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ZAYO GROUP LLC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Certain Factors That May Affect Future Results Information contained or incorporated by reference in this Quarterly Report on Form 10-Q (this "Report") and in other filings by Zayo Group, LLC ("we" or "us"), with the Securities and Exchange Commission (the "SEC") that are not historical by nature constitute "forward-looking statements," and can be identified by the use of forward-looking terminology such as "believes," "expects," "plans," "intends," "estimates," "projects," "could," "may," "will," "should," or "anticipates," or the negatives thereof, other variations thereon or comparable terminology, or by discussions of strategy. No assurance can be given that future results expressed or implied by the forward-looking statements will be achieved, and actual results may differ materially from those contemplated by the forward-looking statements. Such statements are based on our current expectations and beliefs and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied by the forward-looking statements. These risks and uncertainties include, but are not limited to, those relating to our financial and operating prospects, current economic trends, future opportunities, ability to retain existing customers and attract new ones, our acquisition strategy and ability to integrate acquired companies and assets, outlook of customers, reception of new products and technologies, and strength of competition and pricing. Other factors and risks that may affect our business and future financial results are detailed in our SEC filings, including, but not limited to, those described under "Risk Factors" in our Annual Report on Form 10-K filed with the SEC on September 14, 2012 and in this "Management's Discussion and Analysis of Financial Condition and Results of Operations." We caution you not to place undue reliance on these forward-looking statements, which speak only as of their respective dates. We undertake no obligation to publicly update or revise forward-looking statements to reflect events or circumstances after the date of this Report or to reflect the occurrence of unanticipated events, except as may be required by law. The following discussion and analysis should be read together with our unaudited condensed consolidated financial statements and the related notes appearing in this Report and in our audited annual consolidated financial statements as of and for the year ended June 30, 2012, included in our Annual Report on Form 10-K filed with the SEC on September 14, 2012. Amounts presented in this Item 2 are rounded. As such, rounding differences could occur in period over period changes and percentages reported throughout this Item 2. Overview Introduction We are a provider of bandwidth infrastructure and network-neutral colocation and interconnection services, which are key components of telecommunications and Internet infrastructure services. These services enable our customers to manage, operate, and scale their telecommunications and data networks and data center related operations. We provide our bandwidth infrastructure services over our dense metropolitan, regional, national and international fiber networks, enabling our customers to transport data, voice, video, and Internet traffic, as well as to interconnect their networks. Our bandwidth infrastructure services are primarily used by wireless service providers, carriers and other communications service providers, media and content companies, commercial banks, brokerage houses, insurance companies, investment banks, media companies, social networking companies, web-centric companies, law firms, medical and health care institutions and other bandwidth-intensive enterprises. We typically provide our lit bandwidth infrastructure services for a fixed-rate monthly recurring fee under long-term contracts, which average more than three years in length (and average approximately six years for fiber-to-the-tower services). Our dark-fiber contracts are generally longer term in nature, up to 20 years and in a few cases longer. Our network-neutral colocation and interconnection services facilitate the exchange of voice, video, data, and Internet traffic among multiple third-party networks. As of December 31, 2012, our fiber networks spanned approximately 72,893 route miles and 5,568,107 fiber miles, served 271 geographic markets in the United States and Europe, and connected to 11,104 buildings, including 2,845 cellular towers, allowing us to provide our bandwidth infrastructure services to our customers over redundant fiber facilities between key customer locations. We use undersea capacity on the Trans-Atlantic undersea telecommunications network ("TAT-14") and other trans-Atlantic cables to provide connectivity from the U.S. to Europe and from London to continental Europe. We operate a Tier 1 IP network over our metro and long haul networks with connectivity to the U.S. and Europe. The majority of the markets that we serve, and buildings to which we connect, have few other networks capable of providing similar bandwidth infrastructure services, which we believe provides us with a sustainable competitive advantage in these markets. As a result, we believe that the services we provide to our customers would be difficult to replicate in a cost- and time-efficient manner. We provide our network-neutral colocation and interconnection services utilizing our own data centers located within three major 32 -------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIES carrier hotels in the important gateway markets of New York and New Jersey and in facilities located in Chicago, Illinois; Las Vegas, Nevada; Los Angeles, California; Nashville and Memphis Tennessee; Plymouth, Minnesota; Cincinnati, Columbus and Cleveland, Ohio; Pittsburgh and Philadelphia, Pennsylvania; Boston, Massachusetts; Washington, D.C; Baltimore, Maryland; Dallas, Texas and Seattle, Washington. We are a wholly-owned subsidiary of Zayo Group Holdings, Inc., a Delaware corporation ("Holdings"), which is in turn wholly owned by Communications Infrastructure Investments, LLC, a Delaware limited liability company ("CII"). Our fiscal year ends June 30 each year, and we refer to the fiscal year ended June 30, 2012 as "Fiscal 2012" and the year ended June 30, 2013 as "Fiscal 2013." Our Business Units We are organized into three business units: Zayo Bandwidth ("ZB"), Zayo Colocation ("zColo") and Zayo Fiber Solutions ("ZFS"). Each business unit is structured to provide sales, delivery, and customer support for its specific telecom and Internet infrastructure services. Zayo Bandwidth. Through our ZB unit, we provide bandwidth infrastructure services over our regional and metropolitan fiber networks. These services are typically lit bandwidth, meaning that we use optronics to "light" the fiber, and consist of Wavelength, Sonet, Ethernet, IP and Fiber-to-Tower services. Our target customers within this unit are primarily wireless service providers, carriers and other communications service providers (including Incumbent Local Exchange Carriers ("ILECs"), Inter Exchange Carrier ("IXCs"), Rural Local Exchange Carrier ("RLECs"), Competitive Local Exchange Carriers ("CLECs"), and foreign carriers), media and content companies, cable and satellite video providers, commercial banks, brokerage houses, insurance companies, investment banks, social networking companies, web-centric companies, law firms, medical and health care institutions and other Internet-centric businesses that require an aggregate minimum of 10 Gbps of bandwidth across their networks. zColo. Through our zColo unit, we provide network-neutral colocation and interconnection services in three major carrier hotels in the New York metropolitan area (60 Hudson Street and 111 8th Avenue in New York, New York, and 165 Halsey Street in Newark, New Jersey) and in facilities located in Chicago, Illinois; Las Vegas, Nevada; Los Angeles, California; Nashville and Memphis Tennessee; Plymouth, Minnesota; Cincinnati, Columbus and Cleveland, Ohio; Pittsburgh and Philadelphia, Pennsylvania; Boston, Massachusetts; Washington, D.C; Baltimore, Maryland; Dallas, Texas and Seattle, Washington. In addition, we are the exclusive operator of the Meet-Me Room at 60 Hudson Street, which is one of the most important carrier hotels in the United States with approximately 300 domestic and international networks interconnecting within this facility. Our zColo data centers house and power Internet and private-network equipment in secure, environmentally-controlled locations that our customers use to aggregate and distribute data, voice, Internet, and video traffic. Throughout two of the three facilities in the New York City metropolitan area, we operate intra-building interconnect networks that, along with the Meet-Me Room at 60 Hudson Street, are utilized by our customers to efficiently and cost-effectively interconnect with other Internet, data, video, voice, and wireless networks. As of December 31, 2012 and June 30, 2012, the zColo unit managed 141,436 and 96,275 square feet of billable colocation space, respectively. Zayo Fiber Solutions. Through our ZFS unit, we provide dark-fiber and related services primarily on our existing fiber footprint. We lease dark-fiber pairs to our customers and, as part of our service offering, we manage and maintain the underlying fiber network for the customer. Our customers light the fiber using their own optronics, and as such, we do not manage the bandwidth that the customer receives. This allows the customer to manage bandwidth on their own metro and long haul networks according to their specific business needs. ZFS's customers include carriers and other communication service providers, Internet service providers, wireless service providers, major media and content companies, social networking companies, web-centric companies, and other companies that have the expertise to run their own fiber optic networks. We market and sell dark-fiber-related services under long-term contracts (up to 20 years and in a few cases longer); our customers generally pay us on a monthly basis for these services. Factors Affecting Our Results of Operations Business Acquisitions We were founded in 2007 in order to take advantage of the favorable Internet, data and wireless growth trends driving the demand for bandwidth infrastructure services. These trends have continued in the years since our founding, despite volatile economic conditions, and we believe that we are well-positioned to continue to capitalize on those trends. We have built our network and services primarily through 20 acquisitions accounted for as business combinations. 33 -------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIESAboveNet Inc. ("AboveNet") On July 2, 2012 we acquired 100% of the outstanding capital stock of AboveNet, a public company listed on the New York Stock Exchange, for total consideration of approximately $2,212.5 million in cash, net of cash acquired. At the closing, each outstanding share of AboveNet common stock was converted into the right to receive $84 in cash. AboveNet is a provider of bandwidth infrastructure and network-neutral colocation and interconnection services, primarily to large corporate enterprise clients and communication carriers, including Fortune 1000 and FTSE 500 companies in the United States and Europe. AboveNet's commercial strategy has been consistent with the Company's; that is, to focus on leveraging its infrastructure assets to provide bandwidth infrastructure services to a select set of customers with high bandwidth demands. AboveNet provides lit and dark fiber bandwidth infrastructure services over its dense metropolitan, regional, national, and international fiber networks. It also operates a Tier 1 IP network with direct and indirect (through peering arrangements) connectivity in many of the most important bandwidth centers and peering exchanges in the U.S., Europe, and Japan. Its product set is highly aligned with our own, consisting primarily of dark fiber, Wavelength, Ethernet, IP and colocation services. AboveNet has also grown a very strong base of business with enterprise clients, particularly within the financial services segment. The acquisition of AboveNet has added 20,590 new route miles and approximately 2,500,000 fiber miles to our network and adds connections to approximately 4,000 on-net buildings, including more than 2,600 enterprise locations, many of which house some of the largest corporate users of network services in the world. AboveNet's metropolitan networks typically contain 432, and in some cases 864, fiber strands in each cable. This high fiber count allows AboveNet to add new customers in a timely and cost-effective manner by focusing incremental construction and capital expenditures on the laterals that connect to the customer premises. AboveNet's metropolitan networks serve 17 markets in the U.S., with strong network footprints in a number of the largest metropolitan markets including Boston, Massachusetts; Chicago, Illinois; Los Angeles, California; New York, New York; Philadelphia, Pennsylvania; San Francisco, California; Seattle, Washington; and Washington, D.C. It also serves four metropolitan markets in Europe: London, United Kingdom; Amsterdam, Netherlands; Frankfurt, Germany; and Paris, France. These locations also include many private data centers and hub locations that are important for AboveNet's customers. AboveNet uses under-sea capacity on the Japan-U.S. Cable Network to provide connectivity between the U.S and Japan, and capacity on the Trans-Atlantic undersea telecommunications network and other trans-Atlantic cables to provide connectivity from the U.S. to Europe. Included in the purchase price was a business which provided professional services to certain users of bandwidth capacity. As the professional services business ("Zayo Professional Services" or "ZPS") did not align with our primary focus of providing bandwidth infrastructure services, ZPS was spun-off to Holdings on September 30, 2012. On the spin-off date, we estimated the net fair value of the ZPS assets and liabilities that were contributed to Holdings to be $26.7 million. The results of the acquired AboveNet business, excluding ZPS, are included in the operating results of the ZB, ZFS and zColo business units beginning July 2, 2012. FiberGate Holdings, Inc. ("FiberGate") On August 31, 2012, we acquired 100% of the outstanding equity interest in FiberGate for total consideration of $118.3 million, subject to certain post-closing adjustments. The acquisition was funded with cash on hand. Headquartered in Alexandria, Virginia, FiberGate is a provider of dark fiber services throughout the Washington, D.C., Northern Virginia, and Baltimore, Maryland corridor. The FiberGate acquisition adds 779 route miles and 183,000 fiber miles to our metro fiber network in and around the capital region. FiberGate also has 317 on-net buildings, including key government sites, carrier hotels, data centers, cell towers, and enterprise buildings. FiberGate has provided dark fiber services to the federal government since its inception in 1995 and has since expanded its clientele to include large enterprise and carrier customers. The results of the acquired FiberGate business are included in the operating results of the ZFS business unit beginning August 31, 2012. USCarrier Telecom, LLC ("USCarrier") In connection with the American Fiber Systems Holding Corporation acquisition, we acquired an ownership interest in USCarrier. USCarrier is a provider of transport services such as Ethernet and Wavelength primarily to other 34 -------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIES telecommunications providers. As of June 30, 2012, we owned 55% of the outstanding Class A membership units and 34% of the outstanding Class B membership units of USCarrier. On October 1, 2012, we acquired the remaining equity interest in USCarrier not previously owned for total consideration of $15.9 million, subject to certain post-closing adjustments. The acquisition was funded with cash on hand. Prior to our acquisition of the remaining interest, our interest in USCarrier was recorded using the cost basis of accounting and as such, the operating results of the acquired USCarrier business were not included in the operating results of the Company until October 1, 2012. First Telecom Services, LLC ("First Telecom") On December 14, 2012, we acquired 100% of the equity interest in First Telecom, a privately held limited liability company, for total consideration of $110.4 million, subject to certain adjustments at closing and post-closing. The acquisition was funded with cash on hand. First Telecom is a provider of bandwidth infrastructure services throughout the Northeastern and Midwestern United States. First Telecom manages a network of over 8,000 route miles and 350,000 fiber miles and approximately 500 on-net buildings. It is focused on providing dark fiber and wavelength services across an 11 state footprint, with its highest concentration of network and revenue in Pennsylvania and Ohio. The results of the acquired First Telecom business are included in the operating results of the ZB, ZFS and zColo business units beginning December 15, 2012. Litecast/Balticore, LLC ("Litecast") On December 31, 2012, we acquired 100% of the equity interest in Litecast, a provider of metro bandwidth infrastructure services in Baltimore, Maryland, for a price of $22.2 million. The acquisition was funded with cash on hand. Litecast owns and operates a Baltimore metropolitan fiber network, connecting over 110 on-net buildings, including the city's major datacenters and carrier hotel facilities. Litecast is focused on providing dark fiber and Ethernet-based services to a concentrated set of Baltimore enterprise and governmental customers, particularly within the healthcare and education industries. The results of the acquired Litecast business will be included in the operating results of the ZB, ZFS and zColo business units beginning January 1, 2013. Acquisition of 360networks Holdings (USA) Inc. ("360networks") On December 1, 2011, we acquired 100% of the equity of 360networks. We paid the purchase price of approximately $318.1 million, net of approximately $1.0 million in cash acquired and net of an assumed working capital deficiency of approximately $26.0 million. Included in the $318.1million purchase price was VoIP 360, Inc. ("VoIP360"), a legal subsidiary of 360networks. The VoIP360 entity held substantially all of 360networks Voice over Internet Protocol ("VoIP") and other voice product offerings. Effective January 1, 2011, we spun-off our voice operations to Holdings in order to maintain focus on our bandwidth infrastructure business. Concurrently with the closing of the 360networks' acquisition, we spun-off 360networks VoIP operations to Holdings. On the spin-off date, we estimated the net fair value of the VoIP assets and liabilities that were contributed to Holdings to be $11.7 million. The acquired 360networks business operates approximately 19,789 route miles of intercity and metropolitan fiber network across 22 states and British Columbia. 360networks' intercity network interconnects over 70 markets across the central and western United States, including 23 of our fiber markets and a number of new markets such as Albuquerque, New Mexico; Bismarck, North Dakota; Des Moines, Iowa; San Francisco, California; San Diego, California; and Tucson, Arizona. In addition to its intercity network, 360networks operates over 800 route miles of metropolitan fiber networks across 26 markets, including Seattle, Washington; Denver, Colorado; Colorado Springs, Colorado; Omaha, Nebraska; Sacramento, California; and Salt Lake City, Utah. The results of the legacy 360networks business are included in the operating results of the ZB and ZFS business units beginning December 1, 2011. 35 -------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIESAcquisition of Mercury Marquis Holdings, LLC ("MarquisNet") On December 31, 2011, we entered into an Asset Purchase Agreement with MarquisNet. The transactions contemplated by the agreement closed on the same date, at which time our zColo business unit acquired substantially all of the net assets of MarquisNet for total consideration of $13.6 million. The acquisition was funded with a draw on the Company's revolving line-of-credit. The acquired MarquisNet business operates a single 28,000 square foot data center which provides colocation services in Las Vegas, Nevada. The operating results of the acquired business are included in zColo's operating results beginning January 1, 2012. Acquisition of Arialink On May 1, 2012, we acquired 100% of the equity interest in Control Room Technologies, LLC, Allegan Fiber Communications, LLC, and Lansing Fiber Communications (collectively, "Arialink") for net cash consideration of $17.2 million. Included in the $17.2 million purchase price were certain assets and liabilities which supported Arialink's managed service product offerings. Concurrently with the closing of the Arialink acquisition, we spun-off a portion of Arialink's business supporting those managed service product offerings to Holdings. Our estimate of the fair value of the net assets spun-off to Holdings was approximately $1.8 million. The remaining assets were contributed to the ZB and ZFS business units. The results of the acquired business are included in the operating results of the ZB and ZFS business units beginning May 1, 2012. Debt and Equity Financing In connection with the AboveNet acquisition, on July 2, 2012, we issued $750.0 million aggregate principal amount of 8.125% senior secured first-priority notes due 2020 ("Senior Secured Notes") and $500.0 million aggregate principal amount of 10.125% senior unsecured notes due 2020 ("Senior Unsecured Notes", and collectively with the Senior Secured Notes, the "Notes"). We also entered into a new $250.0 million senior secured revolving credit facility (the "Revolver") and a new $1.62 billion senior secured term loan facility, issued at a $30.0 million discount, which accrues interest at floating rates (the "Term Loan Facility"). The effective interest rate on the Term Loan Facility as of July 2, 2012 was 7.125%. In addition, CII concluded the sale of 98,916,060.11 Class C Preferred Units of CII pursuant to certain securities purchase agreements with new private investment funds, as well as certain existing owners of CII and other investors. The total value of the Class C Preferred Units of CII issued pursuant to the securities purchase agreements was approximately $470.3 million, net of $2.0 million in costs associated with raising the additional capital. $133.2 million of the net proceeds from the equity raised were contributed to us in June 2012 and the remaining $337.1 million was contributed during the six months ended December 31, 2012. A portion of the proceeds from the equity contribution, together with (i) the net proceeds from the Notes and the Term Loan Facility, and (ii) cash on hand, were used to pay the outstanding portion of our previously existing credit facilities, to finance the cash tender offer for and subsequent redemption of our $350.0 million outstanding aggregate principal amount of our previously existing notes, to pay the cash consideration for the AboveNet acquisition and associated fees and expenses. In connection with the debt extinguishment activities discussed above, we recognized an expense in July 2012 of $65.0 million associated with debt extinguishment costs, including a non-cash expense of $17.0 million associated with the writing-off of our unamortized debt issuance costs, a cash expense of $39.8 million associated with the payment of early redemption fees on our previous indebtedness, and a non-cash expense of $8.1 million associated with writing off the net unamortized discount on the extinguished debt balances. In connection with the Notes offering and the Term Loan Facility, we recorded an original issue discount of $30.0 million and incurred debt issuance costs of $85.2 million. These costs and the original issue discount will be amortized to interest expense over the respective terms of the underlying debt instruments using the effective interest method. On October 5, 2012, we entered into a second amendment (the "Amendment") to our original credit agreement (the "Credit Agreement"). Per the terms of the Amendment, our $1.62 billion Term Loan Facility will bear interest at LIBOR plus 4.0 %, which represents a downward adjustment of 187.5 basis points from the original credit agreement. Our Revolver, which was undrawn as of December 31, 2012, will bear interest at LIBOR plus 3.5 % (based on our current leverage ratio), which represents a downward adjustment of 187.5 basis points from the original credit agreement. In connection with the 36 -------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIES Amendment, we incurred a re-pricing premium of $16.2 million, which was paid with cash on hand. We recognized an additional debt extinguishment expense in October 2012 of $5.7 million related to the Amendment and incurred an additional $16.1 million in debt issuance costs. The Amendment also reduced the borrowing capacity on our Revolver to $225.0 million from $250.0 million and adjusted the interest rate on the Revolver down by 187.5 basis points. The Revolver was undrawn as of December 31, 2012. Any amounts drawn would bear interest at LIBOR plus 3.5% (based on the Company's current leverage ratio). In August 2012, we entered into forward-starting interest rate swap agreements with an aggregate notional value of $750.0 million, a maturity date of June 30, 2017, and a start date of June 30, 2013. The contracts state that we shall pay a 1.67% fixed rate of interest for the term of the agreement beginning on the start date. The counterparties will pay to us the greater of actual LIBOR or 1.25%, the minimum reference rate on the term loan. We entered in to the forward-starting swap arrangements to reduce the risk of increased interest costs associated with potential future increases in LIBOR rates Substantial Capital Expenditures During the six months ended December 31, 2012 and 2011, we invested $125.6 million (net of stimulus grant reimbursements) and $60.0 million (net of stimulus grant reimbursements), respectively, in capital expenditures related to property and equipment primarily to expand our fiber network, largely in connection with new customer contracts. We expect to continue to make significant capital expenditures in future periods. As a result of the growth of our business from the acquisitions discussed above and capital expenditures and the increased debt used to fund those investing activities, our results of operations for the respective periods presented and discussed herein are not comparable. Critical Accounting Policies and Estimates For a description of our critical accounting policies and estimates, see Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended June 30, 2012. Background for Review of Our Results of Operations Operating Costs Our operating costs consist primarily of colocation facility costs, colocation facility utilities costs and third-party network service costs. Our colocation facility costs include rent and license fees paid to the landlords of the buildings in which our zColo business operates along with the utility costs to power those facilities. Third-party network service costs result from our leasing of certain network facilities, primarily leases of circuits and dark fiber, from other local exchange carriers to augment our owned infrastructure for which we are generally billed a fixed monthly fee. While increases in demand will drive additional operating costs in our business, we expect to primarily utilize our existing network infrastructure and augment, when necessary, with additional circuits or services from third-party providers. Transport costs include the upfront cost of the initial installation of such circuits. Selling, General and Administrative Expenses Our selling, general and administrative ("SG&A") expenses include personnel costs, costs associated with the operation of our network (network operations), and other related expenses, including sales commissions, marketing programs, office rent, professional fees, travel, software maintenance costs, costs incurred related to potential and closed acquisitions (i.e., transaction costs) and other expenses. After compensation and benefits, network operations expenses are the largest component of our SG&A expenses. Network operations expenses include all of the non-personnel related expenses of maintaining our network infrastructure, including contracted maintenance fees, right-of-way costs, rent for locations where fiber is located (including cellular towers), pole attachment fees, and relocation expenses. 37-------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIESStock-Based Compensation We compensate certain members of our management and independent directors through grants of common units of CII, which vest over varying periods of time, depending on the terms of employment of each such member of management or director. In addition, certain of our senior executives and independent directors have been granted preferred units of CII. For the common units granted to members of management and directors, we recognize an expense equal to the fair value of all of those common units vested during the period, and record a liability in respect of that amount. Subsequently, we recognize changes in the fair value of those common units through increases or decreases in stock-based compensation expense and related adjustments to the related stock-based compensation liability. When the preferred units are initially granted, we recognize no expense. We use the straight line method, over the vesting period, to amortize the fair value of those units, as determined on the date of grant. Subsequent changes in the fair value of the preferred units granted to those executive officers and directors are not taken into consideration as we recognize that expense. 38 -------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIES Results of Operations Three months ended December 31, Six months ended December 31, 2012 2011 2012 2011 (amounts in thousands) (amounts in thousands) Revenue Zayo Bandwidth $ 158,650 66 % $ 64,472 72 % $ 310,702 66 % $ 121,015 72 % Zayo Fiber Solutions 71,455 29 15,343 17 137,347 29 28,574 17 zColo 15,434 6 10,154 11 30,727 6 19,823 12 Intercompany eliminations (2,035 ) (1 ) (995 ) (1 ) (5,578 ) (1 ) (1,995 ) (1 ) Total Revenue 243,504 100 88,974 100 473,198 100 167,417 100 Operating costs and expenses Operating costs, excluding depreciation and amortization 34,888 14 19,275 22 67,605 14 37,425 22 Selling, general and administrative expenses 73,048 30 26,059 29 158,842 34 48,655 29 Stock-based compensation 33,445 14 10,372 12 43,926 9 14,077 8 Depreciation and amortization 57,978 24 19,820 22 112,478 24 36,882 22 Total operating costs and expenses 199,359 82 75,526 85 382,851 81 137,039 82 Operating income 44,145 18 13,448 15 90,347 19 30,378 18 Interest expense, net (52,635 ) (22 ) (11,504 ) (13 ) (115,189 ) (24 ) (20,672 ) (12 ) Loss on extinguishment of debt (5,707 ) (2 ) - - (70,682 ) (15 ) - - Other income/(expense), net 224 - (19 ) - 809 - (29 ) - (Loss)/earnings from continuing operations before income taxes (13,973 ) (6 ) 1,925 2 (94,715 ) (20 ) 9,677 6 Benefit/(provision) for income taxes 6,025 2 2,994 3 (21,295 ) (5 ) 7,598 5 (Loss)/earnings from continuing operations $ (19,998 ) (8 )% $ (1,069 ) (1 )% $ (73,420 ) (15 )% $ 2,079 1 % EBITDA (add backs) Depreciation and amortization $ 57,978 $ 19,820 $ 112,478 $ 36,882 Interest expense 52,635 11,504 115,189 20,672 Loss on extinguishment of debt 5,707 - 70,682 - Provision/(benefit) for income taxes 6,025 2,994 (21,295 ) 7,598 Foreign currency gain on intercompany loans (128 ) - (679 ) - Stock-based compensation 33,445 10,372 43,926 14,077 Transaction costs 1,634 1,479 13,018 1,809 Adjusted EBITDA $ 137,298 56 % $ 45,100 51 % $ 259,899 55 % $ 83,117 50 % Selected cash flow data Net cash flows provided by operating activities $ 106,337 $ 33,084 $ 185,408 $ 57,309 Purchases of property and equipment, net of stimulus grants (58,909 ) (31,375 ) (125,565 ) (60,019 ) Acquisitions (145,536 ) (33,498 ) (2,473,701 ) (333,498 ) Net cash flows used in investing activities $ (204,445 ) $ (364,873 ) $ (2,599,266 ) $ (393,517 ) Net cash flows provided by financing activities $ (22,770 ) $ 336,804 $ 2,354,266 $ 336,675 Three Months Ended December 31, 2012 Compared to the Three Months Ended December 31, 2011 Revenue Our total revenue increased by $154.5 million, or 174%, from $89.0 million to $243.5 million for the three months ended December 31, 2011 and 2012, respectively. The increase in revenue was primarily a result of our Fiscal 2012 and Fiscal 2013 acquisitions and organic growth. The table below reflects the revenue recognized by each entity acquired during Fiscal 2011 39 -------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIES and Fiscal 2012 during the quarterly period immediately preceding the respective acquisition date multiplied by 4 ("LQA revenue"). The table also reflects the Company's estimates of the allocation of those revenues, based upon the nature of the service, to each of our business segments. The amounts below include adjustments to the historical amounts recognized by the acquired company resulting from estimated purchase accounting adjustments. Acquired Entity Acquisition Date ZB ZFS zColo Total 360networks December 1, 2011 $ 60,654 $ 18,324 $ - $ 78,978 MarquisNet December 31, 2011 - - 6,636 6,636 Arialink May 1, 2012 3,633 1,016 - 4,649 AboveNet July 2, 2012 298,872 169,908 9,504 478,284 FiberGate August 31, 2012 - 15,132 - 15,132 USCarrier October 1, 2012 15,824 228 228 16,280 First Telecom October 14, 2012 24,633 6,616 - 31,249 In addition to the acquisition related revenue growth during the period resulting from the aforementioned acquisitions was organic growth. As a result of internal sales efforts since December 31, 2011, we have entered into $897.0 million in gross new sales contracts, which will represent an additional $13.7 million in monthly revenue once installation on those contracts is accepted. Since December 31, 2011, we have received acceptance on gross installations that have resulted in additional monthly revenue of $12.5 million as of December 31, 2012 as compared to December 31, 2011. This increase in revenue related to our organic growth is partially offset by total customer churn of $9.3 million in monthly revenue since December 31, 2011. The following table reflects the stratification of our revenues during the three months ended December 31, 2012 and 2011: Three months ended December 31, 2012 2011 (in thousands) Monthly recurring revenue $ 231,019 95 % $ 82,663 93 % Amortization of deferred revenue 8,133 3 % 3,107 3 % Other revenue 4,352 2 % 3,204 4 % Total revenue $ 243,504 100 % $ 88,974 100 % Zayo Bandwidth. Our revenues from our ZB operating segment increased by $94.2 million, or 146%, from $64.5 million to $158.7 million for the three months ended December 31, 2011 and 2012, respectively. The increase is a result of both the acquisition related growth, discussed above, and organic growth. Since December 31, 2011, ZB received acceptance on gross installations that have resulted in additional monthly revenue of $9.2 million as of December 31, 2012, as compared to December 31, 2011. This increase in revenue related to organic growth is partially offset by total customer churn at ZB of $7.0 million in monthly revenue since December 31, 2011. Zayo Fiber Solutions. Our revenues from our ZFS operating segment increased by $52.2 million, or 366%, from $15.3 million to $71.5 million during the three months ended December 31, 2011 and 2012, respectively. The increase is a result of both the acquisition related growth, discussed above, and organic growth. Since December 31, 2011, ZFS received acceptance on gross installations that have resulted in additional monthly revenue of $2.4 million as of December 31, 2012, as compared to December 31, 2011. This increase in revenue related to organic growth is partially offset by total customer churn at ZFS of $1.4 million in monthly revenue since December 31, 2011. zColo. Our revenues from our zColo segment increased by $5.3 million, or 52%, from $10.2 million to $15.4 million during the three months ended December 31, 2011 and 2012, respectively. The increase is a result of both the acquisition related growth, discussed above, and organic growth. Since December 31, 2011, zColo received acceptance on gross installations that have resulted in additional monthly revenue of $1.0 million as of December 31, 2012, as compared to December 31, 2011. This increase in revenue related to organic growth is partially offset by total customer churn at zColo of $0.9 million in monthly revenue since December 31, 2011. Also contributing to the revenue growth is additional intercompany revenue from colocation sites acquired from AboveNet. 40 -------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIESOperating Costs, Excluding Depreciation and Amortization Our operating costs, excluding depreciation and amortization, increased by $15.6 million, or 81%, from $19.3 million to $34.9 million for the three months ended December 31, 2011 and 2012, respectively. The increase in operating costs, excluding depreciation and amortization, primarily relates to additional network costs incurred in order to support new customer contracts entered into subsequent to December 31, 2011 and additional costs associated with the our Fiscal 2012 and Fiscal 2013 acquisitions. The 81% increase in operating costs, excluding depreciation and amortization, occurred during the same period in which our revenues increased by 174%. The lower ratio of operating costs as compared to revenues is primarily a result of gross installed revenues having a lower component of associated operating costs than the prior period's installed revenue base due to a higher percentage of our newly installed revenue being supported by our owned infrastructure assets (i.e., on-net). The ratio also benefited from a higher percentage of acquired revenue being on-net and from synergies realized related to our Fiscal 2012 and Fiscal 2013 acquisitions. Selling, General and Administrative Expenses: The table below sets forth the components of our selling, general and administrative ("SG&A") expenses during the three months ended December 31, 2012 and 2011. Three months ended December 31, 2012 2011 (in thousands) Compensation and benefits expenses $ 31,095 $ 10,780 Network operations expenses 25,738 8,749 Other SG&A expenses 14,581 5,051 Transaction costs 1,634 1,479 Total SG&A expenses $ 73,048 $ 26,059 Compensation and Benefits Expenses. Compensation and benefits expenses increased by $20.3 million, or 188%, from $10.8 million to $31.1 million for the three months ended December 31, 2011 and 2012, respectively. The increase reflects the increased number of employees hired during the year to support our growing business. At December 31, 2012, we had 1,038 full time employees compared to 482 full time employees at December 31, 2011. A majority of the increase to our headcount occurred on July 2, 2012 as a result of hiring certain former employees of AboveNet. Network Operations Expenses. Network operations expenses increased by $17.0 million, or 194%, from $8.7 million to $25.7 million for the three months ended December 31, 2011 and 2012, respectively. The increase in such expenses principally reflects the growth of our network assets and the related expenses of operating that expanded network. Other SG&A. Other SG&A expenses, which includes expenses such as property tax, franchise fees, travel, office expense, and maintenance expense on colocation facilities, increased by $9.5 million, or 189%, from $5.1 million to $14.6 million for the three months ended December 31, 2011 and 2012, respectively. The increase is principally a result of additional expenses attributable to our Fiscal 2013 and Fiscal 2012 acquisitions. Transaction Costs. Transaction costs include expenses associated with professional services (i.e., legal, accounting, regulatory, etc.) rendered in connection with acquisitions, travel expense, severance expense incurred on the date of acquisition and other direct expenses incurred that are associated with potential and closed acquisitions. Transaction costs increased during the three months ended December 31, 2012, as compared to the three months ended December 31, 2011 by $0.2 million as a result of costs associated with our acquisitions of USCarrier, First Telecom and Litecast, which were higher in the aggregate than the transaction costs we incurred during the same period in Fiscal 2012 with the 360networks and Marquisnet acquisitions. 41 -------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIES Stock-Based Compensation Stock-based compensation expenses increased by $23.1 million, or 222%, from $10.4 million to $33.4 million during the three months ended December 31, 2011 and 2012, respectively. The stock-based compensation expense associated with the common units is impacted by both the estimated value of the common units and the number of common units vesting during the period. The following table reflects the estimated fair value of the common units during the relevant periods impacting the stock-based compensation expense for the three months ended December 31, 2012 and 2011. Estimated fair value as of September 30, December 31, September 30, December 31, Common Units 2012 2012 2011 2011 Class A $ 0.95 $ 1.21 $ 0.83 $ 0.94 Class B 0.83 1.06 0.59 0.71 Class C 0.70 0.89 0.36 0.62 Class D 0.67 0.86 0.34 0.53 Class E 0.57 0.73 0.25 0.45 Class F 0.51 0.64 n/a n/a Class G 0.27 0.33 n/a n/a The increase in the value of the common units is primarily a result of our organic growth since December 31, 2011, synergies realized or expected to be realized from our Fiscal 2012 and Fiscal 2013 acquisitions and a reduction to the discount rate utilized in the Company's valuation of the common units resulting from the Company's reduced financing costs. In December 2011, CII and the preferred unit holders of CII authorized a non-liquidating distribution to common unit holders of up to $10.0 million. The eligibility for receiving proceeds from the distribution was determined by the liquidation preference of the unit holder. Receiving proceeds from the authorized distribution was at the election of the common unit holder. As a condition of the early distribution, common unit holders electing to receive an early distribution received 85% of the amount that they would otherwise be entitled to receive if the distribution were in connection with a liquidating distribution. The common unit holders electing to receive the early distribution retained all of their common units and are entitled to receive future distributions only to the extent such future distributions are in excess of the non-liquidating distribution, excluding the 15% discount. During the three months ended December 31, 2011, $9.0 million was distributed to the Company's common unit holders. Common unit holders electing to receive the early distribution forfeited $1.4 million in previously recognized stock-based compensation. During the three months ended December 31, 2011, stock-based compensation expense was reduced by $1.6 million as a result of this distribution. Depreciation and Amortization Depreciation and amortization expense increased by $38.2 million, or 193%, from $19.8 million to $58.0 million for the three months ended December 31, 2011 and 2012, respectively. The increase is a result of the substantial increase to our property and equipment and intangible assets since December 31, 2011, principally a result of our Fiscal 2012 and Fiscal 2013 acquisitions and our $189.7 million in capital expenditures since December 31, 2011. Total Other Expense, Net The table below sets forth the components of our total other expense, net for the three months ended December 31, 2012 and 2011, respectively. Three months ended December 31, 2012 2011 (in thousands) Interest expense $ (52,635 ) $ (11,504 ) Loss on extinguishment of debt (5,707 ) - Other income, net 224 (19 ) Total other expenses, net $ (58,118 ) $ (11,523 ) 42-------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIESInterest Expense Interest expense increased by $41.1 million, or 358%, from $11.5 million to $52.6 million for the three months ended December 31, 2011 and 2012, respectively. The increase is a result of our increased indebtedness during Fiscal 2013 as compared to Fiscal 2012. See Note 6 - Long-Term Debt. Loss on extinguishment of debt In connection with the re-pricing on our $1,620.0 million Term Loan Facility, discussed above, we recognized an expense in October 2012 of $5.7 million associated with debt extinguishment costs, including a cash expense of $1.5 million associated with the payment of an early call premium paid to certain creditors and other third party expenses and $4.2 million associated with the write-off of unamortized debt issuance costs and discounts. Other income, net Other income, net during the three months ended December 31, 2012 primarily relates to an unrealized foreign currency gain on an intercompany loan. Our domestic subsidiaries have an intercompany loan denominated in U.S. dollars with our U.K foreign subsidiary. The intercompany loan balance is eliminated in consolidation, however the strengthening of the British pound over the U.S. dollar during the three months ended December 31, 2012 resulted in an unrealized foreign exchange gain of $0.1 million at our foreign subsidiary. Provision for Income Taxes The Company recorded a provision for income taxes of $6.0 million during the three months ended December 31, 2012 as compared to a provision for income taxes of $2.9 million during the three months ended December 31, 2011. Our provision for income taxes includes both the current provision and a provision for deferred income tax expense resulting from timing differences between tax and financial reporting accounting bases. We are unable to combine our net operating losses ("NOLs") for application to the income of our subsidiaries in some states and thus our state income tax expense is higher than the expected blended rate. In addition, as a result of our stock based compensation and transaction costs not being deductible for income tax purposes, our effective tax rate is higher than the statutory rate. The following table reconciles an expected tax provision based on the statutory federal tax rate applied to our earnings before income taxes. For the three months ended December 31, 2012 2011 Expected provision at statutory rate $ (4,893 ) $ 655 Increase due to: Non-deductible stock-based compensation 10,912 1,822 State income taxes, net of federal benefit 463 381 Transactions costs not deductible for tax purposes 35 91 Foreign tax rate differential (228 ) - Other, net (264 ) 45 (Benefit)/provision for income taxes $ 6,025 $ 2,994 Six Months Ended December 31, 2012 Compared to the Six Months Ended December 31, 2011 Revenue Our total revenue increased by $305.8 million, or 183%, from $167.4 million to $473.2 million for the six months ended December 31, 2011 and 2012, respectively. The increase in revenue was primarily a result of our Fiscal 2012 and Fiscal 2013 acquisitions and organic growth. See - Results of Operations - Three Months Ended December 31, 2012 Compared to the Three Months Ended December 31, 2011, for a summary of revenue acquired from our Fiscal 2012 and 2011 acquisitions and a discussion of organic growth since July 1, 2011. The following table reflects the stratification of our revenues during these periods: 43 -------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIES Six months ended December 31, 2012 2011 (in thousands) Monthly recurring revenue $ 451,059 96 % $ 157,072 94 % Amortization of deferred revenue 15,947 3 % 5,688 3 % Other revenue 6,192 1 % 4,657 3 % Total revenue $ 473,198 100 % $ 167,417 100 % Zayo Bandwidth. Our revenues from our ZB operating segment increased by $189.7 million, or 157%, from $121.0 million to $310.7 million for the six months ended December 31, 2011 and 2012, respectively. The increase is a result of both the acquisition related growth, discussed above, and organic growth. Since December 31, 2011, ZB received acceptance on gross installations that have resulted in additional monthly revenue of $9.2 million as of December 31, 2012, as compared to December 31, 2011. This increase in revenue related to organic growth is partially offset by total customer churn at ZB of $7.0 million in monthly revenue since December 31, 2011. Zayo Fiber Solutions. Our revenues from our ZFS operating segment increased by $108.8 million, or 381%, from $28.6 million to $137.3 million during the six months ended December 31, 2011 and 2012, respectively. The increase is a result of both the acquisition related growth, discussed above, and organic growth. Since December 31, 2011, ZFS received acceptance on gross installations that have resulted in additional monthly revenue of $2.4 million as of December 31, 2012, as compared to December 31, 2011. This increase in revenue related to organic growth is partially offset by total customer churn at ZFS of $1.4 million in monthly revenue since December 31, 2011. zColo. Our revenues from our zColo segment increased by $10.9 million, or 55%, from $19.8 million to $30.7 million during the six months ended December 31, 2011 and 2012, respectively. The increase is a result of both the acquisition related growth, discussed above, and organic growth. Since December 31, 2011, zColo received acceptance on gross installations that have resulted in additional monthly revenue of $1.0 million as of December 31, 2012, as compared to December 31, 2011. This increase in revenue related to organic growth is partially offset by total customer churn at zColo of $0.9 million in monthly revenue since December 31, 2011. Operating Costs, Excluding Depreciation and Amortization Our operating costs, excluding depreciation and amortization, increased by $30.2 million, or 81%, from $37.4 million to $67.6 million for the six months ended December 31, 2011 and 2012, respectively. The increase in operating costs, excluding depreciation and amortization, primarily relates to additional network costs incurred in order to support new customer contracts entered into subsequent to December 31, 2011 and additional costs associated with the our Fiscal 2012 and Fiscal 2013 acquisitions. The 81% increase in operating costs, excluding depreciation and amortization, occurred during the same period in which our revenues increased by 183%. The lower ratio of operating costs as compared to revenues is primarily a result of gross installed revenues having a lower component of associated operating costs than the prior period's installed revenue base due to a higher percentage of our newly installed revenue being supported by our owned infrastructure assets (i.e., on-net). The ratio also benefited from a higher percentage of acquired revenue being on-net and from synergies realized related to our Fiscal 2012 and Fiscal 2013 acquisitions. Selling, General and Administrative Expenses: The table below sets forth the components of our SG&A expenses during the six months ended December 31, 2012 and 2011. Six months ended December 31, 2012 2011 (in thousands) Compensation and benefits expenses $ 64,470 $ 21,222 Network operations expenses 53,231 15,826 Other SG&A expenses 28,123 9,798 Transaction costs 13,018 1,809 Total SG&A expenses $ 158,842 $ 48,655 44-------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIES Compensation and Benefits Expenses. Compensation and benefits expenses increased by $43.3 million, or 204%, from $21.2 million to $64.5 million for the six months ended December 31, 2011 and 2012, respectively. The increase reflects the increased number of employees hired during the year to support our growing business. At December 31, 2012, we had 1,038 full time employees compared to 482 full time employees at December 31, 2011. A majority of the increase to our headcount occurred on July 2, 2012 as a result of hiring certain former employees of AboveNet. Network Operations Expenses. Network operations expenses increased by $37.4 million, or 236%, from $15.8 million to $53.2 million for the six months ended December 31, 2011 and 2012, respectively. The increase in such expenses principally reflects the growth of our network assets and the related expenses of operating that expanded network. Other SG&A. Other SG&A expenses, which includes expenses such as property tax, franchise fees, travel, office expense, and maintenance expense on colocation facilities, increased by $18.3 million, or 187%, from $9.8 million to $28.1 million for the six months ended December 31, 2011 and 2012, respectively. The increase is principally a result of additional expenses attributable to our Fiscal 2012 and Fiscal 2011 acquisitions. Transaction Costs. Transaction costs include expenses associated with professional services (i.e., legal, accounting, regulatory, etc.) rendered in connection with acquisitions, travel expense, severance expense incurred on the date of acquisition and other direct expenses incurred that are associated with potential and closed acquisitions. Transaction costs increased during the six months ended December 31, 2012, as compared to the six months ended December 31, 2011 by $11.2 million as a result of costs associated with our Fiscal 2013 acquisitions. Stock-Based Compensation Stock-based compensation expenses increased by $29.8 million, or 212%, from $14.1 million to $43.9 million during the six months ended December 31, 2011 and 2012, respectively. The stock-based compensation expense associated with the common units is impacted by both the estimated value of the common units and the number of common units vesting during the period. The following table reflects the estimated fair value of the common units during the relevant periods impacting the stock-based compensation expense for the six months ended December 31, 2012 and 2011. Estimated fair value as of June 30, December 31, June 30, December 31, Common Units 2012 2012 2011 2011 Class A $ 0.92 $ 1.21 $ 0.81 $ 0.94 Class B 0.81 1.06 0.58 0.71 Class C 0.68 0.89 0.33 0.62 Class D 0.65 0.86 0.31 0.53 Class E 0.55 0.73 0.23 0.45 Class F 0.49 0.64 n/a n/a Class G n/a 0.33 n/a n/a The increase in the value of the common units is primarily a result of our organic growth since December 31, 2011, synergies realized or expected to be realized from our Fiscal 2012 and Fiscal 2013 acquisitions and a reduction to the discount rate utilized in the Company's valuation of the common units. In December 2011, CII and the preferred unit holders of CII authorized a non-liquidating distribution to common unit holders of up to $10.0 million. The eligibility for receiving proceeds from the distribution was determined by the liquidation preference of the unit holder. Receiving proceeds from the authorized distribution was at the election of the common unit holder. As a condition of the early distribution, common unit holders electing to receive an early distribution received 85% of the amount that they would otherwise be entitled to receive if the distribution were in connection with a liquidating distribution. The common unit holders electing to receive the early distribution retained all of their common units and are entitled to receive future distributions only to the extent such future distributions are in excess of the non-liquidating distribution, excluding the 15% discount. During the six months ended December 31, 2011, $9.0 million was distributed to the Company's common unit holders. Common unit holders electing to receive the early distribution forfeited $1.4 million in previously recognized stock-based compensation. During the six months ended December 31, 2011, stock-based compensation expense was reduced by $1.6 million as a result of this distribution. 45 -------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIESDepreciation and Amortization Depreciation and amortization expense increased by $75.6 million, or 205%, from $36.9 million to $112.5 million for the six months ended December 31, 2011 and 2012, respectively. The increase is a result of the substantial increase to our property and equipment and intangible assets since December 31, 2011, principally a result of our Fiscal 2012 and Fiscal 2013 acquisitions and our $198.7 million in capital expenditures since December 31, 2011. Total Other Expense, Net The table below sets forth the components of our total other expense, net for the six months ended December 31, 2012 and 2011, respectively. Six months ended December 31, 2012 2011 (in thousands) Interest expense $ (115,189 ) $ (20,672 ) Loss on extinguishment of debt (70,682 ) - Other income, net 809 (29 ) Total other expenses, net $ (185,062 ) $ (20,701 ) Interest Expense Interest expense increased by $94.1 million, or 457%, from $20.7 million to $115.2 million for the six months ended December 31, 2011 and 2012, respectively. The increase is a result of our increased indebtedness during Fiscal 2012 as compared to Fiscal 2011. Also contributing to the increase in interest expense was the impact of changes in market value of our interest rate swap during the six months ended December 31, 2012. We recorded an increase to interest expense of $5.2 million during the six months ended December 31, 2012 to reflect the change in the fair value of our interest rate swap. See Note 6 - Long-Term Debt. Loss on extinguishment of debt In connection with the debt refinancing activities discussed above, we recognized an expense of $70.7 million associated with debt extinguishment costs, including a cash expense of $41.3 million associated with the payment of early redemption fees and other third party expenses on our previous indebtedness and non-cash expenses including $29.4 million associated with the write-off of unamortized debt issuance costs and discounts. Other income, net Other income, net during the six months ended December 31, 2012 primarily relates to an unrealized foreign currency gain on an intercompany loan. Our domestic subsidiaries have an intercompany loan denominated in U.S. dollars with our U.K foreign subsidiary. The intercompany loan balance is eliminated in consolidation, however the strengthening of the British pound over the U.S. dollar during the six months ended December 31, 2012 resulted in an unrealized foreign exchange gain of $0.7 million at our foreign subsidiary. Benefit/(provision) for Income Taxes The Company recorded a benefit from income taxes of $21.3 million during the six months ended December 31, 2012 as compared to a provision for income taxes of $7.6 million during the six months ended December 31, 2011. Our provision/(benefit) for income taxes includes both the current provision and a provision for deferred income tax expense resulting from timing differences between tax and financial reporting accounting bases. We are unable to combine our net operating losses ("NOLs") for application to the income of our subsidiaries in some states and thus our state income tax expense is higher than the expected blended rate. In addition, as a result of our stock based compensation and transaction costs not being deductible for income tax purposes, our effective tax rate is higher than the statutory rate. The following table reconciles an expected tax provision based on the statutory federal tax rate applied to our earnings before income taxes. 46 -------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIES For the six months ended December 31, 2012 2011 Expected provision at statutory rate $ (33,150 ) $ 3,291 Increase due to: Non-deductible stock-based compensation 14,580 3,081 State income taxes, net of federal benefit (3,042 ) 967 Transactions costs not deductible for tax purposes 945 203 Foreign tax rate differential (687 ) - Other, net 59 56 (Benefit)/provision for income taxes $ (21,295 ) $ 7,598 Adjusted EBITDA We define Adjusted EBITDA as earnings from continuing operations before interest, income taxes, depreciation and amortization ("EBITDA") adjusted to exclude transaction costs, stock-based compensation, and certain non-cash items. 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 we have debt covenants that restrict our borrowing capacity that are based on a leverage ratio, which utilizes a modified EBITDA, as defined in our Credit Agreement. The modified EBITDA is consistent with our definition of Adjusted EBITDA; however, it includes the pro forma Adjusted EBITDA of and expected synergies from the companies acquired by us during the quarter in which the debt compliance certification is due. Under the terms of our Credit Agreement, we must not exceed a consolidated leverage ratio (funded debt to annualized modified EBITDA), as determined under the Credit Agreement, of 6.25 times the last quarter's annualized modified EBITDA. This total leverage ratio steps down in future periods with the next step down occurring on October 1, 2013, when the leverage ratio adjusts to 6.0 times the quarter's annualized modified EBITDA. Adjusted EBITDA results, along with other quantitative and qualitative information, are also utilized by management and our compensation committee for purposes of determining bonus payouts to employees. Adjusted EBITDA has limitations as an analytical tool and should not be considered in isolation from, or as a substitute for, analysis of our results as reported under GAAP. For example, Adjusted EBITDA: • does not reflect capital expenditures, or future requirements for capital and major maintenance expenditures or contractual commitments; • does not reflect changes in, or cash requirements for, our working capital needs; • does not reflect the significant interest expense, or the cash requirements necessary to service the interest payments, on our debt; and • does not reflect cash required to pay income taxes. Our computation of Adjusted EBITDA may not be comparable to other similarly titled measures computed by other companies because all companies do not calculate Adjusted EBITDA in the same fashion. Reconciliations from net earnings/(loss) from continuing operations to Adjusted EBITDA and net cash provided by operating activities to Adjusted EBITDA are as follows: 47 -------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIESReconciliation from net earnings/(loss) to Adjusted EBITDA Three months ended December 31, 2012 Zayo Bandwidth zColo ZFS Corporate Zayo Group ($ in millions) Net earnings/(loss) $ 42.3 $ 3.0 $ 16.6 $ (81.9 ) $ (20.0 ) Interest expense 0.2 - 0.1 52.3 52.6 Provision for income taxes - - - 6.0 6.0 Depreciation and amortization expense 28.3 1.5 28.1 - 58.0 Transaction costs 1.1 0.1 0.4 - 1.6 Stock-based compensation 10.6 0.5 4.4 17.9 33.4 Loss on extinguishment of debt - - - 5.7 5.7 Foreign currency gain on intercompany loans - - - (0.1 ) (0.1 ) Adjusted EBITDA $ 82.4 $ 5.2 $ 49.7 $ - $ 137.3 Three months ended December 31, 2011 Zayo Bandwidth zColo ZFS Corporate Zayo Group ($ in millions) Net earnings/(loss) $ 12.8 $ 2.3 $ 4.0 $ (20.1 ) $ (1.1 ) Interest expense 0.2 - - 11.2 11.5 Provision for income taxes - - - 3.0 3.0 Depreciation and amortization expense 13.4 1.4 5.0 - 19.8 Transaction costs 1.1 0.2 0.2 - 1.5 Stock-based compensation 3.2 0.4 0.8 5.9 10.4 Adjusted EBITDA $ 30.7 $ 4.3 $ 10.0 $ - $ 45.1 Six months ended December 31, 2012 Zayo Bandwidth zColo ZFS Corporate Zayo Group ($ in millions) Net earnings/(loss) $ 71.8 $ 3.8 $ 36.5 $ (183.8 ) $ (71.8 ) Earnings from discontinued operations, net of taxes - - - (1.8 ) (1.8 ) Interest expense 0.3 - - 114.8 115.1 Benefit for income taxes - - - (21.3 ) (21.3 ) Depreciation and amortization expense 61.7 4.2 46.5 - 112.5 Transaction costs 8.5 1.7 2.9 - 13.0 Stock-based compensation 15.2 - 8.2 20.5 43.9 Loss on extinguishment of debt - - - 70.7 70.7 Foreign currency gain on intercompany loans - - - (0.7 ) (0.7 ) Adjusted EBITDA $ 157.4 $ 9.8 $ 94.1 $ (1.6 ) $ 259.9 48-------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIES Six months ended December 31, 2011 Zayo Bandwidth zColo ZFS Corporate Zayo Group ($ in millions) Net earnings/(loss) $ 25.6 $ 4.0 $ 8.1 $ (35.7 ) $ 2.1 Interest expense 0.4 0.1 - 20.1 20.6 Income tax expense - - - 7.6 7.7 Depreciation and amortization expense 25.1 2.8 9.0 - 36.9 Transaction costs 1.3 0.2 0.3 - 1.8 Stock-based compensation 4.4 0.6 1.1 8.0 14.1 Adjusted EBITDA $ 56.9 $ 7.7 $ 18.5 $ - $ 83.1 49-------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIESLiquidity and Capital Resources Our primary sources of liquidity have been cash provided by operations, equity contributions, and borrowings. Our principal uses of cash have been for acquisitions, capital expenditures, and debt service requirements. See "Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations - Cash Flows," below. We anticipate that our principal uses of cash in the future will be for acquisitions, capital expenditures, working capital, and debt service We have financial covenants under the Indentures governing our Notes and our Credit Agreement that, under certain circumstances, restrict our ability to incur additional indebtedness. Among other limitations, the financial covenants contained in the Credit Agreement prohibit us from maintaining total secured indebtedness of more than 5.0 times our previous quarter's annualized modified EBITDA and total funded debt of 6.25 times our previous quarter's modified EBITDA. The senior secured leverage ratio and the total debt leverage ratio step down in future years with the next step down occurring on October 1, 2013 when the minimum leverage ratio drops to 4.75 times and total funded debt ratio drops to 6.0 times our previous quarter's annualized modified EBITDA, respectively. The modified EBITDA, as defined in the Credit Agreement, is consistent with our definition of Adjusted EBITDA; however, it includes the pro forma effect of and expected synergies from our acquisitions during the quarter for which the debt compliance certification is due. The Indentures governing our Notes limit any increase in our secured indebtedness (other than certain forms of secured indebtedness expressly permitted under the Indenture) to a pro forma secured debt ratio of 4.5 times our previous quarter's annualized modified EBITDA and limit our incurrence of additional indebtedness to a total indebtedness ratio of 5.25 times our previous quarter's annualized modified EBITDA. Similarly, the Credit Agreement limits any increase in our secured indebtedness (other than certain forms of secured indebtedness expressly permitted) to a pro forma secured debt ratio of 4.5 times our previous quarter's annualized EBITDA and limits our incurrence of additional indebtedness to a total indebtedness ratio of 5.00 times our previous quarter's annualized EBITDA. As of December 31, 2012, we had $97.6 million in cash and cash equivalents and a working capital deficit of $56.2 million. Cash and cash equivalents consist of amounts held in bank accounts and highly-liquid U.S. treasury money market funds. Although we have a working capital deficit as of December 31, 2012, a majority of the deficit is a result of a current deferred revenue balance of $44.6 million that we will be recognizing as revenue over the next twelve months. The actual cash outflows associated with fulfilling this deferred revenue obligation during the next twelve months will be significantly less than the December 31, 2012 current deferred revenue balance. Additionally, as of December 31, 2012, we had $218.8 million available under our Revolver. Our capital expenditures, net of stimulus grants, increased by $65.5 million, or 19%, during the six months ended December 31, 2012, as compared to the six months ended December 31, 2011, from $60.0 million to $125.6 million, respectively. Our capital expenditures primarily relate to success-based contracts. The increase in capital expenditures is a result of meeting the needs of our larger customer base resulting from our acquisitions and organic growth. We expect to continue to invest in our network for the foreseeable future. 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 (including available borrowings under our $225.0 million Revolver), equity contributions, and available cash on hand. Cash Flows We believe that our cash flow from operating activities, in addition to cash and cash equivalents currently on-hand, will be sufficient to fund our operating activities 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. The following table sets forth components of our cash flow for the six months ended December 31, 2012 and 2011. 50 -------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIES Six months ended December 31, 2012 2011 (in thousands)Net cash provided by operating activities $ 185,408 $ 57,309 Net cash used in investing activities (2,599,266 ) (393,517 ) Net cash provided by financing activities 2,354,266 336,675 Net Cash Flows from Operating Activities Net cash flows from operating activities increased by $128.1 million, or 224%, from $57.3 million to $185.4 million during the six months ended December 31, 2011 and 2012, respectively. Net cash flows from operating activities during the six months ended December 31, 2012 represents the loss from continuing operations of $73.4 million, plus the add backs of non-cash items deducted in the determination of net loss, principally depreciation and amortization of $112.5 million, stock-based compensation expense of $43.9 million, losses on extinguishment of debt of $70.7 million, additions to deferred revenue of $23.3 and non-cash interest expense of $14.0 million, less amortization of deferred revenue of $15.9 million and the deferred tax provision of $22.1 million plus or minus the net change in working capital components. Net cash flows from operating activities during the six months ended December 31, 2011 represents our net earnings from continuing operations of $2.1 million, plus the add back to our net earnings of non-cash items deducted in the determination of net earnings, principally depreciation and amortization of $36.9 million, the deferred tax provision of $6.6 million and non-cash stock-based compensation expense of $14.1 million, plus the change in working capital components. The increase in net cash flows from operating activities during the six months ended December 31, 2012 as compared to the six months ended December 31, 2011 is primarily a result of additional earnings and synergies realized from our Fiscal 2012 and Fiscal 2013 acquisitions and organic growth. Cash Flows Used for Investing Activities We used cash in investing activities of $2,599.3 million and $393.5 million during the six months ended December 31, 2012 and 2011, respectively. During the six months ended December 31, 2012, our principal uses of cash for investing activities were $2,212.5 million for the acquisition of AboveNet, $118.3 million for the acquisition of FiberGate, $15.9 million for the acquisition of USCarrier, $110.4 million for the acquisition of First Telecom, $22.2 million for the acquisition of Litecast and $125.6 million in additions to property and equipment, net of stimulus grant reimbursements. Offsetting the net cash used in investing activities during the six months ended December 31, 2012 was purchase consideration of $1.9 million and $0.8 million returned from our acquisitions of MarquisNet and Arialink, respectively and $3.0 million in principal payments received during the period against a related party loan. During the six months ended December 31, 2011, our principal uses of cash for investing activities were $318.0 million for the acquisition of 360networks, $15.5 million for our acquisition of MarquisNet and $60.0 million in additions to property and equipment, net of stimulus grant reimbursements. Cash Flows from Financing Activities Our net cash provided by financing activities was $2,354.3 million and $366.7 million during the six months ended December 31, 2012 and 2011, respectively. Our cash flows from financing activities during the six months ended December 31, 2012 primarily comprise $3,024.4 million from the proceeds from long-term debt, $341.5 million in equity contributions from Holdings and $22.4 million in transfers of cash out of restricted cash accounts. These cash inflows were partially offset by $83.4 million in debt issuance costs, $886.8 million in principal repayments on long-term debt obligations, $56.0 million in early redemption fees on debt extinguishments, $7.2 million in cash contributed to ZPS, and $0.6 million in principal payments on capital leases during the six months ended December 31, 2012. Our cash flows from financing activities during the six months ended December 31, 2011 comprise $335.6 million from the proceeds from long-term borrowings, $0.1 million in equity contributions from Holdings and a $10.9 million advance from CII. This cash inflow was partially offset by $9.0 million in debt issuance costs, $0.4 million in transfers of cash to restricted cash accounts and $0.5 million in principal payments on capital leases during the period. 51 -------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIESOff-Balance Sheet Arrangements We do not have any off-balance sheet arrangements other than our operating leases. We do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements. 52 -------------------------------------------------------------------------------- ZAYO GROUP, LLC AND SUBSIDIARIES |