UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





FORM
10-Q





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





For
the quarterly period ended September 30, 2009





OR





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





Commission
File Number: 000-23269





AboveNet,
Inc.





(Exact
Name of Registrant as Specified in Its Charter)





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





360
HAMILTON AVENUE


WHITE
PLAINS, NY 10601


(Address
of Principal Executive Offices)





(914)
421-6700


(Registrant’s
Telephone Number, Including Area Code)





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





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





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




Large
      accelerated filer   ̈
                        Accelerated
      filer  x
                        Non-accelerated
      filer   ̈
                          (Do not check if a small reporting company)
                        Smaller
      reporting company   ̈





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





The
number of shares of the registrant’s common stock, par value $0.01 per share,
outstanding as of November 2, 2009, was 24,191,470.








Table of Contents





ABOVENET,
INC.





INDEX




PagePart
      I.
                                      
                                      FINANCIAL
      INFORMATIONItem
      1.
                                      
                                      Financial
      StatementsConsolidated
      Balance SheetsAs
      of September 30, 2009 (Unaudited) and December 31, 2008
                                      
                                      1Consolidated
      Statements of Operations (Unaudited)Three
      and Nine month periods ended September 30, 2009 and 2008
                                      
                                      2Consolidated
      Statement of Shareholders’ Equity (Unaudited)Nine
      month period ended September 30, 2009
                                      
                                      3Consolidated
      Statements of Cash Flows (Unaudited)Nine
      month periods ended September 30, 2009 and 2008
                                      
                                      4Consolidated
      Statements of Comprehensive Income (Unaudited)Three
      and Nine month periods ended September 30, 2009 and 2008
                                      
                                      5Notes
      to Unaudited Consolidated 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
                                      
                                      59Item
      4.
                                      
                                      Controls
      and Procedures
                                      
                                      60Part
      II.
                                      
                                      OTHER
      INFORMATIONItem
      1.
                                      
                                      Legal
      Proceedings
                                      
                                      61Item
      1A.
                                      
                                      Risk
      Factors
                                      
                                      61Item
      6.
                                      
                                      Exhibits
                                      
                                      62Signatures
                                      
                                      63Exhibit
      Index
                                      
                                      64







PART
I.  FINANCIAL INFORMATION





ITEM
1.  FINANCIAL STATEMENTS





ABOVENET,
INC. AND SUBSIDIARIES





CONSOLIDATED
BALANCE SHEETS


(in
millions, except share and per share information)





September 30,
                          2009
                        
                        
                        December 31,
                          2008(Unaudited)ASSETS:Current
      assets:Cash
      and cash equivalents
                        
                        $
                        122.5
                        
                        
                        $
                        87.1Restricted
      cash and cash equivalents
                        
                        
                        3.5
                        
                        
                        
                        3.5Accounts
      receivable, net of allowances of $1.5 and $1.3 at September 30, 2009 and
      December 31, 2008, respectively
                        
                        
                        22.7
                        
                        
                        
                        19.2Prepaid
      costs and other current assets
                        
                        
                        13.7
                        
                        
                        
                        9.8Total
      current assets
                        
                        
                        162.4
                        
                        
                        
                        119.6Property
      and equipment, net of accumulated depreciation and amortization of $223.5
      and $207.4 at September 30, 2009 and December 31, 2008,
      respectively
                        
                        
                        446.3
                        
                        
                        
                        398.4Other
      assets
                        
                        
                        7.4
                        
                        
                        
                        5.9Total
      assets
                        
                        $
                        616.1
                        
                        
                        $
                        523.9LIABILITIES:Current
      liabilities:Accounts
      payable
                        
                        $
                        4.8
                        
                        
                        $
                        13.9Accrued
      expenses
                        
                        
                        66.6
                        
                        
                        
                        65.9Deferred
      revenue - current portion
                        
                        
                        27.2
                        
                        
                        
                        24.8Note
      Payable - current portion
                        
                        
                        4.3
                        
                        
                        
                        3.2Total
      current liabilities
                        
                        
                        102.9
                        
                        
                        
                        107.8Note
      Payable
                        
                        
                        29.5
                        
                        
                        
                        32.8Deferred
      revenue
                        
                        
                        93.7
                        
                        
                        
                        88.5Other
      long-term liabilities
                        
                        
                        10.3
                        
                        
                        
                        10.5Total
      liabilities
                        
                        
                        236.4
                        
                        
                        
                        239.6Commitments
      and contingenciesSHAREHOLDERS’
      EQUITY:Preferred
      stock, 9,500,000 shares authorized, $0.01 par value, none issued or
      outstanding
                        
                        
                        —
                        
                        
                        
                        —Junior
      preferred stock, 500,000 shares authorized, $0.01 par value, none issued
      or outstanding
                        
                        
                        —
                        
                        
                        
                        —Common
      stock, 30,000,000 shares authorized, $0.01 par value, 24,432,992 issued
      and 23,912,888 outstanding at September 30, 2009, and 23,219,474 issued
      and 22,716,602 outstanding at December 31, 2008
                        
                        
                        0.2
                        
                        
                        
                        0.2Additional
      paid-in capital
                        
                        
                        300.7
                        
                        
                        
                        279.9Treasury
      stock at cost, 520,104 and 502,872 shares at September 30, 2009 and
      December 31, 2008, respectively
                        
                        
                        (16.6
                        )
                        
                        
                        (16.3
                        )Accumulated
      other comprehensive loss
                        
                        
                        (9.1
                        )
                        
                        
                        (9.3
                        )Retained
      earnings
                        
                        
                        104.5
                        
                        
                        
                        29.8Total
      shareholders’ equity
                        
                        
                        379.7
                        
                        
                        
                        284.3Total
      liabilities and shareholders’ equity
                        
                        $
                        616.1
                        
                        
                        $
                        523.9





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 September 30,
                      
                      
                      Nine
      Months Ended September 30,2009
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2008Revenue
                      
                      $
                      92.4
                      
                      
                      $
                      82.1
                      
                      
                      $
                      265.8
                      
                      
                      $
                      230.1Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                      
                      
                      33.9
                      
                      
                      
                      32.1
                      
                      
                      
                      95.6
                      
                      
                      
                      94.5Selling,
      general and administrative expenses
                      
                      
                      20.3
                      
                      
                      
                      22.9
                      
                      
                      
                      61.1
                      
                      
                      
                      68.8Depreciation
      and amortization
                      
                      
                      13.5
                      
                      
                      
                      12.2
                      
                      
                      
                      37.7
                      
                      
                      
                      37.0Operating
      income
                      
                      
                      24.7
                      
                      
                      
                      14.9
                      
                      
                      
                      71.4
                      
                      
                      
                      29.8Other
      income (expense):Interest
      income
                      
                      
                      —
                      
                      
                      
                      0.5
                      
                      
                      
                      0.3
                      
                      
                      
                      1.4Interest
      expense
                      
                      
                      (1.3
                      )
                      
                      
                      (1.1
                      )
                      
                      
                      (3.6
                      )
                      
                      
                      (2.7
                      )Other
      (expense) income, net
                      
                      
                      (0.5
                      )
                      
                      
                      (2.0
                      )
                      
                      
                      1.9
                      
                      
                      
                      (0.5
                      )Income
      before income taxes
                      
                      
                      22.9
                      
                      
                      
                      12.3
                      
                      
                      
                      70.0
                      
                      
                      
                      28.0Provision
      for (benefit from) income taxes
                      
                      
                      0.2
                      
                      
                      
                      1.9
                      
                      
                      
                      (4.7
                      )
                      
                      
                      3.0Net
      income
                      
                      $
                      22.7
                      
                      
                      $
                      10.4
                      
                      
                      $
                      74.7
                      
                      
                      $
                      25.0Income
      per share, basic:Basic
      income per share
                      
                      $
                      0.96
                      
                      
                      $
                      0.47
                      
                      
                      $
                      3.22
                      
                      
                      $
                      1.15Weighted
      average number of common shares
                      
                      
                      23,500,655
                      
                      
                      
                      22,068,514
                      
                      
                      
                      23,151,861
                      
                      
                      
                      21,667,166Income
      per share, diluted:Diluted
      income per share
                      
                      $
                      0.88
                      
                      
                      $
                      0.42
                      
                      
                      $
                      2.96
                      
                      
                      $
                      1.02Weighted
      average number of common shares
                      
                      
                      25,612,176
                      
                      
                      
                      24,465,230
                      
                      
                      
                      25,230,937
                      
                      
                      
                      24,414,920





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


2





ABOVENET,
INC. AND SUBSIDIARIES





CONSOLIDATED
STATEMENT OF SHAREHOLDERS’ EQUITY


(in
millions, except share information)





(Unaudited)





Common Stock
                        
                        
                        Treasury Stock
                        
                        
                        Other Shareholders’ EquityShares
                        
                        
                        Amount
                        
                        
                        Shares
                        
                        
                        Amount
                        
                        
                        Additional
                          Paid-in
                          Capital
                        
                        
                        Accumulated
                          Other
                          Comprehensive
                          Loss
                        
                        
                        Retained
                          Earnings
                        
                        
                        Total
                          Shareholders’
                          EquityBalance
      at January 1, 2009
                        
                        
                        23,219,474
                        
                        
                        $
                        0.2
                        
                        
                        
                        502,872
                        
                        
                        $
                        (16.3
                        )
                        
                        $
                        279.9
                        
                        
                        $
                        (9.3
                        )
                        
                        $
                        29.8
                        
                        
                        $
                        284.3Issuance
      of common stock from exercise of warrants including cashless
      exercise
                        
                        
                        404,208
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        4.8
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        4.8Issuance
      of common stock from vested restricted stock
                        
                        
                        237,000
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —Purchase
      of treasury stock
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        17,232
                        
                        
                        
                        (0.3
                        )
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        (0.3
                        )Change
      in fair value of interest rate swap contracts
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        0.2
                        
                        
                        
                        —
                        
                        
                        
                        0.2Amortization
      of stock-based compensation expense for stock options and restricted stock
      units
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        8.3
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        8.3Exercise
      of options to purchase shares of common stock
                        
                        
                        572,310
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        7.7
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        7.7Net
      income
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        74.7
                        
                        
                        
                        74.7Balance
      at September 30, 2009
                        
                        
                        24,432,992
                        
                        
                        $
                        0.2
                        
                        
                        
                        520,104
                        
                        
                        $
                        (16.6
                        )
                        
                        $
                        300.7
                        
                        
                        $
                        (9.1
                        )
                        
                        $
                        104.5
                        
                        
                        $
                        379.7





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)





Nine Months Ended September 30,2009
                  
                  
                  2008Cash
      flows provided by operating activities:Net
      income
                  
                  $
                  74.7
                  
                  
                  $
                  25.0Adjustments
      to reconcile net income to net cash provided by
operations:Depreciation
      and amortization
                  
                  
                  37.7
                  
                  
                  
                  37.0Provision
      for equipment impairment and asset abandonment
                  
                  
                  0.9
                  
                  
                  
                  2.7Provision
      for bad debts
                  
                  
                  0.4
                  
                  
                  
                  0.4Non-cash
      stock-based compensation expense
                  
                  
                  8.3
                  
                  
                  
                  9.6Loss
      (gain) on sale or disposition of property and equipment,
      net
                  
                  
                  1.0
                  
                  
                  
                  (1.2
                  )Changes
      in operating working capital:Accounts
      receivable
                  
                  
                  (3.4
                  )
                  
                  
                  (1.7
                  )Prepaid
      costs and other current assets
                  
                  
                  (3.7
                  )
                  
                  
                  0.2Accounts
      payable
                  
                  
                  (9.2
                  )
                  
                  
                  (0.9
                  )Accrued
      expenses
                  
                  
                  (7.1
                  )
                  
                  
                  (0.6
                  )Other
      assets
                  
                  
                  (1.5
                  )
                  
                  
                  (0.1
                  )Deferred
      revenue and other long-term liabilities
                  
                  
                  6.9
                  
                  
                  
                  6.0Net
      cash provided by operating activities
                  
                  
                  105.0
                  
                  
                  
                  76.4Cash
      flows used in investing activities:Proceeds
      from sales of property and equipment
                  
                  
                  —
                  
                  
                  
                  1.7Purchases
      of property and equipment
                  
                  
                  (80.0
                  )
                  
                  
                  (82.9
                  )Net
      cash used in investing activities
                  
                  
                  (80.0
                  )
                  
                  
                  (81.2
                  )Cash
      flows provided by financing activities:Proceeds
      from exercise of options to purchase shares of common
stock
                  
                  
                  7.7
                  
                  
                  
                  —Proceeds
      from exercise of warrants
                  
                  
                  4.8
                  
                  
                  
                  10.7Principal
      payment - note payable
                  
                  
                  (2.2
                  )
                  
                  
                  —Principal
      payment - capital lease obligation
                  
                  
                  (0.2
                  )
                  
                  
                  (0.2
                  )Purchase
      of treasury stock
                  
                  
                  (0.3
                  )
                  
                  
                  (1.7
                  )Proceeds
      from note payable, net of financing costs
                  
                  
                  —
                  
                  
                  
                  22.3Change
      in restricted cash and cash equivalents
                  
                  
                  —
                  
                  
                  
                  1.3Net
      cash provided by financing activities
                  
                  
                  9.8
                  
                  
                  
                  32.4Effect
      of exchange rates on cash
                  
                  
                  0.6
                  
                  
                  
                  (0.5
                  )Net
      increase in cash and cash equivalents
                  
                  
                  35.4
                  
                  
                  
                  27.1Cash
      and cash equivalents, beginning of period
                  
                  
                  87.1
                  
                  
                  
                  45.8Cash
      and cash equivalents, end of period
                  
                  $
                  122.5
                  
                  
                  $
                  72.9Supplemental
      cash flow information:Cash
      paid for interest
                  
                  $
                  2.0
                  
                  
                  $
                  1.5Cash
      paid for income taxes
                  
                  $
                  2.8
                  
                  
                  $
                  0.8Non-cash
      financing activity:Non-cash
      exercise of warrants
                  
                  $
                  —
                  
                  
                  $
                  3.2Non-cash
      purchase of shares into treasury
                  
                  $
                  —
                  
                  
                  $
                  3.2





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 September 30,
                    
                    
                    Nine Months Ended September 30,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008Net
      income
                    
                    $
                    22.7
                    
                    
                    $
                    10.4
                    
                    
                    $
                    74.7
                    
                    
                    $
                    25.0Foreign
      currency translation adjustments
                    
                    
                    (0.5
                    )
                    
                    
                    (0.1
                    )
                    
                    
                    —
                    
                    
                    
                    (0.2
                    )Change
      in fair value of interest rate swap contracts
                    
                    
                    —
                    
                    
                    
                    (0.1
                    )
                    
                    
                    0.2
                    
                    
                    
                    (0.1
                    )Comprehensive
      income
                    
                    $
                    22.2
                    
                    
                    $
                    10.2
                    
                    
                    $
                    74.9
                    
                    
                    $
                    24.7





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


5




ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


(in
millions, except share and per share information)





NOTE
1:    BACKGROUND AND ORGANIZATION





Business




AboveNet, Inc.
(together with its subsidiaries, the “Company”) provides high-bandwidth
connectivity solutions to large corporate enterprise clients and communication
carriers, including Fortune 1000 and FTSE 500 companies, in the United States
(“U.S.”) and the United Kingdom (“U.K.”).





NOTE
2:    BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING
POLICIES





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





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, 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 accounting principles generally accepted in the United States of
America for complete financial statements.  In the opinion of
management, all adjustments (consisting of normal recurring accruals),
considered necessary for a fair presentation have been
included.  These unaudited consolidated financial statements should be
read in conjunction with the Company’s consolidated financial statements and
related notes included in the Company’s Annual Report on Form 10-K for the
fiscal year ended December 31, 2008.  Operating results for the
three and nine months ended September 30, 2009 are not necessarily indicative of
the results that may be expected for the year ending December 31,
2009.





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


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. 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
Shareholders’ Rights Plan.  In the event of any liquidation, the
holders of the common stock will be entitled to receive the assets of the
Company available for distribution, after payments to creditors and holders of
preferred stock.





Pursuant
to the Plan of Reorganization, upon the Company’s emergence from bankruptcy, the
Company issued to its pre-petition creditors 17,500,000 shares of common stock,
of which 17,498,276 were delivered and 1,724 were determined to be undeliverable
and were cancelled, rights to purchase 3,338,420 shares of common stock at a
price of $14.9772, under a rights offering, of which rights to purchase
3,337,984 shares 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 Stock Incentive Plan. See Note 6, “Stock-Based
Compensation.”





The
Company’s emergence from bankruptcy resulted in a new reporting entity with no
retained earnings or accumulated losses, effective as of September 8,
2003.  Although the Effective Date of the Plan of Reorganization was
September 8, 2003, the Company accounted for the consummation of the Plan of
Reorganization as if it occurred on August 31, 2003 and implemented fresh start
accounting as of that date.  There were no significant transactions
during the period from August 31, 2003 to September 8, 2003.  Fresh
start accounting requires the Company to allocate the reorganization value of
its assets and liabilities based upon their estimated fair values, in accordance
with Statement of Position 90-7, “Financial Reporting by Entities in
Reorganization under the Bankruptcy Code” (“SOP 90-7”) (now known as FASB
Accounting Standards Codification (“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 based upon
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




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.





In
accordance with 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),
the Company generally amortizes revenue related to installation services on a
straight-line basis over the fixed contract term, which generally ranges from
two to twenty years.





Contract
termination revenue is 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 and nine months ended
September 30, 2009 and 2008, the Company included the receipts of bankruptcy
claim settlements from former customers as contract termination
revenue.  Contract termination revenue is reported together with other
service revenue, and amounted to $0.3 and $4.4 in the three months ended
September 30, 2009 and 2008, respectively, and $3.0 and $6.7 in the nine months
ended September 30, 2009 and 2008, respectively.





Non-Monetary
Transactions




The
Company may exchange capacity with other capacity or service
providers.  In December 2004, the Financial Accounting Standards Board
(“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 153,
“Exchanges of Nonmonetary Assets - An Amendment of APB Opinion No. 29,” (“SFAS
No. 153”) (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 and nine months ended September 30,
2009 and 2008.


8


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





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 credit worthiness, customer’s payment
history, the length of the customer’s relationship with the Company, current
industry trends and the current economic climate.





Property
and Equipment




Property
and equipment owned at the Effective Date are stated at their estimated fair
values as of the Effective Date based on the Company’s reorganization value, 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 September 30, 2009 and December
31, 2008, the Company had $31.5 and $14.8, 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 $2.8 and $2.7 for the three months ended September 30, 2009 and
2008, respectively, and $8.4 and $8.2 for the nine months ended September 30,
2009 and 2008, 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.


9


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





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




Network
      infrastructure assets
                  20
      yearsStorage
      huts
                  20 yearsSoftware
      and computer equipment
                  3
      to 4 yearsTransmission
      and IP equipment
                  3
      to 7 yearsFurniture,
      fixtures and equipment
                  3
      to 10 yearsLeasehold
      improvements
                  Lesser
      of estimated useful life or the lease
term





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





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
$0.9 and $0.5 for the three months ended September 30, 2009 and 2008,
respectively, and $2.6 and $2.0 for the nine months ended September 30, 2009 and
2008, respectively.  The Company fully depreciated the remaining
carrying value of the network infrastructure rendered unusable, which on an
original cost basis, totaled $0.1 and $0.3 ($0.06 and $0.2 on a net book value
basis) for the three and nine months ended September 30, 2009, respectively,
and, which on an original cost basis, totaled $0.3 ($0.2 on a net book value
basis) for the nine months ended September 30, 2008.  To the extent
that relocation requires only the movement of existing network infrastructure to
another location, the related costs are included in our results of
operations.





In
accordance with SFAS No. 34, “Capitalization of Interest Cost,” (now known as
FASB ASC 835-20), the Company will capitalize interest on certain construction
projects.  Such amounts were considered immaterial, and accordingly,
no such amounts were capitalized during the three and nine months ended
September 30, 2009 and 2008.





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 in determining
whether a triggering event has occurred.  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 and $0.4 at September 30, 2009 and 2008,
respectively.  The Company also recorded a provision for equipment
impairment of $0.5 in the nine months ended September 30, 2009 to record the
loss in value of certain equipment eventually sold to an unaffiliated third
party.


10


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





Asset
Abandonment




In 2006,
the Company acquired software for an enterprise resource planning system (“ERP
System”), which was expected to be the Company’s information technology platform
for capitalized costs totaling $2.3.  In September 2008, management
decided to abandon the implementation of this ERP System and investigate other
alternatives, including enhancements and upgrades to its current
systems.  Accordingly, in the three months ended September 30, 2008,
the Company recorded an impairment charge of $2.3 with respect to the
abandonment, which is reflected in selling, general and administrative expenses,
in each of the three and nine months ended September 30, 2008.





Treasury
Stock




Treasury
stock is accounted for under the cost method.





Asset
Retirement Obligations




In
accordance with SFAS No. 143, “Accounting for Asset Retirement Obligations,”
(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 $7.3
and $7.1 at September 30, 2009 and December 31, 2008, respectively, of which
$4.0 were included in “Accrued expenses,” for each period and $3.3 and $3.1,
respectively, were included in “Other long-term liabilities” at such
dates.  Accretion expense, which is included in “Interest expense,”
amounted to $0.1 and $0.07 for the three months ended September 30, 2009
and 2008, respectively, and $0.2 and $0.21 for the nine months ended September
30, 2009 and 2008, respectively.





Income
Taxes




The
Company accounts for income taxes in accordance with SFAS No. 109, “Accounting
for Income Taxes,” (“SFAS No. 109”) (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 carry-forwards, and tax
contingencies.  Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or
settled.  The Company records a valuation allowance against deferred
tax assets to the extent that it is more likely than not that some portion or
all of the deferred tax assets will not be realized.





We are
subject to audit by various taxing authorities, and these audits may result in
proposed assessments where the ultimate resolution results in us owing
additional taxes.  We are required to establish reserves under FASB
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,”
(“Interpretation No. 48”) (now known as FASB ASC 740-10) when, despite our
belief that our tax return positions are appropriate and supportable under
appropriate tax law, we believe there is uncertainty with respect to certain
positions and we may not succeed in realizing the tax position.  We
have evaluated our tax positions for items of uncertainty in accordance with
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 and nine months ended September
30, 2009 and 2008.


11


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





The
provision for income taxes, income taxes payable and deferred income taxes are
provided for in accordance with the liability method.  Deferred tax
assets and liabilities are determined based on differences between the financial
reporting and tax basis of assets and liabilities and are measured by applying
enacted tax rates and laws to taxable years in which such differences are
expected to reverse.  A valuation allowance is provided when the
Company determines that it is more likely than not that a portion of the
deferred tax asset balance will not be realized.





The
Company’s reorganization resulted in a significantly modified capital structure
as a result of applying fresh-start accounting in accordance with 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.  Specifically, fresh start accounting
requires the reversal of such allowances to be recorded as a reduction of
intangible assets until exhausted and thereafter as additional paid in
capital.  This treatment does not result in any change in liabilities
to taxing authorities or in cash flows.





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





The
Company’s policy is to recognize interest and penalties accrued as a component
of operating expense.  As of the date of adoption of Interpretation
No. 48, the Company did not have any accrued interest or penalties associated
with any unrecognized income tax benefits, nor was any interest expense
recognized during the three and nine months ended September 30, 2009 and
2008.  The (benefit from) provision for income taxes is primarily due
to current federal income taxes and state and local income taxes.





Foreign
Currency Translation and Transactions




The
Company’s functional currency is the U.S. dollar. For those subsidiaries not
using the U.S. dollar as their functional currency, assets and liabilities are
translated at exchange rates in effect at the 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.  The
Company’s foreign exchange transaction gains (losses) are generally included in
“other income, net” in the consolidated statements of operations.





Stock
Options




On
September 8, 2003, the Company adopted the fair value provisions of SFAS No.
148, “Accounting for Stock-Based Compensation Transition and Disclosure,” (“SFAS
No. 148”) (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 6, “Stock-Based Compensation.”





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


12


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





Effective
January 1, 2006, the Company adopted SFAS No. 123(R), “Share-Based Payment,”
(“SFAS No. 123(R)”) (now known as FASB ASC 718), using the modified prospective
method.  FASB ASC 718 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 FASB
ASC 718 is similar to the fair value method under FASB ASC 718-10 with respect
to measurement and recognition of stock-based compensation expense except that
FASB ASC 718 requires an estimate of future forfeitures, whereas FASB ASC 718-10
permitted companies to estimate forfeitures or recognize the impact of
forfeitures as they occur.  As the Company recognized the impact of
forfeitures as they occurred under FASB ASC 718-10, the adoption of FASB ASC 718
resulted in a change in our accounting treatment, but it did not have a material
impact on the Company’s consolidated financial statements.  There were
no options to purchase shares of common stock granted during the three and nine
months ended September 30, 2009.  During the nine months ended
September 30, 2008, the Company awarded options to purchase 2,000 shares of
common stock to each of the five non-employee members of the Board of Directors,
all of which were granted on September 8, 2008.  The options have an
exercise price of $30.00 per share, a ten year life and vested on the first
anniversary of the date of grant.





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




Nine Months Ended
                                        September 30,2008Dividend
      yield
                                      
                                      
                                      —Expected
      volatility
                                      
                                      
                                      80.00
                                      %Risk-free
      interest rate
                                      
                                      
                                      2.96
                                      %Expected
      life (years)
                                      
                                      
                                      5.00Weighted
      average fair value of options granted
                                      
                                      $
                                      19.68




Restricted
Stock Units




Compensation
cost for restricted stock unit awards is measured based upon the quoted closing
market price for the stock on the date of grant.  The compensation
cost is recognized on a straight-line basis over the vesting period. See Note 6,
“Stock-Based Compensation.”





Stock
Warrants




In
connection with the Plan of Reorganization described in Note 2, “Basis of
Presentation and Significant Accounting Policies,” the Company issued to holders
of general unsecured claims as part of the settlement of such claims (i) five
year warrants to purchase 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.  Stock warrants to purchase shares of common stock
exercised totaled 390,586 and 1,369,368 during the three months ended September
30, 2009 and 2008, respectively, and 404,208 and 1,379,812 during the nine
months ended September 30, 2009 and 2008, 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 our common stock, as defined in
the Warrant Agreements, 60 days prior to the expiration date of the respective
warrants, is greater than the warrant exercise price, the Company is required to
give each warrant holder notice that at the warrant expiration date, the
warrants would be deemed to have been exercised pursuant to the net exercise
provisions of the respective Warrant Agreements (the “Net Exercise”), unless the
warrant holder elects, by written notice, to not exercise its
warrants.  Under the Net Exercise, shares issued to the warrant
holders would be reduced by the number of shares necessary to cover the
aggregate exercise price of the shares, valuing such shares at the current
market price, as defined in the Warrant Agreements.  Any fractional
shares, otherwise issuable, would be paid in cash.  At September 8,
2008, the expiration date of the five year warrants, the required conditions
were met for the Net Exercise.  In total, five year warrants to
purchase 318,526 shares of common stock were deemed exercised pursuant to the
Net Exercise (including warrants to purchase 778 shares of common stock, which
were exercised on a net exercise basis prior to expiration), of which 213,432
shares were issued to the warrant holders, 105,094 shares were returned to
treasury and $0.004 was paid to recipients for fractional shares.  In
addition, five year warrants to purchase 50 shares of common stock were
cancelled in accordance with instructions from warrant holders.





During
the three and nine months ended September 30, 2009, seven year warrants to
purchase 1,816 shares of common stock were exercised pursuant to the Net
Exercise.  Seven year warrants to purchase 26 shares of common stock
were determined to be undeliverable and were cancelled.  At September
30, 2009, seven year warrants to purchase 1,179,648 shares of common stock were
outstanding.




Derivative
Financial Instruments




The
Company utilizes interest rate swaps, derivative financial instruments
(“derivatives”), to mitigate its exposure to interest rate risk.  The
Company purchased the first interest rate swap on August 4, 2008 to hedge the
interest rate on the $24 (original principal) portion of the Term Loan (as such
term is defined in Note 3, “Note Payable”) and the Company purchased a second
interest rate swap on November 14, 2008 to hedge the interest rate on the
additional $12 (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” (“SFAS
No. 133”) (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 September 30, 2009 and
December 31, 2008 was $1.4 and $1.6, respectively, 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,”
(“SFAS No. 161”) (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.  The Company does not enter into derivatives
for trading or other speculative purposes.





All
derivatives were recorded on the Company’s consolidated balance sheets at fair
value.  Accounting for the gains and losses resulting from changes in
the fair value of derivatives depends on the use of the derivative and whether
it qualifies for hedge accounting in accordance with FASB ASC 815.  As
of September 30, 2009 and December 31, 2008, the Company’s consolidated balance
sheets included net interest rate swap derivative liabilities of $1.4 and $1.6,
respectively.





Derivatives
recorded at fair value in the Company’s consolidated balance sheets as of
September 30, 2009 and December 31, 2008 consisted of the
following:





Derivative LiabilitiesDerivatives designated as hedging instruments
                            
                            September 30, 2009
                            
                            
                            December 31, 2008Interest
      rate swap agreements (*)
                            
                            $
                            1.4
                            
                            
                            $
                            1.6Total
      derivatives designated as hedging instruments
                            
                            $
                            1.4
                            
                            
                            $
                            1.6





(*)
                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 agreements as of September 30, 2009.




Weighted Average RateNotional Amount
                                    
                                    Maturity Date
                                    
                                    Pay
                                    
                                    
                                    Receive$
                                    22.5
                                    
                                    2011
                                    
                                    
                                    3.65%
                                    
                                    
                                    
                                    1.21%11.3
                                    
                                    2011
                                    
                                    
                                    2.635%
                                    
                                    
                                    
                                    0.59%$
                                    33.8




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


15


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





Fair
Value of Financial Instruments




The
Company adopted SFAS No. 157, “Fair Value Measurements,” (“SFAS No. 157”) (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 $113.5 and $81.9 at September 30, 2009 and December 31, 2008,
respectively, is included in cash and cash equivalents on the accompanying
balance sheets and is classified as a Level 1 asset.





The
Company is party to two interest rate swaps, which are utilized to modify the
Company’s interest rate risk.  The Company recorded the mark-to-market
value of the interest rate swap contracts of $1.4 and $1.6 in other
long-term liabilities in the consolidated balance sheets at September 30, 2009
and December 31, 2008, respectively.  The Company used third parties
to value each of the interest rate swap agreements at September 30, 2009 and
December 31, 2008, as well as its own market analysis to determine fair
value.  The fair value of the interest rate swap contracts
are classified as Level 2 liabilities.




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


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





401(k) and
Other Post-Retirement Benefits




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





The
Company contributed $0.3 for each of the three months ended September 30, 2009
and 2008 and contributed $1.2 for each of the nine months ended September 30,
2009 and 2008, net of forfeitures for its obligations under these
plans.





Taxes
Collected from Customers




In
June 2006, the Emerging Issues Task Force (“EITF”) ratified the consensus
on EITF No. 06-3, “How Taxes Collected from Customers and Remitted to
Governmental Authorities Should Be Presented in the Income Statement (That Is,
Gross versus Net Presentation),” (“EITF No. 06-3”) (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 at
December 31, 2008 to conform to the classifications used at September 30,
2009.


17


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





Recently
Issued Accounting Pronouncements




In
September 2006, the FASB issued SFAS No. 157 (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 (“FSP 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 SFAS
No. 157 on January 1, 2008 with respect to its financial assets and liabilities,
as discussed above.





In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations
(Revised),” (“SFAS No. 141(R)”), (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 SFAS No. 141(R) did not have a material impact
on the Company’s financial position, results of operations or cash
flows.





In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements – an amendment of ARB No. 51,” (“SFAS No.
160”) (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 SFAS No. 160 did not have a material impact on
the Company’s financial position, results of operations or cash
flows.




In
December 2007, the SEC issued SAB No. 110, “Certain Assumptions Used in
Valuation Methods – Expected Term,” (“SAB No. 110”) (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 and nine months ended September 30, 2009.





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.  EITF No. 07-5 is effective for financial statements
issued for fiscal years beginning after December 15, 2008 and early application
is not permitted.  The adoption of EITF No. 07-5 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
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.  EITF No. 08-3 is
effective for fiscal years, and interim periods within those fiscal years,
beginning after December 15, 2008.  The adoption of EITF No. 08-3 did
not have a material impact on the Company’s financial position, results of
operations or cash flows.





In June
2008, the FASB issued EITF No. 03-6-1, “Determining Whether Instruments Granted
in Shared-Based Payment Transactions are Participating Securities,” (“EITF No.
03-6-1”) (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.  EITF No. 03-6-1 is effective for
financial statements issued for fiscal years beginning after December 15, 2008,
and interim periods within those fiscal years.  Upon adoption, a
company is required to retrospectively adjust its earnings per share date
(including any amounts related to interim periods, summaries of earnings and
selected financial data) to conform to provisions of FASB ASC
260-10.  The adoption of EITF No. 03-6-1 did not have a material
impact on the Company’s financial position, results of operations or cash
flows.





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).   FSP No. FAS 107-1
and APB 28-1 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.  FSP No. FAS 107-1 and APB 28-1 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.  FSP No. FAS
107-1 and APB 28-1 became effective for the Company for the three months ended
June 30, 2009.  FSP No. FAS 107-1 and APB 28-1 did not have a material
impact on the Company’s financial position, results of operations or cash
flows.





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 SFAS No. 165
did not have a material impact on the Company’s financial position, results of
operations or cash flows.





During
the third quarter of 2009, the Company adopted the FASB Accounting Standards
Update No. 2009-01, “Amendments based on SFAS No. 168 - TheFASB Accounting
Standards CodificationTM 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 prior
references to previous GAAP citations in the Company’s consolidated financial
statements were updated for the new references under the
Codification.


19


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





NOTE
3:  NOTE PAYABLE





Secured
Credit Facility





On
February 29, 2008, the Company, excluding certain foreign subsidiaries, entered
into a $60 senior secured credit facility (the “Secured Credit Facility”),
consisting of an $18 revolving credit facility (the “Revolver”) and a $42 term
loan facility (the “Term Loan”).  The Secured Credit Facility is to be
used for general corporate purposes and for capital investment.  The
initial lenders under the Secured Credit Facility were Societe Generale and CIT
Lending Services Corporation (the “Initial Lenders”).  The Secured
Credit Facility is secured by substantially all of the Company’s domestic
assets.  The Term Loan was comprised of $24, advanced at closing (net
of related fees and certain debt acquisition costs) and up to $18, which
originally could be drawn within nine months of closing at the Company’s option
(the “Delayed Draw Term Loan”).  On September 26, 2008, the Company
executed a joinder agreement to the Secured Credit Facility that added SunTrust
Bank as an additional lender (together with the Initial Lenders, the “Lenders”)
and increased the amount of the Secured Credit Facility to $90 effective October
1, 2008.  The availability under the Revolver increased to $27 and the
Term Loan availability increased to $63, $27 of which represented the Delayed
Draw Term Loan.  The additional amount of the Term Loan of $12 was
advanced on October 1, 2008.  Additionally, the Delayed Draw Term Loan
option, which was originally scheduled to expire on November 25, 2008, was
initially extended to June 30, 2009 and then subsequently extended to December
31, 2009.  The borrowings under the Secured Credit Facility mature on
February 28, 2013.  In connection with the closing of the Secured
Credit Facility on February 29, 2008, the Company paid an upfront fee of 1.5%
($0.9) of the total amount of the Secured Credit Facility and paid $0.3 to its
unaffiliated third party financial advisors who assisted the
Company.  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.  In connection with the joinder agreement,
the Company paid a $0.45 fee at closing and an aggregate of $0.25 of advisory
fees.  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 0.26125% at September 30, 2009).  Additionally, the Company
was originally required to maintain a minimum cash balance at all times of at
least $20.





On June
29, 2009, the Company and the Lenders entered into an amendment to the Secured
Credit Facility, 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 $0.8 on each of June 30, 2009 and September
30, 2009 and a further $0.8 reduction on December 31, 2009 in the event that all
or a portion of the Delayed Draw Term Loan commitments remain undrawn on such
date.  In addition, the obligation to commence making principal
payments on any outstanding Delayed Draw Term Loan was extended to March 31,
2010 and the Company’s obligation to maintain a minimum balance of $20 in cash
deposits at all times was eliminated.  The Company paid the Lenders a
$0.1 amendment fee and paid the administrative agent a work
fee.


20


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





The Term
Loan, which originally totaled $36, provides for monthly payments of interest
and quarterly installments of principal of $1.08, which began 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 (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 (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%.




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


The
outstanding amounts of $33.8 under the Term Loan of the Secured Credit Facility
at September 30, 2009 are scheduled to be repaid in each annual period as
follows:




12 Months Ended September 30,
            
            Amount2010
            
            $
            4.32011
            
            
            4.32012
            
            
            5.02013
            
            
            20.233.8Less:
      current portion of note payable
            
            
            (4.3
            )$
            29.5




Additionally,
the Company executed a $1.0 standby letter of credit in favor of New York City
to secure the Company’s franchise agreement, which was collateralized by $1.0 of
availability under the Revolver.  The standby letter of credit,
originally scheduled to expire May 1, 2009, was renewed and extended until May
1, 2010.





The
Company’s Secured Credit Facility contains certain financial and non-financial
covenants (“Debt Covenants”).  The Company was in compliance with all
of its Debt Covenants as of September 30, 2009.


21


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





NOTE
4:  INCOME TAXES





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




Three Months Ended September 30,
                            
                            
                            Nine Months Ended September 30,2009
                            
                            
                            2008
                            
                            
                            2009
                            
                            
                            2008Current
                            
                            $
                            0.2
                            
                            
                            $
                            1.9
                            
                            
                            $
                            (4.7
                            )
                            
                            $
                            3.0Deferred
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —Total
      income tax provision
                            
                            $
                            0.2
                            
                            
                            $
                            1.9
                            
                            
                            $
                            (4.7
                            )
                            
                            $
                            3.0





Income
taxes have been provided based upon the tax laws and rates in the countries in
which operations are conducted and income is earned.





The
Company recorded a net benefit from income taxes of $4.7 for the nine
months ended September 30, 2009, compared to a provision for income taxes of
$3.0 for the nine months ended September 30, 2008.  The benefit is
based upon the anticipated 2009 loss for income tax purposes.  The
benefit recorded represents the receivable established for the refunds of
federal income tax payments paid with respect to the tax filings for the years
ended December 31, 2007 and 2008 and the reversal of the federal income taxes
accrued at December 31, 2008, net of a provision for alternative minimum taxes
for 2007 and 2008.  Additionally, at September 30, 2009, the Company
provided for certain capital-based state taxes, which partially reduced the
benefit from income taxes.





The
Company adopted the provisions of Interpretation No. 48 on January 1,
2007.  At September 30, 2009 and December 31, 2008, the Company’s tax
positions are highly certain tax positions.  Accordingly, no
adjustments were required to the consolidated financial statements for any of
the periods presented.





The
Company established a valuation allowance related to deferred tax assets based
on current years’ results of operations and anticipated profit levels in future
periods, since it is more likely than not that its deferred tax assets will not
be realized in the future.





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





As of
December 31, 2008, the Company has domestic NOL carryforwards of $827.2 and
foreign NOL carryforwards of $52.3.  Certain of these NOL
carryforwards begin to expire in 2024.  The Company’s use of its
domestic NOL carry forward is subject to annual limitation under the ownership
change rules in the U.S.  Such annual limitation is
$8.1.  Accordingly, the Company estimates that $162.0 of its domestic
NOL carryforwards is available but may be subject to future limitation by United
States Internal Revenue Code Section 382.





The
Company and its subsidiaries’ income tax returns are routinely examined by
various tax authorities.  The statute of limitations is open with
respect to tax years 2001 to 2008.  The statute of limitations for
these years will begin to expire in 2011.


22


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





NOTE
5:  INCOME PER COMMON SHARE





Basic
income per common share is computed as net income or net loss divided by the
weighted average number of common shares outstanding for the
period.  Total weighted average shares utilized in computing basic net
income per common share were 23,500,655 and 22,068,514 for the three months
ended September 30, 2009 and 2008, respectively.  Total weighted
average shares utilized in computing diluted net income per common share were
25,612,176 and 24,465,230 for the three months ended September 30, 2009 and
2008, respectively.  Dilutive securities include options to purchase
shares of common stock, restricted stock units and stock warrants.  For the
three months ended September 30, 2009 and 2008, potentially dilutive securities
to acquire zero and 23,800 shares of common stock, respectively, were excluded
from the calculation of diluted income per share as they were
anti-dilutive.  Total weighted average shares utilized in computing
basic net income per common share were 23,151,861 and 21,667,166 for the nine
months ended September 30, 2009 and 2008, respectively.  Total
weighted average shares utilized in computing diluted net income per common
share were 25,230,937 and 24,414,920 for the nine months ended September 30,
2009 and 2008, respectively.  For the nine months ended September 30,
2009, potentially dilutive securities to acquire 12,900 shares of common stock
were excluded from the calculation of diluted income per common share as they
were anti-dilutive.  For the nine months ended September 30, 2008,
potentially dilutive securities to acquire 13,800 shares of common stock were
excluded from the calculation of diluted income per share as they were
anti-dilutive.





NOTE
6:   STOCK-BASED COMPENSATION




Adoption
of 2008 Equity Incentive Plan





On August
29, 2008, the Board of Directors of the Company approved the Company’s 2008
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 Company common stock may be issued
pursuant to awards granted under the 2008 Plan.  The number of shares
available for grant and the terms of outstanding grants are subject to
adjustment for stock splits, stock dividends and other capital
adjustments.  As of September 30, 2009, 775,534 common shares were
reserved pursuant to outstanding options to purchase shares of common stock and
outstanding restricted stock units, and 724,466 common shares were reserved for
future grants.





Stock-based
compensation expense for each period relates to share-based awards granted
under the Company’s 2008 Plan, described above, and the Company’s 2003 Stock
Incentive Plan reflect awards outstanding during such period, including awards
granted both prior to and during such period.  The 2003 Stock
Incentive Plan became effective on September 8, 2003.  Under the
2003 Stock Incentive Plan, the Company was authorized to issue, in the
aggregate, share-based awards of up to 2,129,912 common shares to employees,
directors and consultants who are selected to participate.  At
September 30, 2009, 1,115,932 common shares had been issued pursuant to vested
restricted stock units (including shares of common stock repurchased by the
Company to fund estimated income tax liabilities and, in certain cases, minimum
withholding obligations), 572,310 common shares had been issued pursuant to the
exercise of options to purchase shares of common stock, 354,592 common shares
were reserved pursuant to outstanding options to purchase shares of common
stock, 53,500 common shares were reserved pursuant to outstanding restricted
stock units and reserves for 33,578 common shares were cancelled.





Stock
Options





The
Company did not award any stock options during the three and nine months
ended September 30, 2009.  On September 8, 2008, the Company awarded
options to purchase 2,000 shares of common stock to each of the five
non-employee members of the Board of Directors.  The options have an
exercise price of $30.00 per share, a ten year life and vest on the first
anniversary of the date of grant.  The Company recognized non-cash
stock-based compensation expense related to outstanding stock options amounting
to $0.1 and $1.2 for the nine months ended September 30, 2009 and 2008,
respectively.  The Company did not recognize any non-cash stock-based
compensation expense for the three months ended September 30, 2009 and
2008.  The non-cash stock-based compensation expense for the nine
months ended September 30, 2008 included $0.8 incurred with respect to the
modification of certain options to purchase common stock (see Note 10,
“Employment Contract Termination”).


23


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 and nine
months ended September 30, 2009.  During the nine months ended September
30, 2008, the Company granted 708,200 restricted stock units of which 690,200
restricted stock units were granted during the three months then
ended.  Of the 690,200 restricted stock units, 380,000 vest 30% in one
year, 10% in two years and 60% in three years, 172,000 of which vested or vest
ratably on each of the first, second and third anniversaries of the date of
grant and 96,200 of which vested on the first anniversary of the date of
grant.  Additionally, William G. LaPerch, the President and Chief
Executive Officer of the Company, may earn 42,000 restricted stock units, which
vest ratably in 2010, 2011 and 2012 based upon certain performance targets for
the fiscal years 2009, 2010 and 2011.  In May 2008, pursuant to the
2003 Plan, the Company awarded 18,000 restricted stock units, which vested on
the first anniversary of the date of grant.  The Company recognized
non-cash stock-based compensation expense related to restricted stock units of
$2.5 and $1.7 for the three months ended September 30, 2009 and 2008,
respectively, and $8.2 and $8.4 for the nine months ended September 30, 2009 and
2008, respectively.  Included in the expense for the nine months ended
September 30, 2008 is a charge of $0.9, with respect to the Company’s purchase
of shares from employees in excess of the minimum withholding requirements, as
provided by FASB ASC 718.  There were no such amounts incurred in the
three and nine months ended September 30, 2009 and the three months ended
September 30, 2008.





NOTE
7:   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 (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, which is included as Exhibit 4.1 to the
Company’s Current Report on Form 8-K filed with the SEC on August 3,
2009.





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.  The Amended and Restated Rights
Agreement includes an exception to the definition of “Acquiring Person” for an
Excluded Stockholder.  “Excluded Stockholder” is defined to mean JGD
Management Corp., York Capital Management, L.P. and certain of their affiliated
funds and managed accounts holding Company securities (the “York Group”) and
their respective affiliates and associates; provided, however, that, except as
otherwise provided in the definition of “Acquiring Person” in the Amended and
Restated Rights Agreement, none of the members of the York Group or their
affiliates or associates will be an Excluded Stockholder if any such party,
individually or collectively, becomes the beneficial owner of 20% or more of the
outstanding Common Shares without the prior written consent of the
Company.


24


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.  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.




In the
event that any person or group of affiliated or associated persons becomes an
Acquiring Person, proper provision will be made so that each holder of a Right,
other than Rights beneficially owned by the Acquiring Person and its associates
and affiliates (which will thereafter be void), will for a 60-day period have
the right to receive upon exercise that number of Common Shares having a market
value of two times the exercise price of the Right (or, if such number of shares
is not and cannot be authorized, the Company may issue preferred shares, cash,
debt, stock or a combination thereof in exchange for the Rights).  This
right will terminate 60 days after the date on which the Rights become
non-redeemable (as described below), unless there is an injunction or similar
obstacle to exercise the Rights, in which event this right will terminate 60
days after the date on which the Rights again become exercisable.





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


25


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





Stock
Split




On August
3, 2009, the Board of Directors of the Company authorized a two-for-one common
stock split, effected in the form of a 100% stock dividend, which was
distributed on September 3, 2009.  Each shareholder of record on
August 20, 2009 received one additional share of common stock for each share of
common stock held on that date.  All share
and per share information, 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.




NOTE
8:  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 to settle the
liability portion of the trial and reimbursed GVN $1.8 for legal
fees.  Additionally, the Company’s legal fees aggregated
$2.4.  Further, the Company has incurred or is obligated for costs
totaling $2.7 to build additional network.  In early August 2008, the
Company reached a settlement agreement under which the Company paid GVN $0.6 and
agreed to provide additional construction of duct at an estimated cost of $1.2
and provide GVN limited additional access to ACUK’s network.  GVN and
ACUK provided mutual releases of all claims against each other, including ACUK’s
repair obligation and chamber construction obligations discussed
above.  We recorded a loss on litigation of $11.7 at December 31,
2007, of which $0.8 and $8.5 was paid in 2007 and 2008, respectively, and $1.2
was included in accrued expenses at December 31, 2008.  The obligation was
denominated in British pounds; therefore, the amounts have been affected by
currency fluctuations.  The Company had $0.7 included in accrued
expenses at September 30, 2009.


26


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





SBC
Telecom, Inc. (“SBC”)





The
Company was a party to a fiber lease agreement with SBC, a subsidiary of
AT&T, entered into in May 2000.  The Company believed that SBC was
obligated under this agreement to lease 40,000 fiber miles, reducible to 30,000
under certain circumstances, for a term of 20 years at a price set forth in the
agreement, which was subject to adjustment based upon the number of fiber miles
leased (the higher the volume of fiber miles leased, the lower the price per
fiber mile).  SBC disagreed with such interpretation of the agreement
and in 2003 the issue was litigated before the Bankruptcy Court.  In
November 2003, the Bankruptcy Court agreed with the Company’s interpretation of
the agreement, which decision SBC did not appeal.  Subsequently, SBC
also alleged that the Company was in breach of its obligations under such
agreement and that therefore the Company was unable to assume the agreement upon
its emergence from bankruptcy.  The Company disagreed with SBC’s
position, however in December 2005, the Bankruptcy Court agreed with
SBC.  In 2006, the Company appealed certain aspects of the decision to
the District Court for the Southern District of New York but the District Court
denied the Company’s appeal.  In March 2007, the Company filed a
notice of appeal to the Second Circuit Court of Appeals seeking relief with
respect to the Bankruptcy Court’s determination that the Company was in default
of the agreement with SBC.  During the term of the agreement, SBC has
paid the Company at the higher rate per fiber mile to reflect the reduced volume
of services SBC believes it was obligated to take, in accordance with its
understanding of the fiber lease agreement.  However, for financial
statement purposes, the Company billed and recorded revenue based on the lower
amount per fiber mile for the fiber miles accepted by SBC, which was $0.7 and
$1.7 for the three and nine months ended September 30, 2008,
respectively.





In July
2008, the Company and SBC entered into the “Stipulation and Release Agreement”
under which a new service agreement was executed for the period from July 10,
2008 to December 31, 2010.  Under this new service agreement, SBC
agreed to continue to purchase the existing services at the current rate for
such services.  Further, SBC will have a fixed minimum payment
commitment, which declines over the contract term.  SBC may cancel
service at any time, subject to the notice provisions, but is subject to the
payment commitment.  The payment commitment may be satisfied by the
existing services or SBC may order new services.  Additionally, the
May 2000 fiber lease agreement with SBC was terminated and the Company and SBC
released each other from any claims related to that agreement.  The
difference between the amount paid by SBC and the amount recognized by the
Company as revenue, which aggregated $3.5 at July 10, 2008, was included as
contract termination revenue in the three and nine months ended September
30, 2008.





Southeastern
Pennsylvania Transportation Authority (“SEPTA”)




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





NOTE
9:  RELATED PARTY TRANSACTIONS





A member
of the Company’s Board of Directors is also the Co-Chairman, Chief Executive
Officer and co-founder of a telecommunications company.  The Company
sold services and/or material in the normal course of business to this
telecommunications company in the amount of $0.1 for each of the three months
ended September 30, 2009 and 2008, and $0.3 for each of the nine months ended
September 30, 2009 and 2008.  No amounts were outstanding at each of
September 30, 2009 and December 31, 2008.  All activity between
the parties was conducted as independent arms length transactions consistent
with similar terms and circumstances with any other customers or
vendors.  All accounts between the two parties are settled in
accordance with invoice terms.


27


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





NOTE
10:   EMPLOYMENT CONTRACT TERMINATION





On March
4, 2008, the employment contract of Michael A. Doris, the Company’s former
Senior Vice President and Chief Financial Officer, was modified and then
terminated.  Pursuant to the modification, the Company paid Mr. Doris
upon termination (i) $0.3; (ii) all salary and bonuses earned but not
yet paid; (iii) all accrued and unused paid time off days; and (iv) health
and welfare benefits for eighteen (18) months or such shorter period if he
receives comparable benefits from another employer, and executed and delivered a
consulting agreement with Mr. Doris.  Pursuant to the consulting
agreement, in exchange for Mr. Doris’ provision of consulting services to
the Company for a period of nine months, Mr. Doris was paid (i) $0.3
(his annual salary prorated per week for nine months); and (ii) (a) a bonus of
$0.05 (the “2006 Filing Bonus”) upon the filing with the SEC of Form 10-K
with respect to the Company’s fiscal year ended December 31, 2006 and
(b) a bonus of $0.05 (the “2007 Filing Bonus”) upon the filing with the SEC
of Form 10-K with respect to the Company’s fiscal year ended
December 31, 2007.  In addition, Mr. Doris’ stock unit agreement
dated as of August 7, 2007 was amended to provide that (i) the shares
underlying the 20,000 restricted stock units (which became vested upon his
termination without cause) be delivered to Mr. Doris on January 5, 2009;
and (ii) the Company repurchase at the then market price such number of
shares as required to meet the Company’s estimate of Mr. Doris’ federal and
state income taxes due with respect to the delivery of the restricted stock
units.  The aggregate value of the benefits delivered to Mr. Doris
(including the value of restricted stock units that vested in accordance with
their terms) was $1.6, of which $1.2 was recognized in selling, general and
administrative expenses in the three months ended March 31,
2008.  Additionally, in the three months ended March 31, 2008, the
Company recorded additional non-cash stock-based compensation expense of $0.7
relating to the modification of his options to purchase common shares in
connection with the modification and termination of Mr. Doris’ employment
agreement.





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 our revenue based on the location of our entity providing service.
 Long-lived assets are based on the physical location of the
assets.  The following table presents revenue and long-lived asset
information for geographic areas:





Three Months Ended September 30,
                                                
                                                
                                                Nine Months Ended September 30,2009
                                                
                                                
                                                2008
                                                
                                                
                                                2009
                                                
                                                
                                                2008RevenueUnited
      States
                                                
                                                $
                                                83.9
                                                
                                                
                                                $
                                                73.9
                                                
                                                
                                                $
                                                242.9
                                                
                                                
                                                $
                                                205.9United
      Kingdom
                                                
                                                
                                                9.6
                                                
                                                
                                                
                                                9.4
                                                
                                                
                                                
                                                25.7
                                                
                                                
                                                
                                                27.5Eliminations
                                                
                                                
                                                (1.1
                                                )
                                                
                                                
                                                (1.2
                                                )
                                                
                                                
                                                (2.8
                                                )
                                                
                                                
                                                (3.3
                                                )Consolidated
      Worldwide
                                                
                                                $
                                                92.4
                                                
                                                
                                                $
                                                82.1
                                                
                                                
                                                $
                                                265.8
                                                
                                                
                                                $
                                                230.1





As ofSeptember 30, 2009
                                
                                
                                December 31, 2008Long-lived
      assetsUnited
      States
                                
                                $
                                418.4
                                
                                
                                $
                                374.5United
      Kingdom
                                
                                
                                27.8
                                
                                
                                
                                23.8Other
                                
                                
                                0.1
                                
                                
                                
                                0.1Consolidated
      Worldwide
                                
                                $
                                446.3
                                
                                
                                $
                                398.4


28


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





NOTE
12: OTHER (EXPENSE) INCOME, NET





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





Three Months Ended
                          September 30,
                        
                        
                        Nine Months Ended
                          September 30,2009
                        
                        
                        2008
                        
                        
                        2009
                        
                        
                        2008Gain
      on settlement or reversal of liabilities
                        
                        $
                        —
                        
                        
                        $
                        —
                        
                        
                        $
                        0.7
                        
                        
                        $
                        0.1(Loss)
      gain on foreign currency
                        
                        
                        (0.5
                        )
                        
                        
                        (1.9
                        )
                        
                        
                        2.1
                        
                        
                        
                        (1.8
                        )(Loss)
      gain on sale or disposition of property and equipment
                        
                        
                        (0.2
                        )
                        
                        
                        (0.1
                        )
                        
                        
                        (1.1
                        )
                        
                        
                        1.1Other
                        
                        
                        0.2
                        
                        
                        
                        —
                        
                        
                        
                        0.2
                        
                        
                        
                        0.1Total
                        
                        $
                        (0.5
                        )
                        
                        $
                        (2.0
                        )
                        
                        $
                        1.9
                        
                        
                        $
                        (0.5
                        )





NOTE
13: COMMITMENTS AND CONTINGENCIES





Employment
Contracts




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





Internal
Revenue Service





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





New
York City Franchise Agreement





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


29


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





Value
Added Tax





In March
2008, the Company, through ACUK, sold certain sub-duct to an unaffiliated third
party for £0.75 British pounds ($1.5 based upon the translation rate at that
time) along with certain duct that was subject to a security interest in favor
of unaffiliated third parties for a nominal amount.  Her Majesty’s
Revenue and Customs (“HMRC”) in the U.K. has raised an issue as to whether the
sale of the duct is deemed an exempt supply, in which case the value added tax
(“VAT”) that was recovered from HMRC at the time of construction, would become
repayable.  The Company believes that based upon the original cost of
the construction, its maximum exposure would be approximately £1.6 British
pounds ($2.5 based upon the September 30, 2009 translation rate), based upon
applicable VAT rates without regard to interest and penalties.  To
date, HMRC has not made any assessment of VAT against the
Company.  The Company believes that it has adequate defenses against
any potential assessment.  Accordingly, the Company has not reflected
an accrual for this liability in the financial statements as of and for the nine
months ended September 30, 2009.





NOTE
14: SUBORDINATED INVESTMENT





In
January 2008, the Company became a strategic member, as defined, of
MediaXstream, LLC, a newly formed limited liability company that was created to
provide transport and managed network services for the production and broadcast
industries (“MediaX”).  MediaX was formed with preferred members who
contributed cash, and strategic members and management members who contribute
services.  The Company’s interest does not provide any voting rights
on MediaX’s Board of Managers.  The Company agreed to contribute
certain monthly services pursuant to a 51 month contract, which commenced April
2008, for an interest in MediaX.  Distributions to the Company are
subordinated to distributions to the preferred members of their original
investment plus a preferred return and the Company’s interest does not provide
any level of control.  Based upon amounts contributed through
September 30, 2009, the Company’s nominal ownership interest is approximately
15.4% of equity.  MediaX is a start-up company with no significant
operating history.  These factors indicated that the fair value of the
Company’s investment in MediaX is not significant.  Accordingly,
the Company has not reflected the services contributed as revenue or the
corresponding investment in MediaX in its financial statements.  The
cost of providing such services is included in costs of revenue in the relevant
period.  The Company contributed services to MediaX of $0.5 and 0.4
during the three months ended September 30, 2009 and 2008, respectively, and
$1.3 and $0.8 during the nine months ended September 30, 2009 and 2008,
respectively, which represent the estimated fair value of the services and not
the actual costs of providing such services, which are not
significant.  The Company will record distributions from MediaX, if
any, as income when received.





Additionally,
the Company provides other services to MediaX on the same basis as it provides
to other customers.  The Company billed MediaX for services and
reimbursements of $0.1 during each of the three months ended September 30, 2009
and 2008, and $0.4 during each of the nine months ended September 30, 2009 and
2008.


30


ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





NOTE
15:   COMMITMENT





In May
2009, the Company and the landlord at its executive offices at 360 Hamilton
Avenue, White Plains, New York, modified and extended the term of the Company’s
lease effective May 1, 2009 (the “Lease Effective Date”), pursuant to the Fourth
Lease Modification, Extension and Rental Reset Agreement (the “Lease
Modification”).  Under the terms of the Lease Modification, the lease,
which was originally scheduled to expire on May 31, 2010, was extended for an
additional term of 10 years to May 31, 2020.  The Lease Modification
provides for Fixed Annual Rent, as defined, totaling $11.9 from the Lease
Effective Date through the extended lease term, less an abatement of $1.1, which
shall be applied in 13 equal monthly installments from May 2009 to December 2009
and from May 2010 to September 2010.





NOTE
16:   SUBSEQUENT EVENTS





In
accordance with SFAS No. 165, the Company evaluated subsequent events through
November 5, 2009 immediately prior to the release of these consolidated
financial statements.




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, 2008.





Business





Overview





AboveNet,
Inc. (which together with its subsidiaries is sometimes hereinafter referred to
as the “Company,” “AboveNet,” “we,” “us,” “our” or “our Company”) provides
high-bandwidth connectivity solutions primarily to large corporate enterprise
clients and communication carriers, including Fortune 1000 and FTSE 500
companies, in the United States (“U.S.”) and the United Kingdom (“U.K.”). 
Our communications infrastructure and global Internet protocol (IP) network are
used by a broad range of companies such as commercial banks, brokerage houses,
insurance companies, investment banks, media companies, social networking
companies, web-centric companies, law firms and medical and health care
institutions.  Our customers rely on our high speed, private optical
network for electronic commerce and other mission-critical services, such as
business Internet applications, regulatory compliance, disaster recovery and
business continuity.  We provide lit broadband services over our metro
networks, long haul network and global IP network utilizing equipment that we
own and operate.  In addition, we also provide dark fiber services to
selected customers.  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 5,000 cable route miles in
the U.S. and in London.  In addition, we have built an inter-city
fiber network between New York and Washington D.C. of over 177,000 fiber
miles.





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





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




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 5,000 cable route
miles.  The network footprint typically allows us to serve central
offices, carrier hotels, network points-of-presence (“POPs”), data centers,
enterprise locations and traffic aggregation points, not just in the central
business district but across the entire metropolitan area in each
market.  Within our metro networks, our infrastructure provides ample
opportunity to access many additional buildings by virtue of its extensive
footprint coverage and over 5,000 network access points that can be utilized to
build laterals or connect to other networks, thereby providing access to
additional locations.





Key
Metro Network Attributes




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





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


34





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





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





On-Net
Buildings




Our metro
networks connect to over 1,900 buildings in our U.S. markets and approximately
300 in London through our lateral cables, which cover over 1,000 route
miles and over 100,000 fiber miles (which are part of the 1.9 million fiber
miles previously described). These connected buildings are referred to as on-net
buildings.





·
            Enterprise Buildings -
      Our network extends to over 1,400 enterprise locations in the U.S. and
      over 200 in London, many of which house some of the biggest corporate
      users of network services in the world.  These locations also
      include many private data centers and hub locations that are mission
      critical for our customers.




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




·
            Central Offices and Data
      Centers - Our network connects to buildings in which over 200
      central offices and approximately 400 data centers
  operate.




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





Long
Haul Network




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





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


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 and
Switch & Data.  We have extended our ability to provide IP connectivity
through our metro networks by using our fiber to bring our services to a wider
set of customers.  In addition to the U.S., the IP network has a presence
in each of London, Amsterdam, Tokyo, Paris and Frankfurt, including the
major exchanges in these markets such as LINX, AMS-IX, and JPIX.





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




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





Network
Management




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





Rights-of-Way




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





Services




Initially,
our primary business was to lease dark fiber to telecommunications carriers,
enterprises, Internet and web-centric businesses and other customers that wanted
to operate their own networks, often under long term
agreements.  Since 2003, we have shifted the focus of our business by
leveraging our extensive fiber footprint and deploying capital to extend our
fiber footprint to customers with high-bandwidth requirements within and between
our metro markets.  This transformation has allowed us to serve a much
larger marketplace with differentiated services principally provided over our
dedicated fiber.




In late
2008, we modified our service groupings and related revenue to more accurately
reflect our focus on delivering high-bandwidth services.  The new
groups are: fiber infrastructure services, metro services and WAN
services.  We recasted our revenue into these groupings, as
applicable, for 2007 and 2006 for comparative purposes and trend
analysis.  However, our revenue for 2007 compared to 2006 included in
Item 7, “Management’s Discussion and Analysis of Financial Condition and Results
of Operations,” in our Annual Report on Form 10-K for the year ended December
31, 2007, reflects the original service groupings as reported.  These
groupings consisted of: fiber services, metro transport services, IP services
and long haul services.  Our data centers, which represented a fifth
service, were sold in 2006.





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


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





WAN
Services




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





Our long
haul services provide inter-city connectivity between our 15 U.S. metro markets
at a variety of speeds ranging from 1 Gbps to 10 Gbps.  We have
deployed a next generation ultra long haul network that takes advantage of
significant capacity and distance improvements available in next generation
networks.  As a result, our service offerings require a minimum of
regeneration sites, which improves our ability to be competitive from both a
price and speed of installation perspective while reducing the number of
equipment interfaces required to deliver our service.





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





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





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





Sales
and Marketing




Our sales
force is based across most of our current 15 U.S. metro markets and
London.  Our U.S. sales force is comprised of over 60 sales
professionals and is supported by a team of sales engineers who provide
technical support during the sales process.  Our sales force primarily
focuses on enterprise customers, including Fortune 1000 companies in the U.S.
and FTSE 500 companies in London, that have large bandwidth
requirements.  This represents a change from our focus on wholesale
sales to carrier customers in previous years.  Since 2004, the vast
majority of our new sales have been to enterprise customers.




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 and data-driven
      companies (i.e. media, web-centric, 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.  Potential 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 and nine months ended September 30,
2009 and 2008, as shown in our unaudited consolidated statements of operations
included elsewhere in this Quarterly Report on Form 10-Q.





Key
Performance Indicators





Our
senior management reviews a group of financial and non-financial performance
metrics in connection with the management of our business.  These
metrics facilitate timely and effective communication of results and key
decisions, allowing management to react to changing requirements and changes in
our key performance indicators.  Some of the key financial indicators
we use include cash flow, monthly expense analysis, incremental contractual
booking of new customer business, new customer installations, churn of existing
business, and capital committed and expended.  Starting with the
quarter ended September 30, 2009, we also began to analyze the dollar value of
customer contract activity based on the following categories: (i) contract
bookings from new customers; (ii) net contract activities with existing
customers; and (iii) final customer contract terminations, the aggregate of
these three indicators representing our net customer contract
activity.  Net customer contract activity represents the net amount of
revenue expected to be added or subtracted from our monthly revenue run rate as
services to customers are installed or disconnected and is an indicator of
future revenue growth.





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 636 as of September
30, 2009, 558 of which were employed in the U.S., 76 in the U.K., one in the
Netherlands and one in Japan.





In late
2008, we modified our service groupings and the related revenue to more
accurately reflect our focus on delivering high-bandwidth
services.  The new groups are: fiber infrastructure services, metro
services and WAN services.  We recasted our revenue into these
groupings, as applicable, for the three and nine months ended September 30, 2008
for comparative purposes and trend analysis.




39


2009
Highlights




Our
consolidated revenue increased by $35.7 million, or 15.5%, from $230.1 million
to $265.8 million for the nine months ended September 30, 2009 compared to the
nine months ended September 30, 2008, driven by increases from our domestic
metro, fiber infrastructure and WAN services.





For the
nine months ended September 30, 2009, we generated operating income of $71.4
million, compared to operating income of $29.8 million for the nine months ended
September 30, 2008 and net income of $74.7 million for the nine months ended
September 30, 2009, compared to $25.0 million for the nine months ended
September 30, 2008.  During the nine months ended September 30, 2009,
we recorded a federal income tax benefit, net of a provision for alternative
minimum taxes and certain capital-based state taxes, of $4.7 million
representing income taxes either provided for or paid with respect to the years
ended December 31, 2007 and 2008.  This benefit was recorded based
upon the expected tax benefit to be realized with respect to tax depreciation in
2009 that was limited in previous years.  At September 30, 2009, we
had $122.5 million of unrestricted cash, compared to $87.1 million of
unrestricted cash at December 31, 2008, an increase in liquidity of $35.4
million.  The increase in cash at September 30, 2009
was primarily attributable to cash generated by operating activities of
$105.0 million and proceeds from the exercise of stock options and stock
warrants totaling $12.5 million, partially offset by cash used to purchase
property and equipment of $80.0 million, scheduled debt payments (including the
capital lease obligation) totaling $2.4 million and stock repurchased into
treasury of $0.3 million for the nine months ended September 30,
2009.  See below in this Item 2 under, “Liquidity and Capital
Resources,” for further discussion.





In the
nine months ended September 30, 2009, our cash flow generated by operating
activities increased compared to the nine months ended September 30, 2008, as a
result of the improvement in operating results.  We believe, based on
our business plan, that our existing cash, cash from our operating activities
and funds available under our Secured Credit Facility will be sufficient to fund
our operations, planned capital expenditures and other liquidity requirements at
least through September 30, 2010.  See below in this Item 2 under,
“Liquidity and Capital Resources,” for further information relating to the
Secured Credit Facility.





Our
revenue increased for the first nine months of 2009 compared to the same period
in 2008.  Our costs of revenue increased marginally during this
period, and our selling, general and administrative expenses decreased in 2009
compared to 2008, which resulted in an improvement in our operating
income.  Our operating results for the nine months ended September 30,
2008 were favorably impacted by the non-cash settlement of our dispute with SBC
of $3.5 million, which was substantially offset by the write-off of our
investment in a new information technology platform of $2.3 million, both of
which were recognized in the three months ended September 30,
2008.  In addition, our operating results for the nine months ended
September 30, 2008 were impacted by the March 2008 charges taken with respect to
Mr. Doris’ severance ($0.7 million), the acceleration of the vesting of Mr.
Doris’ restricted stock units ($0.5 million) and the modification of his stock
option agreement ($0.7 million), which were included in selling, general and
administrative expenses during the nine months ended September 30,
2008.  Furthermore, consolidated professional and consulting fees were
$3.8 million during the nine months ended September 30, 2009, compared to $9.3
million during the nine months ended September 30, 2008, which was attributable
to the normalization of our financial reporting.





Outlook




Our
outlook for the remainder of 2009 and beyond remains tempered by the overall
negative economic trends and weakness in parts of the economy.  We
believe that based upon our contracted projects awaiting delivery to customers,
we will continue to add to our revenue base in the fourth quarter of
2009.  For the three and nine months ended September 30, 2009, net
customer contract activity was lower than net customer contract activity in the
comparable prior year periods.  As we stated in “Key Performance
Indicators” above, net customer contract activity is a key indicator of our
future revenue growth.





We
continue to maintain a strong cash position and additionally, have access to
financing through our Secured Credit Facility, if
needed.




40


Revenue





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





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





Costs
of revenue





Costs of
revenue primarily include the following: (i) real estate expenses for all
operational sites; (ii) costs incurred to operate our networks, such as
licenses, 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 (excluding related bonuses).





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





SG&A
primarily consists of (i) employee-related costs such as salaries and
benefits, and non-cash stock-based compensation expense and bonus accruals;
(ii) real estate expenses for all administrative sites; (iii) professional,
consulting and audit fees; (iv) taxes (other than income taxes), including
property taxes and trust fund-related taxes such as gross receipts taxes; and
(v) regulatory costs, insurance, telecommunications costs, professional
fees, and license and maintenance fees for internal software and
hardware.





Depreciation
and amortization





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





Critical
Accounting Policies and Estimates





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




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
based upon our projections.





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





Revenue
Recognition




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





In
accordance with 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), we generally amortize revenue related to installation services on a
straight-line basis over the fixed contract term, which generally ranges from
two to twenty years.





Contract
termination revenue is 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 and nine months ended September
30, 2009 and 2008, we included the receipts of bankruptcy claim settlements from
former customers as contract termination revenue.  Contract
termination revenue is reported together with other service revenue, and
amounted to $0.3 million and $4.4 million in the three months ended September
30, 2009 and 2008, respectively, and $3.0 million and $6.7 million in the nine
months ended September 30, 2009 and 2008, respectively.




42


Accounts
Receivable Reserves




Sales
Credit Reserves




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





Allowance
for Doubtful Accounts




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





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 September 30, 2009 and December
31, 2008, the Company had $31.5 million and $14.8 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 $2.8 million and
$2.7 million for the three months ended September 30, 2009 and 2008,
respectively, and $8.4 million and $8.2 million for the nine months ended
September 30, 2009 and 2008, 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
              20
      yearsStorage
      huts
              20 yearsSoftware
      and computer equipment
              3
      to 4 yearsTransmission
      and IP equipment
              3
      to 7 yearsFurniture,
      fixtures and equipment
              3
      to 10 yearsLeasehold
      improvements
              Lesser
      of estimated useful life or the lease
term





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





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 $0.9 million and
$0.5 million for the three months ended September 30, 2009 and 2008,
respectively, and $2.6 million and $2.0 million for the nine months ended
September 30, 2009 and 2008, respectively.  We fully depreciated the
remaining carrying value of the network infrastructure rendered unusable, which
on an original cost basis, totaled $0.1 million and $0.3 million ($0.06 million
and $0.2 million on a net book value basis) for the three and nine months ended
September 30, 2009, respectively, and, which on an original cost basis, totaled
$0.3 million ($0.2 million on a net book value basis) for the nine months ended
September 30, 2008.  To the extent that relocation requires only the
movement of existing network infrastructure to another location, the related
costs are included in our results of operations.





In
accordance with Statement of Financial Accounting Standards (“SFAS”) No. 34,
“Capitalization of Interest Cost,” (now known as FASB ASC 835-20), we will
capitalize interest on certain construction projects.  Such amounts
were considered immaterial, and accordingly, no such amounts were capitalized
during the three and nine months ended September 30, 2009 and 2008.





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 asset.  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 in determining whether a
triggering event has occurred.  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 and $0.4 at September 30, 2009 and 2008, respectively.  We
also recorded a provision for equipment impairment of $0.5 in the nine months
ended September 30, 2009 to record the loss in value of certain equipment
eventually sold to an unaffiliated third party.


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 $7.3
million and $7.1 million at September 30, 2009 and December 31, 2008,
respectively, of which $4.0 million were included in “Accrued expenses,” for
each period and $3.3 million and $3.1 million, respectively, were included in
“Other long-term liabilities” at such dates.  Accretion expense, which
is included in “Interest expense,” amounted to $0.1 million and $0.07 million
for the three months ended September 30, 2009 and 2008, respectively, and
$0.2 million, and $0.21 million for the nine months ended September 30, 2009 and
2008, respectively.





Derivative
Financial Instruments




We
utilize interest rate swaps, derivative financial instruments
(“derivatives”), to mitigate our exposure to interest rate risk.  We
purchased the first interest rate swap on August 4, 2008 to hedge the interest
rate on the $24 million (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 million (original principal) portion of the Term Loan
provided by SunTrust Bank.  See Note 3, “Note Payable,” to the
accompanying consolidated financial statements included elsewhere in this
Quarterly Report on Form 10-Q.  We accounted for the derivatives under
SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”
(“SFAS No. 133”) (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 each at September 30, 2009 and
December 31, 2008 was $1.4 million and $1.6 million, respectively, 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,”
(“SFAS No. 161”) (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.  We do not enter into derivatives for trading
or other speculative purposes.





All
derivatives were recorded in our consolidated balance sheets at fair
value.  Accounting for the gains and losses resulting from changes in
the fair value of derivatives depends on the use of the derivative and whether
it qualifies for hedge accounting in accordance with FASB ASC 815.  As
of September 30, 2009 and December 31, 2008, our consolidated balance sheets
included net interest rate swap derivative liabilities of $1.4 million and $1.6
million, respectively.




45





Derivatives
recorded at fair value in our consolidated balance sheets as of September 30,
2009 and December 31, 2008 consisted of the following:





Derivative Liabilities
                        (In millions)Derivatives designated as hedging instruments
                      
                      September 30, 2009
                      
                      
                      December 31, 2008Interest
      rate swap agreements (*)
                      
                      $
                      1.4
                      
                      
                      $
                      1.6Total
      derivatives designated as hedging instruments
                      
                      $
                      1.4
                      
                      
                      $
                      1.6





(*)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 September 30, 2009.





Notional Amount
                                                
                                                
                                                
                                                Weighted Average Rate(In millions)
                                                
                                                Maturity Date
                                                
                                                Pay
                                                
                                                
                                                Receive$
                                                22.5
                                                
                                                2011
                                                
                                                
                                                3.65%
                                                
                                                
                                                
                                                1.21%11.3
                                                
                                                2011
                                                
                                                
                                                2.635%
                                                
                                                
                                                
                                                0.59%$
                                                33.8




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.





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.





Our
investment in overnight money market institutional funds, which amounted to
$113.5 million and $81.9 million at September 30, 2009 and December 31, 2008,
respectively, is included in cash and cash equivalents on the accompanying
balance sheets and is classified as a Level 1 asset.


46





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 $1.4 and $1.6 million in other long-term liabilities in the
consolidated balance sheets at September 30, 2009 and December 31, 2008,
respectively.  We used third parties to value each of the interest
rate swap agreements at September 30, 2009 and December 31, 2008, as well as our
own market analysis to determine fair value.  The fair value of the
interest rate swap contracts are classified as Level 2
liabilities.





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





Concentration
of Credit Risk




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





Foreign
Currency Translation and Transactions




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





Income
Taxes




We
account for income taxes in accordance with SFAS No. 109, “Accounting for Income
Taxes,” (“SFAS No. 109”) (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 carry-forwards, and tax contingencies.  Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled.  We record a valuation allowance
against deferred tax assets to the extent that it is more likely than not that
some portion or all of the deferred tax assets will not be
realized.





We are
subject to audit by various taxing authorities, and these audits may result in
proposed assessments where the ultimate resolution results in us owing
additional taxes.  We are required to establish reserves under FASB
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,”
(“Interpretation No. 48”) (now known as FASB ASC 740-10) when, despite our
belief that our tax return positions are appropriate and supportable under
appropriate tax law, we believe there is uncertainty with respect to certain
positions and we may not succeed in realizing the tax position.  We
have evaluated our tax positions for items of uncertainty in accordance with
Interpretation No. 48 and have determined that our tax positions are highly
certain within the meaning of Interpretation No. 48.  We believe the
estimates and assumptions used to support our evaluation of tax benefit
realization are reasonable.  Accordingly, no adjustments have been
made to the consolidated financial statements for the three and nine months
ended September 30, 2009 and 2008.




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 special and non-recurring items.  Assessment of the
appropriate amount and classification of income taxes is dependent on several
factors, including estimates of the timing and realization of deferred income
tax on income and deductions.  Actual realization of deferred tax
assets and liabilities may materially differ from these estimates as a result of
changes in tax laws, as well as, unanticipated future transactions impacting
related income tax balances.





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




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





Stock-Based
Compensation




On
September 8, 2003, we adopted the fair value provisions of SFAS
No. 148, “Accounting for Stock-Based Compensation Transition and
Disclosure,” (“SFAS No. 148”) (now known as FASB ASC
718-10).  SFAS No. 148 amended SFAS No. 123, “Accounting for
Stock-Based Compensation,” (“SFAS No. 123”) (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
6, “Stock-Based Compensation,” to the accompanying consolidated financial
statements included elsewhere in this Quarterly Report on Form
10-Q.





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





Effective
January 1, 2006, we adopted SFAS No. 123(R), “Share-Based Payment,”
(“SFAS No. 123(R)”) (now known as FASB ASC 718), using the modified
prospective method.  FASB ASC 718 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
FASB ASC 718 is similar to the fair value method under FASB ASC 718 with respect
to measurement and recognition of stock-based compensation expense except that
SFAS No. 123(R) requires an estimate of future forfeitures, whereas FASB
ASC 718-10 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 FASB ASC 718-10, the adoption of FASB ASC 718
resulted in a change in our accounting treatment, but it did not have a material
impact on our consolidated financial statements.  There were no
options to purchase shares of common stock granted during the three and nine
months ended September 30, 2009.  During the nine months ended
September 30, 2008, the Company awarded options to purchase 2,000 shares of
common stock to each of the five non-employee members of the Board of Directors,
all of which were granted on September 8, 2008.  The options have an
exercise price of $30.00 per share, a ten year life and vested on the first
anniversary of the date of grant.





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




Nine Months Ended
                              September 30,2008Dividend
      yield
                            
                            
                            —Expected
      volatility
                            
                            
                            80.00
                            %Risk-free
      interest rate
                            
                            
                            2.96
                            %Expected
      life (years)
                            
                            
                            5.00Weighted
      average fair value of options granted
                            
                            $
                            19.68





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


48





Results
of Operations for the Nine Months Ended September 30, 2009 Compared to the Nine
Months Ended September 30, 2008





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





Nine Months Ended September
      30,
                        
                        
                        $
      Increase/
                        
                        
                        % Increase/2009
                        
                        
                        2008
                        
                        
                        (Decrease)
                        
                        
                        (Decrease)Revenue
                        
                        $
                        265.8
                        
                        
                        $
                        230.1
                        
                        
                        $
                        35.7
                        
                        
                        
                        15.5
                        %Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                        
                        
                        95.6
                        
                        
                        
                        94.5
                        
                        
                        
                        1.1
                        
                        
                        
                        1.2
                        %Selling,
      general and administrative expenses
                        
                        
                        61.1
                        
                        
                        
                        68.8
                        
                        
                        
                        (7.7
                        )
                        
                        
                        (11.2
                        )%Depreciation
      and amortization
                        
                        
                        37.7
                        
                        
                        
                        37.0
                        
                        
                        
                        0.7
                        
                        
                        
                        1.9
                        %Operating
      income
                        
                        
                        71.4
                        
                        
                        
                        29.8
                        
                        
                        
                        41.6
                        
                        
                        
                        139.6
                        %Other
      income (expense):Interest
      income
                        
                        
                        0.3
                        
                        
                        
                        1.4
                        
                        
                        
                        (1.1
                        )
                        
                        
                        (78.6
                        )%Interest
      expense
                        
                        
                        (3.6
                        )
                        
                        
                        (2.7
                        )
                        
                        
                        0.9
                        
                        
                        
                        33.3
                        %Other
      income (expense), net
                        
                        
                        1.9
                        
                        
                        
                        (0.5
                        )
                        
                        
                        (2.4
                        )
                        
                        NMIncome
      before income taxes
                        
                        
                        70.0
                        
                        
                        
                        28.0
                        
                        
                        
                        42.0
                        
                        
                        
                        150.0
                        %(Benefit
      from) provision for income taxes
                        
                        
                        (4.7
                        )
                        
                        
                        3.0
                        
                        
                        
                        (7.7
                        )
                        
                        
                        (256.7
                        )%Net
      income
                        
                        $
                        74.7
                        
                        
                        $
                        25.0
                        
                        
                        $
                        49.7
                        
                        
                        
                        198.8
                        %





NM—not
meaningful










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





Net
Income.  Our net income for the nine months ended September 30,
2009 was $74.7 million, compared to $25.0 million for the nine months ended
September 30, 2008, an increase of $49.7 million, or 198.8%.  The
principal reasons for the increase were an increase in revenue of $35.7 million,
a decrease in selling, general and administrative expenses of $7.7 million, and
the difference between the net income tax benefit of $4.7 million recorded
for the nine months ended September 30, 2009 and the income tax provision of
$3.0 million recorded for the nine months ended September 30, 2008, which were
partially offset by an increase in costs of revenue of $1.1 million, and an
increase in depreciation and amortization of $0.7 million.  These
changes are discussed more fully below.





Revenue.  Consolidated
revenue was $265.8 million for the nine months ended September 30, 2009,
compared to $230.1 million for the nine months ended September 30, 2008, an
increase of $35.7 million, or 15.5%.  Revenue from our U.S. operations
increased by $36.6 million, or 17.8%, from $205.7 million for the nine months
ended September 30, 2008 to $242.3 million for the nine months ended September
30, 2009.  The principal reason for this increase was due to the
continued growth in each of our metro, fiber infrastructure and WAN
services.  The continued growth in revenue for each of 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 $20.9
million, or 43.1%, from $48.5 million for the nine months ended September 30,
2008 to $69.4 million for the nine months ended September 30, 2009, revenue from
fiber infrastructure services increased by $6.2 million, or 5.5%, from $111.9
million for the nine months ended September 30, 2008 to $118.1 million for the
nine months ended September 30, 2009 and revenue from WAN services increased by
$14.2 million, or 40.3%, from $35.2 million for the nine months ended September
30, 2008 to $49.4 million for the nine months ended September 30,
2009.  Revenue from our foreign operations, primarily in the U.K.,
decreased by $0.9 million, or 3.7%, from $24.4 million for the nine months ended
September 30, 2008 to $23.5 million for the nine months ended September 30,
2009.  The primary reason for this decrease was the strengthening of
the U.S. dollar against the British pound during the nine months ended September
30, 2009 compared to the nine months ended September 30, 2008.  The
translation rate of British pounds to U.S. dollars decreased 20.8% in the nine
months ended September 30, 2009 compared to the nine months ended September 30,
2008.




49





Costs of
revenue.  Consolidated costs of revenue for the nine months
ended September 30, 2009 was $95.6 million, compared to $94.5 million for the
nine months ended September 30, 2008, an increase of $1.1 million, or
1.2%.  Consolidated costs of revenue as a percentage of revenue was
36.0% for the nine months ended September 30, 2009, compared to 41.1% for the
nine months ended September 30, 2008, resulting in consolidated gross profit
margin of 64.0% and 58.9% for the nine months ended September 30, 2009 and 2008,
respectively.  The costs of revenue for our U.S. operations was $87.2
million and $87.0 million for the nine months ended September 30, 2009 and 2008,
respectively, an increase of $0.2 million, or 0.2%. The
increase in the domestic costs of revenue for the nine months ended September
30, 2009 compared to the nine months ended September 30, 2008 was attributable
principally to (i) an increase of $2.6 million in co-location expenses, to
support our IP network services and increase our presence in third party data
centers; and (ii) an increase of $2.0 million in payroll-related expenses,
primarily related to the increase in headcount in our network management,
strategic initiatives and fiber operations.  These increases were partially
offset by (i) a decrease of $2.2 million in long haul expenses including $1.0
million incurred in 2008 with respect to temporarily needed leased capacity;
(ii) a decrease of $1.3 million in amounts rebilled to customers for equipment
sales (for which there was a corresponding decrease in related revenue); and
(iii) a decrease of $0.8 million in installation costs.  Additionally,
the nine months ended September 30, 2009 includes a provision for equipment
impairment relating to inventory of $0.9 million, compared to a provision for
equipment impairment relating to inventory of $0.4 million and a lease
abandonment cost of $0.7 million for the nine months ended September 30, 2008.The costs of revenue for our foreign operations was $8.4 million for the
nine months ended September 30, 2009, compared to $7.5 million for the nine
months ended September 30, 2008, an increase of $0.9 million, or
12.0%.  Increases in right-of-way, third party network costs, leased
fiber costs and repairs and maintenance charges were partially offset by the
strengthening of the U.S. dollar against the British pound, decreasing the
comparative translation rates during the nine months ended September 30, 2009
compared to the nine months ended September 30, 2008.




Selling, General
and Administrative Expenses (“SG&A”).  Consolidated
SG&A for the nine months ended September 30, 2009 was $61.1 million,
compared to $68.8 million for the nine months ended September 30, 2008, a
decrease of $7.7 million, or 11.2%.  SG&A as a percentage of
revenue was 23.0% for the nine months ended September 30, 2009, compared to
29.9% for the nine months ended September 30, 2008.  In the U.S.,
SG&A was $53.9 million for the nine months ended September 30, 2009,
compared to $60.3 million for the nine months ended September 30, 2008, a
decrease of $6.4 million, or 10.6%.  SG&A for our U.S. operations
for the nine months ended September 30, 2009 compared to the nine months ended
September 30, 2008 decreased primarily due to a $4.9 million decrease in
professional fees due to the normalization of our financial reporting and a
decrease of $1.7 million in domestic non-cash stock-based compensation expense
from $9.3 million in the nine months ended September 30, 2008 to $7.6 million in
the nine months ended September 30, 2009.  The primary reasons for the
decrease in non-cash stock-based compensation expense were (i) the non-cash
compensation expense associated with the acceleration of the vesting of
restricted stock units relating to the termination of Mr. Doris’ employment
contract; and (ii) the non-cash compensation expense of $0.7 associated
with the modification of options to purchase common stock in connection with Mr.
Doris’ termination, both of which were incurred during the three months ended
March 31, 2008.  See Note 10, “Employment Contract Termination,” for a
further discussion of Mr. Doris’ employment contract.  We also had an
impairment charge of $2.3 million with respect to an asset abandonment during
the nine months ended September 30, 2008 (see Note 2, “Basis of Presentation and
Significant Accounting Policies - Asset Abandonment,” for a further
discussion).  These decreases were partially offset by an increase in
domestic payroll and payroll-related expenses of $1.7 million from $28.1 million
for the nine months ended September 30, 2008 to $29.8 million for the nine
months ended September 30, 2009 primarily due to an increase in headcount and an
increase in bonus accrual of $0.8 million, partially offset by a decrease in
severance expense of $0.7 million.   In addition, transaction-based
taxes increased by $1.1 million during the nine months ended September 30, 2009
compared to the nine months ended September 30, 2008.  SG&A from
our foreign operations was $7.2 million for the nine months ended September 30,
2009, compared to $8.5 million for the nine months ended September 30, 2008, a
decrease of $1.3 million, or 15.3%.  Increases in payroll-related
expenses exceeded the reduction in professional fees in the nine months ended
September 30, 2009 compared to the nine months ended September 30, 2008, which
was more than offset by the strengthening of the U.S. dollar against the British
pound during the nine months ended September 30, 2009 compared to the nine
months ended September 30, 2008.


50





Depreciation and
amortization.  Consolidated depreciation and amortization was
$37.7 million for the nine months ended September 30, 2009, compared to
$37.0 million for the nine months ended September 30, 2008, an increase of
$0.7 million, or 1.9%.  Consolidated depreciation and
amortization as a percentage of revenue was 14.2% for the nine months ended
September 30, 2009, compared to 16.1% for the nine months ended September 30,
2008.  Depreciation and amortization decreased as a result of the
elimination of depreciation expense associated with property and equipment that
became fully depreciated since September 30, 2008.  This decrease was
partially offset by the additions to property and equipment for the nine months
ended September 30, 2009 and the full period effect of depreciation on property
and equipment acquired after December 31, 2007.





Interest
income.  Interest income, substantially all of which was earned
in the U.S., decreased from $1.4 million for the nine months ended
September 30, 2008 to $0.3 million for the nine months ended September 30,
2009.  The decrease of $1.1 million, or 78.6%, was primarily due to
the decrease in short-term interest rates during the nine months ended September
30, 2009 compared to the nine months ended September 30, 2008, 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 increased from $2.7 million for the
nine months ended September 30, 2008 to $3.6 million for the nine months ended
September 30, 2009.  This increase of $0.9 million, or 33.3%, was
primarily due to interest expense incurred relating to the Secured Credit
Facility, of which $36 million was outstanding under the Term Loan for the first
six months of the nine month period ended September 30, 2009 and $34.9 million
was outstanding under the Term Loan for the last three months of the nine month
period ended September 30, 2009, compared to $24 million outstanding under the
Term Loan for only seven months during the nine month period ended September 30,
2008.





Other income
(expense), net.Other income (expense),
net consists primarily of expense or income from non-recurring transactions and
is not comparative from a trend perspective.  Consolidated other income
(expense), net consisted of other income, net of $1.9 million for the nine
months ended September 30, 2009, compared to a net expense of $0.5 million for
the nine months ended September 30, 2008, a difference of $2.4
million.  In the U.S., other income (expense), net consisted of other
income, net of $0.6 million for the nine months ended September 30, 2009,
compared to a net expense of $0.2 million for the nine months ended
September 30, 2008, a difference of $0.8 million.  For our foreign
operations, other income (expense), net consisted of other income, net of $1.3
million for the nine months ended September 30, 2009, compared to a net expense
of $0.3 million for the nine months ended September 30, 2008, a difference of
$1.6 million.  For the nine months ended September 30, 2009,
consolidated other income, net was comprised of a gain on foreign currency of
$2.1 million, gains arising from the reversal of certain tax liabilities of $0.7
million and other gains of 0.2 million, offset by a net loss on the sale or
disposition of property and equipment of $1.1 million.  For the nine
months ended September 30, 2008, consolidated other expense, net was comprised
of a loss on foreign currency of $1.8 million, offset by a gain on the sale of
certain networks in the U.K. of $1.1 million, gains arising from the reversal of
certain tax liabilities of $0.1 million and other gains of $0.1
million.





(Benefit
from) provision for income taxes.We recorded a benefit
from income taxes of $4.7 million for the nine months ended September 30, 2009,
compared to a provision for income taxes of $3.0 million for the nine months
ended September 30, 2008.  The benefit is based upon the anticipated
2009 loss for income tax purposes.  The benefit recorded represents
the receivable established for the refunds of federal income tax payments paid
with respect to the tax filings for the years ended December 31, 2007 and 2008
and the reversal of the federal income taxes accrued at December 31, 2008, net
of the provision for alternative minimum taxes and certain capital-based
state taxes.




51


Results
of Operations for the Three Months Ended September 30, 2009 Compared to the
Three Months Ended September 30, 2008





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





Three Months Ended September
      30,
                    
                    
                    $
      Increase/
                    
                    
                    % Increase/2009
                    
                    
                    2008
                    
                    
                    (Decrease)
                    
                    
                    (Decrease)Revenue
                    
                    $
                    92.4
                    
                    
                    $
                    82.1
                    
                    
                    $
                    10.3
                    
                    
                    
                    12.5
                    %Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                    
                    
                    33.9
                    
                    
                    
                    32.1
                    
                    
                    
                    1.8
                    
                    
                    
                    5.6
                    %Selling,
      general and administrative expenses
                    
                    
                    20.3
                    
                    
                    
                    22.9
                    
                    
                    
                    (2.6
                    )
                    
                    
                    (11.4
                    )%Depreciation
      and amortization
                    
                    
                    13.5
                    
                    
                    
                    12.2
                    
                    
                    
                    1.3
                    
                    
                    
                    10.7
                    %Operating
      income
                    
                    
                    24.7
                    
                    
                    
                    14.9
                    
                    
                    
                    9.8
                    
                    
                    
                    65.8
                    %Other
      income (expense):Interest
      income
                    
                    
                    —
                    
                    
                    
                    0.5
                    
                    
                    
                    (0.5
                    )
                    
                    
                    (100.0
                    )%Interest
      expense
                    
                    
                    (1.3
                    )
                    
                    
                    (1.1
                    )
                    
                    
                    0.2
                    
                    
                    
                    18.2
                    %Other
      expense, net
                    
                    
                    (0.5
                    )
                    
                    
                    (2.0
                    )
                    
                    
                    (1.5
                    )
                    
                    
                    (75.0
                    )%Income
      before income taxes
                    
                    
                    22.9
                    
                    
                    
                    12.3
                    
                    
                    
                    10.6
                    
                    
                    
                    86.2
                    %Provision
      for income taxes
                    
                    
                    0.2
                    
                    
                    
                    1.9
                    
                    
                    
                    (1.7
                    )
                    
                    
                    (89.5
                    )%Net
      income
                    
                    $
                    22.7
                    
                    
                    $
                    10.4
                    
                    
                    $
                    12.3
                    
                    
                    
                    118.3
                    %





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 September
30, 2009 was $22.7 million, compared to $10.4 million for the three months ended
September 30, 2008, an increase of $12.3 million, or 118.3%.  The
principal reasons for the increase were an increase in revenue of $10.3 million,
a decrease in selling, general and administrative expenses of $2.6 million and a
decrease in other expense, net of $1.5 million, partially offset by an increase
in costs of revenue of $1.8 million, and decreases in interest income of $0.5
million and interest expense of $0.2 million.  These changes are
discussed more fully below.





Revenue.  Consolidated
revenue was $92.4 million for the three months ended September 30, 2009,
compared to $82.1 million for the three months ended September 30, 2008, an
increase of $10.3 million, or 12.5%.  Revenue from our U.S. operations
increased by $9.8 million, or 13.3%, from $73.8 million for the three months
ended September 30, 2008 to $83.6 million for the three months ended September
30, 2009.  The principal reason for this increase was due to the
continued growth in each of our metro, fiber infrastructure and WAN
services.  The continued growth in revenue for each of 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 $7.2
million, or 40.9%, from $17.6 million for the three months ended September 30,
2008 to $24.8 million for the three months ended September 30, 2009, revenue
from fiber infrastructure services increased by $2.5 million, or 6.6%, from
$38.0 million for the three months ended September 30, 2008 to $40.5 million for
the three months ended September 30, 2009 and revenue from WAN services
increased by $4.4 million, or 34.6%, from $12.7 million for the three months
ended September 30, 2008 to $17.1 million for the three months ended September
30, 2009.  Revenue from our foreign operations, primarily in the U.K.,
increased by $0.5 million, or 6.0%, from $8.3 million for the three months ended
September 30, 2008 to $8.8 million for the three months ended September 30,
2009.  The primary reason for this increase was the growth in our U.K.
metro revenue, which was partially offset by the strengthening of the U.S.
dollar against the British pound during the three months ended September 30,
2009 compared to the three months ended September 30, 2008.  The
translation rate of British pounds to U.S. dollars decreased 13.5% in the three
months ended September 30, 2009 compared to the three months ended September 30,
2008.




52




Costs of
revenue.  Consolidated costs of revenue for the three months
ended September 30, 2009 was $33.9 million, compared to $32.1 million for the
three months ended September 30, 2008, an increase of $1.8 million, or
5.6%.  Consolidated costs of revenue as a percentage of revenue was
36.7% for the three months ended September 30, 2009, compared to 39.1% for the
three months ended September 30, 2008, resulting in consolidated gross profit
margin of 63.3% and 60.9% for the three months ended September 30, 2009 and
2008, respectively.  The costs of revenue for our U.S. operations was
$30.7 million and $29.4 million for the three months ended September 30, 2009
and 2008, respectively, an increase of $1.3 million, or 4.4%.  The
increase in the domestic costs of revenue for the three months ended September
30, 2009 compared to the three months ended September 30, 2008 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; and (ii) an increase of $1.0 million for expenses associated with third
party network costs.  Additionally, both the three months ended
September 30, 2009 and September 30, 2008 include a provision for equipment
impairment relating to inventory of $0.4 million and the three months ended
September 30, 2008 included a lease abandonment cost of $0.7
million.  The costs of revenue for our foreign operations was $3.2
million for the three months ended September 30, 2009, compared to $2.7 million
for the three months ended September 30, 2008, an increase of $0.5 million, or
18.5%.  Increases in payroll, right-of-way, third party network costs,
leased fiber costs and repairs and maintenance charges exceeded the benefit from
the strengthening of the U.S. dollar against the British pound, decreasing the
comparative translation rates during the three months ended September 30, 2009
compared to the three months ended September 30, 2008.




Selling, General
and Administrative Expenses (“SG&A”).  Consolidated
SG&A for the three months ended September 30, 2009 was $20.3 million,
compared to $22.9 million for the three months ended September 30, 2008, a
decrease of $2.6 million, or 11.4%.  SG&A as a percentage of
revenue was 22.0% for the three months ended September 30, 2009, compared to
27.9% for the three months ended September 30, 2008.  In the U.S.,
SG&A was $18.0 million for the three months ended September 30, 2009,
compared to $19.8 million for the three months ended September 30, 2008, a
decrease of $1.8 million, or 9.1%.  SG&A for our U.S. operations
for the three months ended September 30, 2009 compared to the three months ended
September 30, 2008 decreased primarily due to a $1.9 million decrease in
professional fees due to the normalization of our financial
reporting.  We also had an impairment charge of $2.3 million with
respect to an asset abandonment during the three months ended September 30, 2008
(see Note 2, “Basis of Presentation and Significant Accounting Policies - Asset
Abandonment,” for a further discussion).  These decreases were
partially offset by an increase of $0.8 million in domestic non-cash stock-based
compensation expense from $1.6 million in the three months ended September 30,
2008 to $2.4 million in the three months ended September 30, 2009, an increase
in domestic payroll and payroll-related expenses of $0.8 million from $9.1
million for the three months ended September 30, 2008 to $9.9 million for the
three months ended September 30, 2009 and an increase
in transaction-based taxes of $0.7 million.  SG&A from our
foreign operations was $2.3 million for the three months ended September 30,
2009, compared to $3.1 million for the three months ended September 30, 2008, a
decrease of $0.8 million, or 25.8%, as increases in payroll-related expenses
were more than offset by reductions in professional fees with a further
reduction caused by the strengthening of the U.S. dollar against the British
pound.





Depreciation and
amortization.  Consolidated depreciation and amortization was
$13.5 million for the three months ended September 30, 2009, compared to $12.2
million for the three months ended September 30, 2008, an increase of
$1.3 million, or 10.7%.  Consolidated depreciation and
amortization as a percentage of revenue was 14.6% for the three months ended
September 30, 2009, compared to 14.9% for the three months ended September 30,
2008.  This increase was primarily attributable to additions of
property and equipment for the three months ended September 30, 2009 and the
full period effect of depreciation on property and equipment acquired after June
30, 2008.





Interest
income.  Interest income, substantially all of which was earned
in the U.S., decreased by $0.5 million during the three months ended September
30, 2009 compared to the three months ended September 30, 2008.  The
decrease of $0.5 million was primarily due to the decrease in short-term
interest rates during the three months ended September 30, 2009 compared to the
three months ended September 30, 2008, 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 increased from $1.1 million for the
three months ended September 30, 2008 to $1.3 million for the three months ended
September 30, 2009.  This increase of $0.2 million, or 18.2%, was
primarily due to interest expense incurred relating to the Secured Credit
Facility, of which $34.9 million was outstanding under the Term Loan for the
three month period ended September 30, 2009, compared to $24 million outstanding
under the Term Loan for the three month period ended September 30,
2008.




53


Other expense,
net.Other
expense, net consists primarily of expense or income from non-recurring
transactions and is not comparative from a trend perspective.  Consolidated
other expense, net was a net expense of $0.5 million for the three months ended
September 30, 2009, compared to a net expense of $2.0 million for the three
months ended September 30, 2008, a decrease in other expense of $1.5
million, or 75.0%.  In the U.S., other income, net was $0.2 million
for the three months ended September 30, 2009, compared to $0.1 million for the
three months ended September 30, 2008, an increase in other income of $0.1
million.  For our foreign operations, other expense, net was a net
expense of $0.7 million for the three months ended September 30, 2009, compared
to a net expense of $2.1 million for the three months ended September 30, 2008,
a decrease in other expense of $1.4 million.  For the three months
ended September 30, 2009, consolidated other expense, net was comprised of a
loss on foreign currency of $0.5 million, a loss on the sale or disposition of
property and equipment of $0.2 million offset by other gains of $0.2
million.  For the three months ended September 30, 2008, consolidated
other expense, net was comprised of a loss on foreign currency of $1.9 million
and a loss on sale or disposition of property and equipment of $0.1
million.





Provision for
income taxes.We recorded a provision
for income taxes of $0.2 million for the three months ended September 30, 2009,
compared to a provision for income taxes of $1.9 million for the three months
ended September 30, 2008.  The provision for income taxes during the
three months ended September 30, 2009 was provided for certain capital-based
state taxes.  The provision for income taxes during the three months
ended September 30, 2008 was provided for estimated federal income taxes and
certain capital-based state taxes.





Liquidity
and Capital Resources




We had
working capital of $59.5 million at September 30, 2009, compared to working
capital of $11.8 million at December 31, 2008, an increase of $47.7
million.  This increase was primarily attributable to an increase in
unrestricted cash of $35.4 million from $87.1 million at December 31, 2008 to
$122.5 million at September 30, 2009.  The increase in unrestricted
cash was primarily attributable to cash provided by operating activities,
partially offset by cash used in investing activities, which are discussed more
fully below.  These increases were partially offset by an increase in
prepaid costs and other current assets of $3.7 million, a decrease in accounts
payable and accrued expenses of $9.2 million and $7.1 million, respectively, and
the increase in accounts receivable, net of $3.4 million.





Net cash
provided by operating activities was $105.0 million during the nine months ended
September 30, 2009, compared to $76.4 million during the nine months ended
September 30, 2008, an increase of $28.6 million.  Net cash provided
by operating activities during the nine months ended September 30, 2009 resulted
primarily from the add back of non-cash items deducted in the determination of
net income, principally depreciation and amortization of $37.7 million and
stock-based compensation expense of $8.3 million.  Additionally, cash
provided by operating activities included the collection of $12.0 million in
connection with the delivery of services to a customer in the nine months ended
September 30, 2009, which is being recognized ratably as revenue over the
related 60 month contract term, net of amortization of other installation
payments and prepayments for services.  Net cash provided by operating
activities during the nine months ended September 30, 2008 resulted primarily
from the add back of non-cash items deducted in the determination of net income,
principally depreciation and amortization of $37.0 million and stock-based
compensation expense of $9.6 million.





Net cash
used in investing activities during the nine months ended September 30, 2009 was
$80.0 million, compared to $81.2 million during the nine months ended September
30, 2008, a decrease of $1.2 million.  Net cash used in investing
activities during the nine months ended September 30, 2009 was attributable to
the purchases of property and equipment of $80.0 million.  Net cash
used in investing activities during the nine months ended September 30, 2008 was
attributable to the purchases of property and equipment of $82.9 million,
partially offset by the proceeds generated from sales of property and equipment
of $1.7 million.  The property and equipment that is purchased in each
period is used primarily to connect new customers to our networks and to build
our infrastructure.





Net cash
generated by financing activities was $9.8 million during the nine months ended
September 30, 2009, which is comprised of the proceeds from the exercise of
options to purchase shares of common stock of $7.7 million and the proceeds from
the exercise of warrants of $4.8 million, partially offset by the principal
payment under the Secured Credit Facility of $2.2 million, the purchase of
treasury stock of $0.3 million and the principal payment on our capital lease
obligation of $0.2 million.  Net cash provided by financing activities
was $32.4 million during the nine months ended September 30, 2008, which is
comprised of the $22.3 million of net proceeds received from the funding of the
$24 million Term Loan under the Secured Credit Facility, the proceeds from the
exercise of warrants of $10.7 million and the release of restricted cash and
cash equivalents of $1.3 million, partially offset by the purchase of shares
from employees in connection with the delivery of vested restricted stock units
of $1.7 million and the principal payment on our capital lease obligation of
$0.2 million.


54





During
the nine months ended September 30, 2009, we generated cash from operations that
was sufficient to fund our operating expenses and expenditures for property and
equipment of $80.0 million.





On
February 29, 2008, we (excluding certain foreign subsidiaries) entered into the
$60 million Secured Credit Facility comprised of: (i) an $18 million Revolver;
and (ii) a $42 million Term Loan (including an $18 million Delayed Draw Term
Loan).  The initial lenders under the Secured Credit Facility were
Societe Generale and CIT Lending Services Corporation (the “Initial
Lenders”).  On September 26, 2008, we executed a joinder agreement to
the Secured Credit Facility that added SunTrust Bank as an additional lender
(together with the Initial Lenders, the “Lenders”) and increased the amount of
the Secured Credit Facility to $90 million effective October 1,
2008.  The availability under the Revolver increased to $27 million,
and the Term Loan availability increased to $63 million, $27 million of which
represented the Delayed Draw Term Loan.  Additionally, the Delayed
Draw Term Loan option available under the Secured Credit Facility, which was
originally scheduled to expire on November 25, 2008, was initially extended to
June 30, 2009 and then subsequently extended to December 31,
2009.  The borrowings under the Secured Credit Facility mature on
February 28, 2013.  The Secured Credit Facility is secured by
substantially all of our domestic assets.   Our ability to draw upon
the available commitments under the Revolver is subject to compliance with all
of the covenants contained in the credit agreement and our continued ability to
make certain representations and warranties.  Among other things,
these covenants restrict our ability to pay dividends, limit annual capital
expenditures in 2008, 2009 and 2010, provide that our net total funded debt
ratio cannot at any time exceed a specified amount and require that we maintain
a minimum consolidated fixed charges coverage ratio.  As of September
30, 2009, we had $33.8 million outstanding under the Secured Credit
Facility.  We are party to two interest rate swaps, which are utilized to
modify our interest rate risk under the Secured Credit
Facility.  Under these interest rate swap arrangements, our borrowing
costs with respect to $24 million borrowed under the Term Loan is fixed at 6.65%
per annum through July 31, 2011 and our borrowing costs with respect to $12
million borrowed under the Term Loan is fixed at 5.635% per annum through
November 1, 2011.  We have chosen 30 day LIBOR as the interest rate
during the term of the interest rate swaps (30 day LIBOR was 0.26125% at
September 30, 2009).





On June
29, 2009, we and the Lenders entered into an amendment to the Secured Credit
Facility, 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 $0.8 million on each of June 30, 2009 and
September 30, 2009 and a further $0.8 million reduction on December 31, 2009 in
the event that all or a portion of the Delayed Draw Term Loan commitments remain
undrawn on such date.  In addition, the obligation to commence making
principal payments on any outstanding Delayed Draw Term Loan was extended to
March 31, 2010 and our obligation to maintain a minimum balance of $20 million
in cash deposits at all times was eliminated.  We paid the Lenders a
$0.1 million amendment fee and paid the administrative agent a work
fee.





In May
2009, we entered into a modification and extension of our lease (the “Lease
Modification”) of our executive office, which was originally scheduled to expire
on May 31, 2010.  The Lease Modification provides for an additional
term of 10 years (expiring May 31, 2020) and fixed annual rent totaling $11.9
million over the extended term, less a rent abatement of $1.1
million.





$7.2
million of the availability under the Revolver and $7.1 million of the
availability under the Delayed Draw Term Loan are with CIT Lending Services
Corporation (“CIT
Lending”).  On
November 1, 2009, CIT Group Inc., the parent of CIT Lending, and CIT
Group Funding Company of Delaware LLC filed for protection under
Chapter 11 of the U.S. Bankruptcy Code.  The impact of the bankruptcy
filing has not yet been determined.  The Company may have difficulties
drawing funds from CIT Lending in the future.





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 September 30, 2010.





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




55




Segment
Results





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





United
States:





Three Months Ended September
      30,
                      
                      
                      $
      Increase /
                      
                      
                      % Increase
      /2009
                      
                      
                      2008
                      
                      
                      (Decrease)
                      
                      
                      (Decrease)(Dollars
      in millions)Revenue
                      
                      $
                      83.6
                      
                      
                      $
                      73.8
                      
                      
                      $
                      9.8
                      
                      
                      
                      13.3
                      %Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                      
                      
                      30.7
                      
                      
                      
                      29.4
                      
                      
                      
                      1.3
                      
                      
                      
                      4.4
                      %Selling,
      general and administrative expenses
                      
                      
                      18.0
                      
                      
                      
                      19.8
                      
                      
                      
                      (1.8
                      )
                      
                      
                      (9.1
                      )%Depreciation
      and amortization
                      
                      
                      11.7
                      
                      
                      
                      10.6
                      
                      
                      
                      1.1
                      
                      
                      
                      10.4
                      %Operating
      income
                      
                      
                      23.2
                      
                      
                      
                      14.0
                      
                      
                      
                      9.2
                      
                      
                      
                      65.7
                      %Other
      income (expense):Interest
      income
                      
                      
                      —
                      
                      
                      
                      0.5
                      
                      
                      
                      (0.5
                      )
                      
                      
                      (100.0
                      )%Interest
      expense
                      
                      
                      (1.3
                      )
                      
                      
                      (1.1
                      )
                      
                      
                      0.2
                      
                      
                      
                      18.2
                      %Other
      income, net
                      
                      
                      0.2
                      
                      
                      
                      0.1
                      
                      
                      
                      0.1
                      
                      
                      
                      100.0
                      %Income
      before income taxes
                      
                      
                      22.1
                      
                      
                      
                      13.5
                      
                      
                      
                      8.6
                      
                      
                      
                      63.7
                      %Provision
      for income taxes
                      
                      
                      0.2
                      
                      
                      
                      1.9
                      
                      
                      
                      (1.7
                      )
                      
                      
                      (89.5
                      )%Net
      income
                      
                      $
                      21.9
                      
                      
                      $
                      11.6
                      
                      
                      $
                      10.3
                      
                      
                      
                      88.8
                      %





United
Kingdom and others:





Three Months Ended September
      30,
                      
                      
                      $
      Increase /
                      
                      
                      % Increase
      /2009
                      
                      
                      2008
                      
                      
                      (Decrease)
                      
                      
                      (Decrease)(Dollars
      in millions)Revenue
                      
                      $
                      8.8
                      
                      
                      $
                      8.3
                      
                      
                      $
                      0.5
                      
                      
                      
                      6.0
                      %Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                      
                      
                      3.2
                      
                      
                      
                      2.7
                      
                      
                      
                      0.5
                      
                      
                      
                      18.5
                      %Selling,
      general and administrative expenses
                      
                      
                      2.3
                      
                      
                      
                      3.1
                      
                      
                      
                      (0.8
                      )
                      
                      
                      (25.8
                      )%Depreciation
      and amortization
                      
                      
                      1.8
                      
                      
                      
                      1.6
                      
                      
                      
                      0.2
                      
                      
                      
                      12.5
                      %Operating
      income
                      
                      
                      1.5
                      
                      
                      
                      0.9
                      
                      
                      
                      0.6
                      
                      
                      
                      66.7
                      %Other
      (expense) income:Interest
      income
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —Other
      expense, net
                      
                      
                      (0.7
                      )
                      
                      
                      (2.1
                      )
                      
                      
                      (1.4
                      )
                      
                      
                      (66.7
                      )%Income
      (loss) before income taxes
                      
                      
                      0.8
                      
                      
                      
                      (1.2
                      )
                      
                      
                      (2.0
                      )
                      
                      
                      (166.7
                      )%Provision
      for income taxes
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —Net
      income (loss)
                      
                      $
                      0.8
                      
                      
                      $
                      (1.2
                      )
                      
                      $
                      (2.0
                      )
                      
                      
                      (166.7
                      )%





NM—not
meaningful










The
segment results for the three months ended September 30, 2009 and 2008 (above)
reflect the elimination of any intercompany sales or charges.


56




United
States:





Nine Months Ended September 30,
                              
                              
                              $ Increase
      /
                              
                              
                              % Increase
      /2009
                              
                              
                              2008
                              
                              
                              (Decrease)
                              
                              
                              (Decrease)(Dollars in millions)Revenue
                              
                              $
                              242.3
                              
                              
                              $
                              205.7
                              
                              
                              $
                              36.6
                              
                              
                              
                              17.8
                              %Costs of revenue (excluding
      depreciation and amortization, shown separately
    below)
                              
                              
                              87.2
                              
                              
                              
                              87.0
                              
                              
                              
                              0.2
                              
                              
                              
                              0.2
                              %Selling, general and
      administrative expenses
                              
                              
                              53.9
                              
                              
                              
                              60.3
                              
                              
                              
                              (6.4
                              )
                              
                              
                              (10.6
                              )%Depreciation and
      amortization
                              
                              
                              33.0
                              
                              
                              
                              32.1
                              
                              
                              
                              0.9
                              
                              
                              
                              2.8
                              %Operating
      income
                              
                              
                              68.2
                              
                              
                              
                              26.3
                              
                              
                              
                              41.9
                              
                              
                              
                              159.3
                              %Other income
      (expense):Interest
    income
                              
                              
                              0.3
                              
                              
                              
                              1.3
                              
                              
                              
                              (1.0
                              )
                              
                              
                              (76.9
                              )%Interest
      expense
                              
                              
                              (3.6
                              )
                              
                              
                              (2.7
                              )
                              
                              
                              0.9
                              
                              
                              
                              33.3
                              %Other
      income (expense), net
                              
                              
                              0.6
                              
                              
                              
                              (0.2
                              )
                              
                              
                              (0.8
                              )
                              
                              NMIncome before income
      taxes
                              
                              
                              65.5
                              
                              
                              
                              24.7
                              
                              
                              
                              40.8
                              
                              
                              
                              165.2
                              %(Benefit from) provision for
      income taxes
                              
                              
                              (4.7
                              )
                              
                              
                              3.0
                              
                              
                              
                              (7.7
                              )
                              
                              
                              (256.7
                              )%Net income
                              
                              $
                              70.2
                              
                              
                              $
                              21.7
                              
                              
                              $
                              48.5
                              
                              
                              
                              223.5
                              %





United
Kingdom and others:


Nine Months Ended September 30,
                                          
                                          
                                          $ Increase /
                                          
                                          
                                          % Increase
      /2009
                                          
                                          
                                          2008
                                          
                                          
                                          (Decrease)
                                          
                                          
                                          (Decrease)(Dollars in millions)Revenue
                                          
                                          $
                                          23.5
                                          
                                          
                                          $
                                          24.4
                                          
                                          
                                          $
                                          (0.9
                                          )
                                          
                                          
                                          (3.7
                                          )%Costs of revenue (excluding
      depreciation and amortization, shown separately
    below)
                                          
                                          
                                          8.4
                                          
                                          
                                          
                                          7.5
                                          
                                          
                                          
                                          0.9
                                          
                                          
                                          
                                          12.0
                                          %Selling, general and
      administrative expenses
                                          
                                          
                                          7.2
                                          
                                          
                                          
                                          8.5
                                          
                                          
                                          
                                          (1.3
                                          )
                                          
                                          
                                          (15.3
                                          )%Depreciation and
      amortization
                                          
                                          
                                          4.7
                                          
                                          
                                          
                                          4.9
                                          
                                          
                                          
                                          (0.2
                                          )
                                          
                                          
                                          (4.1
                                          )%Operating
      income
                                          
                                          
                                          3.2
                                          
                                          
                                          
                                          3.5
                                          
                                          
                                          
                                          (0.3
                                          )
                                          
                                          
                                          (8.6
                                          )%Other income
      (expense):Interest
    income
                                          
                                          
                                          —
                                          
                                          
                                          
                                          0.1
                                          
                                          
                                          
                                          (0.1
                                          )
                                          
                                          
                                          (100.0
                                          )%Other income (expense),
      net
                                          
                                          
                                          1.3
                                          
                                          
                                          
                                          (0.3
                                          )
                                          
                                          
                                          (1.6
                                          )
                                          
                                          NMIncome before income
      taxes
                                          
                                          
                                          4.5
                                          
                                          
                                          
                                          3.3
                                          
                                          
                                          
                                          1.2
                                          
                                          
                                          
                                          36.4
                                          %Provision for income
      taxes
                                          
                                          
                                          —
                                          
                                          
                                          
                                          —
                                          
                                          
                                          
                                          —
                                          
                                          
                                          
                                          —Net income
                                          
                                          $
                                          4.5
                                          
                                          
                                          $
                                          3.3
                                          
                                          
                                          $
                                          1.2
                                          
                                          
                                          
                                          36.4
                                          %





NM—not meaningful







The
segment results for the nine months ended September 30, 2009 and 2008 (above)
reflect the elimination of any intercompany sales or charges.


57


Credit
Risk







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





Off-balance
sheet arrangements





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





Inflation





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





Certain
Factors That May Affect Future Results





Information
contained or incorporated by reference in this Quarterly Report on Form 10-Q, in
other SEC filings by the Company, in press releases, and in presentations by the
Company or its management 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, 2008 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.





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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 nine months ended September 30, 2009, our
foreign activities accounted for 8.8% of consolidated revenue.  Due to
the strengthening of the U.S. dollar against the British pound, the translation
rate for the nine months ended September 30, 2009 decreased 20.8% compared to
the translation rate used for the nine months ended September 30,
2008.  We monitor foreign markets and our commitments in such markets
to manage currency and other risks.  To date, based upon our level of
foreign operations, we have not entered into any hedging arrangement designed to
limit exposure to foreign currencies.  If we increase our level of
foreign activities, or if at current levels we determine that such arrangements
would be appropriate, we will consider such arrangements to minimize
risk.





Under the
terms of the Secured Credit Facility, our borrowings bear interest based upon
short-term LIBOR rates or our administrative agent’s (Societe Generale) base
rate, at our discretion, plus the applicable margins, as defined.  If
the operative rate increases, our cost of borrowing would also increase, if not
hedged, thereby increasing the costs of our investment strategy.  For
example, if LIBOR was to increase by 1% for the full year, our borrowing costs,
based on our indebtedness outstanding at September 30, 2009, would increase by
$0.338 million (1% x $33.8 million).  However, effective August 4,
2008, we entered into a swap arrangement under which we fixed our borrowing
costs with respect to the $24 million borrowed under the Term Loan on February
29, 2008 for three years at 3.65% per annum, plus the applicable margin of
3.25%, which was reduced to 3.00% on September 30, 2008 upon the filing of
our Annual Report on Form 10-K for the year ended December 31, 2007.  On
November 14, 2008, we entered into a swap arrangement under which we fixed our
borrowing costs with respect to the $12 million borrowed under the expanded Term
Loan for three years at 2.635% per annum, plus the applicable margin of 3.00%.
 The swaps have had the effect of increasing our current interest expense
compared to the relevant LIBOR rates and reducing our risk of increases in
future interest expenses from increasing LIBOR rates.





As of
September 30, 2009, we had $33.8 million outstanding under the Secured Credit
Facility.  Additionally, we had a capital lease obligation
outstanding, which carried a fixed rate of interest, and as a result, we were
not exposed to related interest rate risk.





59




ITEM
4.  CONTROLS AND PROCEDURES





Evaluation of Disclosure
Controls and Procedures





As of
September 30, 2009, the Company carried out an evaluation, under the supervision
of and with the participation of the Company’s Chief Executive Officer and the
Chief Financial Officer, who are, respectively, the Company’s principal
executive officer and principal financial officer, of the effectiveness of the
Company’s disclosure controls and procedures (as defined in Rules 13a-15(e)
and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)),
pursuant to Exchange Act Rule 13a-15.  Based on such evaluation, the
Company’s Chief Executive Officer and the Chief Financial Officer concluded that
the Company’s disclosure controls and procedures were not effective as of
September 30, 2009.





Remediation





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





Changes
in Internal Control Over Financial Reporting





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





60




PART
II.  OTHER INFORMATION





ITEM
1.  LEGAL PROCEEDINGS





The
information presented in Item 3, “Legal Proceedings,” of the Company’s Annual
Report on Form 10-K for the year ended December 31, 2008 and Note 8,
“Litigation,” to the consolidated financial statements included elsewhere in
this Quarterly Report on Form 10-Q, are hereby incorporated by
reference.





ITEM 1A.  RISK
FACTORS





In
addition to the other information set forth in this Quarterly Report on Form
10-Q, you should carefully consider the factors discussed below and under ”Risk
Factors” in the Company’s Annual Report on Form 10-K for the year ended December
31, 2008, which could materially affect the Company’s business, financial
condition or future results.  The risks described below and 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.  Other than as discussed
below, there have been no material changes in our risk factors from those
disclosed in our Annual Report on Form 10-K for the year ended December 31,
2008.





The
weakness of financial institutions could adversely affect us.





Commitments
of $7.2 million of the availability under the Revolver and $7.1 million of the
availability under the Delayed Draw Term Loan are provided by CIT Lending
Services Corporation (“CIT Lending”).  On
November 1, 2009, CIT Group Inc., the parent of CIT Lending, and CIT Group
Funding Company of Delaware LLC filed for protection under Chapter 11 of the
U.S. Bankruptcy Code.  The impact of the bankruptcy filing has not yet
been determined.  The Company may have difficulties drawing funds from
CIT Lending in the future.





Current economic trends and recessionary
pressure could negatively affect our future operating
results.




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




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




We have experienced a reduction in our
net customer contract activity in the nine months ended September 30, 2009
compared to the nine months ended September 30, 2008, in part we believe due to
the current economic conditions and financial difficulties being experienced by
our customers.  Unless we can increase our net customer contract
activity in the future, we may not be able to sustain the percentage level of
revenue growth we have achieved during 2008 and through September
2009.





61




ITEM 6.  EXHIBITS





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


62





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:November 5, 2009
                        By:
                        /s/ William G.
      LaPerchWilliam G.
      LaPerch
                          President, Chief Executive Officer
      and Director
                          (Principal Executive Officer and
      Duly Authorized
Officer)





Date:November 5,2009
            By:
            /s/ Joseph P.
      CiavarellaJoseph P.
      Ciavarella
              Senior Vice President and Chief
      Financial Officer
              (Principal Financial and
      Accounting Officer)


63





EXHIBIT
INDEX





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


64