) | (0.9) | — | (314.0) | ||||||||||||
Transaction costs | (3.6) | (0.9) | — | — | — | (4.5) | ||||||||||||
Stock-based compensation | (39.4) | (13.0) | (1.3) | (0.5) | — | (54.2) | ||||||||||||
Foreign currency gain on intercompany loans | — | — | — | — | 14.5 | 14.5 | ||||||||||||
Net income/(loss) | $ | 155.6 | $ | (40.4) | $ | (7.5) | $ | 1.2 | $ | (29.6) | $ | 79.3 | ||||||
For the Six Months Ended December 31, 2018 | ||||||||||||||||||
| Zayo Networks |
| zColo |
| Allstream |
| Other |
| Corp/ |
| Total | |||||||
(in millions) | ||||||||||||||||||
Segment and consolidated Adjusted EBITDA | $ | 535.9 | $ | 64.0 | $ | 38.4 | $ | 2.3 | $ | — | $ | 640.6 | ||||||
Interest expense | (135.7) | (22.4) | (8.1) | — | — | (166.2) | ||||||||||||
Provision for income taxes | — | — | (7.7) | — | (35.3) | (43.0) | ||||||||||||
Depreciation and amortization expense | (218.8) | (57.8) | (37.0) | (1.0) | (0.1) | (314.7) | ||||||||||||
Transaction costs | (2.4) | (0.7) | (0.4) | — | — | (3.5) | ||||||||||||
Stock-based compensation | (44.6) | (8.0) | — | (0.3) | — | (52.9) | ||||||||||||
Foreign currency loss on intercompany loans | — | — | — | — | (12.9) | (12.9) | ||||||||||||
Gain on business disposition | — | — | 5.5 | — | — | 5.5 | ||||||||||||
Non-cash loss on investments | (0.6) | — | — | — | — | (0.6) | ||||||||||||
Net income/(loss) | $ | 133.8 | $ | (24.9) | $ | (9.3) | $ | 1.0 | $ | (48.3) | $ | 52.3 | ||||||
57
Liquidity and Capital Resources
Our primary sources of liquidity have been cash provided by operations, equity offerings and incurrence of debt. Historically, our principal uses of cash have been for acquisitions, capital expenditures, working capital, debt service requirements and repurchases of our common stock. We anticipate our principal uses of cash in the future will be for acquisitions, capital expenditures, working capital, and debt service.
We have financial covenants under the indentures governing the 6.00% senior unsecured notes due 2023 (the “2023 Unsecured Notes”), the 6.375% senior unsecured notes due 2025 (the “2025 Unsecured Notes”) and the 5.75% senior unsecured notes due 2027 (the “2027 Unsecured Notes” and collectively with the 2023 and 2025 Unsecured Notes, the “Notes”) and the Credit Agreement that, under certain circumstances, restrict our ability to incur additional indebtedness. The indentures governing the Notes limit any increase in ZGL’s secured indebtedness (other than certain forms of secured indebtedness expressly permitted under such indentures) to a pro forma secured debt ratio of 4.50 times ZGL’s previous quarter’s annualized modified EBITDA (as defined in the indentures), and limit ZGL’s incurrence of additional indebtedness to a total indebtedness ratio of 6.00 times the previous quarter’s annualized modified EBITDA. The Credit Agreement also contains a covenant, applicable only to the Revolver, that ZGL maintain a senior secured leverage ratio below 5.25:1.00 at any time when the aggregate principal amount of loans outstanding under the Revolver is greater than 35% of the commitments under the Revolver. The Credit Agreement also requires ZGL and its subsidiaries to comply with customary affirmative and negative covenants, including covenants restricting the ability of ZGL and its subsidiaries, subject to specified exceptions, to incur additional indebtedness, make additional guaranties, incur additional liens on assets, or dispose of assets, pay dividends, or make other distributions, voluntarily prepay certain other indebtedness, enter into transactions with affiliated persons, make investments and amend the terms of certain other indebtedness. The Credit Agreement contains customary events of default, including among others, non-payment of principal, interest, or other amounts when due, inaccuracy of representations and warranties, breach of covenants, cross default to certain other indebtedness, insolvency or inability to pay debts, bankruptcy, or a change of control.
As of December 31, 2019, we had $180.6 million in cash and cash equivalents which consisted of amounts held in bank accounts and highly-liquid U.S. treasury money market funds. As of December 31, 2019, we also had a working capital deficit of $368.7 million, which includes $170.8 million that we will be recognizing as revenue over the next twelve months. The actual cash outflows associated with fulfilling this deferred revenue obligation during the next twelve months will be significantly less than the December 31, 2019 current deferred revenue balance. The working capital deficit also included $124.7 million of operating lease liabilities. Additionally, as of December 31, 2019, we had $391.2 million available under our Revolver, subject to certain conditions. Accordingly, we believe we have sufficient resources to fund our obligations and foreseeable liquidity requirements in the near term and for the foreseeable future.
Our capital expenditures increased by $87.0 million, or 23%, to $471.7 million during the six months ended December 31, 2019, as compared to $384.7 million for the six months ended December 31, 2018. The increase is primarily due to our continued investment in our network, which we plan to continue for the foreseeable future. As of December 31, 2019, we were contractually committed for $612.7 million of capital expenditures for construction materials and purchases of property and equipment. A majority of these capital expenditure commitments are expected to be satisfied in the next twelve months. These capital expenditures, however, are expected to primarily be success-based; that is, in most situations, we will not invest the capital until we have an executed customer contract that supports the investment.
As part of our corporate strategy, we continue to be regularly involved in discussions regarding potential acquisitions of companies and assets, some of which may be quite large. We expect to fund such acquisitions with cash from operations, debt issuances (including $391.2 million of availability under our Revolver), equity offerings, and available cash on hand. We regularly assess our projected capital requirements to fund future growth in our business, repay our debt obligations, and support our other general corporate and operational needs, and we regularly evaluate our opportunities to raise additional capital. As market conditions permit, we may refinance existing debt, issue new debt or equity securities through the capital markets, or obtain additional bank financing to fund our projected capital requirements or provide additional liquidity. In connection with the Merger, on January 17, 2020, BidCo commenced cash tender offers for any and all of ZGL’s outstanding Notes. On January 31, 2020, BidCo announced that it had received tenders and related consents from the requisite number of holders of each such series of the Notes in order to authorize the amendments proposed as part of its offering. See Note 17—Subsequent Events.
58
Cash Flows
We believe our cash flows from operating activities, in addition to cash and cash equivalents currently on-hand, will be sufficient to fund our operating activities and capital expenditures for the foreseeable future, and in any event for at least the next 12 to 18 months. Given the generally volatile global economic climate, no assurance can be given that this will be the case.
We regularly consider acquisitions and additional strategic opportunities, including large acquisitions, which may require additional debt or equity financing.
The following table sets forth components of our cash flow for the six months ended December 31, 2019 and 2018.
Six Months Ended December 31, | ||||||
| 2019 |
| 2018 | |||
(in millions) | ||||||
Net cash provided by operating activities | $ | 568.2 | $ | 472.4 | ||
Net cash used in investing activities | $ | (471.7) | $ | (345.7) | ||
Net cash used in financing activities | $ | (101.6) | $ | (203.6) | ||
Net Cash Flows provided by Operating Activities
Net cash flows provided by operating activities increased by $95.8 million, or 20%, to $568.2 million during the six months ended December 31, 2019 from $472.4 million during the six months ended December 31, 2018. Net cash flows provided by operating activities during the six months ended December 31, 2019 include our net income of $79.3 million, plus the add backs of non-cash items deducted in the determination of net income, principally depreciation and amortization of $314.0 million, stock-based compensation expense of $54.2 million and deferred income taxes of $28.7 million, partially offset by a foreign currency gain on intercompany loans of $14.5 million. Also contributing to the cash provided by operating activities were additions to deferred revenue of $141.0 million, which were partially offset by amortization of deferred revenue of $81.7 million. Cash flow during the period was increased by the net change in working capital components of $36.8 million.
Net cash flows provided by operating activities during the six months ended December 31, 2018 include our net income of $52.3 million plus the add backs of non-cash items deducted in the determination of net income, principally depreciation and amortization of $314.7 million, stock-based compensation expense of $52.9 million, deferred income taxes of $32.4 million and foreign currency loss on intercompany loans of $12.9 million. Additions to deferred revenue of $81.1 million during the period were partially offset by amortization of deferred revenue of $74.3 million. Cash flow during the period was decreased by the net change in other working capital components of $3.8 million.
The increase in net cash flows from operating activities during the six months ended December 31, 2019 as compared to the six months ended December 31, 2018 is primarily due to an increase in deferred revenue additions and working capital components.
Cash Flows used in Investing Activities
We used cash in investing activities of $471.7 million and $345.7 million during the six months ended December 31, 2019 and 2018, respectively. During the six months ended December 31, 2019, we used $471.7 million of cash for additions to property and equipment.
During the six months ended December 31, 2018, we used $384.7 million of cash for additions to property and equipment, which was partially offset by proceeds from our sale of SRT of $39.0 million.
Cash Flows used in Financing Activities
Our net cash used in financing activities was $101.6 million and $203.6 million during the six months ended December 31, 2019 and 2018, respectively. During the six months ended December 31, 2019, cash used in financing
59
activities was primarily comprised of $95.0 million in payments on the Revolver, $4.1 million in finance lease payments and $2.5 million in principal payments on our long-term debt.
During the six months ended December 31, 2018, our net cash used in financing activities was $203.6 million and was primarily comprised of $402.5 million in purchases of our common stock, $40.0 million in payments on the Revolver, $4.0 million in finance lease payments, $2.6 million in payments on the Santa Clara acquisition financing agreement, $2.5 million in principal payments on our long-term debt and $2.0 million for other financing outflows. These outflows were partially offset by $250.0 million in borrowings under the Revolver.
Contractual Obligations
There were no material changes outside the ordinary course of our business with respect to our contractual obligations during the six months ended December 31, 2019, from those disclosed in our Annual Report on Form 10-K for the year ended June 30, 2019.
Off-Balance Sheet Arrangements
We do not have any special purpose or limited purpose entities that provide off-balance sheet financing, liquidity, or market or credit risk support and we do not engage in hedging, or other similar activities that expose us to any significant liabilities that are not (i) reflected on the face of the condensed consolidated financial statements, (ii) disclosed in Note 11 – Commitments and Contingencies to the condensed consolidated financial statements, or in the Future Contractual Obligations table included in Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report or (iii) discussed under “Item 3: Quantitative and Qualitative Disclosures About Market Risk” below.
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Our exposure to market risk consists of changes in interest rates from time to time and market risk arising from changes in foreign currency exchange rates that could impact our cash flows and earnings.
As of December 31, 2019, we had outstanding $1,430.0 million of 2023 Unsecured Notes, $900.0 million of 2025 Unsecured Notes, $1,650.0 million of 2027 Unsecured Notes, a balance of $486.2 million on our Term Loan Facility due 2021, a balance of $1,269.3 million on our Term Loan Facility due 2024, $50.0 million on our Revolver and $187.5 million of finance lease obligations. As of December 31, 2019, we had $391.2 million available for borrowing under our Revolver, subject to certain conditions.
Based on current market interest rates for debt of similar terms and average maturities and based on recent transactions, we estimate the fair value of our Notes to be $4,068.1 million as of December 31, 2019. Our 2023 Unsecured Notes, 2025 Unsecured Notes and 2027 Unsecured Notes accrue interest at fixed rates of 6.00%, 6.375% and 5.75%, respectively.
Both our Revolver and our Term Loan Facility accrue interest at floating rates subject to certain conditions. The Company’s Term Loan Facility accrues interest at variable rates based upon the one month, three month or six month LIBOR plus i) a spread of 2.0% on the Company’s $500.0 million tranche (which has a LIBOR floor of 0.0%) and ii) a spread of 2.25% on its B-2 Term Loan tranche (which has a LIBOR floor of 1.00%). Our Revolver accrues interest at variable rates based upon LIBOR plus a spread of 1.00% to 1.75% depending on our leverage ratio. As of December 31, 2019, the weighted average interest rates (including margin) on the Term Loan Facility and our Revolver were approximately 4.0% and 3.5%, respectively. A hypothetical increase in the applicable interest rate on our Term Loan Facility and Revolver of one percentage point would increase our annualized interest expense on the Term Loan Facility and Revolver by approximately 23.5%, or $18.1 million, based on the applicable interest rate as of December 31, 2019. Historically, this impact was limited as a result of the applicable interest rate being below the minimum 1.0% LIBOR floor on our Term Loan Facility tranche that matures on January 19, 2024.
60
We are exposed to the risk of changes in interest rates if it is necessary to seek additional funding to support the expansion of our business and to support acquisitions. The interest rate that we may be able to obtain on future debt financings will be dependent on market conditions.
We have exposure to market risk arising from foreign currency exchange rates. During the three and six months ended December 31, 2019, our foreign activities accounted for approximately 20% of our consolidated revenue. We monitor foreign markets and our commitments in such markets to assess currency and other risks. A one percent change in foreign exchange rates would change consolidated revenue by approximately $1.3 million for the quarter ended December 31, 2019. To date, we have not entered into any hedging arrangement designed to limit exposure to foreign currencies. To the extent our level of foreign activities is expected to increase, through further acquisition and/or organic growth, we may determine such hedging arrangements would be appropriate and will consider such arrangements to minimize our exposure to foreign exchange risk.
We do not have any material commodity price risk.
ITEM 4. | CONTROLS AND PROCEDURES |
Disclosure Controls and Procedures
Management has established and maintained disclosure controls and procedures that are designed to ensure that material information relating to the Company and our subsidiaries required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management, including our Chief Executive Officer and Chief Financial Officer, have conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Our Chief Executive Officer and Chief Financial Officer concluded that as of December 31, 2019, our disclosure controls and procedures were effective.
Changes in Internal Controls over Financial Reporting
Beginning July 1, 2019, we adopted Accounting Standards Update 2016-02, Leases (“ASC 842”). We implemented internal controls to ensure we adequately evaluated our contracts, trained applicable personnel and properly assessed the new accounting standard related to lease recognition in our condensed consolidated financial statements.
Other than the internal controls related to the adoption of ASC 842 referenced above there were no changes in the Company's internal control over financial reporting that occurred during the second quarter of 2020 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the ordinary course of business, we are from time to time party to various litigation matters that we believe are incidental to the operation of our business. We record an appropriate provision when the occurrence of loss is probable and can be reasonably estimated. We cannot estimate with certainty our ultimate legal and financial liability with respect to any such pending litigation matters and it is possible one or more of them could have a material adverse effect on us. However, we believe that the outcome of such pending litigation matters will not have a material adverse effect upon our results of operations, our consolidated financial condition or our liquidity.
61
Following the filing of the preliminary proxy statement on June 3, 2019, several complaints were filed against ZGH and its Board of Directors challenging the Merger. Four actions were filed in the United States District Court for the District of Delaware captioned Scarantino v. Zayo Group Holdings, Inc., et al., Case No. 1:19-cv-01068-RGA (D. Del.), Klein v. Zayo Group Holdings, Inc., et al., Case No. 1:19-cv-01085-RGA (D. Del.), Duggan v. Zayo Group Holdings, Inc., et al., Case No. 1:19-cv-01112-RGA (D. Del.), and Dixon v. Zayo Group Holdings, Inc., et al., Case No. 1:19-cv-01123-RGA (D. Del.); one action was filed in the United States District Court for the District of Colorado captioned Graves v. Zayo Group Holdings, Inc., et al., Case No. 1:19-cv-01747-LTB (D. Colo.); and one action was filed in the District Court of Boulder County, Colorado captioned Saroop v. Zayo Group Holdings, Inc., et al., Case No. 2019CV30601. The complaints generally alleged, among other things, that ZGH and its directors disseminated an allegedly false and materially misleading proxy statement or that ZGH’s Board of Directors breached their fiduciary duties in connection with the merger. The complaints sought, among other things, to enjoin the merger, a declaration that the proxy statement violated federal securities laws, unspecified damages, and an award of attorneys’ and experts’ fees.
ZGH issued supplemental disclosures in the definitive proxy statement dated June 26, 2019. In light of those supplemental disclosures during the six months ended December 31, 2019, each of the above-referenced complaints was voluntarily dismissed as moot. Plaintiffs in those actions have reserved the right to seek an award for attorneys’ fees for causing the filing of the supplemental disclosures.
Three ZGH stockholders also filed complaints in the Delaware Court of Chancery pursuant to 8 Del. C. §220 seeking corporate books and records, captioned Teamsters Local 237 Additional Security Benefit Fund, et al. v. Zayo, C.A. No. 2019-0572-TMR (July 25, 2019); Massachusetts Laborers' Annuity Fund v. Zayo Group Holdings, Inc., C.A. No. 2019-0573-TMR; and Waterhouse v. Zayo Group Holdings, Inc., C.A. No. 2019-0589-TMR (July 31, 2019). Three complaints were treated as one consolidated action, and on October 8, 2019, the parties executed a Settlement and Confidentiality Agreement whereby ZGH agreed to produce certain books and records to the plaintiffs in full satisfaction and dismissal of the consolidated action. The parties are meeting and conferring to resolve any outstanding questions regarding production, and plaintiffs are obligated to dismiss their cases once that process concludes.
ITEM 1A. RISK FACTORS
Item 1A of our Annual Report on Form 10-K for the year ended June 30, 2019 sets forth information relating to other important risks and uncertainties that could materially adversely affect our business, financial condition or operating results. Those risk factors, in addition to the other information set forth in this report, continue to be relevant to an understanding of our business, financial condition and operating results for the three months ended December 31, 2019. There have been no material changes in our risk factors from those disclosed in our Annual Report discussed above, except as stated below.
Our business depends on the demand for our bandwidth infrastructure, driven primarily by demand for data, and we may be adversely affected by any slowdown in such demand. Additionally, a reduction in the amount or change in the mix of network investment by our customers may materially and adversely affect our business (including reducing demand for our bandwidth infrastructure or services).
Our customers’ demand for our bandwidth infrastructure depends on the demand for data. The willingness of our customers to utilize our bandwidth infrastructure, or renew or extend existing contracts on our bandwidth infrastructure, is affected by numerous factors, including:
| ● | consumers’ and organizations’ demand for data; |
| ● | availability or capacity of our bandwidth infrastructure or associated land interests; |
| ● | location of our bandwidth infrastructure; |
| ● | financial condition of our customers, including their profitability and availability or cost of capital; |
| ● | willingness of our customers to maintain or increase their network investment or changes in their capital allocation strategy; |
| ● | need for integrated networks and organizations; |
| ● | availability and cost of spectrum for commercial use; |
| ● | increased use of network sharing, roaming, joint development, or resale agreements by our customers; |
| ● | mergers or consolidations by and among our customers; |
62
| ● | changes in, or success of, our customers’ business models; |
| ● | governmental regulations and initiatives, including local or state restrictions on the proliferation of bandwidth infrastructure; |
| ● | cost of constructing bandwidth infrastructure; |
| ● | our market competition, including customers that may elect to self-perform; |
| ● | technological changes, including those affecting the number or type of infrastructure needed to provide data to a given geographic area or which may otherwise serve as substitute or alternative to our infrastructure; and |
| ● | our ability to efficiently satisfy our customers’ service requirements. |
A slowdown in demand for data or our bandwidth infrastructure may negatively impact our growth or otherwise have a material adverse effect on us. If our customers or potential customers are unable to raise adequate capital to fund their business plans, as a result of disruptions in the financial and credit markets or otherwise, they may reduce their spending, which could adversely affect our anticipated growth or the demand for our communications infrastructure or services.
The amount, timing, and mix of our customers’ network investment is variable and can be significantly impacted by the various matters described in these risk factors. Changes in customer network investment typically impact the demand for our bandwidth infrastructure. As a result, changes in customer plans such as delays in the implementation of new systems, new and emerging technologies, or plans to expand coverage or capacity may reduce demand for our bandwidth infrastructure. Furthermore, the industries in which our customer operate (particularly those in the wireless industry) could experience a slowdown or slowing growth rates as a result of numerous factors, including a reduction in consumer demand (including demand for wireless connectivity) or general economic conditions. There can be no assurances that weakness or uncertainty in the economic environment will not adversely impact our customers or their industries, which may materially and adversely affect our business, including by reducing demand for our bandwidth infrastructure or services. Such an industry slowdown or a reduction in customer network investment may materially and adversely affect our business.
Our offerings have a long sales cycle that may harm our revenue and operating results.
A customer’s decision to purchase our offerings typically involves a significant commitment of resources. As a result, we have a long sales cycle. Furthermore, we may devote significant time and resources to pursuing a particular sale or customer that does not result in revenues. We have also expanded our sales force in recent years, and it will take time for these new hires to become fully productive.
Delays due to the length of our sales cycle may materially and adversely affect our revenues and operating results, which could harm our ability to meet our forecasts and cause volatility in our stock price.
Risks Related to a Possible REIT Conversion
If we convert to a REIT, liquidation of assets may jeopardize our REIT qualification.
If we convert to a REIT, we must comply with requirements regarding our assets and our sources of income to qualify as a REIT. If we are subsequently compelled to liquidate our investments to repay obligations under our indebtedness, we may be unable to comply with such requirements, ultimately jeopardizing our qualification as a REIT, or we may be subject to a 100% tax on any resultant gain if we sell assets that are treated as dealer property or inventory.
If we convert to a REIT, we may face other tax liabilities that reduce our cash flows.
If we convert to a REIT, we may be subject to certain U.S. federal, state and local taxes on our income and assets, including taxes on any undistributed income, tax on income from some activities conducted as a result of a foreclosure, and state or local income, property and transfer taxes. In addition, if we convert to a REIT, any of our
63
domestic taxable REIT subsidiaries will be subject to regular corporate federal, state and local taxes. Any of these taxes would decrease cash available for the required principal and interest payments on our indebtedness, including the notes.
Legislative or other actions affecting REITs could have a negative effect on us.
The rules dealing with federal income taxation are constantly under review by persons involved in the legislative process and by the IRS and the U.S. Department of the Treasury (“Treasury”). Changes to the tax laws affecting REITs or TRSs, which may have retroactive application, could adversely affect our stockholders or us. We cannot predict how changes in the tax laws might affect our stockholders or us. Accordingly, we cannot provide assurance that new legislation, Treasury regulations, administrative interpretations or court decisions will not significantly affect our ability to qualify as a REIT, the federal income tax consequences of such qualification, the determination of the amount of REIT taxable income or the amount of tax paid by the TRSs.
64
ITEM 6. EXHIBITS
Exhibit No. |
| Description of Exhibit | ||
|---|---|---|---|---|
3.1** | ||||
3.2** | ||||
4.1** | ||||
4.2** | ||||
4.3** | ||||
4.4** | ||||
4.5** | ||||
4.6** | ||||
31.1* | ||||
31.2* | ||||
32* | ||||
101* | Financial Statements from the Company’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2019, formatted in Inline XBRL: (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Operations, (iii) Condensed Consolidated Statements of Comprehensive Income/(Loss), (iv) Condensed Consolidated Statements of Member’s Equity, (v) Condensed Consolidated Statements of Cash Flows, and (vi) Notes to the Condensed Consolidated Financial Statements, tagged as blocks of text and including detailed tags. | |||
104* | Cover Page Interactive Data File – the cover page XBRL tags are embedded within the Inline XBRL document. | |||
* Filed/furnished herewith.
** Previously filed and incorporated herein by reference.
65
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Zayo Group, LLC | ||||
Date: February 4, 2020 | By: | /s/ Dan Caruso | ||
Dan Caruso | ||||
Chief Executive Officer | ||||
Date: February 4, 2020 | By: | /s/ Matt Steinfort | ||
Matt Steinfort | ||||
Chief Financial Officer |
66