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 September 30, 2008





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  ̈   No x





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





APPLICABLE
ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE
YEARS:





Indicate
by check mark whether the registrant has filed all documents and reports
required to be filed by Section 12, 13 or 15(d) of the Securities Exchange
Act of 1934 subsequent to the distribution of securities under a plan confirmed
by a court.  Yes  ̈   No x





The
number of shares of the registrant’s common stock, par value $0.01 per share,
outstanding as of December 31, 2008, was11,358,301.











Table of
Contents





ABOVENET,
INC.





INDEX





PagePart
      I.
                                        FINANCIAL
      INFORMATIONItem
      1.
                                        Financial
      StatementsConsolidated
      Balance SheetsAs
      of September 30, 2008 (Unaudited) and December 31, 2007
                                        3Consolidated
      Statements of Operations (Unaudited)Three
      and nine month periods ended September 30, 2008 and 2007
                                        4Consolidated
      Statement of Shareholders’ Equity (Unaudited)Nine
      month period ended September 30, 2008
                                        5Consolidated
      Statements of Cash Flows (Unaudited)Nine
      month periods ended September 30, 2008 and 2007
                                        6Consolidated
      Statements of Comprehensive Income (Unaudited)Three
      and nine month periods ended September 30, 2008 and 2007
                                        7Notes
      to Unaudited Consolidated Financial Statements
                                        8Item
      2.
                                        Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                                        30Item
      3.
                                        Quantitative
      and Qualitative Disclosures about Market Risk
                                        45Item
      4.
                                        Controls
      and Procedures
                                        46Part
      II.
                                        OTHER
      INFORMATIONItem
      1.
                                        Legal
      Proceedings
                                        47Item
      1A.
                                        Risk
      Factors
                                        47Item
      6.
                                        Exhibits
                                        49Signatures
                                        
                                        50Exhibit Index
                                        
                                        51


2


PART
I. FINANCIAL INFORMATION





ITEM
1. FINANCIAL STATEMENTS





ABOVENET,
INC. AND SUBSIDIARIES





CONSOLIDATED
BALANCE SHEETS


(in
millions, except share and per share information)





September 30,
                          2008
                        
                        
                        December 31,
                          2007(Unaudited)ASSETS:Current
      assets:Cash
      and cash equivalents
                        
                        $
                        72.9
                        
                        
                        $
                        45.8Restricted
      cash and cash equivalents
                        
                        
                        3.6
                        
                        
                        
                        4.9Accounts
      receivable, net of allowances of $1.1 and $0.7 at September 30, 2008 and
      December 31, 2007, respectively
                        
                        
                        19.1
                        
                        
                        
                        18.4Prepaid
      costs and other current assets
                        
                        
                        11.9
                        
                        
                        
                        12.3Total
      current assets
                        
                        
                        107.5
                        
                        
                        
                        81.4Property
      and equipment, net of accumulated depreciation and amortization of $201.9
      and $172.6 at September 30, 2008 and December 31, 2007,
      respectively
                        
                        
                        386.3
                        
                        
                        
                        347.7Other
      assets
                        
                        
                        4.8
                        
                        
                        
                        3.2Total
      assets
                        
                        $
                        498.6
                        
                        
                        $
                        432.3LIABILITIES:Current
      liabilities:Accounts
      payable
                        
                        $
                        6.9
                        
                        
                        $
                        7.9Accrued
      expenses
                        
                        
                        73.6
                        
                        
                        
                        78.3Deferred
      revenue—current portion
                        
                        
                        25.7
                        
                        
                        
                        20.8Note
      Payable—current portion
                        
                        
                        1.4
                        
                        
                        
                        —Total
      current liabilities
                        
                        
                        107.6
                        
                        
                        
                        107.0Note
      Payable
                        
                        
                        22.6
                        
                        
                        
                        —Deferred
      revenue
                        
                        
                        92.3
                        
                        
                        
                        91.7Other
      long-term liabilities
                        
                        
                        9.1
                        
                        
                        
                        9.9Total
      liabilities
                        
                        
                        231.6
                        
                        
                        
                        208.6Commitments
      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
      oroutstanding
                        
                        
                        —
                        
                        
                        
                        —Common
      stock, 30,000,000 shares authorized, $0.01 par value, 11,582,968 issued
      and 11,358,451 outstanding as of September 30, 2008, and 10,833,049 issued
      and 10,687,956 outstanding as of December 31, 2007
                        
                        
                        0.1
                        
                        
                        
                        0.1Additional
      paid-in capital
                        
                        
                        277.2
                        
                        
                        
                        253.7Treasury
      stock at cost, 224,517 and 145,093 shares at September 30, 2008 and
      December 31, 2007, respectively
                        
                        
                        (15.1
                        )
                        
                        
                        (10.2
                        )Accumulated
      other comprehensive loss
                        
                        
                        (7.7
                        )
                        
                        
                        (7.4
                        )Retained
      earnings (accumulated deficit)
                        
                        
                        12.5
                        
                        
                        
                        (12.5
                        )Total
      shareholders’ equity
                        
                        
                        267.0
                        
                        
                        
                        223.7Total
      liabilities and shareholders’ equity
                        
                        $
                        498.6
                        
                        
                        $
                        432.3





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


3





ABOVENET,
INC. AND SUBSIDIARIES





CONSOLIDATED
STATEMENT OF OPERATIONS


(in
millions, except share and per share information)





(Unaudited)





Three Months Ended
                        September 30,
                      
                      
                      Nine Months Ended
                        September 30,2008
                      
                      
                      2007
                      
                      
                      2008
                      
                      
                      2007Revenue
                      
                      $
                      82.1
                      
                      
                      $
                      67.3
                      
                      
                      $
                      230.1
                      
                      
                      $
                      186.1Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                      
                      
                      32.1
                      
                      
                      
                      27.9
                      
                      
                      
                      94.5
                      
                      
                      
                      78.4Selling,
      general and administrative expenses
                      
                      
                      22.9
                      
                      
                      
                      22.6
                      
                      
                      
                      68.8
                      
                      
                      
                      60.6Depreciation
      and amortization
                      
                      
                      12.2
                      
                      
                      
                      12.0
                      
                      
                      
                      37.0
                      
                      
                      
                      35.5Operating
      income
                      
                      
                      14.9
                      
                      
                      
                      4.8
                      
                      
                      
                      29.8
                      
                      
                      
                      11.6Other
      income (expense):Interest
      income
                      
                      
                      0.5
                      
                      
                      
                      0.8
                      
                      
                      
                      1.4
                      
                      
                      
                      2.5Interest
      expense
                      
                      
                      (1.1
                      )
                      
                      
                      (0.5
                      )
                      
                      
                      (2.7
                      )
                      
                      
                      (1.7
                      )Other
      (expense) income, net
                      
                      
                      (2.0
                      )
                      
                      
                      1.4
                      
                      
                      
                      (0.5
                      )
                      
                      
                      2.9Income
      before income taxes
                      
                      
                      12.3
                      
                      
                      
                      6.5
                      
                      
                      
                      28.0
                      
                      
                      
                      15.3Provision
      for income taxes
                      
                      
                      1.9
                      
                      
                      
                      1.5
                      
                      
                      
                      3.0
                      
                      
                      
                      3.6Net
      income
                      
                      $
                      10.4
                      
                      
                      $
                      5.0
                      
                      
                      $
                      25.0
                      
                      
                      $
                      11.7Income
      per share, basic:Basic
      income per share
                      
                      $
                      0.94
                      
                      
                      $
                      0.46
                      
                      
                      $
                      2.30
                      
                      
                      $
                      1.09Weighted
      average number of common shares
                      
                      
                      11,034,257
                      
                      
                      
                      10,759,052
                      
                      
                      
                      10,833,583
                      
                      
                      
                      10,739,815Income
      per share, diluted:Diluted
      income per share
                      
                      $
                      0.85
                      
                      
                      $
                      0.41
                      
                      
                      $
                      2.05
                      
                      
                      $
                      0.97Weighted
      average number of common shares
                      
                      
                      12,232,615
                      
                      
                      
                      12,213,649
                      
                      
                      
                      12,207,460
                      
                      
                      
                      12,091,084





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


4




ABOVENET,
INC. AND SUBSIDIARIES





CONSOLIDATED
STATEMENTS 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
                  (Accumulated
                  Deficit)
                
                
                Total
                  Shareholders’
                  EquityBalance
      at January 1, 2008
                
                
                10,833,049
                
                
                $
                0.1
                
                
                
                145,093
                
                
                $
                (10.2
                )
                
                $
                253.7
                
                
                $
                (7.4
                )
                
                $
                (12.5
                )
                
                $
                223.7Issuance
      of common stock from exercise of warrants, including cashless
      exercise
                
                
                689,906
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                13.9
                
                
                
                —
                
                
                
                —
                
                
                
                13.9Issuance
      of common stock from vested restricted stock
                
                
                60,875
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —Purchase
      of treasury stock
                
                
                —
                
                
                
                —
                
                
                
                26,877
                
                
                
                (1.7
                )
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (1.7
                )Purchase
      of treasury stock in cashless exercise of stock warrants
                
                
                —
                
                
                
                —
                
                
                
                52,547
                
                
                
                (3.2
                )
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (3.2
                )Foreign
      currency translationadjustments
      and change in fair value of interest rate swap
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (0.3
                )
                
                
                —
                
                
                
                (0.3
                )Amortization
      of stock-based
      compensation expense for stock options andrestricted
      stock units
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                9.6
                
                
                
                —
                
                
                
                —
                
                
                
                9.6Shares
      cancelled at conclusion of bankruptcy case
                
                
                (862
                )
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —Net
      income
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                25.0
                
                
                
                25.0Balance
      at September 30, 2008
                
                
                11,582,968
                
                
                $
                0.1
                
                
                
                224,517
                
                
                $
                (15.1
                )
                
                $
                277.2
                
                
                $
                (7.7
                )
                
                $
                12.5
                
                
                $
                267.0





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


5





ABOVENET,
INC. AND SUBSIDIARIES





CONSOLIDATED
STATEMENTS OF CASH FLOWS


(in
millions)





(Unaudited)





Nine Months Ended September 30,2008
                  
                  
                  2007Cash
      flows provided by (used in) operating activities:Net
      income
                  
                  $
                  25.0
                  
                  
                  $
                  11.7Adjustments
      to reconcile net income to net cash provided by
operations:Depreciation
      and amortization
                  
                  
                  37.0
                  
                  
                  
                  35.5Provision
      for bad debts
                  
                  
                  0.4
                  
                  
                  
                  0.4Non-cash
      stock-based compensation expense
                  
                  
                  9.6
                  
                  
                  
                  5.0Provisions
      for equipment impairment and asset abandonment
                  
                  
                  2.7
                  
                  
                  
                  —(Gain)
      loss on sale or disposition of property and equipment, net
                  
                  
                  (1.2
                  )
                  
                  
                  0.1Changes
      in operating working capital:
                  
                  
                  
                  
                  
                  
                  —Accounts
      receivable
                  
                  
                  (1.7
                  )
                  
                  
                  (1.2
                  )Prepaid
      costs and other current assets
                  
                  
                  0.2
                  
                  
                  
                  (2.4
                  )Accounts
      payable
                  
                  
                  (0.9
                  )
                  
                  
                  (5.9
                  )Accrued
      expenses
                  
                  
                  (0.8
                  )
                  
                  
                  3.9Other
      assets
                  
                  
                  (0.1
                  )
                  
                  
                  (0.1
                  )Deferred
      revenue and other long-term liabilities
                  
                  
                  6.0
                  
                  
                  
                  2.4Net
      cash provided by operating activities
                  
                  
                  76.2
                  
                  
                  
                  49.4Cash
      flows provided by (used in) investing activities:Proceeds
      from sales of property and equipment
                  
                  
                  1.7
                  
                  
                  
                  0.1Proceeds
      from sale of discontinued operations
                  
                  
                  —
                  
                  
                  
                  1.3Purchases
      of property and equipment
                  
                  
                  (82.9
                  )
                  
                  
                  (61.3
                  )Net
      cash used in investing activities
                  
                  
                  (81.2
                  )
                  
                  
                  (59.9
                  )Cash
      flows provided by (used in) financing activities:Proceeds
      from notes payable, net of financing costs
                  
                  
                  22.3
                  
                  
                  
                  —Change
      in restricted cash and cash equivalents
                  
                  
                  1.3
                  
                  
                  
                  0.4Proceeds
      from exercise of warrants
                  
                  
                  10.7
                  
                  
                  
                  0.3Purchase
      of treasury stock
                  
                  
                  (1.7
                  )
                  
                  
                  —Net
      cash provided by financing activities
                  
                  
                  32.6
                  
                  
                  
                  0.7Effect
      of exchange rates on cash
                  
                  
                  (0.5
                  )
                  
                  
                  0.3Net
      increase (decrease) in cash and cash equivalents
                  
                  
                  27.1
                  
                  
                  
                  (9.5
                  )Cash
      and cash equivalents, beginning of period
                  
                  
                  45.8
                  
                  
                  
                  70.7Cash
      and cash equivalents, end of period
                  
                  $
                  72.9
                  
                  
                  $
                  61.2Supplemental
      cash flow information:Cash
      paid for interest
                  
                  $
                  1.5
                  
                  
                  $
                  0.1Cash
      paid for income taxes
                  
                  $
                  0.8
                  
                  
                  $
                  1.5Non-cash
      financing activity:Non-cash
      exercise of five year warrants at maturity
                  
                  $
                  3.2
                  
                  
                  $
                  —Non-cash
      purchase of shares into treasury
                  
                  $
                  3.2
                  
                  
                  $
                  —





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


6





ABOVENET,
INC. AND SUBSIDIARIES





CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME


(in
millions)





(Unaudited)





Three Months Ended
                    September 30,
                  
                  
                  Nine Months Ended
                    September 30,2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007Net
      income
                  
                  $
                  10.4
                  
                  
                  $
                  5.0
                  
                  
                  $
                  25.0
                  
                  
                  $
                  11.7Foreign
      currency translation adjustments
                    and
      change in fair value of interest rate swap
                  
                  
                  (0.2
                  )
                  
                  
                  (0.1
                  )
                  
                  
                  (0.3
                  )
                  
                  
                  0.2Comprehensive
      income
                  
                  $
                  10.2
                  
                  
                  $
                  4.9
                  
                  
                  $
                  24.7
                  
                  
                  $
                  11.9





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


7





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





Bankruptcy
Filing and Reorganization




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





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





The Plan
of Reorganization governed the treatment of claims against and interest in each
of the Debtors.  Under the Plan of Reorganization, creditors of the
Debtors received the following distributions, as set forth in greater detail
therein:





·
                Administrative
      expense claims (post-petition claims relating to actual and necessary
      costs of administering the bankruptcy estates and operating the business
      of the Debtors), professional fee claims, senior indentured trustee fee
      claims and priority tax claims were settled in cash.·
                Certain
      secured claims were settled as follows:1)
                Class 1
      (a) - secured claims received a note secured by substantially all of
      the assets of the Company,2)
                Class 1
      (b) - secured claims were issued 944,773 shares of common stock and
      the right to purchase an allocated percentage of shares of common stock at
      $29.9543 per share,3)
                Class 2
      - other secured claims were issued 3,369,876 shares of common stock and
      the right to purchase an allocated percentage of shares of common stock at
      $29.9543 per share,4)
                Class 3
      - secured tax claims were settled in cash, and5)
                Class 4
      - general secured claims were settled in cash.·
                Class 5
      - other priority claims were settled in cash.·
                Unsecured
      note holder claims and general unsecured claims of MFN were settled by the
      issuance of 1,685,433 shares of common stock, the right to purchase an
      allocated percentage of shares of common stock at $29.9543 per share, five
      year stock warrants to purchase 709,459 shares of common stock at $20.00
      per share (which expired on September 8, 2008) (see Note 2, “Basis of
      Presentation and Significant Accounting Policies”) and seven year stock
      warrants to purchase 834,658 shares of common stock at $24.00 per share
      (expiring September 8, 2010), and certain avoidance proceeds
      collected by the Company.·
                Subsidiary
      unsecured claims were settled by authorizing the issuance of 2,749,918
      shares of common stock and the right to purchase an allocated percentage
      of shares of common stock at $29.9543 per share.·
                Convenience
      claims were settled in
cash.





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.





8


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





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,
2007.  Operating results for the three and nine months ended September
30, 2008 are not necessarily indicative of the results that may be expected for
the year ended December 31, 2008.





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





Fresh
Start Accounting




On
September 8, 2003, the Company authorized 10,000,000 shares of preferred
stock (with a $0.01 par value) and 30,000,000 shares of common stock (with a
$0.01 par value).  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,
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 purchases 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 Equity Incentive Plan. In July
2008, in connection with the conclusion of the bankruptcy case, 862 shares were
unclaimed and cancelled and five year warrants to purchase 10 shares of common
stock and seven year warrants to purchase 12 shares of common stock were
determined to be undeliverable and were cancelled.  See Note 6,
“Stock-Based Compensation and Equity” for further discussion.





9


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





The
Company’s emergence from bankruptcy resulted in a new reporting entity with no
retained earnings or accumulated losses, effective as of September 8, 2003.
Although the Effective Date of the Plan of Reorganization was September 8,
2003, the Company accounted for the consummation of the Plan of Reorganization
as if it occurred on August 31, 2003 and implemented fresh start accounting
as of that date.  There were no significant transactions during the
period from August 31, 2003 to September 8, 2003.  Fresh
start accounting requires the Company to allocate the reorganization value of
its assets and liabilities based upon their estimated fair values, in accordance
with Statement of Position 90-7, “Financial Reporting by Entities in
Reorganization under the Bankruptcy Code” (“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, as
applicable, and its wholly-owned subsidiaries. Consolidation is generally
required for investments of more than 50% of the outstanding voting stock of an
investee, except when control is not held by the majority owner.  All
significant intercompany accounts and transactions have been eliminated in
consolidation.





Revenue
Recognition




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 101, “Revenue Recognition in
Financial Statements,” as amended by SEC Staff Accounting Bulletin 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.





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. 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 nine months ended September 30, 2008 and 2007, we included the receipts of
bankruptcy claim settlements relating to former customers’ contract terminations
as termination revenue.  Termination revenue is reported together with
other service revenue, and amounted to $4.4 and $5.6 in the three months ended
September 30, 2008 and 2007, respectively, and $6.7 and $7.7 in the nine months
ended September 30, 2008 and 2007, respectively.


10


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





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 nine months ended
September 30, 2008 and 2007.





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.





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 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 are stated at their preliminary 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 amounted to $2.7 and $2.1
for the three months ended September 30, 2008 and 2007, respectively, and
$8.2 and $6.3 for the nine months ended September 30, 2008 and 2007,
respectively.  Depreciation and amortization is provided on a
straight-line basis over the estimated useful lives of the assets, with the
exception of leasehold improvements, which are amortized over the lesser of the
estimated useful lives or the term of the lease.





11





ABOVENET,
INC. AND SUBSIDIARIES




NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





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




Building (except certain storage huts which are 20 years)
                  
                  37.5
      yearsNetwork
      infrastructure assets
                  
                  20
      yearsSoftware
      and computer equipment
                  
                  3
      to 4 yearsTransmission
      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, 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 $0.5 and
$0.1 for the three months ended September 30, 2008 and 2007, respectively, and
$2.0 and $1.5 for the nine months ended September 30, 2008 and 2007,
respectively. The Company fully depreciated the remaining carrying value of the
network infrastructure rendered, which on an original cost basis, totaled $0.3
($0.2 on a net book value basis) for the nine months ended September 30,
2008.  To the extent relocations require only the movement of existing
network infrastructure, the related costs are generally 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.  The Company did
not record any capitalized interest during the three and nine months ended
September 30, 2008 and 2007.





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.  Included in costs of revenue for the year ended December
31, 2007 is a provision for equipment impairment of $2.2 recorded to recognize
the loss in value of certain equipment held in inventory, which was recorded in
the three months ended December 31, 2007. The Company recorded a provision for
equipment impairment of $0.4 in the three and nine months ended September 30,
2008. There were no provisions for impairment recorded in the three and nine
month periods ended September 30, 2007.





Asset
Abandonment




In 2006, the Company acquired
software for an enterprise resource planning system (“ERP System”), which was
expected to be the Company’s information technology platform for capitalized
costs totaling $2.3.  In September 2008, management decided to abandon
the implementation of this ERP System and investigate other alternatives,
including enhancements and upgrades to its current
systems.  Accordingly, the Company recorded an impairment charge of
$2.3 with respect to the abandonment, which is reflected in selling, general and
administrative expenses, in the three months ended September 30,
2008.  Additionally, the Company accrued maintenance fees of $0.1
during the year ended December 31, 2007, which were not paid in
2008.





Treasury
Stock




Treasury
stock is accounted for under the cost method.


12


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





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. We have asset retirement obligations related
to the de-commissioning and removal of equipment; restoration of leased
facilities and 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,”
and 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
$6.5 and $6.1 at September 30, 2008 and December 31, 2007, respectively, of
which $3.5 and $3.3, respectively, were included in “Accrued expenses,” and $3.0
and $2.8, respectively, were included in “Other long-term
liabilities.”  Accretion expense, which is included in “Interest
expense,” amounted to $0.07 and $0.05 for the three months ended September
30, 2008 and 2007, respectively, and $0.21 and $0.15 for the nine months ended
September 30, 2008 and 2007, respectively.





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 local tax law, we believe there is
uncertainty with respect to certain positions and we may not succeed in
realizing the tax benefit. 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.  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 nine months ended September 30, 2008
and the year ended December 31, 2007.





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 provisions for domestic taxes have 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.


13





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





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 and nine months ended September 30, 2008 and
2007.  The tax expense is primarily due to current federal income
taxes and minimum state and local income taxes.





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 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
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 and Equity”).





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 consummation of the Company’s Plan of
Reorganization, all outstanding stock options with respect to MFN’s common stock
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 allowed companies to estimate forfeitures or recognize
the impact of forfeitures as they occur.  As the Company recognized
the impact of forfeitures as they occur upon adoption of SFAS No. 123, the
adoption of SFAS No. 123(R) did result in different accounting treatment,
but it did not have a material impact on the Company’s consolidated financial
statements.





The
following are the assumptions used by the Company to calculate the weighted
average fair value of stock options granted during the period:




Nine Months Ended September 30,2008
                      
                      
                      2007Dividend
      yield
                      
                      
                      —
                      
                      
                      
                      —Expected
      volatility
                      
                      
                      80.00
                      %
                      
                      
                      80.00
                      %Risk-free
      interest rate
                      
                      
                      2.96
                      %
                      
                      
                      4.89
                      %Expected
      life (years)
                      
                      
                      5.00
                      
                      
                      
                      5.00Weighted
      average fair value of options granted
                      
                      $
                      39.36
                      
                      
                      $
                      31.16




On September
8, 2008, the Company awarded options to purchase 1,000 shares of common stock to
each of the five non-employee members of the Board of Directors.  The
options have an exercise price of $60.00 per share, a ten year life and vest on
the first anniversary of the date of grant.


14


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





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 and Equity”).





Stock
Warrants




In
connection with the Plan of Reorganization described in Note 1, “Background and
Organization,” the Company issued to holders of general unsecured claims as part
of the settlement of such claims (i) five year warrants to purchase 709,459
shares of common stock with an exercise price of $20.00 per share (which expired
on 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 in accordance with the terms of the
warrant.  Stock warrants to purchase shares of common stock exercised
totaled 684,684 and 4,506 during the three months ended September 30, 2008 and
2007, respectively, and 689,906 and 14,068 during the nine months ended
September 30, 2008 and 2007, 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 unexercised 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, not to 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.  The expiration date for the five year warrants was September
8, 2008 and the Company exercised the unexercised five year warrants pursuant to
Net Exercise.





Exercise
of Warrants




Under the terms of the
Warrant Agreements described in “Stock Warrants” above, if the market price of
the Company’s common stock, as defined in the respective 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 elected, by written
notice, not to exercise its warrants. Under the Net Exercise, shares issued to
the warrant holders were 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, were paid in cash.  The expiration date
for the five year warrants was September 8, 2008.  Accordingly, 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.




Derivative
Financial Instruments
  The
Company utilized a derivative instrument, an interest rate swap, to mitigate the
Company’s exposure to interest rate risk effective August 4,
2008.  See Note 3, “Notes Payable.”  The Company accounted
for this derivative instrument under the SFAS No. 133, “Accounting for
Derivative Instruments and Hedging Activities” (“SFAS No. 133”).  SFAS
No. 133 requires that all derivative instruments 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 derivative financial instruments for trading purposes or for
speculation.  Based on criteria defined in SFAS No. 133, the interest
rate swap was considered a cash flow hedge and was 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 derivative instruments
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) at
September 30, 2008 was $0.04 for the interest rate swap.  This amount
will be reclassified into earnings as the underlying forecasted transactions
occur.  The mark-to-market value of the cash flow hedge was recorded
in other non-current assets or other long-term liabilities and the offsetting
gains or losses in accumulated other comprehensive loss.
 
 Interest
Rate Swap Agreement
  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 agreement as of September 30, 2008.
  Weighted
      Average RateNotional
      Amount
                  
                  Maturity
      Date
                  
                  Pay
                  Receive$24
                  
                  2011
                  
                  3.65%
                  2.47%
  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.
 15


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 cash and cash equivalents 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 $67.7 and $40.9 at September 30, 2008 and December 31, 2007,
respectively, is included in cash and cash equivalents on the accompanying
balance sheets and is classified as a Level 1 asset.




The
Company is a party to an interest rate swap, which is utilized to modify the
Company’s interest rate risk.  The Company recorded the mark-to-market
value of the interest rate swap of $0.4 in other long-term liabilities in the
consolidated balance sheet at September 30, 2008.




The
Company’s consolidated balance sheets include the following financial
instruments: short-term cash investments, trade accounts receivable and trade
accounts payable. The Company believes the carrying amounts in the financial
statements approximates 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. The
Company’s consolidated balance sheet also includes the fair value of the
interest rate swap contract, which is classified as a Level 2
liability.




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 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 negatively
impacted.





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 up to a maximum of 8% when U.K. employee
contributions reach 5% of salary.





The
Company contributed $0.3 for each of the three months ended September 30, 2008
and 2007, respectively, and contributed $1.2 and $1.1 for the nine months ended
September 30, 2008 and 2007, respectively, net of forfeitures for its
obligations under these plans.





16


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





Taxes
Collected from Customers




In
June 2006, the Emerging Issues Task Force (“EITF”) ratified the consensus
on EITF No. 06-3, “How Taxes Collected from Customers and Remitted to
Governmental Authorities Should Be Presented in the Income Statement (That Is,
Gross versus Net Presentation),” (“EITF No. 06-3”).  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.





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 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
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities,” (“SFAS No. 159”).  SFAS
No. 159 gives entities the option to carry most financial assets and liabilities
at fair value, with changes in fair value recorded in earnings. This statement,
which will be effective in the first quarter of fiscal 2009, is not expected to
have a material impact on the Company’s consolidated financial position, results
of operations or cash flows.





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 Company is still
evaluating the impact of SFAS No. 141(R); however, the adoption of this
statement is not expected to have a material impact on its financial position or
results of operations.





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 Company is still evaluating the impact
SFAS No. 160 will have, but the Company does not expect it to have a material
impact on its financial position or results of operations.





In
December 2007, the SEC issued Staff Accounting Bulletin No. 110, (“SAB No.
110”).  SAB No. 110 extends the opportunity to use the “simplified”
method beyond December 31, 2007, as was allowed by SAB No. 107.  Under
SAB No. 110 and SAB No. 107, a company is able to use the “simplified” method in
developing an estimate of expected term based on the date of exercise of “plain
vanilla” share options.  SAB No. 110 allows companies, which do not
have sufficient historical experience, to provide a reasonable estimate to
continue use of the “simplified” method for estimating the expected term of
“plain vanilla” share option grants after December 31, 2007.  The
Company will continue to use the “simplified” method until there is sufficient
historical experience to provide a reasonable estimate of expected term in
accordance with SAB No. 110.  SAB No. 110 was effective for the
Company on January 1, 2008.





17


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





In
February 2008, the FASB issued FASB Staff Position No. FAS 157-2 (“FSP
No. FAS 157-2”).  FSP No. FAS 157-2 permits a delay in the
effective date of SFAS No. 157 to fiscal years beginning after
November 15, 2008, for nonfinancial assets and nonfinancial liabilities,
except for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually). The delay is intended to
allow the FASB and constituents additional time to consider the effect of
various implementation issues that have arisen, or that may arise, from the
application of SFAS No. 157.





In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities – an amendment of FASB Statement No. 133,” (“SFAS No.
161”), which requires additional disclosures about the objectives of using
derivative instruments, the method by which the derivative instruments and
related hedged items are accounted for under FASB Statement No. 133 and its
related interpretations; and the effect of derivative instruments and related
hedged items on financial position, financial performance and cash
flows.  SFAS No. 161 also requires disclosure of the fair values of
derivative instruments and their gains and losses in a tabular
format.  SFAS No. 161 is effective for financial statements issued for
fiscal years and interim periods beginning after November 15, 2008, with early
adoption encouraged.




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.  Adopting EITF No. 07-05 will not have a material impact on
the Company’s
financial position and results of operations.





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 Company does not expect its adoption will have a material
impact on its financial position or results of operations.





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 Company is currently
evaluating the impact, if any, that the adoption of EITF No. 03-6-1 will have on
its financial position and results of operations.


18


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





NOTE
3:  NOTES PAYABLE





Secured
Credit Facility




On
February 29, 2008, the Company, excluding certain foreign subsidiaries, obtained
a $60 senior secured credit facility (the “Secured Credit Facility”) from
Societe Generale and CIT Lending Services Corporation (the “Lenders”),
consisting of an $18 revolving credit facility (the “Revolver”) and a $42 term
loan facility (the “Term Loan”).  The Secured Credit Facility is
secured by substantially all of the Company’s assets.  The Term Loan
was comprised of $24, which was advanced at closing, and up to $18, 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 the unaffiliated third party financial advisor who assisted the
Company with the Secured Credit Facility.  Additionally, the Company
will be liable for an unused commitment fee of 0.50% per annum or 0.75% per
annum, depending on the utilization of undrawn amounts under the Secured Credit
Facility.  Interest will accrue at LIBOR (30, 60, 90 or 180 day rates)
or at the announced base rate of the administrative agent (Societe Generale), at
the Company’s option, plus the applicable margins, as defined under the Secured
Credit Facility.  Additionally, the Company is required to maintain an
unrestricted cash balance at all times of at least $20.  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.





Additionally,
the Company executed a $1.0 standby letter of credit in favor of New York City
to secure certain performance obligations, which was collateralized by $1.0 of
availability under the Revolver.  The standby letter of credit expires
May 1, 2009 and is expected to be renewed.





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,
subject to the terms of the joinder agreement, which required the payment of a
$0.45 fee at closing and an aggregate of $0.25 of advisory fees.  The
availability under the Revolver increased to $27, the Term Loan increased to $36
and the available Delayed Draw Term Loan increased to $27.





Effective
August 4, 2008, the Company entered into a swap arrangement under which it fixed
its borrowing costs with respect to the $24 outstanding under the Term Loan for
three years at 3.65%, plus the applicable margin of 3.25% (which decreased to
3.00% on September 30, 2008).





On
November 12, 2008, the Company entered into a swap agreement under which it
fixed its borrowing costs with respect to the additional $12 provided by
SunTrust Bank under the Term Loan for three years at 2.635%, plus the applicable
margin of 3.00%.


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
provision (benefit) for the income taxes is comprised of the
following:





Three Months Ended September 30,
                          
                          
                          Nine Months Ended September 30,2008
                          
                          
                          2007
                          
                          
                          2008
                          
                          
                          2007Current
                          
                          $
                          1.9
                          
                          
                          $
                          1.5
                          
                          
                          $
                          3.0
                          
                          
                          $
                          3.6Deferred
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Total
      income tax provision
                          
                          $
                          1.9
                          
                          
                          $
                          1.5
                          
                          
                          $
                          3.0
                          
                          
                          $
                          3.6





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 adopted the provisions of Interpretation No. 48 on January 1,
2007.  At September 30, 2008 and December 31, 2007, 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 NOL’s, capital
losses, and tax credit carryforwards, that are not reduced pursuant to 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, 2007, the Company has domestic NOL carryforwards of $686.9, of
which approximately $202.0 may be used and subject to annual limitation of $8.1
pursuant to the ownership change rules under Internal Revenue Code Section 382,
and foreign NOL carryforwards of $184.5.  Certain of these NOL
carryforwards begin to expire in 2024.  Additionally, approximately
$165.0 of 2008 tax depreciation deductions is also subject to limitation because
of the ownership change.





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 2007. 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 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 11,034,257 and 10,759,052 for the three months ended September 30, 2008 and
2007, respectively, and 10,833,583 and 10,739,815 for the nine months ended
September 30, 2008 and 2007, respectively.  Total weighted average
shares utilized in computing diluted net income per common share were 12,232,615
and 12,213,649 for the three months ended September 30, 2008 and 2007,
respectively, and 12,207,460 and 12,091,084 for the nine months ended September
30, 2008 and 2007, respectively.  Dilutive securities include options
to purchase shares of common stock, restricted stock units and stock
warrants.  For the three and nine months ended September 30, 2008,
potentially dilutive securities to acquire 11,900 and 6,900 shares of common
stock, respectively, were excluded from the calculation of income per common
share as they were anti-dilutive.  For the nine months ended September 30,
2007, potentially dilutive securities to acquire 7,800 shares of common stock
were excluded from the calculation of income per common share as they were
anti-dilutive.  There were no potentially dilutive securities excluded from
the calculation of income per share for the three months ended September 30,
2007.





NOTE
6:   STOCK-BASED COMPENSATION AND EQUITY




Stock-based
compensation expense is included in selling, general and administrative expenses
in the consolidated statements of operations. Stock-based compensation expense
for each period relate to share-based awards granted under AboveNet, Inc.’s
2003 Stock Incentive Plan and reflect awards outstanding during such period,
including awards granted both prior to and during such period. The Company
adopted the 2003 Stock Incentive Plan on the Effective Date.  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 such
date, 584,716 common shares had either been delivered to recipients, returned to
treasury to fund tax obligations associated with the delivery or were reserved
for future deliveries pursuant to restricted stock units, 467,025 common shares
were reserved pursuant to outstanding options to purchase common stock and
reserves of 13,215 common shares were cancelled.





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 in accordance with its terms.  The number of shares
available for grant and the terms of outstanding grants are subject to
adjustment for stock splits, stock dividends and other capital adjustments as
provided in the 2008 Plan.





Stock
Options




On
September 8, 2008, the Company awarded options to purchase 1,000 shares of
common stock to each of the five non-employee members of the Board of
Directors.  The options have an exercise price of $60.00 per share, a
ten year life and vest on the first anniversary of the date of
grant.  During the nine months ended September 30, 2007, the Company
awarded options to purchase 13,475 shares of common stock, which have a ten year
life, vested on the first anniversary date of the grant and have a per share
exercise price of $56.00.  The Company recognized non-cash stock-based
compensation expense related to outstanding stock options amounting to $0.0 and
$0.9 for the three months ended September 30, 2008 and 2007, respectively, and
$1.2 and $1.5 for the nine months ended September 30, 2008 and 2007,
respectively.  The non-cash stock-based compensation expense for the
nine months ended September 30, 2008 includes $0.8 incurred with respect to the
modification of certain options to purchase common stock (see Note 9,
“Employment Contract Termination”).


21


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





Restricted
Stock Units




On
September 8, 2008, pursuant to the 2008 Plan, the Company granted to certain
employees and to the members of the Board of Directors, an aggregate 345,100
restricted stock units, 190,000 of which vest 30% in one year, 10% in two years
and 60% in three years, 86,000 of which vest ratably on each of the first,
second and third anniversaries of the date of grant and 48,100 of which vest on
the first anniversary of the date of grant.  Additionally, William G.
LaPerch, the President and Chief Executive Officer of the Company, may earn
21,000 restricted stock units, which vest ratably in 2010, 2011 and 2012 based
upon certain performance targets for the fiscal years 2009, 2010 and
2011.  In May 2008, pursuant to the 2003 Plan, the Company awarded
9,000 restricted stock units in addition to the restricted stock units described
above, which are scheduled to vest the first anniversary of the date of
grant.  The Company recognized non-cash stock-based compensation
expense related to restricted stock units of $1.7 and $2.3 for the three months
ended September 30, 2008 and 2007, respectively, and $8.4 and $3.5 for the nine
months ended September 30, 2008 and 2007, respectively.  Included in
the expense for the nine months ended September 30, 2008 is a charge of $0.9,
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 were no such amounts incurred for the three months
ended September 30, 2008 and the three and nine months ended September 30,
2007.





Rights
Agreement Amendment




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.


22


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





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.





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. Under the Company’s Plan of Reorganization,
essentially all claims against the Company’s U.S. subsidiaries that arose prior
to the confirmation of the Plan of Reorganization on August 21, 2003, were
discharged in accordance with the Plan of Reorganization.  A summary
of the treatment of claims in the bankruptcy proceeding is provided in Note 1
above.





Global
Voice Networks Limited (“GVN”)




AboveNet
Communications UK Limited, the Company’s U.K. operating subsidiary (“ACUK”), is
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 in the
three months ended December 31, 2007, of which $0.8 was paid in 2007 and $10.9
was included in accrued expenses on the consolidated balance sheet at December
31, 2007.  The Company had $3.4 included in accrued expenses at
September 30, 2008.





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 $0.7 and $0.5 for the three months ended
September 30, 2008 and 2007, respectively, and was $1.7 and $1.5 for the nine
months ended September 30, 2008 and 2007, respectively.




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 ($3.2 at December 31,
2007), was recorded as termination revenue in the three months ended September
30, 2008.





Telekenex,
Inc. (“Telekenex”)




In May
2008, Telekenex, a customer, filed a complaint against the Company in the San
Francisco County Superior Court alleging that the Company failed to deliver to
Telekenex fiber optic capacity under a certain ten year contract between
Telekenex and the Company.  Telekenex asserted in the complaint that
it is entitled to such fiber optic capacity and unspecified
damages.  On September 29, 2008, the Company signed a settlement
agreement with Telekenex pursuant to which the Company agreed to pay $0.35 and
provide Telekenex additional fiber access in order to resolve the
dispute.  Pursuant to the settlement agreement, the parties released
each other from any claims related to the dispute and Telekenex dismissed the
complaint.  The Company recovered 100% of the Telekenex settlement
payment under its errors and omissions insurance policy in December
2008.





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 September 30, 2008 and 2007 and $0.3 and $0.2 for the nine months ended
September 30, 2008 and 2007, respectively.  No amounts were
outstanding at each of September 30, 2008 and December 31,
2007.  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 and executed and delivered a
consulting agreement with Mr. Doris.  The consulting agreement
provided that in exchange for Mr. Doris’ provision of consulting services to the
Company for a period of nine months, Mr. Doris was paid (i) his annual
salary of $0.3 pro rated 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 was
$1.6, which was recognized in selling, general and administrative expenses for
financial statement purposes during the three months ended March 31,
2008.  Additionally, the Company incurred non-cash stock-based
compensation expense of $0.7 with respect to the modification of Mr. Doris’
vested options to purchase common stock (see Note 6, “Stock-Based Compensation
and Equity – Stock Options”).




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 September 30,
                                
                                
                                Nine Months Ended September 30,2008
                                
                                
                                2007
                                
                                
                                2008
                                
                                
                                2007RevenueUnited
      States
                                
                                $
                                73.9
                                
                                
                                $
                                60.8
                                
                                
                                $
                                205.9
                                
                                
                                $
                                167.7United
      Kingdom
                                
                                
                                9.4
                                
                                
                                
                                7.6
                                
                                
                                
                                27.5
                                
                                
                                
                                21.0Eliminations
                                
                                
                                (1.2
                                )
                                
                                
                                (1.1
                                )
                                
                                
                                (3.3
                                )
                                
                                
                                (2.6
                                )Consolidated
      Worldwide
                                
                                $
                                82.1
                                
                                
                                $
                                67.3
                                
                                
                                $
                                230.1
                                
                                
                                $
                                186.1





September 30, 2008
                              
                              
                              December 31, 2007Long-lived
      assetsUnited
      States
                              
                              $
                              355.6
                              
                              
                              $
                              317.3United
      Kingdom
                              
                              
                              30.6
                              
                              
                              
                              30.3Other
                              
                              
                              0.1
                              
                              
                              
                              0.1Consolidated
      Worldwide
                              
                              $
                              386.3
                              
                              
                              $
                              347.7





NOTE
11: OTHER (EXPENSE) INCOME, NET





Other
(expense) income, net consists of the following:




Three Months Ended
                      September 30,
                    
                    
                    Nine Months Ended
                      September 30,2008
                    
                    
                    2007
                    
                    
                    2008
                    
                    
                    2007Gain
      on settlement or reversal of liabilities
                    
                    $
                    —
                    
                    
                    $
                    1.1
                    
                    
                    $
                    0.1
                    
                    
                    $
                    1.1Gain
      on legal settlement
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    0.6(Loss)
      gain on foreign currency
                    
                    
                    (1.9
                    )
                    
                    
                    0.7
                    
                    
                    
                    (1.8
                    )
                    
                    
                    0.7(Loss)
      gain on disposition of property and equipment
                    
                    
                    (0.1
                    )
                    
                    
                    (0.1
                    )
                    
                    
                    1.1
                    
                    
                    
                    (0.2
                    )Gain
      on leased asset termination
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    0.3Gain
      on settlement of customer amounts due
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    0.4Other
                    
                    
                    —
                    
                    
                    
                    (0.3
                    )
                    
                    
                    0.1
                    
                    
                    
                    —Total
                    
                    $
                    (2.0
                    )
                    
                    $
                    1.4
                    
                    
                    $
                    (0.5
                    )
                    
                    $
                    2.9


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




In
September 2008, the Company entered into new employment agreements with certain
of its senior officers (the “Executive Officers”).  Each of the
employment agreements is for a term which ends November 16, 2011 with automatic
extensions for an additional one-year period unless cancelled by the executive
or the Company in writing at least 120 days prior to the end of the applicable
term.  Each of the contracts provides for a base rate of compensation,
which may increase (but cannot decrease) during the term of the
contract.  Additionally, each contract provides for incentive cash
bonus targets for each executive. Each of the Executive Officers will generally
be entitled to the same benefits offered to the Company’s other
executives.  Each of the employment contracts provides for the payment
of severance and the provision of certain other benefits in connection with
certain termination events.  The employment contracts also include
confidentiality, non-compete and assignment of intellectual property covenants
by each of the Executive Officers.




Internal
Revenue Service




In
September 2008, the Company was notified by the Internal Revenue Service (the
“IRS”) that the IRS was proposing the reclassification of certain individuals,
classified by the Company as independent contractors, to employees and assessing
related 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 that the Company is reviewing.





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 us that they have temporarily suspended any discussions regarding
renewals of telecommunications franchises in the City of New York. As a result,
it is our understanding that DOITT has not renewed any recently expired
franchise agreement, including our franchise agreement which expired on December
20, 2008. Prior to the expiration of our franchise agreement, we sought out and
received written confirmation from DOITT that our franchise agreement provides a
basis for us to continue to operate in the City of New York pending conclusion
of renewal discussions.  We intend to continue to operate under our
expired franchise agreement pending any renewal. We believe that a number of
other operators in the City of New York are operating on a similar basis. Based
on our discussions with DOITT and the written confirmation that we have
received, we do 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
our operations as the result of our expired franchise agreement could have a
material adverse effect on our 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 the preferred members receiving distributions of their original
investment plus a preferred return.  Based upon amounts contributed
through December 31, 2008 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, the
distributions on the Company’s investment is subordinated to the distributions
to the preferred members and the Company’s interest does not provide any level
of control. 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 cost of revenue in the relevant
period.  The Company contributed services to MediaX of $0.4 and $0.8
in the three and nine months ended September 30, 2008,
respectively.  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 other
customers.  The Company billed MediaX for services and reimbursements of $0.1 and $0.4
during the three and nine months ended September 30, 2008,
respectively.  There were no services provided during the three and
nine months ended September 30, 2007.





NOTE
14: CHANGE IN ESTIMATE




Effective
January 1, 2008, the Company changed the estimated useful lives for its spare
parts (which is classified as inventory) from five years to the respective asset
class lives of such parts, which range from seven to twenty
years.  The effect of this change on the Company’s operating results
for the three and nine months ended September 30, 2008 was not
material.





NOTE
15:   SUBSEQUENT EVENTS





Litigation




In
October 2008, the Southeastern Pennsylvania Transportation Authority (“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.





Stock
Awards Granted




On
October 27, 2008, in conjunction with executing an employment agreement with Mr.
Ciavarella, as discussed below, the Company granted Mr. Ciavarella 35,000
restricted stock units, which are scheduled to vest 30% on November 16, 2009,
10% on November 15, 2010 and 60% on November 15, 2011.





In
October 2008, the Company granted to an employee 1,000 restricted stock units,
which vest on November 16, 2009.





In
December 2008, the Company granted to an employee 3,000 restricted stock units,
which vest on November 16, 2009.


28


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





Stock
Purchase Agreements




In
October 2008, the Company purchased from employees, who had previously received
distributions of common stock pursuant to vested restricted stock units, 18,610
shares of common stock at a price of $50.07 per share or for an aggregate
purchase price of $0.9, such price being determined based on the average trading
price set by the Board of Directors after the filing of the Company’s Annual
Report on Form 10-K for the year ended December 31, 2007.  Each stock
purchase agreement also includes a provision that restricts the employee from
selling or otherwise transferring any shares of common stock or other securities
of the Company until the earlier of (a) six months after the date on which the
Company becomes current with respect to its Securities Exchange Act filing
obligations; and (b) such time as the Company’s common stock becomes listed on a
national securities exchange.




Employment
Contracts




On
October 27, 2008, the Company entered into an employment agreement with Mr.
Joseph P. Ciavarella under which Mr. Ciavarella agreed to become the Company’s
Senior Vice President and Chief Financial Officer.  The employment
agreement is on substantially the same terms as the September 2008 employment
agreements. See Note 12, “Commitments and Contingencies - Employment
Contracts.”


29




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 the Annual
Report on Form 10-K for the year ended December 31, 2007.





Executive
Summary




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, and 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 14 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 approximately 1.8 million fiber miles across approximately 4,500
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 across approximately 230 cable route miles.  In January
2009, we announced the opening of the Austin, Texas market, which will become
our 15th U.S.
market.





Long haul network. Through
construction, acquisition and leasing activities, we have created a nationwide
fiber-optic communications network spanning 10,000 cable route miles that
connects each of our 14 U.S. metro networks. We run advanced dense
wavelength-division multiplexing 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
and Trans-Atlantic undersea telecommunications consortia 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.





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 and nine months ended September 30,
2008 and 2007, as shown in our unaudited consolidated statements of operations
included elsewhere in this Quarterly Report on Form 10-Q.





Industry




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




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.


30


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 592 as of September 30, 2008, 514 of which were employed
in the U.S., 76 in the U.K., one in the Netherlands and one in
Japan.  Our worldwide headcount was 549 as of December 31, 2007, 482
of which were employed in the U.S., 65 in the U.K., one in the Netherlands and
one in Japan.




2008
Highlights and 2009 Outlook




Our
consolidated revenue increased from $186.1 million to $230.1 million, or 23.6%,
for the nine months ended September 30, 2008 compared to the nine months ended
September 30, 2007, due principally to a $24.2 million increase in our domestic
metro transport services.  Additionally, in the U.S., our revenue from
dark fiber services and IP network services increased by $11.6 million for the
nine months ended September 30, 2008 compared to the nine months ended September
30, 2007.  Revenue from our foreign operations, primarily in the U.K.,
increased by $5.8 million in the nine months ended September 30, 2008 compared
to the nine months ended September 30, 2007.




During
the nine months ended September 30, 2008, we generated net income of $25.0
million and as of September 30, 2008, we had $72.9 million of unrestricted cash,
compared to $45.8 million of unrestricted cash at December 31, 2007, an
increase in liquidity of $27.1 million.  This increase was
attributable to the proceeds from the borrowing under the Company’s Secured
Credit Facility and from cash generated by operating activities, partially
offset by cash used in investing activities (purchases of property and equipment
of $82.9 million).  See below in this Item 2 under, “Liquidity and
Capital Resources,” for further discussion.





In the
nine months ended September 30, 2008, our cash flow generated by operating
activities increased as a result of the improvement in operating results
described above. We believe, based on our business plan, that our existing cash,
cash from our operating activities and funds available under our Secured Credit
Facility will be sufficient to fund our operations, planned capital expenditures
and other liquidity requirements at least through March 31, 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 2008 compared to 2007.  Our costs grew at a
slower rate than our revenue and our operating income improved.  Our
operating results for 2008 were favorably impacted by the non-cash settlement of
our dispute with SBC of $3.5 million, which was recognized in the third quarter
of 2008 and the collection of a termination fee of $8.2 million, which will be
recognized in the fourth quarter of 2008.  Offsetting these positive
impacts was the write-off of our investment in a new information technology
platform of $2.3 million that has been taken in the third quarter of
2008.  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 deals 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 the Company’s financial
performance in 2009 and thereafter.  See Item 1, “Financial
Statements,” Note 2, “Basis of Presentation and Significant Accounting Policies
- Asset Abandonment” and Note
7, “Litigation” and Note 15, “Subsequent Events - Litigation.”





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 declines over the contract
term) if the contract were terminated by the customer without basis before its
expiration to ensure that we recover our initial capital investment plus an
acceptable return.  We also derive a portion of our revenues from
month-to-month contracts.


31


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; and (v) regulatory costs,
insurance, telecommunications costs, professional fees, and license and
maintenance fees for internal software and hardware.





Depreciation
and amortization




Depreciation
and amortization consists of the ratable measurement of the use of property and
equipment.  Generally, 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.  We also depreciate
inventory of spare parts equipment on the same basis. See Note 14, “Change in
Estimate.”





Critical
Accounting Policies and Estimates




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





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.


32


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 101, “Revenue Recognition in
Financial Statements,” as amended by SEC Staff Accounting Bulletin 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.





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. 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 is no
longer obligated to provide services for consideration previously received and
for which revenue recognition has been deferred. During the nine months ended
September 30, 2008 and 2007, we included the receipts of bankruptcy claim
settlements from former customers as termination revenue.  Termination
revenue is reported together with other service revenue, and amounted to $4.4
million and $5.6 million in the three months ended September 30, 2008 and 2007,
respectively, and $6.7 million and $7.7 million in the nine months ended
September 30, 2008 and 2007, 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 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.


33


Property
and Equipment




Property
and equipment are stated at their preliminary 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 and
$2.1 million for the three months ended September 30, 2008 and 2007,
respectively, and $8.2 million and $6.3 million for the nine months ended
September 30, 2008 and 2007, respectively.  Depreciation and
amortization is provided on a straight-line basis over the estimated useful
lives of the assets, with the exception of leasehold improvements, which are
amortized over the lesser of the estimated useful lives or the term of the
lease.





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




Building (except certain storage huts which are 20 years)
              
              37.5 yearsNetwork
      infrastructure assets
              
              20
      yearsSoftware
      and computer equipment
              
              3
      to 4 yearsTransmission
      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 $0.5 million and $0.1
million for the three months ended September 30, 2008 and 2007, respectively,
and $2.0 million and $1.5 million for the nine months ended September 30, 2008
and 2007, respectively. We fully depreciated the remaining carrying value of the
network infrastructure rendered unusable, which on an original cost basis,
totaled $0.3 million ($0.2 million on a net book value basis) for the nine
months ended September 30, 2008.  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. 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.  Included in costs of revenue for the year ended December
31, 2007 is a provision for equipment impairment of $2.2 million recorded to
recognize the loss in value of certain equipment held in inventory, which was
recorded in the three months ended December 31, 2007.  We recorded a
provision for equipment impairment of $0.4 million in the three months ended
September 30, 2008. There were no provisions for impairment recorded in the
three and nine month periods ended September 30, 2007.





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
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.


34


Asset
retirement obligations are generally recorded as “other long-term liabilities,”
and 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
$6.5 million and $6.1 million at September 30, 2008 and December 31, 2007,
respectively, of which $3.5 million and $3.3 million, respectively, were
included in “Accrued expenses,” and $3.0 million and $2.8 million, respectively,
were included in “Other long-term liabilities.”  Accretion expense,
which is included in “Interest expense,” amounted to $0.07 million and $0.05
million for the three months ended September 30, 2008 and 2007,
respectively, and $0.21 million and $0.15 million for the nine months ended
September 30 2008 and 2007, respectively.





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 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 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 nine months ended September 30, 2008
and the year ended December 31, 2007.




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 and Equity,” to the accompanying consolidated financial statements
included elsewhere in this Quarterly Report on Form
10-Q).


35


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 occur.  As we had recognized the impact of
forfeitures as they occurred upon adoption of 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.





The
following are the assumptions during the period set forth below used by the
Company to calculate the weighted average fair value of stock options
granted:




Nine months Ended September 30,2008
                      
                      
                      2007Dividend
      yield
                      
                      
                      —
                      
                      
                      
                      —Expected
      volatility
                      
                      
                      80.00
                      %
                      
                      
                      80.00
                      %Risk-free
      interest rate
                      
                      
                      2.96
                      %
                      
                      
                      4.89
                      %Expected
      life (years)
                      
                      
                      5.00
                      
                      
                      
                      5.00Weighted
      average fair value of options granted
                      
                      $
                      39.36
                      
                      
                      $
                      31.16





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





Results
of Operations for the Nine Months Ended September 30, 2008 Compared to the Nine
Months Ended September 30, 2007




Consolidated
Results:




Nine months Ended September 30,
                        
                        
                        $ Increase/
                        
                        
                        % Increase/2008
                        
                        
                        2007
                        
                        
                        (Decrease)
                        
                        
                        (Decrease)(Dollars
      in millions)Revenue
                        
                        $
                        230.1
                        
                        
                        $
                        186.1
                        
                        
                        $
                        44.0
                        
                        
                        
                        23.6
                        %Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                        
                        
                        94.5
                        
                        
                        
                        78.4
                        
                        
                        
                        16.1
                        
                        
                        
                        20.5
                        %Selling,
      general and administrative expenses
                        
                        
                        68.8
                        
                        
                        
                        60.6
                        
                        
                        
                        8.2
                        
                        
                        
                        13.5
                        %Depreciation
      and amortization
                        
                        
                        37.0
                        
                        
                        
                        35.5
                        
                        
                        
                        1.5
                        
                        
                        
                        4.2
                        %Operating
      income
                        
                        
                        29.8
                        
                        
                        
                        11.6
                        
                        
                        
                        18.2
                        
                        
                        
                        156.9
                        %Other
      income (expense):Interest
      income
                        
                        
                        1.4
                        
                        
                        
                        2.5
                        
                        
                        
                        (1.1
                        )
                        
                        
                        (44.0
                        )%Interest
      expense
                        
                        
                        (2.7
                        )
                        
                        
                        (1.7
                        )
                        
                        
                        1.0
                        
                        
                        
                        58.8
                        %Other
      (expense) income, net
                        
                        
                        (0.5
                        )
                        
                        
                        2.9
                        
                        
                        
                        (3.4
                        )
                        
                        
                        (117.2
                        )%Income
      before income taxes
                        
                        
                        28.0
                        
                        
                        
                        15.3
                        
                        
                        
                        12.7
                        
                        
                        
                        83.0
                        %Provision
      for income taxes
                        
                        
                        3.0
                        
                        
                        
                        3.6
                        
                        
                        
                        (0.6
                        )
                        
                        
                        (16.7
                        )%Net
      income
                        
                        $
                        25.0
                        
                        
                        $
                        11.7
                        
                        
                        $
                        13.3
                        
                        
                        
                        113.7
                        %







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.


36


Revenue. Consolidated revenue
was $230.1 million for the nine months ended September 30, 2008, compared to
$186.1 million for the nine months ended September 30, 2007, an increase of
$44.0 million, or 23.6%.  Revenue from our U.S. operations increased
by $38.2 million, or 22.8%, from $167.5 million for the nine months ended
September 30, 2007 to $205.7 million for the nine months ended September 30,
2008.  The principal reason for this increase was due to the continued
growth in our metro transport services and dark fiber services.  U.S.
revenue from metro transport services increased by $24.2 million, or 68.6%, from
$35.3 million for the nine months ended September 30, 2007 to $59.5 million for
the nine months ended September 30, 2008; revenue from dark fiber services
increased by $9.5 million, or 9.8%, from $97.2 million for the nine months ended
September 30, 2007 to $106.7 million for the nine months ended September 30,
2008, and revenue from IP network services increased by $2.1 million, or 11.6%,
from $18.1 million for the nine months ended September 30, 2007 to $20.2 million
for the nine months ended September 30, 2008.  A significant portion
of the growth was attributable to new contracts with existing
customers.  Revenue from our foreign operations, primarily in the
U.K., increased by $5.8 million, or 31.2%, from $18.6 million for the nine
months ended September 30, 2007 to $24.4 million for the nine months ended
September 30, 2008.  The increase was primarily due to our continued
focus on growing our existing services in the U.K.





Costs of
revenue.  Consolidated costs of revenue for the nine months
ended September 30, 2008 was $94.5 million, compared to $78.4 million for the
nine months ended September 30, 2007, an increase of $16.1 million, or
20.5%.  Consolidated costs of revenue as a percentage of revenue was
41.1% for the nine months ended September 30, 2008, compared to 42.1% for the
nine months ended September 30, 2007, resulting in consolidated gross profit
margin of 58.9% for the nine months ended September 30, 2008, compared to 57.9%
for the nine months ended September 30, 2007.  The costs of revenue
for our U.S. operations was $87.0 million and $72.3 million for the nine months
ended September 30, 2008 and 2007, respectively, an increase of $14.7 million,
or 20.3%.  The increase in the domestic costs of revenue for the nine
months ended September 30, 2008 compared to the nine months ended September 30,
2007 was attributable principally to (i) an increase of $3.8 million in
co-location expenses, to support our IP network services and increase our
presence in third party data centers; (ii) an increase of $2.6 million for
repairs and maintenance charges for our cable and transmission equipment; (iii)
an increase of $2.4 million in payroll related expenses, primarily related to
the increase in headcount in our operations technical services and systems
engineering groups; and (iv) an increase of $1.5 million for expenses associated
with third party circuits. Additionally, the nine month period ended September
30, 2008 includes a provision for equipment impairment relating to inventory of
$0.4 million and a lease abandonment cost of $0.7 million, compared to a lease
abandonment cost of $0.3 million for the nine month period ended September 30,
2007.  The costs of revenue for our foreign operations was $7.5
million for the nine months ended September 30, 2008, compared to $6.1 million
for the nine months ended September 30, 2007, an increase of $1.4 million, or
23.0%, which was consistent with our revenue growth.





Selling, General
and Administrative Expenses (“SG&A”).   Consolidated
SG&A for the nine months ended September 30, 2008 was $68.8 million,
compared to $60.6 million for the nine months ended September 30, 2007, an
increase of $8.2 million, or 13.5%.  SG&A as a percentage of
revenue was 29.9% for the nine months ended September 30, 2008, compared to
32.6% for the nine months ended September 30, 2007.  In the U.S.,
SG&A was $60.3 million for the nine months ended September 30, 2008,
compared to $51.7 million for the nine months ended September 30, 2007, an
increase of $8.6 million, or 16.6%.  SG&A for our U.S. operations
for the nine months ended September 30, 2008 compared to the nine months ended
September 30, 2007 increased primarily due to the increase of $4.6 million in
non-cash stock-based compensation expense from $5.0 million in the nine months
ended September 30, 2007 to $9.6 million in the nine months ended September 30,
2008.  The reasons for this increase were (i) the expense associated
with the acceleration of the vesting of restricted stock units relating to the
termination of Mr. Doris’ employment contract recognized in the three months
ended March 31, 2008; and (ii) the $0.7 million expense associated with the
modification of options to purchase common stock in connection with Mr. Doris’
termination also recognized in the three months ended March 31,
2008.  Additionally, payroll and payroll-related expenses increased by
$2.8 million from $25.3 million for the nine months ended September 30, 2007 to
$28.1 million for the nine months ended September 30, 2008 primarily due to the
severance expense associated with the termination of Mr. Doris’ employment
contract and the salaries associated with headcount increases since September
30, 2007.  See Note 9, “Employment Contract Termination,” for a
further discussion of Mr. Doris’ employment contract.  We also had an
impairment charge of $2.3 million with respect to an asset abandonment (see Note
2, “Basis of Presentation and Use of Estimates - Asset Abandonment,” for a
further discussion).  These increases were partially offset by a
reduction in transaction-based taxes of $1.3 million and a reduction in
professional fees of $1.2 million.  SG&A for our foreign
operations was $8.5 million for the nine months ended September 30, 2008,
compared to $8.9 million for the nine months ended September 30, 2007, a
decrease of $0.4 million, or 4.5%.


37


Depreciation and
amortization. Consolidated
depreciation and amortization was $37.0 million for the nine months ended
September 30, 2008, compared to $35.5 million for the nine months ended
September 30, 2007, an increase of $1.5 million, or
4.2%.  Consolidated depreciation and amortization as a percentage of
revenue was 16.1% for the nine months ended September 30, 2008, compared to
19.1% for the nine months ended September 30, 2007.  Depreciation and
amortization increased as a result of additions to property and equipment for
the nine months ended September 30, 2008 and the full period effect of
depreciation on property and equipment acquired after January 1, 2007, which was
partially offset by the elimination of depreciation expense associated with
property and equipment sold or disposed of during the nine months ended
September 30, 2008 and the nine months ended September 30, 2007, and property
and equipment that became fully depreciated during the nine months ended
September 30, 2008.




Interest
income.  Interest income,
substantially all of which was earned in the U.S., decreased from $2.5 million
for the nine months ended September 30, 2007 to $1.4 million for the nine months
ended September 30, 2008.  The decrease of $1.1 million, or 44.0%, was
primarily due to the decrease in average balances available for investment and a
decrease in short-term interest rates.





Interest
expense.
Interest expense, substantially all of which was incurred in the U.S., includes
interest expense and amortization of debt acquisition costs incurred in
connection with the Secured Credit Facility, interest 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 certain asset retirement
obligations.  Interest expense increased from $1.7 million for the
nine months ended September 30, 2007 to $2.7 million for the nine months ended
September 30, 2008.  Interest expense for the nine months ended
September 30, 2008 included interest on amounts outstanding under the Secured
Credit Facility and commitment fees on the available but unused amounts under
the Secured Credit Facility, which were offset by a reduction in interest
incurred on the outstanding balance of deferred fair value rent liabilities and
tax liabilities.





Other (expense)
income, net. Other (expense) income,
net is composed primarily of income from non-recurring transactions and is not
comparative from a trend perspective.




Consolidated
other income, net was a net expense of $0.5 million for the nine months ended
September 30, 2008, compared to other income, net of $2.9 million for the nine
months ended September 30, 2007, a decrease of $3.4 million.  In the
U.S., other income, net was a net expense of $0.2 million for the nine months
ended September 30, 2008, compared to other income, net of $1.4 million for the
nine months ended September 30, 2007, a decrease of $1.6 million.  For
our foreign operations, other income, net was a net expense of $0.3 million for
the nine months ended September 30, 2008, compared to other income, net of $1.5
million for the nine months ended September 30, 2007, a decrease of $1.8
million.  During the nine months ended September 30, 2008,
consolidated other expense, net was comprised primarily of a loss on foreign
currency of $1.8 million, offset by a gain on dispositions of property and
equipment of $1.1 million, gains arising from the reversal of certain tax
liabilities of $0.1 million and other gains of $0.1 million.  For the
nine months ended September 30, 2007, consolidated other income, net was
comprised primarily of gains arising from the reversal of certain tax
liabilities of $1.1 million, gain on legal settlement of $0.6 million, gains on
the settlement of customer amounts due of $0.4 million, gain on a leased asset
termination of $0.3 million and a gain on foreign currency of $0.7 million,
partially offset by a loss on dispositions of property and equipment of $0.2
million.


38


Results
of Operations for the Three Months Ended September 30, 2008 Compared to the
Three Months Ended September 30, 2007




Consolidated
Results (in millions):


Three Months Ended September 30,
                                                                
                                                                
                                                                $ Increase/
                                                                
                                                                
                                                                % Increase/2008
                                                                
                                                                
                                                                2007
                                                                
                                                                
                                                                (Decrease)
                                                                
                                                                
                                                                (Decrease)(Dollars
      in millions)Revenue
                                                                
                                                                $
                                                                82.1
                                                                
                                                                
                                                                $
                                                                67.3
                                                                
                                                                
                                                                $
                                                                14.8
                                                                
                                                                
                                                                
                                                                22.0
                                                                %Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                                                                
                                                                
                                                                32.1
                                                                
                                                                
                                                                
                                                                27.9
                                                                
                                                                
                                                                
                                                                4.2
                                                                
                                                                
                                                                
                                                                15.1
                                                                %Selling,
      general and administrative expenses
                                                                
                                                                
                                                                22.9
                                                                
                                                                
                                                                
                                                                22.6
                                                                
                                                                
                                                                
                                                                0.3
                                                                
                                                                
                                                                
                                                                1.3
                                                                %Depreciation
      and amortization
                                                                
                                                                
                                                                12.2
                                                                
                                                                
                                                                
                                                                12.0
                                                                
                                                                
                                                                
                                                                0.2
                                                                
                                                                
                                                                
                                                                1.7
                                                                %Operating
      income
                                                                
                                                                
                                                                14.9
                                                                
                                                                
                                                                
                                                                4.8
                                                                
                                                                
                                                                
                                                                10.1
                                                                
                                                                
                                                                
                                                                210.4
                                                                %Other
      income (expense):Interest
      income
                                                                
                                                                
                                                                0.5
                                                                
                                                                
                                                                
                                                                0.8
                                                                
                                                                
                                                                
                                                                (0.3
                                                                )
                                                                
                                                                
                                                                (37.5
                                                                )%Interest
      expense
                                                                
                                                                
                                                                (1.1
                                                                )
                                                                
                                                                
                                                                (0.5
                                                                )
                                                                
                                                                
                                                                0.6
                                                                
                                                                
                                                                
                                                                120.0
                                                                %Other
      (expense) income, net
                                                                
                                                                
                                                                (2.0
                                                                )
                                                                
                                                                
                                                                1.4
                                                                
                                                                
                                                                
                                                                (3.4
                                                                )
                                                                
                                                                
                                                                (242.9
                                                                )%Income
      before income taxes
                                                                
                                                                
                                                                12.3
                                                                
                                                                
                                                                
                                                                6.5
                                                                
                                                                
                                                                
                                                                5.8
                                                                
                                                                
                                                                
                                                                89.2
                                                                %Provision
      for income taxes
                                                                
                                                                
                                                                1.9
                                                                
                                                                
                                                                
                                                                1.5
                                                                
                                                                
                                                                
                                                                0.4
                                                                
                                                                
                                                                
                                                                26.7
                                                                %Net
      income
                                                                
                                                                $
                                                                10.4
                                                                
                                                                
                                                                $
                                                                5.0
                                                                
                                                                
                                                                $
                                                                5.4
                                                                
                                                                
                                                                
                                                                108.0
                                                                %










Revenue. Consolidated revenue
was $82.1 million for the three months ended September 30, 2008, compared to
$67.3 million for the three months ended September 30, 2007, an increase of
$14.8 million, or 22.0%.  Revenue from our U.S. operations increased
by $13.1 million, or 21.6%, from $60.7 million for the three months ended
September 30, 2007 to $73.8 million for the three months ended September 30,
2008.  The principal reason for this increase was due to the continued
growth in our metro transport services and dark fiber services.  U.S.
revenue from metro transport services increased by $8.6 million, or 64.7%, from
$13.3 million for the three months ended September 30, 2007 to $21.9 million for
the three months ended September 30, 2008; revenue from dark fiber services
increased by $3.2 million, or 9.7%, from $33.1 million for the three months
ended September 30, 2007 to $36.3 million for the three months ended September
30, 2008; and revenue from IP network services increased by $0.9 million, or
14.8%, from $6.1 million for the three months ended September 30, 2007 to $7.0
million for the three months ended September 30, 2008.  A significant
portion of the growth was attributable to new contracts with existing
customers.  Revenue from our foreign operations, primarily in the
U.K., increased by $1.7 million, or 25.8%, from $6.6 million for the three
months ended September 30, 2007 to $8.3 million for the three months ended
September 30, 2008.  The increase was primarily due to our continued
focus on growing our existing services in the U.K.





Costs of
revenue.  Consolidated costs of revenue for the three months
ended September 30, 2008 was $32.1 million, compared to $27.9 million for the
three months ended September 30, 2007, an increase of $4.2 million, or
15.1%.  Consolidated costs of revenue as a percentage of revenue was
39.1% for the three months ended September 30, 2008, compared to 41.5% for the
three months ended September 30, 2007, resulting in consolidated gross profit
margin of 60.9% and 58.5% for the three months ended September 30, 2008 and
2007, respectively.  The costs of revenue for our U.S. operations was
$29.4 million and $26.0 million for the three months ended September 30, 2008
and 2007, respectively, an increase of $3.4 million, or 13.1%.  The
increase in the domestic costs of revenue for the three months ended September
30, 2008 compared to the three months ended September 30, 2007 was attributable
principally to (i) an increase of $1.3 million in co-location expenses, to
support our IP network services and increase our presence in third party data
centers; and (ii) 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.  These increases were
partially offset by a decrease of $0.5 million in the long-haul circuit expense
as a short-term lease expired in accordance with its
terms.  Additionally, the three month period ended September 30, 2008
includes a provision for equipment impairment relating to inventory of $0.4
million and a lease abandonment cost of $0.7 million, compared to a lease
abandonment cost of $0.3 million for the three month period ended September 30,
2007.  The costs of revenue for our foreign operations was $2.7
million for the three months ended September 30, 2008, compared to $1.9 million
for the three months ended September 30, 2007, an increase of $0.8 million, or
42.1%, which was consistent with our revenue growth.


39


Selling, General
and Administrative Expenses (“SG&A”).   Consolidated
SG&A for the three months ended September 30, 2008 was $22.9 million,
compared to $22.6 million for the three months ended September 30, 2007, an
increase of $0.3 million, or 1.3%.  SG&A as a percentage of
revenue was 27.9% for the three months ended September 30, 2008, compared to
33.6% for the three months ended September 30, 2007.  In the U.S.,
SG&A was $19.8 million for the three months ended September 30, 2008,
compared to $19.4 million for the three months ended September 30, 2007, an
increase of $0.4 million, or 2.1%.  SG&A for our U.S. operations
for the three months ended September 30, 2008 compared to the three months ended
September 30, 2007 increased primarily due to an impairment charge of $2.3
million with respect to an asset abandonment (see Note 2, “Basis of Presentation
and Use of Estimates - Asset Abandonment,” for a further
discussion).  This increase was offset by (i) a decrease of $1.4
million in non-cash stock-based compensation expense from $3.1 million in the
three months ended September 30, 2007 to $1.7 million in the three months ended
September 30, 2008; (ii) a decrease of $0.3 million in transaction-based taxes;
and (iii) a decrease of $0.4 million in professional
fee.    SG&A for our foreign operations was $3.1 million
for the three months ended September 30, 2008, compared to $3.2 million for the
three months ended September 30, 2007, a decrease of $0.1 million, or
3.1%.





Depreciation and
amortization. Consolidated
depreciation and amortization was $12.2 million for the three months ended
September 30, 2008, compared to $12.0 million for the nine months ended
September 30, 2007.  Consolidated depreciation and amortization as a
percentage of revenue was 14.9% for the three months ended September 30, 2008,
compared to 17.8% for the three months ended September 30,
2007.  Depreciation and amortization in the current period resulted
from additions to property and equipment for the three months ended September
30, 2008 and the full period effect of depreciation on property and equipment
acquired after January 1, 2007, which was partially offset, however, by the
elimination of depreciation expense associated with property and equipment sold
or disposed of during the three months ended September 30, 2008 and 2007, and
property and equipment, which became fully depreciated since September 30,
2007.




Interest
income.  Interest income,
substantially all of which was earned in the U.S., decreased from $0.8 million
for the three months ended September 30, 2007 to $0.5 million for the three
months ended September 30, 2008.  The decrease of $0.3 million, or
37.5%, was primarily due to the decrease in average balances available for
investment and a decrease in short-term interest rates.





Interest
expense.
Interest expense, substantially all of which was incurred in the U.S., includes
interest expense and amortization of debt acquisition costs incurred in
connection with the Secured Credit Facility, interest 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 certain asset retirement
obligations.  Interest expense increased from $0.5 million for the
three months ended September 30, 2007 to $1.1 million for the three months ended
September 30, 2008.  Interest expense for the three months ended
September 30, 2008 included interest on amounts outstanding under the Secured
Credit Facility and commitment fees on the available but unused amounts under
the Secured Credit Facility, which were offset by a reduction in interest
incurred on the fair market rent liability and tax liabilities.





Other (expense)
income, net. Other (expense) income,
net is composed primarily of income from non-recurring transactions and is not
comparative from a trend perspective.




Consolidated
other income, net was a net expense of $2.0 million for the three months ended
September 30, 2008, compared to other income, net of $1.4 million for the three
months ended September 30, 2007, a decrease of $3.4 million.  In the
U.S., other income, net was $0.1 million for the three months ended September
30, 2008, compared to other income, net of $0.7 million for the three months
ended September 30, 2007, a decrease of $0.6 million.  For our foreign
operations, other income, net was a net expense of $2.1 million for the three
months ended September 30, 2008, compared to other income, net of $0.7 million
for the three months ended September 30, 2007, a decrease of $2.8
million.  During the three months ended September 30, 2008,
consolidated other expense, net was comprised primarily of a loss on foreign
currency of $1.9 million and a loss on dispositions of property and equipment of
$0.1 million.  For the three months ended September 30, 2007,
consolidated other income, net was comprised of gains arising from the reversal
of certain tax liabilities of $1.1 million and gain on foreign currency of $0.7
million, offset by a loss on dispositions of property and equipment of $0.1
million and other losses of $0.3 million.


40


Liquidity
and Capital Resources




We had
working capital deficit of $0.1 million at September 30, 2008, compared to a
working capital deficit of $25.6 million at December 31, 2007.  The
increase in working capital was due primarily to the increase in cash described
below.  Cash and cash equivalent balances at September 30, 2008 were
$72.9 million, compared to $45.8 million at December 31, 2007, an increase of
$27.1 million.  The increase in cash at September 30, 2008 was
primarily attributable to the proceeds from the funding of the Term Loan
pursuant to the Secured Credit Facility, net of financing costs, of $22.3
million, cash generated by operating activities of $76.0 million and the release
of restricted cash and cash equivalents partially offset by the use of cash to
purchase property and equipment of $82.9 million.





Net cash
provided by operating activities was $76.2 million for the nine months ended
September 30, 2008, compared to $49.4 million for the nine months ended
September 30, 2007, an increase of $26.8 million.  Net cash provided
by operating activities during the nine months ended September 30, 2008 resulted
primarily from the add back of non-cash items deducted in the determination of
net income, principally depreciation and amortization of $37.0 million and
stock-based compensation expense of $9.6 million.  Net cash provided
by operating activities for the nine months ended September 30, 2007 resulted
primarily from the add back of non-cash items deducted in the determination of
net income, principally depreciation and amortization of $35.5 million and
stock-based compensation expense of $5.0 million.




Net cash
used in investing activities during the nine months ended September 30, 2008 was
$81.2 million, compared to $59.9 million for the nine months ended September 30,
2007.  Net cash used in investing activities during the nine months
ended September 30, 2008 was primarily attributable to the purchases of property
and equipment of $82.9 million partially offset by the proceeds generated from
sales of property and equipment of $1.7 million.  Net cash used in
investing activities during the nine months ended September 30, 2007 reflects
the cash used for the purchases of property and equipment totaling $61.3
million, partially offset by the receipt of $1.3 million of cash in connection
with the 2006 sale of AboveNet (UK) and the proceeds generated from sales of
property and equipment of $0.1 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
provided by financing activities was $32.6 million during the nine months ended
September 30, 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, the proceeds from the exercise of warrants of $10.7 million and the
release of restricted cash and cash equivalents of $1.3 million, partially
offset by the purchase of shares from employees in connection with the delivery
of vested restricted stock units of $1.7 million.  Net cash provided
by financing activities was $0.7 million during the nine months ended September
30, 2007, which reflects the release of restricted cash and cash equivalents of
$0.4 million and proceeds from the exercise of warrants of $0.3
million.





On
February 29, 2008, we closed on the $60 million senior Secured Credit Facility
comprised of: (i) an $18 million Revolver; (ii) a $24 million Term Loan; and
(iii) an $18 million Delayed Draw Term Loan.  The Secured Credit
Facility, which matures on February 28, 2013, is secured by substantially all of
our 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 Secured Credit Facility 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 August 31, 2008, the
Term Loan of $24 million was 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, subject to the terms of the joinder agreement, including the
payment of 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, the Term Loan increased to $36 million and the available Delayed Draw
Term Loan increased to $27 million.  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. During
2008, we received $10.6 million proceeds from the exercise of warrants and
utilized $2.9 million of liquidity to purchase shares of common stock in
connection with the delivery of restricted stock and a stock repurchase from
employees. 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 March 31, 2010.




41


At
December 31, 2007, we had $10.9 million accrued with respect to the GVN
litigation, of which $1.6 million and $6.9 million had been paid during the
three and nine months ended September 30, 2008, respectively.  See
Note 7, “Litigation,” for further discussion.





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.





Contractual
Obligations




Certain
of our facilities and equipment are leased under non-cancelable operating and
capital leases.  Additionally, as discussed below, we have certain
long-term obligations for rights-of-way, franchise fees and building access
fees.  The following is a schedule, by fiscal year, of future minimum
rental payments required under current operating leases, our capital lease and
other contractual arrangements as of September 30, 2008:




Payments Due By Period (in millions)Contractual Obligations
                              
                              Total
                              
                              
                              3 Months
                                Ended
                                Dec. 31, 2008
                              
                              
                              1-3
                                Years
                              
                              
                              4-5
                                Years
                              
                              
                              More than
                                5 YearsOperating
      Lease Obligations
                              
                              $
                              68.4
                              
                              
                              $
                              3.6
                              
                              
                              $
                              24.2
                              
                              
                              $
                              15.4
                              
                              
                              $
                              25.2Capital
      Lease Obligations (including interest)
                              
                              
                              2.2
                              
                              
                              
                              —
                              
                              
                              
                              0.5
                              
                              
                              
                              0.5
                              
                              
                              
                              1.2Other
      Rights-of-Way, Franchise Fees and Building Access Fees
                              
                              
                              154.9
                              
                              
                              
                              7.9
                              
                              
                              
                              42.6
                              
                              
                              
                              27.4
                              
                              
                              
                              77.0Note
      Payable under Secured Credit Facility (including interest)
                              
                              
                              29.7
                              
                              
                              
                              0.4
                              
                              
                              
                              8.0
                              
                              
                              
                              8.7
                              
                              
                              
                              12.6Accrued
      Severance Obligations
                              
                              
                              0.4
                              
                              
                              
                              0.4
                              
                              
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              —Total
                              
                              $
                              255.6
                              
                              
                              $
                              12.3
                              
                              
                              $
                              75.3
                              
                              
                              $
                              52.0
                              
                              
                              $
                              116.0




Excluded
from this table are capital commitments (all of which relate to 2008) that
totaled $27.7 million at September 30, 2008, and the obligation related to the
$12 million Term Loan borrowed on October 1, 2008 in connection with the
increase of the Secured Credit Facility to $90 million.  Also
excluded from this table are unused commitment fees payable with respect to the
unused portion of the Secured Credit Facility.  Under the
terms of the restricted stock unit agreements, we may, in certain circumstances,
be required to purchase shares from employees sufficient to pay the minimum
statutory withholding requirement on behalf of our employees.  The
obligation to pay the relevant taxing authorities is not included in the table
above, as the amount is contingent upon continued employment and the existence
of certain conditions at the time of delivery of the restricted stock units.  In
addition, the amount of the obligation is unknown, as it is based in part on the
market price of our common stock when the restricted stock unitsare delivered.
 42
  Segment
Results (in millions)




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




United
States:




Three Months Ended September 30,
                                                                  
                                                                  
                                                                  $ Increase /
                                                                  
                                                                  
                                                                  %
      Increase /2008
                                                                  
                                                                  
                                                                  2007
                                                                  
                                                                  
                                                                  (Decrease)
                                                                  
                                                                  
                                                                  (Decrease)(Dollars
      in millions)Revenue
                                                                  
                                                                  $
                                                                  73.8
                                                                  
                                                                  
                                                                  $
                                                                  60.7
                                                                  
                                                                  
                                                                  $
                                                                  13.1
                                                                  
                                                                  
                                                                  
                                                                  21.6
                                                                  %Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                                                                  
                                                                  
                                                                  29.4
                                                                  
                                                                  
                                                                  
                                                                  26.0
                                                                  
                                                                  
                                                                  
                                                                  3.4
                                                                  
                                                                  
                                                                  
                                                                  13.1
                                                                  %Selling,
      general and administrative expenses
                                                                  
                                                                  
                                                                  19.8
                                                                  
                                                                  
                                                                  
                                                                  19.4
                                                                  
                                                                  
                                                                  
                                                                  0.4
                                                                  
                                                                  
                                                                  
                                                                  2.1
                                                                  %Depreciation
      and amortization
                                                                  
                                                                  
                                                                  10.6
                                                                  
                                                                  
                                                                  
                                                                  10.4
                                                                  
                                                                  
                                                                  
                                                                  0.2
                                                                  
                                                                  
                                                                  
                                                                  1.9
                                                                  %Operating
      income
                                                                  
                                                                  
                                                                  14.0
                                                                  
                                                                  
                                                                  
                                                                  4.9
                                                                  
                                                                  
                                                                  
                                                                  9.1
                                                                  
                                                                  
                                                                  
                                                                  185.7
                                                                  %Other
      income (expense):Interest
      income
                                                                  
                                                                  
                                                                  0.5
                                                                  
                                                                  
                                                                  
                                                                  0.7
                                                                  
                                                                  
                                                                  
                                                                  (0.2
                                                                  )
                                                                  
                                                                  
                                                                  (28.6
                                                                  )%Interest
      expense
                                                                  
                                                                  
                                                                  (1.1
                                                                  )
                                                                  
                                                                  
                                                                  (0.5
                                                                  )
                                                                  
                                                                  
                                                                  0.6
                                                                  
                                                                  
                                                                  
                                                                  120.0
                                                                  %Other income, 
      net
                                                                  
                                                                  
                                                                  0.1
                                                                  
                                                                  
                                                                  
                                                                  0.7
                                                                  
                                                                  
                                                                  
                                                                  (0.6
                                                                  )
                                                                  
                                                                  
                                                                  (85.7
                                                                  )%Income
      before income taxes
                                                                  
                                                                  
                                                                  13.5
                                                                  
                                                                  
                                                                  
                                                                  5.8
                                                                  
                                                                  
                                                                  
                                                                  7.7
                                                                  
                                                                  
                                                                  
                                                                  132.8
                                                                  %Provision
      for income taxes
                                                                  
                                                                  
                                                                  1.9
                                                                  
                                                                  
                                                                  
                                                                  1.5
                                                                  
                                                                  
                                                                  
                                                                  0.4
                                                                  
                                                                  
                                                                  
                                                                  26.7
                                                                  %Net
      income
                                                                  
                                                                  $
                                                                  11.6
                                                                  
                                                                  
                                                                  $
                                                                  4.3
                                                                  
                                                                  
                                                                  $
                                                                  7.3
                                                                  
                                                                  
                                                                  
                                                                  169.8
                                                                  %





United
Kingdom and others:




Three Months Ended September 30,
                                                        
                                                        
                                                        $ Increase /
                                                        
                                                        
                                                        %
      Increase /2008
                                                        
                                                        
                                                        2007
                                                        
                                                        
                                                        (Decrease)
                                                        
                                                        
                                                        (Decrease)(Dollars
      in millions)Revenue
                                                        
                                                        $
                                                        8.3
                                                        
                                                        
                                                        $
                                                        6.6
                                                        
                                                        
                                                        $
                                                        1.7
                                                        
                                                        
                                                        
                                                        25.8
                                                        %Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                                                        
                                                        
                                                        2.7
                                                        
                                                        
                                                        
                                                        1.9
                                                        
                                                        
                                                        
                                                        0.8
                                                        
                                                        
                                                        
                                                        42.1
                                                        %Selling,
      general and administrative expenses
                                                        
                                                        
                                                        3.1
                                                        
                                                        
                                                        
                                                        3.2
                                                        
                                                        
                                                        
                                                        (0.1
                                                        )
                                                        
                                                        
                                                        (3.1
                                                        )%Depreciation
      and amortization
                                                        
                                                        
                                                        1.6
                                                        
                                                        
                                                        
                                                        1.6
                                                        
                                                        
                                                        
                                                        —
                                                        
                                                        
                                                        
                                                        —Operating
      income (loss)
                                                        
                                                        
                                                        0.9
                                                        
                                                        
                                                        
                                                        (0.1
                                                        )
                                                        
                                                        
                                                        1.0
                                                        
                                                        
                                                        NMOther
      income (expense):Interest
      income
                                                        
                                                        
                                                        —
                                                        
                                                        
                                                        
                                                        0.1
                                                        
                                                        
                                                        
                                                        (0.1
                                                        )
                                                        
                                                        NMOther
      (expense) income, net
                                                        
                                                        
                                                        (2.1
                                                        )
                                                        
                                                        
                                                        0.7
                                                        
                                                        
                                                        
                                                        (2.8
                                                        )
                                                        
                                                        NM(Loss)
      income before income taxes
                                                        
                                                        
                                                        (1.2
                                                        )
                                                        
                                                        
                                                        0.7
                                                        
                                                        
                                                        
                                                        (1.9
                                                        )
                                                        
                                                        
                                                        (271.4
                                                        )%Provision
      for income taxes
                                                        
                                                        
                                                        —
                                                        
                                                        
                                                        
                                                        —
                                                        
                                                        
                                                        
                                                        —
                                                        
                                                        
                                                        
                                                        —Net
      (loss) income
                                                        
                                                        $
                                                        (1.2
                                                        )
                                                        
                                                        $
                                                        0.7
                                                        
                                                        
                                                        $
                                                        (1.9
                                                        )
                                                        
                                                        
                                                        (271.4
                                                        )%




NM—not
meaningful





43


United
States:


Nine months Ended September 30,
                                                        
                                                        
                                                        $ Increase /
                                                        
                                                        
                                                        % Increase /2008
                                                        
                                                        
                                                        2007
                                                        
                                                        
                                                        (Decrease)
                                                        
                                                        
                                                        (Decrease)(Dollars
      in millions)Revenue
                                                        
                                                        $
                                                        205.7
                                                        
                                                        
                                                        $
                                                        167.5
                                                        
                                                        
                                                        $
                                                        38.2
                                                        
                                                        
                                                        
                                                        22.8
                                                        %Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                                                        
                                                        
                                                        87.0
                                                        
                                                        
                                                        
                                                        72.3
                                                        
                                                        
                                                        
                                                        14.7
                                                        
                                                        
                                                        
                                                        20.3
                                                        %Selling,
      general and administrative expenses
                                                        
                                                        
                                                        60.3
                                                        
                                                        
                                                        
                                                        51.7
                                                        
                                                        
                                                        
                                                        8.6
                                                        
                                                        
                                                        
                                                        16.6
                                                        %Depreciation
      and amortization
                                                        
                                                        
                                                        32.1
                                                        
                                                        
                                                        
                                                        31.1
                                                        
                                                        
                                                        
                                                        1.0
                                                        
                                                        
                                                        
                                                        3.2
                                                        %Operating
      income
                                                        
                                                        
                                                        26.3
                                                        
                                                        
                                                        
                                                        12.4
                                                        
                                                        
                                                        
                                                        13.9
                                                        
                                                        
                                                        
                                                        112.1
                                                        %Other
      income (expense):Interest
      income
                                                        
                                                        
                                                        1.3
                                                        
                                                        
                                                        
                                                        2.4
                                                        
                                                        
                                                        
                                                        (1.1
                                                        )
                                                        
                                                        
                                                        (45.8
                                                        )%Interest
      expense
                                                        
                                                        
                                                        (2.7
                                                        )
                                                        
                                                        
                                                        (1.7
                                                        )
                                                        
                                                        
                                                        1.0
                                                        
                                                        
                                                        
                                                        58.8
                                                        %Other
      (expense) income, net
                                                        
                                                        
                                                        (0.2
                                                        )
                                                        
                                                        
                                                        1.4
                                                        
                                                        
                                                        
                                                        (1.6
                                                        )
                                                        
                                                        
                                                        (114.3
                                                        )%Income
      before income taxes
                                                        
                                                        
                                                        24.7
                                                        
                                                        
                                                        
                                                        14.5
                                                        
                                                        
                                                        
                                                        10.2
                                                        
                                                        
                                                        
                                                        70.3
                                                        %Provision
      for income taxes
                                                        
                                                        
                                                        3.0
                                                        
                                                        
                                                        
                                                        3.6
                                                        
                                                        
                                                        
                                                        (0.6
                                                        )
                                                        
                                                        
                                                        (16.7
                                                        )%Net
      income
                                                        
                                                        $
                                                        21.7
                                                        
                                                        
                                                        $
                                                        10.9
                                                        
                                                        
                                                        $
                                                        10.8
                                                        
                                                        
                                                        
                                                        99.1
                                                        %
 
 United
Kingdom and others:
  Nine months Ended September 30,
                                                                      
                                                                      
                                                                      $ Increase /
                                                                      
                                                                      
                                                                      % Increase /2008
                                                                      
                                                                      
                                                                      2007
                                                                      
                                                                      
                                                                      (Decrease)
                                                                      
                                                                      
                                                                      (Decrease)(Dollars
      in millions)Revenue
                                                                      
                                                                      $
                                                                      24.4
                                                                      
                                                                      
                                                                      $
                                                                      18.6
                                                                      
                                                                      
                                                                      $
                                                                      5.8
                                                                      
                                                                      
                                                                      
                                                                      31.2
                                                                      %Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                                                                      
                                                                      
                                                                      7.5
                                                                      
                                                                      
                                                                      
                                                                      6.1
                                                                      
                                                                      
                                                                      
                                                                      1.4
                                                                      
                                                                      
                                                                      
                                                                      23.0
                                                                      %Selling,
      general and administrative expenses
                                                                      
                                                                      
                                                                      8.5
                                                                      
                                                                      
                                                                      
                                                                      8.9
                                                                      
                                                                      
                                                                      
                                                                      (0.4
                                                                      )
                                                                      
                                                                      
                                                                      (4.5
                                                                      )%Depreciation
      and amortization
                                                                      
                                                                      
                                                                      4.9
                                                                      
                                                                      
                                                                      
                                                                      4.4
                                                                      
                                                                      
                                                                      
                                                                      0.5
                                                                      
                                                                      
                                                                      
                                                                      11.4
                                                                      %Operating
      income (loss)
                                                                      
                                                                      
                                                                      3.5
                                                                      
                                                                      
                                                                      
                                                                      (0.8
                                                                      )
                                                                      
                                                                      
                                                                      4.3
                                                                      
                                                                      
                                                                      NMOther
      income (expense):Interest
      income
                                                                      
                                                                      
                                                                      0.1
                                                                      
                                                                      
                                                                      
                                                                      0.1
                                                                      
                                                                      
                                                                      
                                                                      —
                                                                      
                                                                      
                                                                      
                                                                      —Other
      (expense) income, net
                                                                      
                                                                      
                                                                      (0.3
                                                                      )
                                                                      
                                                                      
                                                                      1.5
                                                                      
                                                                      
                                                                      
                                                                      (1.8
                                                                      )
                                                                      
                                                                      (120.0
                                                                      )%Income
      before income taxes
                                                                      
                                                                      
                                                                      3.3
                                                                      
                                                                      
                                                                      
                                                                      0.8
                                                                      
                                                                      
                                                                      
                                                                      2.5
                                                                      
                                                                      
                                                                      NMProvision
      for income taxes
                                                                      
                                                                      
                                                                      —
                                                                      
                                                                      
                                                                      
                                                                      —
                                                                      
                                                                      
                                                                      
                                                                      —
                                                                      
                                                                      
                                                                      
                                                                      —Net
      income
                                                                      
                                                                      $
                                                                      3.3
                                                                      
                                                                      
                                                                      $
                                                                      0.8
                                                                      
                                                                      
                                                                      $
                                                                      2.5
                                                                      
                                                                      
                                                                      NM
 NM—not
meaningful





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 negatively impacted.


44


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 covered in such forward-looking statements. Such forward-looking
statements include, but are not limited to, those relating to the Company’s
financial and operating prospects, current economic trends, 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. In addition, such forward-looking statements involve
known and unknown risks, uncertainties, and other factors that could cause the
actual results, performance or achievements of the Company to be materially
different from any future results expressed or implied by such forward-looking
statements. Also, 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 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.





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 2007, our foreign activities accounted for 10.3% of consolidated revenue.
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.





As of
September 30, 2008, we did not have any debt, other than indebtedness under our
Term Loan and a capital lease obligation (which carried a fixed rate of
interest).





On
February, 29, 2008, we closed our Secured Credit Facility. See Item 2,
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources,” and Item 1, “Financial
Statements,” included elsewhere in this Quarterly Report on Form 10-Q. Under the
terms of the Secured Credit Facility, our borrowings bear interest based upon
short-term LIBOR rates or based upon 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 our borrowing costs.  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 October 31, 2008.  Effective August 4, 2008, the Company entered
into a swap arrangement under which it fixed its borrowing costs with respect to
$24 million outstanding under the Term Loan for three years at 3.65% per annum,
plus the applicable margin of 3.25% (which decreased to 3% on September 30,
2008).  On November 12, 2008, the Company entered into a swap
agreement under which it fixed its borrowing costs with respect to the
additional $12 million provided by SunTrust Bank under the Term Loan for three
years at 2.635%, plus the applicable margin of 3%.  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 during the applicable periods.
 45




ITEM
4.  CONTROLS AND PROCEDURES





Evaluation of Disclosure Controls and
Procedures




As of
September 30, 2008, the Company’s management 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 design and operation of the Company’s disclosure controls
and procedures (as such term is 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 September 30, 2008.





Remediation




Management
is in the process of remediating the pervasive material weaknesses in its entity
level controls, financial close and financial statement reporting processes and
numerous financial statement areas. For the year ended December 31, 2007, the
Company created a property and equipment sub-ledger and 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. Currently, the Company operates
several disparate systems that produce financial information. The Company is
investigating methods to integrate these systems or develop processes that
better control information flow. The intention of these efforts is to develop
stronger financial and operating and entity level controls, 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.


46


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, 2007 and Note 7,
“Litigation,” and the “Litigation” section of Note 15, “Subsequent Events” and
Note 12, “Commitments and Contingencies,” 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 information set forth in this Quarterly Report on Form 10-Q,
you should carefully consider the factors discussed below and in Item 1A, “Risk
Factors,” in our Annual Report on Form 10-K for the year ended December 31,
2007, which could materially affect our business, financial condition or future
results.  The risks described below and in our Annual Report on Form
10-K are not the only risks facing our Company. Additional risks and
uncertainties not currently known to us or that we currently deem to be
immaterial may also materially adversely affect our business, financial
condition and results of operations.  Other than discussed below,
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,
2007.





The
weakness of financial institutions could adversely affect the cash and cash
equivalents held by us.




Our cash
and cash equivalents are invested in investment-grade, short-term investment
instruments with high quality financial institutions.  Account
balances generally exceed federally insured limits.  While we believe
that we have taken reasonable measures to ensure that we can maintain access to
these funds, we cannot assure you that access to our cash and cash equivalents
will not be impacted by adverse developments that may be experienced by these
institutions. Our ability to access these cash balances could be negatively
impacted if the financial institutions fail, if there are defaults in the
securities that are held in money market funds or there are other adverse
conditions in the financial markets.





Current
economic trends could negatively affect our future operating
results.




The
current negative economic trends could adversely affect our operations, by among
other things,


·
            reducing
      and/or delaying the demand for our
services,


·
            increasing
      our customer churn, both with respect to customer terminations and with
      respect to reduced prices upon renewals of customer
      agreements,


·
            leading
      to reduced services from our vendors facing economic difficulties,
      and


·
            increasing
      the bad debt ratio of our customer
receivables.





These and
other related factors could negatively affect our future operating results
depending upon the length and severity of the current economic
downturn.





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




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





In the
past, we have had franchises and rights-of-way expire prior to executing a
renewal and in the interim until such renewal was executed, operated pursuant to
the terms of the expired agreement, which is the case currently with respect to
our franchise agreement for our operations in the City of New York. We expect
that these situations will continue to occur in the future. These expirations
have not caused any material adverse effect on our operations in the past, and
we do not expect that they will in the future. However, to the extent that a
municipality or other right-of-way holder attempts to terminate our related
operations upon the expiration of a franchise or right-of-way agreement, it
could materially adversely affect our business, financial condition and results
of operations.


47


As the
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 us that they have temporarily suspended any discussions regarding
renewals of telecommunications franchises in the City of New York. As a result,
it is our understanding that DOITT has not renewed any recently expired
franchise agreement, including our franchise agreement which expired on December
20, 2008. Prior to the expiration of our franchise agreement, we sought out and
received written confirmation from DOITT that our franchise agreement provides a
basis for us to continue to operate in the City of New York pending conclusion
of renewal discussions.  We intend to continue to operate under our
expired franchise agreement pending any renewal. We believe that a number of
other operators in the City of New York are operating on a similar basis. Based
on our discussions with DOITT and the written confirmation that we have
received, we do 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
our operations as the result of our expired franchise agreement could have a
material adverse effect on our business, financial condition and results of
operations.





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





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


48


ITEM 6.
EXHIBITS





Exhibit No.
            
            Description of Exhibit10.1
            
            Employment
      Agreement, dated as of October 27, 2008, between AboveNet, Inc. and Joseph
      P. Ciavarella (incorporated herein by reference to Form 8-K filed with the
      Securities and Exchange Commission on October 29, 2008)10.2
            
            Consulting
      Agreement, dated as of February 15, 2007, between AboveNet Communications,
      Inc. and Joseph Ciavarella (incorporated herein by reference to Form 8-K
      filed with the Securities and Exchange Commission on October 29,
      2008)10.3
            
            Stock
      Unit Agreement, dated as of October 27, 2008, between AboveNet, Inc. and
      Joseph Ciavarella (incorporated herein by reference to Form 8-K filed with
      the Securities and Exchange Commission on October 29,
  2008)10.4
            
            Stock
      Purchase Agreement, dated as of October 28, 2008, between AboveNet, Inc.
      and William G. LaPerch (incorporated herein by reference to Form 8-K filed
      with the Securities and Exchange Commission on October 31,
      2008)10.5
            
            Stock
      Purchase Agreement, dated as of October 28, 2008, between AboveNet, Inc.
      and Robert J. Sokota (incorporated herein by reference to Form 8-K filed
      with the Securities and Exchange Commission on October 31,
      2008)10.6
            
            Stock
      Purchase Agreement, dated as of October 28, 2008, between AboveNet, Inc.
      and Rajiv Datta (incorporated herein by reference to Form 8-K filed with
      the Securities and Exchange Commission on October 31,
  2008)10.7
            
            Stock
      Purchase Agreement, dated as of October 28, 2008, between AboveNet, Inc.
      and Douglas Jendras (incorporated herein by reference to Form 8-K filed
      with the Securities and Exchange Commission on October 31,
      2008)31.1
            
            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 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 Registrant, pursuant to 18 U.S.C. Section
      1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.


49


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:  February
      6, 2009
              By:
              /s/
      William G. LaPerchWilliam
      G. LaPerch
                President,
      Chief Executive Officer and Director
                (Principal
      Executive Officer and Duly Authorized
Officer)





Date:  February 6,
      2009
              By:
              /s/
      Joseph P. CiavarellaJoseph
      P. Ciavarella
                Senior
      Vice President and Chief Financial Officer
                (Principal
      Financial and Accounting
Officer)


50


EXHIBIT
INDEX





Exhibit No.
            
            Description
      of Exhibit10.1
            
            Employment
      Agreement, dated as of October 27, 2008, between AboveNet, Inc. and Joseph
      P. Ciavarella (incorporated herein by reference to Form 8-K filed with the
      Securities and Exchange Commission on October 29, 2008)10.2
            
            Consulting
      Agreement, dated as of February 15, 2007, between AboveNet Communications,
      Inc. and Joseph Ciavarella (incorporated herein by reference to Form 8-K
      filed with the Securities and Exchange Commission on October 29,
      2008)10.3
            
            Stock
      Unit Agreement, dated as of October 27, 2008, between AboveNet, Inc. and
      Joseph Ciavarella (incorporated herein by reference to Form 8-K filed with
      the Securities and Exchange Commission on October 29,
  2008)10.4
            
            Stock
      Purchase Agreement, dated as of October 28, 2008, between AboveNet, Inc.
      and William G. LaPerch (incorporated herein by reference to Form 8-K filed
      with the Securities and Exchange Commission on October 31,
      2008)10.5
            
            Stock
      Purchase Agreement, dated as of October 28, 2008, between AboveNet, Inc.
      and Robert J. Sokota (incorporated herein by reference to Form 8-K filed
      with the Securities and Exchange Commission on October 31,
      2008)10.6
            
            Stock
      Purchase Agreement, dated as of October 28, 2008, between AboveNet, Inc.
      and Rajiv Datta (incorporated herein by reference to Form 8-K filed with
      the Securities and Exchange Commission on October 31,
  2008)10.7
            
            Stock
      Purchase Agreement, dated as of October 28, 2008, between AboveNet, Inc.
      and Douglas Jendras (incorporated herein by reference to Form 8-K filed
      with the Securities and Exchange Commission on October 31,
      2008)31.1
            
            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 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 Registrant, pursuant to 18 U.S.C. Section
      1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.


51