UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 WASHINGTON,
D.C. 20549
 
 FORM
10-Q
 
 x
              QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934
 
 For
the quarterly period ended March 31, 2009
 
 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)
 
 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  ̈   No  ̈
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
 Large accelerated filer   ̈
              Accelerated filer  x
              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 Exchange Act).  Yes  ̈    No x
 
 The
number of shares of the registrant’s common stock, par value $0.01 per share,
outstanding as of May 8, 2009, was11,371,164.
  
  
  Table of
Contents
 
 ABOVENET,
INC.
 
 INDEX
  PagePart
      I.
                            
                            FINANCIAL
      INFORMATIONItem
      1.
                            
                            Financial
      StatementsConsolidated
      Balance SheetsAs
      of March 31, 2009 (Unaudited) and December 31, 2008
                            
                            1Consolidated
      Statements of Operations (Unaudited)Three
      month periods ended March 31, 2009 and 2008
                            
                            2Consolidated
      Statement of Shareholders’ Equity (Unaudited)Three
      month period ended March 31, 2009
                            
                            3Consolidated
      Statements of Cash Flows (Unaudited)Three
      month periods ended March 31, 2009 and 2008
                            
                            4Consolidated
      Statements of Comprehensive Income (Unaudited)Three
      month periods ended March 31, 2009 and 2008
                            
                            5Notes
      to Unaudited Consolidated Financial Statements
                            
                            6Item
      2.
                            
                            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                            
                            29Item
      3.
                            
                            Quantitative
      and Qualitative Disclosures about Market Risk
                            
                            51Item
      4.
                            
                            Controls
      and Procedures
                            
                            52Part
      II.
                            
                            OTHER
      INFORMATIONItem
      1.
                            
                            Legal
      Proceedings
                            
                            53Item
      1A.
                            
                            Risk
      Factors
                            
                            53Item
      5.
                            
                            Other
      Information
                            
                            53Item
      6.
                            
                            Exhibits
                            
                            54Signatures
                            
                            55Exhibit
      Index
  
  PART
I. FINANCIAL INFORMATION
 
 ITEM
1. FINANCIAL STATEMENTS
 
 ABOVENET,
INC. AND SUBSIDIARIES
 
 CONSOLIDATED
BALANCE SHEETS
 (in
millions, except share and per share information)
 
 March 31,
                      2009
                    
                    
                    December 31,
                      2008(Unaudited)ASSETS:Current
      assets:Cash
      and cash equivalents
                    
                    $
                    101.3
                    
                    
                    $
                    87.1Restricted
      cash and cash equivalents
                    
                    
                    3.5
                    
                    
                    
                    3.5Accounts
      receivable, net of allowances of $1.3 each at March 31, 2009 and December
      31, 2008
                    
                    
                    19.8
                    
                    
                    
                    20.9Prepaid
      costs and other current assets
                    
                    
                    12.2
                    
                    
                    
                    9.8Total
      current assets
                    
                    
                    136.8
                    
                    
                    
                    121.3Property
      and equipment, net of accumulated depreciation and amortization of $210.9
      and $207.4 at March 31, 2009 and December 31, 2008,
      respectively
                    
                    
                    411.6
                    
                    
                    
                    398.4Other
      assets
                    
                    
                    5.9
                    
                    
                    
                    5.9Total
      assets
                    
                    $
                    554.3
                    
                    
                    $
                    525.6LIABILITIES:Current
      liabilities:Accounts
      payable
                    
                    $
                    8.7
                    
                    
                    $
                    13.9Accrued
      expenses
                    
                    
                    59.0
                    
                    
                    
                    65.9Deferred
      revenue—current portion
                    
                    
                    28.7
                    
                    
                    
                    26.5Note
      payable - current
                    
                    
                    4.3
                    
                    
                    
                    3.2Total
      current liabilities
                    
                    
                    100.7
                    
                    
                    
                    109.5Note
      payable
                    
                    
                    31.7
                    
                    
                    
                    32.8Deferred
      revenue
                    
                    
                    96.8
                    
                    
                    
                    88.5Other
      long-term liabilities
                    
                    
                    10.1
                    
                    
                    
                    10.5Total
      liabilities
                    
                    
                    239.3
                    
                    
                    
                    241.3Commitments
      and contingenciesSHAREHOLDERS’
      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, 30,000,000 shares authorized, $0.01 par value, 11,621,437 issued
      and 11,365,305 outstanding as of March 31, 2009, and 11,609,737 issued and
      11,358,301 outstanding as of December 31, 2008
                    
                    
                    0.1
                    
                    
                    
                    0.1Additional
      paid-in capital
                    
                    
                    282.9
                    
                    
                    
                    280.0Treasury
      stock at cost, 256,132 and 251,436 shares at March 31, 2009 and December
      31, 2008, respectively
                    
                    
                    (16.4
                    )
                    
                    
                    (16.3
                    )Accumulated
      other comprehensive loss
                    
                    
                    (8.8
                    )
                    
                    
                    (9.3
                    )Retained
      earnings
                    
                    
                    57.2
                    
                    
                    
                    29.8Total
      shareholders’ equity
                    
                    
                    315.0
                    
                    
                    
                    284.3Total
      liabilities and shareholders’ equity
                    
                    $
                    554.3
                    
                    
                    $
                    525.6
 
 The
accompanying notes are an integral part of these consolidated financial
statements.
  1
  ABOVENET,
INC. AND SUBSIDIARIES
 
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 (in
millions, except share and per share information)
 
 (Unaudited)
 
 Three
      Months Ended March 31,2009
                  
                  
                  2008Revenue
                  
                  $
                  85.4
                  
                  
                  $
                  70.9Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                  
                  
                  29.4
                  
                  
                  
                  30.8Selling,
      general and administrative expenses
                  
                  
                  20.7
                  
                  
                  
                  24.8Depreciation
      and amortization
                  
                  
                  11.9
                  
                  
                  
                  12.6Operating
      income
                  
                  
                  23.4
                  
                  
                  
                  2.7Other
      income (expense):Interest
      income
                  
                  
                  0.2
                  
                  
                  
                  0.5Interest
      expense
                  
                  
                  (1.2
                  )
                  
                  
                  (0.7
                  )Other
      (expense) income, net
                  
                  
                  (0.1
                  )
                  
                  
                  1.5Income
      before income taxes
                  
                  
                  22.3
                  
                  
                  
                  4.0(Benefit
      from) provision for income taxes
                  
                  
                  (5.1
                  )
                  
                  
                  0.6Net
      income
                  
                  $
                  27.4
                  
                  
                  $
                  3.4Income
      per share, basic:Basic
      income per share
                  
                  $
                  2.39
                  
                  
                  $
                  0.32Weighted
      average number of common shares
                  
                  
                  11,461,142
                  
                  
                  
                  10,722,975Income
      per share, diluted:Diluted
      income per share
                  
                  $
                  2.22
                  
                  
                  $
                  0.28Weighted
      average number of common shares
                  
                  
                  12,306,856
                  
                  
                  
                  12,238,498
 
 The
accompanying notes are an integral part of these consolidated financial
statements.
  2
 
 ABOVENET,
INC. AND SUBSIDIARIES
 
 CONSOLIDATED
STATEMENT OF SHAREHOLDERS’ EQUITY
 (in
millions, except share information)
 
 (Unaudited)
 
 Common
      Stock
                                                
                                                Treasury
      Stock
                                                
                                                Other Shareholders’
      EquityShares
                                                
                                                Amount
                                                
                                                Shares
                                                
                                                Amount
                                                
                                                Additional
                                                  Paid-in
                                                  Capital
                                                
                                                Accumulated
                                                  Other
                                                  Comprehensive
                                                  Loss
                                                
                                                Retained
      Earnings
                                                
                                                Total
                                                  Shareholders’
                                                  EquityBalance
      at January 1, 2009
                                                11,609,737
                                                
                                                $
                                                0.1
                                                
                                                251,436
                                                
                                                $
                                                (16.3
                                                )
                                                $
                                                280.0
                                                
                                                $
                                                (9.3
                                                )
                                                $
                                                29.8
                                                
                                                $
                                                284.3Issuance
      of common stock from exercise of warrants
                                                200
                                                
                                                —
                                                
                                                —
                                                
                                                —
                                                
                                                —
                                                
                                                —
                                                
                                                —
                                                
                                                —Issuance
      of common stock from vested restricted stock
                                                11,500
                                                
                                                —
                                                
                                                —
                                                
                                                —
                                                
                                                —
                                                
                                                —
                                                
                                                —
                                                
                                                —Purchase
      of treasury stock
                                                —
                                                
                                                —
                                                
                                                4,696
                                                
                                                (0.1
                                                )
                                                —
                                                
                                                —
                                                
                                                —
                                                
                                                (0.1
                                                )Foreign
      currency translationadjustments
                                                —
                                                
                                                —
                                                
                                                —
                                                
                                                —
                                                
                                                —
                                                
                                                0.5
                                                
                                                —
                                                
                                                0.5Amortization
      of stock-based
      compensation expense for stock options andrestricted
      stock units
                                                —
                                                
                                                —
                                                
                                                —
                                                
                                                —
                                                
                                                2.9
                                                
                                                —
                                                
                                                —
                                                
                                                2.9Net
      income
                                                —
                                                
                                                —
                                                
                                                —
                                                
                                                —
                                                
                                                —
                                                
                                                —
                                                
                                                27.4
                                                
                                                27.4Balance
      at March 31, 2009
                                                11,621,437
                                                
                                                $
                                                0.1
                                                
                                                256,132
                                                
                                                $
                                                (16.4
                                                )
                                                $
                                                282.9
                                                
                                                $
                                                (8.8
                                                )
                                                $
                                                57.2
                                                
                                                $
                                                315.0
 
 The
accompanying notes are an integral part of these consolidated financial
statements.
  3
 
 ABOVENET,
INC. AND SUBSIDIARIES
 
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 (in
millions)
 
 (Unaudited)
 
 Three
      Months Ended March 31,2009
                      
                      
                      2008Cash
      flows provided by (used in) operating activities:Net
      income
                      
                      $
                      27.4
                      
                      
                      $
                      3.4Adjustments
      to reconcile net income to net cash provided by
operations:Depreciation
      and amortization
                      
                      
                      11.9
                      
                      
                      
                      12.6Provision
      for bad debts
                      
                      
                      0.1
                      
                      
                      
                      0.2Non-cash
      stock-based compensation expense
                      
                      
                      2.9
                      
                      
                      
                      4.2Loss
      (gain) on sale or disposition of property and equipment,
      net
                      
                      
                      0.2
                      
                      
                      
                      (1.4
                      )Changes
      in operating working capital:Accounts
      receivable
                      
                      
                      0.9
                      
                      
                      
                      (3.2
                      )Prepaid
      costs and other current assets
                      
                      
                      (2.4
                      )
                      
                      
                      2.7Accounts
      payable
                      
                      
                      (5.2
                      )
                      
                      
                      2.7Accrued
      expenses
                      
                      
                      (10.6
                      )
                      
                      
                      (3.2
                      )Other
      assets
                      
                      
                      —
                      
                      
                      
                      (0.1
                      )Deferred
      revenue and other long-term liabilities
                      
                      
                      10.6
                      
                      
                      
                      7.4Net
      cash provided by operating activities
                      
                      
                      35.8
                      
                      
                      
                      25.3Cash
      flows provided by (used in) investing activities:Proceeds
      from sales of property and equipment
                      
                      
                      —
                      
                      
                      
                      1.6Purchases
      of property and equipment
                      
                      
                      (21.2
                      )
                      
                      
                      (28.2
                      )Net
      cash used in investing activities
                      
                      
                      (21.2
                      )
                      
                      
                      (26.6
                      )Cash
      flows provided by (used in) financing activities:Proceeds
      from note payable, net of financing costs
                      
                      
                      —
                      
                      
                      
                      22.3Change
      in restricted cash and cash equivalents
                      
                      
                      —
                      
                      
                      
                      (0.3
                      )Principal
      payment - capital lease obligation
                      
                      
                      (0.2
                      )
                      
                      
                      (0.2
                      )Purchase
      of treasury stock
                      
                      
                      (0.1
                      )
                      
                      
                      (0.1
                      )Net
      cash (used in) provided by financing activities
                      
                      
                      (0.3
                      )
                      
                      
                      21.7Effect
      of exchange rates on cash
                      
                      
                      (0.1
                      )
                      
                      
                      —Net
      increase in cash and cash equivalents
                      
                      
                      14.2
                      
                      
                      
                      20.4Cash
      and cash equivalents, beginning of period
                      
                      
                      87.1
                      
                      
                      
                      45.8Cash
      and cash equivalents, end of period
                      
                      $
                      101.3
                      
                      
                      $
                      66.2Supplemental
      cash flow information:Cash
      paid for interest
                      
                      $
                      0.7
                      
                      
                      $
                      0.2Cash
      paid for income taxes
                      
                      $
                      2.0
                      
                      
                      $
                      0.7
 
 The
accompanying notes are an integral part of these consolidated financial
statements.
  4
  ABOVENET,
INC. AND SUBSIDIARIES
 
 CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME
 (in
millions)
 
 (Unaudited)
 
 Three
      Months Ended March 31,2009
                  
                  
                  2008Net
      income
                  
                  $
                  27.4
                  
                  
                  $
                  3.4Foreign
      currency translation adjustments
                  
                  
                  0.5
                  
                  
                  
                  (0.4
                  )Change
      in fair value of interest rate swap contracts
                  
                  
                  —
                  
                  
                  
                  —Comprehensive
      income
                  
                  $
                  27.9
                  
                  
                  $
                  3.0
 
 The
accompanying notes are an integral part of these consolidated financial
statements.
  5
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 (in
millions, except share and per share information)
 
 NOTE
1:    BACKGROUND AND ORGANIZATION
 
 Business
  AboveNet, Inc.
(together with its subsidiaries, the “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.”).
 
 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:
 
 Basis
of Presentation and Use of Estimates
  The
accompanying unaudited 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”).  These consolidated
financial statements include the accounts of the Company, as
applicable.  They do not include all of the information and footnotes
required by accounting principles generally accepted in the United States of
America for complete financial statements.  In the opinion of
management, all adjustments (consisting of normal recurring accruals),
considered necessary for a fair presentation have been
included.  These unaudited consolidated financial statements should be
read in conjunction with the Company’s consolidated financial statements and
related notes included in the Company’s Annual Report on Form 10-K for the
fiscal year ended December 31, 2008.  Operating results for the
three months ended March 31, 2009 are not necessarily indicative of the results
that may be expected for the year ending December 31, 2009.
 
 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
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. on
August 29, 2003.  Equity interests in MFN received no
distribution under the Plan of Reorganization and the equity securities of MFN
were cancelled.
  6
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 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). The holders of common stock are entitled to one vote for each issued and
outstanding share, and will be 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 Shareholders’ Rights Plan. 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.
 
 Pursuant
to the Plan of Reorganization, upon the Company’s emergence from bankruptcy, the
Company issued to its pre-petition creditors 8,750,000 shares of common stock,
of which 8,749,138 were delivered and 862 were determined to be undeliverable
and were cancelled, rights to purchase 1,669,210 shares of common stock at a
price of $29.9543, under a rights offering, of which rights to purchase
1,668,992 shares have been exercised, five year stock purchase warrants to
purchase 709,459 shares of common stock exercisable at a price of $20.00 per
share, and seven year stock purchase warrants to purchase 834,658 shares of
common stock exercisable at a price of $24.00 per share. In addition, 1,064,956
shares of common stock were reserved for issuance under the Company’s 2003 Stock
Incentive Plan. See Note 6, “Stock-Based Compensation.”
 
 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” (“SOP 90-7”).
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 based upon 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 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.
  7
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 Revenue
Recognition
  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 related service period.
 
 In
accordance with SEC Staff Accounting Bulletin ("SAB") No. 101, “Revenue
Recognition in Financial Statements,” as amended by SEC SAB No. 104, “Revenue
Recognition,” the Company generally amortizes revenue related to installation
services on a straight-line basis over the contracted customer relationship,
which generally ranges from two to twenty years.
 
 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 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. During the three months ended March 31, 2009 and
2008, the Company included the receipts of bankruptcy claim settlements from
former customers as contract termination revenue. Contract termination revenue
is reported together with other service revenue, and amounted to $1.9 and $0.3
for the three months ended March 2009 and 2008, respectively.
 
 Non-Monetary
Transactions
  The
Company may exchange capacity with other capacity or service providers. In
December 2004, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”) No. 153, “Exchanges of
Nonmonetary Assets - An Amendment of APB Opinion No. 29,” (“SFAS No. 153”). SFAS
No. 153 amends Accounting Principles Board Opinion No. 29, “Accounting for
Nonmonetary Transactions,” (“APB No. 29”) 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 three
months ended March 31, 2009 and 2008.
 
 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 2023, 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,” 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.
  8
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 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.
 
 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, corporate and government customers, located primarily in the U.S. and
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 credit worthiness, 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.
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, which is included in network infrastructure assets
on the respective balance sheets. 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 field engineers and IP
engineers and reflects their capitalized salary plus related benefits, and is
based upon an allocation of their time between capitalized and non-capitalized
projects. These individuals’ salaries are considered to be costs directly
associated with the construction of certain infrastructure and customer
build-outs. The salaries and related benefits of non-engineers and supporting
staff that are part of the engineering departments are not considered part of
the pool subject to capitalization. Capitalized direct labor amounted to $2.7
for each of the three months ended March 31, 2009 and 2008. 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 lives or the term of the
lease.
 
 Estimated
useful lives of the Company’s property and equipment are as
follows:
  Storage
      huts
                      
                      20 yearsNetwork
      infrastructure assets
                      
                      20
      yearsSoftware
      and computer equipment
                      
                      3
      to 4 yearsTransmission
      and IP equipment
                      
                      3
      to 7 yearsFurniture,
      fixtures and equipment
                      
                      3
      to 10 yearsLeasehold
      improvements
                      
                      Lesser
      of estimated useful life or the lease
term
 
 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 (loss).
  9
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (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 new fiber and associated construction costs of the relocation
placed into service, which is reduced by any reimbursements received for such
costs. The Company capitalized relocation costs amounting to $0.7 for each of
the three months ended March 31, 2009 and 2008. The Company fully depreciated
the remaining carrying value of the network infrastructure rendered unusable,
which on an original cost basis, totaled $0.1 and $0.2 ($0.07 and $0.1 on a net
book value basis) for the three months ended March 31, 2009 and 2008,
respectively. To the extent that relocation requires only the movement of
existing network infrastructure to another location, the related costs are
included in our results of operations.
 
 In
accordance with SFAS No. 34, “Capitalization of Interest Cost,” the Company will
capitalize interest on certain construction projects. No such amounts were
capitalized for the three months ended March 31, 2009 and 2008.
 
 In
accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets,” 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 asset. There were no provisions for impairment recorded in the three months
ended March 31, 2009 and 2008.
 
 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,” 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.
 
 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 $6.9 and $7.1 at
March 31, 2009 and December 31, 2008, respectively, of which $3.7 and $4.0,
respectively, were included in “Accrued expenses,” and $3.2 and $3.1,
respectively, were included in “Other long-term liabilities” at such dates.
Accretion expense, which is included in “Interest expense,” amounted to $0.1 for
each of the three months ended March 31, 2009 and 2008.
  10
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 Income
Taxes
  The
Company accounts for income taxes in accordance with SFAS No. 109, “Accounting
for Income Taxes,” (“SFAS No. 109”). 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 bases, net operating loss and tax credit carry-forwards,
and tax contingencies. 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. The Company
records a valuation allowance against deferred tax assets to the extent that it
is more likely than not that some portion or all of the deferred tax assets will
not be realized.
 
 We are
subject to audit 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,”
(“Interpretation No. 48”) when, despite our belief that our tax return positions
are appropriate and supportable under appropriate tax law, we believe there is
uncertainty with respect to certain positions and we may not succeed in
realizing the tax position. We have evaluated our tax positions for items of
uncertainty in accordance with Interpretation No. 48 and have determined that
our tax positions are highly certain within the meaning of Interpretation No.
48. 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 three months ended March
31, 2009 and 2008.
 
 The
provision for income taxes, income taxes payable and deferred income taxes are
provided for in accordance with the liability method. Deferred tax assets and
liabilities are determined based on differences between the financial reporting
and tax basis of assets and liabilities and are measured by applying enacted tax
rates and laws to taxable years in which such differences are expected to
reverse. A valuation allowance is provided when the Company determines that it
is more likely than not that a portion of the deferred tax asset balance will
not be realized.
 
 The
Company’s reorganization resulted in a significantly modified capital structure
as a result of applying fresh-start accounting in accordance with SOP 90-7 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. Specifically, fresh start accounting requires the reversal of such
allowances to be recorded as a reduction of intangible assets until exhausted
and thereafter as additional paid in capital. 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 (all 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 calculations; however,
unrecognized 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 Interpretation No. 48, 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 three months ended March 31, 2009 and 2008. The (benefit from) provision for
income taxes is primarily due to current federal income taxes and state and
local income taxes.
  11
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 Foreign
Currency Translation and Transactions
  The
Company’s functional 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 (loss). The Company’s foreign
exchange transaction gains (losses) are generally included in “other (expense)
income, 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”). SFAS No. 148 amended SFAS No. 123, “Accounting for Stock-Based
Compensation,” (“SFAS No. 123”), to provide alternative methods of transition to
SFAS No. 123’s fair value method of accounting for stock-based employee
compensation. See Note 6, “Stock-Based Compensation.”
 
 Under the
fair value provisions of SFAS No. 123, 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 consumation of our 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)”), 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 occur. As the Company 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 the Company’s consolidated financial statements. There were
no options to purchase shares of common stock granted during the three months
ended March 31, 2009 and 2008.
 
 Restricted
Stock Units
  Compensation
cost for restricted stock unit awards is measured based upon the quoted closing
market price for the stock on the date of grant. The compensation cost is
recognized on a straight-line basis over the vesting period. See Note 6,
“Stock-Based Compensation.”
  12
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 Stock
Warrants
  In
connection with the Plan of Reorganization described in Note 2, “Basis of
Presentation and Significant Accounting Policies,” the Company issued to holders
of general unsecured claims as part of the settlement of such claims (i) five
year warrants to purchase 709,459 shares of common stock with an exercise price
of $20.00 per share (expired September 8, 2008) and (ii) seven year warrants to
purchase 834,658 shares of common stock with an exercise price of $24.00 per
share (expiring September 8, 2010). The stock warrants are 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 200 and 1,391
during the three months ended March 31, 2009 and 2008,
respectively.
 
 Under the terms of the five
year and seven year warrant agreements (collectively, the “Warrant Agreements”),
if the market price of our common stock, as defined in the Warrant Agreements,
60 days prior to the expiration date of the respective warrants, is greater than
the warrant exercise price, the Company is 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 elects, 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 159,263 shares of
common stock were deemed exercised pursuant to the Net Exercise (including
warrants to purchase 389 shares of common stock, which were exercised on a net
exercise basis prior to expiration), of which 106,716 shares were issued to the
warrant holders, 52,547 shares were returned to treasury and $0.004 was paid to
recipients for fractional shares. In addition, five year warrants to purchase 25
shares of common stock were cancelled in accordance with instructions from
warrant holders. Finally, seven year warrants to purchase 13 shares of common
stock were determined to be undeliverable and were cancelled.
  Derivative
Financial Instruments
  The
Company utilizes interest rate swaps, derivative financial instruments
(“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 $24 portion of the Term Loan (as such term is defined in Note 3,
“Note Payable”) and the Company purchased a second interest rate swap on
November 14, 2008 to hedge the interest rate on the additional $12 portion of
the Term Loan provided by SunTrust Bank. The Company accounted for the
derivatives under the SFAS No. 133, “Accounting for Derivative Instruments and
Hedging Activities” (“SFAS No. 133”). SFAS No. 133 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 SFAS No. 133, the interest rate swaps were
considered cash flow hedges and were 100% effective. Accordingly, changes in the
fair value of derivatives are and will be recorded each period in accumulated
other comprehensive income (loss). Changes in the fair value of the derivatives
reported in accumulated other comprehensive income (loss) will be reclassified
into earnings in the period in which earnings are 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 income (loss) each at March 31, 2009 and
December 31, 2008 was $1.6 for the interest rate swaps. The mark-to-market value
of the cash flow hedges will be recorded in other non-current assets or other
long-term liabilities, as applicable, and the offsetting gains or losses in
accumulated other comprehensive income (loss).
 
 On
January 1, 2009, the Company adopted SFAS No. 161, “Disclosures about Derivative
Instruments and Hedging Activities – an amendment of FASB Statement No. 133,”
(“SFAS No. 161”). SFAS No. 161 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 SFAS No. 133; and
(iii) how derivatives and related hedged items affect an entity’s financial
position and cash flows.
  13
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 The
Company minimizes 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. The Company does not enter into derivatives for trading
or other speculative purposes.
 
 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 SFAS No. 133. As of March 31,
2009 and December 31, 2008, the Company’s consolidated balance sheets included
net interest rate swap derivative liabilities of $1.6 each.
 
 Derivatives
recorded at fair value in the Company’s consolidated balance sheets as of March
31, 2009 and December 31, 2008 consisted of the following:
 
 Derivative
      LiabilitiesDerivatives
      designated as hedging instruments
                              
                              March
      31, 2009
                              
                              
                              December
      31, 2008Interest
      rate swap agreements (*)
                              
                              $
                              1.6
                              
                              
                              $
                              1.6Total
      derivatives designated as hedging instruments
                              
                              $
                              1.6
                              
                              
                              $
                              1.6
 
 (*)
                    The
      derivative liabilities are interest rate swap agreements with original
      three year terms. They are both considered to be long-term liabilities for
      financial statement
purposes.
 
 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 March 31, 2009.
  Weighted
      Average RateNotional
      Amount
                                      
                                      Maturity
      Date
                                      
                                      Pay
                                      
                                      
                                      Receive$
                                      24
                                      
                                      2011
                                      
                                      
                                      3.65
                                      %
                                      
                                      
                                      1.86
                                      %$
                                      12
                                      
                                      2011
                                      
                                      
                                      2.635
                                      %
                                      
                                      
                                      0.91
                                      %
  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. These interest rate swap agreements were not in place during the
three months ended March 31, 2008.
  14
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 Fair
Value of Financial Instruments
  The
Company adopted SFAS No. 157, “Fair Value Measurements,”(“SFAS No. 157”), 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. SFAS No.
157 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. SFAS No. 157 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. SFAS No. 157 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 $96.0 and $81.9 at March 31, 2009 and December 31, 2008,
respectively, is included in cash and cash equivalents on the accompanying
balance sheets and is classified as a Level 1 asset.
 
 The
Company is party to two interest rate swaps, which are utilized to modify the
Company’s interest rate risk. The Company recorded the mark-to-market value of
the interest rate swap contracts of $1.6 in other long-term liabilities in
each of the consolidated balance sheets at March 31, 2009 and December 31, 2008,
respectively. The Company used third parties to value each of the interest rate
swap agreements at March 31, 2009 and December 31, 2008, as well as its own
market analysis to determine fair value. The fair value of the interest
rate swap contracts are classified as Level 2 liabilities.
  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.
  15
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 Concentration
of Credit Risk
  Financial
instruments which potentially subject the Company to concentration of credit
risk consist principally of temporary 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.  Given recent developments
in the financial markets and the Company’s exposure to customers in the
financial services industry, the Company’s ability to collect contractual
amounts due from certain customers severely impacted by these developments may
be adversely affected.
 
 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 plan under
which 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 5% or more 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 $0.5 for each of the three months ended March 31, 2009
and 2008, net of forfeitures for its obligations under these plans.
 
 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”).  EITF
No. 06-3 requires that companies disclose their accounting policies
regarding the gross or net presentation of certain taxes.  Taxes
within the scope of EITF No. 06-3 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’s policy is to record taxes within the
scope of EITF No. 06-3 on a net basis.
 
 Reclassifications
  Certain
reclassifications have been made to the consolidated financial statements for
the three months ended March 31, 2008 to conform to the classifications used for
the three months ended March 31, 2009.
  16
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 Recently
Issued Accounting Pronouncements
  In
September 2006, the FASB issued SFAS No. 157 effective for fiscal years
beginning after November 15, 2007 and interim periods within those fiscal
years.  SFAS No. 157 establishes a framework for measuring fair value
under accounting principles generally accepted in the U.S. and expands
disclosures about fair value measurement.  In February 2008, the FASB
deferred the adoption of SFAS No. 157 as provided by FASB Staff Position
No. FAS 157-2 (“FSP No. FAS 157-2”) for one year as it applies to
certain items, including assets and liabilities initially measured at fair value
in a business combination, reporting units and certain assets and liabilities
measured at fair value in connection with goodwill impairment tests in
accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” and
long-lived assets measured at fair value for impairment assessments under SFAS
No. 144, “Accounting for the Impairment or Disposal of Long-Lived
Assets.”  The Company adopted SFAS No. 157 on January 1, 2008 with
respect to its financial assets and liabilities, as discussed
above.
 
 In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations
(Revised),” (“SFAS No. 141(R)”), to replace SFAS No. 141, “Business
Combinations.”  SFAS No. 141(R) requires the use of the acquisition
method of accounting, defines the acquirer, establishes the acquisition date and
broadens the scope to all transactions and other events in which one entity
obtains control over one or more other businesses.  This statement is
effective for business combinations or transactions entered into for fiscal
years beginning on or after December 15, 2008.  The adoption of SFAS
No. 141(R) did not have a material impact on the Company’s financial position,
results of operations or cash flows.
 
 In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements – an amendment of ARB No. 51,” (“SFAS No.
160”).  SFAS No. 160 establishes accounting and reporting standards
for the noncontrolling interest in a subsidiary and for the retained interest
and gain or loss when a subsidiary is deconsolidated.  This statement
is effective for financial statements issued for fiscal years beginning on or
after December 15, 2008.  The adoption of SFAS No. 160 did not have a
material impact on the Company’s financial position, results of operations or
cash flows.
  In
December 2007, the SEC issued SAB No. 110, “Certain Assumptions Used in
Valuation Methods – Expected Term,” (“SAB No. 110”).  SAB No. 110
allows companies to continue to use the simplified method, as defined in SAB No.
107, “Share-Based Payment,” to estimate the expected term of stock options under
certain circumstances.  The simplified method for estimating expected
term uses the mid-point between the vesting term and the contractual term of the
stock option.  The Company has analyzed the circumstances in which the
use of the simplified method is allowed.  The Company has opted to use
the simplified method for stock options it granted in 2008 because management
believes that the Company does not have sufficient historical exercise data to
provide a reasonable basis upon which to estimate the expected term due to the
limited period of time the Company’s shares of common stock have been publicly
traded.
 
 In April
2008, the FASB issued EITF No. 07-05, “Determining Whether an Instrument (or
Embedded Feature) Is Indexed to an Entity’s Own Stock,” (“EITF No.
07-05”).  EITF No. 07-05 provides guidance on determining what types
of instruments or embedded features in an instrument held by a reporting entity
can be considered indexed to its own stock for the purpose of evaluating the
first criteria of the scope exception in paragraph 11 (a) of SFAS No.
133.  EITF No. 07-05 is effective for financial statements issued for
fiscal years beginning after December 15, 2008 and early application is not
permitted.  The adoption of EITF No. 07-05 did not have a material
impact on the Company’s financial position, results of operations or cash
flows.
  17
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 In
June 2008, the FASB issued EITF No. 08-3, “Accounting by Lessees for Maintenance
Deposits under Lease Agreements,” (“EITF No. 08-3”).  EITF No. 08-3
mandates that all nonrefundable maintenance deposits should be accounted for as
a deposit.  When the underlying maintenance is performed, the deposit
is expensed or capitalized in accordance with the lessee’s maintenance
accounting policy.  EITF No. 08-3 is effective for fiscal years, and
interim periods within those fiscal years, beginning after December 15,
2008.  The adoption of EITF No. 08-3 did not have a material impact on
the Company’s financial position, results of operations or cash
flows.
 
 In June
2008, the FASB issued EITF No. 03-6-1, “Determining Whether Instruments Granted
in Shared-Based Payment Transactions are Participating Securities,” (“EITF No.
03-6-1”).  EITF No. 03-6-1 provides that unvested share-based payment
awards that contain non-forfeitable rights to dividends or dividend equivalents
(whether paid or unpaid) are participating securities and shall be included in
the computation of earnings per share pursuant to the two-class
method.  EITF No. 03-6-1 is effective for financial statements issued
for fiscal years beginning after December 15, 2008, and interim periods within
those fiscal years.  Upon adoption, a company is required to
retrospectively adjust its earnings per share date (including any amounts
related to interim periods, summaries of earnings and selected financial data)
to conform to provisions of EITF No. 03-6-1.  The adoption of EITF No.
03-6-1 did not have a material impact on the Company’s financial position,
results of operations or cash flows.
 
 NOTE
3:  NOTE PAYABLE
 
 Secured
Credit Facility
 
 On
February 29, 2008, the Company, excluding certain foreign subsidiaries, entered
into a $60 senior secured credit facility (the “Secured Credit Facility”),
consisting of an $18 revolving credit facility (the “Revolver”) and a $42 term
loan facility (the “Term Loan”).  The initial lenders under the
Secured Credit Facility were Societe Generale and CIT Lending Services
Corporation.  The Secured Credit Facility is secured by substantially
all of the Company’s domestic assets.  The Term Loan was comprised of
$24, which was advanced at closing and up to $18 of which originally could be
drawn within nine months of closing at the Company’s option (the “Delayed Draw
Term Loan”).  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.  The Secured Credit Facility is to be used for general
corporate purposes and for capital investment.  The Revolver and the
Term Loan each have a term of five years from the closing date of the Secured
Credit Facility.  The Company paid a non-refundable work fee of $0.1
to the lenders, which was credited against the upfront fee of 1.5% ($0.9) of the
total amount of the Secured Credit Facility that was paid at closing and paid
$0.3 to its unaffiliated third party financial advisors who assisted the
Company.  Additionally, the Company is liable for an unused commitment
fee of 0.50% per annum or 0.75% per annum, depending on the utilization of the
Secured Credit Facility.  Interest accrues 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 has chosen 30 day LIBOR as the interest rate during the term of the
interest rate swap (30 day LIBOR was 0.49688% at March 31,
2009).  Additionally, the Company is required to maintain an
unrestricted cash balance at all times of at least $20.  On February
29, 2008, the Company received proceeds of $24, before the deduction of debt
acquisition costs, under the Term Loan.  As required 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.
  18
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 On
September 26, 2008, the Company executed a joinder agreement to the Secured
Credit Facility that added SunTrust Bank as an additional lender and increased
the amount of the Secured Credit Facility to $90 effective October 1,
2008.  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
availability under the Revolver increased to $27 and the Term Loan availability
increased to $63, $27 of which was the increased amount of the Delayed Draw Term
Loan.  The additional amount of the Term Loan of $12 was advanced on
October 1, 2008.
 
 The Term
Loan provides for monthly payments of interest. The Term Loan also
provides for quarterly installments of principal of $1.08 beginning June 30,
2009, increasing to $1.44 on June 30, 2012 with the balance of $18.72, plus
accrued unpaid interest, due on February 28, 2013.
 
 Effective
August 4, 2008, the Company entered into a swap arrangement under which it fixed
its borrowing costs with respect to the $24 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 upon the filing of the Company’s Annual Report on Form
10-K for the year ended December 31, 2007.
 
 On
November 14, 2008, the Company entered into a swap arrangement under which it
fixed its borrowing costs with respect to the additional $12 under the Term Loan
borrowed on October 1, 2008 for three years at 2.635% per annum, plus the
applicable margin of 3.00%.
 
 The
outstanding amounts of $36.0 under the Term Loan of the Secured Credit Facility
at March 31, 2009 are scheduled to be repaid in each annual period as
follows:
  12 Months Ended March 31,
                    
                    Amount2010
                    
                    $
                    4.32011
                    
                    
                    4.32012
                    
                    
                    4.32013
                    
                    
                    23.136.0Less:
      current portion of note payable
                    
                    
                    (4.3
                    )$
                    31.7
 
 Additionally,
the Company executed a $1.0 standby letter of credit in favor of New York City
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, 2009, was renewed to May 1,
2010.
 
 The
Company’s Secured Credit Facility contains certain financial and non-financial
covenants (“Debt Covenants”).  The Company was in compliance with all
of its Debt Covenants as of March 31, 2009.
  19


ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 NOTE
4:  INCOME TAXES
 
 The
(benefit from) provision for the income taxes is comprised of the
following:
  Three
      Months Ended March 31,2009
              
              
              2008Current
              
              $
              (5.1
              )
              
              $
              0.6Deferred
              
              
              —
              
              
              
              —Total
      income tax (benefit)  provision
              
              $
              (5.1
              )
              
              $
              0.6
  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
Company recorded a benefit from income taxes of $5.1 for the three months
ended March 31, 2009, compared to a provision for income taxes of $0.6 for the
three months ended March 31, 2008.  The benefit is based upon the
anticipated 2009 loss for income tax purposes.  The benefit recorded
represents the receivable established for the refunds of federal income tax
payments paid with respect to the tax filings for the years ended December 31,
2007 and 2008 and the reversal of the federal income taxes accrued at December
31, 2008, net of a provision for alternative minimum taxes for 2007 and
2008.  Additionally, at March 31, 2009, the Company provided for
certain capital-based state taxes, which partially reduced the benefit from
income taxes.
 
 The
Company adopted the provisions of Interpretation No. 48 on January 1,
2007.  At March 31, 2009 and December 31, 2008, the Company’s tax
positions are highly certain tax positions.  Accordingly, no
adjustments were required to the consolidated financial statements for any of
the periods presented.
 
 The
Company established a valuation allowance related to deferred tax assets based
on current years’ results of operations and anticipated profit levels in future
periods, since it is more likely than not that its deferred tax assets will not
be realized in the future.
 
 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 NOLs, 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, will be subject to an overall annual
limitation.
 
 As of
December 31, 2008, the Company has domestic NOL carryforwards of $827.2 and
foreign NOL carryforwards of $52.3.  Certain of these NOL
carryforwards begin to expire in 2024.  The Company’s use of its
domestic NOL carry forward is subject to annual limitation under the ownership
change rules in the U.S.  Such annual limitation is
$8.1.  Accordingly, the Company estimates that $162.0 of its domestic
NOL carryforwards is available but may be subject to future limitation by United
States Internal Revenue Code Section 382.
 
 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 2001 to 2008.  The statute of limitations for
these years will begin to expire in 2011.
  20
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 NOTE
5:  INCOME PER COMMON SHARE
 
 Basic
income per common share is computed as net income or net loss 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 11,461,142 and 10,722,975 for the three months
ended March 31, 2009 and 2008, respectively.  Total weighted average
shares utilized in computing diluted net income per common share were 12,306,856
and 12,238,498 for the three months ended March 31, 2009 and 2008,
respectively.  Dilutive securities include options to purchase shares
of common stock, restricted stock units and stock warrants.  For the
three months ended March 31, 2009, potentially dilutive securities to acquire
49,175 shares of common stock were excluded from the calculation of diluted
income per common share as they were anti-dilutive.  For the three
months ended March 31, 2008, potentially dilutive securities to acquire 7,450
shares of common stock were excluded from the calculation of diluted income per
share as they were anti-dilutive.
 
 NOTE
6:   STOCK-BASED COMPENSATION
  Adoption
of 2008 Equity Incentive Plan
 
 On August
29, 2008, the Board of Directors of the Company approved the Company’s 2008
Equity Incentive Plan (the “2008 Plan”).  The 2008 Plan will be
administered by the Company’s 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 stock, restricted and unrestricted
stock units and stock appreciation rights may be awarded to eligible
participants on a stand alone, combination or tandem basis.  750,000
shares of Company common stock may be issued 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. As of March 31, 2009, 389,100 common
shares were reserved pursuant to outstanding options to purchase shares of
common stock and outstanding restricted stock units, and 360,900 common shares
were reserved for future grants.
 
 Stock-based
compensation expense for each period relates to share-based awards granted
under the Company’s 2008 Plan described above and the Company’s 2003 Stock
Incentive Plan, reflect awards outstanding during such period, including awards
granted both prior to and during such period.  The 2003 Stock
Incentive Plan became effective on September 8, 2003.  Under the
2003 Stock Incentive Plan, the Company was authorized to issue, in the
aggregate, share-based awards of up to 1,064,956 common shares to employees,
directors and consultants who are selected to participate.  At
March 31, 2009, 450,966 common shares had been issued pursuant to vested
restricted stock units (includes shares of common stock repurchased to fund
estimated income tax liabilities and, in certain cases, minimum withholding
obligations), 465,451 common shares were reserved pursuant to outstanding
options to purchase shares of common stock, 133,750 common shares were reserved
pursuant to outstanding restricted stock units (of which 96,500 were vested) and
reserves for 14,789 common shares were cancelled.
 
 Stock
Options
 
 The
Company did not award any stock options during the three months ended March
31, 2009 and 2008.  The Company recognized non-cash stock-based
compensation expense related to outstanding stock options amounting to $0.1 and
$0.9 for the three months ended March 31, 2009 and 2008,
respectively.  The non-cash stock-based compensation expense for the
three months ended March 31, 2008 included $0.7 incurred with respect to the
modification of certain options to purchase common stock (see Note 9,
“Employment Contract Termination”).
 
 Restricted
Stock Units
 
 The
Company did not award any restricted stock units during the three months ended
March 31, 2009 and 2008. The Company recognized non-cash stock-based
compensation expense related to restricted stock units of $2.8 and $3.3 for the
three months ended March 31, 2009 and 2008, respectively.  Included in
the expense for the three months ended March 31, 2008 is a charge of $0.1 with
respect to the Company’s purchase of shares from employees in excess of the
minimum withholding requirements, as provided by SFAS No.
123(R).  There was no such amount incurred in the three months ended
March 31, 2009.
  21
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 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.  The
following description of the Rights Agreement does not purport to be complete
and is qualified in its entirety by reference to the Rights Agreement, which is
included as Exhibit 4.1 to the Company’s Current Report on Form 8-K filed with
the SEC on August 4, 2006.
 
 In
connection with the Rights Agreement, the Company’s Board of Directors declared
a dividend distribution of one preferred share purchase right (a “Right”) for
each 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 (the
“Record Date”) to the stockholders of record on that date.  Each Right
entitles the registered holder to purchase from the Company one one-hundredth of
a share of Series A Junior Participating Preferred Stock, par value $0.01
per share (the “Preferred Shares”), at a price of $100.00 per one one-hundredth
of a Preferred Share (the “Purchase Price”), subject to adjustment.  Each
one one-hundredth of a share of Preferred Shares has designations and powers,
preferences and rights, and the qualifications, limitations and restrictions
which make its value approximately equal to the value of a Common
Share.
 
 Until the
earlier to occur of (i) 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, with respect to any of the Common Share certificates outstanding as
of the Record Date, by such Common Share certificate.  As discussed
below, the definition of “Acquiring Person” was amended in August
2008.
 
 The
Rights are not exercisable until the Distribution Date.  The Rights will
expire on August 7, 2009, unless the Rights are earlier redeemed or exchanged by
the Company.
 
 The
number of outstanding Rights and the number of one one-hundredths of a Preferred
Share issuable upon exercise of each Right 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
Rights Agreement.
 
 Preferred
Shares purchasable upon exercise of the Rights will not be redeemable. 
Each Preferred Share will be entitled to a minimum preferential quarterly
dividend payment of $1.00 but will be entitled to an aggregate dividend of 100
times the dividend declared per Common Share.  In the event of liquidation,
the holders of the Preferred Shares would be entitled to a minimum preferential
liquidation payment of $100.00 per share, but would be entitled to receive an
aggregate payment equal to 100 times the payment made per Common Share. 
Each Preferred Share will have 100 votes, voting together with the Common
Shares.  Finally, in the event of any merger, consolidation or other
transaction in which Common Shares are exchanged, each Preferred Share will be
entitled to receive 100 times the amount of consideration received per Common
Share.  These rights are protected by customary anti-dilution
provisions.  The Preferred Shares would rank junior to any other series of
the Company’s preferred stock.
 
 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 for a 60-day period have
the right to receive upon exercise that number of Common Shares having a market
value of two times the 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).  This
right will terminate 60 days after the date on which the Rights become
non-redeemable (as described below), unless there is an injunction or similar
obstacle to exercise the Rights, in which event this right will terminate 60
days after the date on which the Rights again become exercisable.
  22
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 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 $0.01 per Right (the
“Redemption Price”).  The Rights may also be redeemed at certain other
times as described in the 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.
 
 On
August 7, 2008, the Company entered into an amendment (“Rights Agreement
Amendment”) to its Rights Agreement.  The Rights Agreement Amendment was
filed as Exhibit 4.7 to the Company’s Current Report on Form 8-K filed with the
SEC on August 12, 2008.  Also on August 7, 2008, the Company
entered into a standstill agreement with JGD Management Corp., York Capital
Management, L.P. and certain of their affiliated funds holding Company
securities that are parties thereto (collectively, the “York
Group”).
 
 The
Rights Agreement Amendment amends the Rights Agreement to, among other things,
add an exception to the definition of “Acquiring Person” (as defined in the
Rights Agreement) for an Excluded Stockholder and add a definition of “Excluded
Stockholder.”  “Excluded Stockholder” is defined to mean the
individually identified members of the York Group, funds and accounts managed by
York Capital Management, L.P. that hold any Company securities and their
respective affiliates and associates; provided, however, that, except as
otherwise provided in the definition of “Acquiring Person,” none of the members
of the York Group or their affiliates or associates will be an Excluded
Stockholder if any such party, individually or collectively, become the
beneficial owner of 20% or more of the outstanding Company common stock without
the prior written consent of the Company.
  23
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 NOTE
7:  LITIGATION
 
 The
Company is subject to various legal proceedings and claims which arise in the
normal course of business.  The Company evaluates, among other things,
the degree of probability of an unfavorable outcome and reasonably estimates the
amount of potential loss.
 
 Global
Voice Networks Limited (“GVN”)
 
 AboveNet Communications UK Limited,
the Company’s 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 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, the Company was 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.  The Company also had certain repair and maintenance
obligations that it 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, the Company paid
$3.0 in damages pursuant to the liability trial. Additionally, the Company
reimbursed GVN $1.8 for legal fees.  Additionally, the Company’s legal
fees aggregated $2.4.  Further, the Company has incurred or is
obligated for costs totaling $2.7 to build additional network.  In
early August 2008, the Company reached a settlement agreement under which the
Company paid GVN $0.6 and agreed to provide additional construction of duct at
an estimated cost of $1.2 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 chamber construction
obligations discussed above.  We recorded a loss on litigation of
$11.7 at December 31, 2007, of which $0.8 and $8.5 was paid in 2007 and 2008,
respectively, and $1.2 was included in accrued expenses at December 31,
2008.  The obligation was denominated in British Pounds; therefore, the
amounts have been affected by currency fluctuations.  The Company had
$1.0 included in accrued expenses at March 31, 2009.
 
 SBC
Telecom, Inc. (“SBC”)
 
 The
Company was a party to a fiber lease agreement with SBC, a subsidiary of
AT&T, entered into in May 2000.  The Company believed that SBC was
obligated under this agreement to lease 40,000 fiber miles, reducible to 30,000
under certain circumstances, for a term of 20 years at a price set forth in the
agreement, which was subject to adjustment based upon the number of fiber miles
leased (the higher the volume of fiber miles leased, the lower the price per
fiber mile).  SBC disagreed with such interpretation of the agreement
and in 2003 the issue was litigated before the Bankruptcy Court.  In
November 2003, the Bankruptcy Court agreed with the Company’s interpretation of
the agreement, which decision SBC did not appeal.  Subsequently, SBC
also alleged that the Company was in breach of its obligations under such
agreement and that therefore the Company was unable to assume the agreement upon
its emergence from bankruptcy.  The Company disagreed with SBC’s
position, however in December 2005, the Bankruptcy Court agreed with
SBC.  In 2006, the Company appealed certain aspects of the decision to
the District Court for the Southern District of New York but the District Court
denied the Company’s appeal.  In March 2007, the Company filed a
notice of appeal to the Second Circuit Court of Appeals seeking relief with
respect to the Bankruptcy Court’s determination that the Company was in default
of the agreement with SBC.  During the term of the agreement, SBC has
paid the Company at the higher rate per fiber mile to reflect the reduced volume
of services SBC believes it was obligated to take, in accordance with its
understanding of the fiber lease agreement.  However, for financial
statement purposes, the Company billed and recorded revenue based on the lower
amount per fiber mile for the fiber miles accepted by SBC, which was $0.5, for
the three months ended March 31, 2008.
  24
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 In July
2008, the Company and SBC entered into the “Stipulation and Release Agreement”
under which a new service agreement was executed for the period from July 10,
2008 to December 31, 2010.  Under this new service agreement, SBC
agreed to continue to purchase the existing services at the current rate for
such services.  Further, SBC will have a fixed minimum payment
commitment, which declines over the contract term.  SBC may cancel
service at any time, subject to the notice provisions, but is subject to the
payment commitment.  The payment commitment may be satisfied by the
existing services or SBC may order new services.  Additionally, the
May 2000 fiber lease agreement with SBC was terminated and the Company and SBC
released each other from any claims related to that agreement.  The
difference between the amount paid by SBC and the amount recognized by the
Company as revenue, which aggregated $3.5 at July 10, 2008, was recorded as
contract termination revenue in the year ended December 31,
2008.
 
 Southeastern
Pennsylvania Transportation Authority (“SEPTA”)
  In
October 2008, SEPTA filed a claim in the Philadelphia County Court of Common
Pleas against the Company for trespass with regard to portions of the Company’s
network allegedly residing on SEPTA property in Pennsylvania.  SEPTA
seeks unspecified damages for trespass and/or a determination that the Company’s
network must be removed from SEPTA’s property.  The Company has
responded to the claim and also filed a motion in the Bankruptcy Court seeking a
determination that the claim is barred based on the discharge of claims and
injunction contained in the Plan of Reorganization.  The Company
believes that it has meritorious defenses to SEPTA’s claims.
 
 NOTE
8:  RELATED PARTY TRANSACTIONS
 
 A member
of the Company’s Board of Directors is also the Co-Chairman, Chief Executive
Officer and co-founder of a telecommunications company.  The Company
sold services and/or material in the normal course of business to this
telecommunications company in the amount of $0.1 for each of the three months
ended March 31, 2009 and 2008.  No amounts were outstanding at each of
March 31, 2009 and December 31, 2008.  All activity between the
parties was conducted as independent arms length transactions consistent with
similar terms and circumstances with any other customers or
vendors.  All accounts between the two parties are settled in
accordance with invoice terms.
 
 NOTE
9:   EMPLOYMENT CONTRACT TERMINATION
 
 On March
4, 2008, the employment contract of Michael A. Doris, the Company’s former
Senior Vice President and Chief Financial Officer, was modified and then
terminated.  Pursuant to the modification, the Company paid Mr. Doris
upon termination (i) $0.3; (ii) all salary and bonuses earned but not
yet paid; (iii) all accrued and unused paid time off days; and (iv) health
and welfare benefits for eighteen (18) months or such shorter period if he
receives comparable benefits from another employer, and executed and delivered a
consulting agreement with Mr. Doris.  Pursuant to the consulting
agreement, in exchange for Mr. Doris’ provision of consulting services to
the Company for a period of nine months, Mr. Doris was paid (i) $0.3
(his annual salary prorated per week for nine months); and (ii) (a) a bonus of
$0.05 (the “2006 Filing Bonus”) upon the filing with the SEC of Form 10-K
with respect to the Company’s fiscal year ended December 31, 2006 and
(b) a bonus of $0.05 (the “2007 Filing Bonus”) upon the filing with the SEC
of Form 10-K with respect to the Company’s fiscal year ended
December 31, 2007.  In addition, Mr. Doris’ stock unit agreement
dated as of August 7, 2007 was amended to provide that (i) the shares
underlying the 10,000 restricted stock units (which became vested upon his
termination without cause) be delivered to Mr. Doris on January 5, 2009;
and (ii) the Company repurchase at the then market price such number of
shares as required to meet the Company’s estimate of Mr. Doris’ federal and
state income taxes due with respect to the delivery of the restricted stock
units.  The aggregate value of the benefits delivered to Mr. Doris
(including the value of restricted stock units that vested in accordance with
their terms) was $1.6, of which $1.2 was recognized in selling, general and
administrative expenses in the three months ended March 31,
2008.  Additionally, the Company recorded additional non-cash
stock-based compensation expense of $0.7 relating to the modification of his
options to purchase common shares in connection with the modification and
termination of Mr. Doris’ employment agreement.
  25
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 NOTE
10:  SEGMENT REPORTING
 
 SFAS
No. 131, “Disclosures about Segments of an Enterprise and Related
Information,” defines operating segments as components of an enterprise for
which separate financial information is available and which is evaluated
regularly by the Company’s chief operating decision maker in deciding how to
assess performance and allocate resources.  The Company operates its
business as one operating segment.
 
 Geographic
Information
  Below
is our revenue based on the location of our entity providing service.
 Long-lived assets are based on the physical location of the
assets.  The following table presents revenue and long-lived asset
information for geographic areas:
 
 Three Months Ended March 31,2009
                    
                    
                    2008RevenueUnited
      States
                    
                    $
                    78.6
                    
                    
                    $
                    63.2United
      Kingdom
                    
                    
                    7.6
                    
                    
                    
                    8.8Eliminations
                    
                    
                    (0.8
                    )
                    
                    
                    (1.1
                    )Consolidated
      Worldwide
                    
                    $
                    85.4
                    
                    
                    $
                    70.9
 
 As ofMarch 31, 2009
                    
                    
                    December 31, 2008Long-lived
      assetsUnited
      States
                    
                    $
                    386.4
                    
                    
                    $
                    374.5United
      Kingdom
                    
                    
                    25.1
                    
                    
                    
                    23.8Other
                    
                    
                    0.1
                    
                    
                    
                    0.1Consolidated
      Worldwide
                    
                    $
                    411.6
                    
                    
                    $
                    398.4
 
 NOTE
11: OTHER (EXPENSE) INCOME, NET
 
 Other
(expense) income, net consists of the following:
 
 Three Months Ended
      March 31,2009
                                    
                                    
                                    2008Gain
      on settlement or reversal of liabilities
                                    
                                    $
                                    0.7
                                    
                                    
                                    $
                                    —(Loss)
      gain on foreign currency
                                    
                                    
                                    (0.6
                                    )
                                    
                                    
                                    0.1(Loss)
      gain on disposition of property and equipment
                                    
                                    
                                    (0.2
                                    )
                                    
                                    
                                    1.4Total
                                    
                                    $
                                    (0.1
                                    )
                                    
                                    $
                                    1.5
  26
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 NOTE
12: COMMITMENTS AND CONTINGENCIES
 
 Employment
Contracts
  The
Company maintains employment agreements with its key executives.  The
agreements include, among other things, certain changes in control and severance
provisions.
 
 Internal
Revenue Service
 
 In
September 2008, the Company was notified by the Internal Revenue Service (the
“IRS”) that it was reclassifying certain individuals, classified by the Company
as independent contractors, to employees and, accordingly, assessing certain
payroll taxes and penalties totaling $0.3.  The Company disputed this
position citing relief provided by IRC Section 530 and IRC Section
3509.  On January 13, 2009, the IRS made a settlement offer to the
Company, which the Company executed on March 10, 2009 and returned to the
IRS.  The Company is still waiting to receive the countersigned
agreement.  Under the terms of the proposed settlement agreement, the
Company agreed to pay $0.015 to the IRS to fully discharge any federal
employment tax liability it may owe for 2005.  The IRS agreed not to
dispute the classification of “such workers” for federal employment tax purposes
for any period from January 1, 2005 to March 31, 2009.  Beginning
April 1, 2009, the Company agreed to treat “Consultants,” as described in the
settlement agreement, who perform equivalent duties as employees of the Company
as employees.  Finally, the Company agreed to extend the statute of
limitations with respect to federal employment tax payments for the period
covered by the settlement agreement (January 1, 2005 to March 31, 2009) to April
1, 2012.
 
 New
York City Franchise Agreement
 
 As a
result of certain ongoing litigation with a third party, the Department of
Information Technology and Telecommunications of the City of New York (“DOITT”)
has informed the Company that they have temporarily suspended any discussions
regarding renewals of telecommunications franchises in the City of New
York.  As a result, it is the Company’s understanding that DOITT has
not renewed any recently expired franchise agreement, including the Company’s
franchise agreement, which expired on December 20, 2008.  Prior to the
expiration of the Company’s franchise agreement, the Company sought out and
received written confirmation from DOITT that the Company’s franchise agreement
provides a basis for the Company to continue to operate in the City of New York
pending conclusion of renewal discussions.  The Company intends to
continue to operate under its expired franchise agreement pending any
renewal.  The Company believes that a number of other operators in the
City of New York are operating on a similar basis.  Based on the
Company’s discussions with DOITT and the written confirmation that the Company
has received, the Company does not believe that DOITT intends to take any
adverse actions with respect to the operation of any telecommunications
providers as the result of their expired franchise agreements and, that if it
attempted to do so, it would face a number of legal
obstacles.  Nevertheless, any attempt by DOITT to limit the Company’s
operations as the result of its expired franchise agreement could have a
material adverse effect on the Company’s business, financial condition and
results of operations.
  27
  ABOVENET,
INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 (in
millions, except share and per share information)
 
 NOTE
13: 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 does 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 are
subordinated to distributions to the preferred members of their original
investment plus a preferred return and the Company’s interest does not provide
any level of control.  Based upon amounts contributed through March
31, 2009 and additional amounts committed by the preferred members, the
Company’s nominal ownership interest will be approximately 15.4% of
equity.  MediaX is a start-up company with no operating
history.  These factors indicated that the fair value of the
Company’s investment in MediaX is 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 $0.4 in the
three months ended March 31, 2009, which represents the estimated fair value of
the services and not the actual costs of providing such services, which are not
significant.  The Company did not contribute services to MediaX in the
three months ended March 31, 2008.  The Company will record
distributions from 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 $0.1 and $0.2 during the three months ended March 31, 2009 and
2008, respectively.
 
 NOTE
14:   SUBSEQUENT EVENTS
 
 In May
2009, the Company and the landlord at its executive offices at 360 Hamilton
Avenue, White Plains, New York, modified and extended the term of the lease
effective May 1, 2009 (the “Lease Effective Date”), pursuant to the Fourth Lease
Modification, Extension and Rental Reset Agreement (the “Lease
Modification”).  Under the terms of the Lease Modification, the lease,
which was originally scheduled to expire on May 31, 2010, was extended for an
additional term of 10 years to May 31, 2020.  The Lease Modification
provides for Fixed Annual Rent, as defined, totaling $11.9 from the Lease
Effective Date through the extended lease term.  In addition, subject
to certain provisions and provided that there has not been any event of default,
the Company shall receive an abatement of $1.1, which shall be applied in 13
equal monthly installments.  The Company also agreed to increase the
security deposit by $0.24 to $0.37, which will be reduced to $0.13 on the second
anniversary of the Lease Effective Date, provided that there has not been any
event of default at any time through that date.
  28
 
 ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
  The
following discussion and analysis should be read together with the Company’s
consolidated financial statements and related notes appearing in this Quarterly
Report on Form 10-Q and in the Company’s Annual Report on Form 10-K for the year
ended December 31, 2008.
 
 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 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 operate.  In addition, we also provide dark fiber services to
selected customers.
 
 Metro networks.  We
are a facilities-based provider that operates fiber-optic networks in 15 major
markets in the U.S. and one in the U.K. (London).  We refer to these
networks as our metro networks.  These metro networks have significant
reach and breadth.  They consist of over 1.9 million fiber miles across
over 5,000 cable route miles in the U.S. and in London.  In addition,
we have built an inter-city fiber network between New York and Washington D.C.
of over 177,000 fiber miles.
 
 Long haul
network.  Through construction, acquisition and leasing
activities, we have created a nationwide fiber-optic communications network
spanning over 11,000 cable route miles that connects each of our 15 U.S. metro
networks.  We run advanced dense wavelength-division multiplexing
(“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 are also members of the Japan-US Cable Network (JUS) and
Trans-Atlantic undersea telecommunications consortia (TAT-14) that provide
connectivity between the U.S. and Japan and the U.S. and Europe,
respectively.  We refer to this network as our long haul
network.
 
 IP network.  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.
  29
  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
customers.  The following are the key elements of our
strategy:
 
 ·
              Connect
      to data centers where many enterprise customers locate their information
      technology infrastructure.·
              Target
      broadband communications infrastructure customers who have significant
      bandwidth requirements and high security
needs.
 ·
              Provide
      a high level of customization of our services in order to meet our
      customers’ 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 because most of their networks do not
      have comparable fiber density.
 ·
              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.
 ·
              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.
 
 We are
able to provide high quality, customized services at competitive prices as a
result of a number of factors, including:
 
 ·
              Our
      significant experience providing high-end customized network solutions for
      enterprises and telecommunications carriers (also referred to as
      carriers).·
              Our
      focus on providing certain core optical services rather than the full
      range of 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, and provide us with
      sufficient fiber inventory to supply dedicated fiber services to
      customers.·
              Our
      modern networks with advanced fiber-optic technology are less costly to
      operate and maintain than older
networks.
 ·
              Our
      employment 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, which reduces expansion and upgrade costs in the future,
      and provides significant capacity for future
  growth.
  30
  Our
Networks and Technology
  Metro
Networks
  The
foundation of our business is our metro fiber optic networks in the following
domestic metropolitan areas and London in the U.K.
 
 ·
              Boston·
              New
      York City metro
 ·
              Philadelphia·
              Baltimore
 ·
              Washington,
      D.C./Northern Virginia corridor·
              Atlanta
 ·
              Houston·
              Dallas·
              Austin
 ·
              Phoenix·
              Los
      Angeles
 ·
              San
      Francisco Bay area·
              Portland
 ·
              Seattle·
              Chicago
 
 Including
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 1.9 million fiber miles and over 5,000 cable route
miles.  The network footprint typically allows us to serve central
offices, carrier hotels, network points-of-presence (“POPs”), data centers,
enterprise locations 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 5,000 network access points that can be utilized to
build laterals or connect to other networks, thereby providing access to
additional locations.
 
 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.
 
 ·
              High Performance Architecture
      – We are able to design customer networks with a minimum number of
      POP locations and direct, optimum routing between key areas which enables
      us to deliver our services at a high level of performance.  Because
      most of our metro lit services are delivered over dedicated fibers not
      shared with other customers, each 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, Connecticut 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.
  31
  On-Net
Buildings
  Our metro
networks connect to over 1,800 buildings through our lateral cables, which cover
over 1,000 route miles and over 100,000 fiber miles (which are part of the 1.9
million fiber miles previously described).  These connected buildings
are referred to as on-net buildings.
 
 ·
              Enterprise Buildings -Our network extends to over 1,300 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 and Data
      Centers -Our network connects to buildings in which over 200
      central offices and over 300 data centers
  operate.
  ·
              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 metro
networks that spans over 11,000 route miles.  With the exception of the
route between New York and Washington, D.C., which we constructed and own, 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 next generation 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.
 
 In
addition to our U.S. based facilities, we are a member of the TAT-14
consortium, which provides us with undersea capacity between the U.S. and
Europe.  We are also currently a member of the JUS consortium which
provides us with undersea capacity between the U.S. and Japan.  We use
leased circuit capacity in continental Europe to provide connectivity among our
key IP presence locations.  We also operate lit networks in the U.S.
connecting to certain key undersea cable landing stations including Manasquan
and Tuckerton in New Jersey to connect to the TAT-14 and have leased
capacity to Morrow Bay, California to connect to the JUS. In the U.K., we have
leased fiber between the TAT-14 landing stations in Bude and London over which
we operate a high-capacity DWDM system.  Together, these networks
provide us high-bandwidth capability among our metro networks and certain key
markets in Europe and Japan.
 
 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 15 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 and
Switch & Data.  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 London, Amsterdam, Tokyo, Paris 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.  We believe that this extensive
peering fabric, combined with our advanced network, results in a positive
customer experience.
  32
  Network
Management
  Our
network management center (“NMC”) is located in Herndon, Virginia and provides
round-the-clock 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 and
network outages.  Our NMC responds to all customer network inquiries
via a trouble ticketing system.  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.
 
 Rights-of-Way
  We have
obtained the necessary 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.
 
 Services
  Initially,
our primary business was to lease dark fiber to telecommunications carriers,
enterprises, Internet and web-centric businesses and other customers that wanted
to operate their own networks, often under long term
agreements.  Since 2003, we have shifted the focus of our business by
leveraging our extensive fiber footprint and deploying capital to extend our
fiber footprint to customers with high-bandwidth requirements within and between
our metro markets.  This transformation has allowed us to serve a much
larger marketplace with differentiated services principally provided over our
dedicated fiber.
  In late
2008, we modified our service groupings and related revenue to more accurately
reflect our focus on delivering high-bandwidth services.  The new
groups are: fiber infrastructure services, metro services and WAN
services.  We recasted our revenue into these groupings, as
applicable, for 2007 and 2006 for comparative purposes and trend
analysis.  However, our revenue for 2007 compared to 2006 included in
Item 7, “Management’s Discussion and Analysis of Financial Condition and Results
of Operations,” reflects the original service groupings as reported in our
Annual Report on Form 10-K for the year ended December 31,
2007.  These groupings consisted of: fiber services, metro transport
services, IP services, and long haul services.  Our data centers,
which represented a fifth service, were sold in 2006.
 
 Our
services are grouped into three categories, as described below: fiber
infrastructure, metro and WAN services.
 
 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 and the provisioning of network co-location
and in-building interconnection services, typically at our POP
locations.
 
 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 with direct routing that meets stringent technical
      requirements.·
              Customized
      ring configurations and redundancy requirements in a private dedicated
      service.
 ·
              7x24
      monitoring of the network by our
NMC.
  33
  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 telecom 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 10 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, representing a private network for each
      customer.·
              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.·
              The
      absence of a shared network eliminates many of the equipment interfaces of
      most other networks that can impact performance such as latency and cause
      service interruptions.
 ·
              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.
 
 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 also
offer a full range of Metro Ethernet services including point-to-point and
multi-point service configurations at 100 mbps, 1,000 mbps and 10,000 mbps
speeds.  We offer three different classes of our Metro Ethernet
services with three different price points (higher, middle and lower) based upon
level of service: (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.
  34
  Our long
haul services provide inter-city connectivity between our 15 U.S. metro markets
at a variety of speeds ranging from 1 Gbps to 10 Gbps.  We have
deployed a nextgeneration
ultra long haul network that takes advantage of significant capacity and
distance improvements available in next generation networks.  As a
result, 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 in London, Paris and
Frankfurt.  In addition, we offer IP connectivity in Amsterdam through
resale partners.  We believe our extensive number of peering partners,
global reach and uncongested network approach result in 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 virtual private LAN services, offer point-to-point and
multipoint connectivity solutions based on Multiprotocol Label Switching
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 15 U.S. metro markets and
London.  Our U.S. sales force is comprised of over 60 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 London, that have large bandwidth
requirements.  This represents a change from our focus on wholesale
sales to carrier customers in previous years.  Since 2004, the vast
majority of our new sales have been to enterprise customers.
 
 Our sales
strategy includes:
  ·
              Positioning
      ourselves as a premier provider of private fiber optic transport solutions
      and Internet connectivity services.·
              Focusing
      on Fortune 1000 enterprises as well as content rich data companies (i.e.
      media, health care, 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.
  35
  Customers
  We serve
a broad array of customers including leading companies in the financial
services, web-centric, media/entertainment, and telecommunications
sectors.  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
metro fiber 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, compliance
requirements under complex regulations such as the Sarbanes-Oxley Act or the
Health Insurance Portability and Accountability Act (“HIPAA”) and exponential
growth in data transmissions due to new modalities for communications, media
distribution and commerce.
 
 Executive
Summary
 
 Overview
 
 The
components of our operating income are revenue, costs of revenue, selling and
general and administrative expenses and depreciation and
amortization.  Below is a description of these components.  We
are reporting operating income for the three months ended March 31, 2009 and
2008, as shown in our unaudited consolidated statements of operations included
elsewhere in this Quarterly Report on Form 10-Q.
 
 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, incremental
contractual booking of new customer business, new customer installations and
churn of existing business and capital committed and expended.
 
 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 618 as of March 31,
2009, 539 of which were employed in the U.S., 77 in the U.K., one in the
Netherlands and one in Japan.
 
 In late
2008, we modified our service groupings and the related revenue to more
accurately reflect our focus on delivering high-bandwidth
services.  The new groups are: fiber infrastructure services, metro
services and WAN services.  We recasted our revenue into these
groupings, as applicable, for the three months ended March 31, 2008 for
comparative purposes and trend analysis.
  2009
Highlights
  Our
consolidated revenue increased by $14.5 million, or 20.5%, from $70.9 million to
$85.4 million for the three months ended March 31, 2009 compared to the three
months ended March 31, 2008, due principally to a $7.0 million increase in our
domestic metro services.  Additionally, in the U.S., our revenue from
fiber infrastructure and WAN services increased by $1.9 million and $5.2
million, respectively, for the three months ended March 31, 2009 compared to the
three months ended March 31, 2008.
  36
  For the
three months ended March 31, 2009, we generated operating income of $23.4
million, compared to operating income of $2.7 million for the three months ended
March 31, 2008 and net income of $27.4 million for the three months ended March
31, 2009, compared to $3.4 million for the three months ended March 31,
2008.  During the three months ended March 31, 2009, we recorded a
federal income tax benefit, net of a provision for alternative minimum taxes and
certain capital-based state taxes, of $5.1 million representing income taxes
either provided for or paid with respect to the years ended December 31, 2007
and 2008.  This benefit was recorded based upon the expected tax
benefit to be realized with respect to tax depreciation in 2009 that was limited
in previous years.  At March 31, 2009, we had $101.3 million of
unrestricted cash, compared to $87.1 million of unrestricted cash at
December 31, 2008, an increase in liquidity of $14.2 million.  We
are required to maintain an unrestricted cash balance of at least $20 million at
all times in accordance with the Secured Credit
Facility.  The increase in cash at March 31, 2009
was primarily attributable to cash generated by operating activities of
$35.8 million, partially offset by cash used to purchase property and equipment
of $21.2 million.  See below in this Item 2 under, “Liquidity and
Capital Resources,” for further discussion.
 
 In the
three months ended March 31, 2009, our cash flow generated by operating
activities increased compared to the three months ended March 31, 2008, as a
result of the improvement in operating results.  We believe, based on
our business plan, that our existing cash, cash from our operating activities
and funds available under our Secured Credit Facility will be sufficient to fund
our operations, planned capital expenditures and other liquidity requirements at
least through June 30, 2010.  See below in this Item 2 under,
“Liquidity and Capital Resources,” for further information relating to the
Secured Credit Facility.
 
 Our
revenue increased in 2009 compared to 2008.  Our costs during this
period grew at a slower rate than our revenue, which resulted in an improvement
in our operating income.  Our operating results for 2008 were impacted
by the charges taken with respect to Mr. Doris’ severance ($0.7 million), the
acceleration of the vesting of Mr. Doris’ restricted stock units ($0.5 million)
and the modification of his stock option agreement ($0.7 million), which were
included in selling, general and administrative expenses during the month ended
March 31, 2008.  Additionally, during the three months ended March 31,
2009, we settled a software maintenance obligation in connection with the
abandonment of our planned implementation of our information technology platform
of $0.2 million, which was recorded as a reduction in selling, general and
administrative expenses.  Furthermore, consolidated professional and
consulting fees were $1.8 million during the three months ended March 31, 2009,
compared to $3.6 million during the three months ended March 31,
2008.
 
 2009
Outlook
  Our 2009
outlook is tempered by the overall negative economic trends and the weakness in
the financial services industry, in which we provide services to a significant
number of customers.  We believe that based upon our contracted
projects awaiting delivery to customers, we will continue to add to our revenue
base for the first half of 2009.  Additionally, we have a strong cash
position and access to financing through our Secured Credit Facility, if
needed.  However, we cannot predict the impact customer terminations
or reductions in orders will have on our financial performance for the remainder
of 2009 and thereafter.
 
 Revenue
 
 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 and are subsequently amortized into income over the
related service period.
 
 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, and which are reported as contract
termination revenue.  We also derive a portion of our revenues from
annual and month-to-month contracts.
  37
  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, right-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, stock-based compensation expense for employees not directly
attributable to the operation of our networks; (ii) real estate expenses
for all administrative sites; (iii) professional, consulting and audit fees;
(iv) taxes (other than income taxes), including property taxes and trust
fund-related taxes such as gross receipts taxes; (v) restructuring
costs and (vi) 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.  These estimates, among other things, were
discussed by management with our audit committee.  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 Quarterly Report on
Form 10-Q.
 
 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 Statement of Position 90-7, “Financial Reporting
by Entities in Reorganization under the Bankruptcy Code” (“SOP
90-7”).  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 based upon
our projections.
  38
  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
  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 related service
period.
 
 In
accordance with SEC Staff Accounting Bulletin ("SAB") No. 101, “Revenue
Recognition in Financial Statements,” as amended by SEC SAB No. 104,
“Revenue Recognition,” we generally amortize revenue related to installation
services on a straight-line basis over the contracted customer relationship,
which generally ranges from two 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 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.  During the three months
ended March 31, 2009 and 2008, we included the receipts of bankruptcy claim
settlements from former customers as contract termination
revenue.  Contract termination revenue is reported together with other
service revenue, and amounted to $1.9 million and $0.3 million for the three
months ended March 31, 2009 and 2008, respectively.
 
 Accounts
Receivable Reserves
  Sales
Credit Reserves
  During
each reporting period, we must make estimates for potential future sales credits
to be issued in respect of current revenue, related to billing errors, 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
billing errors and 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 estimation and assumption.
 
 Allowance
for Doubtful Accounts
  During
each reporting period, we must 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.  Due to the current economic climate, the
competitive environment in the telecommunications sector and the volatility of
the financial strength of particular customer segments including resellers and
competitive local exchange carriers, also known as CLECs, the collectability of
receivables and credit worthiness of customers may become more difficult and
unpredictable.  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 contract 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.
  39
  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.  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, which is included in network infrastructure assets on the
respective balance sheets.  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 field engineers and IP engineers and reflects their capitalized salary
plus related benefits, and is based upon an allocation of their time between
capitalized and non-capitalized projects.  These individuals’ salaries
are considered to be costs directly associated with the construction of certain
infrastructure and customer build-outs.  The salaries and related
benefits of non-engineers and supporting staff that are part of the engineering
departments are not considered part of the pool subject to
capitalization.  Capitalized direct labor amounted to $2.7 million for
each of the three months ended March 31, 2009 and
2008.  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 lives or the term of the lease.
 
 Estimated
useful lives of the Company’s property and equipment are as
follows:
  Storage
      huts
                      20 yearsNetwork
      infrastructure assets
                      20
      yearsSoftware
      and computer equipment
                      3
      to 4 yearsTransmission
      and IP equipment
                      3
      to 7 yearsFurniture,
      fixtures and equipment
                      3
      to 10 yearsLeasehold
      improvements
                      Lesser
      of estimated useful life or the lease
term
 
 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 (loss).
 
 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 new fiber and associated construction costs of the relocation
placed into service, which is reduced by any reimbursements received for such
costs.  We capitalized relocation costs amounting to $0.7 million for
each of the three months ended March 31, 2009 and 2008,
respectively.  We fully depreciated the remaining carrying value of
the network infrastructure rendered unusable, which on an original cost basis,
totaled $0.1 million and $0.2 million ($0.07 million and $0.1 million on a net
book value basis) for the three months ended March 31, 2009 and 2008,
respectively.  To the extent that relocation requires only the
movement of existing network infrastructure to another location, 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,” we will capitalize interest on certain
construction projects.  No such amounts were capitalized for the three
months ended March 31, 2009 and 2008.
 
 In
accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets,” 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 asset.   There were no provisions for impairment recorded in the
three months ended March 31, 2009 and 2008.
  40


Asset
Retirement Obligations




In
accordance with SFAS No. 143, “Accounting for Asset Retirement
Obligations,” 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 $6.9
million and $7.1 million at March 31, 2009 and December 31, 2008,
respectively, of which $3.7 million and $4.0 million, respectively, were
included in “Accrued expenses,” and $3.2 million and $3.1 million, respectively,
were included in “Other long-term liabilities” at such
dates.  Accretion expense, which is included in “Interest expense,”
amounted to $0.1 million for each of the three months ended March 31, 2009 and
2008.





Derivative
Financial Instruments




We
utilize interest rate swaps, derivative financial instruments
(“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 $24 million portion of the Term Loan and we purchased a second
interest rate swap on November 14, 2008 to hedge the interest rate on the
additional $12 million portion of the Term Loan provided by SunTrust
Bank.  See Note 3, “Note Payable,” to the accompanying consolidated
financial statements included elsewhere in this Quarterly Report on Form
10-Q.  We accounted for the derivatives under the SFAS No. 133,
“Accounting for Derivative Instruments and Hedging Activities” (“SFAS No.
133”).  SFAS No. 133 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 SFAS No. 133, the interest rate swaps were considered cash
flow hedges and were 100% effective.  Accordingly, changes in the fair
value of derivatives are and will be recorded each period in accumulated other
comprehensive income (loss).  Changes in the fair value of the
derivatives reported in accumulated other comprehensive income (loss) will be
reclassified into earnings in the period in which earnings are 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 income (loss) each at March 31, 2009 and December 31, 2008 was
$1.6 million for the interest rate swaps.  The mark-to-market value of
the cash flow hedges will be recorded in other non-current assets or other
long-term liabilities, as applicable, and the offsetting gains or losses in
accumulated other comprehensive income (loss).





On
January 1, 2009, the Company adopted SFAS No. 161, “Disclosures about Derivative
Instruments and Hedging Activities – an amendment of FASB Statement No. 133,”
(“SFAS No. 161”).  SFAS No. 161 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 SFAS No.
133; and (iii) how derivatives and related hedged items affect an entity’s
financial position and cash flows.





We
minimize 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.  We do not enter into derivatives for trading
or other speculative purposes.





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 SFAS No. 133.  As
of March 31, 2009 and December 31, 2008, our consolidated balance sheets
included net interest rate swap derivative liabilities of $1.6 million
each.




41


Derivatives
recorded at fair value in the Company’s consolidated balance sheets as of March
31, 2009 and December 31, 2008 consisted of the following:





Derivative
      Liabilities
                            (In
      millions)Derivatives
      designated as hedging instruments
                          
                          March 31, 2009
                          
                          
                          December 31, 2008Interest
      rate swap agreements (*)
                          
                          $
                          1.6
                          
                          
                          $
                          1.6Total
      derivatives designated as hedging instruments
                          
                          $
                          1.6
                          
                          
                          $
                          1.6





(*)
              The
      derivative liabilities are interest rate swap agreements with original
      three year terms.  They are both considered to be long-term
      liabilities for financial statement
purposes.





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 March 31, 2009.





Notional
      Amount
                                
                                
                                
                                Weighted
      Average Rate(In
      millions)
                                
                                Maturity
      Date
                                
                                Pay
                                
                                
                                Receive$
                                24
                                
                                2011
                                
                                
                                3.65
                                %
                                
                                
                                1.86
                                %$
                                12
                                
                                2011
                                
                                
                                2.635
                                %
                                
                                
                                0.91
                                %




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.  These interest rate swap agreements were not in place
during the three months ended March 31, 2008.





Fair Value of
Financial Instruments




We
adopted SFAS No. 157, “Fair Value Measurements,”(“SFAS No.
157”), 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.  SFAS No. 157 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.  SFAS No. 157 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.  SFAS No. 157 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.





Our
investment in overnight money market institutional funds, which amounted to
$96.0 million and $81.9 million at March 31, 2009 and December 31, 2008,
respectively, is included in cash and cash equivalents on the accompanying
balance sheets and is classified as a Level 1 asset.


42


We are
party to two interest rate swaps, which are utilized to modify our interest rate
risk.  We recorded the mark-to-market value of the interest rate swap
contracts of $1.6 million in other long-term liabilities in each of the
consolidated balance sheets at March 31, 2009 and December 31, 2008,
respectively.  We used third parties to value each of the interest
rate swap agreements at March 31, 2009 and December 31, 2008, as well as our own
market analysis to determine fair value.  The fair value of the
interest rate swap contracts are classified as Level 2
liabilities.





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 temporary 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.  Given recent
developments in the financial markets and our exposure to customers in the
financial services industry, our ability to collect contractual amounts due from
certain customers severely impacted by these developments may be adversely
affected.





Foreign
Currency Translation and Transactions




Our
functional 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 (loss).  Our foreign
exchange transaction gains (losses) are generally included in “other (expense)
income, net” in the consolidated statements of operations.





Income
Taxes




We
account for income taxes in accordance with SFAS No. 109, “Accounting for Income
Taxes,” (“SFAS No. 109”).  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 bases, net operating loss and tax credit carry-forwards,
and tax contingencies.  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 record a valuation allowance against deferred tax assets
to the extent that it is more likely than not that some portion or all of the
deferred tax assets will not be realized.





We are
subject to audit 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
Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting
for Uncertainty in Income Taxes,” (“Interpretation No. 48”) when, despite our
belief that our tax return positions are appropriate and supportable under
appropriate tax law, we believe there is uncertainty with respect to certain
positions and we may not succeed in realizing the tax position.  We
have evaluated our tax positions for items of uncertainty in accordance with
Interpretation No. 48 and have determined that our tax positions are highly
certain within the meaning of Interpretation No. 48.  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 three months ended March
31, 2009 and 2008.




43


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 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
weight of available evidence that some portion or the entire deferred tax asset
will not be realized.  Deferred tax liabilities are first applied to
the deferred tax assets reducing the need for a valuation
allowance.  Future utilization of the remaining net deferred tax asset
would require the ability to forecast future earnings.  Based on past
performance resulting in net loss positions, sufficient evidence exists to
require a valuation allowance on our net deferred tax asset
balance.




As a
result of our bankruptcy, estimates have been made that impact the deferred tax
balances.  The factors resulting in estimation include, but are not
limited to, the fresh start valuation of assets and liabilities, implications of
cancellation of indebtedness income and various other factors.





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”).  SFAS No. 148 amended SFAS
No. 123, “Accounting for Stock-Based Compensation,” (“SFAS No. 123”),
to provide alternative methods of transition to SFAS No. 123’s fair value
method of accounting for stock-based employee compensation.  See Note
6, “Stock-Based Compensation,” to the accompanying consolidated financial
statements included elsewhere in this Quarterly Report on Form
10-Q.





Under the
fair value provisions of SFAS No. 123, 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)”), 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.  There were no options to purchase shares of common stock
granted during the three months ended March 31, 2009 and 2008.





For a
description of our stock-based compensation programs, see Note 6, “Stock-Based
Compensation,” to the accompanying consolidated financial statements included
elsewhere in this Quarterly Report on Form 10-Q.




44


Results
of Operations for the Three Months Ended March 31, 2009 Compared to the
Three Months Ended March 31, 2008





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





Three Months Ended March 31,
                                                                            
                                                                            
                                                                            $ Increase/
                                                                            
                                                                            
                                                                            
                                                                            % Increase/2009
                                                                            
                                                                            
                                                                            
                                                                            2008
                                                                            
                                                                            
                                                                            (Decrease)
                                                                            
                                                                            
                                                                            
                                                                            (Decrease)Revenue
                                                                            
                                                                            $
                                                                            85.4
                                                                            
                                                                            
                                                                            $
                                                                            70.9
                                                                            
                                                                            
                                                                            $
                                                                            14.5
                                                                            
                                                                            
                                                                            
                                                                            20.5
                                                                            %Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                                                                            
                                                                            
                                                                            29.4
                                                                            
                                                                            
                                                                            
                                                                            30.8
                                                                            
                                                                            
                                                                            
                                                                            (1.4
                                                                            )
                                                                            
                                                                            
                                                                            (4.5
                                                                            )%Selling,
      general and administrative expenses
                                                                            
                                                                            
                                                                            20.7
                                                                            
                                                                            
                                                                            
                                                                            24.8
                                                                            
                                                                            
                                                                            
                                                                            (4.1
                                                                            )
                                                                            
                                                                            
                                                                            (16.5
                                                                            )%Depreciation
      and amortization
                                                                            
                                                                            
                                                                            11.9
                                                                            
                                                                            
                                                                            
                                                                            12.6
                                                                            
                                                                            
                                                                            
                                                                            (0.7
                                                                            )
                                                                            
                                                                            
                                                                            (5.6
                                                                            )%Operating
      income
                                                                            
                                                                            
                                                                            23.4
                                                                            
                                                                            
                                                                            
                                                                            2.7
                                                                            
                                                                            
                                                                            
                                                                            20.7
                                                                            
                                                                            
                                                                            
                                                                            NMOther
      income (expense):Interest
      income
                                                                            
                                                                            
                                                                            0.2
                                                                            
                                                                            
                                                                            
                                                                            0.5
                                                                            
                                                                            
                                                                            
                                                                            (0.3
                                                                            )
                                                                            
                                                                            
                                                                            (60.0
                                                                            )%Interest
      expense
                                                                            
                                                                            
                                                                            (1.2
                                                                            )
                                                                            
                                                                            
                                                                            (0.7
                                                                            )
                                                                            
                                                                            
                                                                            0.5
                                                                            
                                                                            
                                                                            
                                                                            71.4
                                                                            %Other
      (expense) income, net
                                                                            
                                                                            
                                                                            (0.1
                                                                            )
                                                                            
                                                                            
                                                                            1.5
                                                                            
                                                                            
                                                                            
                                                                            (1.6
                                                                            )
                                                                            
                                                                            
                                                                            (106.7
                                                                            )%Income
      before income taxes
                                                                            
                                                                            
                                                                            22.3
                                                                            
                                                                            
                                                                            
                                                                            4.0
                                                                            
                                                                            
                                                                            
                                                                            18.3
                                                                            
                                                                            
                                                                            
                                                                            NM(Benefit
      from) provision for income taxes
                                                                            
                                                                            
                                                                            (5.1
                                                                            )
                                                                            
                                                                            
                                                                            0.6
                                                                            
                                                                            
                                                                            
                                                                            (5.7
                                                                            )
                                                                            
                                                                            
                                                                            NMNet
      income
                                                                            
                                                                            $
                                                                            27.4
                                                                            
                                                                            
                                                                            $
                                                                            3.4
                                                                            
                                                                            
                                                                            $
                                                                            24.0
                                                                            
                                                                            
                                                                            
                                                                            NM





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.





Revenue. Consolidated revenue
was $85.4 million for the three months ended March 31, 2009, compared to $70.9
million for the three months ended March 31, 2008, an increase of $14.5 million,
or 20.5%.  Revenue from our U.S. operations increased by $15.4
million, or 24.4%, from $63.1 million for the three months ended March 31, 2008
to $78.5 million for the three months ended March 31, 2009.  The
principal reason for this increase was due to the continued growth in each of
our metro, fiber infrastructure and WAN services.  The continued
growth in revenue for each of our services is attributable principally to
installations in excess of contract terminations and any price
degradations.  U.S. revenue from metro services increased by $7.0
million, or 48.6%, from $14.4 million for the three months ended March 31, 2008
to $21.4 million for the three months ended March 31, 2009, revenue from fiber
infrastructure services increased by $1.9 million, or 5.2%, from $36.4 million
for the three months ended March 31, 2008 to $38.3 million for the three months
ended March 31, 2009 and revenue from WAN services increased by $5.2 million, or
48.1%, from $10.8 million for the three months ended March 31, 2008 to $16.0
million for the three months ended March 31, 2009.  Revenue from our
foreign operations, primarily in the U.K., decreased by $0.9 million, or 11.5%,
from $7.8 million for the three months ended March 31, 2008 to $6.9 million for
the three months ended March 31, 2009.  The primary reason for this
decrease was the strengthening of the U.S. dollar against the British pound
during the three months ended March 31, 2009 compared to the three months ended
March 31, 2008.  Accordingly, the translation rate decreased 27.3% in
the three months ended March 31, 2009 compared to the three months ended March
31, 2008.


45


Costs of
revenue.  Consolidated costs of revenue for the three months
ended March 31, 2009 was $29.4 million, compared to $30.8 million for the three
months ended March 31, 2008, a decrease of $1.4 million, or
4.5%.  Consolidated costs of revenue as a percentage of revenue was
34.4% for the three months ended March 31, 2009, compared to 43.4% for the three
months ended March 31, 2008, resulting in consolidated gross profit margin of
65.6% and 56.6% for the three months ended March 31, 2009 and 2008,
respectively.  The costs of revenue for our U.S. operations was $27.2
million and $28.5 million for the three months ended March 31, 2009 and 2008,
respectively, a decrease of $1.3 million, or 4.6%.  The decrease in
the domestic costs of revenue for the three months ended March 31, 2009 compared
to the three months ended March 31, 2008 was attributable principally to (i) a
decrease of $1.8 million in long haul expenses including $1.0 million incurred
in 2008 with respect to temporarily needed leased capacity; (ii) a decrease of
$0.3 million for expenses associated with third party circuits; and (iii) a
decrease of $0.3 million for repairs and maintenance charges for our cable and
transmission equipment.  These decreases were partially offset by (i)
an increase of $1.0 million in payroll related expenses, primarily related to
the increase in headcount in our operations’ technical services and systems
engineering groups; and (ii) an increase of $0.9 million in co-location
expenses, to support our IP network services and increase our presence in third
party data centers.  The costs of revenue for our foreign operations
was $2.2 million for the three months ended March 31, 2009, compared to $2.3
million for the three months ended March 31, 2008, a decrease of $0.1 million,
or 4.3%.  Increases in right-of-way, leased fiber costs and repairs
and maintenance charges were offset by the strengthening of the U.S. dollar
against the British pound decreasing comparative translation rates during the
three months ended March 31, 2009 compared to the three months ended March 31,
2008.




Selling, General
and Administrative Expenses (“SG&A”).  Consolidated
SG&A for the three months ended March 31, 2009 was $20.7 million, compared
to $24.8 million for the three months ended March 31, 2008, a decrease of $4.1
million, or 16.5%.  SG&A as a percentage of revenue was 24.2% for
the three months ended March 31, 2009, compared to 35.0% for the three months
ended March 31, 2008.  In the U.S., SG&A was $18.4 million for the
three months ended March 31, 2009, compared to $22.0 million for the three
months ended March 31, 2009, a decrease of $3.6 million, or
16.4%.  SG&A for our U.S. operations for the three months ended
March 31, 2009 compared to the three months ended March 31, 2008 decreased
primarily due to the decrease of $1.6 million in non-cash stock-based
compensation expense from $4.2 million in the three months ended March 31, 2008
to $2.6 million in the three months ended March 31, 2009.  The primary
reasons for this decrease were (i) the non-cash compensation expense associated
with the acceleration of the vesting of restricted stock units relating to the
termination of Mr. Doris’ employment contract; and (ii) the non-cash
compensation expense of $0.7 associated with the modification of options to
purchase common stock in connection with Mr. Doris’ termination, both of which
were incurred during the three months ended March 31,
2008.  Additionally, professional fees decreased by $1.5
million due to the normalization of our financial
reporting.  Payroll and payroll-related expenses also decreased by
$0.1 million from $10.1 million for the three months ended March 31, 2008 to
$10.0 million for the three months ended March 31, 2009 primarily due to a
decrease in severance expense of $0.7 million, which was offset by an increase
in the bonus accrual of $0.6 million.  See Note 9, “Employment
Contract Termination,” for a further discussion of Mr. Doris’ employment
contract. These decreases were partially offset by an increase in
transaction-based taxes of $0.2 million.  SG&A from our foreign
operations was $2.3 million for the three months ended March 31, 2009, compared
to $2.8 million for the three months ended March 31, 2008, a decrease of $0.5
million, or 17.9%.  The primary reason for this decrease was the
strengthening of the U.S. dollar against the British pound during the three
months ended March 31, 2009 compared to the three months ended March 31,
2008.





Depreciation and
amortization. Consolidated
depreciation and amortization was $11.9 million for the three months ended March
31, 2009, compared to $12.6 million for the three months ended March 31,
2008, a decrease of $0.7 million, or 5.6%.  Consolidated
depreciation and amortization as a percentage of revenue was 13.9% for the three
months ended March 31, 2009, compared to 17.8% for the three months ended March
31, 2008.  Depreciation and amortization decreased as a result of
the elimination of depreciation expense associated with property and equipment
that became fully depreciated since March 31, 2008.  This decrease was
partially offset by the additions to property and equipment for the three months
ended March 31, 2009 and the full period effect of depreciation on property and
equipment acquired after January 1, 2008.





Interest
income.  Interest income,
substantially all of which was earned in the U.S., decreased from
$0.5 million for the three months ended March 31, 2008 to $0.2 million
for the three months ended March 31, 2009.  The decrease of $0.3
million, or 60.0%, was primarily due to the decrease in short-term interest
rates during the three months ended March 31, 2009 compared to the three months
ended March 31, 2008, partially offset by an increase in average balances
available for investment.


46


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 increased from $0.7 million for the
three months ended March 31, 2008 to $1.2 million for the three months ended
March 31, 2009. This increase of $0.5 million, or 71.4%, was primarily
due to interest expense incurred relating to the Secured Credit Facility, of
which $36 million was outstanding under the Term Loan for the full three month
period ended March 31, 2009 and $24 million was outstanding under the Term Loan
for one month during the three month period ended March 31, 2008.





Other (expense)
income, net. Other (expense) income,
net is composed primarily of expense or income from non-recurring transactions
and is not comparative from a trend perspective. Consolidated other
(expense) income, net was a net expense of $0.1 million for the three months
ended March 31, 2009, compared to other income, net of $1.5 million for the
three months ended March 31, 2008, a decrease of $1.6 million.  In the
U.S., other (expense) income, net was other income, net of $0.6 million for the
three months ended March 31, 2009, compared to a net expense of $0.2
million for the three months ended March 31, 2008, an increase of $0.8
million.  For our foreign operations, other (expense) income, net was
a net expense of $0.7 million for the three months ended March 31, 2009,
compared to other income, net of $1.7 million for the three months ended March
31, 2008, a decrease of $2.4 million.  For the three months ended
March 31, 2009, consolidated other (expense) income, net was comprised of 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, offset by gains arising
from the settlement or reversal of certain tax liabilities of $0.7
million.  For the three months ended March 31, 2008, consolidated
other income, net was comprised of a net gain on the sale of certain network
assets in the U.K. of $1.4 million and a net gain on foreign currency of $0.1
million.





(Benefit from)
provision for income taxes.We recorded a benefit
from income taxes of $5.1 million for the three months ended March 31, 2009,
compared to a provision for income taxes of $0.6 million for the three months
ended March 31, 2008.  The benefit is based upon the anticipated 2009
loss for income tax purposes.  The benefit recorded represents the
receivable established for the refunds of federal income tax payments paid with
respect to the tax filings for the years ended December 31, 2007 and 2008 and
the reversal of the federal income taxes accrued at December 31, 2008, net
of the provision for alternative minimum taxes through March 31,
2009.  Additionally, at March 31, 2009, we provided for certain
capital-based state taxes, which partially reduced the benefit from income
taxes.





Liquidity
and Capital Resources




We had
working capital of $36.1 million at March 31, 2009, compared to working capital
of $11.8 million at December 31, 2008, an increase of $24.3
million.  This increase was primarily attributable to an increase in
unrestricted cash of $14.2 million, an increase in prepaid costs and other
current assets of $2.4 million, a decrease in accounts payable and accrued
expenses of $5.2 million and $6.9 million, respectively, partially offset by an
increase in the current portion of deferred revenue and the current portion of
the note payable of $2.2 million and $1.1 million, respectively.  We
are required to maintain an unrestricted cash balance of at least $20 million at
all times in accordance with the Secured Credit Facility.  The
increase in cash at March 31, 2009 was primarily attributable to cash generated
by operating activities of $35.8 million including the collection of $12 million
in connection with the delivery of services in the three months ended March 31,
2009, which will be recognized ratably as revenue over the related 60 month
contract term, partially offset by the use of cash to purchase property and
equipment of $21.2 million.





Net cash
provided by operating activities was $35.8 million during the three months ended
March 31, 2009, compared to $25.3 million during the three months ended March
31, 2008, an increase of $10.5 million.  Net cash provided by
operating activities during the three months ended March 31, 2009 resulted
primarily from the add back of non-cash items deducted in the determination of
net income, principally depreciation and amortization of $11.9 million and
stock-based compensation expense of $2.9 million.  Net cash provided by
operating activities during the three months ended March 31, 2008 resulted
primarily from the add back of non-cash items deducted in the determination of
net income, principally depreciation and amortization of $12.6 million and
stock-based compensation expense of $4.2 million.




47


Net cash
used in investing activities during the three months ended March 31, 2009 was
$21.2 million, compared to $26.6 million during the three months ended March 31,
2008, a decrease of $5.4 million.  Net cash used in investing
activities during the three months ended March 31, 2009 was attributable to the
purchases of property and equipment of $21.2 million.  Net cash used
in investing activities during the three months ended March 31, 2008 was
attributable to the purchases of property and equipment of $28.2 million, offset
by the proceeds generated from sales of property and equipment of $1.6
million.  The property and equipment that is purchased in each period
is used primarily to connect new customers to our networks and to build our
infrastructure.





Net cash
used in financing activities was $0.3 million during the three months ended
March 31, 2009, which is comprised of the purchase of treasury stock of
$0.1 million and the principal payment on our capital lease obligation of
$0.2 million.  Net cash provided by financing activities was $21.7
million during the three months ended March 31, 2008, which is composed of the
$22.3 million of net proceeds received from the funding of the $24 million Term
Loan under the Secured Credit Facility, offset by the increase in restricted
cash and cash equivalents of $0.3 million, the purchase of shares from employees
in connection with the delivery of vested restricted stock units of $0.1 million
and the principal payment on our capital lease obligation of $0.2
million.





During
the three months ended March 31, 2009, we generated cash from operations that
was sufficient to fund our operating expenses and expenditures for property and
equipment of $21.2 million.





On
February 29, 2008, we (excluding certain foreign subsidiaries) entered into the
$60 million Secured Credit Facility comprised of: (i) an $18 million Revolver;
and (ii) a $42 million Term Loan (including an $18 million Delayed Draw Term
Loan).  The initial lenders under the Secured Credit Facility were
Societe Generale and CIT Lending Services Corporation.  The Secured
Credit Facility matures on the fifth anniversary of the closing date (February
28, 2013) of the Secured Credit Facility.  The Secured Credit Facility
is secured by substantially all of our domestic assets.  We paid $0.9
million for upfront fees to the lenders and $0.3 million to our financial
advisors that assisted us in obtaining the Secured Credit
Facility.  Our ability to draw upon the available commitments under
the Revolver is subject to compliance with all of the covenants contained in the
credit agreement and our continued ability to make certain representations and
warranties.  Among other things, these covenants restrict our ability
to pay dividends, limit annual capital expenditures in 2008, 2009 and 2010,
require that we maintain a minimum of $20 million in cash deposits at all times,
provide that our net total funded debt ratio cannot at any time exceed a
specified amount and require that we maintain a minimum consolidated fixed
charges coverage ratio.  As of March 31, 2009, we had $36 million
outstanding under the Secured Credit Facility.  On September 26, 2008,
we executed a joinder agreement to the Secured Credit Facility that added
SunTrust Bank as an additional lender and increased the amount of the Secured
Credit Facility to $90 million effective October 1, 2008.  In
connection with the joinder agreement, we paid a $0.45 million fee at closing
and an aggregate of $0.25 million of advisory fees.  The availability
under the Revolver increased to $27 million, and the Term Loan availability
increased to $63 million, $27 million of which was the increased amount of the
Delayed Draw Term Loan.  Additionally, the Delayed Draw Term Loan
option available under the Secured Credit Facility, which was originally
scheduled to expire on November 25, 2008, was extended to June 30,
2009.  We are party to two interest rate swaps, which are utilized to
modify our interest rate risk under the Secured Credit Facility.  We
have chosen 30 day LIBOR as the interest rate during the term of the interest
rate swaps (30 day LIBOR was 0.49688% at March 31, 2009).





In May
2009, we entered into a modification and extension of our lease (the “Lease
Modification”) of our executive office, which was originally scheduled to expire
on May 31, 2010.  The Lease Modification provides for an additional
term of 10 years and fixed annual rent totaling $11.9 million over the extended
term, which may be reduced by a rent abatement of $1.1 million.





We
believe that our existing cash, cash from operating activities and funds
available under our Secured Credit Facility will be sufficient to fund operating
expenses, planned capital expenditures and other liquidity requirements at least
through June 30, 2010.





In
addition, in the future we may consider making acquisitions of other companies
or product lines to support our growth strategy.  We may finance any
such acquisition of other companies or product lines from existing cash
balances, through borrowings from banks or other institutional lenders, and/or
the public or private offerings of debt and/or equity securities.  We
cannot provide assurance that any such funds will be available to us on
favorable terms, or at all.




48




Segment
Results





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





United
States:





ThreeMonthsEndedMarch31,
                    
                    
                    $ Increase /
                    
                    
                    % Increase /2009
                    
                    
                    2008
                    
                    
                    (Decrease)
                    
                    
                    (Decrease)(Dollars in millions)Revenue
                    
                    $
                    78.5
                    
                    
                    $
                    63.1
                    
                    
                    $
                    15.4
                    
                    
                    
                    24.4
                    %Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                    
                    
                    27.2
                    
                    
                    
                    28.5
                    
                    
                    
                    (1.3
                    )
                    
                    
                    (4.6
                    )%Selling,
      general and administrative expenses
                    
                    
                    18.4
                    
                    
                    
                    22.0
                    
                    
                    
                    (3.6
                    )
                    
                    
                    (16.4
                    )%Depreciation
      and amortization
                    
                    
                    10.5
                    
                    
                    
                    11.0
                    
                    
                    
                    (0.5
                    )
                    
                    
                    (4.5
                    )%Operating
      income
                    
                    
                    22.4
                    
                    
                    
                    1.6
                    
                    
                    
                    20.8
                    
                    
                    NMOther
      income (expense):Interest
      income
                    
                    
                    0.2
                    
                    
                    
                    0.5
                    
                    
                    
                    (0.3
                    )
                    
                    
                    (60.0
                    )%Interest
      expense
                    
                    
                    (1.2
                    )
                    
                    
                    (0.7
                    )
                    
                    
                    0.5
                    
                    
                    
                    71.4
                    %Other
      income (expense), net
                    
                    
                    0.6
                    
                    
                    
                    (0.2
                    )
                    
                    
                    0.8
                    
                    
                    NMIncome
      before income taxes
                    
                    
                    22.0
                    
                    
                    
                    1.2
                    
                    
                    
                    20.8
                    
                    
                    NM(Benefit
      from) provision for income taxes
                    
                    
                    (5.1
                    )
                    
                    
                    0.6
                    
                    
                    
                    (5.7
                    )
                    
                    NMNet
      income
                    
                    $
                    27.1
                    
                    
                    $
                    0.6
                    
                    
                    $
                    26.5
                    
                    
                    NM





United Kingdom and
others:





Three Months Ended March 31,
                                
                                $ Increase /
                                
                                % Increase /2009
                                
                                
                                
                                2008
                                
                                
                                (Decrease)
                                
                                (Decrease)(Dollars
      in millions)Revenue
                                
                                $
                                6.9
                                
                                
                                $
                                7.8
                                
                                
                                $
                                (0.9
                                )
                                
                                (11.5
                                )%Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                                
                                
                                2.2
                                
                                
                                
                                2.3
                                
                                
                                
                                (0.1
                                )
                                
                                (4.3
                                )%Selling,
      general and administrative expenses
                                
                                
                                2.3
                                
                                
                                
                                2.8
                                
                                
                                
                                (0.5
                                )
                                
                                (17.9
                                )%Depreciation
      and amortization
                                
                                
                                1.4
                                
                                
                                
                                1.6
                                
                                
                                
                                (0.2
                                )
                                
                                (12.5
                                )%Operating
      income
                                
                                
                                1.0
                                
                                
                                
                                1.1
                                
                                
                                
                                (0.1
                                )
                                
                                (9.1
                                )%Other
      (expense) income:Other
      (expense) income, net
                                
                                
                                (0.7
                                )
                                
                                
                                1.7
                                
                                
                                
                                (2.4
                                )
                                
                                (141.2
                                )%Income
      before income taxes
                                
                                
                                0.3
                                
                                
                                
                                2.8
                                
                                
                                
                                (2.5
                                )
                                
                                (89.3
                                )%Provision
      for income taxes
                                
                                
                                —
                                
                                
                                
                                —
                                
                                
                                
                                —
                                
                                
                                —Net
      income
                                
                                $
                                0.3
                                
                                
                                $
                                2.8
                                
                                
                                $
                                (2.5
                                )
                                
                                (89.3
                                )%





NM—not
meaningful










The
segment results for the three months ended March 31, 2009 and 2008 (above)
reflect the elimination of any intercompany sales or charges.


49


Credit
Risk





Financial
instruments which potentially subject us to 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 in
the U.S. and the U.K.  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.  We
place our cash and cash equivalents primarily in commercial bank accounts in the
U.S.  Account balances generally exceed federally insured
limits.  Given recent developments in the financial markets and our
exposure to customers in the financial services industry, our ability to collect
contractual amounts due from certain customers severely impacted by these
developments may be adversely affected.





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,
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.





Certain
Factors That May Affect Future Results





Information
contained or incorporated by reference in this Quarterly Report on Form 10-Q, in
other SEC filings by the Company, in press releases, and in presentations by the
Company or its management, contains “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 covered by the forward-looking statements will be
achieved, and other factors could also cause actual results to vary materially
from the future results expressed or implied by such forward-looking
statements.  Such statements are based on management’s current
expectations and beliefs and are subject to a number of risks and uncertainties
that could cause actual results to differ materially from those expressed or
implied by the forward-looking statements.  These risks and
uncertainties include, but are not limited to, those relating to the Company’s
financial and operating prospects, current economic trends and recessionary
pressures, future opportunities, ability to retain existing customers and
attract new ones, the Company’s exposure to the financial services industry, the
Company’s acquisition strategy and ability to integrate acquired companies and
assets, outlook of customers, reception of new products and technologies, and
strength of competition and pricing.  Other factors and risks that may
affect the Company’s business or future financial results are detailed in the
Company’s SEC filings, including, but not limited to, those described under
“Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended
December 31, 2008 and “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” in this Quarterly Report on Form
10-Q.  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 Form 10-Q or to reflect the
occurrence of unanticipated events.




50


ITEM
3.  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 three months ended March 31, 2009, our foreign
activities accounted for 8.1% of consolidated revenue.  Due to the
strengthening of the U.S. dollar against the British pound, the translation rate
for the three months ended March 31, 2009 decreased 27.3% compared to the
translation rate used for the three months ended March 31, 2008.  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.  If we increase our level of foreign activities,
or if at current levels we determine that such arrangements would be
appropriate, we will consider such arrangements to minimize risk.





Under the
terms of the Secured Credit Facility, our borrowings bear interest based upon
short-term LIBOR rates or our administrative agent’s (Societe Generale) base
rate, at our discretion, plus the applicable margins, as defined.  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 $0.36 million (1% x $36 million) based upon the amount of the
related debt outstanding at February 28, 2009.  Effective August 4,
2008, we entered into a swap arrangement under which we fixed our borrowing
costs with respect to the $24 million borrowed under the Term Loan on February
29, 2008 for three years at 3.65% per annum, plus the applicable margin of
3.25%, which was reduced to 3.00% on September 30, 2008 upon the filing of
our Annual Report on Form 10-K for the year ended December 31,
2007.  On October 1, 2008, we borrowed an additional $12 million under
the expanded Term Loan.  On November 14, 2008, we entered into a swap
arrangement under which we fixed our borrowing costs with respect to the $12
million for three years at 2.635% per annum, plus the applicable margin of
3.00%.  The swaps had the effect of increasing our current interest expense
compared to the then current LIBOR rate and reducing our risk of increases in
future interest expenses from increasing LIBOR rates.





As of
March 31, 2009, we had $36 million outstanding under the Secured Credit
Facility.  Additionally, we had a capital lease obligation
outstanding, which carried a fixed rate of interest, and as a result, we were
not exposed to related interest rate risk.


51


ITEM
4.  CONTROLS AND PROCEDURES





Evaluation of Disclosure Controls and
Procedures





As of
March 31, 2009, the Company carried out an evaluation, under the
supervision of and with the participation of the Company’s Chief Executive
Officer and the Chief Financial Officer, who are, respectively, the Company’s
principal executive officer and principal financial officer, of the
effectiveness of the Company’s disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934
(the “Exchange Act”)), pursuant to Exchange Act Rule 13a-15.  Based on
such evaluation, the Company’s Chief Executive Officer and the Chief Financial
Officer concluded that the Company’s disclosure controls and procedures were not
effective as of March 31, 2009.





Remediation





Management
is in the process of remediating the material weaknesses in its entity level
controls, financial close and financial statement reporting processes, income
taxes, property and equipment and inventory processes.  The Company
completed and filed all past due federal and state income tax returns in the
fourth quarter of 2008.  The Company reconciled its physical inventory
counts to the financial records at September 30, 2008 and began updating the
perpetual inventory records on a monthly basis.  During the year ended
December 31, 2008 and through March 31, 2009, the Company continued to develop
processes to manage property and equipment, including inventory, through a
property and equipment sub-ledger and it is in the process of converting those
records to a more integrated sub-ledger system.  Management has also
commenced re-engineering efforts and is re-organizing departments to create more
efficiency and lines of responsibility, which will improve the timely recording
of project cost allocations and accrued obligations relating to property and
equipment, including inventory.  Currently, the Company operates
several disparate systems that produce financial information.  The
Company is evaluating methods to integrate these systems or develop
processes that better control information flow.  The intention of
these efforts is to develop stronger financial, operating and entity level
controls, which will eliminate the material weaknesses that currently exist and
provide for timely financial and tax reporting.





Changes
in Internal Control Over Financial Reporting





There has
been no change in internal control over financial reporting that occurred during
the last fiscal quarter that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.





52


PART
II. OTHER INFORMATION





ITEM
1. LEGAL PROCEEDINGS





The
information presented in Item 3, “Legal Proceedings,” of the Company’s Annual
Report on Form 10-K for the year ended December 31, 2008 and Note 7,
“Litigation,” to the consolidated financial statements included elsewhere in
this Quarterly Report on Form 10-Q, are hereby incorporated by
reference.





ITEM 1A. RISK
FACTORS





In
addition to the other information set forth in this Quarterly Report on Form
10-Q, you should carefully consider the factors discussed under ”Risk Factors”
in the Company’s Annual Report on Form 10-K for the year ended December 31,
2008, which could materially affect the Company’s business, financial condition
or future results.  The risks described in the Company’s Annual Report
on Form 10-K are not the only risks facing the Company.  Additional
risks and uncertainties, including those not currently known to the Company or
that the Company currently deems to be immaterial also could materially
adversely affect the Company’s business, financial condition and/or operating
results.  There have been no material changes in our risk factors from
those disclosed in our Annual Report on Form 10-K for the year ended December
31, 2008.





ITEM 5.
OTHER INFORMATION





The
Company adopted procedures by which stockholders may recommend nominees to the
Company’s Board of Directors.  Stockholders who wish to recommend
individuals for consideration by the Governance and Nominating Committee to
become nominees for election to the board may do so by delivering a written
recommendation to the Governance and Nominating Committee at the following
address: AboveNet, Inc., c/o Secretary at 360 Hamilton Avenue, White Plains, NY
10601 at least 120 days prior to the anniversary date of the mailing of the
Company’s proxy statement for the last annual meeting of
stockholders.  Submissions must include the full name of the proposed
nominee, a description of the proposed nominee’s business experience for at
least the previous five years, complete biographical information, a description
of the proposed nominee’s qualifications as a director and a representation that
the nominating stockholder is a beneficial or record holder of the Company’s
stock and has been a holder for at least one year.  Any such
submission must be accompanied by the written consent of the proposed nominee to
be named as a nominee and to serve as a director if elected.  The
Governance and Nominating Committee does not intend to alter the manner in which
it evaluates candidates based on whether or not the candidate was recommended by
a stockholder.




53




ITEM 6.
EXHIBITS





Exhibit No.
                
                Description
      of Exhibit31.1
                
                Certification
      of Chief Executive Officer of the Registrant, pursuant to Rule 13a-14(a)
      of the Securities Exchange Act of 1934.31.2
                
                Certification
      of Chief Financial Officer of the Registrant, pursuant to Rule 13a-14(a)
      of the Securities Exchange Act of 1934.32.1
                
                Certification
      of Chief Executive Officer of the Registrant, pursuant to 18 U.S.C.
      Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.32.2
                
                Certification
      of Chief Financial Officer of the Registrant, pursuant to 18 U.S.C.
      Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.


54





SIGNATURES





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




ABOVENET,
      INC.Date:  May
      11, 2009
                                By:
                                /s/
      William G. LaPerchWilliam
      G. LaPerch
                                  President,
      Chief Executive Officer and Director
                                  (Principal
      Executive Officer and Duly Authorized
Officer)





Date:  May
      11, 2009
                By:
                /s/
      Joseph P. CiavarellaJoseph
      P. Ciavarella
                  Senior
      Vice President and Chief Financial Officer
                  (Principal
      Financial and Accounting
Officer)





55


EXHIBIT
INDEX





Exhibit No.
              
              Description
      of Exhibit31.1
              
              Certification
      of Chief Executive Officer of the Registrant, pursuant to Rule 13a-14(a)
      of the Securities Exchange Act of 1934.31.2
              
              Certification
      of Chief Financial Officer of the Registrant, pursuant to Rule 13a-14(a)
      of the Securities Exchange Act of 1934.32.1
              
              Certification
      of Chief Executive Officer of the Registrant, pursuant to 18 U.S.C.
      Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.32.2
              
              Certification
      of Chief Financial Officer of the Registrant, pursuant to 18 U.S.C.
      Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.