UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





FORM
10-Q





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





For
the quarterly period ended June 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 August 6, 2009, was 11,516,932.













Table
of Contents





ABOVENET,
INC.





INDEX








PagePart
      I.
                            FINANCIAL
      INFORMATIONItem
      1.
                            Financial
      StatementsConsolidated
      Balance SheetsAs
      of June 30, 2009 (Unaudited) and December 31, 2008
                            
                            1Consolidated
      Statements of Operations (Unaudited)Three
      and Six month periods ended June 30, 2009 and 2008
                            
                            2Consolidated
      Statement of Shareholders’ Equity (Unaudited)Six
      month period ended June 30, 2009
                            
                            3Consolidated
      Statements of Cash Flows (Unaudited)Six
      month periods ended June 30, 2009 and 2008
                            
                            4Consolidated
      Statements of Comprehensive Income (Unaudited)Three
      and Six month periods ended June 30, 2009 and 2008
                            
                            5Notes
      to Unaudited Consolidated Financial Statements
                            
                            6Item
      2.
                            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                            
                            31Item
      3.
                            Quantitative
      and Qualitative Disclosures about Market Risk
                            
                            58Item
      4.
                            Controls
      and Procedures
                            
                            59Part
      II.
                            OTHER
      INFORMATIONItem
      1.
                            Legal
      Proceedings
                            
                            60Item
      1A.
                            Risk
      Factors
                            
                            60Item
      4.
                            Submission
      of Matters to a Vote of Security Holders
                            
                            60Item
      6.
                            Exhibits
                            
                            61Signatures
                            
                            62Exhibit
      Index











PART
I.  FINANCIAL INFORMATION





ITEM
1.  FINANCIAL STATEMENTS





ABOVENET,
INC. AND SUBSIDIARIES





CONSOLIDATED
BALANCE SHEETS


(in
millions, except share and per share information)





June 30,
                    2009
                  
                  
                  December 31,2008(Unaudited)ASSETS:Current
      assets:Cash
      and cash equivalents
                  
                  $
                  110.0
                  
                  
                  $
                  87.1Restricted
      cash and cash equivalents
                  
                  
                  3.7
                  
                  
                  
                  3.5Accounts
      receivable, net of allowances of $1.4 and $1.3 at June 30, 2009 and
      December 31, 2008, respectively
                  
                  
                  20.3
                  
                  
                  
                  19.2Prepaid
      costs and other current assets
                  
                  
                  11.2
                  
                  
                  
                  9.8Total
      current assets
                  
                  
                  145.2
                  
                  
                  
                  119.6Property
      and equipment, net of accumulated depreciation and amortization of $225.5
      and $207.4 at June 30, 2009 and December 31, 2008,
      respectively
                  
                  
                  433.5
                  
                  
                  
                  398.4Other
      assets
                  
                  
                  7.0
                  
                  
                  
                  5.9Total
      assets
                  
                  $
                  585.7
                  
                  
                  $
                  523.9LIABILITIES:Current
      liabilities:Accounts
      payable
                  
                  $
                  8.9
                  
                  
                  $
                  13.9Accrued
      expenses
                  
                  
                  62.4
                  
                  
                  
                  65.9Deferred
      revenue - current portion
                  
                  
                  27.8
                  
                  
                  
                  24.8Note
      Payable - current portion
                  
                  
                  4.3
                  
                  
                  
                  3.2Total
      current liabilities
                  
                  
                  103.4
                  
                  
                  
                  107.8Note
      Payable
                  
                  
                  30.6
                  
                  
                  
                  32.8Deferred
      revenue
                  
                  
                  96.2
                  
                  
                  
                  88.5Other
      long-term liabilities
                  
                  
                  10.1
                  
                  
                  
                  10.5Total
      liabilities
                  
                  
                  240.3
                  
                  
                  
                  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
      oroutstanding
                  
                  
                  —
                  
                  
                  
                  —Common
      stock, 30,000,000 shares authorized, $0.01 par value, 11,742,714 issued
      and 11,483,440 outstanding at June 30, 2009, and 11,609,737 issued and
      11,358,301 outstanding at December 31, 2008
                  
                  
                  0.1
                  
                  
                  
                  0.1Additional
      paid-in capital
                  
                  
                  288.7
                  
                  
                  
                  280.0Treasury
      stock at cost, 259,274 and 251,436 shares at June 30, 2009 and December
      31, 2008, respectively
                  
                  
                  (16.6
                  )
                  
                  
                  (16.3
                  )Accumulated
      other comprehensive loss
                  
                  
                  (8.6
                  )
                  
                  
                  (9.3
                  )Retained
      earnings
                  
                  
                  81.8
                  
                  
                  
                  29.8Total
      shareholders’ equity
                  
                  
                  345.4
                  
                  
                  
                  284.3Total
      liabilities and shareholders’ equity
                  
                  $
                  585.7
                  
                  
                  $
                  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 June 30,
                
                
                Six Months Ended June 30,2009
                
                
                2008
                
                
                2009
                
                
                2008Revenue
                
                $
                88.0
                
                
                $
                77.1
                
                
                $
                173.4
                
                
                $
                148.0Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                
                
                32.3
                
                
                
                31.6
                
                
                
                61.7
                
                
                
                62.4Selling,
      general and administrative expenses
                
                
                20.1
                
                
                
                21.1
                
                
                
                40.8
                
                
                
                45.9Depreciation
      and amortization
                
                
                12.3
                
                
                
                12.2
                
                
                
                24.2
                
                
                
                24.8Operating
      income
                
                
                23.3
                
                
                
                12.2
                
                
                
                46.7
                
                
                
                14.9Other
      income (expense):Interest
      income
                
                
                0.1
                
                
                
                0.4
                
                
                
                0.3
                
                
                
                0.9Interest
      expense
                
                
                (1.1
                )
                
                
                (0.9
                )
                
                
                (2.3
                )
                
                
                (1.6
                )Other
      income, net
                
                
                2.5
                
                
                
                —
                
                
                
                2.4
                
                
                
                1.5Income
      before income taxes
                
                
                24.8
                
                
                
                11.7
                
                
                
                47.1
                
                
                
                15.7Provision
      for (benefit from) income taxes
                
                
                0.2
                
                
                
                0.5
                
                
                
                (4.9
                )
                
                
                1.1Net
      income
                
                $
                24.6
                
                
                $
                11.2
                
                
                $
                52.0
                
                
                $
                14.6Income
      per share, basic:Basic
      income per share
                
                $
                2.14
                
                
                $
                1.04
                
                
                $
                4.53
                
                
                $
                1.36Weighted
      average number of common shares
                
                
                11,513,149
                
                
                
                10,741,312
                
                
                
                11,487,289
                
                
                
                10,732,144Income
      per share, diluted:Diluted
      income per share
                
                $
                1.95
                
                
                $
                0.92
                
                
                $
                4.17
                
                
                $
                1.20Weighted
      average number of common shares
                
                
                12,613,503
                
                
                
                12,145,195
                
                
                
                12,484,218
                
                
                
                12,198,657





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





2





ABOVENET,
INC. AND SUBSIDIARIES





CONSOLIDATED
STATEMENTS OF SHAREHOLDERS’ EQUITY


(in
millions, except share information)





(Unaudited)





Common
      Stock
                          
                          
                          Treasury
      Stock
                          
                          
                          Other Shareholders’
      EquityShares
                          
                          
                          Amount
                          
                          
                          Shares
                          
                          
                          Amount
                          
                          
                          Additional
                            Paid-in
                            Capital
                          
                          
                          Accumulated
                            Other
                            Comprehensive
                            Loss
                          
                          
                          Retained
      Earnings
                          
                          
                          Total
                            Shareholders’
                            EquityBalance
      at January 1, 2009
                          
                          
                          11,609,737
                          
                          
                          $
                          0.1
                          
                          
                          
                          251,436
                          
                          
                          $
                          (16.3
                          )
                          
                          $
                          280.0
                          
                          
                          $
                          (9.3
                          )
                          
                          $
                          29.8
                          
                          
                          $
                          284.3Issuance
      of common stock from exercise of warrants
                          
                          
                          6,811
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          0.1
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          0.1Issuance
      of common stock from vested restricted stock
                          
                          
                          20,500
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Purchase
      of treasury stock
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          7,838
                          
                          
                          
                          (0.3
                          )
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          (0.3
                          )Foreign
      currency translation adjustments
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          0.5
                          
                          
                          
                          —
                          
                          
                          
                          0.5Change
      in fair value of interest rate swap contract
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          0.2
                          
                          
                          
                          —
                          
                          
                          
                          0.2Amortization
      of stock-based compensation expense for stock options and restricted stock
      units
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          5.8
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          5.8Exercise
      of options to purchase shares of common stock
                          
                          
                          105,666
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          2.8
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          2.8Net
      income
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          52.0
                          
                          
                          
                          52.0Balance
      at June 30, 2009
                          
                          
                          11,742,714
                          
                          
                          $
                          0.1
                          
                          
                          
                          259,274
                          
                          
                          $
                          (16.6
                          )
                          
                          $
                          288.7
                          
                          
                          $
                          (8.6
                          )
                          
                          $
                          81.8
                          
                          
                          $
                          345.4





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)





Six Months Ended June 30,2009
                
                
                2008Cash
      flows provided by operating activities:Net
      income
                
                $
                52.0
                
                
                $
                14.6Adjustments
      to reconcile net income to net cash provided by
operations:Depreciation
      and amortization
                
                
                24.2
                
                
                
                24.8Provision
      for equipment impairment
                
                
                0.5
                
                
                
                —Provision
      for bad debts
                
                
                0.2
                
                
                
                0.2Non-cash
      stock-based compensation expense
                
                
                5.8
                
                
                
                7.9Loss
      (gain) on sale or disposition of property and equipment,
      net
                
                
                0.9
                
                
                
                (1.2
                )Changes
      in operating working capital:Accounts
      receivable
                
                
                (0.6
                )
                
                
                (0.5
                )Prepaid
      costs and other current assets
                
                
                (1.2
                )
                
                
                1.9Accounts
      payable
                
                
                (5.0
                )
                
                
                2.4Accrued
      expenses
                
                
                (10.6
                )
                
                
                (5.2
                )Other
      assets
                
                
                (1.1
                )
                
                
                —Deferred
      revenue and other long-term liabilities
                
                
                9.4
                
                
                
                8.6Net
      cash provided by operating activities
                
                
                74.5
                
                
                
                53.5Cash
      flows used in investing activities:Proceeds
      from sales of property and equipment
                
                
                —
                
                
                
                1.6Purchases
      of property and equipment
                
                
                (53.5
                )
                
                
                (54.0
                )Net
      cash used in investing activities
                
                
                (53.5
                )
                
                
                (52.4
                )Cash
      flows provided by financing activities:Proceeds
      from exercise of options to purchase shares of common
stock
                
                
                2.8
                
                
                
                —Proceeds
      from exercise of warrants
                
                
                0.1
                
                
                
                0.1Proceeds
      from note payable, net of financing costs
                
                
                —
                
                
                
                22.3Change
      in restricted cash and cash equivalents
                
                
                (0.2
                )
                
                
                1.0Principal
      payment - note payable
                
                
                (1.1
                )
                
                
                —Principal
      payment - capital lease obligation
                
                
                (0.2
                )
                
                
                (0.2
                )Purchase
      of treasury stock
                
                
                (0.3
                )
                
                
                (1.6
                )Net
      cash provided by financing activities
                
                
                1.1
                
                
                
                21.6Effect
      of exchange rates on cash
                
                
                0.8
                
                
                
                —Net
      increase in cash and cash equivalents
                
                
                22.9
                
                
                
                22.7Cash
      and cash equivalents, beginning of period
                
                
                87.1
                
                
                
                45.8Cash
      and cash equivalents, end of period
                
                $
                110.0
                
                
                $
                68.5Supplemental
      cash flow information:Cash
      paid for interest
                
                $
                1.3
                
                
                $
                1.1Cash
      paid for income taxes
                
                $
                2.8
                
                
                $
                0.8





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 June 30,
                  
                  
                  Six Months Ended June 30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Net
      income
                  
                  $
                  24.6
                  
                  
                  $
                  11.2
                  
                  
                  $
                  52.0
                  
                  
                  $
                  14.6Foreign
      currency translation adjustments
                  
                  
                  —
                  
                  
                  
                  0.3
                  
                  
                  
                  0.5
                  
                  
                  
                  (0.1
                  )Change
      in fair value of interest rate swap contracts
                  
                  
                  0.2
                  
                  
                  
                  —
                  
                  
                  
                  0.2
                  
                  
                  
                  —Comprehensive
      income
                  
                  $
                  24.8
                  
                  
                  $
                  11.5
                  
                  
                  $
                  52.7
                  
                  
                  $
                  14.5





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





5





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


(in
millions, except share and per share information)





NOTE
1:    BACKGROUND AND ORGANIZATION





Business




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





NOTE
2:    BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING
POLICIES





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





Basis
of Presentation and Use of Estimates




The
accompanying unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America (“U.S. GAAP”) and pursuant to the rules and regulations of the
Securities and Exchange Commission (the “SEC”).  These consolidated
financial statements include the accounts of the Company, as applicable. 
They do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements.  In the opinion of management, all adjustments
(consisting of normal recurring accruals), considered necessary for a fair
presentation have been included.  These unaudited consolidated financial
statements should be read in conjunction with the Company’s consolidated
financial statements and related notes included in the Company’s Annual Report
on Form 10-K for the fiscal year ended December 31, 2008. 
Operating results for the three and six months ended June 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.





Fresh
Start Accounting





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





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





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





6





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





On
September 8, 2003, the Company authorized 10,000,000 shares of preferred stock
(with a $0.01 par value) and 30,000,000 shares of common stock (with a $0.01 par
value).  The holders of common stock are entitled to one vote for each
issued and outstanding share, and will be entitled to receive dividends, subject
to the rights of the holders of preferred stock when and if declared by the
Board of Directors.  Preferred stock may be issued from time to time in one
or more classes or series, each of which classes or series shall have such
distributive designation as determined by the Board of Directors. During 2006,
the Company reserved for issuance, from the 10,000,000 shares authorized of
preferred stock described above, 500,000 shares of $0.01 par value junior
preferred stock in connection with the adoption of the Shareholders’ Rights
Plan.  In the event of any liquidation, the holders of the common stock
will be entitled to receive the assets of the Company available for
distribution, after payments to creditors and holders of preferred
stock.





Pursuant
to the Plan of Reorganization, upon the Company’s emergence from bankruptcy, the
Company issued to its pre-petition creditors 8,750,000 shares of common stock,
of which 8,749,138 were delivered and 862 were determined to be undeliverable
and were cancelled, rights to purchase 1,669,210 shares of common stock at a
price of $29.9543, under a rights offering, of which rights to purchase
1,668,992 shares have been exercised, five year stock purchase warrants to
purchase 709,459 shares of common stock exercisable at a price of $20.00 per
share, and seven year stock purchase warrants to purchase 834,658 shares of
common stock exercisable at a price of $24.00 per share.  In addition,
1,064,956 shares of common stock were 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”).  The Company
developed a set of financial projections which were utilized by an expert to
assist the Company in estimating the fair value of its assets and
liabilities.  The expert utilized various valuation methodologies,
including, (1) a comparison of the Company and its projected performance to that
of comparable companies, (2) a review and analysis of several recent
transactions of companies in similar industries to the Company, and (3) a
calculation of the enterprise value based upon the future cash flows based upon
the Company’s projections.





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





Principles
of Consolidation




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





7





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





Revenue
Recognition




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





In
accordance with SEC Staff Accounting Bulletin ("SAB") No. 101, “Revenue
Recognition in Financial Statements,” as amended by SEC SAB No. 104, “Revenue
Recognition,” the Company generally amortizes revenue related to installation
services on a straight-line basis over the contracted customer relationship,
which generally ranges from two to twenty years.





Contract
termination revenue is recognized when a customer discontinues service prior to
the end of the contract period for which the Company had previously received
consideration and for which revenue recognition was deferred.  Contract
termination revenue is also recognized when customers have made early
termination payments to the Company to settle contractually committed purchase
amounts that the customer no longer expects to meet or when the Company
renegotiates a contract with a customer and as a result is no longer obligated
to provide services for consideration previously received and for which revenue
recognition has been deferred.  During the three and six months ended June
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 $0.8 and $2.0 in the three months ended June 30, 2009 and 2008,
respectively, and $2.7 and $2.3 in the six months ended June 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”).  SFAS No. 153 amends Accounting Principles Board Opinion No. 29,
“Accounting for Nonmonetary Transactions,” (“APB No. 29”) to eliminate the
exception for nonmonetary exchanges of similar productive assets and replaces it
with a general exception for exchanges of nonmonetary assets that do not have
commercial substance.  SFAS No. 153 is to be applied prospectively for
nonmonetary exchanges occurring in fiscal periods beginning after June 15,
2005.  The Company’s adoption of SFAS No. 153 on July 1, 2005 did not have
a material effect on the consolidated financial position or results of
operations of the Company.  Prior to the Company’s adoption of SFAS No.
153, nonmonetary transactions were accounted for in accordance with APB No. 29,
where an exchange for similar capacity is recorded at a historical carryover
basis and dissimilar capacity is accounted for at fair market value with
recognition of any gain or loss.  There were no gains or losses from
nonmonetary transactions for the three and six months ended June 30, 2009 and
2008.





Operating
Leases




The
Company leases office and equipment space, and maintains equipment rentals,
right-of-way contracts, building access fees and network capacity under various
non-cancelable operating leases.  The lease agreements, which expire at
various dates through 2023, are subject, in many cases, to renewal options and
provide for the payment of taxes, utilities and maintenance.  Certain lease
agreements contain escalation clauses over the term of the lease related to
scheduled rent increases resulting from the pass through of increases in
operating costs, property taxes and the effect on costs from changes in consumer
price indices.  In accordance with SFAS No. 13, “Accounting for Leases,”
the Company recognizes rent expense on a straight-line basis and records a
liability representing the difference between straight-line rent expense and the
amount payable as an increase or decrease to a deferred liability.  Any
leasehold improvements related to operating leases are amortized over the lesser
of their economic lives or the remaining lease term.  Rent-free periods and
other incentives granted under certain leases are recorded as reductions to rent
expense on a straight-line basis over the related lease terms.





8





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





Cash
and Cash Equivalents and Restricted Cash and Cash Equivalents




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





Accounts
Receivable, Allowance for Doubtful Accounts and Sales Credits




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





Property
and Equipment




Property
and equipment owned at the Effective Date are stated at their estimated fair
values as of the Effective Date based on the Company’s reorganization
value.  Purchases of property and equipment subsequent to the Effective
Date are stated at cost, net of depreciation and amortization.  Major
improvements are capitalized, while expenditures for repairs and maintenance are
expensed when incurred.  Costs incurred prior to a capital project’s
completion are reflected as construction in progress, which is included in
network infrastructure assets on the respective balance sheets.  Certain
internal direct labor costs of constructing or installing property and equipment
are capitalized.  Capitalized direct labor is determined based upon a core
group of field engineers and IP engineers and reflects their capitalized salary
plus related benefits, and is based upon an allocation of their time between
capitalized and non-capitalized projects.  These individuals’ salaries are
considered to be costs directly associated with the construction of certain
infrastructure and customer build-outs.  The salaries and related benefits
of non-engineers and supporting staff that are part of the engineering
departments are not considered part of the pool subject to capitalization. 
Capitalized direct labor amounted to $2.9 and $2.8 for the three months ended
June 30, 2009 and 2008, respectively, and $5.6 and $5.5 for the six months
ended June 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.





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.





9





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





From time
to time, the Company is required to replace or re-route existing fiber due to
structural changes such as construction and highway expansions, which is defined
as “relocation.”  In such instances, the Company fully depreciates the
remaining carrying value of network infrastructure removed or rendered unusable
and capitalizes the new fiber and associated construction costs of the
relocation placed into service, which is reduced by any reimbursements received
for such costs.  The Company capitalized relocation costs amounting to $1.0
and $0.8 for the three months ended June 30, 2009 and 2008, respectively, and
$1.7 and $1.5 for the six months ended June 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 $0.2 ($0.07 and $0.14 on a net book value basis) for the
three and six months ended June 30, 2009, respectively, and, which on an
original cost basis, totaled $0.1 and $0.3 ($0.1 and $0.2 on a net book value
basis) for the three and six months ended June 30, 2008, respectively.  To
the extent that relocation requires only the movement of existing network
infrastructure to another location, the related costs are included in our
results of operations.





In
accordance with SFAS No. 34, “Capitalization of Interest Cost,” the Company will
capitalize interest on certain construction projects.  Such amounts were
considered immaterial, and accordingly, no such amounts were capitalized during
the three and six months ended June 30, 2009 and 2008.





In
accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets,” the Company periodically evaluates the recoverability of its
long-lived assets and evaluates such assets for impairment whenever events or
circumstances indicate that the carrying amount of such assets (or group of
assets) may not be recoverable. Impairment is determined to exist if the
estimated future undiscounted cash flows are less than the carrying value of
such asset.  We provided an allowance for impairment of $0.5 in the six
months ended June 30, 2009, which was recorded in the three months ended June
30, 2009.  There were no provisions for impairment recorded in the three
and six months ended June 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,” 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 $7.0 and
$7.1 at June 30, 2009 and December 31, 2008, respectively, of which $3.8 and
$4.0, respectively, were included in “Accrued expenses,” and $3.2 and $3.1,
respectively, were included in “Other long-term liabilities” at such
dates.  Accretion expense, which is included in “Interest expense,”
amounted to $0.02 and $0.07 for the three months ended June 30, 2009 and
2008, respectively, and $0.10 and $0.14 for the six months ended June 30, 2009
and 2008, respectively.





10





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





Income
Taxes




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





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





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





The
Company’s reorganization resulted in a significantly modified capital structure
as a result of applying fresh-start accounting in accordance with SOP 90-7 on
the Effective Date.  Fresh start accounting has important consequences on
the accounting for the realization of valuation allowances, related to net
deferred tax assets that existed on the Effective Date but which arose in
pre-emergence periods.  Specifically, fresh start accounting requires the
reversal of such allowances to be recorded as a reduction of intangible assets
until exhausted and thereafter as additional paid in capital.  This
treatment does not result in any change in liabilities to taxing authorities or
in cash flows.





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





The
Company’s policy is to recognize interest and penalties accrued as a component
of operating expense.  As of the date of adoption of Interpretation No. 48,
the Company did not have any accrued interest or penalties associated with any
unrecognized income tax benefits, nor was any interest expense recognized during
the three and six months ended June 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.





11





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





Foreign
Currency Translation and Transactions




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





Stock
Options




On
September 8, 2003, the Company adopted the fair value provisions of SFAS No.
148, “Accounting for Stock-Based Compensation Transition and Disclosure,” (“SFAS
No. 148”).  SFAS No. 148 amended SFAS No. 123, “Accounting for Stock-Based
Compensation,” (“SFAS No. 123”), to provide alternative methods of transition to
SFAS No. 123’s fair value method of accounting for stock-based employee
compensation. See Note 6, “Stock-Based Compensation.”





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





Effective
January 1, 2006, the Company adopted SFAS No. 123(R), “Share-Based Payment,”
(“SFAS No. 123(R)”), using the modified prospective method.  SFAS No.
123(R) requires all share-based awards granted to employees to be recognized as
compensation expense over the vesting period, based on fair value of the
award.  The fair value method under SFAS No. 123(R) is similar to the fair
value method under SFAS No. 123 with respect to measurement and recognition of
stock-based compensation expense except that SFAS No. 123(R) requires an
estimate of future forfeitures, whereas SFAS No. 123 permitted companies to
estimate forfeitures or recognize the impact of forfeitures as they occur. 
As the Company recognized the impact of forfeitures as they occurred under SFAS
No. 123, the adoption of SFAS No. 123(R) resulted in a change in our accounting
treatment, but it did not have a material impact on the Company’s consolidated
financial statements.  There were no options to purchase shares of common
stock granted during the three and six months ended June 30, 2009 and
2008.





Restricted
Stock Units




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





12





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





Stock
Warrants




In
connection with the Plan of Reorganization described in Note 2, “Basis of
Presentation and Significant Accounting Policies,” the Company issued to holders
of general unsecured claims as part of the settlement of such claims (i) five
year warrants to purchase 709,459 shares of common stock with an exercise price
of $20.00 per share (expired September 8, 2008) and (ii) seven year warrants to
purchase 834,658 shares of common stock with an exercise price of $24.00 per
share (expiring September 8, 2010).  The stock warrants are treated as
equity upon their exercise based upon the terms of the warrant and cash
received.  Stock warrants to purchase shares of common stock exercised
during the three months ended June 30, 2009 and 2008 totaled 6,611 and 3,831,
respectively, and during the six months ended June 30, 2009 and 2008 totaled
6,811 and 5,222, respectively.





Under the
terms of the five year and seven year warrant agreements (collectively, the
“Warrant Agreements”), if the market price of our common stock, as defined in
the Warrant Agreements, 60 days prior to the expiration date of the respective
warrants, is greater than the warrant exercise price, the Company is required to
give each warrant holder notice that at the warrant expiration date, the
warrants would be deemed to have been exercised pursuant to the net exercise
provisions of the respective Warrant Agreements (the “Net Exercise”), unless the
warrant holder elects, by written notice, to not exercise its warrants. 
Under the Net Exercise, shares issued to the warrant holders would be reduced by
the number of shares necessary to cover the aggregate exercise price of the
shares, valuing such shares at the current market price, as defined in the
Warrant Agreements.  Any fractional shares, otherwise issuable, would be
paid in cash.  At September 8, 2008, the expiration date of the five year
warrants, the required conditions were met for the Net Exercise.  In total,
five year warrants to purchase 159,263 shares of common stock were deemed
exercised pursuant to the Net Exercise (including warrants to purchase 389
shares of common stock, which were exercised on a net exercise basis prior to
expiration), of which 106,716 shares were issued to the warrant holders, 52,547
shares were returned to treasury and $0.004 was paid to recipients for
fractional shares.  In addition, five year warrants to purchase 25 shares
of common stock were cancelled in accordance with instructions from warrant
holders.  Finally, seven year warrants to purchase 13 shares of common
stock were determined to be undeliverable and were cancelled.  At June 30,
2009, seven year warrants to purchase 785,117 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 portion of the Term Loan (as such term is defined in
Note 3, “Note Payable”) and the Company purchased a second interest rate swap on
November 14, 2008 to hedge the interest rate on the additional $12 portion of
the Term Loan provided by SunTrust Bank.  The Company accounted for the
derivatives under SFAS No. 133, “Accounting for Derivative Instruments and
Hedging Activities” (“SFAS No. 133”).  SFAS No. 133 requires that all
derivatives be recognized in the financial statements and measured at fair value
regardless of the purpose or intent for holding them.  By policy, the
Company has not historically entered into derivatives for trading purposes or
for speculation.  Based on criteria defined in SFAS No. 133, the interest
rate swaps were considered cash flow hedges and were 100% effective. 
Accordingly, changes in the fair value of derivatives are and will be recorded
each period in accumulated other comprehensive 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 June
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”).  SFAS No. 161 changes the disclosure requirements for
derivatives and hedging activities.  Entities are required to provide
enhanced disclosures about (i) how and why an entity uses derivatives; (ii) how
derivatives and related hedged items are accounted for under SFAS No. 133; and
(iii) how derivatives and related hedged items affect an entity’s financial
position and cash flows.





13





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





The
Company minimizes its credit risk relating to counterparties of its derivatives
by transacting with multiple, high-quality counterparties, thereby limiting
exposure to individual counterparties, and by monitoring the financial condition
of its counterparties.  The Company does not enter into derivatives for
trading or other speculative purposes.





All
derivatives were recorded on the Company’s consolidated balance sheets at fair
value.  Accounting for the gains and losses resulting from changes in the
fair value of derivatives depends on the use of the derivative and whether it
qualifies for hedge accounting in accordance with SFAS No. 133.  As of June
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 June
30, 2009 and December 31, 2008 consisted of the following:





Derivative LiabilitiesDerivatives designated as hedging
      instruments
                    
                    June 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 June 30, 2009.




Weighted Average RateNotional Amount
                                      
                                      Maturity Date
                                      
                                      Pay
                                      
                                      
                                      Receive$
                                      24
                                      
                                      2011
                                      
                                      
                                      3.65%
                                      
                                      
                                      
                                      1.46%$
                                      12
                                      
                                      2011
                                      
                                      
                                      2.635%
                                      
                                      
                                      
                                      0.71%




Interest
expense under these agreements, and the respective debt instruments that they
hedge, are recorded at the net effective interest rate of the hedged
transaction.  These interest rate swap agreements were not in place during
the three and six months ended June 30, 2008.





14





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





Fair
Value of Financial Instruments




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




Level
      1:
            Observable
      inputs such as quoted prices for identical assets or liabilities in active
      markets.





Level
      2:
            Observable
      inputs other than quoted prices that are directly or indirectly observable
      for the asset or liability, including quoted prices for similar assets or
      liabilities in active markets; quoted prices for similar or identical
      assets or liabilities in markets that are not active; and model-derived
      valuations whose inputs are observable or whose significant value drivers
      are observable.





Level
      3:
            Unobservable
      inputs that reflect the reporting entity’s own
  assumptions.





The
Company’s investment in overnight money market institutional funds, which
amounted to $101.8 and $81.9 at June 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 June 30, 2009 and
December 31, 2008, respectively.  The Company used third parties to value
each of the interest rate swap agreements at June 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.





15





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





Concentration
of Credit Risk




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





401(k) and
Other Post-Retirement Benefits




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





The
Company contributed $0.4 for each of the three months ended June 30, 2009 and
2008 and contributed $0.9 for each of  the six months ended June 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”).  EITF
No. 06-3 requires that companies disclose their accounting policies
regarding the gross or net presentation of certain taxes.  Taxes within the
scope of EITF No. 06-3 are any taxes assessed by a governmental authority
that are directly imposed on a revenue-producing transaction between a seller
and a customer and may include, but are not limited to, sales, use, value added
and some excise taxes.  In addition, if such taxes are significant, and are
presented on a gross basis, the amounts of those taxes should be
disclosed.  The Company adopted EITF No. 06-3 effective January 1,
2007.  The Company’s policy is to record taxes within the scope of EITF
No. 06-3 on a net basis.





Reclassifications




Certain
reclassifications have been made to the consolidated financial statements at
December 31, 2008 to conform to the classifications used at June 30,
2009.





16





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





Recently
Issued Accounting Pronouncements




In
September 2006, the FASB issued SFAS No. 157 effective for fiscal years
beginning after November 15, 2007 and interim periods within those fiscal
years.  SFAS No. 157 establishes a framework for measuring fair value under
accounting principles generally accepted in the U.S. and expands disclosures
about fair value measurement.  In February 2008, the FASB deferred the
adoption of SFAS No. 157 as provided by FASB Staff Position No. FAS
157-2 (“FSP No. FAS 157-2”) for one year as it applies to certain items,
including assets and liabilities initially measured at fair value in a business
combination, reporting units and certain assets and liabilities measured at fair
value in connection with goodwill impairment tests in accordance with SFAS No.
142, “Goodwill and Other Intangible Assets,” and long-lived assets measured at
fair value for impairment assessments under SFAS No. 144, “Accounting for the
Impairment or Disposal of Long-Lived Assets.”  The Company adopted SFAS No.
157 on January 1, 2008 with respect to its financial assets and liabilities, as
discussed above.





In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations
(Revised),” (“SFAS No. 141(R)”), to replace SFAS No. 141, “Business
Combinations.”  SFAS No. 141(R) requires the use of the acquisition method
of accounting, defines the acquirer, establishes the acquisition date and
broadens the scope to all transactions and other events in which one entity
obtains control over one or more other businesses.  This statement is
effective for business combinations or transactions entered into for fiscal
years beginning on or after December 15, 2008.  The adoption of SFAS No.
141(R) did not have a material impact on the Company’s financial position,
results of operations or cash flows.





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




In
December 2007, the SEC issued SAB No. 110, “Certain Assumptions Used in
Valuation Methods – Expected Term,” (“SAB No. 110”).  SAB No. 110 allows
companies to continue to use the simplified method, as defined in SAB No. 107,
“Share-Based Payment,” to estimate the expected term of stock options under
certain circumstances.  The simplified method for estimating expected term
uses the mid-point between the vesting term and the contractual term of the
stock option.  The Company has analyzed the circumstances in which the use
of the simplified method is allowed.  The Company has opted to use the
simplified method for stock options it granted in 2008 because management
believes that the Company does not have sufficient historical exercise data to
provide a reasonable basis upon which to estimate the expected term due to the
limited period of time the Company’s shares of common stock have been publicly
traded.  No stock options were granted in the six months ended June 30,
2009.





In April
2008, the FASB issued EITF No. 07-05, “Determining Whether an Instrument (or
Embedded Feature) Is Indexed to an Entity’s Own Stock,” (“EITF No.
07-05”).  EITF No. 07-05 provides guidance on determining what types of
instruments or embedded features in an instrument held by a reporting entity can
be considered indexed to its own stock for the purpose of evaluating the first
criteria of the scope exception in paragraph 11 (a) of SFAS No. 133.  EITF
No. 07-05 is effective for financial statements issued for fiscal years
beginning after December 15, 2008 and early application is not permitted. 
The adoption of EITF No. 07-05 did not have a material impact on the Company’s
financial position, results of operations or cash flows.





17





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





In
June 2008, the FASB issued EITF No. 08-3, “Accounting by Lessees for Maintenance
Deposits under Lease Agreements,” (“EITF No. 08-3”).  EITF No. 08-3
mandates that all nonrefundable maintenance deposits should be accounted for as
a deposit.  When the underlying maintenance is performed, the deposit is
expensed or capitalized in accordance with the lessee’s maintenance accounting
policy.  EITF No. 08-3 is effective for fiscal years, and interim periods
within those fiscal years, beginning after December 15, 2008.  The adoption
of EITF No. 08-3 did not have a material impact on the Company’s financial
position, results of operations or cash flows.





In June
2008, the FASB issued EITF No. 03-6-1, “Determining Whether Instruments Granted
in Shared-Based Payment Transactions are Participating Securities,” (“EITF No.
03-6-1”).  EITF No. 03-6-1 provides that unvested share-based payment
awards that contain non-forfeitable rights to dividends or dividend equivalents
(whether paid or unpaid) are participating securities and shall be included in
the computation of earnings per share pursuant to the two-class method. 
EITF No. 03-6-1 is effective for financial statements issued for fiscal years
beginning after December 15, 2008, and interim periods within those fiscal
years.  Upon adoption, a company is required to retrospectively adjust its
earnings per share date (including any amounts related to interim periods,
summaries of earnings and selected financial data) to conform to provisions of
EITF No. 03-6-1.  The adoption of EITF No. 03-6-1 did not have a material
impact on the Company’s financial position, results of operations or cash
flows.





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”).   FSP No. FAS 107-1 and APB 28-1 amends SFAS
No. 107, “Disclosures about Fair Value of Financial Instruments”, 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,” 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")
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 SFAS No.
165 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, SFAS No. 165 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.





In June
2009, the FASB issued SFAS No. 168, “TheFASB Accounting
Standards CodificationTM and the
Hierarchy of Generally Accepted Accounting Principles - a replacement of FASB
Statement No. 162,” (“SFAS No. 168”) to formally establish the FASB Accounting
Standards CodificationTM (the
“Codification”) as the single source of authoritative, nongovernmental U.S.
GAAP.  All existing accounting standards documents are superseded as
described in SFAS No. 168.  All other accounting literature not included in
the Codification is nonauthoritative. The Codification is effective for
interim and annual periods ending after September 15, 2009. The Company
believes the adoption of SFAS No. 168 will not have a material impact on its
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)





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 extended to June 30, 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 0.32% at June 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 will reduce these
commitments by $0.8 on each of June 30, 2009, September 30, 2009 and December
31, 2009 in the event that all or a portion of the Delayed Draw Term Loan
commitments remain undrawn on any 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.





19





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





The Term
Loan, which totaled $36 prior to the June 30, 2009 principal payment, 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 Term Loan outstanding for three
years at 3.65%, plus the applicable margin of 3.25%, which was reduced to 3.00%
on September 30, 2008 upon the filing of the Company’s Annual Report on Form
10-K for the year ended December 31, 2007.





On
November 14, 2008, the Company entered into a swap arrangement under which it
fixed its borrowing costs with respect to the additional $12 under the Term Loan
borrowed on October 1, 2008 for three years at 2.635% per annum, plus the
applicable margin of 3.00%.





The
outstanding amounts of $34.9 under the Term Loan of the Secured Credit Facility
at June 30, 2009 are scheduled to be repaid in each annual period as
follows:




12 Months Ended June 30,
                  
                  Amount2010
                  
                  $
                  4.32011
                  
                  
                  4.32012
                  
                  
                  4.72013
                  
                  
                  21.634.9Less:
      current portion of note payable
                  
                  
                  (4.3
                  )$
                  30.6





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





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





20





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





NOTE
4:  INCOME TAXES





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




Three Months Ended June 30,
                  
                  
                  Six Months Ended June 30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Current
                  
                  $
                  0.2
                  
                  
                  $
                  0.5
                  
                  
                  $
                  (4.9
                  )
                  
                  $
                  1.1Deferred
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Total
      income tax provision
                  
                  $
                  0.2
                  
                  
                  $
                  0.5
                  
                  
                  $
                  (4.9
                  )
                  
                  $
                  1.1





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 $4.9 for the six months
ended June 30, 2009, compared to a provision for income taxes of $1.1 for the
six months ended June 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 June 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 June 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.





21





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





NOTE
5:  INCOME PER COMMON SHARE





Basic
income per common share is computed as net income or net loss divided by the
weighted average number of common shares outstanding for the period.  Total
weighted average shares utilized in computing basic net income per common share
were 11,513,149 and 10,741,312 for the three months ended June 30, 2009 and
2008, respectively.  Total weighted average shares utilized in computing
diluted net income per common share were 12,613,503 and 12,145,195 for the three
months ended June 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 June 30, 2009, potentially
dilutive securities to acquire 6,700 shares of common stock were excluded from
the calculation of diluted income per common share as they were
anti-dilutive.  For the three months ended June 30, 2008, potentially
dilutive securities to acquire 7,250 shares of common stock 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 11,487,289 and 10,732,144 for the six months ended June 30, 2009 and
2008, respectively.  Total weighted average shares utilized in computing
diluted net income per common share were 12,484,218 and 12,198,657 for the six
months ended June 30, 2009 and 2008, respectively.  For the six months
ended June 30, 2009 and 2008, potentially dilutive securities to acquire 26,325
and 7,250 shares of common stock were excluded from the calculation of diluted
income per share as they were anti-dilutive.





NOTE
6:   STOCK-BASED COMPENSATION




Adoption
of 2008 Equity Incentive Plan





On August
29, 2008, the Board of Directors of the Company approved the Company’s 2008
Equity Incentive Plan (the “2008 Plan”).  The 2008 Plan will be
administered by the Company’s Compensation Committee unless otherwise determined
by the Board of Directors.  Any employee, officer, director or consultant
of the Company or subsidiary of the Company selected by the Compensation
Committee is eligible to receive awards under the 2008 Plan.  Stock
options, restricted stock, restricted and unrestricted stock units and stock
appreciation rights may be awarded to eligible participants on a stand alone,
combination or tandem basis.  750,000 shares of Company common stock may be
issued pursuant to awards granted under the 2008 Plan.  The number of
shares available for grant and the terms of outstanding grants are subject to
adjustment for stock splits, stock dividends and other capital
adjustments.  As of June 30, 2009, 388,600 common shares were reserved
pursuant to outstanding options to purchase shares of common stock and
outstanding restricted stock units, and 361,400 common shares were reserved for
future grants.





Stock-based
compensation expense for each period relates to share-based awards granted
under the Company’s 2008 Plan, described above, and the Company’s 2003 Stock
Incentive Plan reflect awards outstanding during such period, including awards
granted both prior to and during such period.  The 2003 Stock Incentive
Plan became effective on September 8, 2003.  Under the 2003 Stock
Incentive Plan, the Company was authorized to issue, in the aggregate,
share-based awards of up to 1,064,956 common shares to employees, directors and
consultants who are selected to participate.  At June 30, 2009, 459,966
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),
105,666 common shares had been issued pursuant to the exercise of options to
purchase shares of common stock, 359,635 common shares were reserved pursuant to
outstanding options to purchase shares of common stock, 124,750 common shares
were reserved pursuant to outstanding restricted stock units (of which 96,500
were vested) and reserves for 14,939 common shares were cancelled.





Stock
Options





The
Company did not award any stock options during the three and six months
ended June 30, 2009 and 2008.  The Company recognized non-cash stock-based
compensation expense related to outstanding stock options amounting to $0.3 for
the three months ended June 30, 2008 and $0.1 and $1.2 for the six months ended
June 30, 2009 and 2008, respectively.  The Company did not recognize any
non-cash stock-based compensation expense for the three months ended June 30,
2009.  The non-cash stock-based compensation expense for the three and six
months ended June 30, 2008 included $0.1 and $0.8 incurred with respect to the
modification of certain options to purchase common stock (see Note 10,
“Employment Contract Termination”).





22





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 six months
ended June 30, 2009.  During the six months ended June 30, 2008, the
Company awarded 9,000 restricted stock units, which vested on the first
anniversary of the date of grant, all of which were granted in the three months
ended June 30, 2008.  The Company recognized non-cash stock-based
compensation expense related to restricted stock units of $2.9 and $3.4 for the
three months ended June 30, 2009 and 2008, respectively, and $5.7 and $6.7 for
the six months ended June 30, 2009 and 2008, respectively.  Included in the
expense for the three and six months ended June 30, 2008 are charges of $0.8 and
$0.9, respectively, with respect to the Company’s purchase of shares from
employees in excess of the minimum withholding requirements, as provided by SFAS
No. 123(R).  There were no such amounts incurred in the three and six
months ended June 30, 2009.





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”).  See Note 16, “Subsequent Events - Rights Agreement,” for
additional information on the Amended and Restated Rights Agreement.  The
following description of the Rights Agreement does not purport to be complete
and is qualified in its entirety by reference to the Rights Agreement, which is
included as Exhibit 4.1 to the Company’s Current Report on Form 8-K filed with
the SEC on August 4, 2006.





In
connection with the Rights Agreement, the Company’s Board of Directors declared
a dividend distribution of one preferred share purchase right (a “Right”) for
each outstanding share of the Company’s common stock, par value $0.01 per share
(the “Common Shares”).  The dividend was paid on August 7, 2006 (the
“Record Date”) to the stockholders of record on that date.  Each Right
entitles the registered holder to purchase from the Company one one-hundredth of
a share of Series A Junior Participating Preferred Stock, par value $0.01
per share (the “Preferred Shares”), at a price of $100.00 ($160.00 as provided
in the Amended and Restated Rights Agreement) per one one-hundredth of a
Preferred Share (the “Purchase Price”), subject to adjustment.  Each one
one-hundredth of a share of Preferred Shares has designations and powers,
preferences and rights, and the qualifications, limitations and restrictions
which make its value approximately equal to the value of a Common
Share.





Until the
earlier to occur of (i) the date of a public announcement that a person, entity
or group of affiliated or associated persons have acquired beneficial ownership
of 15% or more of the outstanding Common Shares (an “Acquiring Person”) or (ii)
10 business days (or such later date as may be determined by action of the
Company’s Board of Directors prior to such time as any person or entity becomes
an Acquiring Person) following the commencement of, or announcement of an
intention to commence, a tender offer or exchange offer the consummation of
which would result in any person or entity becoming an Acquiring Person (the
earlier of such dates being called the “Distribution Date”), the Rights will be
evidenced, with respect to any of the Common Share certificates outstanding as
of the Record Date, by such Common Share certificate.  As discussed below,
the definition of “Acquiring Person” was amended in August 2008.





The
Rights are not exercisable until the Distribution Date.  The Rights, which
were originally scheduled to expire on August 7, 2009, 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 one one-hundredths of a Preferred
Share issuable upon exercise of each Right are also subject to adjustment in the
event of a stock split of the Common Shares or a stock dividend on the Common
Shares payable in Common Shares or subdivisions, consolidation or combinations
of the Common Shares occurring, in any case, prior to the Distribution
Date.  The Purchase Price payable and the number of Preferred Shares or
other securities or other property issuable, upon exercise of the Rights are
subject to adjustment from time to time to prevent dilution as described in the
Rights Agreement.





23





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





Preferred
Shares purchasable upon exercise of the Rights will not be redeemable. 
Each Preferred Share will be entitled to a minimum preferential quarterly
dividend payment of $1.00 but will be entitled to an aggregate dividend of 100
times the dividend declared per Common Share.  In the event of liquidation,
the holders of the Preferred Shares would be entitled to a minimum preferential
liquidation payment of $100.00 per share, but would be entitled to receive an
aggregate payment equal to 100 times the payment made per Common Share. 
Each Preferred Share will have 100 votes, voting together with the Common
Shares.  Finally, in the event of any merger, consolidation or other
transaction in which Common Shares are exchanged, each Preferred Share will be
entitled to receive 100 times the amount of consideration received per Common
Share.  These rights are protected by customary anti-dilution
provisions.  The Preferred Shares would rank junior to any other series of
the Company’s preferred stock.





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





At any
time prior to the earlier of (i) such time that a person has become an Acquiring
Person or (ii) the final expiration date, the Company may redeem all, but not
less than all, of the outstanding Rights at a price of $0.01 per Right (the
“Redemption Price”).  The Rights may also be redeemed at certain other
times as described in the Rights Agreement.  Immediately upon any
redemption of the Rights, the right to exercise the Rights will terminate and
the only right of the holders of Rights will be to receive the Redemption
Price.





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





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





On
August 7, 2008, the Company entered into an amendment (the “Rights
Agreement Amendment”) to its Rights Agreement.  The Rights Agreement
Amendment was filed as Exhibit 4.7 to the Company’s Current Report on Form 8-K
filed with the SEC on August 12, 2008.  Also on August 7, 2008, the
Company entered into a standstill agreement with JGD Management Corp., York
Capital Management, L.P. and certain of their affiliated funds holding Company
securities that are parties thereto (collectively, the “York
Group”).





The
Rights Agreement Amendment amends the Rights Agreement to, among other things,
add an exception to the definition of “Acquiring Person” (as defined in the
Rights Agreement) for an Excluded Stockholder and add a definition of “Excluded
Stockholder.”  “Excluded Stockholder” is defined to mean the individually
identified members of the York Group, funds and accounts managed by York Capital
Management, L.P. that hold any Company securities and their respective
affiliates and associates; provided, however, that, except as otherwise provided
in the definition of “Acquiring Person,” none of the members of the York Group
or their affiliates or associates will be an Excluded Stockholder if any such
party, individually or collectively, become the beneficial owner of 20% or more
of the outstanding Company common stock without the prior written consent of the
Company.





24





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





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 $0.8
included in accrued expenses at June 30, 2009.





SBC
Telecom, Inc. (“SBC”)





The
Company was a party to a fiber lease agreement with SBC, a subsidiary of
AT&T, entered into in May 2000.  The Company believed that SBC was
obligated under this agreement to lease 40,000 fiber miles, reducible to 30,000
under certain circumstances, for a term of 20 years at a price set forth in the
agreement, which was subject to adjustment based upon the number of fiber miles
leased (the higher the volume of fiber miles leased, the lower the price per
fiber mile).  SBC disagreed with such interpretation of the agreement and
in 2003 the issue was litigated before the Bankruptcy Court.  In November
2003, the Bankruptcy Court agreed with the Company’s interpretation of the
agreement, which decision SBC did not appeal.  Subsequently, SBC also
alleged that the Company was in breach of its obligations under such agreement
and that therefore the Company was unable to assume the agreement upon its
emergence from bankruptcy.  The Company disagreed with SBC’s position,
however in December 2005, the Bankruptcy Court agreed with SBC.  In 2006,
the Company appealed certain aspects of the decision to the District Court for
the Southern District of New York but the District Court denied the Company’s
appeal.  In March 2007, the Company filed a notice of appeal to the Second
Circuit Court of Appeals seeking relief with respect to the Bankruptcy Court’s
determination that the Company was in default of the agreement with SBC. 
During the term of the agreement, SBC has paid the Company at the higher rate
per fiber mile to reflect the reduced volume of services SBC believes it was
obligated to take, in accordance with its understanding of the fiber lease
agreement.  However, for financial statement purposes, the Company billed
and recorded revenue based on the lower amount per fiber mile for the fiber
miles accepted by SBC, which was $0.5 and $1.0 for the three and six months
ended June 30, 2008, respectively.





25





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





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





Southeastern
Pennsylvania Transportation Authority (“SEPTA”)




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





NOTE
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 June 30, 2009 and 2008, and $0.2 for each of the six months ended June 30,
2009 and 2008.  No amounts were outstanding at each of June 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.





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 10,000 restricted stock units (which became vested upon his
termination without cause) be delivered to Mr. Doris on January 5, 2009;
and (ii) the Company repurchase at the then market price such number of
shares as required to meet the Company’s estimate of Mr. Doris’ federal and
state income taxes due with respect to the delivery of the restricted stock
units.  The aggregate value of the benefits delivered to Mr. Doris
(including the value of restricted stock units that vested in accordance with
their terms) was $1.6, of which $1.2 was recognized in selling, general and
administrative expenses in the three months ended March 31, 2008. 
Additionally, 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.





26





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





NOTE
11:  SEGMENT REPORTING





SFAS
No. 131, “Disclosures about Segments of an Enterprise and Related
Information,” 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 June 30,
                    
                    
                    Six Months Ended June 30,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008RevenueUnited
      States
                    
                    $
                    80.4
                    
                    
                    $
                    68.8
                    
                    
                    $
                    159.0
                    
                    
                    $
                    132.0United
      Kingdom
                    
                    
                    8.5
                    
                    
                    
                    9.3
                    
                    
                    
                    16.1
                    
                    
                    
                    18.1Eliminations
                    
                    
                    (0.9
                    )
                    
                    
                    (1.0
                    )
                    
                    
                    (1.7
                    )
                    
                    
                    (2.1
                    )Consolidated
      Worldwide
                    
                    $
                    88.0
                    
                    
                    $
                    77.1
                    
                    
                    $
                    173.4
                    
                    
                    $
                    148.0





As ofJune 30, 2009
                        
                        
                        December 31, 2008Long-lived
      assetsUnited
      States
                        
                        $
                        404.4
                        
                        
                        $
                        374.5United
      Kingdom
                        
                        
                        29.0
                        
                        
                        
                        23.8Other
                        
                        
                        0.1
                        
                        
                        
                        0.1Consolidated
      Worldwide
                        
                        $
                        433.5
                        
                        
                        $
                        398.4





NOTE
12: OTHER INCOME, NET





Other
income, net consists of the following:





Three Months Ended June 30,
                      
                      
                      Six Months Ended June 30,2009
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2008Gain
      on settlement or reversal of liabilities
                      
                      $
                      —
                      
                      
                      $
                      0.1
                      
                      
                      $
                      0.7
                      
                      
                      $
                      0.1Gain
      on foreign currency
                      
                      
                      3.2
                      
                      
                      
                      —
                      
                      
                      
                      2.6
                      
                      
                      
                      0.1(Loss)
      gain on disposition of property and equipment
                      
                      
                      (0.7
                      )
                      
                      
                      (0.2
                      )
                      
                      
                      (0.9
                      )
                      
                      
                      1.2Other
                      
                      
                      —
                      
                      
                      
                      0.1
                      
                      
                      
                      —
                      
                      
                      
                      0.1Total
                      
                      $
                      2.5
                      
                      
                      $
                      —
                      
                      
                      $
                      2.4
                      
                      
                      $
                      1.5





27





ABOVENET,
INC. AND SUBSIDIARIES





NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(in
millions, except share and per share information)





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.





28





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 an unaffiliated third party 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 original construction for the four duct build-outs was
approximately £36 British pounds.  The Company believes that its maximum
exposure would be approximately £1.6 British pounds ($2.6 based upon the June
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 statement as of and for
the six months ended June 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 June 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 $0.4 in each of the three months ended June 30, 2009 and 2008, and
$0.8 and $0.4 in the six months ended June 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 $0.2 and $0.1 during the three months ended June 30, 2009 and
2008, respectively, and $0.3 during the six months ended June 30, 2009 and
2008.





29





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.  In addition, subject to
certain provisions and provided that there has not been any event of default,
the Company shall receive an abatement of $1.1, which shall be applied in 13
equal monthly installments.





NOTE
16:   SUBSEQUENT EVENTS





Stock
Split




On August
3, 2009, the Board of Directors of the Company authorized a two-for-one stock
split, to be effected in the form of a 100% stock dividend, which will take
effect on September 3, 2009.  Each shareholder of record on August 20, 2009
will receive one additional share of common stock for each share of common stock
held on that date.





Rights
Agreement (See Note 7, “Shareholders’ Equity - Rights Agreement,” for the
discussion)





On August
3, 2009, the Board of Directors approved the extension of its Rights Agreement,
which was set to expire on August 7, 2009, through entering into an amended and
restated Rights Agreement (the “Restated Rights Agreement”).  The Restated
Rights Agreement is substantially similar to the Company’s current Rights
Agreement.  In addition to extending the term, the principal differences
are that the Restated Rights Agreement will be submitted to the Company’s
stockholders for ratification, certain derivative securities will be included in
the beneficial ownership test under the agreement and the purchase price for
each right has been increased to $160.00.  The Restated Rights Agreement
will expire on August 3, 2010 if 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.





In
accordance with SFAS No. 165, the Company evaluated subsequent events through
August 10, 2009 immediately prior to the release of these consolidated financial
statements.





30





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.




31




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.





32





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.





33




·
            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 1,800 buildings through our lateral cables, which cover
over 1,000 route miles and over 100,000 fiber miles (which are part of the 1.9
million fiber miles previously described).  These connected buildings are
referred to as on-net buildings.




·
            Enterprise Buildings -
      Our network extends to over 1,300 enterprise locations, many of which
      house some of the biggest corporate users of network services in the
      world.  These locations also include many private data centers and
      hub locations that are mission critical for our
  customers.




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





·
            Central Offices and Data
      Centers - Our network connects to buildings in which over 200
      central offices and 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.




34


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,” reflects the original service
groupings as reported in our Annual Report on Form 10-K for the year ended
December 31, 2007.  These groupings consisted of: fiber services, metro
transport services, IP services, and long haul services.  Our data centers,
which represented a fifth service, were sold in 2006.





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




35


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 10 Gbps connectivity.  These services range from
simple point-to-point ethernet connectivity to complex multi-node
wavelength-division multiplexing (“WDM”) solutions.  Our metro services
have a number of important features that differentiate us from many of our
competitors:





·
            A
      substantial portion of our metro services are deployed over dedicated
      fiber from end-to-end, representing a private network for each
      customer.


·
            This
      dedicated fiber provides customers with significant scalability for any
      increasing traffic demand.


·
            A
      service based on dedicated fiber provides a high level of security, a key
      concern for many high-bandwidth customers across a range of
      industries.


·
            The
      absence of a shared network eliminates many of the equipment interfaces of
      most other networks that can impact performance such as latency and cause
      service interruptions.


·
            Some
      of our metro services are offered without the need for the customer to
      provide space and power, which may be difficult or expensive to obtain in
      many data centers.





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





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


36





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.




37


Our sales
strategy includes:




·
            Positioning
      ourselves as a premier provider of private fiber optic transport solutions
      and Internet connectivity services.


·
            Focusing
      on Fortune 1000 enterprises as well as content rich data companies (i.e.
      media, health care, and financial services) that require customized
      private optical solutions.


·
            Expanding
      our sales reach through independent sales agents who specialize in
      specific geographic and vertical
markets.


·
            Emphasizing
      the high quality, cost effective, secure and scalable nature of our
      private optical solutions.


·
            Communicating
      our capabilities through targeted marketing communication campaigns aimed
      at specific vertical markets to increase our brand awareness in a cost
      effective manner.





Customers




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





Executive
Summary





Overview





The
components of our operating income are revenue, costs of revenue, selling and
general and administrative expenses and depreciation and amortization. 
Below is a description of these components.  We are reporting operating
income for the three and six months ended June 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 quickly to changing requirements and changes in our
key performance indicators.  Some of the key financial indicators we use
include cash flow, monthly expense analysis, incremental contractual booking of
new customer business, new customer installations, churn of existing business,
and capital committed and expended.





Some of
the most important non-financial performance metrics measure headcount, IP
traffic growth, installation intervals and network service performance
levels.  We manage our employee headcount changes to ensure sufficient
resources are available to service our customers and control expenses.  All
employees have been categorized into, and are managed within, integrated groups
such as sales, operations, engineering, finance, legal and human
resources.  Our worldwide headcount was 620 as of June 30, 2009, 545 of
which were employed in the U.S., 73 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 six months ended June 30, 2008 for comparative purposes and trend
analysis.




38


2009
Highlights




Our
consolidated revenue increased by $25.4 million, or 17.2%, from $148.0 million
to $173.4 million for the six months ended June 30, 2009 compared to the six
months ended June 30, 2008, driven by increases from our domestic metro, fiber
infrastructure and WAN services.





For the
six months ended June 30, 2009, we generated operating income of $46.7 million,
compared to operating income of $14.9 million for the six months ended June 30,
2008 and net income of $52.0 million for the six months ended June 30, 2009,
compared to $14.6 million for the six months ended June 30, 2008.  During
the six months ended June 30, 2009, we recorded a federal income tax benefit,
net of a provision for alternative minimum taxes and certain capital-based state
taxes, of $4.9 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 June 30,
2009, we had $110.0 million of unrestricted cash, compared to $87.1 million of
unrestricted cash at December 31, 2008, an increase in liquidity of $22.9
million.  The increase in cash at June 30, 2009 was primarily
attributable to cash generated by operating activities of $74.5 million,
partially offset by cash used to purchase property and equipment of $53.5
million.  See below in this Item 2 under, “Liquidity and Capital
Resources,” for further discussion.





In the
six months ended June 30, 2009, our cash flow generated by operating activities
increased compared to the six months ended June 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 six months of 2009 compared to the same period
in 2008.  Our costs during this period declined, which resulted in an
improvement in our operating income.  Our operating results for the six
months ended June 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 six months ended June 30, 2008. 
Additionally, during the three months ended March 31, 2009, we settled a
software maintenance obligation in connection with the abandonment of our
planned implementation of our information technology platform of $0.2 million,
which was reflected as a reduction in selling, general and administrative
expenses for the six months ended June 30, 2009.  Furthermore, consolidated
professional and consulting fees were $2.7 million during the six months ended
June 30, 2009, compared to $6.2 million during the six months ended June 30,
2008, a substantial portion of which was due to the hiring of consultants as
employees during 2008.





2009
Outlook




Our 2009
outlook is tempered by the overall negative economic trends and weaknesses in
some parts of the financial services industry, in which we provide services to a
significant number of customers.  We believe that based upon our contracted
projects awaiting delivery to customers, we will continue to add to our revenue
base in the second half of 2009.  Additionally, we have a strong cash
position and access to financing through our Secured Credit Facility, if
needed.





Revenue





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





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




39




Costs
of revenue





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





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





SG&A
primarily consists of (i) employee-related costs such as salaries and
benefits, and non-cash stock-based compensation expense; (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.





Fresh
Start Accounting




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




40





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





Revenue
Recognition




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





In
accordance with SEC Staff Accounting Bulletin ("SAB") No. 101, “Revenue
Recognition in Financial Statements,” as amended by SEC SAB No. 104,
“Revenue Recognition,” we generally amortize revenue related to installation
services on a straight-line basis over the contracted customer relationship,
which generally ranges from two to twenty years.





Contract
termination revenue is recognized when a customer discontinues service prior to
the end of the contract period for which we had previously received
consideration and for which revenue recognition was deferred.  Contract
termination revenue is also recognized when customers have made early
termination payments to us to settle contractually committed purchase amounts
that the customer no longer expects to meet or when we renegotiate a contract
with a customer and as a result are no longer obligated to provide services for
consideration previously received and for which revenue recognition has been
deferred.  During the three and six months ended June 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 $0.8 million and $2.0
million in the three months ended June 30, 2009 and 2008, respectively, and $2.7
million and $2.3 million in the six months ended June 30, 2009 and 2008,
respectively.





Accounts
Receivable Reserves




Sales
Credit Reserves




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




41


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. 
Purchases of property and equipment subsequent to the Effective Date are stated
at cost, net of depreciation and amortization.  Major improvements are
capitalized, while expenditures for repairs and maintenance are expensed when
incurred.  Costs incurred prior to a capital project’s completion are
reflected as construction in progress, which is included in network
infrastructure assets on the respective balance sheets.  Certain internal
direct labor costs of constructing or installing property and equipment are
capitalized.  Capitalized direct labor is determined based upon a core
group of field engineers and IP engineers and reflects their capitalized salary
plus related benefits, and is based upon an allocation of their time between
capitalized and non-capitalized projects.  These individuals’ salaries are
considered to be costs directly associated with the construction of certain
infrastructure and customer build-outs.  The salaries and related benefits
of non-engineers and supporting staff that are part of the engineering
departments are not considered part of the pool subject to capitalization. 
Capitalized direct labor amounted to $2.9 million and $2.8 million for the three
months ended June 30, 2009 and 2008, respectively, and $5.6 million and
$5.5 million for the six months ended June 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.





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 (loss).




42


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 $1.0 million and $0.8
million for the three months ended June 30, 2009 and 2008, respectively, and
$1.7 million and $1.5 million for the six months ended June 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 $0.2 million ($0.07 million and $0.14 million on a net
book value basis) for the three and six months ended June 30, 2009,
respectively, and, which on an original cost basis, totaled $0.1 million and
$0.3 million ($0.1 million and $0.2 million on a net book value basis) for the
three and six months ended June 30, 2008, respectively.  To the extent that
relocation requires only the movement of existing network infrastructure to
another location, the related costs are included in our results of
operations.





In
accordance with Statement of Financial Accounting Standards (“SFAS”) No. 34,
“Capitalization of Interest Cost,” we will capitalize interest on certain
construction projects.  Such amounts were considered immaterial, and
accordingly, no such amounts were capitalized during the three and six months
ended June 30, 2009 and 2008.





In
accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets,” we periodically evaluate the recoverability of our
long-lived assets and evaluate such assets for impairment whenever events or
circumstances indicate that the carrying amount of such assets (or group of
assets) may not be recoverable.  Impairment is determined to exist if the
estimated future undiscounted cash flows are less than the carrying value of
such asset.  We provided an allowance for impairment of $0.5 million in the
six months ended June 30, 2009, which was recorded in the three months ended
June 30, 2009.  There were no provisions for impairment recorded in the
three and six months ended June 30, 2008.





Asset
Retirement Obligations




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





Asset
retirement obligations are generally recorded as “other long-term liabilities,”
are capitalized as part of the carrying amount of the related long-lived assets
included in property and equipment, net, and are depreciated over the life of
the associated asset.  Asset retirement obligations aggregated $7.0 million
and $7.1 million at June 30, 2009 and December 31, 2008, respectively, of which
$3.8 million and $4.0 million, respectively, were included in “Accrued
expenses,” and $3.2 million and $3.1 million, respectively, were included in
“Other long-term liabilities” at such dates.  Accretion expense, which is
included in “Interest expense,” amounted to $0.02 million and $0.07 million for
the three months ended June 30, 2009 and 2008, respectively, and $0.10
million, and $0.14 million for the six months ended June 30, 2009 and 2008,
respectively.




43


Derivative
Financial Instruments




We
utilize interest rate swaps, derivative financial instruments
(“derivatives”), to mitigate our exposure to interest rate risk.  We
purchased the first interest rate swap on August 4, 2008 to hedge the interest
rate on the $24 million portion of the Term Loan and we purchased a second
interest rate swap on November 14, 2008 to hedge the interest rate on the
additional $12 million portion of the Term Loan provided by SunTrust Bank. 
See Note 3, “Note Payable,” to the accompanying consolidated financial
statements included elsewhere in this Quarterly Report on Form 10-Q.  We
accounted for the derivatives under SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities” (“SFAS No. 133”).  SFAS No. 133
requires that all derivatives be recognized in the financial statements and
measured at fair value regardless of the purpose or intent for holding
them.  By policy, we have not historically entered into derivatives for
trading purposes or for speculation.  Based on criteria defined in SFAS No.
133, the interest rate swaps were considered cash flow hedges and were 100%
effective.  Accordingly, changes in the fair value of derivatives are and
will be recorded each period in accumulated other comprehensive 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 June 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”).  SFAS No. 161 changes the disclosure requirements for
derivatives and hedging activities.  Entities are required to provide
enhanced disclosures about (i) how and why an entity uses derivatives; (ii) how
derivatives and related hedged items are accounted for under SFAS No. 133; and
(iii) how derivatives and related hedged items affect an entity’s financial
position and cash flows.





We
minimize our credit risk relating to counterparties of our derivatives by
transacting with multiple, high-quality counterparties, thereby limiting
exposure to individual counterparties, and by monitoring the financial condition
of our counterparties.  We do not enter into derivatives for trading or
other speculative purposes.





All
derivatives were recorded in our consolidated balance sheets at fair
value.  Accounting for the gains and losses resulting from changes in the
fair value of derivatives depends on the use of the derivative and whether it
qualifies for hedge accounting in accordance with SFAS No. 133.  As of June
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.





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




Derivative Liabilities
                                        (In millions)Derivatives designated as hedging instruments
                                      
                                      June 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.




44


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 June
30, 2009.





Notional Amount
                                        
                                        
                                        
                                        Weighted Average Rate(In millions)
                                        
                                        Maturity Date
                                        
                                        Pay
                                        
                                        
                                        Receive$
                                        24
                                        
                                        2011
                                        
                                        
                                        3.65%
                                        
                                        
                                        
                                        1.46%$
                                        12
                                        
                                        2011
                                        
                                        
                                        2.635%
                                        
                                        
                                        
                                        0.71%




Interest
expense under these agreements, and the respective debt instruments that they
hedge, are recorded at the net effective interest rate of the hedged
transaction.  These interest rate swap agreements were not in place during
the three and six months ended June 30, 2008.





Fair Value
of Financial Instruments




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




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





Our
investment in overnight money market institutional funds, which amounted to
$101.8 million and $81.9 million at June 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.





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 June 30, 2009 and December 31, 2008,
respectively.  We used third parties to value each of the interest rate
swap agreements at June 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.




45





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





Concentration
of Credit Risk




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





Foreign
Currency Translation and Transactions




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





Income
Taxes




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





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


46




Deferred
Taxes




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





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




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





Stock-Based
Compensation




On
September 8, 2003, we adopted the fair value provisions of SFAS
No. 148, “Accounting for Stock-Based Compensation Transition and
Disclosure,” (“SFAS No. 148”).  SFAS No. 148 amended SFAS
No. 123, “Accounting for Stock-Based Compensation,” (“SFAS No. 123”),
to provide alternative methods of transition to SFAS No. 123’s fair value
method of accounting for stock-based employee compensation.  See Note 6,
“Stock-Based Compensation,” to the accompanying consolidated financial
statements included elsewhere in this Quarterly Report on Form
10-Q.





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





Effective
January 1, 2006, we adopted SFAS No. 123(R), “Share-Based Payment,”
(“SFAS No. 123(R)”), using the modified prospective method.  SFAS
No. 123(R) requires all share-based awards granted to employees to be
recognized as compensation expense over the vesting period, based on fair value
of the award.  The fair value method under SFAS No. 123(R) is similar
to the fair value method under SFAS No. 123 with respect to measurement and
recognition of stock-based compensation expense except that SFAS No. 123(R)
requires an estimate of future forfeitures, whereas SFAS No. 123 permitted
companies to estimate forfeitures or recognize the impact of forfeitures as they
occurred.  As we had recognized the impact of forfeitures as they occurred
under SFAS No. 123, the adoption of SFAS No. 123(R) resulted in a
change in our accounting treatment, but it did not have a material impact on our
consolidated financial statements.  There were no options to purchase
shares of common stock granted during the three and six months ended June 30,
2009 and 2008.





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




47




Results
of Operations for the Six Months Ended June 30, 2009 Compared to the Six Months
Ended June 30, 2008





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





SixMonthsEndedJune30,
                                        
                                        
                                        $ Increase/
                                        
                                        
                                        % Increase/2009
                                        
                                        
                                        2008
                                        
                                        
                                        (Decrease)
                                        
                                        
                                        (Decrease)Revenue
                                        
                                        $
                                        173.4
                                        
                                        
                                        $
                                        148.0
                                        
                                        
                                        $
                                        25.4
                                        
                                        
                                        
                                        17.2
                                        %Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                                        
                                        
                                        61.7
                                        
                                        
                                        
                                        62.4
                                        
                                        
                                        
                                        (0.7
                                        )
                                        
                                        
                                        (1.1
                                        )%Selling,
      general and administrative expenses
                                        
                                        
                                        40.8
                                        
                                        
                                        
                                        45.9
                                        
                                        
                                        
                                        (5.1
                                        )
                                        
                                        
                                        (11.1
                                        )%Depreciation
      and amortization
                                        
                                        
                                        24.2
                                        
                                        
                                        
                                        24.8
                                        
                                        
                                        
                                        (0.6
                                        )
                                        
                                        
                                        (2.4
                                        )%Operating
      income
                                        
                                        
                                        46.7
                                        
                                        
                                        
                                        14.9
                                        
                                        
                                        
                                        31.8
                                        
                                        
                                        
                                        213.4
                                        %Other
      income (expense):Interest
      income
                                        
                                        
                                        0.3
                                        
                                        
                                        
                                        0.9
                                        
                                        
                                        
                                        (0.6
                                        )
                                        
                                        
                                        (66.7
                                        )%Interest
      expense
                                        
                                        
                                        (2.3
                                        )
                                        
                                        
                                        (1.6
                                        )
                                        
                                        
                                        0.7
                                        
                                        
                                        
                                        43.8
                                        %Other
      income, net
                                        
                                        
                                        2.4
                                        
                                        
                                        
                                        1.5
                                        
                                        
                                        
                                        0.9
                                        
                                        
                                        
                                        60.0
                                        %Income
      before income taxes
                                        
                                        
                                        47.1
                                        
                                        
                                        
                                        15.7
                                        
                                        
                                        
                                        31.4
                                        
                                        
                                        
                                        200.0
                                        %(Benefit
      from) provision for income taxes
                                        
                                        
                                        (4.9
                                        )
                                        
                                        
                                        1.1
                                        
                                        
                                        
                                        (6.0
                                        )
                                        
                                        NMNet
      income
                                        
                                        $
                                        52.0
                                        
                                        
                                        $
                                        14.6
                                        
                                        
                                        $
                                        37.4
                                        
                                        
                                        
                                        256.2
                                        %





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 six months ended June 30, 2009
was $52.0 million, compared to $14.6 million for the six months ended June 30,
2008, an increase of $37.4 million.  The principal reasons for the
increase were an increase in revenue of $25.4 million, a decrease in
selling, general and administrative expenses of $5.1 million, a decrease in
costs of revenue of $0.7 million, a decrease in depreciation and amortization of
$0.6 million, and the difference between net income tax benefit of $4.9 million
recorded for the six months ended June 30, 2009 and the income tax provision of
$1.1 million recorded for the six months ended June 30, 2008.  These
changes are discussed more fully below.


Revenue. 
Consolidated revenue was $173.4 million for the six months ended June 30, 2009,
compared to $148.0 million for the six months ended June 30, 2008, an increase
of $25.4 million, or 17.2%.  Revenue from our U.S. operations increased by
$26.8 million, or 20.3%, from $131.9 million for the six months ended June 30,
2008 to $158.7 million for the six months ended June 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 installations
in excess of contract terminations and any price decreases.  U.S. revenue
from metro services increased by $13.7 million, or 44.3%, from $30.9 million for
the six months ended June 30, 2008 to $44.6 million for the six months ended
June 30, 2009, revenue from fiber infrastructure services increased by $3.7
million, or 5.0%, from $73.9 million for the six months ended June 30, 2008 to
$77.6 million for the six months ended June 30, 2009 and revenue from WAN
services increased by $9.8 million, or 43.6%, from $22.5 million for the six
months ended June 30, 2008 to $32.3 million for the six months ended June 30,
2009.  Revenue from our foreign operations, primarily in the U.K.,
decreased by $1.4 million, or 8.7%, from $16.1 million for the six months ended
June 30, 2008 to $14.7 million for the six months ended June 30, 2009.  The
primary reason for this decrease was the strengthening of the U.S. dollar
against the British pound during the six months ended June 30, 2009 compared to
the six months ended June 30, 2008.  The translation rate of British pounds
to U.S. dollars decreased 24.4% in the six months ended June 30, 2009 compared
to the six months ended June 30, 2008.




48




Costs of
revenue.  Consolidated costs of revenue for the six months ended
June 30, 2009 was $61.7 million, compared to $62.4 million for the six months
ended June 30, 2008, a decrease of $0.7 million, or 1.1%.  Consolidated
costs of revenue as a percentage of revenue was 35.6% for the six months ended
June 30, 2009, compared to 42.2% for the six months ended June 30, 2008,
resulting in consolidated gross profit margin of 64.4% and 57.8% for the six
months ended June 30, 2009 and 2008, respectively.  The costs of revenue
for our U.S. operations was $56.5 million and $57.6 million for the six months
ended June 30, 2009 and 2008, respectively, a decrease of $1.1 million, or
1.9%.  The decrease in the domestic costs of revenue for the six months
ended June 30, 2009 compared to the six months ended June 30, 2008 was
attributable principally to (i) a decrease of $2.0 million in long haul expenses
including $1.0 million incurred in 2008 with respect to temporarily needed
leased capacity; (ii) a decrease of $1.6 million in
amounts rebilled to customers (there is a corresponding decrease in related
revenue); (iii) a
decrease of $0.5 million for repairs and maintenance charges for our cable and
transmission equipment; and (iv) a decrease of $0.4 million for expenses
associated with third party network costs.  These decreases were partially
offset by (i) an increase of $1.6 million in payroll related expenses, primarily
related to the increase in headcount in our fiber operations, network management
and systems engineering groups; and (ii) an increase of $1.5 million in
co-location expenses, to support our IP network services and increase our
presence in third party data centers.  Additionally, the six month period
ended June 30, 2009 includes a provision for equipment impairment relating to
inventory of $0.5 million, which was recorded in the three months ended June 30,
2009.  There was no provision for equipment impairment recorded in the six
month period ended June 30, 2008.  The costs of revenue for our foreign
operations was $5.2 million for the six months ended June 30, 2009, compared to
$4.8 million for the six months ended June 30, 2008, an increase of $0.4
million, or 8.3%.  Increases in right-of-way, 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 six months ended June 30, 2009 compared to the six
months ended June 30, 2008.




Selling, General
and Administrative Expenses (“SG&A”).  Consolidated SG&A
for the six months ended June 30, 2009 was $40.8 million, compared to $45.9
million for the six months ended June 30, 2008, a decrease of $5.1 million, or
11.1%.  SG&A as a percentage of revenue was 23.5% for the six months
ended June 30, 2009, compared to 31.0% for the six months ended June 30,
2008.  In the U.S., SG&A was $35.9 million for the six months ended
June 30, 2009, compared to $40.5 million for the six months ended June 30, 2008,
a decrease of $4.6 million, or 11.4%.  SG&A for our U.S. operations for
the six months ended June 30, 2009 compared to the six months ended June 30,
2008 decreased primarily due to a $3.0 million decrease in professional fees due
to the normalization of our financial reporting and a decrease of $2.5 million
in domestic non-cash stock-based compensation expense from $7.7 million in
the six months ended June 30, 2008 to $5.2 million in the six months ended June
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.  These
decreases were partially offset by an increase in domestic payroll and
payroll-related expenses of $0.9 million from $19.0 million for the six months
ended June 30, 2008 to $19.9 million for the six months ended June 30, 2009
primarily due to an increase in headcount and bonus accrual, partially offset by
a decrease in severance expense of $0.7 million.  See Note 10, “Employment
Contract Termination,” for a further discussion of Mr. Doris’ employment
contract.  In addition, transaction-based taxes increased by $0.4 million
during the six months ended June 30, 2009 compared to the six months ended June
30, 2008.  SG&A from our foreign operations was $4.9 million for the
six months ended June 30, 2009, compared to $5.4 million for the six months
ended June 30, 2008, a decrease of $0.5 million, or 9.3%. Increases in payroll
related expenses exceeded the reduction in professional fees in the six
months ended June 30, 2009 compared to the six months ended June
30, 2008, but this was more than offset by the strengthening of
the U.S. dollar against the British pound during the six months ended June 30,
2009 compared to the six months ended June 30, 2008.





49




Depreciation and
amortization.  Consolidated depreciation and amortization was $24.2
million for the six months ended June 30, 2009, compared to $24.8 million
for the six months ended June 30, 2008, a decrease of $0.6 million, or
2.4%.  Consolidated depreciation and amortization as a percentage of
revenue was 14.0% for the six months ended June 30, 2009, compared to 16.8% for
the six months ended June 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 June 30,
2008.  This decrease was partially offset by the additions to property and
equipment for the six months ended June 30, 2009 and the full period effect of
depreciation on property and equipment acquired after January 1,
2008.





Interest
income.  Interest income, substantially all of which was earned in
the U.S., decreased from $0.9 million for the six months ended June 30,
2008 to $0.3 million for the six months ended June 30, 2009.  The
decrease of $0.6 million, or 66.7%, was primarily due to the decrease in
short-term interest rates during the six months ended June 30, 2009 compared to
the six months ended June 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 $1.6 million for the six
months ended June 30, 2008 to $2.3 million for the six months ended June 30,
2009.  This increase of $0.7 million, or 43.8%, was primarily due to
interest expense incurred relating to the Secured Credit Facility, of which $36
million was outstanding under the Term Loan for the full six month period ended
June 30, 2009, compared to $24 million outstanding under the Term Loan for only
four months during the six month period ended June 30, 2008.





Other income,
net.Other
income, net is composed primarily of expense or income from non-recurring
transactions and is not comparative from a trend perspective.  Consolidated
other income, net was $2.4 million for the six months ended June 30, 2009,
compared to other income, net of $1.5 million for the six months ended June 30,
2008, an increase of $0.9 million.  In the U.S., other income (expense),
net consisted of other income, net of $0.4 million for the six months ended June
30, 2009, compared to a net expense of $0.3 million for the six months
ended June 30, 2008, an increase of $0.7 million.  For our foreign
operations, other income, net was $2.0 million for the six months ended June 30,
2009, compared to $1.8 million for the six months ended June 30, 2008, an
increase of $0.2 million, or 11.1%.  For the six months ended June 30,
2009, consolidated other income, net was comprised of a gain on foreign currency
of $2.6 million and gains arising from the reversal of certain tax liabilities
of $0.7 million, offset by a net loss on the sale or disposition of property and
equipment of $0.9 million.  For the six months ended June 30, 2008,
consolidated other income, net was comprised of gains on the sale of certain
networks in the U.K. of $1.2 million, gains arising from the reversal of certain
tax liabilities of $0.1 million, gain on foreign currency 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 $4.9 million for the six months ended June 30, 2009,
compared to a provision for income taxes of $1.1 million for the six months
ended June 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.




50




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





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





ThreeMonthsEndedJune30,
                                        
                                        
                                        $ Increase/
                                        
                                        
                                        % Increase/2009
                                        
                                        
                                        2008
                                        
                                        
                                        (Decrease)
                                        
                                        
                                        (Decrease)Revenue
                                        
                                        $
                                        88.0
                                        
                                        
                                        $
                                        77.1
                                        
                                        
                                        $
                                        10.9
                                        
                                        
                                        
                                        14.1
                                        %Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                                        
                                        
                                        32.3
                                        
                                        
                                        
                                        31.6
                                        
                                        
                                        
                                        0.7
                                        
                                        
                                        
                                        2.2
                                        %Selling,
      general and administrative expenses
                                        
                                        
                                        20.1
                                        
                                        
                                        
                                        21.1
                                        
                                        
                                        
                                        (1.0
                                        )
                                        
                                        
                                        (4.7
                                        )%Depreciation
      and amortization
                                        
                                        
                                        12.3
                                        
                                        
                                        
                                        12.2
                                        
                                        
                                        
                                        0.1
                                        
                                        
                                        
                                        0.8
                                        %Operating
      income
                                        
                                        
                                        23.3
                                        
                                        
                                        
                                        12.2
                                        
                                        
                                        
                                        11.1
                                        
                                        
                                        
                                        91.0
                                        %Other
      income (expense):Interest
      income
                                        
                                        
                                        0.1
                                        
                                        
                                        
                                        0.4
                                        
                                        
                                        
                                        (0.3
                                        )
                                        
                                        
                                        (75.0
                                        )%Interest
      expense
                                        
                                        
                                        (1.1
                                        )
                                        
                                        
                                        (0.9
                                        )
                                        
                                        
                                        0.2
                                        
                                        
                                        
                                        22.2
                                        %Other
      income, net
                                        
                                        
                                        2.5
                                        
                                        
                                        
                                        —
                                        
                                        
                                        
                                        2.5
                                        
                                        
                                        NMIncome
      before income taxes
                                        
                                        
                                        24.8
                                        
                                        
                                        
                                        11.7
                                        
                                        
                                        
                                        13.1
                                        
                                        
                                        
                                        112.0
                                        %Provision
      for income taxes
                                        
                                        
                                        0.2
                                        
                                        
                                        
                                        0.5
                                        
                                        
                                        
                                        (0.3
                                        )
                                        
                                        
                                        (60.0
                                        ) %Net
      income
                                        
                                        $
                                        24.6
                                        
                                        
                                        $
                                        11.2
                                        
                                        
                                        $
                                        13.4
                                        
                                        
                                        
                                        119.6
                                        %





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 June 30,
2009 was $24.6 million, compared to $11.2 million for the three months ended
June 30, 2008, an increase of $13.4 million.  The principal reasons
for the increase were an increase in revenue of $10.9 million, a decrease
in selling, general and administrative expenses of $1.0 million and an increase
in other income, net of $2.5 million, partially offset by increases in costs of
revenue of $0.7 million and interest expense of $0.2 million and a decrease in
interest income of $0.3 million.  These changes are discussed more
fully below.


Revenue. 
Consolidated revenue was $88.0 million for the three months ended June 30, 2009,
compared to $77.1 million for the three months ended June 30, 2008, an increase
of $10.9 million, or 14.1%.  Revenue from our U.S. operations increased by
$11.4 million, or 16.6%, from $68.8 million for the three months ended June 30,
2008 to $80.2 million for the three months ended June 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 installations
in excess of contract terminations and any price decreases.  U.S. revenue
from metro services increased by $6.7 million, or 40.6%, from $16.5 million for
the three months ended June 30, 2008 to $23.2 million for the three months ended
June 30, 2009, revenue from fiber infrastructure services increased by $1.8
million, or 4.8%, from $37.5 million for the three months ended June 30, 2008 to
$39.3 million for the three months ended June 30, 2009 and revenue from WAN
services increased by $4.6 million, or 39.3%, from $11.7 million for the three
months ended June 30, 2008 to $16.3 million for the three months ended June 30,
2009.  Revenue from our foreign operations, primarily in the U.K.,
decreased by $0.5 million, or 6.0%, from $8.3 million for the three months ended
June 30, 2008 to $7.8 million for the three months ended June 30, 2009. 
The primary reason for this decrease was the strengthening of the U.S. dollar
against the British pound during the three months ended June 30, 2009 compared
to the three months ended June 30, 2008.  The translation rate of British
pounds to U.S. dollars decreased 21.5% in the three months ended June 30, 2009
compared to the three months ended June 30, 2008.




51




Costs of
revenue.  Consolidated costs of revenue for the three months ended
June 30, 2009 was $32.3 million, compared to $31.6 million for the three months
ended June 30, 2008, an increase of $0.7 million, or 2.2%.  Consolidated
costs of revenue as a percentage of revenue was 36.7% for the three months ended
June 30, 2009, compared to 41.0% for the three months ended June 30, 2008,
resulting in consolidated gross profit margin of 63.3% and 59.0% for the three
months ended June 30, 2009 and 2008, respectively.  The costs of revenue
for our U.S. operations was $29.3 million and $29.1 million for the three months
ended June 30, 2009 and 2008, respectively, an increase of $0.2 million, or
0.7%.  The increase in the domestic costs of revenue for the three months
ended June 30, 2009 compared to the three months ended June 30, 2008 was
attributable principally to (i) an increase of $0.6 million in payroll related
expenses, primarily related to the increase in headcount in our fiber
operations, network management and systems engineering groups; and (ii) an
increase of $0.6 million in co-location expenses, to support our IP network
services and increase our presence in third party data centers.  These
increases were partially offset by (i) a decrease of $0.7 million in
amounts rebilled to customers (there is a corresponding decrease in related
revenue); (ii) a decrease of $0.2 million in long haul expenses; (iii) a
decrease of $0.2 million for repairs and maintenance charges for our cable and
transmission equipment; (iv) a decrease of $0.2 million in occupancy related
costs; and (v) a decrease of $0.1 million for expenses associated with
third party network costs.  Additionally, the three month period ended June
30, 2009 includes a provision for equipment impairment relating to inventory of
$0.5 million.  There was no provision for equipment impairment recorded in
the three month period ended June 30, 2008.  The costs of revenue for our
foreign operations was $3.0 million for the three months ended June 30, 2009,
compared to $2.5 million for the three months ended June 30, 2008, an increase
of $0.5 million, or 20.0%.  Increases in payroll, right-of-way, 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 June 30, 2009
compared to the three months ended June 30, 2008.




Selling, General
and Administrative Expenses (“SG&A”).  Consolidated SG&A
for the three months ended June 30, 2009 was $20.1 million, compared to $21.1
million for the three months ended June 30, 2008, a decrease of $1.0 million, or
4.7%.  SG&A as a percentage of revenue was 22.8% for the three months
ended June 30, 2009, compared to 27.4% for the three months ended June 30,
2008.  In the U.S., SG&A was $17.5 million for the three months ended
June 30, 2009, compared to $18.5 million for the three months ended June 30,
2008, a decrease of $1.0 million, or 5.4%.  SG&A for our U.S.
operations for the three months ended June 30, 2009 compared to the three months
ended June 30, 2008 decreased primarily due to a $1.5 million decrease in
professional fees due to the normalization of our financial reporting and a
decrease of $0.9 million in domestic non-cash stock-based compensation
expense from $3.5 million in the three months ended June 30, 2008 to $2.6
million in the three months ended June 30, 2009.  These decreases were
partially offset by an increase in domestic payroll and payroll-related expenses
of $1.0 million from $8.9 million for the three months ended June 30, 2008 to
$9.9 million for the three months ended June 30, 2009 (primarily due to an
increase in the bonus accrual of $0.2 million and an increase in commissions of
$0.2 million) and transaction-based taxes of $0.2 million.  SG&A from
our foreign operations stayed constant at $2.6 million for each of the three
months ended June 30, 2009 and 2008 as
increases in payroll related expenses were offset by the strengthening of the
U.S. dollar against the British pound.





Depreciation and
amortization.  Consolidated depreciation and amortization was $12.3
million for the three months ended June 30, 2009, compared to $12.2 million for
the three months ended June 30, 2008, an increase of $0.1 million, or
0.8%.  Consolidated depreciation and amortization as a percentage of
revenue was 14.0% for the three months ended June 30, 2009, compared to 15.8%
for the three months ended June 30, 2008.  This increase was primarily
attributable to additions of property and equipment for the three months ended
June 30, 2009 and the full period effect of depreciation on property and
equipment acquired after January 1, 2008.





Interest
income.  Interest income, substantially all of which was earned in
the U.S., decreased from $0.4 million for the three months ended June 30, 2008
to $0.1 million for the three months ended June 30, 2009.  The decrease of
$0.3 million, or 75.0%, was primarily due to the decrease in short-term interest
rates during the three months ended June 30, 2009 compared to the three months
ended June 30, 2008, partially offset by an increase in average balances
available for investment.




52




Interest
expense.
Interest expense, substantially all of which was incurred in the U.S., includes
interest expense on borrowed amounts under the Secured Credit Facility,
availability fees on the unused portion of the Secured Credit Facility, the
amortization of debt acquisition costs (including upfront fees) related to the
Secured Credit Facility, interest expense related to a capital lease obligation,
interest accrued on certain tax liabilities, interest on the
outstanding balance of the deferred fair value rent liabilities established
at fresh start and interest accretion relating to asset retirement
obligations.  Interest expense increased from $0.9 million for the three
months ended June 30, 2008 to $1.1 million for the three months ended June 30,
2009.  This increase of $0.2 million, or 22.2%, 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 three month period ended
June 30, 2009, compared to $24 million outstanding under the Term Loan for the
three month period ended June 30, 2008.





Other income,
net.Other
income, net is composed primarily of expense or income from non-recurring
transactions and is not comparative from a trend perspective.  Consolidated
other income, net was $2.5 million for the three months ended June 30, 2009,
compared to other income, net of zero for the three months ended June 30,
2008.  In the U.S., other expense, net was a net expense of $0.2 million
for the three months ended June 30, 2009, compared to a net expense of $0.1
million for the three months ended June 30, 2008, an increase of $0.1
million.  For our foreign operations, other income, net was $2.7 million
for the three months ended June 30, 2009, compared to $0.1 million for the three
months ended June 30, 2008, an increase of $2.6 million.  For the three
months ended June 30, 2009, consolidated other income, net was comprised of a
gain on foreign currency of $3.2 million offset by a loss on the sale or
disposition of property and equipment of $0.7 million.  For the three
months ended June 30, 2008, consolidated other income, net was comprised of
gains arising from the reversal of certain tax liabilities of $0.1 million and
other gains of $0.1 million, partially offset by a loss on disposition of
property and equipment of $0.2 million.





Provision for
income taxes.We recorded a provision
for income taxes of $0.2 million for the three months ended June 30, 2009,
compared to a provision for income taxes of $0.5 million for the three months
ended June 30, 2008.  The provision for income taxes during the three
months ended June 30, 2009 was provided for certain capital-based state
taxes.  The provision for income taxes during the three months ended June
30, 2008 was provided for estimated federal income taxes and certain
capital-based state taxes.





Liquidity
and Capital Resources




We had
working capital of $41.8 million at June 30, 2009, compared to working capital
of $11.8 million at December 31, 2008, an increase of $30.0 million.  This
increase was primarily attributable to an increase in unrestricted cash of $22.9
million from $87.1 million at December 31, 2008 to $110.0 million at June 30,
2009.  The increase in unrestricted cash was primarily attributable to cash
generated by operating activities of $74.5 million including the collection of
$12.0 million in connection with the delivery of services to a customer in the
six months ended June 30, 2009, which is being recognized ratably as revenue
over the related 60 month contract term, partially offset by the use of cash to
purchase property and equipment of $53.5 million.  Additionally, prepaid
costs and other current assets increased by $1.4 million and accounts payable
and accrued expenses decreased by $5.0 million and $3.5 million, respectively,
which was partially offset by an increase in the deferred revenue and the
current portion of the note payable of $10.7 million and $1.1 million,
respectively.





Net cash
provided by operating activities was $74.5 million during the six months ended
June 30, 2009, compared to $53.5 million during the six months ended June 30,
2008, an increase of $21.0 million.  Net cash provided by operating
activities during the six months ended June 30, 2009 resulted primarily from the
add back of non-cash items deducted in the determination of net income,
principally depreciation and amortization of $24.2 million and stock-based
compensation expense of $5.8 million.  Net cash provided by operating
activities during the six months ended June 30, 2008 resulted primarily from the
add back of non-cash items deducted in the determination of net income,
principally depreciation and amortization of $24.8 million and stock-based
compensation expense of $7.9 million.




Net cash
used in investing activities during the six months ended June 30, 2009 was $53.5
million, compared to $52.4 million during the six months ended June 30, 2008, an
increase of $1.1 million.  Net cash used in investing activities during the
six months ended June 30, 2009 was attributable to the purchases of property and
equipment of $53.5 million.  Net cash used in investing activities during
the six months ended June 30, 2008 was attributable to the purchases of property
and equipment of $54.0 million, partially offset by the proceeds generated from
sales of property and equipment of $1.6 million.  The property and
equipment that is purchased in each period is used primarily to connect new
customers to our networks and to build our infrastructure.


53





Net cash
generated by financing activities was $1.1 million during the six months ended
June 30, 2009, which is comprised of the proceeds from the exercise of
options to purchase shares of common stock of $2.8 million and the proceeds from
the exercise of warrants of $0.1 million, partially offset by the principal
payment under the Secured Credit Facility of $1.1 million, the purchase of
treasury stock of $0.3 million, the principal payment on our capital lease
obligation of $0.2 million and the increase in restricted cash and cash
equivalents of $0.2 million.  Net cash provided by financing activities was
$21.6 million during the six months ended June 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 release of restricted cash and
cash equivalents of $1.0 million, and the proceeds from the exercise of warrants
of $0.1 million, partially offset by the purchase of shares from employees in
connection with the delivery of vested restricted stock units of $1.6 million
and the principal payment on our capital lease obligation of $0.2
million.





During
the six months ended June 30, 2009, we generated cash from operations that was
sufficient to fund our operating expenses and expenditures for property and
equipment of $53.5 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, 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 extended to June 30, 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 June 30, 2009,
we had $34.9 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.  We have chosen 30 day LIBOR as the
interest rate during the term of the interest rate swaps (30 day LIBOR was 0.32%
at June 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 will reduce these
commitments by $0.8 million on each of June 30, 2009, September 30, 2009 and
December 31, 2009 in the event that all or a portion of the Delayed Draw Term
Loan commitments remain undrawn on any 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 and fixed annual rent totaling $11.9 million over the extended term,
which may be reduced by a rent abatement of $1.1 million.





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





54




Segment
Results





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





United
States:





ThreeMonthsEndedJune30,
                                            
                                            
                                            $ Increase /
                                            
                                            
                                            % Increase /2009
                                            
                                            
                                            2008
                                            
                                            
                                            (Decrease)
                                            
                                            
                                            (Decrease)(Dollars
      in millions)Revenue
                                            
                                            $
                                            80.2
                                            
                                            
                                            $
                                            68.8
                                            
                                            
                                            $
                                            11.4
                                            
                                            
                                            
                                            16.6
                                            %Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                                            
                                            
                                            29.3
                                            
                                            
                                            
                                            29.1
                                            
                                            
                                            
                                            0.2
                                            
                                            
                                            
                                            0.7
                                            %Selling,
      general and administrative expenses
                                            
                                            
                                            17.5
                                            
                                            
                                            
                                            18.5
                                            
                                            
                                            
                                            (1.0
                                            )
                                            
                                            
                                            (5.4
                                            )%Depreciation
      and amortization
                                            
                                            
                                            10.8
                                            
                                            
                                            
                                            10.5
                                            
                                            
                                            
                                            0.3
                                            
                                            
                                            
                                            2.9
                                            %Operating
      income
                                            
                                            
                                            22.6
                                            
                                            
                                            
                                            10.7
                                            
                                            
                                            
                                            11.9
                                            
                                            
                                            
                                            111.2
                                            %Other
      income (expense):Interest
      income
                                            
                                            
                                            0.1
                                            
                                            
                                            
                                            0.3
                                            
                                            
                                            
                                            (0.2
                                            )
                                            
                                            
                                            (66.7
                                            )%Interest
      expense
                                            
                                            
                                            (1.1
                                            )
                                            
                                            
                                            (0.9
                                            )
                                            
                                            
                                            0.2
                                            
                                            
                                            
                                            22.2
                                            %Other
      expense, net
                                            
                                            
                                            (0.2
                                            )
                                            
                                            
                                            (0.1
                                            )
                                            
                                            
                                            0.1
                                            
                                            
                                            
                                            100.0
                                            %Income
      before income taxes
                                            
                                            
                                            21.4
                                            
                                            
                                            
                                            10.0
                                            
                                            
                                            
                                            11.4
                                            
                                            
                                            
                                            114.0
                                            %(Benefit
      from) provision for income taxes
                                            
                                            
                                            0.2
                                            
                                            
                                            
                                            0.5
                                            
                                            
                                            
                                            (0.3
                                            )
                                            
                                            
                                            (60.0
                                            )%Net
      income
                                            
                                            $
                                            21.2
                                            
                                            
                                            $
                                            9.5
                                            
                                            
                                            $
                                            11.7
                                            
                                            
                                            
                                            123.2
                                            %





United
Kingdom and others:





ThreeMonthsEndedJune30,
                                        
                                        
                                        $ Increase /
                                        
                                        
                                        % Increase /2009
                                        
                                        
                                        2008
                                        
                                        
                                        (Decrease)
                                        
                                        
                                        (Decrease)(Dollars in millions)Revenue
                                        
                                        $
                                        7.8
                                        
                                        
                                        $
                                        8.3
                                        
                                        
                                        $
                                        (0.5
                                        )
                                        
                                        
                                        (6.0
                                        )%Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                                        
                                        
                                        3.0
                                        
                                        
                                        
                                        2.5
                                        
                                        
                                        
                                        0.5
                                        
                                        
                                        
                                        20.0
                                        %Selling,
      general and administrative expenses
                                        
                                        
                                        2.6
                                        
                                        
                                        
                                        2.6
                                        
                                        
                                        
                                        —
                                        
                                        
                                        
                                        —Depreciation
      and amortization
                                        
                                        
                                        1.5
                                        
                                        
                                        
                                        1.7
                                        
                                        
                                        
                                        (0.2
                                        )
                                        
                                        
                                        (11.8
                                        )%Operating
      income
                                        
                                        
                                        0.7
                                        
                                        
                                        
                                        1.5
                                        
                                        
                                        
                                        (0.8
                                        )
                                        
                                        
                                        (53.3
                                        )%Other
      (expense) income:Interest
      income
                                        
                                        
                                        —
                                        
                                        
                                        
                                        0.1
                                        
                                        
                                        
                                        (0.1
                                        )
                                        
                                        
                                        (100.0
                                        )%Other
      income, net
                                        
                                        
                                        2.7
                                        
                                        
                                        
                                        0.1
                                        
                                        
                                        
                                        2.6
                                        
                                        
                                        NMIncome
      before income taxes
                                        
                                        
                                        3.4
                                        
                                        
                                        
                                        1.7
                                        
                                        
                                        
                                        1.7
                                        
                                        
                                        
                                        100.0
                                        %Provision
      for income taxes
                                        
                                        
                                        —
                                        
                                        
                                        
                                        —
                                        
                                        
                                        
                                        —
                                        
                                        
                                        
                                        —Net
      income
                                        
                                        $
                                        3.4
                                        
                                        
                                        $
                                        1.7
                                        
                                        
                                        $
                                        1.7
                                        
                                        
                                        
                                        100.0
                                        %





NM—not
meaningful







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


55




United
States:





SixMonthsEndedJune30,
                                        
                                        
                                        $ Increase /
                                        
                                        
                                        % Increase /2009
                                        
                                        
                                        2008
                                        
                                        
                                        (Decrease)
                                        
                                        
                                        (Decrease)(Dollars in millions)Revenue
                                        
                                        $
                                        158.7
                                        
                                        
                                        $
                                        131.9
                                        
                                        
                                        $
                                        26.8
                                        
                                        
                                        
                                        20.3
                                        %Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                                        
                                        
                                        56.5
                                        
                                        
                                        
                                        57.6
                                        
                                        
                                        
                                        (1.1
                                        )
                                        
                                        
                                        (1.9
                                        )%Selling,
      general and administrative expenses
                                        
                                        
                                        35.9
                                        
                                        
                                        
                                        40.5
                                        
                                        
                                        
                                        (4.6
                                        )
                                        
                                        
                                        (11.4
                                        )%Depreciation
      and amortization
                                        
                                        
                                        21.3
                                        
                                        
                                        
                                        21.5
                                        
                                        
                                        
                                        (0.2
                                        )
                                        
                                        
                                        (0.9
                                        )%Operating
      income
                                        
                                        
                                        45.0
                                        
                                        
                                        
                                        12.3
                                        
                                        
                                        
                                        32.7
                                        
                                        
                                        
                                        265.9
                                        %Other
      income (expense):Interest
      income
                                        
                                        
                                        0.3
                                        
                                        
                                        
                                        0.8
                                        
                                        
                                        
                                        (0.5
                                        )
                                        
                                        
                                        (62.5
                                        )%Interest
      expense
                                        
                                        
                                        (2.3
                                        )
                                        
                                        
                                        (1.6
                                        )
                                        
                                        
                                        0.7
                                        
                                        
                                        
                                        43.8
                                        %Other
      income (expense), net
                                        
                                        
                                        0.4
                                        
                                        
                                        
                                        (0.3
                                        )
                                        
                                        
                                        0.7
                                        
                                        
                                        
                                        233.3
                                        %Income
      before income taxes
                                        
                                        
                                        43.4
                                        
                                        
                                        
                                        11.2
                                        
                                        
                                        
                                        32.2
                                        
                                        
                                        
                                        287.5
                                        %(Benefit
      from) provision for income taxes
                                        
                                        
                                        (4.9
                                        )
                                        
                                        
                                        1.1
                                        
                                        
                                        
                                        (6.0
                                        )
                                        
                                        NMNet
      income
                                        
                                        $
                                        48.3
                                        
                                        
                                        $
                                        10.1
                                        
                                        
                                        $
                                        38.2
                                        
                                        
                                        
                                        378.2
                                        %





United
Kingdom and others:





SixMonthsEndedJune30,
                                                  
                                                  
                                                  $ Increase /
                                                  
                                                  
                                                  % Increase /2009
                                                  
                                                  
                                                  2008
                                                  
                                                  
                                                  (Decrease)
                                                  
                                                  
                                                  (Decrease)(Dollars in millions)Revenue
                                                  
                                                  $
                                                  14.7
                                                  
                                                  
                                                  $
                                                  16.1
                                                  
                                                  
                                                  $
                                                  (1.4
                                                  )
                                                  
                                                  
                                                  (8.7
                                                  )%Costs
      of revenue (excluding depreciation and amortization, shown separately
      below)
                                                  
                                                  
                                                  5.2
                                                  
                                                  
                                                  
                                                  4.8
                                                  
                                                  
                                                  
                                                  0.4
                                                  
                                                  
                                                  
                                                  8.3
                                                  %Selling,
      general and administrative expenses
                                                  
                                                  
                                                  4.9
                                                  
                                                  
                                                  
                                                  5.4
                                                  
                                                  
                                                  
                                                  (0.5
                                                  )
                                                  
                                                  
                                                  (9.3
                                                  )%Depreciation
      and amortization
                                                  
                                                  
                                                  2.9
                                                  
                                                  
                                                  
                                                  3.3
                                                  
                                                  
                                                  
                                                  (0.4
                                                  )
                                                  
                                                  
                                                  (12.1
                                                  )%Operating
      income
                                                  
                                                  
                                                  1.7
                                                  
                                                  
                                                  
                                                  2.6
                                                  
                                                  
                                                  
                                                  (0.9
                                                  )
                                                  
                                                  
                                                  (34.6
                                                  )%Other
      (expense) income:Interest
      income
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  0.1
                                                  
                                                  
                                                  
                                                  (0.1
                                                  )
                                                  
                                                  
                                                  (100.0
                                                  )%Other
      income, net
                                                  
                                                  
                                                  2.0
                                                  
                                                  
                                                  
                                                  1.8
                                                  
                                                  
                                                  
                                                  0.2
                                                  
                                                  
                                                  
                                                  11.1
                                                  %Income
      before income taxes
                                                  
                                                  
                                                  3.7
                                                  
                                                  
                                                  
                                                  4.5
                                                  
                                                  
                                                  
                                                  (0.8
                                                  )
                                                  
                                                  
                                                  (17.8
                                                  )%Provision
      for income taxes
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —Net
      income
                                                  
                                                  $
                                                  3.7
                                                  
                                                  
                                                  $
                                                  4.5
                                                  
                                                  
                                                  $
                                                  (0.8
                                                  )
                                                  
                                                  
                                                  (17.8
                                                  )%





NM—not
meaningful







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


56


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.




57





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 six months ended June 30, 2009, our foreign
activities accounted for 8.5% of consolidated revenue.  Due to the
strengthening of the U.S. dollar against the British pound, the translation rate
for the six months ended June 30, 2009 decreased 24.4% compared to the
translation rate used for the six months ended June 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 will also increase, thereby
increasing the costs of our investment strategy.  For example, if LIBOR was
to increase by 1% for the full year, our borrowing costs would increase by $0.36
million (1% x $36 million) based upon the amount of the related debt outstanding
at February 28, 2009.  Effective August 4, 2008, we entered into a swap
arrangement under which we fixed our borrowing costs with respect to the $24
million borrowed under the Term Loan on February 29, 2008 for three years at
3.65% per annum, plus the applicable margin of 3.25%, which was reduced to
3.00% on September 30, 2008 upon the filing of our Annual Report on Form
10-K for the year ended December 31, 2007.  On October 1, 2008, we borrowed
an additional $12 million under the expanded Term Loan.  On November 14,
2008, we entered into a swap arrangement under which we fixed our borrowing
costs with respect to the $12 million for three years at 2.635% per annum, plus
the applicable margin of 3.00%.  The swaps had the effect of increasing our
current interest expense compared to the then current LIBOR rate and reducing
our risk of increases in future interest expenses from increasing LIBOR
rates.





As of
June 30, 2009, we had $34.9 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.





58




ITEM
4.  CONTROLS AND PROCEDURES





Evaluation of Disclosure Controls and
Procedures





As of
June 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 June
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 June 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-organizing departments to create more
efficiency and lines of responsibility, which will improve the timely recording
of project cost allocations and accrued obligations relating to property and
equipment, including inventory.  Currently, the Company operates several
disparate systems that produce financial information.  The Company
is evaluating methods to integrate these systems or develop processes that
better control information flow.  The intention of these efforts is to
develop stronger financial, operating and entity level controls, which will
eliminate the material weaknesses that currently exist and provide for timely
financial and tax reporting.





Changes
in Internal Control Over Financial Reporting





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




59




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





ITEM
4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS




The
Annual Meeting of Stockholders of the Company was held on June 25, 2009. 
The only proposals voted upon at the meeting were (i) the re-election of the
incumbent Board of Directors; and (ii) the ratification of the appointment of
the Company’s independent registered public accountants for the fiscal year
ending December 31, 2009.  The votes for each proposal were cast as
follows:




Proposal
One:  Election of the Board of Directors:




Nominee
                      
                      Vote
      For
                      
                      Vote
      WithheldJeffrey
      A. Brodsky
                      
                      9,991,794
                      
                      45,049Michael
      J. Embler
                      
                      10,034,086
                      
                      2,757Richard
      Postma
                      
                      9,991,890
                      
                      44,953Richard
      Shorten, Jr.
                      
                      9,991,794
                      
                      45,049Stuart
      Subotnick
                      
                      10,036,585
                      
                      258William
      G. LaPerch
                      
                      10,036,681
                      
                      162





Proposal
Two:  The ratification of the appointment of BDO Seidman, LLP as the
Company’s independent registered public accountants:




For:
                  10,035,648Against:
                  7Abstain:
                  1,186





There
were no broker non-votes with respect to these proposals.


60


ITEM 6. 
EXHIBITS





Exhibit No.
                
                Description
      of Exhibit4.1
                
                Amended
      and Restated Rights Agreement, dated as of August 3, 2009, between
      AboveNet, Inc. and American Stock Transfer & Trust Company, LLC
      (incorporated herein by reference to Form 8-K filed with the Securities
      and Exchange Commission on August 3, 2009).4.2
                
                Form
      of Right Certificate (incorporated herein by reference to Form 8-K filed
      with the Securities and Exchange Commission on August 3,
      2009).10.1
                
                Amendment
      No. 2, dated as of June 29, 2009, to Credit and Guaranty Agreement among
      AboveNet, Inc., AboveNet Communications, Inc., AboveNet of Utah,
      LLC, AboveNet of VA, LLC, AboveNet International, Inc., the Lenders
      party thereto, Societe Generale, as Administrative Agent, and CIT Lending
      Services Corporation, as Documentation Agent, dated as of
      February 29, 2008 (incorporated herein by reference to Form 8-K
      filed with the Securities and Exchange Commission on July 2,
      2009)31.1
                
                Certification
      of Chief Executive Officer of the Registrant, pursuant to Rule 13a-14(a)
      of the Securities Exchange Act of 1934.31.2
                
                Certification
      of Chief Financial Officer of the Registrant, pursuant to Rule 13a-14(a)
      of the Securities Exchange Act of 1934.32.1
                
                Certification
      of Chief Executive Officer of the Registrant, pursuant to 18 U.S.C.
      Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.32.2
                
                Certification
      of Chief Financial Officer of the Registrant, pursuant to 18 U.S.C.
      Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.




61





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:  August
      10, 2009
              By:
              /s/ William G. LaPerchWilliam
      G. LaPerch
                President,
      Chief Executive Officer and Director
                (Principal
      Executive Officer and Duly Authorized
Officer)





Date:  August
      10, 2009
              By:
              /s/ Joseph P. CiavarellaJoseph
      P. Ciavarella
                Senior
      Vice President and Chief Financial Officer
                (Principal
      Financial and Accounting
Officer)




62





EXHIBIT
INDEX





Exhibit No.
                  
                  Description
      of Exhibit4.1
                  
                  Amended
      and Restated Rights Agreement, dated as of August 3, 2009, between
      AboveNet, Inc. and American Stock Transfer & Trust Company, LLC
      (incorporated herein by reference to Form 8-K filed with the Securities
      and Exchange Commission on August 3, 2009).4.2
                  
                  Form
      of Right Certificate (incorporated herein by reference to Form 8-K filed
      with the Securities and Exchange Commission on August 3,
      2009).10.1
                  
                  Amendment
      No. 2, dated as of June 29, 2009, to Credit and Guaranty Agreement among
      AboveNet, Inc., AboveNet Communications, Inc., AboveNet of Utah,
      LLC, AboveNet of VA, LLC, AboveNet International, Inc., the Lenders
      party thereto, Societe Generale, as Administrative Agent, and CIT Lending
      Services Corporation, as Documentation Agent, dated as of
      February 29, 2008 (incorporated herein by reference to Form 8-K
      filed with the Securities and Exchange Commission on July 2,
      2009)31.1
                  
                  Certification
      of Chief Executive Officer of the Registrant, pursuant to Rule 13a-14(a)
      of the Securities Exchange Act of 1934.31.2
                  
                  Certification
      of Chief Financial Officer of the Registrant, pursuant to Rule 13a-14(a)
      of the Securities Exchange Act of 1934.32.1
                  
                  Certification
      of Chief Executive Officer of the Registrant, pursuant to 18 U.S.C.
      Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.32.2
                  
                  Certification
      of Chief Financial Officer of the Registrant, pursuant to 18 U.S.C.
      Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.


63