UNITED STATES


SECURITIES ANDEXCHANGE COMMISSION


WASHINGTON, D.C.
20549





FORM 10-Q





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





Forthe quarterly period ended March 31,
2010





OR





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





Commission File Number:
000-23269





AboveNet, Inc.





(Exact Name of Registrant as Specified
in Its Charter)





DELAWARE
              
              11-3168327(State or other jurisdiction
      of
                incorporation or
      organization)
              
              (I.R.S. Employer Identification
      No.)





360 HAMILTON AVENUE


WHITE PLAINS, NY
10601


(Address of Principal Executive
Offices)





(914) 421-6700


(Registrant’s Telephone Number,
Including Area Code)




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





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





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


Large accelerated
      filer ̈
            Accelerated
      filerx
            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 theExchange
Act).  Yes ̈Nox





The
number of shares of the registrant’s common stock, par value $0.01 per share,
outstanding as of May 1, 2010, was 25,129,717.









Table of
Contents





ABOVENET, INC.





INDEX




PagePart
      I.
                              
                              FINANCIAL
      INFORMATIONItem
      1.
                              
                              Financial
      StatementsConsolidated
      Balance SheetsAs
      ofMarch
      31, 2010(Unaudited)
      and December 31, 2009
                              
                              1Consolidated
      Statements of Operations (Unaudited)ThreemonthperiodsendedMarch
      31, 2010 and 2009
                              
                              2Consolidated
      Statement of Shareholders’ Equity (Unaudited)Three
      monthperiod
      endedMarch
      31, 2010
                              
                              3Consolidated
      Statements of Cash Flows (Unaudited)Three
      monthperiodsendedMarch
      31, 2010 and 2009
                              
                              4Consolidated
      Statements of Comprehensive Income (Unaudited)ThreemonthperiodsendedMarch
      31, 2010 and 2009
                              
                              5Notes
      to UnauditedConsolidated Financial
      Statements
                              
                              6Item
      2.
                              
                              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                              
                              32Item
      3.
                              
                              Quantitative
      and Qualitative Disclosures about Market
Risk
                              
                              55Item
      4.
                              
                              Controls
      and Procedures
                              
                              56Part
      II.
                              
                              OTHER
      INFORMATIONItem
      1.
                              
                              Legal
      Proceedings
                              
                              57Item
      1A.
                              
                              Risk
      Factors
                              
                              57Item
      2.
                              
                              Unregistered
      Sales of Equity Securities and Use of
    Proceeds
                              
                              57Item
      6.
                              
                              Exhibits
                              
                              58Signatures
                              
                              59Exhibit
      Index







PART I.FINANCIAL
INFORMATION





ITEM 1.FINANCIAL STATEMENTS





ABOVENET,
INC. AND SUBSIDIARIES





CONSOLIDATED
BALANCE SHEETS


(in
millions, except share and per share information)




March 31,
                          2010
                        
                        
                        December 31,
                          2009(Unaudited)ASSETS:Current
      assets:Cash
      and cash equivalents
                        
                        $
                        166.7
                        
                        
                        $
                        165.3Restricted
      cash and cash equivalents
                        
                        
                        3.7
                        
                        
                        
                        3.7Accounts
      receivable, net of allowances of $1.8 and $2.0, at March 31, 2010 and
      December 31, 2009, respectively
                        
                        
                        20.6
                        
                        
                        
                        20.1Prepaid
      costs and other current assets
                        
                        
                        14.0
                        
                        
                        
                        13.5Total
      current assets
                        
                        
                        205.0
                        
                        
                        
                        202.6Property
      and equipment, net of accumulated depreciation and amortization of $249.6
      and $236.5 at March 31, 2010 and December 31, 2009,
      respectively
                        
                        
                        476.9
                        
                        
                        
                        469.1Deferred
      tax assets
                        
                        
                        173.5
                        
                        
                        
                        183.0Other
      assets
                        
                        
                        6.9
                        
                        
                        
                        7.3Total
      assets
                        
                        $
                        862.3
                        
                        
                        $
                        862.0LIABILITIES:Current
      liabilities:Accounts
      payable
                        
                        $
                        6.6
                        
                        
                        $
                        10.7Accrued
      expenses
                        
                        
                        60.7
                        
                        
                        
                        68.4Deferred
      revenue - current portion
                        
                        
                        26.3
                        
                        
                        
                        27.3Note
      payable - current portion
                        
                        
                        7.6
                        
                        
                        
                        7.6Total
      current liabilities
                        
                        
                        101.2
                        
                        
                        
                        114.0Note
      payable
                        
                        
                        47.9
                        
                        
                        
                        49.7Deferred
      revenue
                        
                        
                        92.3
                        
                        
                        
                        93.8Other
      long-term liabilities
                        
                        
                        10.3
                        
                        
                        
                        10.3Total
      liabilities
                        
                        
                        251.7
                        
                        
                        
                        267.8Commitments
      and contingenciesSHAREHOLDERS’
      EQUITY:Preferred
      stock, 9,500,000 shares authorized, $0.01 par value, none issued or
      outstanding
                        
                        
                        —
                        
                        
                        
                        —Junior
      preferred stock, 500,000 shares authorized, $0.01 par value, none issued
      or outstanding
                        
                        
                        —
                        
                        
                        
                        —Common
      stock, 30,000,000 shares authorized, $0.01 par value, 25,710,998 issued
      and 25,122,617 outstanding at March 31, 2010 and 25,271,788 issued
      and 24,750,560 outstanding at December 31, 2009
                        
                        
                        0.3
                        
                        
                        
                        0.3Additional
      paid-in capital
                        
                        
                        315.4
                        
                        
                        
                        308.2Treasury
      stock at cost, 588,381  and 521,228 shares at March 31, 2010 and
      December 31, 2009, respectively
                        
                        
                        (20.9
                        )
                        
                        
                        (16.7
                        )Accumulated
      other comprehensive loss
                        
                        
                        (9.2
                        )
                        
                        
                        (9.0
                        )Retained
      earnings
                        
                        
                        325.0
                        
                        
                        
                        311.4Total
      shareholders’ equity
                        
                        
                        610.6
                        
                        
                        
                        594.2Total
      liabilities and shareholders’ equity
                        
                        $
                        862.3
                        
                        
                        $
                        862.0




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


1





ABOVENET,
INC. AND SUBSIDIARIES





CONSOLIDATED
STATEMENTS OF OPERATIONS


(in
millions, except share and per share information)





(Unaudited)





Three Months Ended March 31,2010
                        
                        
                        2009Revenue
                        
                        $
                        97.2
                        
                        
                        $
                        85.4Costs
      of revenue (excluding depreciation and  amortization, shown
      separately below)
                        
                        
                        33.1
                        
                        
                        
                        29.4Selling,
      general and administrative expenses
                        
                        
                        23.6
                        
                        
                        
                        20.7Depreciation
      and amortization
                        
                        
                        15.5
                        
                        
                        
                        11.9Operating
      income
                        
                        
                        25.0
                        
                        
                        
                        23.4Other
      income (expense):Interest
      income
                        
                        
                        —
                        
                        
                        
                        0.2Interest
      expense
                        
                        
                        (1.2
                        )
                        
                        
                        (1.2
                        )Other
      expense, net
                        
                        
                        (0.6
                        )
                        
                        
                        (0.1
                        )Income
      before income taxes
                        
                        
                        23.2
                        
                        
                        
                        22.3Provision
      for (benefit from) income taxes
                        
                        
                        9.6
                        
                        
                        
                        (5.1
                        )Net
      income
                        
                        $
                        13.6
                        
                        
                        $
                        27.4Income
      per share, basic:Basic
      net income per share
                        
                        $
                        0.55
                        
                        
                        $
                        1.19Weighted
      average number of common shares
                        
                        
                        24,944,514
                        
                        
                        
                        22,922,284Income
      per share, diluted:Diluted
      net income per share
                        
                        $
                        0.52
                        
                        
                        $
                        1.11Weighted
      average number of common shares
                        
                        
                        26,218,755
                        
                        
                        
                        24,613,712




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


2





ABOVENET,
INC. AND SUBSIDIARIES





CONSOLIDATED
STATEMENT OF SHAREHOLDERS’ EQUITY


(in
millions, except share information)





(Unaudited)




Common
      Stock
                              
                              Treasury
      Stock
                              
                              
                              Other Shareholders’
      EquityShares
                              
                              Amount
                              
                              Shares
                              
                              
                              Amount
                              
                              
                              Additional
                                Paid-in
                                Capital
                              
                              
                              Accumulated
                                Other
                                Comprehensive
                                Loss
                              
                              
                              Retained
      Earnings
                              
                              
                              Total
                                Shareholders’
                                EquityBalance
      at January 1, 2010
                              
                              25,271,788
                              
                              $
                              0.3
                              
                              521,228
                              
                              
                              $
                              (16.7
                              )
                              
                              $
                              308.2
                              
                              
                              $
                              (9.0
                              )
                              
                              $
                              311.4
                              
                              
                              $
                              594.2Issuance
      of common stock from exercise of warrants
                              
                              419,426
                              
                              
                              —
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              5.0
                              
                              
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              5.0Issuance
      of common stock from vested restricted stock
                              
                              14,000
                              
                              
                              —
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              —Issuance
      of common stock from exercise of options to purchase shares of common
      stock
                              
                              5,784
                              
                              
                              —
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              0.1
                              
                              
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              0.1Purchase
      of treasury stock
                              
                              —
                              
                              
                              —
                              
                              5,459
                              
                              
                              
                              (0.3
                              )
                              
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              (0.3
                              )Purchase
      of treasury stock in cashless exercise of stock
      warrants .
                              
                              —
                              
                              
                              —
                              
                              61,694
                              
                              
                              
                              (3.9
                              )
                              
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              (3.9
                              )Foreign
      currency translationadjustments
                              
                              —
                              
                              
                              —
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              (0.2
                              )
                              
                              
                              —
                              
                              
                              
                              (0.2
                              )Amortization
      of stock-based compensation expense for stock options and restricted stock
      units
                              
                              —
                              
                              
                              —
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              2.1
                              
                              
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              2.1Net
      income
                              
                              —
                              
                              
                              —
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              13.6
                              
                              
                              
                              13.6Balance
      at March 31, 2010
                              
                              25,710,998
                              
                              $
                              0.3
                              
                              588,381
                              
                              
                              $
                              (20.9
                              )
                              
                              $
                              315.4
                              
                              
                              $
                              (9.2
                              )
                              
                              $
                              325.0
                              
                              
                              $
                              610.6




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




3





ABOVENET,
INC. AND SUBSIDIARIES





CONSOLIDATED
STATEMENTS OF CASH FLOWS


(in
millions)





(Unaudited)





Three Months Ended March 31,2010
                  
                  
                  2009Cash
      flows provided by operating activities:Net
      income
                  
                  $
                  13.6
                  
                  
                  $
                  27.4Adjustments
      to reconcile net income to net cash provided by
operations:Depreciation
      and amortization
                  
                  
                  15.5
                  
                  
                  
                  11.9Provision
      for bad debts
                  
                  
                  0.1
                  
                  
                  
                  0.1Non-cash
      stock-based compensation expense
                  
                  
                  2.1
                  
                  
                  
                  2.9(Gain)
      loss on sale ordisposition of
      property and equipment, net
                  
                  
                  (0.1
                  )
                  
                  
                  0.2Change
      in deferred tax assets
                  
                  
                  9.5
                  
                  
                  
                  —Changes
      in operating working capital:Accounts
      receivable
                  
                  
                  (0.9
                  )
                  
                  
                  0.9Prepaid
      costs and other current assets
                  
                  
                  (0.6
                  )
                  
                  
                  (2.4
                  )Accounts
      payable
                  
                  
                  (3.9
                  )
                  
                  
                  (5.2
                  )Accrued
      expenses
                  
                  
                  (3.7
                  )
                  
                  
                  (10.6
                  )Other
      assets
                  
                  
                  0.2
                  
                  
                  
                  —Deferred
      revenue and other long-term liabilities
                  
                  
                  (1.8
                  )
                  
                  
                  10.6Net
      cash provided by operating activities
                  
                  
                  30.0
                  
                  
                  
                  35.8Cash
      flows used in investing activities:Purchases
      of property and equipment
                  
                  
                  (27.4
                  )
                  
                  
                  (21.2
                  )Proceeds
      from sales of property and equipment
                  
                  
                  0.2
                  
                  
                  
                  —Net
      cash used in investing activities
                  
                  
                  (27.2
                  )
                  
                  
                  (21.2
                  )Cash
      flows used in financing activities:Proceeds
      from exercise of warrants
                  
                  
                  1.2
                  
                  
                  
                  —Proceeds
      from exercise of options to purchase shares of common
stock
                  
                  
                  0.1
                  
                  
                  
                  —Principal
      payment - note payable
                  
                  
                  (1.9
                  )
                  
                  
                  —Principal
      payment - capital lease obligation
                  
                  
                  —
                  
                  
                  
                  (0.2
                  )Purchase
      of treasury stock
                  
                  
                  (0.3
                  )
                  
                  
                  (0.1
                  )Net
      cash used in financing activities
                  
                  
                  (0.9
                  )
                  
                  
                  (0.3
                  )Effect
      of exchange rates on cash
                  
                  
                  (0.5
                  )
                  
                  
                  (0.1
                  )Net
      increase in cash and cash equivalents
                  
                  
                  1.4
                  
                  
                  
                  14.2Cash
      and cash equivalents, beginning of period
                  
                  
                  165.3
                  
                  
                  
                  87.1Cash
      and cash equivalents, end of period
                  
                  $
                  166.7
                  
                  
                  $
                  101.3Supplemental
      cash flow information:Cash
      paid for interest
                  
                  $
                  0.8
                  
                  
                  $
                  0.7Cash
      paid for income taxes
                  
                  $
                  0.3
                  
                  
                  $
                  2.0Supplemental
      non-cash financing activities:Issuance
      of shares of common stock in cashless exercise of stock purchase
      warrants
                  
                  $
                  3.9
                  
                  
                  $
                  —Non-cash
      purchase of shares into treasury in cashless exercise of stock purchase
      warrants
                  
                  $
                  3.9
                  
                  
                  $
                  —




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


4




ABOVENET,
INC. AND SUBSIDIARIES





CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME


(in
millions)





(Unaudited)





Three Months Ended March 31,2010
                        
                        
                        2009Net
      income
                        $
                        13.6
                        
                        
                        $
                        27.4Foreign
      currency translation adjustments
                        
                        (0.2
                        )
                        
                        
                        0.5Comprehensive
      income
                        $
                        13.4
                        
                        
                        $
                        27.9




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


5




ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS


(in millions, except share and per share
information)





NOTE
1:    BACKGROUND AND ORGANIZATION





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.”).





NOTE
2:    BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING
POLICIES





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





Stock
Split




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





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 U.S. GAAP 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, 2009.  Operating results for the
three months ended March 31, 2010 are not necessarily indicative of the results
that may be expected for the year ending December 31, 2010.





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.


6


ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





Fresh
Start Accounting





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





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





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





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
Amended and Restated Rights Agreement (as defined in Note 8, “Shareholders’
Equity,” below).  In the event of any liquidation, the holders of the
common stock will be entitled to receive the assets of the Company available for
distribution, after payments to creditors and holders of preferred
stock.





In 2003,
the Company issued 17,500,000 shares of common stock, of which 17,498,276 were
delivered and 1,724 shares were determined to be undeliverable and were
cancelled, the rights to purchase 3,338,420 shares of common stock at a price of
$14.97715 per share, under a rights offering (of which rights to purchase
3,337,984 shares of common stock have been exercised), five year stock purchase
warrants to purchase 1,418,918 shares of common stock exercisable at a price of
$10.00 per share, and seven year stock purchase warrants to purchase 1,669,316
shares of common stock exercisable at a price of $12.00 per share.  In
addition, 2,129,912 shares of common stock were originally reserved for issuance
under the Company’s 2003 Plan.  See Note 7, “Stock-Based
Compensation.”





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


7


ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





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





Principles
of Consolidation




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





Revenue
Recognition




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





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





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





Contract
termination revenue is recognized when a customer discontinues service prior to
the end of the contract period for which the Company had previously received
consideration and for which revenue recognition was
deferred.  Contract termination revenue is also recognized when
customers have made early termination payments to the Company to settle
contractually committed purchase amounts that the customer no longer expects to
meet or when the Company renegotiates or discontinues a contract with a customer
and as a result is no longer obligated to provide services for consideration
previously received and for which revenue recognition has been
deferred.  During the three months ended March 31, 2010 and 2009, the
Company included the receipts of bankruptcy claim settlements from former
customers as contract termination revenue.  Contract termination
revenue is reported together with other service revenue, and amounted to $1.0
and $1.9 in the three months ended March 31, 2010 and 2009,
respectively.




8


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





Operating
Leases




The
Company leases office and equipment space, and maintains equipment rentals,
right-of-way contracts, building access fees and network capacity under various
non-cancelable operating leases. The lease agreements, which expire at various
dates through 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,” (now known as FASB ASC
840), the Company recognizes rent expense on a straight-line basis and records a
liability representing the difference between straight-line rent expense and the
amount payable as an increase or decrease to a deferred liability. Any leasehold
improvements related to operating leases are amortized over the lesser of their
economic lives or the remaining lease term. Rent-free periods and other
incentives granted under certain leases are recorded as reductions to rent
expense on a straight-line basis over the related lease terms.





Cash
and Cash Equivalents and Restricted Cash and Cash Equivalents




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





Accounts
Receivable, Allowance for Doubtful Accounts and Sales Credits




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




9


ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





Property
and Equipment




Property
and equipment owned at the Effective Date are stated at their estimated fair
values as of the Effective Date based on the Company’s reorganization value, net
of accumulated depreciation and amortization incurred since the Effective Date.
Purchases of property and equipment subsequent to the Effective Date are stated
at cost, net of depreciation and amortization. Major improvements are
capitalized, while expenditures for repairs and maintenance are expensed when
incurred. Costs incurred prior to a capital project’s completion are reflected
as construction in progress and are a part of network infrastructure assets, as
described below and included in property and equipment on the respective balance
sheets. At March 31, 2010 and December 31, 2009, the Company had $32.9 and
$26.9, respectively, of construction in progress. Certain internal direct labor
costs of constructing or installing property and equipment are capitalized.
Capitalized direct labor is determined based upon a core group of 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
installations. 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 $3.0
and $2.7 for the three months ended March 31, 2010 and 2009, respectively.
Depreciation and amortization is provided on a straight-line basis over the
estimated useful lives of the assets, with the exception of leasehold
improvements, which are amortized over the lesser of the estimated useful lives
or the term of the lease.





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




Network
      infrastructure assets and storage huts (except for risers, which are 5
      years)
                            
                            20
      yearsHVAC
      and power equipment
                            
                            12
      to 20 yearsSoftware
      and computer equipment
                            
                            3
      to 4 yearsTransmission
      and IP equipment
                            
                            5
      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.





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
$0.2 and $0.7 for the three months ended March 31, 2010 and 2009,
respectively.  The Company fully depreciated the remaining carrying
value of the network infrastructure rendered unusable, which on an original cost
basis, totaled $0.02 and $0.10 ($0.01 and $0.07 on a net book value basis) for
each of the three months ended March 31, 2010 and 2009,
respectively.  To the extent that relocation requires only the
movement of existing network infrastructure to another location, the related
costs are included in the Company’s results of operations.





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




10


ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





In
accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets,” (now known as FASB ASC 360-10-35), the Company periodically
evaluates the recoverability of its long-lived assets and evaluates such assets
for impairment whenever events or circumstances indicate that the carrying
amount of such assets (or group of assets) may not be
recoverable.  Impairment is determined to exist if the estimated
future undiscounted cash flows are less than the carrying value of such
asset.  The Company considers various factors to determine if an
impairment test is necessary.  The factors include: consideration of
the overall economic climate, technological advances with respect to equipment,
its strategy and capital planning.  Since June 30, 2006, no event has
occurred nor has the business environment changed to trigger an impairment test
for assets in revenue service and operations.  The Company also
considers the removal of assets from the network as a triggering event for
performing an impairment test.  Once an item is removed from service,
unless it is to be redeployed, it may have little or no future cash flows
related to it.  The Company performed annual physical counts of such
assets that are not in revenue service or operations (e.g., inventory, primarily
spare parts) at September 30, 2009 and 2008.  With the assistance of a
valuation report of the assets in inventory, prepared by an independent
third party on a basis consistent with SFAS No. 157, “Fair Value
Measurements,” (now known as FASB ASC 820-10), and pursuant to FASB ASC
360-10-35, the Company determined that the fair value of certain of such assets
was less than the carrying value and thus recorded a provision for
equipment impairment of $0.4 for the year ended December 31,
2009.  The Company also recorded a provision for equipment impairment
of $0.8 in the year ended December 31, 2009 to record the loss in value of
certain equipment, most of which was eventually sold to an unaffiliated third
party.  See Note 3,
“Change in Estimate.”  There were no provisions for impairment
recorded in the three months ended March 31, 2010 and 2009.





Treasury
Stock




Treasury
stock is accounted for under the cost method.





Asset
Retirement Obligations




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





Asset
retirement obligations are generally recorded as “other long-term liabilities,”
are capitalized as part of the carrying amount of the related long-lived assets
included in property and equipment, net, and are depreciated over the life of
the associated asset.  Asset retirement obligations aggregated $7.2
each at March 31, 2010 and December 31, 2009, of which $3.8 was included in
“Accrued expenses,” and $3.4 was included in “Other long-term liabilities” at
such dates.  Accretion expense, which is included in “Interest
expense,” amounted to $0.07 and $0.08 for the three months ended March 31, 2010
and 2009, respectively.


11


ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





Income
Taxes




The
Company accounts for income taxes in accordance with SFAS No. 109, “Accounting
for Income Taxes,” (now known as FASB ASC 740).  Deferred tax assets
and liabilities are recognized for the future tax consequences attributable to
differences between financial statement carrying amounts of existing assets and
liabilities and their respective tax bases, net operating loss and tax credit
carryforwards, 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.  After an evaluation of the realizability of the
Company’s deferred tax assets, the Company reduced its valuation allowance by
$183.0 during the fourth quarter of 2009.  See Note 5, “Income Taxes,”
for a further discussion.





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





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





Undistributed
earnings of the Company’s foreign subsidiaries are considered to be indefinitely
reinvested and therefore, no provision for domestic taxes 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 calculation; however, unrecognized foreign tax
credit carryforwards would be available to reduce some portion of the domestic
liability.




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




12


ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





Foreign
Currency Translation and Transactions




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





Stock
Options




On
September 8, 2003, the Company adopted the fair value provisions of SFAS No.
148, “Accounting for Stock-Based Compensation Transition and Disclosure,” (“SFAS
No. 148”), (now known as FASB ASC 718-10).  SFAS No. 148
amended SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS
No. 123”), (also now known as FASB ASC 718-10), to provide alternative
methods of transition to SFAS No. 123’s fair value method of accounting for
stock-based employee compensation.  (See Note 7, “Stock-Based
Compensation.”)





Under the
fair value provisions of SFAS No. 123, the fair value of each stock-based
compensation award is estimated at the date of grant, using the Black-Scholes
option pricing model for stock option awards.  The Company did not
have a historical basis for determining the volatility and expected life
assumptions in the model due to the Company’s limited market trading history;
therefore, the assumptions used for these amounts are an average of those used
by a select group of related industry companies.  Most stock-based
awards have graded vesting (i.e. portions of the award vest at different dates
during the vesting period).  The Company recognizes the related
stock-based compensation expense of such awards on a straight-line basis over
the vesting period for each tranche in an award.  Upon consummation of
the Company’s Plan of Reorganization, all then outstanding stock options were
cancelled.





Effective
January 1, 2006, the Company adopted SFAS No. 123R, “Share-Based
Payment,” (“SFAS No. 123R”), (now known as FASB ASC 718), using the
modified prospective method.  SFAS No. 123R 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. 123R 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. 123R requires an estimate of
future forfeitures, whereas SFAS No. 123 allowed companies to estimate
forfeitures or recognize the impact of forfeitures as they occur.  As
the Company recognized the impact of forfeitures as they occurred under SFAS
No. 123, the adoption of SFAS No. 123R did result in different
accounting treatment, but it did not have a material impact on the Company’s
consolidated financial statements.





There
were no options to purchase shares of common stock granted during the three
months ended March 31, 2010 and 2009.





Restricted
Stock Units




Compensation
cost for restricted stock unit awards is measured based upon the quoted closing
market price for the Company’s stock on the date of grant.  The
compensation cost is recognized on a straight-line basis over the vesting
period.  See Note 7, “Stock-Based Compensation.”





Stock
Warrants




In
connection with the Plan of Reorganization described in Note 1, “Background and
Organization,” the Company issued to holders of general unsecured claims as part
of the settlement of such claims (i) five year warrants to purchase
1,418,918 shares of common stock with an exercise price of $10.00 per share
(expired September 8, 2008) and (ii) seven year warrants to purchase
1,669,316 shares of common stock with an exercise price of $12.00 per share
(expiring September 8, 2010).  The stock warrants are treated as
equity upon their exercise based upon the terms of the warrant and cash
received.  419,426 and 400 stock warrants to purchase shares of common
stock were exercised during the three months ended March 31, 2010 and 2009,
respectively.




13


ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





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





During
the three months ended March 31, 2010, seven year warrants to purchase 323,084
shares of common stock were exercised pursuant to the Net Exercise provisions
described above, of which 261,390 were issued and 61,694 were deemed
repurchased.  There were no Net Exercises during the three months
ended March 31, 2009.  Additionally, seven year warrants to purchase
96,342 shares of common stock were exercised.  At March 31, 2010,
seven year warrants to purchase 439,104 shares of common stock were
outstanding.





Derivative
Financial Instruments




The
Company utilizes derivative financial instruments known as interest rate swaps
(“derivatives”) to mitigate its exposure to interest rate risk.  The
Company purchased the first interest rate swap on August 4, 2008 to hedge the
interest rate on the $24.0 (original principal) portion of the Term Loan (as
such term is defined in Note 4, “Note Payable”) and the Company purchased a
second interest rate swap on November 14, 2008 to hedge the interest rate on the
additional $12.0 (original principal) portion of the Term Loan provided by
SunTrust Bank.  The Company accounted for the derivatives under SFAS
No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (now
known as FASB ASC 815).  FASB ASC 815 requires that all derivatives be
recognized in the financial statements and measured at fair value regardless of
the purpose or intent for holding them.  By policy, the Company has
not historically entered into derivatives for trading purposes or for
speculation.  Based on criteria defined in FASB ASC 815, the interest
rate swaps were considered cash flow hedges and were 100%
effective.  Accordingly, changes in the fair value of derivatives are,
and will be, recorded each period in accumulated other comprehensive
loss.  Changes in the fair value of the derivatives reported in
accumulated other comprehensive 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 loss at each of March 31, 2010 and
December 31, 2009 was $1.2 for the interest rate swaps.  The
mark-to-market value of the cash flow hedges will be recorded in other
non-current assets or other long-term liabilities, as applicable, and the
offsetting gains or losses in accumulated other comprehensive loss.




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




14


ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





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





All
derivatives were recorded on the Company’s consolidated balance sheets at fair
value.  Accounting for the gains and losses resulting from changes in
the fair value of derivatives depends on the use of the derivative and whether
it qualifies for hedge accounting in accordance with FASB ASC 815.  At
each of March 31, 2010 and December 31, 2009, the Company’s consolidated balance
sheet included net interest rate swap derivative liabilities of
$1.2.





Derivatives
recorded at fair value in the Company’s consolidated balance sheets as of March
31, 2010 and December 31, 2009 consisted of the following:





Derivative LiabilitiesDerivatives designated as hedging instruments
                              
                              March 31, 2010
                              
                              
                              December 31, 2009Interest
      rate swap agreements (*)
                              
                              $
                              1.2
                              
                              
                              $
                              1.2Total
      derivatives designated as hedging instruments
                              
                              $
                              1.2
                              
                              
                              $
                              1.2





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





Interest
Rate Swap Agreements




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




Weighted
      Average RateNotional
      Amount
                                                
                                                Maturity
      Date
                                                
                                                Pay
                                                
                                                
                                                Receive$
                                                21.1
                                                
                                                2011
                                                
                                                
                                                3.65
                                                %
                                                
                                                
                                                0.92
                                                %10.6
                                                
                                                2011
                                                
                                                
                                                2.635
                                                %
                                                
                                                
                                                0.46
                                                %$
                                                31.7




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





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




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,” (now known as FASB ASC
820-10), for the Company’s financial assets and liabilities effective January 1,
2008.  This pronouncement defines fair value, establishes a framework
for measuring fair value, and requires expanded disclosures about fair value
measurements.  FASB ASC 820-10 emphasizes that fair value is a
market-based measurement, not an entity-specific measurement, and defines fair
value as the price that would be received to sell an asset or transfer a
liability in an orderly transaction between market participants at the
measurement date.  FASB ASC 820-10 discusses valuation techniques,
such as the market approach (comparable market prices), the income approach
(present value of future income or cash flow) and the cost approach (cost to
replace the service capacity of an asset or replacement cost), which are each
based upon observable and unobservable inputs.  Observable inputs
reflect market data obtained from independent sources, while unobservable inputs
reflect the Company’s market assumptions. FASB ASC 820-10 utilizes a fair value
hierarchy that prioritizes inputs to fair value measurement techniques into
three broad levels:




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





The
Company’s investment in overnight money market institutional funds, which
amounted to $152.7 and $154.1 at March 31, 2010 and December 31, 2009,
respectively, is included in cash and cash equivalents on the accompanying
balance sheets and is classified as a Level 1 asset.





The
Company is party to two interest rate swaps, which are utilized to modify the
Company’s interest rate risk.  The Company recorded the mark-to-market
value of the interest rate swap contracts of $1.2 in other long-term
liabilities in the consolidated balance sheet at each of March 31, 2010 and
December 31, 2009.  The Company used third parties to value each of
the interest rate swap agreements at March 31, 2010 and December 31, 2009, as
well as its own market analysis to determine fair
value.  The fair value of the interest rate swap contracts
are classified as Level 2 liabilities.




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


16





ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





Concentration
of Credit Risk




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





401(k) and
Other Post-Retirement Benefits




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





The
Company contributed $0.5 for each of the three months ended March 31, 2010
and 2009, net of forfeitures for its obligations under these plans.





Taxes
Collected from Customers




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





Reclassifications




Certain
reclassifications have been made to the consolidated financial statements for
the three months ended March 31, 2009 to conform to the classifications used for
the three months ended March 31, 2010.


17


ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





Recently
Issued Accounting Pronouncements




During
the third quarter of 2009, the Company adopted the FASB Accounting Standards
Update No. 2009-01, “Amendments based on SFAS No. 168 - The  FASB Accounting
Standards Codification TM and the
Hierarchy of Generally Accepted Accounting Principles,” (the
“Codification”).  The Codification became the single source of
authoritative GAAP in the U.S., other than rules and interpretative releases
issued by the SEC.  The Codification reorganized GAAP into a topical
format that eliminates the previous GAAP hierarchy and instead established two
levels of guidance – authoritative and nonauthoritative.  All
non-grandfathered, non-SEC accounting literature that was not included in the
Codification became nonauthoritative.  The adoption of the
Codification did not change previous GAAP, but rather simplified user access to
all authoritative literature related to a particular accounting topic in one
place.  Accordingly, the adoption had no impact on the Company’s
financial position, results of operations or cash flows.  All
references to previous GAAP citations in the Company’s consolidated financial
statements have been updated for the new references under the
Codification.





In
September 2006, the FASB issued SFAS No. 157, “The Fair Value Measurements,”
(“SFAS No. 157”), (now known as FASB ASC 820-10), effective for fiscal years
beginning after November 15, 2007 and interim periods within those fiscal
years.  FASB ASC 820-10 establishes a framework for measuring fair
value under accounting principles generally accepted in the U.S. and expands
disclosures about fair value measurement.  In February 2008, the FASB
deferred the adoption of SFAS No. 157 as provided by FASB Staff Position
No. FAS 157-2, (also now known as FASB ASC 820-10), 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,” (now
known as FASB ASC 350), 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,” (now known as FASB ASC 360-10-35). 
The Company adopted this statement 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,” (now known as FASB ASC
825).  FASB ASC 825 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 was effective in the first quarter of
fiscal 2009, did not 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)”), (now known as FASB ASC 805), to replace SFAS
No. 141, “Business Combinations.”  FASB ASC 805 requires the use of
the acquisition method of accounting, defines the acquirer, establishes the
acquisition date and broadens the scope to all transactions and other events in
which one entity obtains control over one or more other
businesses.  This statement is effective for business combinations or
transactions entered into for fiscal years beginning on or after December 15,
2008.  The adoption of this statement did not have a material impact
on the Company’s financial position, results of operations or cash
flows.





In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements – an amendment of ARB No. 51,” (“SFAS No.
160”), (now known as FASB ASC 810-10-65).  FASB ASC 810-10-65
establishes accounting and reporting standards for the noncontrolling interest
in a subsidiary and for the retained interest and gain or loss when a subsidiary
is deconsolidated.  This statement is effective for financial
statements issued for fiscal years beginning on or after December 15,
2008.  The adoption of this statement did not have a material impact
on the Company’s financial position, results of operations or cash
flows.


18


ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





In
December 2007, the SEC issued SAB No. 110, “Certain Assumptions Used in
Valuation Methods – Expected Term,” (now known as FASB ASC
718-10).  FASB ASC 718-10 allows companies to continue to use the
simplified method, as defined in SAB No. 107, “Share-Based Payment,” (also now
known as FASB ASC 718-10), to estimate the expected term of stock options under
certain circumstances.  The simplified method for estimating expected
term uses the mid-point between the vesting term and the contractual term of the
stock option.  The Company has analyzed the circumstances in which the
use of the simplified method is allowed.  The Company has opted to use
the simplified method for stock options it granted in 2008 because management
believes that the Company does not have sufficient historical exercise data to
provide a reasonable basis upon which to estimate the expected term due to the
limited period of time the Company’s shares of common stock have been publicly
traded.  There were no options to purchase shares of common stock
granted during the three months ended March 31, 2010 and 2009.





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”),(now known as FASB ASC815),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, (also
now known as FASB ASC 815)and its related interpretations; and the
effect of derivative instruments and related hedged items on financial position,
financial performance and cash flows.This statementalso requires disclosure of the fair
values of derivative instruments and their gains and losses in a tabular
format.This statementis effective for financial statements
issued for fiscal years and interim periods beginning after November 15, 2008,
with early adoption encouraged.The adoption of this
statement did not have a material impact on the Company’s financial position,
results of operations or cash flows.





In April
2008, the FASB issued EITF No. 07-5, “Determining Whether an Instrument (or
Embedded Feature) Is Indexed to an Entity’s Own Stock,” (“EITF No. 07-5”), (now
known as FASB ASC 815-40).  FASB ASC 815-40 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.  This issue is effective for financial statements issued
for fiscal years beginning after December 15, 2008 and early application is not
permitted.  The adoption of this issue did not have a material impact
on the Company’s financial position, results of operations or cash
flows.





In June
2008, the FASB issued EITF No. 08-3, “Accounting by Lessees for Maintenance
Deposits under Lease Agreements,” (“EITF No. 08-3”), (now known as FASB ASC
840-10).  FASB ASC 840-10 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.  This issue is
effective for fiscal years, and interim periods within those fiscal years,
beginning after December 15, 2008.  The adoption of this issue did not
have a material impact on the Company’s financial position, results of
operations or cash flows.





In June
2008, the FASB issued EITF No. 03-6-1, “Determining Whether Instruments Granted
in Shared-Based Payment Transactions are Participating Securities,” (“EITF No.
03-6-1”), (now known as FASB ASC 260-10).  FASB ASC 260-10 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.  This issue 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 FASB ASC
260-10.  The adoption of this issue did not have a material impact on
the Company’s financial position, results of operations or cash
flows.





In April
2009, the FASB issued Staff Position No. FAS 107-1 and APB 28-1, “Interim
Disclosures about Fair Value of Financial Instruments,” (“FSP No. FAS 107-1
and APB 28-1”), (now known as FASB ASC 825).  This
statement amends SFAS No. 107, “Disclosures about Fair Value of
Financial Instruments,” (now known as FASB ASC 825-10), to require disclosures
about fair value of financial instruments in interim as well as in annual
financial statements.  This statement also amends APB Opinion No. 28,
“Interim Financial Reporting,” (now known as FASB ASC 270-10-50), to
require those disclosures in all interim financial results, financial position
and financial statement disclosures.  This statement became effective
for the Company for the three months ended June 30, 2009.  This
statement did not have a material impact on the Company’s financial position,
results of operations or cash flows.


19


ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





In May
2009, the FASB issued SFAS No. 165, "Subsequent Events," ("SFAS No. 165"), (now
known as FASB ASC 855-10), effective for interim or annual financial periods
ending after June 15, 2009.  For calendar year entities, SFAS No. 165
became effective for the three months ended June 30, 2009.  The
objective of FASB ASC 855-10 is to establish general standards of accounting for
and disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued.  In
particular, FASB ASC 855-10 sets forth (1) the period after the balance sheet
date during which management of a reporting entity should evaluate events or
transactions that may occur for potential recognition or disclosure in the
financial statements; (2) the circumstances under which an entity should
recognize events or transactions occurring after the balance sheet date in its
financial statements; and (3) the disclosures that an entity should make about
events or transactions that occurred after the balance sheet
date.  The adoption of this statement did not have a material impact
on the Company’s financial position, results of operations or cash
flows.





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





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





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





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




20


ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





NOTE
3: CHANGE IN ESTIMATE




Effective
January 1, 2008, the Company changed the estimated useful lives for its spare
parts (which are 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 was not
material.  Effective October 1, 2009, the Company changed the
estimated useful lives for certain HVAC and power equipment from 20 years to 12
to 15 years and certain components of infrastructure (risers) from 20 years to 5
years.  Effective January 1, 2010, the Company changed the estimated
useful lives for its IP equipment from 7 years to 5 years.  Additionally,
the Company changed the estimated useful lives for certain capitalized labor
from 20 years to 7 years.The effect of these changes on the
Company’s future operating results will not be material.





NOTE
4:  NOTE PAYABLE





Secured
Credit Facility





On
February 29, 2008, the Company, excluding certain foreign subsidiaries, entered
into a Credit and Guaranty Agreement (as amended, the “Credit Agreement”)
providing for a $60.0 senior secured credit facility (the “Secured Credit
Facility”), consisting of an $18.0 revolving credit facility (the “Revolver”)
and a $42.0 term loan facility (the “Term Loan”).  The initial lenders
under the Secured Credit Facility were Societe Generale and CIT Lending Services
Corporation.  The Secured Credit Facility is secured by substantially
all of the Company’s domestic assets.  The Term Loan was comprised of
$24.0, which was advanced at closing and up to $18.0 of which originally could
be drawn within nine months of closing at the Company’s option (the “Delayed
Draw Term Loan”).  In September 2008, the Delayed Draw Term Loan
option, which was originally scheduled to expire on November 25, 2008, was
extended to June 30, 2009 and then subsequently extended to December 31,
2009.  The Revolver and the Term Loan each have a term of five years
from the closing date of the Secured Credit Facility.  The Company
paid a non-refundable work fee of $0.1 to the lenders, which was credited
against the upfront fee of 1.5% ($0.9) of the total amount of the Secured Credit
Facility that was paid at closing and paid $0.3 to its unaffiliated third party
financial advisors who assisted the Company.  Additionally, the
Company is liable for an unused commitment fee of 0.50% per annum or 0.75% per
annum, depending on the utilization of the Secured Credit
Facility.  Interest accrues at LIBOR (30, 60, 90 or 180 day rates) or
at the announced base rate of the administrative agent at the Company’s option,
plus the applicable margins, as defined.  The Company has chosen 30
day LIBOR as the interest rate during the term of the interest rate swap (30 day
LIBOR was 0.22875% at March 31, 2010).  Additionally, the Company was
originally required to maintain an unrestricted cash balance at all times of at
least $20.0.  On February 29, 2008, the Company received proceeds of
$24.0, before the deduction of debt acquisition costs, under the Term
Loan.  As required under the provisions of the Term Loan, the initial
advance was at the base rate of interest, plus the margin (8.25% at February 29,
2008) and converted to LIBOR, plus 3.25% per annum (6.26%) on March 5,
2008.





In addition, the Company’sability to draw upon the available
commitments under the Revolver is subject to compliance with all of the
covenants contained in theCreditAgreement andthe Company’scontinued ability to make certain
representations and warranties.Among other things, these
covenants limit annual capital expenditures in 2008, 2009 and 2010, provide that
the Company’s net total funded debt ratio cannot at any time exceed a specified
amount and require that the Company maintain a minimum consolidated fixed
charges coverage ratio.  In addition, the Credit Agreement prohibits
the Company from paying dividends (other than in its own shares or other equity
securities) and from making certain other payments, including payments to
acquire the Company’s equity securities other than under specified
circumstances, which include the repurchase of the Company’s equity securities
from employees and directors in an aggregate amount not to exceed
$15.0.  The Company is in compliance with all of its debt covenants as
of March 31, 2010.




21


ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





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





The Term Loan provides for monthly
payments of interest and quarterly installments of principal of $1.08, which
commenced June 30, 2009, increasing to $1.44 on June 30, 2012 with the balance
of $18.72, plus accrued unpaid interest, due on February 28,
2013.





Effective
August 4, 2008, the Company entered into a swap arrangement under which it fixed
its borrowing costs with respect to the $24.0 (original principal) Term Loan
outstanding for three years at 3.65%, plus the applicable margin of 3.25%, which
was reduced to 3.00% on September 30, 2008 upon the filing of the Company’s
Annual Report on Form 10-K for the year ended December 31, 2007.





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





On June 29, 2009, the Company and the
Lenders entered into an amendment to the Credit Agreement (“Amendment No. 2
to Credit Agreement”), which extended the availability of the Delayed Draw Term
Loan commitments from June 30, 2009 to December 31, 2009, and provided for the
reduction of these commitments by $0.81 on each of June 30, 2009, September 30,
2009 and December 31, 2009.In addition,the Company’s obligation to maintain a
minimum balance of $20.0 in cash deposits at all times was
eliminated.





On December 31, 2009, the Company
borrowed $24.57 under the Delayed Draw Term Loan.  The borrowings
under the Delayed Draw Term Loan bear interest at 30 day LIBOR (0.22875% at
March 31, 2010) plus the applicable margin of 3.00%.  The Delayed Draw
Term Loan provides for monthly payments of interest and, beginning March 31,
2010, quarterly payments of principal of $0.81 increasing to $1.08 starting on
June 30, 2012 with the balance of $14.04 plus accrued interest due on February
28, 2013.





On March
4, 2010, the Company and the Lenders entered into an amendment to the Credit
Agreement to clarify the principal repayment schedule for the Delayed Draw Term
Loan.





The
Company executed a $1.0 standby letter of credit in favor of New York City to
secure the Company’s franchise agreement, which is collateralized by $1.0 of
availability under the Revolver.  The standby letter of credit,
originally scheduled to expire May 1, 2010, was renewed and extended until May
1, 2011.  At March 31, 2010, the Company had
$26.0available under the
Revolver.


22


ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





NOTE
5:  INCOME TAXES





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




Three Months Ended March 31,2010
                                            
                                            
                                            2009Federal
                                            
                                            $
                                            8.0
                                            
                                            
                                            $
                                            (5.3
                                            )State
                                            
                                            
                                            1.3
                                            
                                            
                                            
                                            0.2Foreign
                                            
                                            
                                            0.3
                                            
                                            
                                            
                                            —Total
      provision for (benefit from) income taxes
                                            
                                            $
                                            9.6
                                            
                                            
                                            $
                                            (5.1
                                            )





At the end of each interim period, the
Company estimates the annual effective tax rate and applies that rate to its
ordinary quarterly earnings.The tax expense or benefit related
tosignificant, unusual or
extraordinary items that will be separately reported or reported net of their
related tax effect, and are
individually computed,are
recognized in the interim period in which those items occur.In addition, the effect of changes
in enacted tax laws or
rates or tax status is recognized in the interim period in which the change
occurs.





The computation of the annual estimated
effective tax rate at each interim period requires certain estimates and
significant judgment including, butnot limited to, the expected operating
income for the year, projections of the proportion of income earned and taxed in
various jurisdictions, permanent and temporary differences, and the likelihood
of recovering deferred tax assets generated in the current year.The accounting estimates used to compute
the provision for income taxes may change as new events occur, more experience
is acquired, additional information is obtained or as the tax environment
changes.





For the three months ended
March 31, 2010 and
2009, the effective income tax rateswere41.4%and (22.9)%, respectively.





The
Company believes it is more likely than not that it will utilize these assets to
reduce or eliminate tax payments in future periods.  The Company’s
evaluation encompassed (i) a review of its recent history of profitability
in the U.S. for the past three years; (ii) a review of internal financial
forecasts demonstrating its expected capacity to utilize deferred tax assets;
and (iii) a reassessment of tax benefits recognition under FASB
ASC 740.





NOTE
6:  INCOME PER COMMON SHARE





Basic net
income per common share is computed as net income or net loss divided by the
weighted average number of common shares outstanding for the
period.  Total weighted average shares utilized in computing basic net
income per common share were 24,944,514 and 22,922,284 for the three months
ended March 31, 2010 and 2009, respectively.  Total weighted
average shares utilized in computing diluted net income per common share were
26,218,755 and 24,613,712 for the three months ended March 31, 2010 and
2009, respectively.  Dilutive securities include options to purchase
shares of common stock, restricted stock units and stock
warrants.  For the three months ended March 31, 2010, there were
no potentially dilutive securities excluded from the calculation of diluted
income per common share.  For the three months ended March 31, 2009,
potentially dilutive securities to acquire 98,050 shares of common stock were
excluded from the calculation of diluted income per common share as they were
anti-dilutive.




23




ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





NOTE
7:   STOCK-BASED COMPENSATION




2008
Equity Incentive Plan





On August
29, 2008, the Board of Directors of the Company approved the Company’s 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.  1,500,000 shares of the Company’s common stock may be
issued pursuant to awards granted under the 2008 Plan.  The number of
shares available for grant and the terms of outstanding grants are subject to
adjustment for stock splits, stock dividends and other capital
adjustments.





Stock-based
compensation expense for each period relates to share-based awards granted
under the Company’s 2008 Plan described above and the Company’s 2003 Plan, and
reflect awards outstanding during such period, including awards granted both
prior to and during such period.  The 2003 Plan became effective on
September 8, 2003.  Under the 2003 Plan, the Company was
authorized to issue, in the aggregate, share-based awards of up to 2,129,912
common shares to employees, directors and consultants who are selected to
participate.  At March 31, 2010, 1,169,432 common shares had been
issued pursuant to vested restricted stock units (including shares repurchased
by the Company), 746,410 shares had been issued pursuant to options exercised to
purchase common shares, 179,992 common shares were reserved pursuant to
outstanding options to purchase shares of common stock and 34,078 common shares
were cancelled.





As of
March 31, 2010, 2,000 common shares had been issued pursuant to the exercise of
options to purchase shares of common stock, 307,862 common shares were issued
pursuant to the delivery of vested restricted stock units (including shares
repurchased by the Company), 8,000 common shares were reserved pursuant to
outstanding options to purchase shares of common stock, 640,372 were reserved
pursuant to outstanding restricted stock units and 541,766 common shares were
reserved for future grants.





Stock
Options





There
were no options to purchase shares of common stock granted during the three
months ended March 31, 2010 and 2009.





The
Company recognized non-cash stock-based compensation expense amounting to $0.1
for the three months ended March 31, 2009 with respect to stock options
granted, which did not have a measurable effect on net income for the three
months ended March 31, 2009.  The Company did not recognize
stock-based compensation expense for the three months ended March 31,
2010.




24





ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





Restricted
Stock Units





The
Company did not award any restricted stock units during the three months ended
March 31, 2010 and 2009.  The Company recognized non-cash stock-based
compensation expense related to restricted stock units of $2.1 and $2.8 for the
three months ended March 31, 2010 and 2009, respectively, which had the effect
of decreasing net income by $0.05 per basic and diluted common share for the
three months ended March 31, 2010 and by $0.13 per basic common share and by
$0.12 per diluted common share for the three months ended March 31, 2009. 
Additionally,
during the three months ended March 31, 2010, the Company delivered 14,000
shares of common stock to its Chief Executive Officer, William LaPerch, pursuant
to vested performance-based restricted stock units granted to him in
September 2008.  In accordance with the terms of Mr. LaPerch’s stock
unit agreement, the Company purchased an aggregate of 5,459 shares of
common stock from Mr. LaPerch at $54.73 per share, the closing price of the
Company’s common stock on the date of delivery, in order to satisfy minimum tax
withholding obligations.





NOTE
8:   SHAREHOLDERS’ EQUITY





Rights
Agreement




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





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





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




25


ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





The
Rights are not exercisable until the Distribution Date.  Each Right,
upon becoming exercisable, will entitle the holder to purchase from the Company
a specified fraction of a share of the Company’s Series A Junior Participating
Preferred Stock (the “Preferred Shares”) at the then effective purchase
price.  The Rights will expire on August 7, 2012, unless earlier
redeemed or exchanged, subject to shareholder ratification by August 3,
2010.





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





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





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





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





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





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





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





Stock
Split




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


26


ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





NOTE
9:  LITIGATION





The
Company is subject to various legal proceedings and claims which arise in the
normal course of business.  The Company evaluates, among other things,
the degree of probability of an unfavorable outcome and reasonably estimates the
amount of potential loss.





Global
Voice Networks Limited (“GVN”)





AboveNet Communications UK Limited,
the Company’s U.K. operating subsidiary (“ACUK”), was a party to a duct
purchase and fiber lease agreement (the “Duct Purchase Agreement”) with EU
Networks Fiber UK Ltd, formerly GVN.  A dispute between the parties
arose regarding the extent of the network duct that was sold and fiber that was
leased to GVN pursuant to the Duct Purchase Agreement.  As a result of
this dispute, in 2006, GVN filed a claim against ACUK in the High Court of
Justice in London seeking ownership of the disputed portion of the network duct,
the right to lease certain fiber and associated damages.  In
December 2007, the court ruled in favor of GVN with respect to the disputed
duct and fiber.  In early February 2008, ACUK delivered most of
the disputed duct and fiber to GVN.  Additionally, under the
original ruling, the Company was also required to construct the balance
of the disputed duct and fiber and deliver it to GVN pursuant to a schedule
ordered by the court.  Additional portions of the disputed duct
and fiber were constructed and subsequently delivered and other portions are
scheduled for delivery.The Company also had certain repair
and maintenance obligations that it must perform with respect to such
duct.  GVN was also seeking to enforce an option requiring ACUK
to construct 180 to 200 chambers for GVN along the network.  In
June 2008, the Company paid $3.0 in damages pursuant to the liability
trial.  Additionally, the Company reimbursed GVN $1.8 for legal
fees.  Additionally, the Company’s legal fees aggregated
$2.4.  Further, the Company has incurred or is obligated for costs
totaling $2.7 to build additional network.  In early August 2008, the
Company reached a settlement agreement under which the Company paid GVN $0.6 and
agreed to provide additional construction of duct at an estimated cost of $1.2
and provide GVN limited additional access to ACUK’s network.  GVN and
ACUK provided mutual releases of all claims against each other, including ACUK’s
repair obligation and chamber construction obligations discussed
above.  The Company recorded a loss on litigation of $11.7 at December
31, 2007, of which $0.8, $8.5 and $0.7 was paid in 2007, 2008 and 2009,
respectively, and $0.6 was included in accrued expenses at December 31,
2009.  The obligation was denominated in British Pounds; therefore, the
amounts have been affected by currency fluctuations.  The Company had
a remaining balance of $0.4 for this loss on litigation included in accrued
expenses at March 31, 2010.





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 $2.3 and
$2.0, for the years ended December 31, 2008 and 2007,
respectively.


27


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 contract termination revenue for the year ended
December 31, 2008.





SEC
Investigation




The SEC
initiated a formal investigation of MFN (the pre-bankruptcy emergence
predecessor to the Company) in June 2002.  On December 15,
2006, the Company received a “Wells” notice from the SEC staff in connection
with such investigation indicating that the SEC staff was considering
recommending that the SEC bring a civil injunctive action against the Company
alleging that the Company violated various provisions of the federal securities
laws.  In response to the Wells notice, the Company provided the SEC
with a written submission setting forth reasons why the Company believed that a
civil injunctive action should not be authorized by the SEC.  On
March 19, 2007, the Company received a notice from the SEC staff stating
that the investigation of MFN has been terminated and that no enforcement action
has been recommended to the SEC.  Such notice was provided to the
Company under the guidelines of the final paragraph of Securities Act Release
No. 5310 which states, among other things, that “[such notice] must in no
way be construed as indicating that the party has been exonerated or that no
action may ultimately result from the staff’s investigation of that particular
matter.  All that such a communication means is that the staff has
completed its investigation and that at that time no enforcement action has been
recommended to the SEC.”





Southeastern
Pennsylvania Transportation Authority (“SEPTA”)




In
October 2008, SEPTA filed a claim in the Philadelphia County Court of Common
Pleas against the Company for trespass with regard to portions of the Company’s
network allegedly residing on SEPTA property in Pennsylvania.  SEPTA
seeks unspecified damages for trespass and/or a determination that the Company’s
network must be removed from SEPTA’s property.  The Company has
responded to the claim and also filed a motion in the Bankruptcy Court seeking a
determination that the claim is barred based on the discharge of claims and
injunction contained in the Plan of Reorganization.  The Company
believes that it has meritorious defenses to SEPTA’s claims.





NOTE
10:  RELATED PARTY TRANSACTIONS





A member
of the Company’s Board of Directors, Richard Postma, is also the Co-Chairman,
Chief Executive Officer and co-founder of a telecommunications
company.  The Company sold services and/or material in the normal
course of business to this telecommunications company in the amount of $0.1 for
each of the three months ended March 31, 2010 and 2009.  No amounts
were outstanding at each of March 31, 2010 and December 31,
2009.  Mr. Postma also serves as the Chief Executive Officer of and
holds a minority ownership interest in a construction company.  The
Company purchased $0.03 in services in 2009 and $0.13 in services in 2008 from
such construction firm.  All activity between the Company and these
entities were 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.




28


ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





NOTE
11:  SEGMENT REPORTING





SFAS
No. 131, “Disclosures about Segments of an Enterprise and Related
Information,” (now known as FASB ASC 280-10), 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 the Company’s revenue based on
the location of its entity providing service.  Long-lived assets are
based on the physical location of the assets.  The following table
presents revenue and long-lived asset information for geographic
areas:





Three Months Ended March 31,2010
                  
                  
                  2009RevenueUnited
      States
                  
                  $
                  88.4
                  
                  
                  $
                  78.6United
      Kingdom
                  
                  
                  10.1
                  
                  
                  
                  7.6Eliminations
                  
                  
                  (1.3
                  )
                  
                  
                  (0.8
                  )Consolidated
      Worldwide
                  
                  $
                  97.2
                  
                  
                  $
                  85.4





As ofMarch 31, 2010
                  
                  
                  December 31, 2009Long-lived
      assetsUnited
      States
                  
                  $
                  450.2
                  
                  
                  $
                  440.8United
      Kingdom
                  
                  
                  26.7
                  
                  
                  
                  28.3Other
                  
                  
                  —
                  
                  
                  
                  —Consolidated
      Worldwide
                  
                  $
                  476.9
                  
                  
                  $
                  469.1




29


ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





NOTE
12: OTHER EXPENSE, NET





Other
expense, net consists of the following:





Three Months Ended March 31,2010
                                          
                                          
                                          2009Gain
      on settlement or reversal of liabilities
                                          
                                          $
                                          0.4
                                          
                                          
                                          $
                                          0.7Loss
      on foreign currency
                                          
                                          
                                          (1.1
                                          )
                                          
                                          
                                          (0.6
                                          )Gain
      (loss) on disposition of property and equipment
                                          
                                          
                                          0.1
                                          
                                          
                                          
                                          (0.2
                                          )Total
                                          
                                          $
                                          (0.6
                                          )
                                          
                                          $
                                          (0.1
                                          )





NOTE
13: COMMITMENTS AND CONTINGENCIES





Employment
Contracts




The
Company maintains employment agreements with its key executives.  The
agreements include, among other things, certain change in control and severance
provisions.





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.





In
October 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 general terms as the September 2008 employment
agreements described above.





Internal
Revenue Service





In
September 2008, the Company was notified by the Internal Revenue Service (the
“IRS”) that it was reclassifying certain individuals, classified by the Company
as independent contractors, to employees and, accordingly, assessing certain
payroll taxes and penalties totaling $0.3.  The Company disputed this
position citing relief provided by IRC Section 530 and IRC Section
3509.  On January 13, 2009, the IRS made a settlement offer to the
Company, which the Company executed on March 10, 2009 and the IRS countersigned
on May 11, 2009.  Under the terms of the proposed settlement
agreement, the Company agreed to pay $0.015 to the IRS to fully discharge any
federal employment tax liability it may owe for 2005.  The IRS agreed
not to dispute the classification of “such workers” for federal employment tax
purposes for any period from January 1, 2005 to March 31,
2009.  Beginning April 1, 2009, the Company agreed to treat
“Consultants,” as described in the settlement agreement, who perform equivalent
duties as employees of the Company as employees.  Finally, the Company
agreed to extend the statute of limitations with respect to federal employment
tax payments for the period covered by the settlement agreement (January 1, 2005
to March 31, 2009) to April 1, 2012.




30


ABOVENET, INC. AND
SUBSIDIARIES





NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


(in millions, except share and per share
information)





New
York City Franchise Agreement





As a
result of certain ongoing litigation with a third party, the Department of
Information Technology and Telecommunications of the City of New York (“DOITT”)
has informed the Company that they have temporarily suspended any discussions
regarding renewals of telecommunications franchises in the City of New
York.  As a result, it is the Company’s understanding that DOITT has
not renewed any recently expired franchise agreement, including the Company’s
franchise agreement which expired on December 20, 2008.  Prior to the
expiration of the Company’s franchise agreement, the Company sought out and
received written confirmation from DOITT that the Company’s franchise agreement
provides a basis for the Company to continue to operate in the City of New York
pending conclusion of renewal discussions.  The Company intends to
continue to operate under its expired franchise agreement pending any
renewal.  The Company believes that a number of other operators in the
City of New York are operating on a similar basis.  Based on the
Company’s discussions with DOITT and the written confirmation that the Company
has received, the Company does not believe that DOITT intends to take any
adverse actions with respect to the operation of any telecommunications
providers as the result of their expired franchise agreements and, that if it
attempted to do so, it would face a number of legal
obstacles.  Nevertheless, any attempt by DOITT to limit the Company’s
operations as the result of its expired franchise agreement could have a
material adverse effect on the Company’s business, financial condition and
results of operations.




31





ITEM 2.  MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS




The
following discussion and analysis should be read together with the Company’s
consolidated financial statements and related notes appearing in this Quarterly
Report on Form 10-Q and in the Company’s Annual Report on Form 10-K for the year
ended December 31, 2009.





Business





Overview





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





Metro
networks.We are
a facilities-based provider that operates fiber-optic networks in 15 major
markets in the U.S. and one in the U.K. (London).  We refer to these
networks as our metro networks.  These metro networks have significant
reach and breadth.  They consist of over 1.9 million fiber miles
across over 5,400 cable route miles in the U.S. and in London.  In
addition, we have built an inter-city fiber network between New York and
Washington D.C. of over 177,000 fiber miles.





Long haul
network.  Through
construction, acquisition and leasing activities, we have created a nationwide
fiber-optic communications network spanning over 11,000 cable route miles that
connects each of our 15 U.S. metro networks.  We run advanced dense
wavelength-division multiplexing (“DWDM”) equipment over this fiber to provide
large amounts of bandwidth capability between our metro networks for our
customer needs and for our IP network.  We are also members of the
Japan-US Cable Network (“JUS”) and Trans-Atlantic undersea telecommunications
consortia (“TAT-14”) that provide connectivity between the U.S. and Japan and
the U.S. and Europe, respectively.  We refer to this network as our long
haul network.





IP
network.We operate a Tier 1 IP network over our
metro and long haul networks with connectivity to the U.S., Europe and
Japan.Our IP network operates using advanced
routers and switches that facilitate the delivery of IP transit services and
IP-based virtual private network (“VPN”) services.A hallmark of our IP network is that we
have direct connectivity to a large number of IP networks operated by others
through peering agreements and to many of the most important bandwidth centers
and peering exchanges.




32





Business Strategy




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





·
            Connect to data centers where many
      enterprise customers locate their information
      technology infrastructure.·
            Target broadband communications
      infrastructure customers who have significant bandwidth requirements and
      high security needs.·
            Provide a high level of
      customization of our services in order to meet our customers’
      requirements.·
            Deliver the services we offer over
      our metro networks, which often provide our customers with a dedicated
      pair of fibers.  This use of dedicated fiber is a low
      latency, physically secure, flexible and scalable communications solution,
      which we believe is difficult for many of our competitors to
      replicate because most of their networks do not have comparable fiber
      density.·
            Use our metro fiber assets to
      drive the adoption of leading edge inter-city wide area network (WAN)
      services such as IP VPN services and long haul connectivity
      solutions.·
            Intensify our focus on sales to
      media companies with high-bandwidth
requirements.·
            Fulfill
      the needs of customers that are required to comply with financial and
      other regulations related to data availability, disaster recovery and
      business continuity.·
            Target
      Internet connectivity customers that can leverage the scalability and
      flexibility of fiber access to their premises to drive their electronic
      commerce and other high-bandwidth applications, such as social networking,
      gaming and digital media
transmission.





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





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


33


Our Networks and
Technology




Metro Networks




The
foundation of our business is our metro fiber optic networks in the following
domestic metropolitan areas and London in the U.K.





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





Including
fiber acquired by us through leases and indefeasible rights-of-use (“IRUs”), as
well as fiber provided by us to others through leases and IRUs, our metro
networks consist of over 1.9 million fiber miles and over 5,400 cable route
miles.  The network footprint typically allows us to serve central
offices, carrier hotels, network POPs, data centers, enterprise locations and
traffic aggregation points, not just in the central business district but across
the entire metropolitan area in each market.  Within our metro
networks, our infrastructure provides ample opportunity to access many
additional buildings by virtue of its extensive footprint coverage and over
5,600 network access points that can be utilized to build laterals or connect to
other networks, thereby providing access to additional locations.





Key
Metro Network Attributes




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





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




34





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





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





On-Net
Buildings




Our metro
networks connect to over 2,300 buildings in the U.S. and the U.K. through our
lateral cables, which cover approximately 1,200 route miles and approximately
140,000 fiber miles (which are part of the 1.9 million fiber miles previously
described).  These connected buildings are referred to as on-net
buildings.





·
            Enterprise Buildings -Our network extends to over 1,800 enterprise locations, many of
      which house some of the biggest corporate users of network services in the
      world.  These locations also include many private data centers
      and hub locations that are mission critical for our
    customers.




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




·
            Central Offices, Carrier Hotels
      and Data Centers -Our network connects to over 200 central offices
      in the markets that we serve.  The network also has a presence
      in most significant carrier hotels and data centers within our active
      markets.




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





Long Haul Network




Weoperate a nationwide long haul network
interconnecting each of our metro networks that spans over 11,000 route
miles.  With the exception of the route between New York and
Washington, D.C., which we constructed and own, our long haul network is based
on fiber either leased or acquired, typically under long-term
agreements.  We have deployed DWDM equipment along this network that
provides significant bandwidth capability between our metro
networks.  This next generation network is based on ultra long haul
technology that requires fewer intermediate regeneration points to deliver our
services between major cities and expands our high-bandwidth service capability
between our metro markets.





In addition to our U.S.-based
facilities, we are a member of the TAT-14 consortium, which provides us with
undersea capacity between the U.S. and Europe.  We are also currently
a member of the JUS consortium which provides us with undersea capacity between
the U.S. and Japan.  We use leased circuit capacity in continental
Europe to provide connectivity among our key IP presence
locations.  We also operate lit networks in the U.S. connecting to
certain key undersea cable landing stations including Manasquan and Tuckerton in
New Jersey to connect to the TAT-14 and have leased capacity to Morrow Bay,
California to connect to the JUS.  In the U.K., we have leased fiber
between the TAT-14 landing stations in Bude and London over which we operate a
high-capacity DWDM system.  Together, these networks provide us
high-bandwidth capability among our metro networks and certain key markets in
Europe and Japan.




35


IP Network




We operate a global Tier 1 IP network
with connectivity in the U.S., Europe and Japan.  In the U.S., most of
our 15 metro networks have multiple IP hubs where we can provide Internet
connectivity.  We peer and provide connectivity in high-bandwidth data
centers and Internet exchange locations, including many of those operated by the
major providers, such as Equinix.  We have extended our ability to provide
IP connectivity through our metro networks by using our fiber to bring our
services to a wider set of customers.  In addition to the U.S., the IP
network has a presence in each of London, Amsterdam, Tokyo, Paris and Frankfurt,
including the major exchanges in these markets such as LINX, AMS-IX, and
JPIX.





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




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





Network
Management




Our
network management center (“NMC”) is located in Herndon, Virginia and provides
round-the-clock surveillance, provisioning and customer service.  Our
metro networks, long haul network, IP network and the private networks we set up
for our customers, which link together two or more of their locations, are
constantly monitored in order to respond to any degrading network conditions and
network outages.  Our NMC responds to all customer network inquiries
via a trouble ticketing system.  The NMC’s staff serves as the focal
point for managing our service level agreements, or SLAs, with our customers and
coordinating network maintenance activities.





Rights-of-Way




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





Services




Initially,
our primary business was to lease dark fiber to telecommunications carriers,
enterprises, Internet and web-centric businesses and other customers that wanted
to operate their own networks, often under long term
agreements.  Since 2003, we have shifted the focus of our business by
leveraging our extensive fiber footprint and deploying capital to extend our
fiber footprint to customers with high-bandwidth requirements within and between
our metro markets.  This transformation has allowed us to serve a much
larger marketplace with differentiated services principally provided over our
dedicated fiber.  Unlike
CLECs, we do not provide voice services, services to residential customers or a
wide range of lower-bandwidth services.





In late
2008, we modified our service groupings and related revenue to more accurately
reflect our focus on delivering high-bandwidth services.  The new
groups are: fiber infrastructure services, metro services and WAN
services.





Our
services are grouped into three categories, as described below: fiber
infrastructure, metro and WAN services.




36


Fiber Infrastructure
Services




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





Our fiber
infrastructure services feature:




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





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





Metro
Services




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





·
            A
      substantial portion of our metro services are deployed over dedicated
      fiber from end-to-end, representing a private network for each
      customer.·
            This
      dedicated fiber provides customers with significant scalability for any
      increasing traffic demand.·
            A
      service based on dedicated fiber provides a high level of security, a key
      concern for many high-bandwidth customers across a range of
      industries.·
            The
      absence of a shared network eliminates many of the equipment interfaces of
      most other networks that can impact performance such as latency and cause
      service interruptions.·
            Some
      of our metro services are offered without the need for the customer to
      provide space and power, which may be difficult or expensive to obtain in
      many data centers.





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





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


37





We also
offer a full range of Metro Ethernet services including point-to-point and
multi-point service configurations at 100 Mbps, 1000 Mbps and 10,000 Mbps
speeds.  We offer three different classes of our Metro Ethernet
services with three different price points (higher, middle and lower) based upon
level of service: (1) Private Metro Ethernet which utilizes customer dedicated
equipment and fiber to deliver a completely private service with all of the
associated operational, performance and security benefits; (2) Dedicated Metro
Ethernet which utilizes shared equipment with reserved/guaranteed capacity,
delivered to the customer location through dedicated fiber; and (3) Standard
Metro Ethernet which utilizes shared equipment on a shared capacity basis,
delivered to the customer location through dedicated fiber.





WAN
Services




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





Our long
haul services provide inter-city connectivity between our 15 U.S. metro markets
at a variety of speeds ranging from 1 Gbps to 10 Gbps on our ultra long haul
network.  Our service
offerings require a minimum of regeneration sites, which improves our ability to
be competitive from both a price and speed of installation perspective while
reducing the number of equipment interfaces required to deliver our
service.





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





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





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





Sales
and Marketing




Our sales force is based across most of
our current 15 U.S. metro markets and London.  Our U.S. sales force is
comprised of approximately 80 sales professionals and is supported by a
team of sales engineers who provide technical support during the sales
process.  Our sales force primarily focuses on enterprise customers,
including Fortune 1000 companies in the U.S. and FTSE 500 companies in London,
that have large bandwidth requirements.  This represents a change from
our focus on wholesale sales to carrier customers in previous
years.  Since 2004, the vast majority of our new sales have been to
enterprise customers.




38





Our sales
strategy includes:




·
            Positioning ourselves as a premier
      provider of private fiber optic transport solutions and Internet
      connectivity services.·
            Focusing on Fortune 1000
      enterprises as well as content rich data companies (i.e. media, health
      care and financial services) that require customized private optical
      solutions.·
            Expanding our sales reach through
      independent sales agents who specialize in specific geographic and
      vertical markets.·
            Emphasizing the high quality, cost
      effective, secure and scalable nature of our private optical
      solutions.·
            Communicating our capabilities
      through targeted marketing communication campaigns aimed at specific
      vertical markets to increase our brand awareness in a cost effective
      manner.





Customers




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





Executive
Summary





Overview





The
components of our operating income are revenue, costs of revenue, selling and
general and administrative expenses and depreciation and amortization. Below is
a description of these components. We are reporting operating income for the
three months ended March 31, 2010 and 2009, 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
challenging and constantly shifting and the current economic environment could
adversely affect demand, 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,
new customer installations, net new revenue booked and capital committed and
expended.





Some of the most important non-financial
performance metrics measure headcount, IP traffic growth, installation intervals
and network service performance levels. We manage our employee headcount changes
to ensure sufficient resources are available to service our customers and
control expenses. All employees have been categorized into, and are managed
within, integrated groups such as sales, operations, engineering, finance, legal
and human resources. Our worldwide headcount was 656 as of March 31, 2010, 579
of which were employed in the U.S., 75 in the U.K., one in the Netherlands and
one in Japan.


39


First
Quarter 2010 Highlights




Our
consolidated revenue increased by $11.8 million, or 13.8%, from $85.4 million
for the three months ended March 31, 2009 to $97.2 million for the three months
ended March 31, 2010, due principally to a $5.6 million increase in our domestic
metro services. Additionally, in the U.S., our revenue from fiber infrastructure
and WAN services increased by $2.9 million and $2.4 million, respectively, for
the three months ended March 31, 2010 compared to the three months ended March
31, 2009. Other revenue (which includes contract termination revenue) was $1.5
million for the three months ended March 31, 2010, compared to $2.8 million for
the three months ended March 31, 2009. Revenue from our foreign operations,
primarily in the U.K., increased by $2.2 million for the three months ended
March 31, 2010 compared to the three months ended March 31, 2009.





For the three months ended March 31,
2010, we generated operating income of $25.0 million, compared to operating
income of $23.4 million for the three months ended March 31, 2009 and net income
of $13.6 million for the three months ended March 31, 2010, compared to $27.4
million for the three months ended March 31, 2009. At March 31, 2010, we had
$166.7 million of unrestricted cash, compared to $165.3 million of unrestricted
cash at December 31, 2009, an increase in liquidity of $1.4 million. The
increase in cash at March 31, 2010 was primarily attributable to cash generated
by operatingactivities of
$30.0 million and cash provided by the exercise of stock purchase warrants and
options to purchase shares of common stock totaling $1.3 million, offset
bycash used to purchase
property and equipment of $27.4 million.See below in this Item 2 under,
“Liquidity and Capital Resources,” for further discussion.





In the first quarter of 2010, 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, 2011. See below in this Item 2 under, “Liquidity and
Capital Resources,” for further information relating to the Secured Credit
Facility.




Outlook




We
believe that based upon our contracted projects awaiting delivery to customers,
we will continue to add to our revenue base in 2010. Additionally, we have a
strong cash position and access to financing through our Secured Credit
Facility, if needed. Our 2010 revenue growth will be negatively effected by the
full year impact of higher 2009 customer terminations and downgrades compared to
2008. Additionally, we cannot predict the impact of 2010 customer terminations
and downgrades.





In the
fourth quarter of 2009, we reduced the valuation allowance with respect to
certain deferred tax assets. These deferred tax assets are expected to be used
to reduce income tax payments in 2010 and future years. Provisions for income
tax expense in 2010 will be reported based upon pre-tax book income plus
permanent differences at our effective state, federal and foreign income tax
rates, as applicable. These tax provisions will have the effect of reducing net
income and earnings per share.





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 in the accompanying consolidated balance sheets and are
subsequently amortized into income over the fixed contract term.





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


40





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, benefits and 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) certain taxes (other than income
taxes), including property taxes and trust fund-related taxes not passed through
to customers; and (v) regulatory costs, insurance, telecommunications costs,
professional fees, and license and maintenance fees for internal software and
hardware.





Depreciation
and amortization





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





Critical
Accounting Policies and Estimates





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


41


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”) (now known as FASB ASC
852-10). We developed a set of financial projections, which were utilized by an
expert to assist us in estimating the fair value of our assets and liabilities.
The expert utilized various valuation methodologies, including (1) a comparison
of the Company and our projected performance to that of comparable companies;
(2) a review and analysis of several recent transactions of companies in similar
industries to ours; and (3) a calculation of the enterprise value based upon the
future cash flows of our projections.





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





Revenue
Recognition




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





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





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





Contract
termination revenue is recognized when a customer discontinues service prior to
the end of the contract period for which we had previously received
consideration and for which revenue recognition was deferred. Contract
termination revenue is also recognized when customers have made early
termination payments to us to settle contractually committed purchase amounts
that the customer no longer expects to meet or when we renegotiate or
discontinue a contract with a customer and as a result are no longer obligated
to provide services for consideration previously received and for which revenue
recognition has been deferred. During the three months ended March 31, 2010 and
2009, we included the receipts of bankruptcy claim settlements from former
customers as contract termination revenue. Contract termination revenue is
reported together with other service revenue, and amounted to $1.0 million and
$1.9 million in the three months ended March 31, 2010 and 2009,
respectively.





42


Accounts
Receivable Reserves




Sales
Credit Reserves




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





Allowance
for Doubtful Accounts




During each reporting period, we make
estimates for potential losses resulting from the inability of our customers to
make required payments. We analyze our reserve requirements using several
factors, including the length of time a particular customer’s receivables are
past due, changes in the customer’s creditworthiness, the customer’s payment
history, the length of the customer’s relationship with us, the current economic
climate and current industry trends. A specific reserve requirement review is
performed on customer accounts with larger balances. A reserve analysis is also
performed on accounts not subject to specific review utilizing the factors
previously mentioned. 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 CLECs, the
collectability of receivables and creditworthiness 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.





Property
and Equipment




Property
and equipment owned at the Effective Date are stated at their estimated fair
values as of the Effective Date based on our reorganization value, net of
accumulated depreciation and amortization incurred since the Effective Date.
Purchases of property and equipment subsequent to the Effective Date are stated
at cost, net of depreciation and amortization. Major improvements are
capitalized, while expenditures for repairs and maintenance are expensed when
incurred. Costs incurred prior to a capital project’s completion are reflected
as construction in progress and are part of network infrastructure assets, as
described below and included in property and equipment on the respective balance
sheets. At March 31, 2010 and December 31, 2009, we had $32.9 million and $26.9
million, respectively, of construction in progress. Certain internal direct
labor costs of constructing or installing property and equipment are
capitalized. Capitalized direct labor is determined based upon a core group of
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 installations. 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 $3.0 million and $2.7 million for the three months
ended March 31, 2010 and 2009, respectively. Depreciation and amortization is
provided on a straight-line basis over the estimated useful lives of the assets,
with the exception of leasehold improvements, which are amortized over the
lesser of the estimated useful lives or the term of the lease.


43


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




Network
      infrastructure assets and storage huts (except for risers, which are 5
      years)
              
              20
      yearsHVAC
      and power equipment
              
              12
      to 20 yearsSoftware
      and computer equipment
              
              3
      to 4 yearsTransmission
      and IP equipment
              
              5
      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.





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 $0.2 million and $0.7 million for the
three months ended March 31, 2010 and 2009, respectively. We fully depreciated
the remaining carrying value of the network infrastructure rendered unusable,
which on an original cost basis, totaled $0.02 million and $0.10 million ($0.01
million and $0.07 million on a net book value basis) for each of the three
months ended March 31, 2010 and 2009, respectively. To the extent that
relocation requires only the movement of existing network infrastructure to
another location, the related costs are included in our results of
operations.





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





In
accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets,” (now known as FASB ASC 360-10-35), we periodically evaluate
the recoverability of our long-lived assets and evaluate such assets for
impairment whenever events or circumstances indicate that the carrying amount of
such assets (or group of assets) may not be recoverable. Impairment is
determined to exist if the estimated future undiscounted cash flows are less
than the carrying value of such assets. We consider various factors to determine
if an impairment test is necessary. The factors include: consideration of the
overall economic climate, technological advances with respect to equipment, our
strategy and capital planning. Since June 30, 2006, no event has occurred nor
has the business environment changed to trigger an impairment test for assets in
revenue service and operations. We also consider the removal of assets from the
network as a triggering event for performing an impairment test. Once an item is
removed from service, unless it is to be redeployed, it may have little or no
future cash flows related to it. We performed annual physical counts of such
assets that are not in revenue service or operations (e.g., inventory, primarily
spare parts) at September 30, 2009 and 2008. With the assistance of a valuation
report of the assets in inventory, prepared by an independent third party on a
basis consistent with SFAS No. 157, “Fair Value Measurements,” (now known as
FASB ASC 820-10), and pursuant to FASB ASC 360-10-35, we determined that the
fair value of certain of such assets was less than the carrying value and thus
recorded a provision for equipment impairment of $0.4 million for the year ended
December 31, 2009. The Company also recorded a provision for equipment
impairment of $0.8 million in the year ended December 31, 2009 to record the
loss in value of certain equipment, most of which was eventually sold to an
unaffiliated third party. See Note
3, “Change in Estimate,” to the accompanying consolidated financial statements
included elsewhere in this Quarterly Report on Form 10-Q.There were no
provisions for impairment recorded in the three months ended March 31, 2010 and
2009.


44


Asset
Retirement Obligations




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





Asset
retirement obligations are generally recorded as “other long-term liabilities,”
are capitalized as part of the carrying amount of the related long-lived assets
included in property and equipment, net, and are depreciated over the life of
the associated asset. Asset retirement obligations aggregated $7.2 million each
at March 31, 2010 and December 31, 2009, respectively, of which $3.8 million was
included in “Accrued expenses,” and $3.4 million was included in “Other
long-term liabilities” at such dates. Accretion expense, which is included in
“Interest expense,” amounted to $0.07 million and $0.08 million for the three
months ended March 31, 2010 and 2009, respectively.





Derivative
Financial Instruments




We
utilize derivative financial instruments known as interest rate swaps
(“derivatives”) to mitigate our exposure to interest rate risk. We purchased the
first interest rate swap on August 4, 2008 to hedge the interest rate on the
$24.0 million (original principal) portion of the Term Loan and we purchased a
second interest rate swap on November 14, 2008 to hedge the interest rate on the
additional $12.0 million (original principal) portion of the Term Loan provided
by SunTrust Bank. See Note 4, “Note Payable,” to the accompanying consolidated
financial statements included elsewhere in this Quarterly Report on Form 10-Q.
We accounted for the derivatives under SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities,” (now known as FASB ASC 815). FASB ASC 815
requires that all derivatives be recognized in the financial statements and
measured at fair value regardless of the purpose or intent for holding them. By
policy, we have not historically entered into derivatives for trading purposes
or for speculation. Based on criteria defined in FASB ASC 815, the interest rate
swaps were considered cash flow hedges and were 100% effective. Accordingly,
changes in the fair value of derivatives are, and will be, recorded each period
in accumulated other comprehensive loss. Changes in the fair value of the
derivatives reported in accumulated other comprehensive 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 loss at each of March 31, 2010
and December 31, 2009 was $1.2 million for the interest rate swaps. The
mark-to-market value of the cash flow hedges will be recorded in other
non-current assets or other long-term liabilities, as applicable, and the
offsetting gains or losses in accumulated other comprehensive loss.





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





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





All
derivatives were recorded in our consolidated balance sheets at fair value.
Accounting for the gains and losses resulting from changes in the fair value of
derivatives depends on the use of the derivative and whether it qualifies for
hedge accounting in accordance with FASB ASC 815. At each of March 31, 2010 and
December 31, 2009, our consolidated balance sheet included net interest rate
swap derivative liabilities of $1.2 million.


45





Derivatives
recorded at fair value in our consolidated balance sheets as of March 31, 2010
and December 31, 2009 consisted of the following:





Derivative Liabilities
                        (In millions)Derivatives designated as hedging
      instruments
                      
                      March 31, 2010
                      
                      
                      December 31, 2009Interest
      rate swap agreements (*)
                      
                      $
                      1.2
                      
                      
                      $
                      1.2Total
      derivatives designated as hedging instruments
                      
                      $
                      1.2
                      
                      
                      $
                      1.2





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





Interest
Rate Swap Agreements




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





Notional Amount
                            
                            
                            
                            Weighted Average Rate(In millions)
                            
                            Maturity Date
                            
                            Pay
                            
                            
                            Receive$
                            21.1
                            
                            2011
                            
                            
                            3.65
                            %
                            
                            
                            0.92
                            %10.6
                            
                            2011
                            
                            
                            2.635
                            %
                            
                            
                            0.46
                            %$
                            31.7




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





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





Fair
Value of Financial Instruments




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




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.




46





Our
investment in overnight money market institutional funds, which amounted to
$152.7 million and $154.1 million at March 31, 2010 and December 31, 2009,
respectively, is included in cash and cash equivalents on the accompanying
balance sheets and is classified as a Level 1 asset.





We are
party to two interest rate swaps, which are utilized to modify our interest rate
risk. We recorded the mark-to-market value of the interest rate swap contracts
of $1.2 million in other long-term liabilities in the consolidated balance sheet
at each of March 31, 2010 and December 31, 2009. We used third parties to value
each of the interest rate swap agreements at March 31, 2010 and December 31,
2009, as well as our own market analysis to determine fair value. The fair value
of the interest rate swap contracts are classified as Level 2
liabilities.





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





Concentration
of Credit Risk




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





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





Income
Taxes




We
account for income taxes in accordance with SFAS No. 109, “Accounting for Income
Taxes,” (now known as FASB ASC 740). Deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases, net operating loss and tax credit carryforwards, 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 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,” (now known
as FASB ASC 740-10), when we believe there is uncertainty with respect to
certain positions and we may not succeed in realizing the tax position. We
believe that our tax return positions are appropriate and supportable under
appropriate tax law. We have evaluated our tax positions for items of
uncertainty in accordance with FASB ASC 740-10 and have determined that our tax
positions are highly certain within the meaning of FASB ASC 740-10. We believe
the estimates and assumptions used to support our evaluation of tax benefit
realization are reasonable. Accordingly, no adjustments have been made to the
consolidated financial statements for the three months ended March 31, 2010 and
2009.


47


Deferred
Taxes




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





The assessment of a valuation allowance
on deferred tax assets is based on thelikelihood that a portion of
ourdeferred tax
assetswill be realizedin future periods.The weight of all available evidence is
considered in determining realizability of our deferred tax assets.Deferred tax liabilities are first
applied to the deferred tax assets reducing the need for a valuation allowance.Future utilization of the
remaining net deferred tax assetswould require the ability to forecast
future earnings. Based on past performanceand management’s estimation of future
income, we do not believe that sufficient evidence exists to release the entire
valuation allowance as of December 31, 2009.




As part
of our evaluation of deferred tax assets in the fourth quarter of 2009, we
recognized a tax benefit of $183.0 million at December 31, 2009 relating to the
reduction of certain valuation allowances previously established in the U.S. and
the U.K. We believe it is more likely than not that we will utilize these
deferred tax assets to reduce or eliminate tax payments in future periods. This
reduction in valuation allowance had the effect of increasing net income by
$183.0 million for the year ended December 31, 2009. Our evaluation encompassed
(i) a review of our recent history of profitability in the U.S. and the U.K. for
the past three years; and (ii) a review of internal financial forecasts
demonstrating our expected capacity to utilize deferred tax assets.





Stock-Based
Compensation




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





Under the
fair value provisions of SFAS No. 123, the fair value of each stock-based
compensation award is estimated at the date of grant, using the Black-Scholes
option pricing model for stock option awards. We did not have a historical basis
for determining the volatility and expected life assumptions in the model due to
our limited market trading history; therefore, the assumptions used for these
amounts are an average of those used by a select group of related industry
companies. Most stock-based awards have graded vesting (i.e. portions of the
award vest at different dates during the vesting period). We recognize the
related stock-based compensation expense of such awards on a straight-line basis
over the vesting period for each tranche in an award. Upon consummation of our
Plan of Reorganization, all then outstanding stock options were
cancelled.





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





For a
description of our stock-based compensation programs, see Note 7, “Stock-Based
Compensation,” to the accompanying consolidated financial statements included
elsewhere in this Quarterly Report on Form 10-Q.





There
were no options to purchase shares of common stock granted during the three
months ended March 31, 2010 and 2009.


48


Results of Operations for the Three
Months Ended March 31, 2010 Compared to the Three Months Ended March 31,
2009




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




Three MonthsEndedMarch31,2010
                  
                  
                  2009
                  
                  
                  $ Increase/
                    (Decrease)
                  
                  
                  %Increase/
                    (Decrease)Revenue
                  
                  $
                  97.2
                  
                  
                  $
                  85.4
                  
                  
                  $
                  11.8
                  
                  
                  
                  13.8
                  %Costs of revenue (excluding
      depreciation and amortization, shown separately
    below)
                  
                  
                  33.1
                  
                  
                  
                  29.4
                  
                  
                  
                  3.7
                  
                  
                  
                  12.6
                  %Selling, general and
      administrative expenses
                  
                  
                  23.6
                  
                  
                  
                  20.7
                  
                  
                  
                  2.9
                  
                  
                  
                  14.0
                  %Depreciation and
      amortization
                  
                  
                  15.5
                  
                  
                  
                  11.9
                  
                  
                  
                  3.6
                  
                  
                  
                  30.3
                  %Operating
      income
                  
                  
                  25.0
                  
                  
                  
                  23.4
                  
                  
                  
                  1.6
                  
                  
                  
                  6.8
                  %Other income
      (expense):Interest
    income
                  
                  
                  —
                  
                  
                  
                  0.2
                  
                  
                  
                  (0.2
                  )
                  
                  
                  (100.0
                  )
      %Interest
      expense
                  
                  
                  (1.2
                  )
                  
                  
                  (1.2
                  )
                  
                  
                  —
                  
                  
                  
                  —Other expense,
      net
                  
                  
                  (0.6
                  )
                  
                  
                  (0.1
                  )
                  
                  
                  0.5
                  
                  
                  NMIncome from continuing operations,
      before income taxes
                  
                  
                  23.2
                  
                  
                  
                  22.3
                  
                  
                  
                  0.9
                  
                  
                  
                  4.0
                  %Provision for(benefit from)income
taxes
                  
                  
                  9.6
                  
                  
                  
                  (5.1
                  )
                  
                  
                  14.7
                  
                  
                  NMNet income
                  
                  $
                  13.6
                  
                  
                  $
                  27.4
                  
                  
                  $
                  (13.8
                  )
                  
                  
                  (50.4
                  )
      %




NM—not meaningful








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




Net
Income.  Our net income for the three months ended March 31,
2010 was $13.6 million, compared to $27.4 million for the three months ended
March 31, 2009, a decrease of $13.8 million.  The reasons for the
decrease in net income were the change from a net benefit from income taxes
of $5.1 million to a provision for income taxes of $9.6 million totaling $14.7
million, an increase in costs of revenue of $3.7 million, an increase in
selling, general and administrative expenses of $2.9 million, an increase in
depreciation and amortization of $3.6 million, a decrease in interest income of
$0.2 million and a change (increase) in other expense, net, of $0.5 million,
which was partially offset by an increase in revenue of $11.8
million.  These changes are discussed more fully
below.




Revenue.
Consolidated revenue was $97.2 million for the three months ended March 31,
2010, compared to $85.4 million for the three months ended March 31, 2009, an
increase of $11.8 million, or 13.8%. Revenue from our U.S. operations increased
by $9.6 million, or 12.2%, from $78.5 million for the three months ended March
31, 2009 to $88.1 million for the three months ended March 31, 2010. The
principal reason for this increase was the continued growth in each of our
metro, fiber infrastructure and WAN services. This continued growth in revenue
for each of these services is attributable principally to revenue from service
installations exceeding reductions in revenue from contract terminations and any
contractual price decreases. U.S. revenue from metro services increased by $5.6
million, or 26.2%, from $21.4 million for the three months ended March 31, 2009
to $27.0 million for the three months ended March 31, 2010, U.S. revenue from
fiber infrastructure services increased by $2.9 million, or 7.6%, from $38.3
million for the three months ended March 31, 2009 to $41.2 million for the three
months ended March 31, 2010 and U.S. revenue from WAN services increased by $2.4
million, or 15.0%, from $16.0 million for the three months ended March 31, 2009
to $18.4 million for the three months ended March 31, 2010. These increases were
partially offset by a reduction in other revenue, which includes contract
termination revenue, for the three months ended March 31, 2010, compared to the
three months ended March 31, 2009. Revenue from our foreign operations,
primarily in the U.K., increased by $2.2 million, or 31.9%, from $6.9 million
for the three months ended March 31, 2009 to $9.1 million for the three months
ended March 31, 2010.  The
primary reasons for this increase was due to an increase in revenue volume
at the local currency level and an 8.6% increase in the translation rate due to
the strengthening of the British pound to the U.S. dollar in the three months
ended March 31, 2010 compared to the three months ended March 31,
2009.  49





Costs of
revenue. Consolidated costs of revenue for the three months ended March
31, 2010 was $33.1 million, compared to $29.4 million for the three months ended
March 31, 2009, an increase of $3.7 million, or 12.6%. Consolidated costs of
revenue as a percentage of revenue was 34.1% for the three months ended March
31, 2010, compared to 34.4% for the three months ended March 31, 2009, resulting
in consolidated gross profit margin of 65.9% and 65.6% for the three months
ended March 31, 2010 and 2009, respectively. The costs of revenue for our U.S.
operations was $29.9 million and $27.2 million for the three months ended March
31, 2010 and 2009, respectively, an increase of $2.7 million, or 9.9%. The
increase in the domestic costs of revenue for the three months ended March 31,
2010 compared to the three months ended March 31, 2009 was attributable
principally to (i) an increase of $1.1 million in co-location expenses, to
support our IP network services and increase our presence in third party data
centers; (ii) an increase of $0.6 million for expenses associated with third
party network costs; (iii) an increase of $0.4 million in long haul expenses
from 2009 levels; and (iv) an increase of $0.2 million in amounts rebilled to
customers for equipment sales (for which there was a corresponding increase in
related revenue). The costs of revenue for our foreign operations was $3.2
million for the three months ended March 31, 2010, compared to $2.2 million for
the three months ended March 31, 2009, an increase of $1.0 million, or 45.5%.
This increase was due primarily to increases in third party network costs,
co-location expenses, leased fiber costs and repairs and maintenance charges,
which were needed to support the increases in our current and future operations
combined with the increase in the translation rate during the three months ended
March 31, 2010 compared to the three months ended March 31, 2009.




Selling, General
and Administrative Expenses (“SG&A”). Consolidated SG&A for
the three months ended March 31, 2010 was $23.6 million, compared to $20.7
million for the three months ended March 31, 2009, an increase of $2.9 million,
or 14.0%. SG&A as a percentage of revenue was 24.3% for the three months
ended March 31, 2010, compared to 24.2% for the three months ended March 31,
2009. In the U.S., SG&A was $21.1 million for the three months ended March
31, 2010, compared to $18.4 million for the three months ended March 31, 2009,
an increase of $2.7 million, or 14.7%. SG&A for our U.S. operations for the
three months ended March 31, 2010 compared to the three months ended March 31,
2009 increased primarily due to a $2.2 million increase in domestic payroll and
payroll-related expenses from $10.0 million for the three months ended March 31,
2009 to $12.2 million for the three months ended March 31, 2010, which is
attributable to an increase in headcount and an increase in sales commissions
including a sales incentive program in the 2010 period. In addition,
transaction-based taxes increased by $0.4 million during the three months ended
March 31, 2010 compared to the three months ended March 31, 2009. SG&A from
our foreign operations was $2.5 million for the three months ended March 31,
2010, compared to $2.3 million for the three months ended March 31, 2009, an
increase of $0.2 million, or 8.7%. Increases in payroll-related expenses and the
year over year increase in the translation rate were the reasons for the
increases.





Depreciation and
amortization. Consolidated
depreciation and amortization was $15.5 millionfor the three months ended March 31,
2010, compared to $11.9million for the three months ended March 31,
2009, an increase of $3.6million, or 30.3%. Consolidated depreciation
and amortization as a percentage of revenue was 15.9% for the three months ended
March 31, 2010, compared to 13.9% for the three months ended March 31, 2009.This increase was primarily attributable to (i) additions of property and
equipment for the three months ended March 31, 2010 and the full period effect
of depreciation on property and equipment acquired during 2009; and (ii) the
change (reduction) in estimated useful lives of certain property and equipment
effectuated on October 1, 2009 and January 1, 2010.





Interest
income. Interest income,
substantially all of which was earned in the U.S., decreased by $0.2million for the three
months ended March 31, 2010 compared to the three months ended March 31, 2009.
This decrease was primarily due to the decrease in short-term interest rates
during the three months ended March 31, 2010 compared to the three months ended
March 31, 2009, partially offset by an increase in average balances available
for investment.





Interest
expense.Interest
expense, substantially all of which was incurred in the U.S., includes interest
expense on borrowed amounts under the Secured Credit Facility, availability fees
on the unused portion of the Secured Credit Facility, the amortization of debt
acquisition costs (including upfront fees) related to the Secured Credit
Facility, interest expense related to a capital lease obligation, interest
accrued on certain tax liabilities, interest on the outstanding balance of the
deferred fair value rent liabilities established at fresh start and interest
accretion relating to asset retirement obligations. Interest expense was $1.2
million for each of the three
month periods ended March 31,2010 and 2009.


50


Other expense,
net.Other expense, net is composed primarily
of income or expense from non-recurring transactions and is not comparative from
a trend perspective.Consolidated other expense, net was a net expense of
$0.6 million for the three months ended March 31, 2010, compared to a net
expense of $0.1 million for the three months ended March 31, 2009, a change of
$0.5 million. In the U.S., other income, net was $0.5 million for the three
months ended March 31, 2010, compared to other income, net of $0.6 million for
the three months ended March 31, 2009, a decrease of $0.1 million. For our
foreign operations, other expense, net was a net expense of $1.1 million for the
three months ended March 31, 2010, compared to a net expense of $0.7 million for
the three months ended March 31, 2009, a change of $0.4 million. For the three
months ended March 31, 2010, consolidated other expense, net was comprised of a
net loss on foreign currency of $1.1 million, offset by gains arising from the
settlement or reversal of certain tax liabilities of $0.4 million and a net gain
on the sale or disposition of property and equipment of $0.1 million. For the
three months ended March 31, 2009, consolidated otherexpense, net wascomprised of a net loss
on foreign currency of $0.6 million and a net loss on the sale or disposition of
property and equipment of $0.2 million, offset by gains arising from the
settlement or reversal of certain tax liabilities of $0.7 million





Provision for
(benefit from) income taxes.We recorded a provision for
income taxes of $9.6 million for the three months ended March 31, 2010, compared
to a net benefit from income taxes of $5.1 million for the three months ended
March 31, 2009. The provision for income taxes for the three months ended March
31, 2010 was calculated at our effective tax rate based upon our pre-tax book
income adjusted for permanent differences in both the U.S. and the U.K. totaling
$9.5 million, plus a provision for certain capital-based state taxes of
$0.1 million. The benefit recorded for the three months ended March 31, 2009 was
based upon the anticipated 2009 loss for federal income tax purposes. In
addition, this benefit represents the receivable established for the refunds of
federal income tax payments paid with respect to the tax filings for the years
ended December 31, 2007 and 2008 and the reversal of the federal income taxes
accrued at December 31, 2008, net of the provision for alternative minimum taxes
and certain capital-based state taxes.





Liquidity
and Capital Resources




We had working capital of $103.8 million
at March 31, 2010, compared to a working capital of $88.6 million at December
31, 2009, an increase of $15.2 million.This increase was primarily
attributable to an increase in unrestricted cash of $1.4 million from $165.3
million at December 31, 2009 to $166.7 at March 31, 2010, a decrease in accrued
expenses of $7.7 million and a decrease in accounts payable of $4.1 million.
The increase in unrestricted cash
at March 31, 2010 was primarily attributable to cash provided by operating
activities of $30.0 million and cash generated by the exercise of stock purchase
warrants and options to purchase shares of common stock totaling $1.3
million, partially offset
by the use of cash to purchase property and equipment of $27.4 million and the
scheduled debt payment of $1.9 million.





Net cash provided by operating
activities was $30.0millionduring the three months
ended March 31, 2010,
comparedto $35.8 million
during the three months ended March 31, 2009,adecreaseof $5.8 million. Net cash provided by
operating activitiesduring the three months ended March 31, 2010represents net income plus the add back
to net income of non-cash items deducted in the determination of net income,
principally depreciation and amortization of $15.5 million, the change in
deferred tax assets of $9.5 million, stock-based compensation expense of $2.1
million plus the changes in working capital components. Net cash provided by
operating activitiesduring the three months ended March 31, 2009
represents net income plusthe add
back to net income of non-cash items deducted in the determination of net
income, principally depreciation and amortization of $11.9 million and
stock-based compensation expense of $2.9 million plus the changes in working
capital components. The year over year decrease in net cash provided by
operating activities is due to the decrease in net income adjusted for
non-cash activities and the difference in the changes in working capital
components, the most significant one of which was deferred revenue, a
significant source of cash from operating activities in the 2009
period.





Net cash used in investing activities
was $27.2millionduring the three months ended March 31, 2010, compared to $21.2 million during the
three months ended March 31, 2009,an increaseof $6.0 million. Net cash used in
investing activitiesduring the three months ended March 31, 2010was attributable to the purchases of
property and equipment of $27.4 million, offset by the proceeds generated
from sales of property and equipment of $0.2 million. Net cash used in investing activitiesduring the three months ended March 31, 2009 was attributable to the purchases of
property and equipment of $21.2 million.


51


Net cash
used in financing activities was $0.9millionduring the three months
ended March 31, 2010, which is comprised of the


principal
payment under the Secured Credit Facility of $1.9 million and the purchase of
treasury stock of $0.3 million, offset by the proceeds from the exercise of
warrants of $1.2 million and the proceeds from the exercise of options to
purchase shares of common stock of $0.1 million. Net cash used in financing
activities was $0.3 million during the three months ended March 31, 2009, which
is comprised of the purchase of treasury stock of $0.1 millionand the principal payment on our
capital lease obligation of $0.2 million.





During
the three months ended March 31, 2010, we generated cash from
operating
activitiesthat was
sufficient to fund our operating expenses and expenditures for property
and equipment of $27.4 million.We expect that our cash
from operations will continue to exceed our operating expenses and plan to
continue to fund a portion of our future capital projects for both our existing
business and growth with our net cash from operations.





On February 29,2008,we (excluding certain
foreign subsidiaries) entered into
the SecuredCredit Facility
comprised of: (i) an $18.0 million Revolver; (ii) a $24.0 million Term Loan: and
(iii) an $18.0 million Delayed Draw Term Loan. The initial lenders under the
Secured Credit Facility were Societe Generale and CIT Lending Services
Corporation. The Secured Credit Facility matures on the fifth anniversary of the
closing date (February 28, 2013). The Secured Credit Facility is secured by
substantially all of our domestic assets. We paid $0.9 million for upfront fees
to the lenders and $0.3 million to our financial advisors that assisted us in
obtaining the Secured Credit Facility. Our ability to draw upon the available
commitments under the Revolver is subject to compliance with all of the
covenants contained in the credit agreement and our continued ability to make
certain representations and warranties.Among other things, these
covenants limit annual capital expenditures in 2008, 2009 and 2010, 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,
and originally required that we maintain a minimum of $20.0 million in cash
deposits at all times (which minimum cash deposit requirement has been removed).
In addition, the Secured Credit Facility prohibits us from paying dividends
(other than in our own shares or other equity securities) and from making
certain other payments, including payments to acquire our equity securities
other than under specified circumstances, which include the repurchase of our
equity securities from employees and directors in an aggregate amount not to
exceed $15.0 million. On September
26, 2008, we executed a joinder agreementto the Secured Credit Facility that
added SunTrust Bank as an additional lender and increased the amount of the
Secured Credit Facility to $90.0 million effective October 1, 2008. In
connection with the joinder agreement, we paid a $0.45 million fee at closing
and an aggregate of $0.25 million of advisory fees. The availability under the Revolver
increased to $27.0 million, the Term Loan increased to $36.0 million and the
available Delayed Draw Term Loan increased to $27.0 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 and subsequently extended to December
31, 2009. On December 31, 2009, we borrowed $24.57 million under the Delayed
Draw Term Loan. We are party to two interest rate swaps, which are utilized to
modify our interest rate risk under the $24.0 million Term Loan and the $12.0
million Term Loan. We have chosen 30 day LIBOR as the interest rate during the
term of the interest rate swaps (30 day LIBOR was 0.22875% at March 31,
2010).  At March
31, 2010, we had $26.0 million available under the Revolver. 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, 2011.




In the future we may consider
making acquisitions of other companies or product lines to support our growth.
We may finance any such acquisition of other companies or product lines from
existing cash balances, 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.


52


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





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





United
States:




Three Months Ended March 31,
                            
                            
                            $Increase/
                            
                            
                            %Increase/2010
                            
                            
                            2009
                            
                            
                            (Decrease)
                            
                            
                            (Decrease)Revenue
                            
                            $
                            88.1
                            
                            
                            $
                            78.5
                            
                            
                            $
                            9.6
                            
                            
                            
                            12.2
                            %Costs of revenue (excluding
      depreciation and amortization, shown separately below)
                            
                            
                            29.9
                            
                            
                            
                            27.2
                            
                            
                            
                            2.7
                            
                            
                            
                            9.9
                            %Selling, general and
      administrative expenses
                            
                            
                            21.1
                            
                            
                            
                            18.4
                            
                            
                            
                            2.7
                            
                            
                            
                            14.7
                            %Depreciation and
      amortization
                            
                            
                            13.6
                            
                            
                            
                            10.5
                            
                            
                            
                            3.1
                            
                            
                            
                            29.5
                            %Operating
      income
                            
                            
                            23.5
                            
                            
                            
                            22.4
                            
                            
                            
                            1.1
                            
                            
                            
                            4.9
                            %Other income
      (expense):Interest
    income
                            
                            
                            —
                            
                            
                            
                            0.2
                            
                            
                            
                            (0.2
                            )
                            
                            
                            (100.0
                            )
      %Interest
      expense
                            
                            
                            (1.2
                            )
                            
                            
                            (1.2
                            )
                            
                            
                            —
                            
                            
                            
                            —Other income,
      net
                            
                            
                            0.5
                            
                            
                            
                            0.6
                            
                            
                            
                            (0.1
                            )
                            
                            
                            (16.7
                            )
      %Income before income
      taxes
                            
                            
                            22.8
                            
                            
                            
                            22.0
                            
                            
                            
                            0.8
                            
                            
                            
                            3.6
                            %(Benefit from) provision for income
      taxes
                            
                            
                            9.3
                            
                            
                            
                            (5.1
                            )
                            
                            
                            14.4
                            
                            
                            NMNet income
                            
                            $
                            13.5
                            
                            
                            $
                            27.1
                            
                            
                            $
                            (13.6
                            )
                            
                            
                            (50.2
                            )
      %




United Kingdom and
others:




Three Months Ended March 31,
                                
                                
                                $Increase/
                                
                                
                                %Increase/2010
                                
                                
                                2009
                                
                                
                                (Decrease)
                                
                                
                                (Decrease)Revenue
                                
                                $
                                9.1
                                
                                
                                $
                                6.9
                                
                                
                                $
                                2.2
                                
                                
                                
                                31.9
                                %Costs of revenue (excluding
      depreciation and amortization, shown separately
    below)
                                
                                
                                3.2
                                
                                
                                
                                2.2
                                
                                
                                
                                1.0
                                
                                
                                
                                45.5
                                %Selling, general and
      administrative expenses
                                
                                
                                2.5
                                
                                
                                
                                2.3
                                
                                
                                
                                0.2
                                
                                
                                
                                8.7
                                %Depreciation and
      amortization
                                
                                
                                1.9
                                
                                
                                
                                1.4
                                
                                
                                
                                0.5
                                
                                
                                
                                35.7
                                %Operating
      income
                                
                                
                                1.5
                                
                                
                                
                                1.0
                                
                                
                                
                                0.5
                                
                                
                                
                                50.0
                                %Other income
      (expense):Other expense,
      net
                                
                                
                                (1.1
                                )
                                
                                
                                (0.7
                                )
                                
                                
                                0.4
                                
                                
                                
                                57.1
                                %Income before income
      taxes
                                
                                
                                0.4
                                
                                
                                
                                0.3
                                
                                
                                
                                0.1
                                
                                
                                
                                33.3
                                %Provision for income
      taxes
                                
                                
                                0.3
                                
                                
                                
                                —
                                
                                
                                
                                0.3
                                
                                
                                NMNet income
                                
                                $
                                0.1
                                
                                
                                $
                                0.3
                                
                                
                                $
                                (0.2
                                )
                                
                                
                                (66.7
                                )
      %




NM—not
meaningful







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


53




Credit
Risk





Financial instruments which potentially
subject us to concentration of credit risk consist principally of temporary cash
investments and accounts receivable. We do not enter into financial instruments
for trading or speculative purposes and do not own auction rate notes. We place
our cash and cash equivalents in short-term investment instruments with high
quality financial institutions in the U.S. and the U.K. Our trade receivables,
which are unsecured, are geographically dispersed throughout the U.S. and the
U.K. and include both large and small corporate entities spanning numerous
industries. We perform ongoing credit evaluations of our customers’ financial
condition. We place our cash and cash equivalents primarily in commercial bank
accounts in the U.S. Account balances generally exceed federally insured limits.
Given recent developments in the financial markets and our exposure to customers
in the financial services industry, our ability to collect contractual amounts
due from certain customers severely impacted by these developments may be
adversely affected.





Off-balance
sheet arrangements





We do not have any off-balance sheet
arrangements other than our operating leases. We do not participate in
transactions that generate relationships with unconsolidated entities or
financial partnerships, such as entities often referred to as structured finance
or special purpose entities (“SPEs”), which would have been established for the
purpose of facilitating off-balance sheet arrangements or other contractually
narrow or limited purposes.





Inflation





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





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 that are not historical by nature constitute
“forward-looking statements” within the meaning of the Private Securities
Litigation Reform Act of 1995 which can be identified by the use of
forward-looking terminology such as “believes,” “expects,” “plans,” “intends,”
“estimates,” “projects,” “could,” “may,” “will,” “should,” or “anticipates” or
the negatives thereof, other variations thereon or comparable terminology, or by
discussions of strategy. No assurance can be given that future results expressed
or implied by the forward-looking statements will be achieved. Such statements
are based on management’s current expectations and beliefs and are subject to a
number of risks and uncertainties that could cause actual results to differ
materially from those expressed or implied by the forward-looking statements.
These risks and uncertainties include, but are not limited to, those relating to
the Company’s financial and operating prospects, current economic trends and
recessionary pressures, future opportunities, ability to retain existing
customers and attract new ones, the Company’s exposure to the financial services
industry, the Company’s acquisition strategy and ability to integrate acquired
companies and assets, outlook of customers, reception of new products and
technologies, and strength of competition and pricing. Other factors and risks
that may affect the Company’s business or future financial results are detailed
in the Company’s SEC filings, including, but not limited to, those described
under “Risk Factors” in the Company’s Annual Report on Form 10-K for the year
ended December 31, 2009 and “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” in such Annual Report on Form 10-K and in
this Quarterly Report on Form 10-Q. The Company’s business could be materially
adversely affected and the trading price of the Company’s common stock could
decline if any such risks and uncertainties develop into actual events. The
Company cautions you not to place undue reliance on these forward-looking
statements, which speak only as of their respective dates. The Company
undertakes no obligation to publicly update or revise forward-looking statements
to reflect events or circumstances after the date of this Form 10-Q or to
reflect the occurrence of unanticipated events.




54




ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





In the
normal course of business we are exposed to market risk arising from changes in
foreign currency exchange rates that could impact our cash flows and earnings.
During the three months ended March 31, 2010, our foreign activities accounted
for 9.4% of consolidated revenue. Due to the strengthening of the British pound
compared to the U.S. dollar, the translation rate for the three months
ended March 31, 2010 increased 8.6% compared to the translation rate used for
the three months ended March 31, 2009. We monitor foreign markets and our
commitments in such markets to manage currency and other risks. To date, based
upon our level of foreign operations, we have not entered into any hedging
arrangement designed to limit exposure to foreign currencies. If we increase our
level of foreign activities, or if at current levels we determine that such
arrangements would be appropriate, we will consider such arrangements to
minimize risk.




Under the
terms of the Secured Credit Facility, our borrowings bear interest based upon
short-term LIBOR rates or our administrative agent’s (Societe Generale) base
rate, at our discretion, plus the applicable margins, as defined.  If
the operative rate increases, our cost of borrowing would also increase, if not
hedged, thereby increasing the costs of our investment strategy.  We
have chosen 30 day LIBOR as the interest rate.  On August 4, 2008, we
entered into a swap arrangement under which we fixed our borrowing costs with
respect to the $24.0 million borrowed under the Term Loan for three years at
3.65% per annum, plus the applicable margin of 3.00%.  On October 1, 2008,
we borrowed an additional $12.0 million under the expanded Term
Loan.  On November 14, 2008, we entered into a swap arrangement under
which we fixed our borrowing costs with respect to the $12.0 million for three
years at 2.635% per annum, plus the applicable margin of 3.00%.  The swaps
had the effect of increasing our current interest expense with respect to the
Term Loans compared to the then current LIBOR rate and reducing our risk of
increases in future interest expenses from increasing LIBOR
rates.  Also, in December 2009, we borrowed $24.57 million available
under the Delayed Draw Term Loan.  The interest rate was 30 day LIBOR
(0.23094% at December 29, 2009) plus the applicable margin of
3.00%.  The interest rate at March 31, 2010 was 3.22875% (30 day LIBOR
of 0.22875% at March 31, 2010, plus the applicable margin of
3.00%).  We have not entered into a swap arrangement to fix our
borrowing costs under the Delayed Draw Term Loan.  Thus, we remain
subject to interest fluctuations on the outstanding balance under the Delayed
Draw Term Loan ($23.76 million at March 31, 2010), which is currently not
hedged.  After the expiration of each interest rate swap, the
corresponding Term Loan will bear interest at 30 day LIBOR, plus the applicable
margin of 3.00%.


As of
March 31, 2010, we had $55.5 million outstanding under the Secured Credit
Facility. Additionally, we had a
$1.7million capital lease obligation
outstanding, which carried a fixed rate of interest of 8.0%, and as a result, we
were not exposed to related
interest rate risk.





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


55





ITEM
4. CONTROLS AND PROCEDURES





Evaluation of Disclosure
Controls and Procedures





As of
March 31, 2010, the Company carried out an assessment, under the supervision of
and with the participation of the Company’s Chief Executive Officer and the
Chief Financial Officer, of the effectiveness of the design and operation of the
Company’s disclosure controls and procedures (as defined in the Exchange Act
Rules 13a-15(e) and 15d-15(e)). The Chief Executive Officer and the Chief
Financial Officer concluded that the Company’s disclosure controls and
procedures were effective as of March 31, 2010 to ensure that all information
required to be disclosed in the reports that it files or submits under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in SEC rules and forms and is accumulated and communicated to
the Company’s management, including the Company’s Chief Executive Officer and
the Chief Financial Officer, or persons performing similar functions, as
appropriate to allow timely decisions regarding required
disclosure.





Remediation





During
2009, management remediated the material weaknesses in our entity level
controls, financial close and financial statement reporting processes, income
taxes, property and equipment and inventory processes. The Company completed and
filed all past due federal and state income tax returns in the fourth quarter of
2008. The Company reconciled its physical inventory counts to the financial
records at September 30, 2008 and began updating the perpetual inventory records
on a monthly basis through December 31, 2009. During the years ended December
31, 2009 and 2008, the Company continued to develop processes to manage property
and equipment, including inventory, through a property and equipment sub-ledger
and it is in the process of converting those records to a more integrated
sub-ledger system. Management also completed re-engineering efforts and is
re-aligning departments to create more efficiency and lines of responsibility,
which will improve the timely recording of project cost allocations and accrued
obligations relating to property and equipment, including inventory. The Company
continues to evaluate methods to integrate processes and systems for better
information flow.





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.




56




PART
II. OTHER INFORMATION





ITEM
1. LEGAL PROCEEDINGS





The
information presented in Note 9, “Litigation,” to the consolidated financial
statements included elsewhere in this Quarterly Report on Form 10-Q is
hereby incorporated by reference.





ITEM
1A. RISK FACTORS





In
addition to the other information set forth in this Quarterly Report on Form
10-Q, you should carefully consider the factors discussed under ”Risk Factors”
in the Company’s Annual Report on Form 10-K for the year ended December 31,
2009, which could materially affect the Company’s business, financial condition
or future results. The risks described in the Company’s Annual Report on Form
10-K are not the only risks facing the Company. Additional risks and
uncertainties, including those not currently known to the Company or that the
Company currently deems to be immaterial also could materially adversely affect
the Company’s business, financial condition and/or operating results. There have
been no material changes in our risk factors from those disclosed in our Annual
Report on Form 10-K for the year ended December 31, 2009.





ITEM 2. UNREGISTERED SALES OF EQUITY
SECURITIES AND USE OF PROCEEDS.





Share
Repurchase




In March
2010, we delivered 14,000 shares of common stock to our Chief Executive Officer,
William LaPerch, representing the vested shares underlying restricted stock
units granted to him in September 2008. In accordance with the terms of Mr.
LaPerch’s stock unit agreement, we purchased an aggregate of 5,459 shares of
common stock from Mr. LaPerch at $54.73 per share, the closing price on the New
York Stock Exchange of our common stock on the date of our repurchase, in order
to provide him with funds sufficient to satisfy minimum tax withholding
obligations.  The aggregate value of the shares purchased by us of $0.3
million was charged to treasury stock.  Below is a summary of this
repurchase.




Period
                      
                      Total Number of Shares
                        Purchased
                      
                      
                      Price Paid Per
                        Share
                      
                      
                      Total Number of Shares
                        Purchased as Part of
                        Publicly Announced
                        Plans or Programs
                      
                      
                      Maximum Number of
                        Shares that may yet be
                        Purchased Under the
                        Plans or
      ProgramsMarch
      1 to 31, 2010
                      
                      
                      5,459
                      
                      
                      $
                      54.73
                      
                      
                      
                      0
                      
                      
                      
                      0




57





ITEM 6.  EXHIBITS





Exhibit No.
            
            Description of Exhibit10.1
            
            Amendment No. 3, dated as of March
      4, 2010, to Credit
      and Guaranty Agreement among AboveNet, Inc., AboveNet
      Communications, Inc., AboveNet of Utah, LLC, AboveNet of VA, LLC,
      AboveNet International, Inc., the Lenders party thereto, Societe
      Generale, as Administrative Agent, and CIT Lending Services Corporation,
      as Documentation Agent, dated as of February 29, 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 the Registrant, pursuant to Rule 13a-14(a)
      of the Securities Exchange Act of 1934.32.1
            
            Certification
      of Chief Executive Officer of the Registrant, pursuant to 18 U.S.C.
      Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.32.2
            
            Certification
      of Chief Financial Officer of the Registrant, pursuant to 18 U.S.C.
      Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.




58





SIGNATURES





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




ABOVENET,
    INC.Date:May 7, 2010
              By:
              /s/ William G.
      LaPerchWilliam G.
      LaPerch
                President, Chief Executive Officer
      and Director
                (Principal Executive
      Officer)





Date:May 7, 2010
            By:
            /s/ Joseph P.
      CiavarellaJoseph P.
      Ciavarella
              Senior Vice President and Chief
      Financial Officer
              (Principal Financial and
      Accounting Officer)


59





EXHIBIT
INDEX





Exhibit No.
            
            Description of Exhibit10.1
            
            Amendment No. 3, dated as of March
      4, 2010, to Credit
      and Guaranty Agreement among AboveNet, Inc., AboveNet
      Communications, Inc., AboveNet of Utah, LLC, AboveNet of VA, LLC,
      AboveNet International, Inc., the Lenders party thereto, Societe
      Generale, as Administrative Agent, and CIT Lending Services Corporation,
      as Documentation Agent, dated as of February 29, 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 the Registrant, pursuant to Rule 13a-14(a)
      of the Securities Exchange Act of 1934.32.1
            
            Certification
      of Chief Executive Officer of the Registrant, pursuant to 18 U.S.C.
      Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.32.2
            
            Certification
      of Chief Financial Officer of the Registrant, pursuant to 18 U.S.C.
      Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.


60