10-K 1 v303647_10k.htm 10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-K

 

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

 

For the fiscal year ended December 31, 2011

 

OR

 

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

 

Commission File Number: 000-23269

 

AboveNet, Inc.

 

(Exact Name of Registrant as Specified in Its Charter)

 

DELAWARE   11-3168327

(State or other jurisdiction of

incorporation or organization)

  (I.R.S. Employer Identification No.)

 

360 HAMILTON AVENUE

WHITE PLAINS, NY 10601

(Address of Principal Executive Offices)

 

(914) 421-6700

(Registrant’s Telephone Number, Including Area Code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class Name of each exchange on which registered
Common Stock, $0.01 par value New York Stock Exchange

  

Securities registered pursuant to Section 12(g) of the Act:

Preferred Share Purchase Rights

Title of Class

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  x    No  ¨

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  ¨    No  x

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x    No  ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x   No £

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

 

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

   
Large accelerated filer  x Accelerated filer  ¨

Non-accelerated filer  ¨

(Do not check if a small reporting company)

Smaller reporting company  ¨
   
       

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

 

The aggregate market value of the common stock of the registrant held by non-affiliates of the registrant as of June 30, 2011 was approximately $1.462 billion.

 

The number of shares of the registrant’s common stock, par value $0.01 per share, outstanding as of February 24, 2012, was 26,243,473.

 

DOCUMENTS INCORPORATED BY REFERENCE: NOT APPLICABLE

 
 

 

 

 

Table of Contents

 

 ABOVENET, INC.

 

For The Year Ended December 31, 2011

 

INDEX

 

       
      Page
PART I.    
       
ITEM 1. BUSINESS   1
ITEM 1A. RISK FACTORS   17
ITEM 1B. UNRESOLVED STAFF COMMENTS   23
ITEM 2. PROPERTIES   23
ITEM 3. LEGAL PROCEEDINGS   24
ITEM 4. MINE SAFETY DISCLOSURES   24
       
Part II.    
       
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES   25
ITEM 6. SELECTED FINANCIAL DATA   30
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS   32
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK   54
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA   55
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE   101
ITEM 9A. CONTROLS AND PROCEDURES   101
ITEM 9B. OTHER INFORMATION   103
       
Part III.    
       
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE   104
ITEM 11. EXECUTIVE COMPENSATION   112
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS   132
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE   136
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES   137
       
Part IV.    
       
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES   138
       
Signatures   140
       
Exhibit Index   141
       

 

 
 

  

PART I

 

ITEM 1. BUSINESS

 

Overview

 

AboveNet, Inc. (which together with its subsidiaries is sometimes hereinafter referred to as the “Company,” “AboveNet,” “we,” “us,” “our” or “our Company”) provides high-bandwidth connectivity solutions primarily to large corporate enterprise clients and communication carriers, including Fortune 1000 and FTSE 500 companies, in the United States (“U.S.”) and the United Kingdom (“U.K.”). Our communications infrastructure and global Internet protocol (“IP”) network are used by a broad range of companies such as commercial banks, brokerage houses, insurance companies, investment banks, media companies, social networking companies, web-centric companies, law firms and medical and health care institutions. Our customers rely on our high speed, private optical network for electronic commerce and other mission-critical services, such as business Internet and cloud applications, regulatory compliance, disaster recovery and business continuity. We provide lit broadband services over our metro networks, long haul network and global IP network utilizing equipment that we own and in some cases, lease and operate. In addition, we also provide dark fiber services to selected customers. Unlike competitive local exchange carriers (“CLECs”), we do not provide voice services, services to residential customers or a wide range of lower-bandwidth services. We also sometimes resell equipment and provide certain other services to customers, which are sold at our cost, plus a margin. We have included a Glossary of Terms beginning on page 14 to explain the many technical terms that are commonly used in our industry to assist you to better understand our business.  We recommend that you refer to this Glossary as you review the description of our business.

 

We are a facilities-based provider of high-bandwidth connectivity solutions that provides services in 17 markets in the U.S. and four markets in Europe through our fiber-optic networks in metro markets, our long haul network connecting those markets and our IP network. Our metro market networks have significant reach and breadth and span over 2.2 million fiber miles across over 9,000 cable route miles. Our long haul fiber-optic communications network spans over 13,000 cable route miles and interconnects each of our U.S. metro networks and each of our European markets. We operate DWDM equipment over this fiber to provide large amounts of bandwidth capability between our metro networks for our customer needs and for our IP network. We use undersea capacity on the Japan-US Cable Network (“JUS”) to provide connectivity between the U.S. and Japan and 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., Europe and Japan. Our IP network operates using advanced routers and switches that facilitate the delivery of IP transit services and IP-based virtual private network (“VPN”) services. A hallmark of our IP network is that we have direct connectivity to a large number of IP networks operated by others through peering agreements and to many of the most important bandwidth centers and peering exchanges.

 

We opened the Denver, Paris, Amsterdam and Frankfurt markets in early 2011. Our metro and long haul market metrics discussed herein are as of December 31, 2011 and do not include additions to the networks made in those or other markets since that date. We intend to open Toronto as a market and to substantially expand operations in Atlanta in 2012.

 

1
 

  

Business Strategy

 

Our primary strategy is to become the preferred provider of high-bandwidth connectivity solutions in our target markets. Specifically, we are focused on the sale of high-bandwidth transport solutions to enterprise and carrier customers. The following are the key elements of our strategy:

 

  · Use the depth and breadth of our metro networks to provide our solutions, not only in central business districts, but also into the suburbs where many data centers, office parks and back office data center operations reside.
  · Leverage our excellent relationships with our customers and our strong balance sheet to invest in customers in ways our competition may find difficult.
  · Provide connectivity in Tier 1 markets with a density of enterprise and carrier customers and third party data centers, where many potential customers locate their IT infrastructure.
  · Connect to data centers where many enterprise customers locate their information technology infrastructure.
  · When needed, differentiate ourselves by providing a high level of customization of our services designed to meet our customer’s requirements.
  · Deliver the services we offer over our metro networks, which often provide our customers with a dedicated pair of fibers.  This use of dedicated fiber is a low latency, physically secure, flexible and scalable communications solution, which we believe is difficult for many of our competitors to replicate.
  · Use our metro fiber assets to drive the adoption of leading edge inter-city wide area network (WAN) services such as IP VPN services and long haul connectivity solutions.
  · Intensify our focus on sales to media companies with high-bandwidth requirements.
  · Provide the infrastructure services that our customers need as their networks expand through the use of virtualization and cloud services.
  · Fulfill the needs of customers that are required to comply with financial and other regulations related to data availability, disaster recovery and business continuity.
  · Target Internet connectivity customers that can leverage the scalability and flexibility of fiber access to their premises to drive their electronic commerce and other high-bandwidth applications, such as social networking, gaming and digital media transmission.
  · Provide telecommunications carriers, also referred to as carriers, that lack a last mile solution for their customers with a broad array of lit solution alternatives.
  · Develop and use independent sales agents as a means to provide our services to a wider array of potential customers.

 

We are able to provide high quality, customized services at competitive prices as a result of a number of factors, including:

 

  · Our significant experience in providing high-end customized network solutions (such as DWDM) for enterprises and telecommunications carriers.
  · Our focus on providing certain core optical and Ethernet-based services rather than the full range of more complex legacy telecommunications services.
  · Our metro networks typically include fiber cables with 432, and in some cases 864, fibers in each cable, which is substantially more fiber than we believe most of our competitors have installed.  This provides us with sufficient fiber inventory to supply dedicated fiber services to customers, as appropriate.
  · Our modern networks with advanced fiber-optic technology are less costly to operate and maintain than older copper-based networks.
  · Our use of state-of-the-art technology in all elements of our networks, from fiber to optical and IP equipment, provides leading edge solutions to customers.
  · The architecture of our metro networks, which facilitates high performance solutions in terms of loss and latency.
  · The spare conduit we install, where practical, allows us to install additional fiber-optic cables on many routes without the need for additional rights-of-way.  This use of the depth and breadth of our network reduces expansion and upgrade costs in the future, and provides significant capacity for future growth.

 

2
 

 

Our Networks and Technology

 

Service Coverage

 

Through our metro, long haul and IP networks, we provide services in and between the following markets:

 

  · Boston
  · New York City metro
  · Philadelphia
  · Baltimore
  · Washington, D.C./Northern Virginia corridor
  · Atlanta
  · Miami
  · Houston
  · Dallas
  · Austin
  · Denver
  · Phoenix
  · Los Angeles
  · San Francisco Bay area
  · Portland
  · Seattle
  · Chicago
  · London
  · Paris
  · Amsterdam
  · Frankfurt

 

We operate metro networks in each of these markets, except Miami. We offer a limited number of WAN services in a number of other markets. Including fiber we own, fiber acquired by us through leases and indefeasible rights-of-use (“IRUs”), as well as fiber provided by us to others through leases and IRUs, our metro networks consist of over 2.2 million fiber miles and over 9,000 cable route miles. Our network footprint typically allows us to serve data centers, enterprise locations, network POPs, central offices, carrier hotels and traffic aggregation points, not just in the central business district but across the entire metropolitan area in each market. Within our metro networks, our infrastructure provides ample opportunity to access many additional buildings by virtue of its extensive footprint coverage and over 6,800 network access points that can be utilized to build laterals or connect to other networks, thereby providing access to additional locations. In Miami, we provide services over our long haul and IP networks. In Paris, Amsterdam and Frankfurt, we provide services over a shared network operating on leased fiber as well as over our long haul and IP networks.

 

Key Metro Network Attributes

 

  · Network Density - Our metro networks typically contain 432 and up to 864 fiber strands in each cable. We believe that this fiber density is significantly greater than that of most of our competitors. This high fiber count allows us to add new customers in a timely and cost effective manner by focusing incremental construction and capital expenditures on the laterals that serve customer premises, as opposed to fiber and capacity upgrades in our core networks. Thus, we have spare network capacity available for future growth to connect an increasing number of customers.

 

  · Modern Fiber - We have deployed modern, high quality optical fiber that can be used for a wide range of network applications. Standard single mode fiber is typically included on most cables while longer routes also contain non-zero dispersion shifted fiber that is optimized for longer distance applications operating in the 1550 nm range. Much of our network is well positioned to support the more stringent requirements of transport at rates of 40 Gbps and above.

 

3
 

  

 

  · High Performance Architecture - We design customer networks with direct, optimum routing between key areas and in a manner that minimizes the number of POP locations, which enables us to deliver our services at a high level of performance. Because many of our metro lit services are delivered over dedicated fibers not shared with other customers, a customer’s private network can be optimized for its specific application. Further, by using dedicated fiber, we can deliver our services without the need to transition between various shared or legacy networks. As a result, our customers experience enhanced performance in terms of parameters such as latency and jitter, which can be caused by equipment interface transitions. The use of dedicated fibers for customers also permits us to address future technology changes that may take place on a customer specific basis.

 

  · Extensive Reach - Our metro markets typically have significant footprints and cover a wide geography. For example, the New York market includes a significant Manhattan presence and extends from Stamford, CT in the north through Delaware in the south, covering a large part of New Jersey. Similarly, the San Francisco market extends through to San Jose and the Dallas network incorporates the Fort Worth area.

 

On-Net Buildings

 

Our metro networks connect to over 3,100 buildings in the U.S. and the U.K. through our lateral cables, which cover approximately 1,300 cable route miles and over 150,000 fiber miles (which are part of the 2.2 million fiber miles previously described).  These connected buildings are referred to as on-net buildings.

 

  · Enterprise Buildings Our network extends to over 2,500 enterprise locations, many of which house some of the biggest corporate users of network services in the world. These locations also include many private data centers and hub locations that are mission-critical for our customers.

 

  · Network POPs We operate over 120 network POPs with functionality ranging from simple, passive cross-connect locations to sites that offer interconnectivity to other service providers and co-location facilities for customer equipment, including over 20 Type 1 POPs. These POPs are typically larger presences located in major carrier hotels complete with network co-location and interconnectivity services.

 

  · Central Offices, Carrier Hotels and Data Centers Our network connects to over 200 central offices in the markets that we serve. The network also has a presence in most significant carrier hotels within our active markets. We currently connect to buildings containing over 500 data centers, of which over 340 are third party data center locations.

 

  · Additional Buildings In addition to the on-net buildings that we connect to with our own fiber laterals, we have access to additional buildings through other network providers with which we have agreements to provide fiber connectivity to our customers.

 

Long Haul Network

 

We operate a nationwide long haul network interconnecting each of our markets that spans over 13,000 cable route miles. With the exception of the route between New York and Washington, D.C., which we constructed and own, the overland portion of our long haul network is based on fiber either leased or acquired, typically under long-term agreements. We have deployed DWDM equipment along this network that provides significant bandwidth capability between our metro networks.  This network is based on ultra long haul technology that requires fewer intermediate regeneration points to deliver our services between major cities and expands our high-bandwidth service capability between our metro markets. We are currently in the process of updating most of the network to at least 40 Gbps capacity from 10 Gbps capacity. We connect the U.S. and European portions of our long haul network with undersea capacity, including capacity on the TAT-14 cable. We also connect our U.S. markets to Tokyo on the JUS cable.

4
 

 

IP Network

 

We operate a global Tier 1 IP network with connectivity in the U.S., Europe and Japan. In the U.S., most of our metro networks have multiple IP hubs where we can provide Internet connectivity. We peer and provide connectivity in high-bandwidth data centers and Internet exchange locations, including many of those operated by the major providers, such as Equinix.  We have extended our ability to provide IP connectivity through our metro networks by using our fiber to bring our services to a wider set of customers. In addition to the U.S., the IP network has a presence in each of Tokyo, London, Paris, Amsterdam and Frankfurt, including the major exchanges in these markets such as LINX, AMS-IX and JPIX.

 

The core portion of our IP backbone network is based on multiple 10 Gbps long haul links and utilizes advanced Juniper and Cisco routers and switches to direct traffic to appropriate destinations. Our IP core infrastructure is based on next generation equipment that supports advanced IP services such as VPNs and is optimized to support high-bandwidth customers.

 

As a Tier 1 IP network provider, we have peering arrangements with most other providers which allow us to exchange traffic with these other IP networks. We have devoted a substantial amount of time and resources to building our substantial peering infrastructure and relationships and we believe that this extensive peering fabric, combined with our advanced network, produces a positive customer experience.

 

 Network Management

 

Our global network management center (“NMC”) is located in Herndon, Virginia and provides round-the-clock network surveillance, provisioning and customer service. Our metro networks, long haul network, IP network and the private networks we set up for our customers, which link together two or more of their locations, are constantly monitored in order to respond to any degrading network conditions or network outages. The NMC’s staff serves as the focal point for managing our service level agreements, or SLAs, with our customers and coordinating network maintenance activities. Our NMC also serves as our focal point for provisioning new services on our optical network. We work closely with our customers to ensure that all services are turned up in a timely and error free manner.

 

Rights-of-Way

 

We obtain right-of-way agreements and governmental authorizations to enable us to install, operate, access and maintain our networks, which are located on both public and private property. In some jurisdictions, a construction permit from the local municipality is all that is required for us to install and operate that portion of the network. In other jurisdictions, a license agreement, permit or franchise may also be required. These licenses, permits and franchises are generally for a term of limited duration. Where necessary, we enter into right-of-way agreements for use of private property, often under multi-year agreements. We lease underground conduit and overhead pole space and license rights-of-way from entities such as incumbent local exchange carriers (“ILECs”), utilities, railroads, state highway authorities, local governments and transit authorities. We strive to obtain rights-of-way that afford us the opportunity to expand our networks as our business further develops. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Contractual Obligations.”

 

Services

 

We provide high-bandwidth connectivity solutions, primarily in three service groups: fiber infrastructure services, metro services and WAN services. We also resell equipment and provide technical services to customers, which are sold at our cost, plus a margin. Unlike CLECs, we do not provide voice services, services to residential customers or a wide range of lower-bandwidth services.

5
 

 

Fiber  Infrastructure Services

 

Our fiber infrastructure services focus on the lease of dedicated dark fiber to telecommunications carriers, enterprises, Internet and web-centric businesses and other customers that operate their own networks independent of the incumbent telecom companies. In addition to leasing dark fiber, we offer maintenance of dark fiber networks, the provisioning of co-location and in-building interconnection services, typically at our POP locations, and also provide certain telecommunication services on a time and materials basis.

 

Our fiber infrastructure services feature:

 

  · An extensive network footprint that extends well beyond the central business district in most markets.
  · The expertise and capability to add off-net locations to the network in a cost competitive manner.
  · Modern, high quality fiber that meets stringent technical requirements.
  · Customized ring configurations and redundancy requirements in a private dedicated service.
  · 7x24 monitoring of the network by our NMC.

 

Demand for fiber services is driven by key business initiatives including business continuity and disaster recovery, network consolidation and convergence, growth of wireless communications, and industry-specific applications such as high definition video transport and patient record management. Typically, Fortune 1000 and FTSE 500 enterprises with data intensive needs in industries such as financial services, social networking, technology, media, retail, energy and healthcare comprise the target customer base for our fiber optic infrastructure offerings.

 

Metro Services

 

We offer a number of high-bandwidth metro service offerings in our active metro markets ranging from 100 Mbps to 40 Gbps connectivity. These services range from simple point-to-point Ethernet connectivity to complex multi-node wavelength-division multiplexing (“WDM”) solutions.  Our metro services have a number of important features that differentiate us from many of our competitors:

 

  · A substantial portion of our metro services are deployed over dedicated fiber from end-to-end, or out from a shared router.
  · This dedicated fiber provides customers with significant scalability for any increasing traffic demand.
  · A service based on dedicated fiber provides a high level of security, a key concern for many high-bandwidth customers across a range of industries.
  · Our network architecture is not based on routing through central offices, which reduces network distances between customer locations and the resulting latency.
  · Some of our metro services are offered without the need for the customer to provide space and power, which may be difficult or expensive to obtain in many data centers.
  · A significant portion of our service offerings are Ethernet-based, not older TDM-based services.

 

We offer private, customized optical network deployments that we build for our largest customers with very specific needs. These customers are typically large enterprise companies that have significant bandwidth requirements and value a completely private solution. These solutions often involve extensive network construction to specific critical customer locations such as private data centers and trading platforms with dedicated WDM equipment configured in accordance with the customer’s needs.

 

In the past several years, we have expanded our metro services capability beyond customers with very high-bandwidth (multiple wave) requirements by offering a number of wave and Ethernet products aimed to serve more moderate bandwidth/circuit requirements.  These offerings include basic and enhanced wave services, which are based on dedicated, private fiber and equipment infrastructure from end-to-end and provide a solution for customers looking for a WDM-based service between two metro locations.  The Basic Wave offering provides our lowest cost wave service, while our Enhanced Wave service has a slightly higher initial cost, but provides the customer substantial ability to expand its service capabilities.

 

We have also expanded our WDM solutions in a number of markets through our Core Wave offering, which provides wave services through pre-positioned equipment and allows faster turn up of services and greater flexibility of use.

6
 

 

We also offer a full range of Metro Ethernet services including point-to-point and multi-point service configurations at speeds from 100 Mbps to 10 Gbps (10000 Mbps) speeds. We offer three different classes of our Metro Ethernet services with three different price points (higher, middle and lower) based upon the level of service provided: (1) Private Metro Ethernet which utilizes customer dedicated equipment and fiber to deliver a completely private service with all of the associated operational, performance and security benefits; (2) Dedicated Metro Ethernet which utilizes shared equipment with reserved/guaranteed capacity, delivered to the customer location through dedicated fiber; and (3) Standard Metro Ethernet which utilizes shared equipment on a shared capacity basis, delivered to the customer location through dedicated fiber.

 

WAN Services

 

We offer a number of wave, Ethernet and IP-based services within our WAN Services offering.  Most of these services provide connectivity solutions between our metro markets and target high-bandwidth customers requiring transmission speeds of at least 100 Mbps.  In addition, we provide high-speed Internet connectivity to our customers including high-end enterprise, web-centric and carrier/cable companies.  Each of our WAN services is differentiated by our significant metro fiber resources that allow us to extend the capability of our core networks to the customer in a secure and cost-effective manner.

 

Our long haul services provide inter-city connectivity between our metro markets on our ultra long haul network at a variety of speeds ranging from 1 Gbps to 10 Gbps. Our service offerings require a minimum of regeneration sites, which improves our ability to be competitive from both a price and speed of installation perspective while reducing the number of equipment interfaces required to deliver our service.

 

The attractiveness of our long haul services to our customers is further enhanced by our ability to extend the service from our long haul POP to the customer’s premises through our metro networks, thereby providing an end-to-end solution.  This flexibility and reach enables us to provide our long haul services on a differentiated basis.

 

We operate a Tier 1 IP network that provides high quality Internet connectivity for enterprise, web-centric, Internet and cable companies.  We offer connectivity to the Internet at 100 Mbps, 1 Gbps and 10 Gbps port levels in most of our active metro markets in the U.S. and Europe.  We believe our extensive number of peering partners, global reach and uncongested network approach produces a positive experience for our customers.  In addition to selling IP connectivity at data centers and other major IP exchanges, we offer our Metro IP service where we combine our metro fiber reach to deliver Internet connectivity to customer premises.  This service offering extends our significant IP capability, without the dilutive impact of traditional, shared access methods, to the customer location over dedicated fiber that will support full port speeds.

 

We also offer a suite of advanced Ethernet and IP VPN services that provide connectivity between multiple locations in different cities for our customers. These services provide flexibility such as the ability to prioritize different traffic streams and the ability to converge multiple services across the same infrastructure.  These advanced VPN services, which include VPLS services, offer point-to-point and multipoint connectivity solutions based on MPLS technologies with the same high-bandwidth scalability that our IP connectivity service allows.  Unlike most of our competitors, these services can be extended from our POPs to customer locations within one of our metro markets through dedicated fiber, thereby avoiding transitions through shared or legacy networks that can reduce performance quality.

 

Sales and Marketing

 

Our sales force is based across most of our current U.S. and European service markets, is comprised of approximately 105 sales professionals and is supported by a team of sales engineers who provide technical support during the sales process.  Our sales force primarily focuses on enterprise customers, including Fortune 1000 companies in the U.S. and FTSE 500 companies in Europe, that have large bandwidth requirements. We also sell through independent third party agents to reach specific geographic and vertical markets.

7
 

  

Our sales strategy includes:

 

  · Positioning ourselves as a premier provider of high-bandwidth connectivity solutions.
  · Focusing on Fortune 1000 enterprises as well as content rich data companies (i.e. media, healthcare and financial services) that require customized private optical solutions.
  · Expanding our sales reach through independent sales agents who specialize in specific geographic and vertical markets.
  · Emphasizing the high quality, cost effective, secure and scalable nature of our private optical solutions.
  · Communicating our capabilities through targeted marketing communication campaigns aimed at specific vertical markets to increase our brand awareness in a cost effective manner.
  · Providing last mile lit solutions to long haul carriers who lack the capability to provide this to their customers.
  · Capitalizing on our presence in over 500 data center locations, which house IT infrastructure for many enterprises and cloud computing capabilities.
  · Leveraging our strong balance sheet with a willingness to invest capital to grow with our customers.

 

Customers

 

We serve a broad array of customers including leading companies in the financial services, web-centric, media/entertainment and telecommunications sectors, as well as certain local, state and federal government entities, in some cases through third party integrators. Our networks meet the requirements of many large enterprise customers with high data transfer and storage needs and stringent security demands. Major web-centric companies similarly have needs for significant bandwidth and reliable networks.  Media and entertainment companies that deliver bandwidth-intensive video and multimedia applications over their networks are also a growing component of our customer base.  Telecommunications service providers continue to utilize our networks to connect to their customers, as well as to data centers and other traffic aggregation points. Key drivers for growth in the consumption of telecommunications and bandwidth services include the increasing demand for disaster recovery and business continuity solutions, the expansion of cloud computing service offerings, the fast paced growth of social networking and gaming, compliance requirements under complex regulations such as the Sarbanes-Oxley Act and the Health Insurance Portability and Accountability Act (HIPAA) and exponential growth in data transmissions due to new modalities for communications, media distribution and commerce.

 

Segments

 

We operate our business as one operating segment and include segmented results based on geography.

 

Below is our revenue based on the location of our entity providing the service.  Long-lived assets are based on the physical location of the assets. The following tables present revenue and long-lived asset information for geographic areas (in millions): 

 

    Years Ended December 31,  
    2011     2010     2009  
Revenue                  
United States   $ 428.5     $ 372.8     $ 328.0  
United Kingdom and Others     51.3       42.6       35.9  
Eliminations     (7.3 )     (5.7 )     (3.8 )
Consolidated Worldwide   $ 472.5     $ 409.7     $ 360.1  

 

    December 31,  
    2011     2010  
Long-lived assets            
United States   $ 561.7     $ 502.9  
United Kingdom and Others     49.8       37.9  
Consolidated Worldwide   $ 611.5     $ 540.8  

 

 

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Segment Results,” and Note 17, “Segment Reporting,” to the accompanying consolidated financial statements included elsewhere in this Annual Report on Form 10-K.  See also Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for details relating to our domestic revenues by service during the three years ended December 31, 2011 and our “revenue generated in the U.K. and other” during the three years ended December 31, 2011.

8
 

 

Research and Development

 

We depend upon our equipment vendors for technology developments in telecommunications equipment. We test, combine and implement these technology developments to provide the highest level of services to our customers.

 

Competition

 

The telecom industry is intensely competitive and has undergone significant consolidation over the past few years. Although there are multiple reasons for this consolidation, among the most prominent is the need to create scale given the capital intense nature of building networks. With respect to our larger competitors, Verizon and AT&T (formerly SBC) have accounted for most of the consolidation through their purchases of MCI and AT&T, respectively. In the mid-market, Level 3 was responsible for a significant portion of the consolidation by acquiring a large number of facilities-based telecommunications providers, including Global Crossing in 2011. In addition, Lightower has combined a number of facilities-based service providers in the New York and Boston metro areas.

 

We face competition from CLECs and other facilities-based telecommunications providers including the ILECs who currently have a large share of the local markets and are aggressively deploying their own fiber.  CLECs generally offer a much broader array of services than we do and tend to compete more directly with each other and the ILECs across a larger segment of customers than our customer base.

 

The Internet connectivity business is intensely competitive and includes many providers such as AT&T, Verizon, Level 3 and Cogent. As a result of this competition, while Internet traffic has continued to grow at a substantial rate over the past five years, pricing has declined significantly, which has negatively affected revenue growth. Our other WAN services face significant competition from a number of providers including XO and Level 3.

 

Our fiber infrastructure services face competition from numerous local and regional fiber providers and in some cases from CLECs.

 

In the European market, we compete with a number of other telecommunications companies, including British Telecom, Cable & Wireless, Colt Telecom, Level 3 and EU Networks.

 

Personnel

 

Our workforce levels have increased over the last three years as our business has expanded. As of December 31, 2011, 2010 and 2009 our work force was deployed as follows:

 

   December 31, 
   2011   2010   2009 
U.S   616    598    567 
U.K   93    90    77 
Japan   1    1    1 
Netherlands   1    1    1 
Germany   1    1     
France   1    1     
   Total   713    692    646 

 

We consider our relations with our workforce to be good. None of our employees is represented by a union.

 

Regulation

 

In the U.S., the Federal Communications Commission, which we refer to as the FCC, and various state regulatory bodies regulate some aspects of certain of our services. In some local jurisdictions, we must obtain approval to operate or construct our networks. In Europe, we are subject to regulation by the agencies having jurisdiction over the provision of transmission services. In addition, we are subject to numerous federal, state and local taxes, fees or surcharges on our products and services.

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Federal

 

In the U.S., federal telecommunications law directly shapes the market in which we compete. We offer two types of services that fall under the jurisdiction of the FCC-the leasing of dark fiber and the provision of telecommunications transmission services-that are subject to varying degrees of regulation by the FCC pursuant to the provisions of the Communications Act of 1934, as amended by the Telecommunications Act of 1996, which we refer to as the 1996 Communications Act, and by FCC regulations implementing and interpreting the 1996 Communications Act.

 

Dark fiber leasing. The FCC considers dark fiber a “network element” and not a “telecommunications service.” As a result, we believe that our provision of dark fiber is not subject to many of the legal requirements imposed on the sale of telecommunications services.

 

Telecommunications services. For most of our telecommunications services offerings, we are not required to provide such services on a common carrier basis (i.e., the provision of services to all customers on uniform terms and conditions). Our revenue from transmission services, whether or not provided as a common carrier, is subject to FCC Universal Service Fund assessments to the extent that these services are purchased by end users (i.e., not by wholesale providers or resellers). To the extent we provide telecommunications services on a common carrier basis, being regulated as a “telecommunications carrier” gives us certain legal benefits. In particular, state and local governments have the obligation to manage access to the public rights-of-way in a competitively neutral nondiscriminatory manner to telecommunications carriers. In addition, we are entitled to access existing telecommunications infrastructure by interconnecting our fiber-optic networks with the ILECs’ central offices and other facilities. Under the 1996 Communications Act, ILECs must, among other things: (1) allow interconnection with other telecommunications carriers at any technically feasible point and provide service equal in quality to that provided to others, and (2) provide other telecommunications carriers with access to their poles, ducts, conduits and other rights-of-way on just, reasonable and non-discriminatory terms.

 

In most states, the FCC exercises jurisdiction over the rates that many power utilities and telecommunications carriers charge to other companies to lease space on their telephone poles or electrical towers or in their conduits in order to install fiber optic cable. This jurisdiction derives from Section 224 of the Federal Communications Act of 1978, later expanded in the 1996 Communications Act. The statute makes it possible for states to preempt the FCC’s jurisdiction over rates for and access to poles and conduits where the state certifies to the FCC that it regulates such rates and access. The purpose of the law is to make it easier for cable companies and competitive telecommunications providers to build out their own networks. We have many pole attachment agreements with ILECs and power utilities – some of these agreements reflect rates that were voluntarily negotiated, but many reflect rates established pursuant to the FCC’s regulations, which implement provisions of Section 224. In recent years, some utilities have interpreted the regulations in a way that can impose what we believe to be excessive costs on competitive carriers, including us. To the extent utilities are successful in maintaining these interpretations of the rules they can increase our cost of doing business. In 2011, the FCC adopted revised pole attachment rules and procedures. While we believe that these revised rules and procedures will reduce uncertainty in our dealings with the utilities and limit their opportunities to raise our costs, it is still possible that these entities may continue to advance interpretations of the statutes and rules that could increase our costs of doing business.

 

Internet access services, including IP connectivity services that we provide, are treated as unregulated “information services” under Title I of the 1996 Communications Act, and are not subject to regulatory fees. The FCC has issued orders confirming that other forms of broadband Internet access services, including Digital Subscriber Line service, Cable Modem service and Broadband over Powerline service, are defined as “information services” and so are not subject to regulatory fees. However, the dramatic growth of Voice over Internet Protocol (“VoIP”) services has caused intense focus on the regulatory status of IP services. The FCC recently required that providers of interconnected VoIP service must provide access to emergency 911 services, must comply with federal law enforcement and “wiretap” statutes, contribute to the federal universal service fund, and must pay certain regulatory fees. The FCC also recently extended its reciprocal compensation rules to encompass VoIP traffic. Some of these FCC decisions are under appeal before federal courts of appeals. While these decisions have focused on providers of interconnected VoIP service, which we do not provide, there is nevertheless substantial uncertainty concerning the regulatory status of IP-based services generally. This general uncertainty raises the concern that the FCC may continue to extend other traditional telecommunications regulation to VoIP and /or other IP-based services (e.g., network outage reporting requirements), including the IP connectivity services that we offer. If this occurs, it could lead to an increase in the universal service contributions and regulatory fees required to be paid by us related to such services.

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The FCC adopted a National Broadband Plan (“NBP”) in March 2010 that is intended to serve as a roadmap for a host of regulatory measures and reforms that are intended to facilitate and accelerate the deployment of broadband services across the U.S. The NBP is not self-executing; it envisions a series of actions taken in related ongoing and future FCC proceedings to implement its recommendations. Some of the recommendations, if ultimately implemented, could be unfavorable to our business. Other NBP recommendations, if implemented, could be favorable to our business. For example, we could benefit from implementation of a finding that low and uniform pole attachment rates should be established, and from implementation of policies designed to encourage a shift to IP-to-IP interconnection where efficient. These and other NBP recommendations will be considered for implementation in a series of FCC proceedings over the next few years. Through these proceedings and related judicial appeals, the FCC is expected to defend its ability to regulate information services, including the IP connectivity services that we offer. Outcomes of these proceedings could result in additional regulation which may raise our costs of doing business.

 

State

 

The 1996 Communications Act prohibits state and local governments from enforcing any law, rule or legal requirement that prohibits, or has the effect of prohibiting, any person from providing any interstate or intrastate telecommunications service. This provision of the 1996 Communications Act enables us to provide telecommunications services in states that previously prohibited competitive entry.

 

Under the 1996 Communications Act, states retain jurisdiction, on a competitively neutral basis, to adopt regulations necessary to preserve universal service, protect public safety and welfare, manage public rights-of-way, ensure the continued quality of intrastate communications services and safeguard the rights of consumers.

 

States are responsible for mediating and arbitrating interconnection agreements between ILECs and other carriers if voluntary agreements are not reached. Accordingly, state involvement in local telecommunications services is substantial.

 

Each state (and the District of Columbia) has its own statutory requirements for regulating providers of intrastate telecommunications services if they are “common carriers” or “public utilities.” As with the federal regulatory scheme, we believe that our leasing of dark fiber facilities does not render us a common carrier or public utility such that we would be subject to this type of regulation in the provision of dark fiber in most jurisdictions in which we currently have facilities. Our offering of transmission services (as distinct from leasing dark fiber capacity), however, is subject to regulation in each of these jurisdictions to the extent that these services are offered for intrastate use. Under current FCC policies, any dedicated transmission service or facility that the user certifies is used more than 10% of the time for the purpose of interstate or foreign communications is subject to federal tariffs and rates, which fall under FCC jurisdiction to the exclusion of state regulation.

 

State regulation of the telecommunications industry is changing rapidly, and the regulatory environment varies substantially from state to state. We are currently authorized to provide intrastate telecommunications services in Arizona, California, Colorado, Connecticut, Delaware, the District of Columbia, Florida, Georgia, Illinois, Kansas, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Missouri, Nevada, New Jersey, New Mexico, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, Texas, Utah, Virginia, Washington and West Virginia. At present, we do not anticipate that the regulatory requirements to which we will be subject in the states in which we currently operate or intend to operate will have any material adverse effect on our operations. These regulations may require, among other things, that we maintain certifications to operate and utilize the public rights-of-way, that we obtain certain environmental approvals before we construct new facilities, and that we provide notification of, or obtain authorization for, specified corporate transactions, such as incurring debt or encumbering our telecommunications assets. We will incur costs to comply with these and other regulatory requirements, such as the filing of tariffs, submission of periodic financial and operational reports to regulators, and payment of regulatory fees and assessments, including, in some states, contributions to state universal service programs. Notwithstanding federal and state laws and regulations requiring nondiscriminatory access to public rights-of-way, in some jurisdictions certain of our competitors, especially ILECs, have certain advantages by reason of having obtained approvals for operation under prior, less regulatory intensive regimes. For example, in California, certain competitors of ours are subject to less rigorous environmental review procedures for proposed construction than we are, thereby enabling them potentially to construct new facilities more quickly than us and at a lower cost. The issue is currently under review by the California Public Utility Commission. In some jurisdictions, our pricing flexibility for intrastate services may be limited because of regulation, although our direct competitors will be subject to similar restrictions.

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Some states may also impose a state universal service fund assessment on intrastate telecommunications services to fund state universal service projects. The rate of assessment varies by state. To the extent the state assessment applies to our dark fiber revenue or transmission services, we are required to pay into the state funds.

 

Some states have certified to the FCC that they regulate the leasing of poles and conduits owned by incumbent utilities, including telecom, electric and gas utilities. In many of these states, the pole attachment and conduit occupancy rates are calculated in a similar manner to that provided for by the FCC formulas implemented by the states, although in some cases state regulators have adjusted the FCC formula in certain respects. In other states, although the state may have certified to the FCC that it regulates such rates, the state has not yet adopted clear rules regarding such matters. Where there are state-adopted formulas, the rates generally are more advantageous than what we believe we could negotiate on a market basis. The leasing of pole and conduit facilities in such states that have certified that they regulate pole and conduit rates and access is determined by a commercially negotiated contract as influenced by whatever state regulation is in place. Such regulations may change in the future to our disadvantage and additional states may certify to the FCC that they regulate pole and conduit access rates, terms and conditions, and such states may impose regulations that are less advantageous than are the FCC’s regulations.

 

Local

 

In addition to federal and state laws, local governments exercise legal authority that can affect our business. For example, local governments, such as the City of New York, typically manage access to public rights-of-way subject to the limitation that local governments may not prohibit persons from providing telecommunications services, may only collect fair and reasonable compensation from telecommunications providers for access to public rights-of-way and may not treat telecommunications providers in a discriminatory manner. Because of the general need for telecommunications providers to obtain approvals from local governments to access the public rights-of-way, local authorities can affect the timing and costs associated with our use of public rights-of-way. In addition, the City of New York recently issued a request for proposal concerning franchise fees potentially applicable to information service providers. The outcome of this process could raise our costs of doing business.

 

Regulation of the Internet

 

Laws and regulations that apply directly to the Internet are becoming more prevalent. The U.S. Congress frequently considers laws regarding privacy and security relating to the collection and transmission of information over the Internet. Congress also addressed the need for regulation on the protection of children, copyrights, trademarks, domain names, taxation and the transmission of sexually explicit material over the Internet. The European Union adopted its own privacy regulations and other countries may do so in the future. Other countries have taken actions to restrict the free flow of material deemed objectionable over the Internet.

 

The scope of laws and regulations applicable to the Internet is subject to conflicting interpretations and developments. The applicability to the Internet of laws and regulations from various jurisdictions governing issues such as property ownership, sales tax, libel and personal privacy is unsettled and may take years to resolve. For example, the 1996 Communications Act prohibits the transmission of certain types of information and content over the Internet but the scope of this prohibition is currently unsettled. In addition, although the courts have held substantial parts of the Communication Decency Act to be unconstitutional, federal or state governments may enact, and courts may uphold, similar legislation as well as laws covering issues such as intellectual property rights over the Internet and the characteristics and quality of Internet services and consumer protection laws. In the U.S., federal agencies, such as the FCC and the Federal Trade Commission, occasionally have overlapping jurisdiction in matters regarding privacy, consumer protection and fraud that are part of Internet-based services or transactions. In addition, several state regulators and lawmakers also exercise jurisdiction in these areas. Foreign countries have also enacted laws in these fields.

 

The current application of most of these laws does not directly affect us in a material manner, although these laws do affect many of our Internet connectivity customers. The extent that Internet connectivity providers such as ourselves are held directly or contributorily liable for violations of such laws by their customers or others involved with Internet-based services or transactions is an area of law that is only now becoming established, and it is possible that we may face increased legal liability and costs of legal compliance.

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Regulation in the European Union

 

European Union regulation

 

A package of five key European directives: the Framework Directive, the Authorisation Directive, the Access Directive, the Universal Services Directive and the Privacy Directive (collectively known as the “2003 regime”) provide for a common regulatory framework for electronic communications networks, services, interconnection and privacy in the European Union.

 

Under the Framework Directive, the European Commission was required to review the effectiveness of the 2003 regime. This review led to recent amendments involving the enactment of three legislative measures: the Better Regulation Directive that amends the Framework Directive, the Access Directive and the Authorization Directive; the Citizens’ Rights Directive that amends the Universal Services Directive and the Privacy Directive; and a regulation establishing the Body of European Regulators for Electronic Communications (“BEREC”) to ensure fair competition and more consistency of regulation of the telecommunications markets across the European Union member states. The Better Regulation Directive and the Citizens’ Rights Directive became effective as of December 19, 2009 and the BEREC became effective as of January 7, 2010.

 

Implementation of the 2003 regime and the new directives

 

In respect of the 2003 regime, the European Union member states were required to pass legislation to implement the 2003 regime. France, Germany, the Netherlands and the U.K., through various legislative enactments, have implemented the 2003 regime into their local laws.

 

In respect of the Better Regulation Directive and the Citizens’ Rights Directive (the “2009 Directives”), European Union member states (this includes France, Germany, the Netherlands and the U.K.) must adopt measures to implement these directives by May 25, 2011. France and the U.K., through various legislative enactments, have implemented the 2009 Directives into their local law. The 2009 Directives have not yet been implemented into German or Dutch law. It is expected that they will be implemented in Germany in the first quarter of 2012. It is not yet known when they will be implemented in The Netherlands.

 

Regulation in the United Kingdom

 

In the U.K., the Communications Act 2003 provides for a general authorization regime that imposes an obligation on electronic communication providers to comply with conditions, known as the General Conditions of Entitlement. A breach of any of these conditions could lead the regulator, the Office of Communications (OFCOM), to impose fines and, potentially, suspend or revoke the right to provide electronic communications networks and services. The Communications Act 2003 provides certain operators with Code Powers. We hold such Code Powers as a result of automatic entitlement arising from our previous status as a license holder. Code Powers provide operators with legal powers to construct and maintain networks on both public and private land, including the right to install networks on public highways. We are entitled to provide electronic communication networks and services throughout the U.K. and are liable for property taxation (“Business Rates”) on the amount of fiber in use and in our control during each fiscal year. These Business Rates are levied on companies by the U.K. local government authorities for the boroughs through which the fiber passes.

 

Regulation in France, Germany and the Netherlands

 

France, Germany and the Netherlands each have general authorization regimes that are similar to the U.K. and are administered by their respective regulatory authorities. In each, we have secured the necessary registrations to provide publicly available electronic communications services and/or operate a public electronic communications network. As a result, we are subject to certain local general regulatory obligations in each jurisdiction, which include availability, secrecy, neutrality, safety measures and data retention. In addition, we may be required to respond, whether periodically or on an ad hoc basis, to information requests of a technical, financial and commercial nature in order to allow such authority to calculate regulatory fees or further its market analysis or view on compliance.

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Corporate History

 

We were formed as National Fiber Network, Inc. on April 8, 1993 and our name was changed to Metromedia Fiber Network, Inc. (also referred to as “MFN”) on August 12, 1997. Initially, we focused on providing dark fiber to carrier customers in the U.S. and later, as we expanded, in Europe. In September 1999, we acquired AboveNet Communications, Inc., a data center facility and Internet connectivity provider as well as PAIX.net, Inc., an AboveNet Communications, Inc. subsidiary that operated Internet peering exchanges. In February 2001, we acquired SiteSmith, Inc., a provider of managed web-hosting services.

 

In 2003, in connection with our emergence from bankruptcy protection, we changed the name of our parent company to AboveNet, Inc. and shifted our focus to taking advantage of our extensive fiber-optic assets by selling high-bandwidth solutions, primarily to enterprise customers. As a result, we sold or disposed of businesses and assets not deemed central to this focus, including our managed web-hosting services business and data center business.

 

Glossary of Terms

 

Cable route miles – the length of fiber cable installed in a network. This does not necessarily correspond to geographical footprint. For example, if two cables are installed along the same path, the length of both cables would count in assessing “cable route miles.”

 

Carrier hotel  a facility containing many telecommunications service providers that are widely interconnected. The facility is generally industrial in nature with high-capacity power service, backup batteries and generators, fuel storage, riser cable systems, large cooling capability and advanced fire suppression systems.

 

Central Office – a facility used to house telecommunications equipment (e.g. switching equipment) that is used to make connections between the local loops (local distribution network) in the vicinity of the facility to regional or long distance telecommunications facilities. Central Offices are typically operated by the ILEC.

 

CLEC – this is an acronym for “competitive local exchange carrier,” a carrier providing telecommunications services in competition with the ILEC.

 

Co-location – the placement of equipment in a telecommunications POP, data center or central office.

 

Data Center – a facility used to house computer systems and associated components. It generally includes environmental controls (air conditioning, fire suppression, etc.), redundant/backup power supplies, redundant data communications connections and high security.

 

Dark Fiber – fiber that has not yet been connected to telecommunications transmission equipment and therefore not yet activated or “lit” for the transmission of voice, data or video traffic.

 

DWDM this is an acronym for Dense Wavelength-Division Multiplexing. The term “dense” refers to the number of channels being multiplexed – a DWDM system typically has the capability to multiplex greater than 16 wavelengths.

 

Ethernet – the standard local area network (LAN) protocol. Ethernet was originally specified to connect devices on a company or home network as well as to a cable modem or DSL modem for Internet access. Due to its ubiquity in the LAN, Ethernet has become a popular transmission protocol in the metro and long haul networks as well. Ethernet is defined by the IEEE in the 802.3 standard.

 

Facilities-based provider – a provider that predominately utilizes its own facilities and transmission and termination equipment (whether owned or leased) in the provision of telecommunications services rather than the facilities of other telecommunications services providers.

 

Fiber miles – the route miles of a network multiplied by the number of fibers within each cable on the network. For example, if a 10 mile network segment with one cable of 432 count fiber is installed, it would represent 10x1x432 or 4,320 fiber miles.

 

Gbps – gigabits per second, a measure of telecommunications transmission speed. One gigabit equals 1 billion bits of information.

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IEEE – The Institute of Electrical and Electronics Engineers or IEEE (pronounced as eye-triple-e) is an international non-profit, professional organization for the advancement of technology related to electricity.  It sets numerous standards in the telecommunications industry.

 

ILEC – incumbent local exchange carrier, typically one of the historic regional Bell operating companies.

 

IP – Internet protocol, the transmission protocol used in the transmission of data over the Internet.

 

JUS – this is an acronym for the Japan-US Cable Network, a trans-Pacific undersea telecommunications cable system running between the U.S. and Japan.

 

Lateral – an extension from the main or core portion of a network to a customer’s premises or other connection point.

 

Mbps – megabits per second, a measure of telecommunications transmission speed. One megabit equals 1 million bits of information.

 

MPLS – this is an acronym for MultiProtocol Label Switching, which is a standards-based technology for speeding up network traffic flow and making it easier to manage. MPLS involves setting up a specific path for a given source/destination pair, identified by a label put in each packet, thus saving the time needed for a router or switch to look up the address for the next node to which the packet is to be sent.

 

Multiplexing an electronic or optical process that combines a large number of lower speed transmissions into one higher speed data stream. Multiplexing can be accomplished via either time-division (TDM) or wavelength-division (WDM) methods.

 

Nm (nanometer) – the unit of measure used to quantify wavelength.  The term “nm range” is used to quantify a portion of the optical spectrum in which a particular optical transmission system operates.

 

NZDSF – this is an acronym for non-zero dispersion shifted fiber, a fiber type optimized for long distance transmission in the 1550 nm range.

 

Packet – a packet is a formatted block of information carried by a communications network. Traditional point-to-point communications networks simply transmit data as a series of bytes, characters or bits alone.

 

OC – this is an acronym for optical carrier level, a measure of the transmission rate of optical telecommunications traffic. For example: OC-1 = 51.85 Mbps.

 

Optical – relating to the transmission of telecommunications traffic through the use of light through fiber.

 

Peering – the interconnection between Internet service providers pursuant to which they exchange traffic from their respective customers.

 

Peering exchange – a facility at which multiple Internet service providers peer or exchange customer traffic to reach other parts of the Internet.

 

POP – this is an acronym for point-of-presence, a facility at which certain telecommunications services, ranging from co-location to transmission to fiber termination, occur.

 

TAT-14 – this is an acronym for a trans-Atlantic undersea telecommunications cable system running between the U.S. and a number of points in Europe.

 

Tier 1 – a network generally operated by an Internet service provider that connects to the entire Internet solely via peering connections.

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Although there is no formal definition of the "Internet Tier hierarchy," the generally accepted definition among networking professionals is:

 

  · Tier 1 – A network that peers with every other network to reach the Internet.
     
  · Tier 2 – A network that peers with some networks, but still purchases IP transit (i.e., routing of traffic to all other places on the Internet) to reach at least some portion of the Internet.
     
  · Tier 3 – A network that solely purchases transit from other networks to reach the Internet.

 

TDM – this is an acronym for time division multiplexing, an electronic process that combines a large number of lower speed data streams into one high speed transmission through the use of fixed time slots within the high-speed stream.

 

Transport service – a telecommunication service moving data from one place to another.

 

UNE – this is an acronym for unbundled network element, which is a regulatory term used to describe a segment of an ILEC telecommunications network that must be offered on a stand-alone basis, and is used in the provision of telecommunications services.

 

VPLS this is an acronym for virtual private LAN service, a multipoint VPN service using MPLS or other protocols.

 

VPN – this is an acronym for virtual private network, a private communications network used by companies or organizations to communicate confidentially over a shared (not a dedicated) network. VPN traffic can be carried over a shared networking infrastructure on top of standard protocols, or over a service provider's private network.

 

WAN – this is an acronym for wide area network, or a network crossing a large geographical area.

 

Wavelength – a channel of light that carries telecommunications traffic through the process of wavelength-division multiplexing.

 

WDMin fiber-optic communications, wavelength-division multiplexing or WDM is a technology that combines (multiplexes) multiple optical signals onto a single optical fiber by using different wavelengths (colors) of laser light to carry the different signals.

 

Special Note Regarding Forward-looking Statements

 

Information contained or incorporated by reference in this Annual Report on Form 10-K, in other filings with the Securities and Exchange Commission (“SEC”) by the Company, in press releases and in presentations by the Company or its management that are not historical by nature constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, which can be identified by the use of forward-looking terminology such as “believes,” “expects,” “plans,” “intends,” “estimates,” “projects,” “could,” “may,” “will,” “should,” or “anticipates” or the negatives thereof, other variations thereon or comparable terminology, or by discussions of strategy. No assurance can be given that future results expressed or implied by the forward-looking statements will be achieved. Such statements are based on management’s current expectations and beliefs and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied by the forward-looking statements. These risks and uncertainties include, but are not limited to, those relating to the Company’s financial and operating prospects, strength of competition and pricing, negative economic trends, rapid technology changes, ability to retain existing customers and attract new ones, outlook of customers, and the Company’s acquisition strategy and ability to integrate acquired companies and assets.

 

Other factors and risks that may affect the Company’s business and future financial results are detailed in the Company’s SEC filings, including, but not limited to, those described under “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in this Annual Report on Form 10-K. The Company’s business could be materially adversely affected and the trading price of the Company’s common stock could decline if any such risks and uncertainties develop into actual events. The Company cautions you not to place undue reliance on these forward-looking statements, which speak only as of their respective dates. The Company undertakes no obligation to publicly update or revise forward-looking statements to reflect events or circumstances after the date of this Annual Report on Form 10-K or to reflect the occurrence of unanticipated events.

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Available Information

 

We file with the SEC our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and Proxy Statements.  These reports, and any amendments to these reports, are available at the SEC’s Public Reference Room at 100 F Street NE, Washington, D.C. 20549. Additionally, this information is available at the SEC’s website (http://www.sec.gov). All of our SEC filings are available, free of charge, and as soon as practicable after they are filed with, or furnished to, the SEC on our website at www.above.net at the Investors - SEC Filings tab.

 

ITEM 1A. RISK FACTORS

 

You should consider carefully, among other things, the risk factors set forth below as well as the other information contained in this Annual Report on Form 10-K and in our other filings with the SEC before deciding to purchase, hold or sell our common stock. If any of the identified risks actually occurs, or is adversely resolved, our consolidated financial statements could be materially, adversely impacted in a particular fiscal quarter or year and our business, financial condition and results of operations may suffer materially. As a result, the market price of our common stock could decline and you could lose all or part of your investment in our common stock.  The identified risks are not the only risks we face.  Additional risks and uncertainties, including those not currently known to us or that we currently deem to be immaterial, also could materially adversely affect our business, financial condition and results of operations.

 

Our success depends on our ability to compete effectively in our industry.

 

The telecommunications industry is extremely competitive, particularly with respect to price and service.  Our failure to compete effectively with our competitors could have a material adverse effect on our business, financial condition and results of operations.  A significant increase in industry capacity or reduction in overall demand would adversely affect our ability to maintain or increase prices.  Further, we anticipate that prices for certain telecommunications services such as IP bandwidth will continue to decline due to a number of factors including (a) price competition as various network providers attempt to gain market share to cover the fixed costs of their network investments and/or install new networks that might compete with our networks; and (b) technological advances that permit substantial increases in the transmission capacity of many of our competitors’ networks.

 

In the telecommunications industry, we compete against ILECs, which have historically provided local telephone services and currently occupy significant market positions in their local telecommunications markets.  In addition to these carriers, other competitors, such as facilities-based communications service providers including CLECs, cable television companies, electric utilities and large end-users with private networks offer services similar to those offered by us.  Many of our competitors have greater financial, managerial, sales and marketing and research and development resources than we do.  Certain competitors in our largest market have consolidated or undergone a change in control.  Increased activity by these competitors could result in downward pricing pressure or loss of customers, which could adversely affect our business, financial condition and results of operations.

 

Problems in the economy could negatively affect our future operating results.

 

The problems in the economy could adversely affect our operations, by among other things,

 

  · reducing and/or delaying the demand for our services;
  · increasing our customer churn, both with respect to customer terminations and with respect to reduced prices upon renewals of customer agreements;
  · leading to reduced services from our vendors facing economic difficulties; and
  · increasing the bad debts in our customer receivables.

 

These and other related factors could negatively affect our future operating results.

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Our franchises, licenses, permits, rights-of-way, conduit leases and property leases could be canceled or not renewed, which would impair our ability to provide our services.

 

We must maintain rights-of-way, franchises and other permits from railroads, utilities, state highway authorities, local governments, transit authorities and others to operate our networks.  We cannot assure you that we will be successful in maintaining these right-of-way agreements or obtaining future agreements on acceptable terms.  Some of these agreements may be short-term or revocable at will, and we cannot assure you that we will continue to have access to existing rights-of-way after these agreements have expired or terminated.  If a material portion of these agreements were terminated or could not be renewed and we were forced to abandon our networks, the termination could have a material adverse effect on our business, financial condition and results of operations.  In addition, in some cases landowners have asserted that railroad companies, utilities and others to whom they granted easements to their properties are not entitled as a result of these easements to grant rights-of-way to telecommunications providers.  If these disputes are resolved in the landowners' favor, we could be obligated to make payments to these landowners for the lease of these rights-of-way or to indemnify the right-of-way holder for its losses.

 

In the past, we have had franchises and rights-of-way expire prior to executing a renewal and in the interim until such renewal was executed, operated without an agreement, which is the case currently with respect to our franchise agreement for our operations in the City of New York.  We expect that these situations will continue to occur in the future.  These expirations have not caused any material adverse effect on our operations in the past, and we do not expect that they will in the future.  However, to the extent that a municipality or other right-of-way holder attempts to terminate our related operations upon the expiration of a franchise or right-of-way agreement, it could materially adversely affect our business, financial condition and results of operations.

 

As the result of certain ongoing litigation with a third party, for several years the Department of Information Technology and Telecommunications of the City of New York (“DOITT”) suspended any discussions regarding renewals of telecommunications franchises in the City of New York.  As a result, it is our understanding that DOITT has not renewed any recently expired franchise agreement, including our franchise agreement which expired on December 20, 2008.  Prior to the expiration of our franchise agreement, we sought out and received written confirmation from DOITT that our franchise agreement provides a basis for us to continue to operate in the City of New York pending conclusion of renewal discussions.  We believe that a number of other operators in the City of New York are operating on a similar basis.

 

DOITT recently issued a solicitation for bids for franchises authorizing the installation of landline facilities in the City of New York’s rights-of-way for the provision of information services and telecommunications services. Based on our review of the solicitation and our discussions with officials from DOITT, we understand that franchises to be issued in connection with the solicitation will replace the existing broadband franchises for service providers in the City of New York. The fees for providers proposed in the solicitation are substantially higher than the franchise fees paid by us. We plan to submit an application for a franchise under such solicitation.

 

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

 

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

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We depend on third party service providers for important parts of our business operations and the failure of those third parties to provide their services could negatively affect our services.

 

We rely on third party service providers for important parts of our business, including provision of the fibers on which our long haul network operates and significant portions of the conduits into which our fiber optic cables are installed in our metro networks. If these third party providers fail to perform the services required under the terms of our contracts with them or fail to renew agreements on reasonable terms and conditions, it could materially and adversely affect the performance of our services, and we may experience difficulties locating alternative service providers on favorable terms, if at all. We rely on equipment vendors to provide the telecommunications equipment that we use to provide services to our customers. In the event such equipment vendors do not continue to provide us equipment on a timely basis, or fail to provide reliable, high quality equipment, our operations could be negatively affected.

 

Rapid technological changes could affect the continued use of our services.

 

The telecommunications industry is subject to rapid and significant changes in technology that could materially affect the continued use of our services. Changes in technology could negatively affect the desire of customers to purchase our existing services and may require us to make significant investments in order to meet customer demands for services incorporating new technologies.  We also cannot assure you that technological changes in the communications industry and Internet-related industry will not have a material adverse effect on our business, financial condition and results of operations.

 

Our revenue growth may be negatively affected if we are unable to extend existing customer commitments.

 

While most of our revenue is derived from fixed term customer contracts, a meaningful portion of our revenue is generated from orders under agreements that are past their contractual expiration date for which we provide services that are billed on a month-to-month basis. To the extent that our fixed term contractual revenue is not renewed or our month-to-month revenue is not extended or put under a new fixed term contract, our revenue growth and cash flow may be negatively affected.

 

We are dependent on key personnel.

 

Our business is managed by certain key management and operating personnel.  We believe that the success of our business strategy and our ability to operate successfully depend on the continued employment of such employees and the ability to attract qualified employees.  We face significant competition from a wide range of companies in our recruiting efforts, and we could experience difficulties in recruiting and retaining qualified personnel in the future.

 

We may not be able to successfully implement our business strategy because we depend on factors beyond our control, which could adversely affect our results of operations.

 

Our future success largely depends on our ability to implement our business strategy to create new business and revenue opportunities.  Our results of operations will be adversely affected if we cannot fully implement our business strategy.  Successful implementation depends on numerous factors beyond our control, including economic, competitive, regulatory and other conditions and uncertainties, the ability to obtain licenses, permits, franchises and rights-of-way on reasonable terms and conditions and the ability to hire and retain qualified management personnel.

 

We may not be able to develop and maintain systems and controls to operate our business effectively.

 

We have experienced severe difficulties developing and maintaining financial and other systems necessary to operate our business properly and for a period of over six years we could not file our periodic reports with the SEC for periods prior to December 31, 2008.

 

Our history of rapid initial growth, expansion through acquisitions with attendant integration issues, significant reorganization and restructuring activities and associated significant staffing reductions, budgetary constraints and attendant limitations on investment in internal systems had contributed to the risk of internal control deficiencies.

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Under Section 404 of the Sarbanes-Oxley Act, management is required to assess the effectiveness of our internal control over financial reporting on a periodic basis. Pursuant to our assessment of internal control over financial reporting as of December 31, 2011, 2010 and 2009, our management concluded that our internal control over financial reporting was effective as of December 31, 2011, 2010 and 2009. Our management concluded that our internal control over financial reporting was not effective as of December 31, 2008 and as of December 31, 2007 as we had material weaknesses in our internal control over financial reporting. These weaknesses meant that there was more than a remote likelihood that we would not prevent or detect a material misstatement in our financial statements.

 

We are currently in the process of upgrading our systems that mange much of our pre-sales process, post-sales implementation, accounting and financial reporting. If we are unable to upgrade and improve our systems, or if the upgrading of such systems is not properly implemented, it could adversely affect our current levels of operations and our ability to grow.

 

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

 

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

 

We are required to maintain, repair, upgrade and replace our network and facilities, and our failure to do so could harm our business.

 

Our business requires that we maintain, upgrade, repair and periodically replace our facilities and networks.  This requires and will continue to require, management time and the expenditure of capital on a regular basis.  In the event that we fail to maintain, upgrade or replace essential portions of our network or facilities, it could lead to a material degradation in the level of services that we provide to our customers which would adversely affect our business.  Our networks can be damaged in a number of ways, including by other parties engaged in construction close to our network facilities.  In the event of such damage, we will be required to incur expenses to repair the network in order to maintain services to customers.  We could be subject to significant network repair and replacement expenses in the event a terrorist attack or natural disaster damages our network.  Further, the operation of our network requires the coordination and integration of sophisticated and highly specialized hardware and software technologies. Our failure to maintain or properly operate this hardware and software can lead to degradations or interruptions in service. Our failure to provide a higher level of service can result in claims from our customers for credits or damages and can damage our reputation for service, thereby limiting future sales opportunities.

 

Governmental regulation may negatively affect our operations.

 

Existing and future government laws and regulations greatly influence how we operate our business.  U.S. federal and state laws directly shape the telecommunications and Internet markets.  Consequently, regulatory requirements and changes could adversely affect our operations and also influence the markets for telecommunications and Internet services.  We cannot predict the future regulatory framework of our business.

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Local governments also exercise legal authority that may have an adverse effect on our business because of our need to obtain rights-of-way for our fiber networks.  While local governments may not prohibit persons from providing telecommunications services nor treat telecommunication service providers in a discriminatory manner, they can affect the timing and costs associated with our use of public rights-of-way.

 

Government regulation of the Internet may subject us to liability.

 

Laws and regulations that apply to the Internet are becoming more prevalent.  The U.S. Congress has considered Internet laws regarding privacy and security relating to the collection and transmission of information over the Internet, entrusting the Federal Trade Commission with strong enforcement power.  The U.S. Congress also has adopted laws that regulate the protection of children, copyrights, trademarks, domain names, taxation and the transmission of sexually explicit material over the Internet.  The European Union adopted its own privacy regulations and other countries may do so in the future.  Other nations have taken actions to restrict the free flow of material deemed objectionable over the Internet.

  

The scope of many of these laws and regulations is subject to conflicting interpretations and significant uncertainty that may take years to resolve. As a result of this uncertainty, we may be exposed to direct liability for our actions and to contributory liability for the actions of our customers or information distributed over our networks.

 

Requests to relocate portions of our network can result in additional expenses.

 

We are periodically required to relocate portions of our network by municipalities, railroads, highway authorities and other entities that engage in construction or other activities in areas close to our network.  These relocations can be expensive and time consuming to management and can result in interruptions of service to customers.  If we are required to engage in an increased amount of relocation activities resulting from increased government spending on infrastructure or other reasons, it could adversely affect our business, financial condition and results of operations.

 

We have incurred significant net losses and we cannot assure you that we will generate net income or that we will sustain positive operating cash flow in the future.

 

We incurred net losses from our inception through December 31, 2005. In 2006, we generated net income, principally from the sale of our remaining data centers and in 2007, 2008, 2009, 2010 and 2011, we generated operating income and net income. The net income reported for 2007 included the non-cash gain of $10.3 million on the reversal of foreign currency translation adjustments from the liquidation of certain subsidiaries. The net income reported for 2008 of $42.3 million included termination fees of $15.4 million. The net income reported for 2009 of $281.6 million included the recognition of non-cash tax benefits of $183.0 million relating to the reduction of certain valuation allowances previously established in the U.S. and the U.K.

 

In order for us to continue to generate positive operating cash flow and net income, we will need to continue to obtain new customers, increase our revenue from our existing customers and manage our costs effectively.  In the event we are unable to do so, or if we lose customers, we may not be able to continue to generate operating cash flow or net income in the future.

 

If our operations do not produce sufficient cash to fund our operating expenses and capital requirements, we may be required to raise additional capital through a debt or equity financing.

 

If our operating expenses or our investments in property and equipment increase, we may need to rely on our existing cash balance and funds available under our $250 Million Secured Revolving Credit Facility (described below) to meet our cash needs.  Our future capital requirements may increase if we acquire or invest in additional businesses, assets, services or technologies, which may require us to issue additional equity or debt.  We may also face unforeseen capital requirements for new technology that we require to remain competitive or to comply with new regulatory requirements, for unforeseen maintenance of our network and facilities and for other unanticipated expenses associated with running our business. We cannot assure you that we will have access to necessary capital, nor can we assure you that any such financing will be available on terms that are acceptable to us.  If we issue equity securities to raise additional funds, our existing stockholders may be diluted.  Additionally, our $250 Million Secured Revolving Credit Facility imposes limitations on the amount of additional indebtedness we may incur.

 

We have incurred secured indebtedness.

 

At February 24, 2012, we had $55.0 million outstanding under our $250 million revolving secured credit facility (the “$250 Million Secured Revolving Credit Facility”), which we closed on January 28, 2011.  The $250 Million Secured Revolving Credit Facility is secured by substantially all of our domestic assets and 65% of our ownership interests in the Company’s principal foreign subsidiaries. A portion of the proceeds drawn at closing was used to repay in full and terminate our then existing secured credit facility (the “Secured Credit Facility”) and the remaining capacity is available for general corporate purposes, including capital investment and the Repurchase Program.

 

We may not be able to generate sufficient cash flows in the future to repay the loans due under the $250 Million Secured Revolving Credit Facility. Additionally, we may not be able to satisfy the requirements under the loan covenants. See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources” and Note 9, “Long-Term Debt,” to the accompanying consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

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Demand for our services from certain customers in the financial services industry may be negatively affected by regulatory changes.

 

Certain of our financial services customers utilize our networks for high-frequency trading.  To the extent that regulatory changes restrict this activity, the needs of these customers for our services may be reduced or eliminated.

 

Prior to the filing of our Annual Report on Form 10-K for the year ended December 31, 2008, we were not in compliance with our reporting obligations under the Securities Exchange Act of 1934.

 

We had not made any timely periodic filings with the SEC required by the Securities Exchange Act of 1934, as amended (the “Exchange Act”), from 2002 through September 30, 2008.  Since filing our Annual Report on Form 10-K for the year ended December 31, 2008, we have made all periodic filings on a timely basis.  As a result of our past failure to make timely periodic filings with the SEC, we could be subject to civil penalties and other administrative proceedings by the SEC.

 

Our inability to produce audited financial statements prevented us from filing our federal and state income taxes in a timely manner.

 

Because we were unable to produce audited financial statements on a timely basis, we delayed the filing of our federal and state income tax returns for 2003 to 2006.  In January 2008, we filed the 2003 to 2005 income tax returns and in December 2008, we filed our income tax returns for the years ended December 31, 2006 and 2007.  Our income tax returns for 2008, 2009 and 2010 were timely filed. However, we are still subject to federal and state tax audits.  We believe that we will not owe any material amount of income taxes, related penalties or interest in these jurisdictions due to the losses incurred by us.

 

We cannot predict our future tax liabilities.  If we become subject to increased levels of taxation, our financial condition and results of operations could be adversely affected.

 

We provide telecommunication and other services in multiple jurisdictions across the United States and Europe and are therefore subject to multiple sets of complex and varying tax laws and rules.  We cannot predict the amount of future tax liabilities to which we may become subject. Any increase in the amount of taxation incurred as a result of our operations or due to legislative or regulatory changes could result in a material adverse effect on our sales, financial condition and results of operations. While we believe that our current provisions for taxes are reasonable and appropriate, we cannot assure you that these items will be settled for the amounts accrued or that we will not identify additional exposures in the future.

 

Customer agreements contain service level and delivery obligations that could subject us to liability or the loss of revenue and could damage our reputation.

 

Our contracts with customers generally contain service guarantees and service delivery date targets, which if not met by us, enable customers to claim credits against their payments to us and, under certain conditions, terminate their agreements.  If we are unable to meet our service level guarantees or service delivery dates, it could adversely affect our revenue and cash flow and could damage our reputation.

 

Our charter documents, our Amended and Restated Stockholders’ Rights Agreement and Delaware law may inhibit a takeover that stockholders may consider favorable.

 

Provisions in our restated certificate of incorporation, our amended and restated bylaws, our Amended and Restated Stockholders’ Rights Agreement and Delaware law could delay or prevent a change of control or change in management that would provide stockholders with a premium to the market price of their common stock.  Our Amended and Restated Stockholders’ Rights Agreement has significant anti-takeover effects by causing substantial dilution under certain circumstances to a person or group that attempts to acquire us on terms not approved by our Board of Directors.  In addition, the authorization of undesignated preferred stock gives our Board of Directors the ability to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to acquire control of us.  If a change of control or change in management is delayed or prevented, this premium may not be realized or the market price of our common stock could decline.

22
 

  

Future sales, or the perception of future sales, of a substantial amount of our shares of common stock could have a negative impact on the market price of our common stock.

 

In August 2010, we filed with the Securities and Exchange Commission a Form S-3 shelf registration statement on behalf of certain funds advised by Franklin Mutual Advisers, LLC that beneficially own an aggregate of 4,591,633 shares of our common stock. These shares, which may be offered and sold from time to time, represent 17.6% of our outstanding shares based on the number of shares of our common stock outstanding as of February 24, 2012.  Sales by these stockholders of a substantial number of shares, or the perception that these sales might occur, could have a negative impact on the market price of our common stock.

 

Our revenue includes certain fees that are not predictable.

 

Historically, a portion of our revenue has included certain termination payments received by the Company to settle contractual commitments, which are referred to as termination revenue.  Additionally, from time to time, we receive settlements of our claims in various customer bankruptcy cases, which is also included in termination revenue.  Consolidated termination revenue amounted to $4.4 million, $2.7 million and $3.9 million in 2011, 2010 and 2009, respectively.  This revenue is not predictable and may not be sustainable.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2. PROPERTIES

 

Our principal properties currently are fiber optic networks and their component assets. We own substantially all of the communications equipment required for operating our networks and our business. Such assets are located at leased locations in the areas that we serve.

 

We lease our principal executive offices in White Plains, New York and London, U.K., as well as significant sales, administrative and other support offices. We lease properties to locate the POPs necessary to operate our networks. Our executive office located at 360 Hamilton Avenue, White Plains, New York is approximately 33,000 square feet and leased under an agreement that expires in May 2020. Office and POP space is leased in the markets where we maintain our networks and generally ranges from 100 to 33,000 square feet under agreements that expire over the next 18 years (as of December 31, 2011), with the majority of leases expiring over the next 10 years.

 

The majority of our leases have renewal provisions at either fair market value or a stated escalation above the last year of the current term.

 

Our existing properties are in good condition and are suitable for the conduct of our business.

 

We do not own any real property. As of December 31, 2011, we conducted our business in the U.S. through 120 operating leases totaling approximately 506,000 rentable square feet.

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ITEM 3. LEGAL PROCEEDINGS

 

Our significant legal proceedings are as follows:

 

AboveNet Communications UK Limited, our principal U.K. operating subsidiary (“ACUK”), was a party to a duct purchase and fiber lease agreement (the “Duct Purchase Agreement”) with EU Networks Fiber UK Ltd, formerly Global Voice Networks Limited (“GVN”). A dispute between the parties arose regarding the extent of the network duct that was sold and fiber that was leased to GVN pursuant to the Duct Purchase Agreement. As a result of this dispute, in 2006, GVN filed a claim against ACUK in the High Court of Justice in London seeking ownership of the disputed portion of the network duct, the right to lease certain fiber and associated damages.  In December 2007, the court ruled in favor of GVN with respect to the disputed duct and fiber. In early February 2008, ACUK delivered most of the disputed duct and fiber to GVN. Additionally, under the original ruling, we were also required to construct the balance of the disputed duct and fiber and deliver it to GVN pursuant to a schedule ordered by the court.  Additional portions of the disputed duct and fiber were constructed and subsequently delivered and other portions are scheduled for delivery.  We also had certain repair and maintenance obligations that we must perform with respect to such duct. GVN was also seeking to enforce an option requiring ACUK to construct 180 to 200 chambers for GVN along the network. In June 2008, we paid $3.0 million in damages pursuant to the ruling in the liability trial. Additionally, we reimbursed GVN $1.8 million for legal fees and incurred our own legal fees of $2.4 million.  Further, we have incurred or are obligated for costs totaling $2.7 million to build additional network. In early August 2008, we reached a settlement agreement under which we paid GVN $0.6 million and agreed to provide additional construction of duct at an estimated cost of $1.2 million and provide GVN limited additional access to ACUK’s network. GVN and ACUK provided mutual releases of all claims against each other, including ACUK’s repair obligation and the chamber construction obligations discussed above.  We recorded a loss on litigation of $11.7 at December 31, 2007.  Through December 31, 2011, we paid $10.9 million in connection with this litigation. During 2010, we recorded an additional provision of $0.9 million to record additional expenses for repairs covered by the settlement. The obligations were denominated in British pounds, and accordingly, the amounts have been adjusted for changes in currency translation rates as appropriate. We have a remaining accrual balance of $0.7 million relating to this litigation included in our consolidated balance sheets at both December 31, 2011 and 2010.

 

On July 11, 2011, we terminated the employment of Douglas Jendras, our former Senior Vice President of Operations. On August 3, 2011, Mr. Jendras filed a complaint in the United States District Court for the Southern District of New York alleging breach of his employment contract and seeking damages of $0.4 million for salary and benefits and approximately $4.6 million and specific performance with respect to 66,738 restricted stock units that were cancelled in connection with the termination of Mr. Jendras’ employment, plus recovery of legal fees and costs, and punitive damages.  On September 30, 2011, we filed an answer to the complaint. We believe we have meritorious defenses that we intend to pursue vigorously.

 

From time to time, other legal matters in which we may be named as a defendant arise in the normal course of our business activities. The resolution of these legal matters against us cannot be accurately predicted. We do not anticipate that the outcome of such matters (or the other matters described above) will have a material adverse effect on our business, financial condition or results of operations.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

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PART II

 

ITEM 5.   MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Stock Split

 

On August 3, 2009, the Board of Directors of the Company authorized a two-for-one common stock split, affected in the form of a 100% stock dividend, which was distributed on September 3, 2009.  Each shareholder of record on August 20, 2009 received one additional share of common stock for each share of common stock held on that date. All share and per share information for prior periods, including warrants, options to purchase common shares, restricted stock units, warrant and option exercise prices, shares reserved under the Company’s 2003 Incentive Stock Option and Stock Unit Grant Plan (the “2003 Plan”) and the Company’s 2008 Equity Incentive Plan  (the “2008 Plan”), weighted average fair value of options granted, common stock and additional paid-in capital accounts on the consolidated balance sheets and consolidated statement of shareholders’ equity, have been retroactively adjusted, where applicable, to reflect the two-for-one stock split.

 

Market Information

 

Our common stock has been listed on the New York Stock Exchange under the symbol “ABVT” since May 12, 2009. Our shares traded on the over-the-counter market prior to our New York Stock Exchange listing. The table below sets forth, on a per share basis, for the periods indicated, the intra-day high and low sales prices for our common shares on the New York Stock Exchange from January 1, 2010 through December 31, 2011.

 

Year ended December 31, 2011   High     Low  
First Quarter Ended March 31, 2011   $ 67.00     $ 58.69  
Second Quarter Ended June 30, 2011   $ 78.07     $ 62.65  
Third Quarter Ended September 30, 2011   $ 71.10     $ 48.79  
Fourth Quarter Ended December 31, 2011   $ 66.59     $ 51.31  
                 
Year ended December 31, 2010                
First Quarter Ended March 31, 2010   $ 67.00     $ 49.78  
Second Quarter Ended June 30, 2010   $ 54.59     $ 41.12  
Third Quarter Ended September 30, 2010   $ 55.24     $ 45.88  
Fourth Quarter Ended December 31, 2010   $ 63.80     $ 51.89 *

 

* See discussion below regarding the Special Cash Dividend paid on December 27, 2010.

  

There were approximately 1,319 stockholders of record of AboveNet’s common stock as of February 24, 2012.

 

Repurchase Program

 

On December 7, 2011, the Board of Directors of the Company authorized a share repurchase program of up to $200.0 million of the Company’s common stock through December 31, 2012 (the “Repurchase Program”). The Board also authorized management to enter into one or more prearranged stock repurchase plans under Rule 10b5-1 of the Securities Act of 1934 in connection with the Repurchase Program.

 

Through December 31, 2011, the Company purchased 29,457 shares pursuant to the Repurchase Program at a cost of $1.9 million. From January 1, 2012 through February 24, 2012, the Company purchased an additional 11,700 shares pursuant to the Repurchase Program at a cost of $0.8 million.

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Cash Dividend and Related Matters

 

On November 23, 2010, we announced that our Board of Directors declared a special cash dividend of $5.00 per share on our common stock (the “Special Cash Dividend”). We had previously received a waiver from the lenders under the Secured Credit Facility permitting the payment of such dividend. The Special Cash Dividend was paid on December 27, 2010 to stockholders of record at the close of business on December 6, 2010. The aggregate amount of the payment made in connection with the Special Cash Dividend was approximately $129 million.  On December 20, 2010, our Board of Directors granted 40,508 restricted stock units to holders of unvested restricted stock units (the “RSU Dividend”) on the record date of the Special Cash Dividend and granted 9,281 shares of common stock (which were delivered on December 27, 2010) to holders of vested unexercised stock options (the “Option Dividend”) in order to provide these holders with an amount of securities that approximated the amount of the Special Cash Dividend. Of the 40,508 restricted stock units granted, 1,246 vested in February 2011 based upon the achievement of certain performance targets established for fiscal year 2010, 28,656 vested on November 15, 2011, 9,360 vested on November 16, 2011 and 1,246 vested on February 10, 2012 based upon the determination by the Compensation Committee of the Board of Directors that certain performance targets established for fiscal year 2011 had been met. We recorded stock-based compensation expense of $0.7 million in connection with the RSU Dividend and Option Dividend in 2010 and incurred additional non-cash stock-based compensation expense of $1.9 million with respect to the RSU Dividend in 2011. Additionally, we paid an aggregate of $7,000 in cash to one former employee holding vested stock options and to the estate of one deceased employee who held vested stock options.

 

We had not previously declared a cash dividend and we have no current intention of paying cash dividends in the future. Any future determination with respect to the payment of cash dividends will be at the discretion of our Board of Directors and will be dependent upon, among other things, our liquidity, operations, capital requirements and surplus, general financial condition and such other factors as our Board of Directors may deem relevant. Additionally, the Company’s $250 Million Secured Revolving Credit Facility contains certain restrictions on the Company’s ability to pay dividends. (See Note 9, “Long-Term Debt - $250 Million Secured Revolving Credit Facility,” to the accompanying consolidated financial statements included elsewhere in this Annual Report on Form 10-K.)

 

Description of AboveNet’s Equity Securities

 

In 2003, upon emerging from bankruptcy, we issued

 

  · 17,500,000 shares of common stock, of which 17,498,276 were delivered and 1,724 shares were determined to be undeliverable and were cancelled;
     
  · rights to purchase 3,338,420 shares of common stock at a price of $14.97715 per share, under a rights offering, of which the rights to purchase 3,337,930 shares of common stock were exercised;
     
  · five year stock purchase warrants to purchase 1,418,918 shares of common stock exercisable at a price of $10.00 per share (the “Five Year Warrants”), of which 70 Five Year Warrants were cancelled, 105,094 shares of common stock were returned to treasury to settle the aggregate exercise price in connection with net exercises and 1,313,754 shares of common stock were issued to warrant holders upon exercise; and
     
  · seven year stock purchase warrants to purchase 1,669,316 shares of common stock exercisable at a price of $12.00 per share (the “Seven Year Warrants”), of which 26 Seven Year Warrants were cancelled, 89,906 shares of common stock were returned to treasury to settle the aggregate exercise price in connection with net exercises and 1,579,384 shares of common stock were issued to warrant holders upon exercise.

 

In addition, 2,129,912 shares of common stock were originally reserved for issuance under our 2003 Plan.

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On August 29, 2008, the Board of Directors of the Company approved our 2008 Plan.  The 2008 Plan is (and will continue to be) administered by our Compensation Committee unless otherwise determined by the Board of Directors.  Any employee, officer, director or consultant of the Company or subsidiary of the Company selected by the Compensation Committee is eligible to receive awards under the 2008 Plan.  Stock options, restricted and unrestricted stock, restricted and unrestricted stock units and stock appreciation rights may be awarded to eligible participants on a stand alone, combination or tandem basis.  1,500,000 shares of the Company’s common stock may be issued pursuant to awards granted under the 2008 Plan in accordance with its terms.  The number of shares available for grant and the terms of outstanding grants are subject to adjustment for stock splits, stock dividends and other capital adjustments as provided in the 2008 Plan.

 

On May 11, 2011, the Board of Directors of the Company approved the AboveNet, Inc. 2011 Equity Incentive Plan, which was subsequently approved by the Company’s stockholders at the 2011 annual meeting (the “2011 Plan”). The 2011 Plan is (and will continue to be) administered by our Compensation Committee unless otherwise determined by the Board of Directors.  Any employee, officer, director or consultant of the Company or subsidiary of the Company selected by the Compensation Committee is eligible to receive awards under the 2011 Plan.  Stock options, restricted stock, restricted stock units, stock appreciation rights and other stock and cash-based awards may be awarded to eligible participants on a stand alone, combination or tandem basis.  1,600,000 shares of the Company’s common stock may be issued pursuant to awards granted under the 2011 Plan in accordance with its terms.  The number of shares available for grant and the terms of outstanding grants are subject to adjustment for stock splits, stock dividends and other capital adjustments as provided in the 2011 Plan.

 

The following table provides the details as of December 31, 2011, regarding our issuance and repurchase of shares of common stock since 2003.

 

Description   Number of Shares Issued     Shares Repurchased     Shares Outstanding  
Shares issued at fresh start   17,498,276         17,498,276  
Shares issued pursuant to the rights offering     3,337,930             3,337,930 (1)
Shares issued pursuant to the exercise of Five Year Warrants     1,418,848       105,094 (2)     1,313,754  
Shares issued pursuant to the exercise of Seven Year Warrants     1,669,290       89,906 (2)     1,579,384  
Shares issued pursuant  to the delivery of vested restricted stock units under the 2003 Plan     1,169,432       378,438       790,994  
Shares repurchased from executives           37,220       (37,220 )
Shares issued pursuant to the exercise of options to purchase shares of common stock under the 2003 Plan     850,643             850,643  
Shares issued pursuant to the delivery of vested restricted stock units under the 2008 Plan     940,418       16,089       924,329  
Shares issued pursuant to the exercise of options to purchase shares of common stock under the 2008 Plan     3,288             3,288  
Shares issued pursuant to the employee stock purchase plan     16,702             16,702  
Shares issued in December 2010 pursuant to the Option Dividend     9,281       2,731 (3)     6,550  
Shares repurchased pursuant to the Repurchase Program           29,457       (29,457 )
Balance, December 31, 2011     26,914,108       658,935       26,255,173

 

 

(1) 54 shares were cancelled in 2010.  
(2) Shares deemed repurchased to fund the exercise price in connection with net exercises.  
(3) Shares repurchased to cover minimum withholding requirements for federal, state and local income taxes.  

 

The following table provides the details as of December 31, 2011, of the shares of common stock underlying previously granted and outstanding securities granted under our 2003 Plan, our 2008 Plan and our 2011 Plan.

 

Description  2003 Plan   2008 Plan   2011 Plan 
Options to purchase shares of common stock   75,459    6,712     
Restricted stock units subject to vesting       387,950    396,200 
Restricted stock units granted subject to vesting upon the attainment of performance targets       15,246     
    75,459    409,908    396,200 

 

There are no shares available for grant under the 2003 Plan.  At December 31, 2011, there were 137,105 shares available for future grant under the 2008 Plan and 1,203,800 shares available for future grant under the 2011 Plan.

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Common and Preferred Stock

 

Our amended and restated certificate of incorporation authorizes 10,000,000 shares of preferred stock, $0.01 par value, and 200,000,000 shares of common stock, $0.01 par value.  The holders of common stock are entitled to one vote for each issued and outstanding share and are entitled to receive dividends, subject to the rights of the holders of preferred stock.  Preferred stock may be issued from time to time in one or more classes or series, each of which classes or series shall have such terms as determined by the Board of Directors.  In the event of any liquidation, the holders of the common stock will be entitled to receive the assets of the Company available for distribution, after payments to creditors and preferred rights of any outstanding preferred stock.  In 2006, we designated 500,000 shares as Series A Junior Participating Preferred Stock in connection with the adoption by the Board of Directors of a stockholder rights agreement.

 

Table of Securities Authorized for Issuance under Equity Compensation Plans

 

The information called for by this item relating to “Securities Authorized for Issuance under Equity Compensation Plans” is provided in Part III, Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters-Equity Compensation Plan Information - Table of Securities Authorized for Issuance under Equity Compensation Plans,” of this Annual Report on Form 10-K.

 

Share Repurchases

 

During 2011, we repurchased 35,408 shares of common stock, of which 29,457 shares were repurchased pursuant to the Repurchase Program and 5,951 shares were repurchased to fund minimum tax withholding obligations associated with the delivery of shares pursuant to vested restricted stock units. (See Note 10, “Shareholders’ Equity – Repurchase Program,” to the accompanying consolidated financial statements included elsewhere in this Annual Report on Form 10-K, for a description of the Repurchase Program.”)

 

During 2010, we repurchased 102,299 shares of common stock of which 10,138 shares were repurchased to fund minimum tax withholding obligations associated with the delivery of shares pursuant to vested restricted stock units, 89,430 shares were deemed repurchased pursuant to a cashless exercise of stock purchase warrants and 2,731 shares were repurchased to fund minimum tax withholding obligations associated with the December 27, 2010 delivery pursuant to the Option Dividend.

 

Below is a summary of the Company’s common stock repurchases in 2010 and 2011.

 

Period  

Total Number

of Shares Purchased

   

Average Price

Paid Per Share

    Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs     Maximum Number (or approximate dollar value in millions) of Shares that may yet be Purchased Under the Plans or Programs  
January 1 to March 31, 2010 (1)      67,153     $ 62.19           $  
April 1 to June 30, 2010         $              
July 1 to September 30, 2010 (2)     27,736     $ 51.45              
October 1 to October 31, 2010         $              
November 1 to November 30, 2010 (3)     4,679     $ 61.60              
December 1 to December 31, 2010 (4)     2,731     $ 58.07              
Total repurchased in 2010     102,299     $ 59.14              
January 1 to March 31, 2011     5,951     $ 60.24              
April 1 to June 30, 2011         $              
July 1 to September 30, 2011         $              
October 1 to October 31, 2011         $              
November 1 to November 30, 2011         $              
December 1 to December 31, 2011     29,457 (5)   $ 64.74       29,457     $ 198.1  
Total repurchased in 2011     35,408     $ 63.98       29,457     $ 198.1  
Total repurchased in 2010 and 2011     137,707     $ 60.38       29,457     $ 198.1  

  

(1)Of this amount, 61,694 shares were deemed repurchased pursuant to cashless exercises of stock purchase warrants and 5,459 shares were repurchased to fund minimum tax withholding obligations.

 

(2)Shares deemed repurchased pursuant to cashless exercises of stock purchase warrants.

 

(3)Shares repurchased to fund minimum tax withholding obligations with respect to the delivery of shares in connection with vested restricted stock units.

 

(4)Shares deemed repurchased to fund minimum tax withholding obligations with respect to the delivery of 9,281 shares of common stock pursuant to the Option Dividend.

 

(5)On December 7, 2011, the Board of Directors authorized a share repurchase program of up to $200.0 million of the Company’s common stock. The Company is authorized to make repurchases under the Repurchase Program through December 31, 2012.

 

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Performance Graph

 

The following graph compares the cumulative total stockholder return (stock price appreciation) of our common stock with the cumulative return (including reinvested dividends) of the NASDAQ (U.S.) Index and the NASDAQ Telecommunications Index, for the period from December 31, 2006 through December 31, 2011 assuming a $100 investment on December 31, 2006. The stock price performance shown on the graph represents past performance and should not be considered indicative of future price performance. Our shares are currently listed on the New York Stock Exchange and traded on the over-the-counter market for all periods presented prior to our New York Stock Exchange listing on May 12, 2009. The stock price performance shown on the graph represents past performance and should not be considered indicative of future price performance.

 

 

 

 

   12/31/06   12/31/07   12/31/08   12/31/09   12/31/10   12/31/11 
AboveNet, Inc.  $100   $130   $48   $217   $195   $217 
NASDAQ (U.S.)  $100   $110   $65   $94   $110   $108 
NASDAQ Telecommunications  $100   $109   $62   $92   $96   $84 

 

The foregoing performance graph and related information shall not be deemed "filed" with the SEC and is not to be incorporated by reference into any Company filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing.

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ITEM 6. SELECTED FINANCIAL DATA

 

The table below represents selected consolidated financial data of the Company as of and for the years ended December 31, 2011, 2010, 2009, 2008 and 2007. The historical financial data as of December 31, 2011 and 2010 and for the years ended December 31, 2011, 2010 and 2009, have been derived from the historical consolidated financial statements presented elsewhere in this Annual Report on Form 10-K and should be read in conjunction with such consolidated financial statements and the accompanying notes.

 

Upon emergence from bankruptcy on September 8, 2003 (the “Effective Date”), we adopted fresh start accounting and reporting in accordance with Statement of Position 90-7, “Financial Reporting by Entities in Reorganization under the Bankruptcy Code” (now known as Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) 852-10), which resulted in material adjustments to the historical carrying amounts of our assets and liabilities. Fresh start accounting required us to allocate the reorganization value to our assets and liabilities based upon their estimated fair values. Adopting fresh start accounting has resulted in material adjustments to the historical carrying amount of our assets and liabilities. We engaged an independent appraiser to assist in the allocation of the reorganization value, and in determining the fair market value of our property and equipment and overall enterprise value.  The determination of fair values of assets and liabilities is subject to significant estimation and assumptions. (See Note 1, “Background and Organization - Bankruptcy Filing and Reorganization,” and Note 2, “Basis of Presentation and Significant Accounting Policies - Fresh Start Accounting,” to the accompanying consolidated financial statements included elsewhere in this Annual Report on Form 10-K, for a description of the fresh start accounting impacts on our Effective Date balance sheet.)

 

(In millions, except share and per share information, for the tables set forth below)

   Years Ended December 31, 
   2011   2010   2009   2008   2007 
Statements of Operations data:                    
Revenue  $472.5   $409.7   $360.1   $319.9   $253.6 
Costs of revenue (including provisions for impairment of $1.2, $2.0, $1.2, $0.4 and $2.2 for the years ended December 31, 2011, 2010, 2009, 2008 and 2007, respectively)   162.7    142.8    130.7    126.0    110.3 
Selling, general and administrative expenses (including provision for abandonment of $2.3 for the year ended December 31, 2008)   116.4    96.6    82.5    90.5    80.9 
Depreciation and amortization   75.3    63.3    52.0    48.3    47.5 
Loss on litigation                   11.7 
Operating income   118.1    107.0    94.9    55.1    3.2 
Gain on reversal of foreign currency translation adjustments from liquidation of subsidiaries                   10.3 
Interest income   0.1    0.1    0.3    1.8    3.3 
Interest expense   (4.5)   (5.2)   (4.8)   (3.9)   (2.3)
Other (expense) income, net   (1.0)   2.0    3.6    (2.4)   3.8 
Income before income taxes   112.7    103.9    94.0    50.6    18.3 
Provision for (benefit from) income taxes   40.0    34.5    (187.6)   8.3    4.5 
Net income  $72.7   $69.4   $281.6   $42.3   $13.8 
                          
Net income per share, basic  $2.81   $2.74   $11.98   $1.93   $0.64 
Shares used in computing basic net income per share   25,902,123    25,293,188    23,504,077    21,985,284    21,503,842 
                          
Net income per share, diluted  $2.71   $2.65   $11.06   $1.73   $0.57 
Shares used in computing diluted net income per share   26,822,614    26,242,696    25,468,405    24,454,150    24,368,278 

 

 

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   At December 31, 
   2011   2010   2009   2008   2007 
Balance Sheet data:                    
Cash and cash equivalents  $118.4   $61.6   $165.3   $87.1   $45.8 
Working capital (deficit)   55.5    (8.5)   88.6    11.8    (26.1)
Property and equipment, net   611.5    540.8    469.1    398.4    347.7 
Total assets   911.0    807.8    862.0    523.9    432.3 
Long-term debt (*)   56.0    43.3    51.0    34.3    1.6 
Total shareholders’ equity   647.9    552.5    594.2    284.3    223.7 
Special Cash Dividend declared per share       5.00             

 

(*) These amounts include the long-term obligation under a capital lease of $1.0 million, $1.2 million, $1.3 million, $1.5 million and $1.6 million at December 31, 2011, 2010, 2009, 2008 and 2007, respectively, plus the long-term portion of amounts outstanding under the relevant credit facility.  The long-term obligation under the capital lease amounts are included in other long-term liabilities on the respective consolidated balance sheets.  (See Note 9, “Long-Term Debt - Obligation under Capital Lease.”)

 

   Years Ended December 31, 
   2011   2010   2009   2008   2007 
Cash flow data:                    
Net cash provided by operating activities  $206.9   $162.8   $157.2   $116.1   $69.7 
Net cash used in investing activities   (147.7)   (135.3)   (118.4)   (115.6)   (89.3)
Net cash (used in) provided by financing activities   (2.7)   (131.0)   38.9    42.6    (5.4)

 

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ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis should be read together with our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K.

 

Executive Summary

 

Overview

 

We provide data transport services primarily in and between 17 major metropolitan markets in the U.S. and four in Europe. Our services include high-bandwidth fiber-optic connectivity solutions primarily to large corporate enterprise clients and communication carriers that have large bandwidth transport requirements, including Fortune 1000 and FTSE 500 companies, as well as governmental entities, in the U.S. and Europe.

 

The components of our operating income are revenue, costs of revenue, selling, general and administrative expenses and depreciation and amortization.  Below is a description of these components. We are reporting operating income for each of the years ended December 31, 2011, 2010 and 2009, as shown in our consolidated statements of operations included elsewhere in this Annual Report on Form 10-K.

 

The demand for high-bandwidth data transport services continues to increase. We believe that our experience in the provision of these services, our customer base and our robust and extensive network should enable us to take advantage of this growing demand. Although the competitive landscape in our industry is challenging and constantly shifting, we believe that we continue to be well positioned for continued growth in the future.

 

Strategy

 

See Item 1, “Business - Business Strategy,” for a discussion of our business strategy.

 

Key Performance Indicators

 

Our senior management reviews a group of financial and non-financial performance metrics in connection with the management of our business.  These metrics facilitate timely and effective communication of results and key decisions, allowing management to react quickly to changing requirements and changes in our key performance indicators. Some of the key financial indicators we use include cash flow, monthly expense analysis, new customer installations, net new revenue booked, capital committed and expended and net revenue attrition. We define net revenue attrition as the reduction in monthly recurring revenue (“MRR”) for customers with net decreases in MRR (as a result of terminations, price declines and other decreases, which are offset by any increases) divided by total revenue (excluding contract termination revenue) over a given period.

 

Some of the most important non-financial performance metrics measure headcount, IP traffic growth, installation intervals and network service performance levels. We manage our employee headcount changes to ensure sufficient resources are available to service our customers and control expenses. All employees have been categorized into, and are managed within, integrated groups such as sales, operations, engineering, finance, legal and human resources. Our worldwide headcount was 713 employees as of December 31, 2011, 616 of which were employed in the U.S., 93 in the U.K. and one each in the Netherlands, Germany, France and Japan.

 

2011 Highlights

 

Our consolidated revenue increased by $62.8 million, or 15.3%, from $409.7 million for the year ended December 31, 2010 to $472.5 million for the year ended December 31, 2011, which reflected a $15.1 million increase in our domestic metro services. Additionally, in the U.S., our revenue from fiber infrastructure and WAN services increased by $11.5 million and $22.1 million, respectively, for the year ended December 31, 2011 compared to the year ended December 31, 2010. Consolidated other revenue, which includes contract termination revenue of $4.4 million and equipment sales of $8.8 million, was $13.2 million for the year ended December 31, 2011, compared to $6.1 million for the year ended December 31, 2010. Revenue from our foreign operations, primarily in the U.K., increased by $7.0 million for the year ended December 31, 2011 compared to the year ended December 31, 2010.

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For the year ended December 31, 2011, we generated operating income of $118.1 million, compared to operating income of $107.0 million for the year ended December 31, 2010 and net income of $72.7 million for the year ended December 31, 2011, compared to net income of $69.4 million for the year ended December 31, 2010. At December 31, 2011, we had $118.4 million of unrestricted cash, compared to $61.6 million of unrestricted cash at December 31, 2010, an increase in liquidity of $56.8 million. The increase in cash at December 31, 2011 was primarily attributable to the cash generated by operating activities of $206.9 million less cash used to purchase property and equipment of $147.8 million adjusted for the changes in working capital components.

 

For the year ended December 31, 2011, our cash flow generated by operating activities increased compared to 2010 as a result of the improvement in operating results described above.  We believe, based on our business plan, that our existing cash, cash from our operating activities and funds available under our $250 Million Secured Revolving Credit Facility will be sufficient to fund our operations, planned capital expenditures and other liquidity requirements at least through March 31, 2013.

 

Significant and continuous judgment of management is required in determining the provision for income tax, deferred tax assets and liabilities, and related valuation allowance established against the deferred tax assets.  As part of our evaluation of deferred tax assets in the fourth quarter of 2011, we recognized a non-cash tax benefit of $9.2 million.  This benefit related to the release of the remaining valuation allowance previously established in the U.K.  In total, the valuation allowance with respect to deferred tax assets decreased by $9.1 million in 2011, which was comprised of the reversal of $9.2 million described above, partially offset by $0.1 million attributable to foreign currency translation.

 

2012 Outlook

 

We believe that based upon our contracted projects awaiting delivery to customers and our sales pipeline, we will continue to add to our revenue base in 2012.  We have access to financing through our $250 Million Secured Revolving Credit Facility, if needed. Sales orders for the year ended December 31, 2011 were higher than sales orders for the year ended December 31, 2010 but slightly below our internal 2011 sales target. Churn, which is comprised of terminations and downgrades of orders, was also higher in 2011 than our 2011 internal target. Net revenue attrition, as previously defined, for the year ended December 31, 2011, was in line with net revenue attrition for the year ended December 31, 2010 as a percentage of revenue. We cannot predict our net revenue attrition, sales orders or churn for 2012. While most of our revenue is derived from fixed term customer contracts, a meaningful portion of our revenue is generated from orders that are past their contractual expiration date for which we provide services that are billed on a month-to-month basis. To the extent that our fixed term contractual revenue is not renewed or our month-to-month revenue is not extended or put under a new fixed term contract, or new sales orders do not replace the revenue loss from churn, our revenue growth rate may be lower than our historical revenue growth rate and our cash flow may be negatively affected.

 

In early 2011, we connected Miami to our long haul network, opened the Denver metro market and began providing certain services over leased fiber in Paris, Amsterdam and Frankfurt. In 2012, we plan to commence operations in Toronto and significantly expand operations in Atlanta.

 

In 2011, we also increased our investments in customer capital (capital spent to fulfill customer service orders) for laterals to customer locations (including both enterprise locations and data centers) and backbone network infrastructure in our existing markets in order to extend the reach of our networks and improve services to existing and prospective customers and increase revenue opportunities. For 2012, we will continue to make these investments in customer capital and infrastructure to increase the reach of our networks.

 

On December 7, 2011, our Board of Directors authorized the Repurchase Program for the purchase of up to $200.0 million of our common stock through December 31, 2012. Through February 24, 2012, we purchased 41,157 shares at a total cost of $2.7 million, under the Repurchase Program. We will utilize our $250 Million Secured Revolving Credit Facility and cash generated from operating activities in excess of cash used to purchase property and equipment to fund the Repurchase Program.

  

Revenue

 

Revenue derived from leasing fiber optic data transport infrastructure and the provision of data transport and co-location services is recognized as services are provided. Non-refundable payments received from customers before the relevant criteria for revenue recognition are satisfied are included in deferred revenue in the accompanying consolidated balance sheets and are subsequently amortized into income over the fixed contract term.

33
 

 

A substantial portion of our revenue is derived from multi-year contracts for services we provide. We are often required to make an initial outlay of capital to extend our network and purchase equipment for the provision of services to our customers. Under the terms of most contracts, the customer is required to pay a termination fee or contractual damages (which decline over the contract term) if the contract were terminated by the customer without basis before its expiration to ensure that we recover our initial capital investment, plus an acceptable return.  We also derive revenues from annual and month-to-month contracts.

 

Costs of revenue

 

Costs of revenue primarily include the following: (i) real estate expenses for all operational sites; (ii) costs incurred to operate our networks, such as licenses, rights-of-way, permit fees and professional fees related to our networks; (iii) third party telecommunications, fiber and conduit expenses; (iv) repairs and maintenance costs incurred in connection with our networks; and (v) employee-related costs relating to the operation of our networks.

 

Selling, General and Administrative Expenses (“SG&A”)

 

SG&A primarily consist of (i) employee-related costs such as salaries and benefits for employees not directly attributable to the operation of our networks, in addition to stock-based compensation expenses and incentive bonus expenses for all employees; (ii) real estate expenses for all administrative sites; (iii) professional, consulting and audit fees; (iv) certain taxes (other than income taxes), including property taxes and trust fund-related taxes not passed through to customers; and (v) regulatory costs, insurance, telecommunications costs, professional fees, and license and maintenance fees for internal software and hardware.

 

Depreciation and amortization

 

Depreciation and amortization consists of the ratable measurement of the use of property and equipment. Depreciation and amortization for network assets commences when such assets are placed in service and is provided on a straight-line basis over the estimated useful lives of the assets, with the exception of leasehold improvements, which are amortized over the lesser of the estimated useful lives or the term of the lease.

 

Critical Accounting Policies and Estimates

 

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. (“U.S. GAAP”). The preparation of these financial statements in conformity with U.S. GAAP requires management to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenue and expenses during the reporting period. Management continually evaluates its judgments, estimates and assumptions based on historical experience and available information. The following is a discussion of the items within our consolidated financial statements that involve significant judgments, assumptions, uncertainties and estimates. The estimates involved in these areas are considered critical because they require high levels of subjectivity and judgment to account for highly uncertain matters, and if actual results or events differ materially from those contemplated by management in making these estimates, the impact on our consolidated financial statements could be material. For a full description of our significant accounting policies, see Note 2, “Basis of Presentation and Significant Accounting Policies,” to the accompanying consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

34
 

  

Fresh Start Accounting

 

Our emergence from bankruptcy resulted in a new reporting entity with no retained earnings or accumulated losses, effective as of September 8, 2003. Although the Effective Date of the Plan of Reorganization was September 8, 2003, we accounted for the consummation of the Plan of Reorganization as if it occurred on August 31, 2003 and implemented fresh start accounting as of that date.  There were no significant transactions during the period from August 31, 2003 to September 8, 2003. Fresh start accounting requires us to allocate the reorganization value of our assets and liabilities based upon their estimated fair values, in accordance with FASB ASC 852-10.  We developed a set of financial projections, which were utilized by an expert to assist us in estimating the fair value of our assets and liabilities.  The expert utilized various valuation methodologies, including (1) a comparison of the Company and our projected performance to that of comparable companies; (2) a review and analysis of several recent transactions of companies in similar industries to ours; and (3) a calculation of the enterprise value based upon the future cash flows of our projections.

 

Adopting fresh start accounting resulted in material adjustments to the historical carrying values of our assets and liabilities. The reorganization value was allocated to our assets and liabilities based upon their fair values.  We engaged an independent appraiser to assist us in determining the fair market value of our property and equipment.  The determination of fair values of assets and liabilities was subject to significant estimates and assumptions.  The unaudited fresh start adjustments reflected at September 8, 2003 consisted of the following: (i) reduction of property and equipment; (ii) reduction of indebtedness; (iii) reduction of vendor payables; (iv) reduction of the carrying value of deferred revenue; (v) increase of deferred rent to fair market value; (vi) cancellation of MFN’s common stock and additional paid-in capital, in accordance with the Plan of Reorganization; (vii) issuance of new AboveNet, Inc. common stock and additional paid-in capital; and (viii) elimination of the comprehensive loss and accumulated deficit accounts.

 

Revenue Recognition

 

We follow SEC Staff Accounting Bulletin ("SAB") No. 101, “Revenue Recognition in Financial Statements,” (now known as FASB ASC 605-10), as amended by SEC SAB No. 104, “Revenue Recognition,” (also now known as FASB ASC 605-10).

 

Revenue derived from leasing fiber optic telecommunications infrastructure and the provision of telecommunications and co-location services is recognized as services are provided. Non-refundable payments received from customers before the relevant criteria for revenue recognition are satisfied are included in deferred revenue in the accompanying consolidated balance sheets and are subsequently amortized into income over the fixed contract term.

 

Prior to October 1, 2009, we generally amortized revenue related to installation services on a straight-line basis over the contracted customer relationship (two to twenty years).  In the fourth quarter of 2009, we completed a study of our historic customer relationship period.  As a result, commencing October 1, 2009, we began amortizing revenue related to installation services on a straight-line basis generally over the estimated customer relationship period (generally ranging from three to twenty years).

 

Contract termination revenue is recognized when a customer discontinues service prior to the end of the contract period for which we had previously received consideration and for which revenue recognition was deferred. Contract termination revenue is also recognized when customers have made early termination payments to us to settle contractually committed purchase amounts that the customer no longer expects to meet or when we renegotiate or discontinue a contract with a customer and as a result are no longer obligated to provide services for consideration previously received and for which revenue recognition has been deferred. Additionally, we include receipts of bankruptcy claim settlements from former customers as contract termination revenue when received. Contract termination revenue amounted to $4.4 million, $2.7 million and, $3.9 million in 2011, 2010 and 2009, respectively.

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Accounts Receivable Reserves

 

Sales Credit Reserves

 

During each reporting period, we make estimates for potential future sales credits to be issued in respect of current revenue, related to service interruptions and customer disputes, which are recorded as a reduction in revenue. We analyze historical credit activity and changes in customer demand related to current billing and service interruptions when evaluating our credit reserve requirements. We reserve for known service interruptions as incurred. We review customer disputes and reserve against those we believe to be valid claims. We also estimate a sales credit reserve related to unknown billing errors and disputes based on such historical credit activity. The determination of the general sales credit and customer dispute credit reserve requirements involves significant estimations and assumptions.

 

Allowance for Doubtful Accounts

 

During each reporting period, we make estimates for potential losses resulting from the inability of our customers to make required payments. We analyze our reserve requirements using several factors, including the length of time a particular customer’s receivables are past due, changes in the customer’s creditworthiness, the customer’s payment history, the length of the customer’s relationship with us, the current economic climate and current industry trends. A specific reserve requirement review is performed on customer accounts with larger balances. A reserve analysis is also performed on accounts not subject to specific review utilizing the factors previously mentioned. Changes in the financial viability of significant customers, worsening of economic conditions and changes in our ability to meet service level requirements may require changes to our estimate of the recoverability of the receivables. Revenue previously unrecognized, which is recovered through litigation, negotiations, settlements and judgments, is recognized as termination revenue in the period collected. The determination of both the specific and general allowance for doubtful accounts reserve requirements involves significant estimations and assumptions.

 

Property and Equipment

 

Property and equipment owned at the Effective Date are stated at their estimated fair values as of the Effective Date based on our reorganization value, net of accumulated depreciation and amortization incurred since the Effective Date.  Purchases of property and equipment subsequent to the Effective Date are stated at cost, net of depreciation and amortization.  Major improvements are capitalized, while expenditures for repairs and maintenance are expensed when incurred.  Costs incurred prior to a capital project’s completion are reflected as construction in progress and are part of network infrastructure assets, as described below and included in property and equipment on the respective balance sheets.  At December 31, 2011 and December 31, 2010, we had $57.8 million and $54.0 million, respectively, of construction in progress. Certain internal direct labor costs of constructing or installing property and equipment are capitalized.  Capitalized direct labor is determined based upon a core group of project managers, field engineers, network infrastructure engineers and equipment engineers. Capitalized direct labor is based upon time spent on capitalized projects and consists of salary, plus certain related benefits.  These individuals’ capitalized labor costs are directly associated with the construction and installation of network infrastructure and equipment and customer installations. The salaries and related benefits of non-engineers and supporting staff that are part of the operations and engineering departments are not considered part of the pool subject to capitalization.  Capitalized direct labor amounted to $10.2 million, $10.0 million, and $11.4 million for the years ended December 31, 2011, 2010 and 2009, respectively. Depreciation and amortization is provided on a straight-line basis over the estimated useful lives of the assets, with the exception of leasehold improvements, which are amortized over the lesser of the estimated useful life of the improvement or the term of the lease.

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Estimated useful lives of our property and equipment are as follows:

 

Network infrastructure assets and storage huts (except for risers and certain project installation costs, which are 5 years)   20 years
     
HVAC and power equipment   12 to 20 years
     
Transmission and IP equipment   5 to 7 years
     
Furniture, fixtures and equipment   4 to 7 years
     
Software and computer equipment   3 to 5 years
     
Leasehold improvements  

Lesser of the estimated useful life of the

improvement or the term of the lease

 

When property and equipment is retired or otherwise disposed of, the cost and accumulated depreciation is removed from the accounts, and resulting gains or losses are reflected in net income.

 

From time to time, we are required to replace or re-route existing fiber due to structural changes such as construction and highway expansions, which is defined as “relocation.”  In such instances, we fully depreciate the remaining carrying value of network infrastructure removed or rendered unusable and capitalize the costs of the new infrastructure placed into service. In certain circumstances, the local municipality or agency is responsible for some or all of such amounts. We record our share of relocation costs in property and equipment and record the third party portion of such costs as accounts receivable. We capitalized relocation costs amounting to $1.8 million, $1.5 million and $3.1 million for the years ended December 31, 2011, 2010 and 2009, respectively. We fully depreciated the remaining carrying value of the network infrastructure rendered unusable, which on an original cost basis, totaled $0.31 million ($0.15 million on a net book value basis) for the year ended December 31, 2011 and, which on an original cost basis, totaled $0.21 million ($0.14 million on a net book value basis) for the year ended December 31, 2010 and, which on an original cost basis, totaled $0.3 million ($0.2 million on a net book value basis) for the year ended December 31, 2009. To the extent that relocation is temporary in nature, or requires only the movement of existing network infrastructure to another location or construction for an insignificant portion of the entire segment, the related costs are included in our results of operations.

 

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 34, “Capitalization of Interest Cost,” (now known as FASB ASC 835-20), interest on certain construction projects would be capitalized.  Such amounts were considered immaterial, and accordingly, no such amounts were capitalized during each of the years ended December 31, 2011, 2010 and 2009.

 

In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” (now known as FASB ASC 360-10-35), we periodically evaluate the recoverability of our long-lived assets and evaluate such assets for impairment whenever events or circumstances indicate that the carrying amount of such assets (or group of assets) may not be recoverable. Impairment is determined to exist if the estimated future undiscounted cash flows are less than the carrying value of such assets.  We consider various factors to determine if an impairment test is necessary.  The factors include: consideration of the overall economic climate, technological advances with respect to equipment, our strategy, capital planning and certain operational issues. Since June 30, 2006, no event has occurred nor has the business environment changed to trigger an impairment test for assets in revenue service and operations.  We also consider the removal of assets from the network as a triggering event for performing an impairment test.  Once an item is removed from service, unless it is to be redeployed, it may have little or no future cash flows related to it.  We performed annual physical counts of such assets that are not in revenue service or operations at or around September 30 of each year. With the assistance of a valuation report of the assets that are not in revenue service, prepared by an independent third party on a basis consistent with SFAS No. 157, “Fair Value Measurements,” (now known as FASB ASC 820-10), and pursuant to FASB ASC 360-10-35, we determined that the fair value of certain of these assets was less than the carrying value and accordingly, recorded provisions for impairment totaling $1.2 million for the year ended December 31, 2011, $0.5 million for the year ended December 31, 2010 and $0.4 million for the year ended December 31, 2009. Additionally, at December 31, 2010, we recorded a $1.5 million provision for impairment with respect to a discreet group of assets because of certain operational issues. We also recorded a provision for equipment impairment of $0.8 million in the year ended December 31, 2009 to record the loss in value of certain equipment, most of which was eventually sold to an unaffiliated third party. (See Note 6, “Changes in Estimate,” to the accompanying consolidated financial statements included elsewhere in this Annual Report on Form 10-K.)

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Asset Retirement Obligations

 

In accordance with SFAS No. 143, “Accounting for Asset Retirement Obligations,” (now known as FASB ASC 410-20), we recognize the fair value of a liability for an asset retirement obligation in the period in which it is incurred if a reasonable estimate of fair value can be made. We have asset retirement obligations related to the de-commissioning and removal of equipment, restoration of leased facilities and the removal of certain fiber and conduit systems. Considerable management judgment is required in estimating these obligations. Important assumptions include estimates of asset retirement costs, the timing of future asset retirement activities and the likelihood of contractual asset retirement provisions being enforced. Changes in these assumptions based on future information could result in adjustments to these estimated liabilities.

 

Asset retirement obligations are generally recorded as “other long-term liabilities,” are capitalized as part of the carrying amount of the related long-lived assets included in property and equipment, net, and are depreciated over the life of the associated asset. Asset retirement obligations aggregated $8.1 million and $7.9 million at December 31, 2011 and 2010, respectively, of which $4.5 million and $4.3 million, respectively, were included in “Accrued expenses,” at such dates, and $3.6 million was included in “Other long-term liabilities” at both dates.  Accretion expense, which is included in “Interest expense,” amounted to $0.27 million for each of the years ended December 31, 2011 and 2009 and $0.28 million for the year ended December 31, 2010.

 

Derivative Financial Instruments

 

We have utilized and may, from time to time in the future, utilize derivative financial instruments known as interest rate swaps (“derivatives”) to mitigate our exposure to interest rate risk.  We purchased the first interest rate swap on August 4, 2008 to hedge the interest rate on the initial $24.0 million (original principal) term loan under the Secured Credit Facility and we purchased a second interest rate swap on November 14, 2008 to hedge the interest rate on the additional $12.0 million (original principal) term loan under the Secured Credit Facility provided by SunTrust Bank.  (See Note 9, “Long-Term Debt - Secured Credit Facility,” to the accompanying consolidated financial statements included elsewhere in this Annual Report on Form 10-K.)  We accounted for the derivatives under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (now known as FASB ASC 815). FASB ASC 815 requires that all derivatives be recognized in the financial statements and measured at fair value regardless of the purpose or intent for holding them.  By policy, we have not historically entered into derivatives for trading purposes or for speculation. Based on criteria defined in FASB ASC 815, the interest rate swaps were considered cash flow hedges and were 100% effective.  Accordingly, changes in the fair value of derivatives were recorded each period in accumulated other comprehensive loss.  Changes in the fair value of the derivatives reported in accumulated other comprehensive loss were reclassified into earnings in the period in which earnings were impacted by the variability of the cash flows of the hedged item. The ineffective portion of all hedges, if any, is recognized in current period earnings.  The unrealized net loss recorded in accumulated other comprehensive loss at December 31, 2010 was $0.6 million for the interest rate swaps.  The mark-to-market value of the cash flow hedges was recorded in current assets, current liabilities, other non-current assets or other long-term liabilities, as applicable, and the offsetting gains or losses in accumulated other comprehensive loss. Both interest rate swaps were settled in January 2011.

 

On January 1, 2009, we adopted SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133,” (now known as FASB ASC 815-10).  FASB ASC 815-10 changes the disclosure requirements for derivatives and hedging activities.  Entities are required to provide enhanced disclosures about (i) how and why an entity uses derivatives; (ii) how derivatives and related hedged items are accounted for under FASB ASC 815-10; and (iii) how derivatives and related hedged items affect an entity’s financial position and cash flows.

 

We have, when applicable, minimized our credit risk relating to counterparties of our derivatives by transacting with multiple, high quality counterparties, thereby limiting exposure to individual counterparties, and by monitoring the financial condition of our counterparties.

 

All derivatives were recorded in our consolidated balance sheets at fair value.  Accounting for the gains and losses resulting from changes in the fair value of derivatives depends on the use of the derivative and whether it qualifies for hedge accounting in accordance with FASB ASC 815-10. At December 31, 2010, net interest rate swap derivative liabilities of $0.6 million were included in “Accrued expenses” in our consolidated balance sheet and at December 31, 2009, net interest rate swap derivative liabilities of $1.2 million were included in “Other long-term liabilities” in our consolidated balance sheet. The swap agreements were settled in January 2011 as described below.

 

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Derivatives recorded at fair value in our consolidated balance sheets as of December 31, 2011 and December 31, 2010 consisted of the following:

 

    Derivative Liabilities  
    (In millions)  
Derivatives designated as hedging instruments   December 31, 2011     December 31, 2010  
Interest rate swap agreement expiring August 1, 2011 (*)   $     $ 0.4  
                 
Interest rate swap agreement expiring November 1, 2011 (*)           0.2  
                 
Total derivatives designated as hedging instruments   $     $ 0.6  

  

(*)The derivative liabilities are two interest rate swap agreements with original three year terms, which were included in “Accrued expenses” in the Company’s consolidated balance sheet at December 31, 2010.

 

Interest Rate Swap Agreements

 

The notional amounts provide an indication of the extent of our involvement in such agreements but do not represent our exposure to market risk.  The following table shows the notional amount outstanding, maturity date, and the weighted average receive and pay rates of the interest rate swap agreements as of December 31, 2011 and 2010.

 

Notional Amount
(in millions)
     Weighted Average Rate
December 31, 2011  December 31, 2010  Maturity Date  Pay  Receive
$—  $18.9  August 1, 2011  3.65%  0.72%
        
  9.5  November 1, 2011  2.635%  0.40%
            
$—  $28.4     

  

 

Interest expense under these agreements, and the respective debt instruments that they hedge, are recorded at the net effective interest rate of the hedged transaction.

 

The notional amounts of the swap arrangements have since been reduced by amounts corresponding to reductions in the outstanding principal balances.

 

The swap agreements were settled in January 2011 in connection with the repayment of the term loans under the Secured Credit Facility and the closing of the $250 Million Secured Revolving Credit Facility. The cost of $0.5 million to settle the swap agreements was included in “Other (expense) income, net” in our consolidated statement of operations for the year ended December 31, 2011.

 

Fair Value of Financial Instruments

 

We adopted SFAS No. 157, “Fair Value Measurements,” (“SFAS No. 157”) (now known as FASB ASC 820-10), for our financial assets and liabilities effective January 1, 2008.  This pronouncement defines fair value, establishes a framework for measuring fair value, and requires expanded disclosures about fair value measurements.  FASB ASC 820-10 emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and defines fair value as the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date. FASB ASC 820-10 discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow) and the cost approach (cost to replace the service capacity of an asset or replacement cost), which are each based upon observable and unobservable inputs.  Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions.  FASB ASC 820-10 utilizes a fair value hierarchy that prioritizes inputs to fair value measurement techniques into three broad levels:

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Level 1: Observable inputs such as quoted prices for identical assets or liabilities in active markets.
   
Level 2: Observable inputs other than quoted prices that are directly or indirectly observable for the asset or liability, including quoted prices for similar assets or liabilities in active markets; quoted prices for similar or identical assets or liabilities in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
   
Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.

 

Our investment in overnight money market institutional funds, which amounted to $110.0 million and $48.2 million at December 31, 2011 and 2010, respectively, is included in cash and cash equivalents on the accompanying balance sheets and is classified as a Level 1 asset.

 

We were party to two interest rate swaps, which were utilized to modify our interest rate risk.  We recorded the mark-to-market value of the interest rate swap contracts of $0.6 million (which was included in “Accrued expenses”) in our consolidated balance sheet at December 31, 2010.  At December 31, 2010, we used third parties, as well as our own market analysis to determine the fair value of each of the interest rate swap agreements.  The fair value of the interest rate swap contracts are classified as Level 2 liabilities. The swap agreements were settled in January 2011 in connection with the repayment of the term loans under the Secured Credit Facility and the closing of the $250 Million Secured Revolving Credit Facility. The cost of $0.5 to settle the swap agreements was included in “Other (expense) income, net” in our consolidated statement of operations for the year ended December 31, 2011.

 

Our consolidated balance sheets include the following financial instruments: short-term cash investments, trade accounts receivable, trade accounts payable and note payable.  We believe the carrying amounts in the financial statements approximate the fair value of these financial instruments due to the relatively short period of time between the origination of the instruments and their expected realization or the interest rates which approximate current market rates.

 

Concentration of Credit Risk

 

Financial instruments, which potentially subject us to concentration of credit risk, consist principally of short-term cash investments and accounts receivable.  We do not enter into financial instruments for trading or speculative purposes.  Our cash and cash equivalents are invested in investment-grade, short-term investment instruments with high quality financial institutions. Our trade receivables, which are unsecured, are geographically dispersed, and no single customer accounts for greater than 10% of consolidated revenue or accounts receivable, net.  We perform ongoing credit evaluations of our customers’ financial condition. The allowance for non-collection of accounts receivable is based upon the expected collectability of all accounts receivable. We place our cash and cash equivalents primarily in commercial bank accounts in the U.S.  Account balances generally exceed federally insured limits.

 

Foreign Currency Translation and Transactions

 

Our reporting currency is the U.S. dollar. For those subsidiaries not using the U.S. dollar as their functional currency, assets and liabilities are translated at exchange rates in effect at the applicable balance sheet date and income and expense transactions are translated at average exchange rates during the period.  Resulting translation adjustments are recorded directly to a separate component of shareholders’ equity and are reflected in the accompanying consolidated statements of comprehensive income. Our foreign exchange transaction gains (losses) are generally included in “Other income (expense), net” in the consolidated statements of operations.

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Income Taxes

 

We account for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes,” (now known as FASB ASC 740). Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax basis and net operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

 

We are subject to audits by various taxing authorities, and these audits may result in proposed assessments where the ultimate resolution results in us owing additional taxes.  We are required to establish reserves under FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (now known as FASB ASC 740-10), when we believe there is uncertainty with respect to certain positions and we may not succeed in realizing the tax benefit.  We believe that our tax return positions are appropriate and supportable under relevant tax law. We believe the estimates and assumptions used to support our evaluation of tax benefit realization are reasonable. Accordingly, no adjustments have been made to the consolidated financial statements for the years ended December 31, 2011, 2010 and 2009.

 

Deferred Taxes

 

Our current and deferred income taxes, and associated valuation allowances, are impacted by events and transactions arising in the normal course of business as well as by both special and non-recurring items. Assessment of the appropriate amount and classification of income taxes is dependent on several factors, including estimates of the timing and realization of deferred income tax on income and deductions. Actual realization of deferred tax assets and liabilities may materially differ from these estimates as a result of changes in tax laws as well as unanticipated future transactions impacting related income tax balances.

 

The assessment of a valuation allowance on deferred tax assets is based on the likelihood that a portion of our deferred tax assets will be realized in future periods. The weight of all available evidence is considered in determining realizability of our deferred tax assets. Deferred tax liabilities are first applied to the deferred tax assets reducing the need for a valuation allowance.

 

 As part of our evaluation of deferred tax assets in the fourth quarters of 2011 and 2010, we recognized tax benefits of $9.2 million and $7.3 million reported at December 31, 2011 and 2010, respectively, relating to the reduction of certain valuation allowances established in the U.K. As part of our evaluation of deferred tax assets in the fourth quarter of 2009, we recognized a tax benefit of $183.0 million at December 31, 2009 relating to the reduction of certain valuation allowances previously established in the U.S. and the U.K. We believe it is more likely than not that we will utilize these deferred tax assets to reduce or eliminate tax payments in future periods. This reduction in valuation allowances had the effect of increasing net income by $9.2 million, $7.3 million and $183.0 million for the years ended December 31, 2011, 2010 and 2009, respectively. Our evaluations encompassed (i) reviews of our recent history of profitability in the U.S. and the U.K. for the past three years; and (ii) reviews of internal financial forecasts demonstrating our expected capacity to utilize deferred tax assets. We review our deferred tax assets and liabilities on a quarterly basis as part of our FASB ASC 740 review. Significant and continuous judgment of management is required in determining the provision for income tax, deferred tax assets and liabilities, and related valuation allowances established against the deferred tax assets. It is possible that the valuation allowances could be further adjusted, as necessary.

 

Stock-Based Compensation

 

On September 8, 2003, we adopted the fair value provisions of SFAS No. 148, “Accounting for Stock-Based Compensation Transition and Disclosure,” (“SFAS No. 148”), (now known as FASB ASC 718-10). SFAS No. 148 amended SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS No. 123”), (also now known as FASB ASC 718-10), to provide alternative methods of transition to SFAS No. 123’s fair value method of accounting for stock-based employee compensation. See Note 12, “Stock-Based Compensation,” to the accompanying consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

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Under the fair value provisions of FASB ASC 718-10, the fair value of each stock-based compensation award is estimated at the date of grant, using the Black-Scholes option pricing model for stock option awards.  We did not have a historical basis for determining the volatility and expected life assumptions in the model due to our limited market trading history; therefore, the assumptions used for these amounts are an average of those used by a select group of related industry companies. Most stock-based awards have graded vesting (i.e. portions of the award vest at different dates during the vesting period).  We recognize the related stock-based compensation expense of such awards on a straight-line basis over the vesting period for each tranche in an award. Upon consummation of our Plan of Reorganization, all then outstanding stock options were cancelled.

 

Effective January 1, 2006, we adopted SFAS No. 123(R), “Share-Based Payment,” (“SFAS No. 123(R)”), (now known as FASB ASC 718), using the modified prospective method.  SFAS No. 123(R) requires all share-based awards granted to employees to be recognized as compensation expense over the vesting period, based on fair value of the award.  The fair value method under SFAS No. 123(R) is similar to the fair value method under SFAS No. 123 with respect to measurement and recognition of stock-based compensation expense except that SFAS No. 123(R) requires an estimate of future forfeitures, whereas SFAS No. 123 permitted companies to estimate forfeitures or recognize the impact of forfeitures as they occurred.  As we had recognized the impact of forfeitures as they occurred under SFAS No. 123, the adoption of SFAS No. 123(R) resulted in a change in our accounting treatment, but it did not have a material impact on our consolidated financial statements.

 

For a description of our stock-based compensation programs, see Note 12, “Stock-Based Compensation,” to the accompanying consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

 

There were no options to purchase shares of common stock granted during the years ended December 31, 2011, 2010 and 2009.

 

Results of Operations for the Year Ended December 31, 2011 Compared to the Year Ended December 31, 2010

 

Consolidated Results (dollars in millions for the table set forth below):

   Years  Ended December 31,     
   2011   2010   $ Increase/
(Decrease)
   % Increase/
(Decrease)
 
Revenue  $472.5   $409.7   $62.8    15.3 %
Costs of revenue (excluding depreciation and amortization, shown separately below, and including provisions for impairment of $1.2 and $2.0 for the years ended December 31, 2011 and 2010, respectively)   162.7    142.8    19.9    13.9 %
Selling, general and administrative expenses   116.4    96.6    19.8    20.5 %
Depreciation and amortization   75.3    63.3    12.0    19.0 %
Operating income   118.1    107.0    11.1    10.4 %
Other income (expense):                   
Interest income   0.1    0.1        
Interest expense   (4.5)   (5.2)   (0.7)   13.5 %
Other (expense) income, net   (1.0)   2.0    (3.0)   NM
Income before income taxes   112.7    103.9    8.8    8.5 %
Provision for income taxes   40.0    34.5    5.5    15.9 %
Net income  $72.7   $69.4   $3.3    4.8 %

NM—not meaningful

 

We use the term “consolidated” below to describe the total results of our two geographic segments, the U.S. and the U.K. and others. Throughout this document, unless otherwise noted, amounts discussed are consolidated amounts.

 

Net Income.  Our net income for the year ended December 31, 2011 was $72.7 million, compared to $69.4 million for the year ended December 31, 2010, an increase of $3.3 million.  The primary reasons for the increase in net income were the increase in revenue of $62.8 million, partially offset by increases in costs of revenue of $19.9 million, selling, general and administrative expenses of $19.8 million and depreciation and amortization of $12.0 million. These changes are discussed more fully below.

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Revenue.  Consolidated revenue was $472.5 million for the year ended December 31, 2011, compared to $409.7 million for the year ended December 31, 2010, an increase of $62.8 million, or 15.3%.  Revenue from our U.S. operations increased by $55.8 million, or 15.0%, from $371.8 million for the year ended December 31, 2010 to $427.6 million for the year ended December 31, 2011.  The principal reason for this increase was the continued growth in each of our metro, fiber infrastructure and WAN services.  This continued growth in revenue for each of these services is attributable principally to revenue from service installations exceeding reductions in revenue from contract terminations and any contractual price reductions.  U.S. revenue from metro services increased by $15.1 million, or 13.2%, from $114.4 million for the year ended December 31, 2010 to $129.5 million for the year ended December 31, 2011, U.S. revenue from fiber infrastructure services increased by $11.5 million, or 6.7%, from $170.6 million for the year ended December 31, 2010 to $182.1 million for the year ended December 31, 2011 and U.S. revenue from WAN services increased by $22.1 million, or 27.4%, from $80.7 million for the year ended December 31, 2010 to $102.8 million for the year ended December 31, 2011.  Additionally, other revenue, which includes domestic contract termination revenue and equipment sales, increased from $6.1 million for the year ended December 31, 2010 to $13.2 million for the year ended December 31, 2011. Revenue from our foreign operations, primarily in the U.K., increased by $7.0 million, or 18.5%, from $37.9 million for the year ended December 31, 2010 to $44.9 million for the year ended December 31, 2011.  The primary reason for this increase was due to an increase in provisioning of services in the U.K. bolstered by a 3.7% increase in the translation rate due to the strengthening of the British pound compared to the U.S. dollar during the year ended December 31, 2011 compared to the year ended December 31, 2010.

 

Costs of revenue.  Consolidated costs of revenue for the year ended December 31, 2011 was $162.7 million, compared to $142.8 million for the year ended December 31, 2010, an increase of $19.9 million, or 13.9%.  Consolidated costs of revenue as a percentage of revenue was 34.4% for the year ended December 31, 2011, compared to 34.9% for the year ended December 31, 2010, resulting in consolidated gross profit margin of 65.6% and 65.1% for the years ended December 31, 2011 and 2010, respectively.  The costs of revenue for our U.S. operations was $149.2 million and $129.6 million for the years ended December 31, 2011 and 2010, respectively, an increase of $19.6 million, or 15.1%. The increase in domestic costs of revenue for the year ended December 31, 2011 compared to the year ended December 31, 2010 was attributable principally to (i) an increase of $4.7 million in amounts rebilled to customers for equipment sales (for which there was a corresponding increase in related revenue); (ii) an increase of $4.6 million for expenses associated with third party network costs; (iii) an increase of $4.2 million in payroll-related expenses due to headcount added since the year ended December 31, 2010; (iv) an increase of $3.2 million in co-location expenses, to support our IP network services and increase our presence in third party data centers; (v) an increase of $1.6 million for right-of-way expenses; and (vi) an increase of $1.6 million for repairs and maintenance charges for our cable and transmission equipment. Additionally, the years ended December 31, 2011 and 2010 include provisions for equipment impairment with respect to domestic operations of $0.2 million and $2.0 million, respectively. The costs of revenue for our foreign operations was $13.5 million for the year ended December 31, 2011, compared to $13.2 million for the year ended December 31, 2010, an increase of $0.3 million, or 2.3%.  This change was primarily due to increases in expenses required to support our European operations and the needs of our existing customers, payroll-related expenses needed to support our provisioning of services and repairs and maintenance charges, offset by the benefit from the reversal of accruals for certain business tax rates on installed fiber of $3.0 million. Additionally, the U.K. operating results for the year ended December 31, 2011included provisions for equipment impairment totaling $1.0 million. The results for the year ended December 31, 2011 compared to the year ended December 31, 2010 reflect a 3.7% increase in the translation rate of the British pound compared to the U.S. dollar.

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Selling, General and Administrative Expenses (“SG&A”).  Consolidated SG&A for the year ended December 31, 2011 was $116.4 million, compared to $96.6 million for the year ended December 31, 2010, an increase of $19.8 million, or 20.5%.  SG&A as a percentage of revenue was 24.6% for the year ended December 31, 2011, compared to 23.6% for the year ended December 31, 2010. In the U.S., SG&A was $102.2 million for the year ended December 31, 2011, compared to $85.6 million for the year ended December 31, 2010, an increase of $16.6 million, or 19.4%.  SG&A for our U.S. operations for the year ended December 31, 2011 compared to the year ended December 31, 2010 increased primarily due to (i) an increase of $11.2 million in domestic non-cash stock-based compensation expense from $11.4 million for the year ended December 31, 2010 to $22.6 million for the year ended December 31, 2011; (ii) an increase of $2.1 million in domestic payroll and payroll-related expenses from $45.5 million for the year ended December 31, 2010 to $47.6 million for the year ended December 31, 2011, which is attributable principally to an increase in sales commissions paid to our sales force due to the year over year increase in sales; (iii) an increase of $0.7 million in transaction and ad valorem taxes; (iv) an increase of $0.5 million in occupancy-related expenses; and (v) an increase of $2.1 million in other operating expenses, which include increases in computer software and maintenance of $0.5 million, and commissions paid to third party sales agents of $1.3 million attributable to the increased revenue base generated by these sales agents. SG&A from our foreign operations was $14.2 million for the year ended December 31, 2011, compared to $11.0 million for the year ended December 31, 2010, an increase of $3.2 million, or 29.1%.  Our foreign operations reported increases in payroll and payroll-related expenses of $1.0 million, non-cash stock-based compensation expense of $0.6 million, provision for bad debts of $0.5 million and occupancy costs of $0.4 million, primarily related to the relocation of our London office. In addition, the results for the year ended December 31, 2010 included the reversal of a prior year accrual of a VAT tax obligation totaling $0.6 million. Finally, the results for the year ended December 31, 2011 compared to the year ended December 31, 2010 reflect a 3.7% increase in the translation rate of the British pound compared to the U.S. dollar.

 

Depreciation and amortization.  Consolidated depreciation and amortization was $75.3 million for the year ended December 31, 2011, compared to $63.3 million for the year ended December 31, 2010, an increase of $12.0 million, or 19.0%.  Consolidated depreciation and amortization as a percentage of revenue was 15.9% for the year ended December 31, 2011, compared to 15.5% for the year ended December 31, 2010. The increase in consolidated depreciation and amortization was primarily attributable to (i) additions of property and equipment for the year ended December 31, 2011, and the full period effect of depreciation on property and equipment placed into service during the year ended December 31, 2010, and (ii) the change in estimated useful lives of certain property and equipment effectuated on October 1, 2011. This increase was partially offset by the reduction of depreciation with respect to certain assets, which became fully depreciated between the two periods.

 

Interest income.  Interest income, substantially all of which was earned in the U.S., was $0.1 million for each of the years ended December 31, 2011 and 2010, as a result of relatively low interest rates and the Company’s conservative investment strategy.

 

Interest expense.  Interest expense, substantially all of which was incurred in the U.S., includes interest expense on borrowed amounts under the $250 Million Secured Revolving Credit Facility (which commenced January 28, 2011) and the Secured Credit Facility, which was repaid January 28, 2011, availability fees on the unused portion of the relevant facility during the respective period, the amortization of debt issuance costs (including upfront fees) related to the relevant facility outstanding during the respective period, interest expense related to a capital lease obligation, interest accrued on certain tax liabilities, interest on the outstanding balance of the deferred fair value rent liabilities established at fresh start and interest accretion relating to asset retirement obligations. Interest expense was $4.5 million for the year ended December 31, 2011, compared to $5.2 million for the year ended December 31, 2010, a decrease of $0.7 million, or 13.5%.

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Other income (expense), net. Other income (expense), net is composed primarily of income or expense from non-recurring transactions and is not comparative from a trend perspective. Consolidated other income (expense), net was a net expense of $(1.0) million for the year ended December 31, 2011, compared to other income, net of $2.0 million for the year ended December 31, 2010, a change of $3.0 million.  In the U.S., other income (expense), net was a net expense of $(0.7) million for the year ended December 31, 2011, compared to other income, net of $2.6 million for the year ended December 31, 2010, a change of $3.3 million.  For our foreign operations, other income (expense), net was a net expense of $(0.3) million for the year ended December 31, 2011, compared to a net expense of $(0.6) million for the year ended December 31, 2010, a change of $0.3 million. For the year ended December 31, 2011, consolidated other income (expense), net was comprised of the write-off of unamortized debt issuance costs of $(1.1) million and the settlement of the two interest rate swaps at a total cost of $(0.5) million, both of which were associated with the Secured Credit Facility (which were recorded in connection with the Company’s closing of the $250 Million Secured Revolving Credit Facility on January 28, 2011), a net loss on foreign currency of $(0.4) million and a net loss on the sale or disposition of property and equipment of $(0.2) million, offset by gains arising from the settlement or reversal of certain tax liabilities of $0.4 million, a net gain arising from the recovery of property taxes previously paid of $0.4 million, a net gain from the settlement of an insurance claim of $0.1 million and other gains of $0.3 million.  For the year ended December 31, 2010, consolidated other income (expense), net was comprised of gains arising from the settlement or reversal of certain tax liabilities of $2.2 million, a net gain from the settlement of an insurance claim of $0.3 million and other gains of $0.3 million, partially offset by a net loss on foreign currency of $(0.6) million and a net loss on the sale or disposition of property and equipment of $(0.2) million.

 

Provision for income taxes. For the year ended December 31, 2011, we recorded a provision for income taxes of $49.2 million and recognized an additional deferred tax benefit of $9.2 million (associated with the reversal of the remaining valuation allowances previously established with respect to deferred tax assets in the U.K.), which resulted in a net tax provision for 2011 of $40.0 million. The provision for income taxes for the year ended December 31, 2011 was calculated at our effective tax rate based upon our pre-tax book income (adjusted for permanent differences in both the U.S. and the U.K.), resulting in an income tax provision of $38.7 million, plus a provision for certain capital-based state taxes of $1.3 million. We recorded a provision for income taxes of $41.8 million for the year ended December 31, 2010 and recognized a deferred tax benefit of $7.3 million (associated with the reduction of valuation allowances previously established with respect to deferred tax assets in the U.K.), which resulted in a net tax provision for 2010 of $34.5 million. The provision for income taxes for the year ended December 31, 2010 was calculated at our effective tax rate based upon our pre-tax book income (adjusted for permanent differences in both the U.S. and the U.K.), resulting in an income tax provision of $33.2 million, plus a provision for certain capital-based state taxes of $1.3 million.

 

Results of Operations for the Year Ended December 31, 2010 Compared to the Year Ended December 31, 2009

 

Consolidated Results (dollars in millions for the table set forth below):

    Years Ended December 31,              
    2010     2009    

$ Increase/

(Decrease)

   

% Increase/

(Decrease)

 
Revenue   $ 409.7     $ 360.1     $ 49.6       13.8 %
Costs of revenue (excluding depreciation and amortization, shown separately below, and including provisions for impairment of  $2.0 and $1.2 for the years ended December 31, 2010 and 2009, respectively)     142.8       130.7       12.1       9.3 %
Selling, general and administrative expenses     96.6       82.5       14.1       17.1 %
Depreciation and amortization     63.3       52.0       11.3       21.7 %
Operating income     107.0       94.9       12.1       12.8 %
Other income (expense):                                
     Interest income     0.1       0.3       (0.2 )     (66.7 ) %
     Interest expense     (5.2 )     (4.8 )     0.4       8.3 %
     Other income, net     2.0       3.6       (1.6 )     (44.4 ) %
Income before income taxes     103.9       94.0       9.9       10.5 %
     Provision for (benefit from) income taxes     34.5       (187.6 )     (222.1 )   NM  
Net income   $ 69.4     $ 281.6     $ (212.2 )     (75.4 ) %

NM—not meaningful

 

We use the term “consolidated” below to describe the total results of our two geographic segments, the U.S. and the U.K. and others.  Throughout this document, unless otherwise noted, amounts discussed are consolidated amounts.

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Net Income.  Our net income for the year ended December 31, 2010 was $69.4 million, compared to $281.6 million for the year ended December 31, 2009, a decrease of $212.2 million.  The primary reason for the decrease in net income was the $187.6 million change from a net benefit for income taxes recognized in 2009 compared to the provision for income taxes of $34.5 million (total change of $222.1 million). Revenue increased by $49.6 million and costs to support that revenue growth also increased; costs of revenue increased by $12.1 million, selling, general and administrative expenses increased by $14.1 million and depreciation and amortization increased by $11.3 million. Additionally, other income, net, decreased by $1.6 million.

 

Revenue.  Consolidated revenue was $409.7 million for the year ended December 31, 2010, compared to $360.1 million for the year ended December 31, 2009, an increase of $49.6 million, or 13.8%.  Revenue from our U.S. operations increased by $44.5 million, or 13.6%, from $327.3 million for the year ended December 31, 2009 to $371.8 million for the year ended December 31, 2010. The principal reason for this increase was the continued growth in each of our metro, fiber infrastructure and WAN services. This continued growth in revenue for each of these services is attributable principally to revenue from service installations exceeding reductions in revenue from contract terminations and any contractual price reductions.  U.S. revenue from metro services increased by $19.6 million, or 20.7%, from $94.8 million for the year ended December 31, 2009 to $114.4 million for the year ended December 31, 2010, U.S. revenue from fiber infrastructure services increased by $12.3 million, or 7.8%, from $158.3 million for the year ended December 31, 2009 to $170.6 million for the year ended December 31, 2010 and U.S. revenue from WAN services increased by $13.7 million, or 20.4%, from $67.0 million for the year ended December 31, 2009 to $80.7 million for the year ended December 31, 2010.  These increases were partially offset by a decrease of $1.1 million, or 15.3%, in other revenue, which includes domestic contract termination revenue, from $3.9 million for the year ended December 31, 2009 to $2.5 million for the year ended December 31, 2010. Revenue from our foreign operations, primarily in the U.K., increased by $5.1 million, or 15.5%, from $32.8 million for the year ended December 31, 2009 to $37.9 million for the year ended December 31, 2010. The primary reason for this increase was due to an increase in provisioning of services in the U.K. Also contributing to this increase was $0.2 million of contract termination revenue earned during the year ended December 31, 2010. There was no contract termination revenue earned in the U.K. during the year ended December 31, 2009. The translation rate of the British pound to the U.S. dollar for each year was substantially the same.

 

Costs of revenue.  Consolidated costs of revenue for the year ended December 31, 2010 was $142.8 million, compared to $130.7 million for the year ended December 31, 2009, an increase of $12.1 million, or 9.3%.  Consolidated costs of revenue as a percentage of revenue was 34.9% for the year ended December 31, 2010, compared to 36.3% for the year ended December 31, 2009, resulting in consolidated gross profit margin of 65.1% and 63.7% for the years ended December 31, 2010 and 2009, respectively. The costs of revenue for our U.S. operations was $129.6 million and $119.3 million for the years ended December 31, 2010 and 2009, respectively, an increase of $10.3 million, or 8.6%. The increase in the domestic costs of revenue for the year ended December 31, 2010 compared to the year ended December 31, 2009 was attributable principally to (i) an increase of $5.1 million in co-location expenses, to support our IP network services and increase our presence in third party data centers; (ii) an increase of $2.7 million in payroll-related expenses; (iii) an increase of $2.0 million for expenses associated with third party network costs; and (iv) an increase of $0.9 million in installation costs. Additionally, the years ended December 31, 2010 and 2009 include a provision for impairment of $2.0 million and $1.2 million, respectively. These increases were partially offset by (i) a decrease of $0.9 million for repairs and maintenance charges for our cable and transmission equipment; and (ii) the reversal of $0.4 million for right-of-way expenses during the three months ended June 30, 2010 due to previously accrued right-of-way expenses as a result of favorable negotiations with the relevant jurisdiction. The costs of revenue for our foreign operations was $13.2 million for the year ended December 31, 2010, compared to $11.4 million for the year ended December 31, 2009, an increase of $1.8 million, or 15.8%.  This increase was primarily because of increases in third party network costs, co-location expenses, repairs and maintenance charges, leased fiber costs and increases in payroll related expenses totaling $2.7 million needed to support our provisioning of services, partially offset by a one-time benefit from a reduction in certain business tax rates on fiber by the Valuation Office Agency in the U.K., which was effective retroactively back to 2005, resulting in a $1.1 million benefit in 2010. As previously described, the translation rate of the British pound to the U.S. dollar for each year was substantially the same.

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Selling, General and Administrative Expenses (“SG&A”).  Consolidated SG&A for the year ended December 31, 2010 was $96.6 million, compared to $82.5 million for the year ended December 31, 2009, an increase of $14.1 million, or 17.1%.  SG&A as a percentage of revenue was 23.6% for the year ended December 31, 2010, compared to 22.9% for the year ended December 31, 2009. In the U.S., SG&A was $85.6 million for the year ended December 31, 2010, compared to $71.2 million for the year ended December 31, 2009, an increase of $14.4 million, or 20.2%.  SG&A for our U.S. operations for the year ended December 31, 2010 compared to the year ended December 31, 2009 increased primarily due to (i) an increase of $5.8 million in domestic payroll and payroll-related expenses from $39.7 million for the year ended December 31, 2009 to $45.5 million for the year ended December 31, 2010 (which is attributable to an increase in annual merit increases for domestic employees effectuated on March 1, 2010, an increase in sales commissions due to an increase in year over year sales and a sales incentive program in effect in the first quarter of 2010); (ii) an increase of $2.6 million in domestic non-cash stock-based compensation expense from $8.8 million for the year ended December 31, 2009 to $11.4 million for the year ended December 31, 2010; (iii) an increase of $1.0 million for professional fees; (iv) an increase of $0.8 million in occupancy charges; (v) an increase of $0.7 million in transaction and ad valorem taxes; and (vi) an increase of $3.4 million in other operating expenses, primarily due to increases in computer software and maintenance of $0.8 million and commissions paid to third party sales agents and related marketing expenses of $1.4 million for the year ended December 31, 2010. SG&A from our foreign operations was $11.0 million for the year ended December 31, 2010, compared to $11.3 million for the year ended December 31, 2009, a net reduction of $0.3 million, or 2.7%.  Our foreign operations reported increases in payroll related expenses of $0.8 million, professional fees of $0.4 million and non-cash stock-based compensation expense of $0.2 million. However, these increases were more than offset by the reversal of a December 31, 2009 accrual for a VAT tax obligation totaling $0.6 million, which was settled during the fourth quarter of the year and a reduction in other operating expenses.

 

Depreciation and amortization.  Consolidated depreciation and amortization was $63.3 million for the year ended December 31, 2010, compared to $52.0 million for the year ended December 31, 2009, an increase of $11.3 million, or 21.7%.  Consolidated depreciation and amortization as a percentage of revenue was 15.5% for the year ended December 31, 2010, compared to 14.4% for the year ended December 31, 2009. The increase in consolidated depreciation and amortization was primarily attributable to (i) additions of property and equipment in the year ended December 31, 2010, and the full period effect of depreciation on property and equipment acquired during the year ended December 31, 2009 and (ii) the change (reduction) in estimated useful lives of certain property and equipment effectuated on October 1, 2009 and January 1, 2010.

 

Interest income.  Interest income, substantially all of which was earned in the U.S., decreased from $0.3 million for the year ended December 31, 2009 to $0.1 million for the year ended December 31, 2010.  The decrease of $0.2 million was primarily due to the decline in short-term interest rates during the year ended December 31, 2010 compared to the year ended December 31, 2009, partially offset by an increase in average balances available for investment during most of the year.

 

Interest expense.  Interest expense, substantially all of which was incurred in the U.S., includes interest expense on borrowed amounts under the Secured Credit Facility, availability fees on the unused portion of the Secured Credit Facility, the amortization of debt acquisition costs (including upfront fees) related to the Secured Credit Facility, interest expense related to a capital lease obligation, interest accrued on certain tax liabilities, interest on the outstanding balance of the deferred fair value rent liabilities established at fresh start and interest accretion relating to asset retirement obligations.  Interest expense was $5.2 million for the year ended December 31, 2010, compared to $4.8 million for the year ended December 31, 2009, an increase of $0.4 million, or 8.3%. The increase was primarily attributable to the interest incurred on the balance of the Delayed Draw Term Loan outstanding in 2010, which was funded on December 31, 2009.

 

Other income, net. Other income, net is composed primarily of income or expense from non-recurring transactions and is not comparative from a trend perspective. Consolidated other income, net was $2.0 million for the year ended December 31, 2010, compared to $3.6 million for the year ended December 31, 2009, a reduction of $1.6 million.  In the U.S., other income, net was $2.6 million for the year ended December 31, 2010, compared to $2.7 million for the year ended December 31, 2009, a decrease of $0.1 million, or 3.7%.  For our foreign operations, other (expense) income, net was a net expense of $(0.6) million for the year ended December 31, 2010, compared to other income, net of $0.9 million for the year ended December 31, 2009, a change (decrease) of $(1.5) million. For the year ended December 31, 2010, consolidated other income, net was comprised of gains arising from the settlement or reversal of certain tax liabilities of $2.2 million, a gain from the settlement of an insurance claim of $0.3 million and other gains of $0.3 million, partially offset by a net loss on foreign currency of $(0.6) million and net loss on the sale or disposition of property and equipment of $(0.2) million.  For the year ended December 31, 2009, consolidated other income, net was comprised of gains arising from the settlement or reversal of certain tax liabilities of $2.9 million, gains on foreign currency of $1.9 million and other gains of $0.1 million, offset by a net loss on the sale or disposition of property and equipment of $(1.3) million.

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Provision for (benefit from) income taxes. We recorded a provision for income taxes of $41.8 million for the year ended December 31, 2010 and recognized an additional deferred tax benefit of $7.3 million (associated with the reduction of valuation allowances previously established with respect to deferred tax assets in the U.K.), which resulted in a net tax provision for 2010 of $34.5 million. The provision for income taxes for the year ended December 31, 2010 was calculated at our effective tax rate based upon our pre-tax book income (adjusted for permanent differences in both the U.S. and the U.K.), resulting in a tax provision of $33.2 million, plus a provision for certain capital-based state taxes of $1.3 million. At December 31, 2009, we recognized $183.0 million of non-cash tax benefits as a result of reducing certain valuation allowances previously established with respect to deferred tax assets in the U.S. and the U.K. We believe it is more likely than not that these deferred tax assets will be utilized to reduce or eliminate tax payments in future periods. Our evaluation encompassed (i) a review of our recent history of profitability in the U.S. and U.K. for the past three years; and (ii) a review of internal financial forecasts demonstrating our expected capacity to utilize deferred tax assets. Additionally, based on our ability to fully absorb current book income with our deferred tax assets and our ability to carryback certain portions of these losses to 2008 and 2007, we recorded a current federal benefit from income taxes of $5.3 million in 2009. We also provided $0.7 million for state income taxes in 2009.

 

Liquidity and Capital Resources

 

We had working capital of $55.5 million at December 31, 2011, compared to a working capital deficit of $(8.5) million at December 31, 2010, an increase of $64.0 million.  This increase was primarily attributable to the increase in unrestricted cash of $56.8 million from $61.6 million at December 31, 2010 to $118.4 million at December 31, 2011 because of the cash provided by operating activities of $206.9 million in excess of the use of cash to purchase property and equipment of $147.8 million. Working capital was also affected by increases to (i) accounts receivable of $8.2 million; (ii) accrued expenses of $5.0 million; and (iii) deferred revenue – current portion of $2.7 million; and (iv) accounts payable of $1.3 million; partially offset by a reduction in note payable – current portion of $7.6 million and prepaid costs and other current assets of $0.6 million.

 

Net cash provided by operating activities was $206.9 million during the year ended December 31, 2011, compared to $162.8 million during the year ended December 31, 2010, an increase of $44.1 million.  Net cash provided by operating activities during the year ended December 31, 2011 represents net income, plus the add back to net income of non-cash items deducted in the determination of net income, principally depreciation and amortization of $75.3 million, the change in deferred tax assets of $38.7 million and non-cash stock-based compensation expense of $24.4 million, plus the changes in working capital components.  Net cash provided by operating activities during the year ended December 31, 2010 represents net income, plus the add back to net income of non-cash items deducted in the determination of net income, principally depreciation and amortization of $63.3 million, the change in deferred tax assets of $33.2 million and non-cash stock-based compensation expense of $12.5 million, plus the changes in working capital components.  The year over year increase in net cash provided by operating activities is primarily due to the increase in net income adjusted for non-cash activities (depreciation and amortization, change in deferred tax assets and non-cash stock-based compensation expense), and the change (use) in working capital components in the December 31, 2011 period, compared to the December 31, 2010 period.

 

Net cash used in investing activities was $147.7 million during the year ended December 31, 2011, compared to $135.3 million during the year ended December 31, 2010, an increase of $12.4 million. Net cash used in investing activities during the year ended December 31, 2011 was attributable to the purchases of property and equipment of $147.8 million, offset by the proceeds generated from sales of property and equipment of $0.1 million. Net cash used in investing activities during the year ended December 31, 2010 was attributable to the purchases of property and equipment of $135.7 million, offset by the proceeds generated from sales of property and equipment of $0.4 million. The increase in capital expenditures in 2011 compared to 2010 was attributable to the continued investment in our network during the year ended December 31, 2011 and a higher level of orders implemented, which resulted in higher capital expenditures needed to provide service.

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Net cash used in financing activities was $2.7 million during the year ended December 31, 2011, which is comprised of the payoff of the outstanding principal of the Secured Credit Facility of $49.7 million, the change in restricted cash and cash equivalents of $1.0 million, the purchase of treasury stock of $2.2 million, the payment of debt issuance costs of $0.5 million and the principal payment on our capital lease obligation of $0.2 million, offset by the net proceeds from our borrowing under the $250 Million Secured Revolving Credit Facility of $50.0 million, the proceeds from the issuance of stock pursuant to the employee stock purchase plan of $0.6 million and the proceeds from the exercise of options to purchase shares of common stock of $0.3 million. Net cash used in financing activities was $131.0 million during the year ended December 31, 2010, which is comprised of the Special Cash Dividend of $5.00 per common share totaling $129.0 million, principal payments under the Secured Credit Facility of $7.6 million and the purchase of treasury stock of $0.8 million, offset by the proceeds from the exercise of warrants of $5.0 million and the proceeds from the exercise of options to purchase shares of common stock and the sale of shares under our employee stock purchase plan of $1.4 million.

 

On February 29, 2008, we (excluding certain foreign subsidiaries) entered into the Secured Credit Facility comprised of: (i) an $18.0 million Revolver; (ii) a $24.0 million Term Loan: and (iii) an $18.0 million Delayed Draw Term Loan. The Secured Credit Facility was scheduled to mature on the fifth anniversary of the closing date (February 28, 2013). The Secured Credit Facility was secured by substantially all of our domestic assets. On September 26, 2008, we executed a joinder agreement to the Secured Credit Facility that added an additional lender and increased the amount of the Secured Credit Facility to $90.0 million effective October 1, 2008; the Revolver increased to $27.0 million, the Term Loan increased to $36.0 million and the available Delayed Draw Term Loan increased to $27.0 million.  At December 31, 2010, the outstanding balance was $49.7 million. In connection with the Special Cash Dividend, in November 2010, we obtained a commitment for a $250 Million Secured Revolving Credit Facility. The $250 Million Secured Revolving Credit Facility closed on January 28, 2011. We drew down $55.0 million at closing, of which $49.9 million was used to repay the outstanding Secured Credit Facility (including accrued interest), $5.0 million was used to pay bank fees and related expenses associated with the $250 Million Secured Revolving Credit Facility and the balance was used for general corporate purposes.

 

On December 7, 2011, our Board of Directors authorized the Repurchase Program for the purchase of up to $200.0 million of our common stock through December 31, 2012. Through February 24, 2012, we purchased 41,157 shares under the Repurchase Program at a total cost of $2.7 million.

 

During the year ended December 31, 2011, we generated cash from operating activities that was sufficient to fund our operating expenses, debt service and expenditures for property and equipment.  As discussed above, we paid a Special Cash Dividend in December 2010 totaling $129.0 million, which reduced liquidity.  In January 2011, we repaid our Secured Credit Facility, comprised of term loans with $49.7 million outstanding and closed the $250 Million Secured Revolving Credit Facility. The new facility provides us with the flexibility and capability to fund operations, as required. We expect that our cash from operations will continue to exceed our operating expenses and plan to continue to use, as needed, our net cash from operations, cash reserves and the $250 Million Secured Revolving Credit Facility to fund our operating expenses, future capital projects and the Repurchase Program.

 

We, from time to time, commit capital for, among other things, (i) customer capital (to connect customers to the network); (ii) expansion and improvement of infrastructure; and (iii) equipment. We also commit capital for investments in selected markets. In 2010 through January 2011, we opened up Denver as a market and expanded into Paris, Amsterdam and Frankfurt in Europe. Additionally, we connected Miami to our long haul network and received a favorable ruling from the Canadian authorities regarding our ability to lease and light fiber for our operations in Toronto. Based on our success in these markets, we may increase our presence in these markets or we may develop other markets in the U.S. or internationally. We believe we have sufficient financial resources to execute these plans.

 

We believe that our existing cash, cash from operating activities and funds available under the $250 Million Secured Revolving Credit Facility will be sufficient to fund operating expenses, planned capital expenditures and other liquidity requirements including the Repurchase Program at least through March 31, 2013.

 

Additionally, in the future we may consider making acquisitions of other companies or product lines to support our growth. We may finance any such acquisition of other companies or product lines from existing cash balances and borrowings under our $250 Million Secured Revolving Credit Facility, through additional borrowings from banks or other institutional lenders, and/or the public or private offerings of debt and/or equity securities.  We cannot provide assurances that any such additional funds will be available to us on favorable terms, or at all.

49
 

 

 

Contractual Obligations

 

Certain of our facilities and equipment are leased under non-cancelable operating and capital leases.  Additionally, as discussed below, we have certain long-term obligations for rights-of-way, franchise fees, building access fees and network operating contracts. The following is a schedule, by fiscal year, of future minimum rental payments required under current operating leases, our capital lease and other contractual arrangements as of December 31, 2011 measured from December 31, 2011:

   Payments Due By Period (In Millions) 
Contractual Obligations  Total   Less than
1 Year
   1-3
Years
   4-5
Years
   More than
5 Years
 
                     
Note Payable (including Carrying Costs)  $63.6   $2.1   $4.2   $57.3   $ 
Operating Lease Obligations   139.1    14.2    27.4    24.2    73.3 
Capital Lease Obligations (including Interest)   1.5    0.3    0.5    0.5    0.2 
Other Rights-of-Way, Franchise Fees, Building Access Fees and
                         
Network Operating Contracts   220.8    55.4    57.0    35.9    72.5 
Capital Commitments   17.7    17.7             
Total  $442.7   $89.7   $89.1   $117.9   $146.0 

 

Capital commitments of $17.7 million at December 31, 2011 represent estimated capital costs associated with the delivery of signed customer orders and costs to complete other construction in progress.

 

The above table reflects the $55.0 million outstanding pursuant to the $250 Million Secured Revolving Credit Facility and the related carrying costs (interest charges based upon the 2.53% rate at December 31, 2011 and the unused fee on the available amount ($195.0 million) under the $250 Million Secured Revolving Credit Facility) during its term.

50
 

  

Segment Results (dollars in millions for the tables set forth below)

 

Our results (excluding intercompany activity) are segmented according to groupings based on geography.

 

United States:

                $ Increase /     % Increase /  
    2011     2010     (Decrease)     (Decrease)  
Revenue   $ 427.6     $ 371.8     $ 55.8       15.0 %
Costs of revenue (excluding depreciation and amortization, shown separately below, and including provisions for impairment of  $0.2 and $2.0 for the years ended December 31, 2011 and 2010, respectively)     149.2       129.6       19.6       15.1 %
Selling, general and administrative expenses     102.2       85.6       16.6       19.4 %
Depreciation and amortization     67.2       56.1       11.1       19.8 %
Operating income     109.0       100.5       8.5       8.5 %
Other income (expense):                                
     Interest income     0.1       0.1              
     Interest expense     (4.5 )     (5.2 )     (0.7 )     (13.5 ) %
     Other (expense) income, net     (0.7 )     2.6       (3.3 )   NM  
Income before income taxes     103.9       98.0       5.9       6.0 %
     Provision for income taxes     46.1       39.6       6.5       16.4 %
Net income   $ 57.8     $ 58.4     $ (0.6 )     (1.0 ) %

 

United Kingdom and others:

                $ Increase /     % Increase /  
    2011     2010     (Decrease)     (Decrease)  
Revenue   $ 44.9     $ 37.9     $ 7.0       18.5 %
Costs of revenue (excluding depreciation and amortization, shown separately below, and including provisions for impairment of  $1.0 for the year ended December 31, 2011)     13.5       13.2       0.3       2.3 %
Selling, general and administrative expenses     14.2       11.0       3.2       29.1 %
Depreciation and amortization     8.1       7.2       0.9       12.5 %
Operating income     9.1       6.5       2.6       40.0 %
Other income (expense):                                
     Other (expense), net     (0.3 )     (0.6 )     (0.3 )     (50.0 )%
Income before income taxes     8.8       5.9       2.9       49.2 %
     Benefit from income taxes     (6.1 )     (5.1 )     1.0       19.6 %
Net income   $ 14.9     $ 11.0     $ 3.9       35.5 %

NM—not meaningful

 

The segment results for the years ended December 31, 2011 and 2010 (above) reflect the elimination of any intercompany sales or charges.

51
 

United States:

       $ Increase /   % Increase / 
   2010   2009   (Decrease)   (Decrease) 
Revenue  $371.8   $327.3   $44.5    13.6%
Costs of revenue (excluding depreciation and amortization, shown separately below, and including provisions for impairment of  $2.0 and $1.2 for the years ended December 31, 2010 and 2009, respectively)   129.6    119.3    10.3    8.6%
Selling, general and administrative expenses   85.6    71.2    14.4    20.2%
Depreciation and amortization   56.1    45.5    10.6    23.3%
Operating income   100.5    91.3    9.2    10.1%
Other income (expense):                    
Interest income   0.1    0.3    (0.2)   (66.7)%
Interest expense   (5.2)   (4.8)   0.4    8.3%
Other income, net   2.6    2.7    (0.1)   (3.7)%
Income before income taxes   98.0    89.5    8.5    9.5%
Provision for (benefit from) income taxes   39.6    (184.6)   224.2    121.5%
Net income  $58.4   $274.1   $(215.7)   (78.7)%
                     

 

United Kingdom and others:

       $ Increase /   % Increase / 
   2010   2009   (Decrease)   (Decrease) 
Revenue  $37.9   $32.8   $5.1    15.5%
Costs of revenue (excluding depreciation and amortization, shown separately below)   13.2    11.4    1.8    15.8%
Selling, general and administrative expenses   11.0    11.3    (0.3)   (2.7)%
Depreciation and amortization   7.2    6.5    0.7    10.8%
Operating income   6.5    3.6    2.9    80.6%
Other income (expense):                    
Other (expense) income, net   (0.6)   0.9    (1.5)   NM 
Income before income taxes   5.9    4.5    1.4    31.1%
Benefit from income taxes   (5.1)   (3.0)   2.1    70.0%
Net income  $11.0   $7.5   $3.5    46.7%
                     

NM—not meaningful

 

The segment results for the years ended December 31, 2010 and 2009 (above) reflect the elimination of any intercompany sales or charges.

52
 

 

Credit Risk

 

Financial instruments which potentially subject us to a concentration of credit risk, consist principally of temporary cash investments and accounts receivable. We do not enter into financial instruments for trading or speculative purposes and do not own auction rate notes. We place our cash and cash equivalents in short-term investment instruments with high quality financial institutions (primarily commercial banks) in the U.S. and the U.K. Domestic account balances generally exceed federally insured limits. Our trade receivables, which are unsecured, are geographically dispersed throughout the U.S. and the U.K. and include both large and small corporate entities spanning numerous industries. We perform ongoing credit evaluations of our customers’ financial condition.

 

Off-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 (SPEs), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

 

Inflation

 

We believe that our business is impacted by inflation to the same degree as the general economy.

 

Recently Issued Accounting Pronouncements

 

In August 2009, the FASB issued ASU No. 2009-5, "Fair Value Measurements and Disclosures (Topic 820) - Measuring Liabilities at Fair Value." ASU No. 2009-5 provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using a valuation technique that uses the quoted price of the identical liability when traded as an asset, quoted prices for similar liabilities or similar liabilities when traded as assets, or another valuation technique that is consistent with the principles of ASC Topic 820. ASU No. 2009-5 is effective for the first reporting period (including interim periods) beginning after issuance. The adoption of ASU No. 2009-5 did not have a material impact on our financial position, results of operations or cash flows.

 

In October 2009, the FASB issued ASU No. 2009-13, "Revenue Recognition (Topic 605) - Multiple Deliverable Revenue Arrangements." ASU No. 2009-13 eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method and expands the disclosures related to multiple-deliverable revenue arrangements. ASU No. 2009-13 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier adoption permitted. The adoption of ASU No. 2009-13 did not have a material impact on our financial position, results of operations or cash flows.

 

In January 2010, the FASB issued ASU No. 2010-02, "Consolidation (Topic 810) - Accounting and Reporting for Decreases in Ownership of a Subsidiary - a Scope Clarification." ASU No. 2010-02 clarifies that the scope of the decrease in ownership provisions of Topic 810 applies to a subsidiary or group of assets that is a business, a subsidiary that is a business that is transferred to an equity method investee or a joint venture or an exchange of a group of assets that constitutes a business for a noncontrolling interest in an entity and does not apply to sales in substance of real estate. ASU No. 2010-02 is effective as of the beginning of the period in which an entity adopts SFAS No. 160 or, if SFAS No. 160 has been previously adopted, the first interim or annual period ending on or after December 15, 2009, applied retrospectively to the first period that the entity adopted SFAS No. 160. The adoption of ASU No. 2010-02 did not have a material impact on our financial position, results of operations or cash flows.

 

In January 2010, the FASB issued ASU No. 2010-06, "Fair Value Measurements and Disclosures (Topic 820) - Improving Disclosures about Fair Value Measurements." ASU 2010-06 requires new disclosures regarding transfers in and out of the Level 1 and 2 and activity within Level 3 fair value measurements and clarifies existing disclosures of inputs and valuation techniques for Level 2 and 3 fair value measurements. ASU 2010-06 also includes conforming amendments to employers' disclosures about postretirement benefit plan assets. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosure of activity within Level 3 fair value measurements, which is effective for fiscal years beginning after December 15, 2010, and for interim periods within those years. The adoption of ASU No. 2010-06 did not have a material impact on our financial position, results of operations or cash flows.

53
 

 

In February 2010, the FASB issued ASU 2010-09, "Subsequent Events (Topic 855) - Amendments to Certain Recognition and Disclosure Requirements." ASU 2010-09 requires an entity that is an SEC filer to evaluate subsequent events through the date that the financial statements are issued and removes the requirement that an SEC filer disclose the date through which subsequent events have been evaluated. ASU 2010-09 was effective upon issuance. The adoption of ASU 2010-09 had no effect on our financial position, results of operations or cash flows.

 

In April 2010, the FASB issued ASU 2010-13, "Compensation - Stock Compensation (Topic 718) - Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades." ASU 2010-13 provides amendments to Topic 718 to clarify that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity's equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. The amendments in ASU 2010-13 are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. The adoption of ASU 2010-13 did not have a material impact on our financial position, results of operations or cash flows.

 

 ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

In the normal course of business, we are exposed to market risk arising from changes in foreign currency exchange rates that could impact our cash flows and earnings. During the year ended December 31, 2011, our foreign activities accounted for 9.5% of consolidated revenue. Due to the strengthening of the British pound compared to the U.S. dollar, the translation rate for the year ended December 31, 2011 increased 3.7% compared to the translation rate used for the year ended December 31, 2010. We monitor foreign markets and our commitments in such markets to manage currency and other risks. To date, based upon our level of foreign operations, we have not entered into any hedging arrangement designed to limit exposure to foreign currencies. Because of our European expansion, our level of foreign activities is expected to increase and if it does, we may determine that such hedging arrangements would be appropriate and we will consider such arrangements to minimize risk.

 

Under the terms of the $250 Million Secured Revolving Credit Facility, which was entered into on January 28, 2011, our borrowings bear interest, for any interest period of one, two or three months or if agreed to, longer interest periods at our option, at either the Base Rate (as defined in the $250 Million Secured Revolving Credit Facility) plus the applicable margin ranging from 1.25% to 2.00%, or alternatively, the Adjusted LIBO Rate (as defined in the $250 Million Secured Revolving Credit Facility) plus the applicable margin ranging from 2.25% to 3.00%. At closing, the Company borrowed $55.0 million. The initial borrowings under the $250 Million Secured Revolving Credit Facility carried an interest rate of 4.50% (base rate of 3.25% plus applicable margin of 1.25%). We converted the interest rate to the Adjusted LIBO Rate option as of February 4, 2011, at which time the interest rate was changed to 2.52% (0.27% Adjusted LIBO Rate plus applicable margin of 2.25%). We have not entered into a swap arrangement to fix our borrowing costs under the $250 Million Secured Revolving Credit Facility. Thus, if the operative rate increases, our cost of borrowing will also increase, thereby increasing the costs of our investment strategy. For example, if LIBOR was to increase by 1% for the full year, our borrowing costs would increase by $0.55 million (1% x $55.0 million) based upon the amount of the related debt outstanding at December 31, 2011.

 

As of December 31, 2011, we had an aggregate $55.0 million outstanding under the $250 Million Secured Revolving Credit Facility, none of which is subject to swap arrangements. Additionally, we had a $1.2 million capital lease obligation outstanding, which carried a fixed rate of interest of 8.0%, and as a result, we were not exposed to related interest rate risk on this capital lease.

 

Our interest income is most sensitive to fluctuations in the general level of U.S. interest rates, which affect the interest we earn on our cash and cash equivalents. Our investment policy and strategy are focused on the preservation of capital and supporting our liquidity requirements and requires investments to be short-term and investment grade, primarily rated AAA or better with the objective of minimizing the potential risk of principal loss. Investments in both fixed rate and floating rate interest earning securities carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than predicted if interest rates fall. We may suffer losses in principal if we are forced to sell securities that have declined in market value due to changes in interest rates. Our investments in cash equivalents are primarily floating rate investments.

54
 

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

 

ABOVENET, INC. AND SUBSIDIARIES

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

    Page  
       
Report of Independent Registered Public Accounting Firm   56  
       
Consolidated Balance Sheets as of December 31, 2011 and 2010   57  
       
Consolidated Statements of Operations for the years ended December 31, 2011, 2010 and 2009   58  
       
Consolidated Statements of Comprehensive Income for the years ended December 31, 2011, 2010 and 2009   59  
       
Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2011, 2010 and 2009   60  
       
Consolidated Statements of Cash Flows for the years ended December 31, 2011, 2010 and 2009   61  
       
Notes to Consolidated Financial Statements   62  

 

55
 

  

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Shareholders of

AboveNet, Inc.

White Plains, New York

 

We have audited the accompanying consolidated balance sheets of AboveNet, Inc. (the “Company”) as of December 31, 2011 and 2010 and the related consolidated statements of operations, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with auditing standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of AboveNet, Inc. at December 31, 2011 and 2010, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of AboveNet, Inc.’s internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organization of the Treadway Commission (COSO) and our report dated February 29, 2012 expressed an unqualified opinion thereon.

 

/s/  BDO USA, LLP
 
New York, NY
February 29, 2012

 

56
 

 

 

ABOVENET, INC. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

(in millions, except share and per share information)

 

   December 31, 
   2011   2010 
ASSETS:        
Current assets:        
Cash and cash equivalents  $118.4   $61.6 
Restricted cash and cash equivalents   4.7    3.7 
Accounts receivable, net of allowances for doubtful accounts of $2.6 and $1.8 at December 31, 2011 and 2010, respectively   35.7    27.5 
Prepaid costs and other current assets   14.2    14.8 
Total current assets   173.0    107.6 
           
Property and equipment, net of accumulated depreciation and amortization of $353.9 and $285.3 at December 31, 2011 and 2010, respectively   611.5    540.8 
Deferred tax assets   110.7    149.7 
Other assets   15.8    9.7 
Total assets  $911.0   $807.8 
           
LIABILITIES:          
Current liabilities:          
Accounts payable  $10.7   $9.4 
Accrued expenses   76.8    71.8 
Deferred revenue - current portion   30.0    27.3 
        Note payable - current portion       7.6 
Total current liabilities   117.5    116.1 
           
Note payable   55.0    42.1 
Deferred revenue   79.3    87.0 
Other long-term liabilities   11.3    10.1 
Total liabilities   263.1    255.3 
           
Commitments and contingencies          
           
SHAREHOLDERS’ EQUITY:          
Preferred stock, 9,500,000 shares authorized, $0.01 par value, none issued or outstanding        
Junior preferred stock, 500,000 shares authorized, $0.01 par value, none issued or outstanding        
Common stock, 200,000,000 shares authorized, $0.01 par value, 26,914,108 issued and 26,255,173 outstanding at December 31, 2011 and 26,422,885 issued and 25,799,358 outstanding at December 31, 2010   0.3    0.3 
Additional paid-in capital   357.7    332.4 
Treasury stock, at cost 658,935 and 623,527 shares at December 31, 2011 and 2010, respectively   (25.0)   (22.8)
Accumulated other comprehensive loss   (9.6)   (9.2)
Retained earnings   324.5    251.8 
Total shareholders’ equity   647.9    552.5 
Total liabilities and shareholders’ equity  $911.0   $807.8 
           

 

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

57
 

 

ABOVENET, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(in millions, except share and per share information)

 

    Years Ended December 31,  
    2011     2010     2009  
Revenue   $ 472.5     $ 409.7     $ 360.1  
                         

Costs of revenue (excluding depreciation and amortization, shown separately below, and including provisions for impairment of $1.2, $2.0 and  $1.2 for the years ended December 31, 2011, 2010 and 2009, respectively)

    162.7       142.8       130.7  
Selling, general and administrative expenses     116.4       96.6       82.5  
Depreciation and amortization     75.3       63.3       52.0  
                         
Operating income     118.1       107.0       94.9  
                         
Other income (expense):                        
   Interest income     0.1       0.1       0.3  
   Interest expense     (4.5 )     (5.2 )     (4.8 )
   Other (expense) income, net     (1.0 )     2.0       3.6  
                         
Income before income taxes     112.7       103.9       94.0  
                         
   Provision for (benefit from) income taxes     40.0       34.5       (187.6 )
                         
Net income   $ 72.7     $ 69.4     $ 281.6  
                         
Income per share, basic:                        
   Basic net income per share   $ 2.81     $ 2.74     $ 11.98  
                         
   Weighted average number of common shares     25,902,123       25,293,188       23,504,077  
                         
Income per share, diluted:                        
   Diluted net income per share   $ 2.71     $ 2.65     $ 11.06  
                         
   Weighted average number of common shares     26,822,614       26,242,696       25,468,405  

  

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

 

58
 

 

ABOVENET, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in millions)

 

 

    Years Ended December 31,  
    2011     2010     2009  
Net income                                                                                                   $ 72.7     $ 69.4     $ 281.6  
Foreign currency translation adjustments                                                                                                     (1.0 )     (0.8 )     (0.1 )
Change in fair value of interest rate swap contracts     0.6       0.6       0.4  
Comprehensive income                                                                                                   $ 72.3     $ 69.2     $ 281.9  

 

 

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

59
 

  

ABOVENET, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(in millions, except share information)

 

    Common Stock     Treasury Stock     Other Shareholders’ Equity            
    Shares     Amount     Shares     Amount    

Additional

Paid-in

Capital

   

Accumulated

Other

Comprehensive

Loss

    Retained Earnings    

Total

Shareholders’

Equity

     
Balance at January 1, 2009                                                    23,219,474     $ 0.2       502,872     $ (16.3 )   $ 279.9     $ (9.3 )   $ 29.8     $ 284.3      
Issuance of common stock from exercise of warrants     725,326                         8.7                   8.7      
Issuance of common stock from vested restricted stock units     584,362                                                
Issuance of common stock from exercise of options to purchase shares of common stock      742,626       0.1                   9.9                   10.0      
Purchase of treasury stock                 17,880       (0.4 )                       (0.4 )    
Purchase of treasury stock in cashless exercise of stock warrants                 476                                    
Foreign currency translation adjustments                                   (0.1 )           (0.1 )    
Change in fair value of interest rate swap contracts                                   0.4             0.4      
Amortization of stock-based compensation expense for stock options and restricted stock units                             9.7                   9.7      
Net income                                         281.6       281.6      
Balance at December 31, 2009     25,271,788       0.3       521,228       (16.7 )     308.2       (9.0 )     311.4       594.2      
Shares cancelled     (54 )                                              
Issuance of common stock from exercise of warrants     858,530                         10.3                   10.3      
Issuance of common stock from vested restricted stock units      192,148                                                
Issuance of common stock from exercise of options to purchase shares of common stock      86,778                         1.2                   1.2      
Issuance of common stock pursuant to the employee stock purchase plan     4,414                         0.2                   0.2      
Issuance of common stock to holders of vested unexercised options to purchase common shares     9,281                         0.5                   0.5      
Purchase of treasury stock                  12,869       (0.8 )                       (0.8 )    
Purchase of treasury stock in cashless exercises of stock warrants .                 89,430       (5.3 )                       (5.3 )    
Foreign currency translation adjustments                                   (0.8 )           (0.8 )    
Change in fair value of interest rate swap contracts                                   0.6             0.6      
Amortization of stock-based compensation expense for restricted stock units                             11.9                   11.9      
Amortization of stock-based compensation expense for employee stock purchase plan                             0.1                   0.1      
Cash dividend paid ($5.00 per share)                                         (129.0 )     (129.0 )    
Net income                                         69.4       69.4      
Balance at December 31, 2010     26,422,885       0.3       623,527       (22.8 )     332.4       (9.2 )     251.8       552.5      
Issuance of common stock from vested restricted stock units      454,408                                                
Issuance of common stock from exercise of options to purchase shares of common stock      24,527                         0.3                   0.3      
Issuance of common stock pursuant to the employee stock purchase plan     12,288                         0.6                   0.6      
Purchase of treasury stock                  5,951       (0.3 )                       (0.3 )    
Foreign currency translation adjustments                                   (1.0 )           (1.0 )    
Settlement of interest rate swap contracts                                   0.6             0.6      
Amortization of stock-based compensation expense for restricted stock units                             24.3                   24.3      
Amortization of stock-based compensation expense for employee stock purchase plan                             0.1                   0.1      
Stock purchased pursuant to the Repurchase Program                 29,457       (1.9 )                       (1.9 )    
Net income                                         72.7       72.7      
Balance at December 31, 2011     26,914,108     $ 0.3       658,935     $ (25.0 )   $ 357.7     $ (9.6 )   $ 324.5     $ 647.9      

 

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

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CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions)

 

    Years Ended December 31,  
    2011     2010     2009  
Cash flows provided by operating activities:                  
Net income   $ 72.7     $ 69.4     $ 281.6  
Adjustments to reconcile net income to net cash provided by operations:                        
Depreciation and amortization     75.3       63.3       52.0  
Loss on sale or disposition of property and equipment, net     0.2       0.1       1.3  
Provisions for impairment     1.2       2.0       1.2  
Provision for bad debts     0.9       0.5       0.9  
Non-cash stock-based compensation expense for restricted stock units     24.3       12.4       9.7  
Non-cash stock-based compensation expense for employee stock purchase plan     0.1       0.1        
Reversal of valuation allowance on deferred tax assets     (9.2 )     (7.3 )     (183.0 )
Change in deferred tax assets     47.9       40.5        
Changes in operating working capital:                        
Accounts receivable     (9.1 )     (8.1 )     (1.2 )
Prepaid costs and other current assets     1.7       (1.2 )     (3.5 )
Other assets     1.8       (2.5 )     (1.3 )
Accounts payable     (0.4 )     (1.2 )     (3.4 )
Accrued expenses     3.8       0.8       (4.6 )
Deferred revenue     (5.1 )     (6.8 )     7.0  
Other long-term liabilities     0.8       0.8       0.5  
Net cash provided by operating activities     206.9       162.8       157.2  
Cash flows used in investing activities:                        
Proceeds from sales of property and equipment     0.1       0.4       0.3  
Purchases of property and equipment     (147.8 )     (135.7 )     (118.7 )
Net cash used in investing activities     (147.7 )     (135.3 )     (118.4 )
Cash flows (used in) provided by financing activities:                        
Proceeds from borrowing under $250 Million Secured Revolving Credit Facility, net of certain debt issuance costs     50.0              
Debt issuance costs     (0.5 )            
Proceeds from exercise of options to purchase shares of common stock     0.3       1.2       10.0  
Proceeds from exercise of warrants           5.0       8.7  
Proceeds from issuance of stock pursuant to the employee stock purchase plan     0.6       0.2        
Change in restricted cash and cash equivalents     (1.0 )           (0.2 )
Proceeds from note payable, net of financing costs                 24.5  
Principal payments - note payable     (49.7 )     (7.6 )     (3.2 )
Principal payments - capital lease obligation     (0.2 )           (0.5 )
Purchase of treasury stock     (2.2 )     (0.8 )     (0.4 )
Cash dividend paid to shareholders           (129.0 )      
Net cash (used in) provided by financing activities     (2.7 )     (131.0 )     38.9  
Effect of exchange rates on cash     0.3       (0.2 )     0.5  
Net increase (decrease) in cash and cash equivalents     56.8       (103.7 )     78.2  
Cash and cash equivalents, beginning of year     61.6       165.3       87.1  
Cash and cash equivalents, end of year   $ 118.4     $ 61.6     $ 165.3  
                         
Supplemental cash flow information:                        
Cash paid for interest   $ 2.2     $ 3.0     $ 2.7  
Cash paid for income taxes   $ 1.9     $ 0.4     $ 2.8  
                         
Supplemental non-cash financing activities:                        
Issuance of shares of common stock in cashless exercise of stock purchase warrants   $     $ 5.3     $  
Non-cash purchase of shares into treasury in cashless exercise of stock purchase warrants   $     $ 5.3     $  

 

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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

NOTE 1:    BACKGROUND AND ORGANIZATION

 

Bankruptcy Filing and Reorganization

 

On May 20, 2002, Metromedia Fiber Network, Inc. (“MFN”) and substantially all of its domestic subsidiaries (each a “Debtor” and collectively, the “Debtors”) filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”) with the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”).  The Debtors remained in possession of their assets and properties and continued to operate their businesses and manage their properties as debtors-in-possession under the jurisdiction of the Bankruptcy Court.

 

On July 1, 2003, the Debtors filed an amended Plan of Reorganization (“Plan of Reorganization”) and amended Disclosure Statement (“Disclosure Statement”).  On July 2, 2003, the Bankruptcy Court approved the Disclosure Statement and related voting procedures.  On August 21, 2003, the Bankruptcy Court confirmed the Plan of Reorganization.

 

The Debtors emerged from proceedings under Chapter 11 of the Bankruptcy Code on September 8, 2003 (the “Effective Date”).  In accordance with its Plan of Reorganization, MFN changed its name to AboveNet, Inc. (together with its subsidiaries, the “Company”) on August 29, 2003.  Equity interests in MFN received no distribution under the Plan of Reorganization and the equity securities of MFN were cancelled.

 

Business

 

The Company is a facilities-based provider of technologically advanced, high-bandwidth, fiber optic communications infrastructure and co-location services to communications carriers and corporate and government customers, principally in the United States (“U.S.”) and Europe.

 

NOTE 2:    BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

 

A summary of the basis of presentation and the significant accounting policies followed in the preparation of these consolidated financial statements is as follows:

 

Stock Split

 

On August 3, 2009, the Board of Directors of the Company authorized a two-for-one common stock split, effected in the form of a 100% stock dividend, which was distributed on September 3, 2009.  Each shareholder of record on August 20, 2009 received one additional share of common stock for each share of common stock held on that date.  All share and per share information for prior periods, including warrants, options to purchase common shares, restricted stock units, warrant and option exercise prices, shares reserved under the Company’s 2003 Incentive Stock Option and Stock Unit Grant Plan (the “2003 Plan”) and the Company’s 2008 Equity Incentive Plan  (the “2008 Plan”), weighted average fair value of options granted, common stock and additional paid-in capital accounts on the consolidated balance sheets and consolidated statement of shareholders’ equity, have been retroactively adjusted, where applicable, to reflect the two-for-one stock split.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

Basis of Presentation and Use of Estimates

 

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”).

 

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements, the disclosure of contingent assets and liabilities in the consolidated financial statements and the accompanying notes and the reported amounts of revenue and expenses during the periods presented.  Estimates are used when accounting for certain items such as accounts receivable allowances, property taxes, transaction taxes and deferred taxes.  The estimates the Company makes are based on historical factors, current circumstances and the experience and judgment of the Company’s management.  The Company evaluates its assumptions and estimates on an ongoing basis and may employ outside experts to assist in the Company’s evaluations.  Actual amounts and results could differ from such estimates due to subsequent events which could have a material effect on the Company’s financial statements covering future periods.

 

Fresh Start Accounting

 

On September 8, 2003, the Company authorized 10,000,000 shares of preferred stock (with a $0.01 par value) and 30,000,000 shares of common stock (with a $0.01 par value).  On June 24, 2010, the shareholders approved an amendment to the Company’s certificate of incorporation, increasing the number of authorized shares of common stock from 30,000,000 to 200,000,000.  See Note 10, “Shareholders’ Equity - Amendment to the Company’s Amended and Restated Certificate of Incorporation.”

 

The holders of common stock are entitled to one vote for each issued and outstanding share, and are entitled to receive dividends, subject to the rights of the holders of preferred stock, when and if declared by the Board of Directors.  Preferred stock may be issued from time to time in one or more classes or series, each of which classes or series shall have such distributive designation as determined by the Board of Directors.  During 2006, the Company reserved for issuance, from the 10,000,000 shares authorized of preferred stock described above, 500,000 shares of $0.01 par value junior preferred stock in connection with the adoption of the Amended and Restated Rights Agreement (as defined in Note 10, “Shareholders’ Equity,” below).  In the event of any liquidation, the holders of the common stock will be entitled to receive the assets of the Company available for distribution, after payments to creditors and holders of preferred stock.

 

In 2003, the Company issued 17,500,000 shares of common stock, of which 17,498,276 were delivered and 1,724 shares were determined to be undeliverable and were cancelled, the rights to purchase 3,338,420 shares of common stock at a price of $14.97715 per share, under a rights offering (of which rights to purchase 3,337,930 shares of common stock have been exercised), five year stock purchase warrants to purchase 1,418,918 shares of common stock exercisable at a price of $10.00 per share, and seven year stock purchase warrants to purchase 1,669,316 shares of common stock exercisable at a price of $12.00 per share.  In addition, 2,129,912 shares of common stock were originally reserved for issuance under the Company’s 2003 Plan.  (See Note 12, “Stock-Based Compensation.”)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

The Company’s emergence from bankruptcy resulted in a new reporting entity with no retained earnings or accumulated losses, effective as of September 8, 2003.  Although the Effective Date of the Plan of Reorganization was September 8, 2003, the Company accounted for the consummation of the Plan of Reorganization as if it occurred on August 31, 2003 and implemented fresh start accounting as of that date.  There were no significant transactions during the period from August 31, 2003 to September 8, 2003.  Fresh start accounting requires the Company to allocate the reorganization value of its assets and liabilities based upon their estimated fair values, in accordance with Statement of Position 90-7, “Financial Reporting by Entities in Reorganization under the Bankruptcy Code” (now known as Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) 852-10).  The Company developed a set of financial projections, which were utilized by an expert to assist the Company in estimating the fair value of its assets and liabilities.  The expert utilized various valuation methodologies, including (1) a comparison of the Company and its projected performance to that of comparable companies; (2) a review and analysis of several recent transactions of companies in similar industries to the Company; and (3) a calculation of the enterprise value based upon the future cash flows of the Company’s projections.

 

Adopting fresh start accounting resulted in material adjustments to the historical carrying values of the Company’s assets and liabilities.  The reorganization value was allocated by the Company to its assets and liabilities based upon their fair values.  The Company engaged an independent appraiser to assist the Company in determining the fair market value of its property and equipment.  The determination of fair values of assets and liabilities was subject to significant estimates and assumptions.  The unaudited fresh start adjustments reflected at September 8, 2003 consisted of the following: (i) reduction of property and equipment; (ii) reduction of indebtedness; (iii) reduction of vendor payables; (iv) reduction of the carrying value of deferred revenue; (v) increase of deferred rent to fair market value; (vi) cancellation of MFN’s common stock and additional paid-in capital, in accordance with the Plan of Reorganization; (vii) issuance of new AboveNet, Inc. common stock and additional paid-in capital; and (viii) elimination of the accumulated other comprehensive loss and accumulated deficit accounts.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of the Company, and its wholly-owned subsidiaries.  Consolidation is generally required for investments of more than 50% of the outstanding voting stock of an investee, except when control is not held by the majority owner.  All significant intercompany accounts and transactions have been eliminated in consolidation.

 

Revenue Recognition

 

The Company follows SEC Staff Accounting Bulletin ("SAB") No. 101, “Revenue Recognition in Financial Statements,” (now known as FASB ASC 605-10), as amended by SEC SAB No. 104, “Revenue Recognition,” (also now known as FASB ASC 605-10).

 

Revenue derived from leasing fiber optic telecommunications infrastructure and the provision of telecommunications and co-location services is recognized as services are provided.  Non-refundable payments received from customers before the relevant criteria for revenue recognition are satisfied are included in deferred revenue in the accompanying consolidated balance sheets and are subsequently amortized into income over the fixed contract term.

 

Prior to October 1, 2009, the Company generally amortized revenue related to installation services on a straight-line basis over the contracted customer relationship (two to twenty years).  In the fourth quarter of 2009, the Company completed a study of its historic customer relationship period.  As a result, commencing October 1, 2009, the Company began amortizing revenue related to installation services on a straight-line basis generally over the estimated customer relationship period (generally ranging from three to twenty years).

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

Contract termination revenue is recognized when a customer discontinues service prior to the end of the contract period for which the Company had previously received consideration and for which revenue recognition was deferred.  Contract termination revenue is also recognized when customers have made early termination payments to the Company to settle contractually committed purchase amounts that the customer no longer expects to meet or when the Company renegotiates or discontinues a contract with a customer and as a result is no longer obligated to provide services for consideration previously received and for which revenue recognition has been deferred.  Additionally, the Company includes receipts of bankruptcy claim settlements from former customers as contract termination revenue when received.  Contract termination revenue amounted to $4.4, $2.7, and $3.9 in 2011, 2010 and 2009, respectively.

 

Non-Monetary Transactions

 

The Company may exchange capacity with other capacity or service providers.  In December 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 153, “Exchanges of Nonmonetary Assets - An Amendment of APB Opinion No. 29,” (“SFAS No. 153”), (now known as FASB ASC 845-10).  SFAS No. 153 amends Accounting Principles Board Opinion No. 29, “Accounting for Nonmonetary Transactions,” (“APB No. 29”) (also now known as FASB ASC 845-10) to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance.  SFAS No. 153 is to be applied prospectively for nonmonetary exchanges occurring in fiscal periods beginning after June 15, 2005.  The Company’s adoption of SFAS No. 153 on July 1, 2005 did not have a material effect on the consolidated financial position or results of operations of the Company.  Prior to the Company’s adoption of SFAS No. 153, nonmonetary transactions were accounted for in accordance with APB No. 29, where an exchange for similar capacity is recorded at a historical carryover basis and dissimilar capacity is accounted for at fair market value with recognition of any gain or loss.  There were no gains or losses from nonmonetary transactions for the years ended December 31, 2011, 2010 and 2009.

 

Operating Leases

 

The Company leases office and equipment space, and maintains equipment rentals, right-of-way contracts, building access fees and network capacity under various non-cancelable operating leases.  The lease agreements, which expire at various dates through 2030, are subject, in many cases, to renewal options and provide for the payment of taxes, utilities and maintenance.  Certain lease agreements contain escalation clauses over the term of the lease related to scheduled rent increases resulting from the pass through of increases in operating costs, property taxes and the effect on costs from changes in consumer price indices.  In accordance with SFAS No. 13, “Accounting for Leases,” (now known as FASB ASC 840), the Company recognizes rent expense on a straight-line basis and records a liability representing the difference between straight-line rent expense and the amount payable as an increase or decrease to a deferred liability.  Any leasehold improvements related to operating leases are amortized over the lesser of their economic lives or the remaining lease term.  Rent-free periods and other incentives granted under certain leases are recorded as reductions to rent expense on a straight-line basis over the related lease terms.

 

Cash and Cash Equivalents and Restricted Cash and Cash Equivalents

 

For the purposes of the consolidated statements of cash flows, the Company considers cash in banks and short-term highly liquid investments with an original maturity of three months or less to be cash and cash equivalents.  Cash and cash equivalents and restricted cash and cash equivalents are stated at cost, which approximates fair value.  Restricted cash and cash equivalents are comprised of amounts that secure outstanding letters of credit issued in favor of various third parties.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

Accounts Receivable, Allowance for Doubtful Accounts and Sales Credits

 

Accounts receivable are customer obligations for services sold to such customers under normal trade terms.  The Company’s customers are primarily communications carriers, and corporate enterprise and government customers, located primarily in the U.S. and the United Kingdom (“U.K.”).  The Company performs periodic credit evaluations of its customers’ financial condition.  The Company provides allowances for doubtful accounts and sales credits.  Provisions for doubtful accounts are recorded in selling, general and administrative expenses, while allowances for sales credits are recorded as reductions of revenue.  The adequacy of the reserves is evaluated utilizing several factors including length of time a receivable is past due, changes in the customer’s creditworthiness, customer’s payment history, the length of the customer’s relationship with the Company, current industry trends and the current economic climate.

 

Property and Equipment

 

Property and equipment owned at the Effective Date are stated at their estimated fair values as of the Effective Date based on the Company’s reorganization value, net of accumulated depreciation and amortization incurred since the Effective Date.  Purchases of property and equipment subsequent to the Effective Date are stated at cost, net of depreciation and amortization.  Major improvements are capitalized, while expenditures for repairs and maintenance are expensed when incurred.  Costs incurred prior to a capital project’s completion are reflected as construction in progress and are part of network infrastructure assets, as described below and included in property and equipment on the respective balance sheets.  At December 31, 2011 and December 31, 2010, the Company had $57.8 and $54.0, respectively, of construction in progress.  Certain internal direct labor costs of constructing or installing property and equipment are capitalized.  Capitalized direct labor is determined based upon a core group of project managers, field engineers, network infrastructure engineers and equipment engineers.  Capitalized direct labor is based upon time spent on capitalized projects and consists of salary, plus certain related benefits.  These individuals’ capitalized labor costs are directly associated with the construction and installation of network infrastructure and equipment and customer installations.  The salaries and related benefits of non-engineers and supporting staff that are part of the operations and engineering departments are not considered part of the pool subject to capitalization.  Capitalized direct labor amounted to $10.2, $10.0, and $11.4 for the years ended December 31, 2011, 2010 and 2009, respectively.  Depreciation and amortization is provided on a straight-line basis over the estimated useful lives of the assets, with the exception of leasehold improvements, which are amortized over the lesser of the estimated useful life of the improvement or the term of the lease.

 

Estimated useful lives of the Company’s property and equipment are as follows:

 

Network infrastructure assets and storage huts (except for risers and certain project installation costs, which are 5 years)   20 years
     
HVAC and power equipment   12 to 20 years
     
Transmission and IP equipment   5 to 7 years
     
Furniture, fixtures and equipment   4 to 7 years
     
Software and computer equipment   3 to 5 years
     
Leasehold improvements  

Lesser of the estimated useful life of the

improvement or the term of the lease

 

When property and equipment is retired or otherwise disposed of, the cost and accumulated depreciation is removed from the accounts, and resulting gains or losses are reflected in net income.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

From time to time, the Company is required to replace or re-route existing fiber due to structural changes such as construction and highway expansions, which is defined as “relocation.”  In such instances, the Company fully depreciates the remaining carrying value of network infrastructure removed or rendered unusable and capitalizes the costs of the new infrastructure placed into service.  In certain circumstances, the local municipality or agency is responsible for some or all of such amounts.  The Company records its share of relocation costs in property and equipment and records the third party portion of such costs as accounts receivable.  The Company capitalized relocation costs amounting to $1.8, $1.5 and $3.1 for the years ended December 31, 2011, 2010 and 2009, respectively.  The Company fully depreciated the remaining carrying value of the network infrastructure rendered unusable, which on an original cost basis, totaled $0.31 ($0.15 on a net book value basis) for the year ended December 31, 2011 and, which on an original cost basis, totaled $0.21 ($0.14 on a net book value basis) for the year ended December 31, 2010 and, which on an original cost basis, totaled $0.3 ($0.2 on a net book value basis) for the year ended December 31, 2009.  To the extent that relocation is temporary in nature, or requires only the movement of existing network infrastructure to another location or construction for an insignificant portion of the entire segment, the related costs are included in the Company’s results of operations.

 

In accordance with SFAS No. 34, “Capitalization of Interest Cost,” (now known as FASB ASC 835-20), interest on certain construction projects would be capitalized.  Such amounts were considered immaterial, and accordingly, no such amounts were capitalized during each of the years ended December 31, 2011, 2010 and 2009.

 

In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” (now known as FASB ASC 360-10-35), the Company periodically evaluates the recoverability of its long-lived assets and evaluates such assets for impairment whenever events or circumstances indicate that the carrying amount of such assets (or group of assets) may not be recoverable.  Impairment is determined to exist if the estimated future undiscounted cash flows are less than the carrying value of such assets.  The Company considers various factors to determine if an impairment test is necessary.  The factors include: consideration of the overall economic climate, technological advances with respect to equipment, Company strategy, capital planning and certain operational issues.  Since June 30, 2006, no event has occurred nor has the business environment changed to trigger an impairment test for assets in revenue service and operations.  The Company also considers the removal of assets from the network as a triggering event for performing an impairment test.  Once an item is removed from service, unless it is to be redeployed, it may have little or no future cash flows related to it.  The Company performed annual physical counts of such assets that are not in revenue service or operations at or around September 30 of each year.  With the assistance of a valuation report of the assets that are not in revenue service, prepared by an independent third party on a basis consistent with SFAS No. 157, “Fair Value Measurements,” (now known as FASB ASC 820-10), and pursuant to FASB ASC 360-10-35, the Company determined that the fair value of certain of these assets was less than the carrying value and accordingly, recorded provisions for impairment totaling $1.2 for the year ended December 31, 2011, $0.5 for the year ended December 31, 2010 and $0.4 for the year ended December 31, 2009.  Additionally, at December 31, 2010, the Company recorded a $1.5 provision for impairment with respect to a discreet group of assets because of certain operational issues.  The Company also recorded a provision for equipment impairment of $0.8 in the year ended December 31, 2009 to record the loss in value of certain equipment, most of which was eventually sold to an unaffiliated third party.  (See Note 6, “Changes in Estimate.”)

 

Treasury Stock

 

Treasury stock is accounted for under the cost method.

 

Asset Retirement Obligations

 

In accordance with SFAS No. 143, “Accounting for Asset Retirement Obligations,” (now known as FASB ASC 410-20), the Company recognizes the fair value of a liability for an asset retirement obligation in the period in which it is incurred if a reasonable estimate of fair value can be made.  The Company has asset retirement obligations related to the de-commissioning and removal of equipment, restoration of leased facilities and the removal of certain fiber and conduit systems.  Considerable management judgment is required in estimating these obligations.  Important assumptions include estimates of asset retirement costs, the timing of future asset retirement activities and the likelihood of contractual asset retirement provisions being enforced.  Changes in these assumptions based on future information could result in adjustments to these estimated liabilities.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

Asset retirement obligations are generally recorded as “other long-term liabilities,” are capitalized as part of the carrying amount of the related long-lived assets included in property and equipment, net, and are depreciated over the life of the associated asset.  Asset retirement obligations aggregated $8.1 and $7.9 at December 31, 2011 and 2010, respectively, of which $4.5 and $4.3, respectively, were included in “Accrued expenses,” at such dates, and $3.6 was included in “Other long-term liabilities” at both dates.  Accretion expense, which is included in “Interest expense,” amounted to $0.27 for each of the years ended December 31, 2011 and 2009 and $0.28 for the year ended December 31, 2010.

 

Income Taxes

 

The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes,” (now known as FASB ASC 740).  Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax basis and net operating losses and tax credit carryforwards.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  After an evaluation of the realizability of the Company’s deferred tax assets, the Company reduced its valuation allowance by $9.1, $7.3 and $183.0 during 2011, 2010 and 2009, respectively.  See Note 8, “Income Taxes,” for a further discussion of the Company’s provision for income taxes.

 

The Company is subject to audits by various taxing authorities, and these audits may result in proposed assessments where the ultimate resolution results in the Company owing additional taxes.  The Company is required to establish reserves under FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (now known as FASB ASC 740-10), when the Company believes there is uncertainty with respect to certain positions and the Company may not succeed in realizing the tax benefit.  The Company believes that its tax return positions are appropriate and supportable under relevant tax law.  The Company believes the estimates and assumptions used to support its evaluation of tax benefit realization are reasonable.  Accordingly, no adjustments have been made to the consolidated financial statements for the years ended December 31, 2011, 2010 and 2009.

 

The Company’s reorganization resulted in a significantly modified capital structure as a result of applying fresh-start accounting in accordance with FASB ASC 852-10 on the Effective Date.  Fresh start accounting has important consequences on the accounting for the realization of valuation allowances, related to net deferred tax assets that existed on the Effective Date but which arose in pre-emergence periods.  Prior to 2009, fresh start accounting required the reversal of these allowances to be recorded as a reduction of intangible assets until exhausted and thereafter as additional paid in capital.  Beginning in 2009, in accordance with SFAS141(R), “Business Combinations (Revised),” (now known as FASB ASC 805), future utilization of such benefit will reduce income tax expense.  This treatment does not result in any change in liabilities to taxing authorities or in cash flows.

 

Undistributed earnings of the Company’s foreign subsidiaries are considered to be indefinitely reinvested and therefore, no provision for domestic taxes has been provided thereon.  Upon repatriation of those earnings, in the form of dividends or otherwise, the Company would be subject to domestic income taxes, offset (in whole or in part) by foreign tax credits, related to income and withholding taxes payable to the various foreign countries.  Determination of the amount of unrecognized deferred domestic income tax liability is not practicable due to the complexities associated with its hypothetical calculation; however, foreign tax credit carryforwards would be available to reduce some portion of the domestic liability.

 

The Company’s policy is to recognize interest and penalties accrued as a component of operating expense.  As of the date of adoption of FASB ASC 740-10, the Company did not have any accrued interest or penalties associated with any unrecognized income tax benefits, nor was any interest expense recognized during the years ended December 31, 2011, 2010 and 2009.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

Foreign Currency Translation and Transactions

 

The Company’s reporting currency is the U.S. dollar.  For those subsidiaries not using the U.S. dollar as their functional currency, assets and liabilities are translated at exchange rates in effect at the balance sheet date and income and expense transactions are translated at average exchange rates during the period.  Resulting translation adjustments are recorded directly to a separate component of shareholders’ equity and are reflected in the accompanying consolidated statements of comprehensive income.  The Company’s foreign exchange transaction gains (losses) are generally included in “other income (expense), net” in the consolidated statements of operations.

 

Stock Options

 

On September 8, 2003, the Company adopted the fair value provisions of SFAS No. 148, “Accounting for Stock-Based Compensation Transition and Disclosure,” (“SFAS No. 148”), (now known as FASB ASC 718-10).  SFAS No. 148 amended SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS No. 123”), (also now known as FASB ASC 718-10), to provide alternative methods of transition to SFAS No. 123’s fair value method of accounting for stock-based employee compensation.  See Note 12, “Stock-Based Compensation.”

 

Under the fair value provisions of FASB ASC 718-10, the fair value of each stock-based compensation award is estimated at the date of grant, using the Black-Scholes option pricing model for stock option awards.  The Company did not have a historical basis for determining the volatility and expected life assumptions in the model due to the Company’s limited market trading history; therefore, the assumptions used for these amounts are an average of those used by a select group of related industry companies.  Most stock-based awards have graded vesting (i.e. portions of the award vest at different dates during the vesting period).  The Company recognizes the related stock-based compensation expense of such awards on a straight-line basis over the vesting period for each tranche in an award.  Upon consummation of the Company’s Plan of Reorganization, all then outstanding stock options were cancelled.

 

Effective January 1, 2006, the Company adopted SFAS No. 123(R), “Share-Based Payment,” (“SFAS No. 123(R)”), (now known as FASB ASC 718), using the modified prospective method.  SFAS No. 123(R) requires all share-based awards granted to employees to be recognized as compensation expense over the vesting period, based on fair value of the award.  The fair value method under SFAS No. 123(R) is similar to the fair value method under SFAS No. 123 with respect to measurement and recognition of stock-based compensation expense except that SFAS No. 123(R) requires an estimate of future forfeitures, whereas SFAS No. 123 allowed companies to estimate forfeitures or recognize the impact of forfeitures as they occur.  As the Company recognized the impact of forfeitures as they occurred under SFAS No. 123, the adoption of SFAS No. 123(R) did result in different accounting treatment, but it did not have a material impact on the Company’s consolidated financial statements.

 

There were no options to purchase shares of common stock granted during the years ended December 31, 2011, 2010 and 2009.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

Restricted Stock Units

 

Compensation cost for restricted stock unit awards that are not performance-based is measured based upon the quoted closing market price for the Company’s stock on the date of grant.  The related compensation cost is recognized on a straight-line basis over the vesting period.  Compensation expense for performance-based restricted stock unit awards is measured based upon the quoted market price for the Company’s stock on the date that the performance targets have been established and communicated to the grantee.  Related compensation cost is recognized based upon a review of the performance targets and determination that such performance targets have been achieved, on a straight-line basis over the vesting period.  See Note 12, “Stock-Based Compensation.”

 

Stock Warrants

 

In connection with the Plan of Reorganization described in Note 1, “Background and Organization,” the Company issued to holders of general unsecured claims as part of the settlement of such claims (i) five year warrants to purchase 1,418,918 shares of common stock with an exercise price of $10.00 per share (expired September 8, 2008) (the “Five Year Warrants”) and (ii) seven year warrants to purchase 1,669,316 shares of common stock with an exercise price of $12.00 per share (expired September 8, 2010) (the “Seven Year Warrants”).  The stock warrants were treated as equity upon their exercise based upon the terms of the warrant and cash received.  Stock warrants to purchase shares of common stock exercised totaled 858,530 and 725,326 in 2010 and 2009, respectively.

 

Under the terms of the five year and seven year warrant agreements (collectively, the “Warrant Agreements”), if the market price of the Company’s common stock, as defined in the Warrant Agreements, 60 days prior to the expiration date of the respective warrants, was greater than the warrant exercise price, the Company was required to give each warrant holder notice that at the warrant expiration date, the warrants would be deemed to have been exercised pursuant to the net exercise provisions of the respective Warrant Agreements (the “Net Exercise”), unless the warrant holder elected, by written notice, to not exercise its warrants.  Under the Net Exercise, shares issued to the warrant holders would be reduced by the number of shares necessary to cover the aggregate exercise price of the shares, valuing such shares at the current market price, as defined in the Warrant Agreements.  Any fractional shares, otherwise issuable, would be paid in cash.

 

At September 8, 2008, the expiration date of the Five Year Warrants, the required conditions were met for the Net Exercise.  In total, Five Year Warrants to purchase 318,526 shares of common stock were deemed exercised on a net exercise basis (including warrants to purchase 778 shares of common stock, which were exercised on a net exercise basis prior to expiration), of which 213,432 shares were issued to the warrant holders, 105,094 shares were returned to treasury and $0.004 was paid to recipients for fractional shares.  In addition, Five Year Warrants to purchase 50 shares of common stock were cancelled in accordance with instructions from warrant holders.  The exercises of the Five Year Warrants by holders generated cash of $11.0.

 

At September 8, 2010, the expiration date of the Seven Year Warrants, the required conditions were met for the Net Exercise and accordingly, Seven Year Warrants to purchase 13,626 shares of common stock were exercised at expiration, of which 10,409 shares were issued to warrant holders and 3,217 shares were returned to treasury and $0.004 was paid to recipients for fractional shares.  In total, Seven Year Warrants to purchase 443,504 shares of common stock were deemed exercised on a net exercise basis (441,688 in 2010), of which 353,598 shares were issued to the warrant holders, 89,906 shares were returned to treasury and $0.004 was paid to recipients for fractional shares.  In addition, Seven Year Warrants to purchase 26 shares of common stock were determined to be undeliverable and were cancelled.  The exercises of the Seven Year Warrants by holders generated cash of $14.7.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

Derivative Financial Instruments

 

The Company has utilized and may, from time to time in the future, utilize derivative financial instruments known as interest rate swaps (“derivatives”) to mitigate its exposure to interest rate risk.  The Company purchased the first interest rate swap on August 4, 2008 to hedge the interest rate on the initial $24.0 (original principal) term loan under the Secured Credit Facility (as such term is defined in Note 9, “Long-Term Debt - Secured Credit Facility,” below) and the Company purchased a second interest rate swap on November 14, 2008 to hedge the interest rate on the additional $12.0 (original principal) term loan provided by SunTrust Bank.  (See Note 9, “Long-Term Debt - Secured Credit Facility.”)  The Company accounted for the derivatives under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (now known as FASB ASC 815).  FASB ASC 815 requires that all derivatives be recognized in the financial statements and measured at fair value regardless of the purpose or intent for holding them.  By policy, the Company has not historically entered into derivatives for trading purposes or for speculation.  Based on criteria defined in FASB ASC 815, the interest rate swaps were considered cash flow hedges and were 100% effective.  Accordingly, changes in the fair value of derivatives were recorded each period in other comprehensive loss.  Changes in the fair value of the derivatives reported in accumulated other comprehensive loss were reclassified into earnings in the period in which earnings were impacted by the variability of the cash flows of the hedged item.  The ineffective portion of all hedges, if any, would be recognized in current period earnings.  The unrealized net loss recorded in accumulated other comprehensive loss at December 31, 2010 was $0.6 for the interest rate swaps.  The mark-to-market value of the cash flow hedges was recorded in current assets, current liabilities, other non-current assets or other long-term liabilities, as applicable, and the offsetting gains or losses in other comprehensive loss.  Both interest rate swaps were settled in January 2011.

 

On January 1, 2009, the Company adopted SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133,” (now known as FASB ASC 815-10).  FASB ASC 815-10 changes the disclosure requirements for derivatives and hedging activities.  Entities are required to provide enhanced disclosures about (i) how and why an entity uses derivatives; (ii) how derivatives and related hedged items are accounted for under FASB ASC 815-10; and (iii) how derivatives and related hedged items affect an entity’s financial position and cash flows.

 

The Company has, when applicable, minimized its credit risk relating to counterparties of its derivatives by transacting with multiple, high quality counterparties, thereby limiting exposure to individual counterparties, and by monitoring the financial condition of its counterparties.

 

All derivatives were recorded on the Company’s consolidated balance sheets at fair value.  Accounting for the gains and losses resulting from changes in the fair value of derivatives depends on the use of the derivative and whether it qualifies for hedge accounting in accordance with FASB ASC 815-10.  At December 31, 2010, net interest rate swap derivative liabilities of $0.6 were included in “Accrued expenses” in the Company’s consolidated balance sheet.  The swap agreements were settled in January 2011 as described below.

 

Derivatives recorded at fair value in the Company’s consolidated balance sheets as of December 31, 2011 and 2010 consisted of the following:

 

    Derivative Liabilities  
Derivatives designated as hedging instruments   December 31, 2011     December 31, 2010  
Interest rate swap agreement expiring August 1, 2011 (*)   $     $ 0.4  
                 
Interest rate swap agreement expiring November 1, 2011 (*)           0.2  
                 
Total derivatives designated as hedging instruments   $     $ 0.6  

 

   
(*) The derivative liabilities are two interest rate swap agreements with original three year terms, which were included in “Accrued expenses” in the Company’s consolidated balance sheet at December 31, 2010.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

Interest Rate Swap Agreements

 

The notional amounts provide an indication of the extent of the Company’s involvement in such agreements but do not represent its exposure to market risk.  The following table shows the notional amount outstanding, maturity date, and the weighted average receive and pay rates of the interest rate swap agreements as of December 31, 2011 and 2010.

 

Notional Amount       Weighted Average Rate  
December 31, 2011     December 31, 2010   Maturity Date   Pay     Receive  
$     $ 18.9   August 1, 2011     3.65 %     0.72 %
                               
        9.5   November 1, 2011     2.635 %     0.40 %
                               
$     $ 28.4                    

 

Interest expense under these agreements, and the respective debt instruments that they hedge, are recorded at the net effective interest rate of the hedged transaction.

 

The swap agreements were settled in January 2011 in connection with the repayment of the term loans under the Secured Credit Facility and the closing of the $250 Million Secured Revolving Credit Facility (as such terms are defined in Note 9, “Long-Term Debt - $250 Million Secured Revolving Credit Facility,” below).  The cost of $0.5 to settle the swap agreements was included in “Other (expense) income, net” in the Company’s consolidated statement of operations for the year ended December 31, 2011.

 

Fair Value of Financial Instruments

 

The Company adopted SFAS No. 157, “Fair Value Measurements,” (now known as FASB ASC 820-10), for the Company’s financial assets and liabilities effective January 1, 2008.  This pronouncement defines fair value, establishes a framework for measuring fair value, and requires expanded disclosures about fair value measurements.  FASB ASC 820-10 emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and defines fair value as the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date.  FASB ASC 820-10 discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow) and the cost approach (cost to replace the service capacity of an asset or replacement cost), which are each based upon observable and unobservable inputs.  Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions.  FASB ASC 820-10 utilizes a fair value hierarchy that prioritizes inputs to fair value measurement techniques into three broad levels:

 

Level 1: Observable inputs such as quoted prices for identical assets or liabilities in active markets.
   
Level 2: Observable inputs other than quoted prices that are directly or indirectly observable for the asset or liability, including quoted prices for similar assets or liabilities in active markets; quoted prices for similar or identical assets or liabilities in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
   
Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.

 

The Company’s investment in overnight money market institutional funds, which amounted to $110.0 and $48.2 at December 31, 2011 and December 31, 2010, respectively, is included in cash and cash equivalents on the accompanying balance sheets and is classified as a Level 1 asset.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

The Company was party to two interest rate swaps, which were utilized to modify the Company’s interest rate risk.  The Company recorded the mark-to-market value of the interest rate swap contracts of $0.6 (which was included in “Accrued expenses”) in the Company’s consolidated balance sheet at December 31, 2010.  At December 31, 2010, the Company used third parties, as well as its own market analysis to determine the fair value of each of the interest rate swap agreements.  The fair value of the interest rate swap contracts were classified as Level 2 liabilities.  The swap agreements were settled in January 2011 in connection with the repayment of the term loans under the Secured Credit Facility and the closing of the $250 Million Secured Revolving Credit Facility.  The cost of $0.5 to settle the swap agreements was included in “Other (expense) income, net” in the Company’s consolidated statement of operations for the year ended December 31, 2011.

 

The Company’s consolidated balance sheets include the following financial instruments: short-term cash investments, trade accounts receivable, trade accounts payable and note payable.  The Company believes the carrying amounts in the financial statements approximate the fair value of these financial instruments due to the relatively short period of time between the origination of the instruments and their expected realization or the interest rates which approximate current market rates.

 

Concentration of Credit Risk

 

Financial instruments which potentially subject the Company to concentration of credit risk consist principally of short-term cash investments and accounts receivable.  The Company does not enter into financial instruments for trading or speculative purposes.  The Company’s cash and cash equivalents are invested in investment-grade, short-term investment instruments with high quality financial institutions.  The Company’s trade receivables, which are unsecured, are geographically dispersed, and no single customer accounts for greater than 10% of consolidated revenue or accounts receivable, net.  The Company performs ongoing credit evaluations of its customers’ financial condition.  The allowance for non-collection of accounts receivable is based upon the expected collectability of all accounts receivable.  The Company places its cash and cash equivalents primarily in commercial bank accounts in the U.S.  Account balances generally exceed federally insured limits.

 

401(k) and Other Post-Retirement Benefits

 

The Company has a Profit Sharing and 401(k) Plan (the “Plan”) for its employees in the U.S., which permits employees to make contributions to the Plan on a pre-tax salary reduction basis in accordance with the provisions of the Internal Revenue Code and permits the employer to provide discretionary contributions.  All full-time U.S. employees are eligible to participate in the Plan at the beginning of the month following three months of service.  Eligible employees may make contributions subject to the limitations defined by the Internal Revenue Code.  The Company matches 50% of a U.S. employee’s contributions, up to the amount set forth in the Plan.  Matched amounts vest based upon an employee’s length of service.  The Company’s subsidiaries in the U.K. have a different plan under which contributions are made up to a maximum of 8% when U.K. employee contributions reach 5% of salary.  Under the U.K. plan, contributions are made at two levels.  When a U.K. employee contributes 3% or more but less than 5% of their salary to the plan, the Company’s contribution is fixed at 5% of the salary.  When a U.K. employee contributes over 5% of their salary to the plan, the Company’s contribution is fixed at 8% of the salary (regardless of the percentage of the contribution in excess of 5%).

 

The Company contributed $1.6 for the year ended December 31, 2011 and $1.5 for each of the years ended December 31, 2010 and 2009, net of forfeitures for its obligations under these plans.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

Taxes Collected from Customers

 

In June 2006, the Emerging Issues Task Force (“EITF”) ratified the consensus on EITF No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation),” (“EITF No. 06-3”), (now known as FASB ASC 605-45).  FASB ASC 605-45 requires that companies disclose their accounting policies regarding the gross or net presentation of certain taxes.  Taxes within the scope of FASB ASC 605-45 are any taxes assessed by a governmental authority that are directly imposed on a revenue-producing transaction between a seller and a customer and may include, but are not limited to, sales, use, value added and some excise taxes.  In addition, if such taxes are significant, and are presented on a gross basis, the amounts of those taxes should be disclosed.  The Company adopted EITF No. 06-3 effective January 1, 2007.  The Company records Universal Service Fund (“USF”) contributions relating to certain services it provides on a net basis in accordance with the guidelines of EITF No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent,” (also now known as FASB ASC 605-45).  The Company’s policy is to record all such fees, contributions and taxes within the scope of FASB ASC 605-45 on a net basis.

 

Reclassifications

 

Certain reclassifications have been made to the consolidated financial statements for the year ended December 31, 2011 to conform to the classifications used for the year ended December 31, 2010.

 

Recently Issued Accounting Pronouncements

 

In August 2009, the FASB issued ASU No. 2009-5, "Fair Value Measurements and Disclosures (Topic 820) - Measuring Liabilities at Fair Value."  ASU No. 2009-5 provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using a valuation technique that uses the quoted price of the identical liability when traded as an asset, quoted prices for similar liabilities or similar liabilities when traded as assets, or another valuation technique that is consistent with the principles of ASC Topic 820.  ASU No. 2009-5 is effective for the first reporting period (including interim periods) beginning after issuance.  The adoption of ASU No. 2009-5 did not have a material impact on the Company’s financial position, results of operations or cash flows.

 

In October 2009, the FASB issued ASU No. 2009-13, "Revenue Recognition (Topic 605) - Multiple Deliverable Revenue Arrangements."  ASU No. 2009-13 eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method and expands the disclosures related to multiple-deliverable revenue arrangements.  ASU No. 2009-13 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier adoption permitted.  The adoption of ASU No. 2009-13 did not have a material impact on the Company’s financial position, results of operations or cash flows.

 

In January 2010, the FASB issued ASU No. 2010-02, "Consolidation (Topic 810) - Accounting and Reporting for Decreases in Ownership of a Subsidiary - a Scope Clarification." ASU No. 2010-02 clarifies that the scope of the decrease in ownership provisions of Topic 810 applies to a subsidiary or group of assets that is a business, a subsidiary that is a business that is transferred to an equity method investee or a joint venture or an exchange of a group of assets that constitutes a business for a noncontrolling interest in an entity and does not apply to sales in substance of real estate.  ASU No. 2010-02 is effective as of the beginning of the period in which an entity adopts SFAS No. 160 or, if SFAS No. 160 has been previously adopted, the first interim or annual period ending on or after December 15, 2009, applied retrospectively to the first period that the entity adopted SFAS No. 160.  The adoption of ASU No. 2010-02 did not have a material impact on the Company’s financial position, results of operations or cash flows.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

In January 2010, the FASB issued ASU No. 2010-06, "Fair Value Measurements and Disclosures (Topic 820) - Improving Disclosures about Fair Value Measurements."  ASU 2010-06 requires new disclosures regarding transfers in and out of the Level 1 and 2 and activity within Level 3 fair value measurements and clarifies existing disclosures of inputs and valuation techniques for Level 2 and 3 fair value measurements.  ASU 2010-06 also includes conforming amendments to employers' disclosures about postretirement benefit plan assets.  The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosure of activity within Level 3 fair value measurements, which is effective for fiscal years beginning after December 15, 2010, and for interim periods within those years.  The adoption of ASU No. 2010-06 did not have a material impact on the Company’s financial position, results of operations or cash flows.

 

In February 2010, the FASB issued ASU 2010-09, "Subsequent Events (Topic 855) - Amendments to Certain Recognition and Disclosure Requirements."  ASU 2010-09 requires an entity that is an SEC filer to evaluate subsequent events through the date that the financial statements are issued and removes the requirement that an SEC filer disclose the date through which subsequent events have been evaluated.  ASU 2010-09 was effective upon issuance.  The adoption of ASU 2010-09 had no effect on the Company’s financial position, results of operations or cash flows.

 

In April 2010, the FASB issued ASU 2010-13, "Compensation - Stock Compensation (Topic 718) - Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades."  ASU 2010-13 provides amendments to Topic 718 to clarify that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity's equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition.  Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity.  The amendments in ASU 2010-13 are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010.  The adoption of ASU 2010-13 did not have a material impact on the Company’s financial position, results of operations or cash flows.

 

NOTE 3:   PREPAID COSTS AND OTHER CURRENT ASSETS

 

Prepaid costs and other current assets as of December 31, 2011 and 2010 consist of the following:

 

    December 31,  
    2011     2010  
Prepaid property taxes                                                                                                           $ 2.8     $ 2.7  
Prepaid right-of-way charges                                                                                                             2.5       2.3  
Prepaid telecom                                                                                                             2.1       1.5  
Prepaid insurance                                                                                                             1.6       1.0  
Prepaid maintenance                                                                                                             0.8       1.6  
Prepaid rent                                                                                                             0.8       0.6  
Reimbursable relocation costs                                                                                                             0.5       2.6  
State income tax deposits in 2011 and state and federal income tax deposits in 2010     0.2       0.4  
Other receivables                                                                                                             1.7       0.8  
Other prepaids                                                                                                             1.2       0.9  
Deposits                                                                                                                   0.4  
     Total   $ 14.2     $ 14.8  

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

NOTE 4:  PROPERTY AND EQUIPMENT

 

Property and equipment as of December 31, 2011 and 2010 consist of the following:

 

    December 31,  
    2011     2010  
Leasehold improvements   $ 8.7     $ 5.8  
Furniture, fixtures and equipment     39.7       32.2  
Network infrastructure assets, including transmission and IP equipment     917.0       788.1  
     Total property and equipment     965.4       826.1  
Accumulated depreciation and amortization     (353.9 )     (285.3 )
     Property and equipment, net   $ 611.5     $ 540.8  

 

Included in network infrastructure assets was certain transmission and IP equipment held in inventory for future use, which had an original cost of $40.5 and $32.4, accumulated depreciation of $20.1 and $15.0 and net carrying values of $20.4 and $17.4 at December 31, 2011 and 2010, respectively.

 

In addition, at December 31, 2011 and 2010, the Company had assets held for sale or disposition with net book values totaling $0.1 and $0.6, respectively, (net of allowances for equipment impairment of $0.3 and $0.5 at December 31, 2011 and 2010, respectively), which were included in network infrastructure assets, including transmission and IP equipment above.

 

Depreciation and amortization expense related to property and equipment for the years ended December 31, 2011, 2010, and 2009 was approximately $75.3, $63.3 and $52.0, respectively.

 

Included in costs of revenue for the years ended December 31, 2011, 2010 and 2009 are provisions for impairment of $1.2, $2.0 and $1.2, respectively, with respect to certain assets removed from the network and either sold or disposed or made available for sale or disposition.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

NOTE 5: SUBORDINATED INVESTMENT

 

In January 2008, the Company became a strategic member, as defined, of MediaXstream, LLC, a newly formed limited liability company that was created to provide transport and managed network services for the production and broadcast industries (“MediaX”).  MediaX was formed with preferred members who contributed cash and strategic members and management members who contribute services.  The Company’s interest did not provide any voting rights on MediaX’s Board of Managers.  The Company agreed to contribute certain monthly services pursuant to a 51 month contract, which commenced April 2008, for an interest in MediaX.  Distributions to the Company were subordinated to distributions to the preferred members of their original investment plus a preferred return.  Based upon amounts contributed, the Company’s nominal ownership interest was approximately 15.4% of equity.  MediaX was a start-up company with no operating history.  Distributions on the Company’s investment were subordinated to the distributions to the preferred members and the Company’s interest did not provide any level of control.  These factors indicated that the fair value of the Company’s investment in MediaX was not significant.  Accordingly, the Company has not reflected the services contributed as revenue or the corresponding investment in MediaX in its financial statements.  The cost of providing such services is included in costs of revenue in the relevant period.  The Company contributed services to MediaX of $1.7 in each of the years ended December 31, 2011, 2010 and 2009, which represents the estimated fair value of the services and not the actual costs of providing such services, which are not significant.  In December 2009, all of the ownership interests in MediaX, including the ownership interest held by us, were purchased by Hibernia Group ehf .  Pursuant to the purchase agreement, the Company is entitled to an earnout payment in the event that MediaX achieves certain financial performance results.  The Company will continue to contribute services in accordance with the original contract.  The Company will record distributions from its investment in MediaX, if any, as income when received.

 

Additionally, the Company provides other services to MediaX on the same basis as it provides to other customers.  The Company billed MediaX for services and reimbursements of $0.7 during each of the years ended December 31, 2011 and 2010 and $0.6 during the year ended December 31, 2009.

 

NOTE 6: CHANGES IN ESTIMATE

 

Effective January 1, 2010, the Company changed the estimated useful lives for its IP equipment from seven years to five years.  Additionally, the Company changed the estimated useful lives for certain capitalized labor from 20 years to seven years.  Effective as of October 1, 2011, the Company changed the estimated useful lives for certain capitalized labor from seven to five years, and began depreciating assets under the Company’s sparing program, in accordance with their respective asset class lives.  The effect of these changes on the Company’s operating results has not been and will not be material.

77
 

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

NOTE 7:  ACCRUED EXPENSES

 

Accrued expenses as of December 31, 2011 and 2010 consist of the following:

    December 31,  
    2011     2010  
Accrued transaction taxes   $ 21.5     $ 18.3  
Accrued capital expenditures     15.2       13.0  
Accrued payroll, bonuses and employee benefits     12.8       12.2  
Accrued property tax     5.8       7.6  
Accrued telecommunication costs     4.6       3.7  
Asset retirement obligations     4.5       4.3  
Accrued conduit, right-of-way and occupancy expenses     3.7       3.7  
Current income taxes payable     2.5       3.1  
Accrued repairs and maintenance     1.8       1.0  
Accrued litigation costs     0.7       0.7  
Current portion of deferred fair market value rent liability     0.6       0.6  
Accrued other professional fees, including directors’ fees     0.4       0.7  
Accrued utilities     0.3       0.4  
Accrued accounting and auditing fees     0.3       0.2  
Capital lease obligation, current     0.2       0.1  
Accrued interest     0.1       0.2  
Other     1.8       2.0  
     Total   $ 76.8     $ 71.8  

 

NOTE 8:  INCOME TAXES

 

Income taxes have been provided based upon the tax laws and rates in the countries in which operations are conducted and income is earned.  The provision for (benefit from) income taxes for the years ended December 31, 2011, 2010 and 2009 are as follows:

 

    Years Ended December 31,  
    2011     2010     2009  
Current                  
     Federal   $     $     $ (5.3 )
     State     1.3       1.3       0.7  
     Foreign                  
      1.3       1.3       (4.6 )
Deferred                        
     Federal     39.2       33.5       (157.5 )
     State     5.6       4.8       (22.5 )
     Foreign     (6.1 )     (5.1 )     (3.0 )
      38.7       33.2       (183.0 )
Total provision for (benefit from) income taxes   $ 40.0     $ 34.5     $ (187.6 )

 

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ABOVENET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

Deferred income taxes result from temporary differences in the financial reporting basis and tax basis of assets and liabilities.  The following is a summary of the significant items giving rise to the components of the Company’s deferred tax assets and liabilities.

 

    December 31,  
    2011     2010  
Deferred tax assets:            
Property and equipment   $ 70.9     $ 153.0  
Net operating loss (“NOL”) carryforwards     118.0       91.5  
Accruals and reserves     13.0       12.9  
Rent     0.4       0.6  
Deferred compensation     4.9       2.4  
Other     11.6       11.2  
Total deferred tax assets     218.8       271.6  
Valuation allowance     (49.1 )     (58.2 )
Net deferred tax assets     169.7       213.4  
Deferred tax liability: deferred revenue     (59.0 )     (63.7 )
     Total net deferred tax assets   $ 110.7     $ 149.7  

 

For each of the years ended December 31, 2011 and 2010, the Company recorded a current net tax expense for capital-based state taxes of $1.3.  The Company provided for income taxes at the statutory rate for 2011, 2010 and 2009.  In 2011, 2010 and 2009, the Company recognized $9.2, $7.3 and $183.0 of non-cash tax benefits as a result of reducing certain valuation allowances previously established with respect to deferred tax assets in the U.S. and the U.K.  We believe it is more likely than not that we will utilize these assets to reduce or eliminate tax payments in future periods.  The Company’s evaluation encompassed (i) a review of its recent history of profitability in the U.S. and U.K. for the past three years; (ii) a review of internal financial forecasts demonstrating its expected capacity to utilize deferred tax assets; and (iii) a reassessment of tax benefits recognition under FASB ASC 740.

 

    Years Ended December 31,  
    2011     2010     2009  
Income before income taxes:                  
Domestic   $ 103.9     $ 98.0     $ 89.5  
Foreign     8.8       5.9       4.5  
     Total   $ 112.7     $ 103.9     $ 94.0  
Rate Reconciliation:                        
Tax at statutory rate     35.0 %     35.0 %     35.0 %
State income tax, net of federal benefit     5.7 %     4.7 %     0.5 %
Valuation allowance     (8.2 )%     (7.1 )%     (233.0 )%
Permanent items     3.0 %     0.6 %     (2.1 )%
Tax provision (benefit)     35.5 %     33.2 %     (199.6 )%

 

 

79
 

  

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

In connection with the Company’s emergence from bankruptcy, the Company realized substantial cancellation of debt income (“CODI”).  This income was not taxable for U.S. income tax purposes because the CODI resulted from the Company’s reorganization under the Bankruptcy Code.  However, for U.S. income tax reporting purposes, the Company is required to reduce certain tax attributes, including (a) net operating loss carryforwards, (b) capital losses, (c) certain tax credit carryforwards, and (d) tax basis in assets, in a total amount equal to the gain on the extinguishment of debt.  The reorganization of the Company on the Effective Date constituted an ownership change under Section 382 of the Internal Revenue Code, and the use of any of the Company’s NOL’s, capital losses, and tax credit carryforwards, remaining after applying these provisions, and certain subsequently recognized “built-in” losses and deductions, if any, existing prior to the ownership change, were subject to an overall annual limitation through December 31, 2008.

 

As of December 31, 2011, the Company has domestic NOL carryforwards of $283.5 and foreign NOL carryforwards of $41.1.  Certain of these NOL carryforwards begin to expire in 2024.  The Company’s use of $137.7 of its domestic NOL carryforward is limited to $8.1 per annum and $145.8 is unlimited.  These NOL carryforwards may be subject to future limitation by Section 382 of the United States Internal Revenue Code.

 

The Company and its subsidiaries’ income tax returns are routinely examined by various tax authorities.  The statute of limitations is open with respect to tax years 2007 to 2010.  The statute of limitations for returns filed with respect to these years will begin to expire in 2012.

 

NOTE 9:  LONG-TERM DEBT

 

$250 Million Secured Revolving Credit Facility

 

On January 28, 2011, the Company closed a five year $250 secured revolving credit facility (the “$250 Million Secured Revolving Credit Facility”) with the lender parties thereto (the “Lenders”) and SunTrust Bank, as Administrative Agent (the “Administrative Agent”).  The Lenders received a first priority security interest in and lien on substantially all of the Company’s domestic assets and 65% of the ownership interest in the Company’s principal foreign subsidiaries.  Loans under the $250 Million Secured Revolving Credit Facility bear interest, for any interest period of one, two or three months or if agreed to, longer interest periods at the Company’s option, at either the Base Rate (as defined in the $250 Million Secured Revolving Credit Facility) plus the applicable margin ranging from 1.25% to 2.00%, or alternately, the Adjusted LIBO Rate (as defined in the $250 Million Secured Revolving Credit Facility) plus the applicable margin ranging from 2.25% to 3.00%.  The Company is also required to pay an unused commitment fee ranging from 0.375% to 0.50% per annum based on the daily average undrawn portion of the $250 Million Secured Revolving Credit Facility.  The applicable margin and the unused commitment fee will be determined based on the Company’s Leverage Ratio based on Consolidated Total Debt to Consolidated EBITDA (each as defined in the $250 Million Secured Revolving Credit Facility).

 

The $250 Million Secured Revolving Credit Facility includes an uncommitted accordion feature that permits the Company to increase the aggregate principal amount by up to $125.0 through one or more term loans or additional revolving credit, subject to the agreement by one or more Lenders to provide such additional principal amount.

 

The Company borrowed $55.0 at closing, of which $5.0 was used to pay bank fees and legal expenses, $49.9 was used to repay the Secured Credit Facility (as defined below) and $0.1 was used for general corporate purposes.  The initial borrowings under the $250 Million Secured Revolving Credit Facility carried an interest rate of 4.50% (base rate of 3.25% plus applicable margin of 1.25%).  The Company converted the interest rate to the Adjusted LIBO Rate option as of February 4, 2011, at which time the interest rate was changed to 2.52% (0.27% Adjusted LIBO Rate plus applicable margin of 2.25%).  At December 31, 2011, the $250 Million Secured Revolving Credit Facility carried an interest rate of 2.53% (0.28% Adjusted LIBO Rate plus applicable margin of 2.25%).

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ABOVENET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

The Company has the right to prepay any outstanding loan under the $250 Million Secured Revolving Credit Facility prior to its maturity without premium or penalty.

 

The Company is required to comply with a number of affirmative, negative and financial covenants.  Among other things, these covenants require the Company to provide notices of material events and information regarding collateral, restrict the Company’s ability, subject to certain exceptions and baskets, to incur additional indebtedness, grant liens on assets, undergo fundamental changes, make investments, sell assets, make restricted payments (including the ability to pay dividends) and engage in affiliate transactions, and require the Company to maintain a Leverage Ratio not greater than 2.5 to 1.0 and an Interest Coverage Ratio (as such terms are defined in the $250 Million Secured Revolving Credit Facility) of not less than 3.0 to 1.0.  At December 31, 2011, based upon the Company’s Leverage Ratio, its cash balance and its availability under the $250 Million Secured Revolving Credit Facility, $257.5 of retained earnings is unrestricted for dividend purposes and the balance is restricted.

 

The $250 Million Secured Revolving Credit Facility contains customary events of default (subject to customary grace periods, cure rights and materiality thresholds), including, among others, failure to pay principal, interest or fees, violation of covenants, material inaccuracy of representations and warranties, cross-default and cross-acceleration of material indebtedness, certain bankruptcy and insolvency events, certain judgments, certain ERISA events and a change of control.

 

Following an event of default under the $250 Million Secured Revolving Credit Facility, the Administrative Agent and the Lenders would be entitled to take various actions, including the acceleration of amounts due under the $250 Million Secured Revolving Credit Facility and seek other customary remedies that may be taken by secured creditors.

 

The outstanding principal amount of all revolving credit loans, together with accrued and unpaid interest thereon, will be due and payable on January 28, 2016.

 

In connection with the January 2011 closing of the $250 Million Secured Revolving Credit Facility, the Company also settled the two interest rate swaps at a total cost of $0.5, which is included in “Other income (expense), net” in the Company’s consolidated statement of operations for the year ended December 31, 2011.  The Company also wrote-off $1.1 in unamortized debt issuance costs associated with the Secured Credit Facility, which is also included in “Other income (expense), net” in the Company’s consolidated statement of operations for the year ended December 31, 2011.

 

As of December 31, 2011, $195.0 was available for borrowings under the $250 Million Secured Revolving Credit Facility.

 

The Company was in compliance with all of its debt covenants as of December 31, 2011.

 

Secured Credit Facility

 

On February 29, 2008, the Company, excluding certain foreign subsidiaries, entered into a Credit and Guaranty Agreement (as amended, the “Credit Agreement”) providing for a $60.0 senior secured credit facility (the “Secured Credit Facility”), consisting of an $18.0 revolving credit facility (the “Revolver”) and a $42.0 term loan facility (the “Term Loan”), which was comprised of $24.0 advanced at closing and up to $18.0 of which originally could be drawn within nine months of closing at the Company’s option (the “Delayed Draw Term Loan”).  The Secured Credit Facility was secured by substantially all of the Company’s domestic assets.  In September 2008, the Delayed Draw Term Loan option, which was originally scheduled to expire on November 25, 2008, was extended to June 30, 2009 and then subsequently extended to December 31, 2009.  The Revolver and the Term Loan each had a term of five years from February 29, 2008.  The Company paid an upfront fee of 1.5% ($0.9) of the total amount of the Secured Credit Facility and paid $0.3 to its unaffiliated third party financial advisors who assisted the Company.  The Company was also liable for an unused commitment fee of 0.75% per annum.  Interest accrued at LIBOR (30, 60, 90 or 180 day rates) or at the announced base rate of the administrative agent at the Company’s option, plus the applicable margins, as defined.  The Company chose 30 day LIBOR as the interest rate, plus the applicable margin of 3% effective September 30, 2008.  Additionally, the Company was originally required to maintain an unrestricted cash balance at all times of at least $20.0.  On February 29, 2008, the Company received proceeds, pursuant to the Term Loan of $24.0, less debt issuance costs.  Under the provisions of the Term Loan, the initial advance was at the base rate of interest, plus the margin (8.25% at February 29, 2008) and converted to LIBOR, plus 3.25% per annum (6.26%) on March 5, 2008.

81
 

 

ABOVENET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

The Company’s ability to draw upon the available commitments under the Revolver was subject to compliance with all of the covenants contained in the Credit Agreement and the Company’s continued ability to make certain representations and warranties.  Among other things, these covenants imposed limits on annual capital expenditures (through 2010), provided that the Company’s net total funded debt ratio could not at any time exceed a specified amount and required that the Company maintained a minimum consolidated fixed charges coverage ratio.  In addition, the Credit Agreement prohibited the Company from paying dividends (other than in its own shares or other equity securities) and from making certain other payments, including payments to acquire the Company’s equity securities other than under specified circumstances, which include the repurchase of the Company’s equity securities from employees and directors in an aggregate amount not to exceed $15.0.  The Company obtained a waiver from the Lenders to effectuate the dividend paid in December 2010.

 

On September 26, 2008, the Company executed a joinder agreement to the Secured Credit Facility that added an additional lender and increased the amount of the Secured Credit Facility to $90.0 effective October 1, 2008; the Revolver increased to $27.0, the Term Loan increased to $36.0 and the available Delayed Draw Term Loan increased to $27.0.  In connection with the joinder agreement, the Company paid a $0.45 fee at closing and an aggregate of $0.25 of advisory fees.  The additional amount of the Term Loan of $12.0 was advanced on October 1, 2008.

 

Effective August 4, 2008, the Company entered into a swap arrangement under which it fixed its borrowing costs with respect to the $24.0 (original principal) Term Loan outstanding for three years at 3.65%, plus the applicable margin of 3.25%, which was reduced to 3.00% on September 30, 2008.  On November 14, 2008, the Company entered into a swap arrangement under which it fixed its borrowing costs with respect to the additional $12.0 (original principal) under the Term Loan borrowed on October 1, 2008 for three years at 2.635% per annum, plus the applicable margin of 3.00%.

 

On June 29, 2009, the Company and the Lenders entered into an amendment to the Credit Agreement, which extended the availability of the Delayed Draw Term Loan commitments from June 30, 2009 to December 31, 2009, and provided for the reduction of these commitments by $0.81 on each of June 30, 2009, September 30, 2009 and December 31, 2009.  In addition, the Company’s obligation to maintain a minimum balance of $20.0 in cash deposits at all times was eliminated.

 

On December 31, 2009, the Company borrowed $24.57 under the Delayed Draw Term Loan, which carried interest at 30 day LIBOR (0.25750% at December 31, 2010), plus the applicable margin of 3.00%.  The Delayed Draw Term Loan provided for payment terms similar to the Term Loan.

 

The Term Loan provided for monthly payments of interest and quarterly installments of principal of $1.08, which commenced on June 30, 2009.  The quarterly installment of principal increased to $1.89 beginning March 31, 2010 to take into consideration the Delayed Draw Term Loan repayment schedule.  The aggregate quarterly principal repayment was scheduled to increase to $2.52 on June 30, 2012 with the balance of $32.76, plus accrued unpaid interest, due on February 28, 2013.

 

Additionally, the Company executed a $1.0 standby letter of credit in favor of the City of New York to secure the Company’s franchise agreement, which was collateralized by $1.0 of availability under the Revolver.  The standby letter of credit, originally scheduled to expire May 1, 2010, was renewed and extended.

 

The Term Loan and the Delayed Draw Term Loan, plus accrued interest, totaling $49.9 were repaid on January 28, 2011 upon the closing of the $250 Million Secured Revolving Credit Facility.  The standby letter of credit in favor of the City of New York was terminated in connection with the repayment and replaced by $1.0 standby letter of credit (secured by a $1.0 restricted cash balance) with a term scheduled to expire January 2013, subject to annual renewals at the Company’s option to January 2016.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

Obligation under Capital Lease

 

The Company is obligated under a capital lease for certain indefeasible rights-of-use, which is included as a network infrastructure asset in property and equipment, net.

 

At December 31, 2011, future minimum payments under the capital lease are as follows:

 

Year   Amount  
2012   $ 0.3  
2013     0.2  
2014     0.3  
2015     0.2  
2016     0.3  
Thereafter     0.2  
Total minimum lease payments     1.5  
Less: amount representing interest     (0.3 )
Obligation under capital lease     1.2  
Less: current portion     (0.2 )
Total long-term obligation   $ 1.0  

 

The long-term portion is reported within “Other long-term liabilities.”

 

NOTE 10:  SHAREHOLDERS’ EQUITY

 

Dividends

 

In November 2010, we obtained waivers from our lenders (Societe Generale, SunTrust Bank and CIT Lending Services Corporation) to permit a $5.00 per share dividend.  On November 23, 2010, we announced that our Board of Directors declared a special one-time cash dividend of $5.00 per share on our common stock (the “Special Cash Dividend”).  The Special Cash Dividend was paid on December 27, 2010 to the stockholders of record at the close of business on December 6, 2010.  The aggregate amount of the payment made in connection with the Special Cash Dividend was approximately $129.0.  On December 20, 2010, the Company’s Board of Directors granted restricted stock units (the “RSU Dividend”) to holders of unvested restricted stock units on the record date of the Special Cash Dividend in order to provide these holders with an amount that approximated the value of the Special Cash Dividend.  In total, the Company granted 40,508 restricted stock units pursuant to the RSU Dividend, of which 1,246 restricted stock units vested in February 2011 based upon the achievement of certain performance targets established for fiscal year 2010, of which 28,656 restricted stock units vested on November 15, 2011, of which 9,360 vested on November 16, 2011 and of which 1,246 restricted stock units vested on February 10, 2012 based upon the determination by the Compensation Committee of the Board of Directors that certain performance targets established for fiscal year 2011 had been met.

 

Additionally, on December 20, 2010, the Company’s Board of Directors granted shares of common stock (the “Option Dividend”) to holders of vested unexercised options to purchase shares of common stock in order to provide these holders with an amount that approximated the value of the Special Cash Dividend.  On December 27, 2010, the Company delivered 9,281 shares of common stock pursuant to the Option Dividend.  Additionally, the Company paid cash to one former employee and to the estate of one deceased employee totaling $0.007.  In the fourth quarter of 2010, the Company recorded stock-based compensation expense of $0.5 in connection with the Option Dividend.

83
 

 

ABOVENET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

Stock Split

 

On August 3, 2009, the Board of Directors of the Company authorized a two-for-one common stock split, effected in the form of a 100% stock dividend, which was distributed on September 3, 2009.  Each shareholder of record on August 20, 2009 received one additional share of common stock for each share of common stock held on that date.  All share and per share information for prior periods, including warrants, options to purchase common shares, restricted stock units, warrant and option exercise prices, shares reserved under the 2003 Plan and the 2008 Plan, weighted average fair value of options granted, common stock and additional paid-in capital accounts on the consolidated balance sheets and consolidated statement of shareholders’ equity, have been retroactively adjusted, where applicable, to reflect the two-for-one stock split.

 

Amendment to the Company’s Amended and Restated Certificate of Incorporation

 

On June 24, 2010, the Company’s stockholders approved an amendment to the Company’s Amended and Restated Certificate of Incorporation (the “Amendment”) to increase the number of authorized shares of our common stock, par value $0.01 per share, from 30 million to 200 million.  The number of authorized shares of preferred stock remained at 10 million.

 

The increase in the number of our authorized shares of common stock could have an anti-takeover effect by discouraging or hindering efforts to acquire control of the Company.  The Company would be able to use the additional shares to oppose a hostile takeover attempt or delay or prevent changes in control or management of the Company.  This was not the intent of the Board of Directors in adopting the Amendment, nor was the Amendment adopted in response to any known threat to acquire control of the Company.

 

The increase in the authorized shares of common stock became effective upon the filing of the Amendment with the Secretary of State of the State of Delaware on June 24, 2010.

 

Rights Agreement

 

On August 3, 2006, the Company entered into a Rights Agreement (the “Rights Agreement”) with American Stock Transfer & Trust Company, as rights agent, which was amended and restated on August 3, 2009 and subsequently amended as of January 26, 2010 (as amended, the “Amended and Restated Rights Agreement”).  The Amended and Restated Rights Agreement was ratified by the Company’s stockholders at its annual meeting on June 24, 2010.  As a result, the Rights (as defined below) under the Amended and Restated Rights Agreement will remain in effect until August 7, 2012, unless sooner terminated by the Company’s Board of Directors.  The following description of the Amended and Restated Rights Agreement does not purport to be complete and is qualified in its entirety by reference to the Amended and Restated Rights Agreement included as Exhibit 4.1 to the Company’s Current Report on Form 8-K filed with the SEC on August 3, 2009, and the Amendment to Amended and Restated Rights Agreement, dated as of January 26, 2010, between AboveNet, Inc. and American Stock Transfer & Trust Company, LLC included as Exhibit 4.1 to the Company’s Current Report on Form 8-K filed with the SEC on January 28, 2010.

 

In connection with the initial Rights Agreement, the Company’s Board of Directors declared a dividend distribution of one preferred share purchase right (a “Right”) for each then outstanding share of the Company’s common stock, par value $0.01 per share (the “Common Shares”).  The dividend was paid on August 7, 2006 to the stockholders of record on that date.

 

Until the earlier to occur of (i) the date that is 10 days following the date of a public announcement that a person, entity or group of affiliated or associated persons have acquired beneficial ownership of 15% or more of the outstanding Common Shares (an “Acquiring Person”) or (ii) 10 business days (or such later date as may be determined by action of the Company’s Board of Directors prior to such time as any person or entity becomes an Acquiring Person) following the commencement of, or announcement of an intention to commence, a tender offer or exchange offer the consummation of which would result in any person or entity becoming an Acquiring Person (the earlier of such dates being called the “Distribution Date”), the Rights will be evidenced by the Common Share certificates or book-entry shares.

84
 

 

ABOVENET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

The Rights are not exercisable until the Distribution Date.  Each Right, upon becoming exercisable, will entitle the holder to purchase from the Company a specified fraction of a share of the Company’s Series A Junior Participating Preferred Stock (the “Preferred Shares”) at the then effective purchase price.  The Rights will expire on August 7, 2012, unless earlier redeemed or exchanged.

 

The number of outstanding Rights and the number of Preferred Shares issuable upon exercise of the Rights are also subject to adjustment in the event of a stock split of the Common Shares or a stock dividend on the Common Shares payable in Common Shares or subdivisions, consolidation or combinations of the Common Shares occurring, in any case, prior to the Distribution Date.  The purchase price payable and the number of preferred shares or other securities or other property issuable upon exercise of the Rights are subject to adjustment from time to time to prevent dilution as described in the Amended and Restated Rights Agreement.  As a result of the Company’s stock split discussed above, appropriate adjustments under the Amended and Restated Rights Agreement have been made.

 

In the event that any person or group of affiliated or associated persons becomes an Acquiring Person, proper provision will be made so that each holder of a Right, other than Rights beneficially owned by the Acquiring Person and its associates and affiliates (which will thereafter be void), will have the right to receive upon exercise, in lieu of Preferred Shares, that number of Common Shares having a market value of two times the then effective exercise price of the Right (or, if such number of shares is not and cannot be authorized, the Company may issue preferred shares, cash, debt, stock or a combination thereof in exchange for the Rights).

 

In the event that the Company is acquired in a merger or other business combination transaction or 50% or more of its consolidated assets or earning power are sold to an Acquiring Person, its associates or affiliates or certain other persons, proper provision will be made so that each holder of a Right, other than Rights beneficially owned by the Acquiring Person and its associates and affiliates (which will thereafter be void), will thereafter have the right to receive, upon the exercise thereof at the then current exercise price of the Right, in lieu of Preferred Shares, that number of shares of common stock of the acquiring company, which at the time of such transaction will have a market value of two times the then effective exercise price per Right.

 

At any time after a person becomes an Acquiring Person and prior to the acquisition by such Acquiring Person of 50% or more of the outstanding Common Shares, the Company may exchange the Rights (other than Rights owned by such Acquiring Person or group which have become void), in whole or in part, at an exchange ratio of one share of common stock per Right (or, at the election of the Company, the Company may issue cash, debt, stock or a combination thereof in exchange for the Rights), subject to adjustment.

 

At any time prior to the earlier of (i) such time that a person has become an Acquiring Person or (ii) the final expiration date, the Company may redeem all, but not less than all, of the outstanding Rights at a price of $0.005 per Right (the “Redemption Price”).  The Rights may also be redeemed at certain other times as described in the Amended and Restated Rights Agreement.  Immediately upon any redemption of the Rights, the right to exercise the Rights will terminate and the only right of the holders of Rights will be to receive the Redemption Price.

 

The terms of the Rights may be amended by the Company’s Board of Directors without the consent of the holders of the Rights, except that from and after such time as the rights are distributed no such amendment may adversely affect the interest of the holders of the Rights other than the interests of an Acquiring Person or its affiliates or associates.

 

Until a Right is exercised, the holder thereof, as such, will have no rights as a stockholder of the Company, including, without limitation, the right to vote or to receive dividends.

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ABOVENET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

Repurchase Program

 

On December 7, 2011, the Board of Directors of the Company authorized a share repurchase program of up to $200.0 of the Company’s common stock through December 31, 2012 (the “Repurchase Program”).  The Board also authorized management to enter into one or more prearranged stock repurchase plans under Rule 10b5-1 of the Securities Act of 1934 in connection with the Repurchase Program.

 

Through December 31, 2011, the Company purchased 29,457 shares pursuant to the Repurchase Program at a cost of $1.9.  From January 1, 2012 through February 24, 2012, the Company purchased an additional 11,700 shares pursuant to the Repurchase Program at a cost of $0.8.

 

Stock Warrants

 

Under the Plan of Reorganization, unsecured note holder claims and general secured claims were settled, in part, by the distribution of the Five Year Warrants and the Seven Year Warrants.  (See Note 1, “Background and Organization - Bankruptcy Filing and Reorganization.”)

 

The following table summarizes the activity for the Company’s warrants for the periods presented:

 

   

Five Year

Warrants

   

Seven Year

Warrants

   

Weighted Average Warrant

Exercise Price

 
Balance as of January 1, 2008     1,352,680       1,611,122     $ 11.08  
Exercised     (1,034,084 )     (27,240 )   $ 10.05  
Exercised under the Net Exercise provisions of the Warrant Agreements     (318,526 (1)         $ 10.00  
Cancelled in connection with conclusion of the bankruptcy case     (20 )     (24 )   $ 11.09  
Cancelled in accordance with instructions from the warrant holders     (50 )         $ 10.00  
Balance as of December 31, 2008           1,583,858     $ 12.00  
Exercised           (723,510 )   $ 12.00  
Exercised under the Net Exercise provisions of the Warrant Agreements           (1,816 )(2)   $ 12.00  
Cancelled           (2 )   $ 12.00  
Balance as of December 31, 2009           858,530     $ 12.00  
Exercised           (416,842 )   $ 12.00  
Exercised under the Net Exercise provisions of the Warrant Agreements           (441,688 )(3)   $ 12.00  
Balance as of December 31, 2010               $  

 

(1) Includes 105,094 shares that were returned to treasury to settle the aggregate exercise price in connection with Net Exercises.

 

(2) Includes 476 shares that were returned to treasury to settle the aggregate exercise price in connection with Net Exercises.

 

(3) Includes 89,430 shares that were returned to treasury to settle the aggregate exercise price in connection with Net Exercises.

 

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ABOVENET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

Under the terms of the Warrant Agreements described in Note 2, “Basis of Presentation and Significant Accounting Policies - Stock Warrants” if the market price of the Company’s common stock, as defined in the Warrant Agreements, 60 days prior to the expiration date of the respective warrants, was greater than the warrant exercise price, the Company was required to give each warrant holder notice that at the warrant expiration date, the warrants would be deemed to have been exercised pursuant to the net exercise provisions of the respective Warrant Agreements (the “Net Exercise”), unless the warrant holder elected, by written notice, to not exercise its warrants.  Under the Net Exercise, shares issued to the warrant holders would be reduced by the number of shares necessary to cover the aggregate exercise price of the shares, valuing such shares at the current market price, as defined in the Warrant Agreements.  Any fractional shares, otherwise issuable, would be paid in cash.  Prior to the expiration date of the five year warrants, five year warrants to purchase 778 shares of common stock were exercised on a Net Exercise basis, resulting in the issuance of 520 common shares being issued and 258 common shares being returned to treasury.  At September 8, 2008, the expiration date of the five year warrants, the required conditions were met for Net Exercise.  Five year warrants to purchase 50 shares of common stock were cancelled in accordance with instructions from warrant holders.  Additionally, five year warrants to purchase 317,748 shares of common stock were deemed exercised on a Net Exercise basis, of which 212,912 shares were issued to the warrant holders, an additional 104,836 shares were returned to treasury and $0.004 was paid to recipients for fractional shares.

 

At September 8, 2010, the expiration date of the seven year warrants, the required conditions were met for the Net Exercise and accordingly, seven year warrants to purchase 13,626 shares of common stock were exercised at expiration, of which 10,409 shares were issued to warrant holders and 3,217 shares were returned to treasury and $0.004 was paid to recipients for fractional shares.  In total, seven year warrants to purchase 443,504 shares of common stock were deemed exercised on a net exercise basis, of which 353,598 shares were issued to the warrant holders, 89,906 shares were returned to treasury and $0.004 was paid to recipients for fractional shares.  In addition, seven year warrants to purchase 26 shares of common stock were determined to be undeliverable and were cancelled.

 

NOTE 11:  INCOME PER COMMON SHARE

 

Basic net income per common share is computed as net income divided by the weighted average number of common shares outstanding for the period.  Total weighted average shares utilized in computing basic net income per common share were 25,902,123, 25,293,188 and 23,504,077 for the years ended December 31, 2011, 2010, and 2009, respectively.  Total weighted average shares utilized in computing diluted net income per common share were 26,822,614, 26,242,696 and 25,468,405 for the years ended December 31, 2011, 2010, and 2009, respectively.  Dilutive securities include options to purchase shares of common stock, restricted stock units and stock warrants.  For the years ended December 31, 2011, 2009 and 2010, there were no potentially dilutive securities excluded from the calculation of diluted income per common share.

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 ABOVENET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

NOTE 12: STOCK-BASED COMPENSATION

 

2011 Equity Incentive Plan, 2008 Equity Incentive Plan and 2003 Plan

 

On May 11, 2011, the Board of Directors of the Company adopted the AboveNet, Inc. 2011 Equity Incentive Plan (the “2011 Plan”), which provides for the availability of a maximum of 1,600,000 shares of the Company’s common stock to be awarded to the Company’s employees (including officers), directors and consultants in the form of restricted stock unit awards, restricted stock awards, incentive stock options, non-qualified stock options, stock appreciation rights, performance-based awards and other stock- or cash-based awards.  The 2011 Plan was approved by the Company’s stockholders at the Company’s 2011 annual meeting of stockholders held on June 23, 2011.  The 2011 Plan will be administered by the Compensation Committee, which will, in its sole discretion, determine which individuals may participate in the 2011 Plan and the type, extent and terms of the awards to be granted.  The number of shares available for grant and the terms of outstanding grants are subject to adjustment for stock splits, stock dividends and other capital adjustments.  As of December 31, 2011, 396,200 common shares were reserved pursuant to outstanding restricted stock units and 1,203,800 common shares were available for future grants.

 

On August 29, 2008, the Board of Directors of the Company approved the Company’s 2008 Plan.  The 2008 Plan is administered by the Company’s Compensation Committee.  Any employee, officer, director or consultant of the Company or subsidiary of the Company selected by the Compensation Committee is eligible to receive awards under the 2008 Plan.  Stock options, restricted and unrestricted stock, restricted and unrestricted stock units and stock appreciation rights may be awarded to eligible participants on a stand alone, combination or tandem basis.  1,500,000 shares of the Company’s common stock were initially reserved for issuance pursuant to awards granted under the 2008 Plan.  The number of shares available for grant and the terms of outstanding grants are subject to adjustment for stock splits, stock dividends and other capital adjustments.  Under the 2008 Plan, as of December 31, 2011, 940,418 common shares were issued pursuant to the delivery of vested restricted stock units (including shares repurchased by the Company), 3,288 common shares had been issued pursuant to the exercise of options to purchase shares of common stock, 9,281 common shares were issued pursuant to the Option Dividend on December 20, 2010, 403,196 common shares were reserved pursuant to outstanding restricted stock units, 6,712 common shares were reserved pursuant to outstanding options to purchase shares of common stock and 137,105 common shares were available for future grants.

 

On September 8, 2003, the 2003 Plan became effective.  Under the 2003 Plan, the Company was authorized to issue, in the aggregate, share-based awards of up to 2,129,912 common shares to employees, directors and consultants who were selected to participate.  The number of shares available for grant and the terms of outstanding grants are subject to adjustment for stock splits, stock dividends and other capital adjustments.  Under the 2003 Plan, as of December 31, 2011, 1,169,432 common shares had been issued pursuant to vested restricted stock units (including shares repurchased by the Company), 850,643 common shares had been issued pursuant to options exercised to purchase common shares, 75,459 common shares were reserved pursuant to outstanding vested options to purchase shares of common stock and 34,378 common shares were cancelled.  No shares are available for future grants under the 2003 Plan.

 

Stock-based compensation expense for each period presented relates to share-based awards granted under the Company’s 2011 Plan described above, the 2008 Plan described above and the Company’s 2003 Plan, as applicable, and reflects awards outstanding during the applicable period, including awards granted both prior to and during such period.

 

Stock Options

 

There were no options to purchase shares of common stock granted during the years ended December 31, 2011, 2010 and 2009.

 

The Company recognized non-cash stock-based compensation expense amounting to $0.2 for the year ended December 31, 2009 with respect to stock options granted, which had an effect of decreasing net income by $0.01 per basic common share and by $0.01 per diluted common share for the year ended December 31, 2009.  There was no non-cash stock-based compensation expense recognized with respect to options to purchase shares of common stock during the years ended December 31, 2011 and 2010.

 

All such options are subject to forfeiture as specified in the respective award agreement.

88
 

 

ABOVENET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

Information regarding options to purchase common stock granted, exercised and outstanding for the years ended December 31, 2011, 2010 and 2009 is summarized below:

    Number Outstanding    

Weighted Average

Exercise Price

Per Share

   

Aggregate Intrinsic

Value

   

Weighted Average Grant Date

Fair Value

Per Share

 
Balance as of January 1, 2009     942,102     $ 13.84           $ 8.76  
Exercised                                                    (742,626 )   $ 13.52           $ 8.62  
Forfeited                                                    (5,500 )   $ 18.46           $ 12.09  
Balance as of December 31, 2009     193,976     $ 14.93           $ 9.66  
Exercised                                                    (86,778 )   $ 13.79           $ 8.91  
Forfeited                                                    (300 )   $ 25.33           $ 16.99  
Balance as of December 31, 2010     106,898     $ 15.83           $ 10.24  
Exercised                                                    (24,527 )   $ 14.23           $ 9.28  
Forfeited                                                    (200 )   $ 36.50           $ 24.58  
Balance as of December 31, 2011     82,171     $ 16.25     $ 4.0     $ 10.50  
Vested as of December 31, 2011     82,171     $ 16.25             $ 10.50  
Exercisable as of December 31, 2011     82,171     $ 16.25     $ 4.0     $ 10.50  

 

The grant date fair value of vested options to purchase common stock was as follows at December 31:

 

   

Number of Options

to Purchase Common

Stock Vested

   

Total Grant Date Fair

Value of Vested Options

 
2011                         82,171     $ 0.9  
2010                         106,898     $ 1.1  
2009                         193,976     $ 1.9  

 

The aggregate grant date fair value of options to purchase shares of common stock that vested during the year ended December 31, 2009 was $0.2 (10,000 shares).  No options to purchase shares of common stock vested during the years ended December 31, 2011 and 2010.

 

At December 31, 2010, all options to purchase shares of common stock were vested and, accordingly, the Company had no unearned stock-based compensation expense associated with options to purchase shares of common stock.

 

In November 2005, the FASB issued FASB Staff Position No. SFAS 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards.” The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (“APIC Pool”) related to the tax effects of employee share-based compensation, and to determine the subsequent impact on the APIC Pool and consolidated statements of cash flows of the tax effects of employee share-based compensation awards that are outstanding upon adoption of SFAS No. 123(R).  The Company has adopted this method and determined the APIC Pool to be $2.8.  The Company reduced the APIC Pool by $0.1 in 2008 to reflect the tax effect of the delivery of common shares underlying restricted stock units in 2008.  There were 24,527, 86,778 and 742,626 options to purchase common shares exercised in the years ended December 31, 2011, 2010 and 2009, respectively.

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ABOVENET, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share information)

 

The following table summarizes information concerning outstanding and exercisable options to purchase common stock at December 31, 2011:

 

Exercise Prices    

Options Outstanding and

Exercisable

    Weighted Average Remaining Contractual Life (Years)    

Weighted Average Exercise Price

Per Share of Options Outstanding and Exercisable

 
$10.48       34,259       1.7     $ 10.48  
$12.50       15,265       3.6     $ 12.50  
$15.00 - $19.99       12,660       2.7     $ 16.42  
$20.00 - $24.99       3,300       3.9     $ 20.00  
$25.00 - $29.99       5,975       4.7     $ 27.52  
$30.00       6,712       6.7     $ 30.00  
$36.50       4,000       5.6     $ 36.50  
Total       82,171       3.1     $ 16.25  

 

Restricted Stock Units

 

On December 1, 2011, pursuant to the 2011 Plan, the Board of Directors of the Company awarded 381,200 restricted stock units to certain employees, including 3,000 each to the five non-employee members of the Board of Directors and an aggregate 152,000 restricted stock units to the Company’s named executive officers as follows:

 

Name   Total  
William G. LaPerch     65,000  
Rajiv Datta     45,000  
Joseph P. Ciavarella     21,000  
Robert Sokota     21,000  

 

The fair value of the grants was $59.49 per share, the closing price of the Company’s common stock on the New York Stock Exchange on that day.  The restricted stock units are scheduled to vest 127,059, 127,059 and 127,082 on November 16, 2012, November 16, 2013 and November 16, 2014, respectively.

 

On August 26, 2011, pursuant to the 2011 Plan, the Board of Directors of the Company awarded 15,000 restricted stock units to a named executive officer.  The fair value of the grant was $57.54 per share, the closing price of the Company’s common stock on the New York Stock Exchange on that day.  The restricted stock units are scheduled to vest 10,000 shares on November 16, 2012 and 5,000 shares on November 16, 2013.

 

On January 25, 2011, pursuant to the 2008 Plan, the Company granted an aggregate 213,100 restricted stock units, of which 190,000 were granted to the Company’s named executive officers as follows (including the 15,000 restricted stock units granted to Mr. Datta in connection with his appointment as Chief Operating Officer):

 

Name   Total  
William G. LaPerch     65,000  
Rajiv Datta     60,000  
Joseph P. Ciavarella     21,000  
Robert Sokota     21,000  
John Jacquay     23,000  

 

The fair value of each restricted stock unit granted was $59.25, the closing price of the Company’s common stock on the New York Stock Exchange on January 25, 2011.  The 213,100 restricted stock units were originally scheduled to vest as follows: 15,000 on November 16, 2011, 132,066 on November 16, 2012 and 66,034 on November 16, 2013.  Mr. Jacquay’s restricted stock units that were scheduled to vest in 2012 and 2013 were forfeited upon his resignation effective December 31, 2011. An additional 21,000 restricted stock units granted in 2011 were forfeited in 2011.

90