UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

Commission file number 001-12475

 

 

Terremark Worldwide, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

2 South Biscayne Blvd., Suite 2800, Miami, Florida 33131

(Address of Principal Executive Offices, Including Zip Code)

 

Registrant’s telephone number, including area code:

(305) 856-3200

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Act.  Yes o     No þ

 

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 þ     No o

 

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 o     No o

 

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. (Check one):

 

 

Indicate by check mark if the registrant is a shell Company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

 

 

TABLE OF CONTENTS

 

 

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)

 

 

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

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)

 

 

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

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
(In thousands)
(Unaudited)

 

 

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

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

 

 

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

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

Terremark Worldwide, Inc. and subsidiaries (“Terremark” or the “Company”) is a global provider of managed IT solutions leveraging its highly connected carrier-neutral data centers across major networking hubs in the United States, Europe and Latin America. The Company delivers a comprehensive suite of managed solutions including colocation, managed hosting, managed network, disaster recovery, security and cloud computing services. Terremark serves approximately 1,300 customers worldwide across a broad range of sectors, including enterprise, government agencies, systems integrators, network service providers, internet content and portal companies and internet infrastructure companies. The Company delivers its solutions through specialized data centers, including its three primary facilities: NAP of the Americas in Miami, Florida; NAP of the Capital Region in Culpeper, Virginia outside downtown Washington, D.C.; and NAP of the Americas/West in Santa Clara, California.

 

 

The accompanying unaudited condensed consolidated financial statements include the accounts of Terremark Worldwide, Inc. and all entities in which Terremark Worldwide, Inc. has a controlling voting interest (“subsidiaries”) required to be consolidated in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) (collectively referred to as “Terremark”). All significant intercompany accounts and transactions between consolidated companies have been eliminated in consolidation.

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the accounting policies described in the 2009 Annual Report on Form 10-K, and should be read in conjunction with the consolidated financial statements and notes thereto. These statements do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included and the disclosures herein are adequate. The operating results for interim periods are unaudited and are not necessarily indicative of the results that can be expected for a full year.

 

Reclassifications

 

Certain reclassifications have been made to the prior period’s condensed consolidated financial statements to conform to the current presentation.

 

Use of estimates

 

The Company prepares its financial statements in conformity with U.S. GAAP, which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenue and expenses during the reporting period. Key estimates include: revenue recognition and allowance for bad debts, derivatives, income taxes, share-based compensation, impairment of long-lived assets, intangibles and goodwill. Estimates are based on historical experience and on various other assumptions that Terremark believes to be reasonable under the circumstances, the results of which form the basis for judgments about results and the carrying values of assets and liabilities. Actual results could differ from such estimates.

 

Revenue recognition and allowance for bad debts

 

Revenues principally consist of monthly recurring fees for colocation, exchange point, managed and professional services fees. Colocation revenues also include monthly rental income for unconditioned space in the NAP of the Americas. Revenues from colocation, exchange point services, and hosting, as well as rental income for unconditioned space, are recognized ratably over the term of the applicable contract. Installation fees and related direct costs are deferred and recognized ratably over the expected life of the customer installation which is

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

estimated to be 36 to 48 months. Managed and professional services are recognized in the period in which the services are provided. Revenues also include equipment resales which are generally recognized in the period in which the equipment is delivered, title transfers and is accepted by the customer. Revenue from contract settlements is generally recognized when collectability is reasonably assured and no remaining performance obligation exists. Taxes collected from customers and remitted to the government are excluded from revenues.

 

The Company may enter into revenue arrangements which consist of more than one element such as equipment, installation and colocation or hosting services. For these multiple deliverable arrangements, the Company allocates revenue between the elements based on acceptable fair value allocation methodologies, provided that each element meets the criteria for treatment as a separate unit of accounting. An item is considered a separate unit of accounting if it has value to the customer on a standalone basis and there is objective and reliable evidence of the fair value of the undelivered items. The fair value of the undelivered elements is determined by the price charged when the element is sold separately, or in cases when the item is not sold separately, by using other acceptable objective evidence. Management applies judgment to ensure appropriate application of revenue recognition for revenue arrangements with multiple deliverables, including the determination of whether delivered items have standalone value, and the determination of fair value for the multiple deliverables, among others. For those arrangements where the deliverables do not qualify as a separate unit of accounting, revenue from all deliverables are treated as one accounting unit and recognized ratably over the term of the arrangement.

 

Significant concentrations

 

The federal sector accounted for revenues of approximately 22% and 23% for the nine and three months ended December 31, 2009, respectively. The federal sector accounted for revenues of approximately 19% and 22% for the nine and three months ended December 31, 2008, respectively. No other customer accounted for more than 10% of revenues for the nine and three months ended December 31, 2009 and 2008, respectively.

 

Derivatives

 

The Company has, in the past, used financial instruments, including interest cap agreements and interest rate swap agreements, to manage exposures to movements in interest rates. The use of these financial instruments modifies the exposure of these risks with the intent to reduce the risk or cost to the Company. The Company does not hold or issue derivative instruments for trading purposes.

 

The Company entered into two interest rate swap agreements as required under the provisions of the $250 million mortgage loan entered into on July 31, 2007. The interest rate swaps were settled on June 24, 2009. See Note 11.

 

The Company’s 6.625% Senior Convertible Notes, due June 15, 2013, (the “6.625% Senior Convertible Notes”) contain embedded derivatives that require separate valuation from the 6.625% Senior Convertible Notes. The Company recognizes these derivatives as assets or liabilities in its balance sheet, measures them at their estimated fair value, and recognizes changes in their estimated fair value in earnings in the period of change.

 

The Company estimates the fair value of its embedded derivatives using available market information and appropriate valuation methodologies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company may eventually pay to settle these embedded derivatives.

 

Share-based compensation

 

The fair value of stock option and nonvested stock awards with only service conditions, which are subject to graded vesting, are expensed on a straight-line basis over the vesting period of the awards.

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

Tax benefits resulting from tax deductions in excess of share-based compensation expense recognized under the fair value method (windfall tax benefits) are credited to additional paid-in capital. Realized tax shortfalls are first offset against the cumulative balance of windfall tax benefits, if any, and then charged directly to income tax expense.

 

Earnings (loss) per share

 

The Company’s 6.625% Senior Convertible Notes contain contingent interest provisions that allow the holders of the Senior Convertible Notes to participate in any dividends declared on the Company’s common stock. Further, the Company’s Series I preferred stock contains participation rights that entitle the holders to receive dividends in the event the Company declares dividends on its common stock. Accordingly, the Senior Convertible Notes and the Series I preferred stock are considered participating securities.

 

Basic earnings per share (“EPS”) is calculated as income (loss) available to common stockholders divided by the weighted average number of shares of common stock outstanding during the period. If the effect is dilutive, participating securities are included in the computation of basic EPS. Nonvested stock granted to employees and directors are not included in the computation of basic EPS until the security vests. The Company’s participating securities do not have a contractual obligation to share in the losses in any given period. As a result, these participating securities will not be allocated any losses in the periods of net losses, but will be allocated income in the periods of net income using the two-class method. The two-class method is an earnings allocation formula that determines earnings for each class of common stock and participating securities according to dividends declared or accumulated and participation rights in undistributed earnings. Under the two-class method, net income is reduced by the amount of dividends declared in the current period for each class of stock and by the contractual amounts of dividends that must be paid for the current period. The remaining earnings are then allocated to common stock and participating securities to the extent that each security may share in earnings as if all of the earnings for the period had been distributed. Diluted EPS is calculated using the treasury stock and “if converted” methods for potential dilutive instruments that are convertible into common stock, as applicable.

 

Other comprehensive income (loss)

 

Other comprehensive income (loss) presents a measure of all changes in stockholders’ equity except for changes resulting from transactions with stockholders in their capacity as stockholders. Other comprehensive income (loss) consists of net income (loss) and foreign currency translation adjustments, and is presented in the accompanying condensed consolidated statement of changes in stockholders’ equity.

 

The Company’s foreign operations generally use the local currency as their functional currency. Assets and liabilities of these operations are translated at the exchange rates in effect on the balance sheet date. Income statement items are translated at the average rates for the year. If exchangeability between the functional currency and the U.S. dollar is temporarily lacking at the balance sheet date, the first subsequent rate at which exchanges can be made is used to translate assets and liabilities.

 

Construction in progress

 

Construction in progress is stated at its original cost and includes direct expenditures associated with the expansion of the Company’s data center footprint and upgrades to infrastructure of current data center footprint. In addition, the Company has capitalized certain interest costs during the construction phase. Once an expansion project becomes operational, these capitalized costs are allocated to certain property and equipment categories and are depreciated at the appropriate rates consistent with the estimated useful life of the underlying assets. Interest

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

incurred is capitalized if certain criteria are met. The following table sets forth total interest cost incurred and total interest cost capitalized (in thousands):

 

 

Fair value of financial instruments

 

The Company’s short-term financial instruments, including cash and cash equivalents, restricted cash, accounts receivable, prepaid expenses and other assets, accounts payable and other liabilities, consist primarily of instruments without extended maturities, the fair value of which, based on management’s estimates, reasonably approximate their book value. The fair value of capital lease obligations is based on management estimates and reasonably approximates their book value after comparison to obligations with similar interest rates and maturities. The fair value of the Company’s redeemable preferred stock is estimated to be its liquidation value, which includes accumulated and unpaid dividends. The fair value of the Company’s secured loans (see Note 9) and convertible debt (see Note 10), which, at this time, are not actively traded in the market, are estimated by considering the Company’s credit rating, current rates available to the Company for similar debt and the Company’s stock price volatility. The fair value of secured loans and convertible debt as of December 31, 2009 and March 31, 2009 is as follows (in thousands):

 

 

The book value for the Company’s secured loans and convertible debt is net of the unamortized discount to debt principal. See Notes 9 and 10.

 

Fair value measurements

 

The Company carries various assets and liabilities at fair value in the accompanying condensed consolidated balance sheets. Fair value is defined as the amount that would be received for an asset or paid to transfer a liability (i.e., an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. Three levels of inputs that may be used to measure fair value are as follows:

 

Level 1:  Quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical assets and liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.

 

Level 2:  Observable prices that are based on inputs not quoted on active markets but corroborated by market data.

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

Level 3:  Unobservable inputs when there is little or no market data available, thereby requiring an entity to develop its own assumptions. The fair value hierarchy gives the lowest priority to Level 3 inputs.

 

The table below summarizes the fair values of our financial assets (liabilities) as of December 31, 2009 (in thousands):

 

 

The following is a description of the valuation methodologies used for these items, as well as the general classification of such items:

 

Money market fund instruments — these instruments are valued using quoted prices for identical instruments in active markets. Therefore, the instruments are classified within Level 1 of the fair value hierarchy. These money market funds are included in cash and cash equivalents.

 

Embedded derivatives — these instruments are embedded within the Company’s 6.625% Senior Convertible Notes. These instruments were valued using pricing models which incorporate the Company’s stock price, credit risk, volatility, U.S. risk free rate, transaction details such as contractual terms, maturity and amount of future cash inflows, as well as assumptions about probability and the timing of certain events taking place in the future. For a summary of the changes in the fair value of these embedded derivatives, see Note 11.

 

Income taxes

 

Income taxes are accounted for under the asset and liability method. 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 and operating loss and tax credit carryforwards. 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 effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce tax assets to the amounts expected to be realized. In assessing the likelihood of realization, management considers estimates of future taxable income.

 

Recent accounting pronouncements

 

In December 2007, the FASB issued accounting guidance to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Among other requirements, the guidance clarifies that a noncontrolling interest in a subsidiary, which was previously referred to as minority interest, is to be reported as a separate component of equity in the consolidated financial statements. The guidance also requires consolidated net income to include the amounts attributable to both the parent and the noncontrolling interest and to disclose those amounts on the face of the consolidated statement of income.

 

The guidance must be applied prospectively for fiscal years, and interim periods within those fiscal years, beginning in the Company’s fiscal 2010, except for the presentation and disclosure requirements, which will be applied retrospectively for all periods presented. The Company adopted this guidance on April 1, 2009. The adoption did not have any impact on the Company’s financial position, results of operations or cash flow.

 

In April 2008, the FASB issued guidance that amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. This guidance is

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

effective for fiscal years beginning after December 31, 2008, and interim periods within those fiscal years. The Company adopted this guidance on April 1, 2009. The adoption did not have an impact on the Company’s financial position, results of operations or cash flow.

 

In May 2009, the FASB issued guidance that establishes 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. This guidance will be effective for interim and annual financial periods ending after June 15, 2009. The Company adopted this guidance during the three months ended June 30, 2009 and evaluated subsequent events through the issuance date of the financial statements. The adoption of this guidance did not have any impact on the Company’s financial position, results of operations or cash flow.

 

In June 2009, the FASB issued guidance that establishes the FASB Accounting Standards Codification as the source of authoritative U.S. GAAP recognized by the FASB to be applied by nongovernmental entities. The Company adopted this guidance during the three months ended December 31, 2009, and its adoption did not have any impact on the Company’s financial position, results of operations or cash flow.

 

In June 2009, the FASB issued new accounting guidance which addresses the elimination of the concept of a qualifying special purpose entity. The amendments also replace the quantitative-based risks and rewards calculation for determining which enterprise has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity and the obligation to absorb losses of the entity or the right to receive benefits from the entity. Additionally, the new amendments provide more timely and useful information about an enterprise’s involvement with a variable interest entity. The amendments will become effective in the first annual reporting period that begins after November 15, 2009 and for interim periods within that first annual reporting period. The Company is currently evaluating the impact of this standard on its consolidated financial statements.

 

In June 2009, the Company adopted new accounting guidance that requires an entity to provide disclosures of fair value of financial instruments in interim financial information. The Company has included disclosures about the fair value of all financial instruments for which it is practicable to estimate the value, whether recognized or not on its balance sheet, when summarized financial information for interim reporting periods is issued. The Company adopted this guidance during the three months ended September 30, 2009, and its adoption did not have any impact on the Company’s financial position, results of operations or cash flow.

 

In October 2009, the FASB issued guidance which addresses the accounting for multiple-deliverable arrangements to enable vendors to account for products or services (deliverables) separately, rather than as a combined unit. The guidance is effective prospectively for revenue arrangements entered into or materially modified beginning in fiscal years on or after June 15, 2010. Early adoption is permitted. The Company is currently evaluating the impact that the adoption of this standard will have on its consolidated financial statements, if any.

 

 

On November 12, 2009, the Company entered into a purchase agreement to acquire the stock of DS3 Data Vaulting, L.L.C., a data management solutions provider, for a purchase price of $11.5 million in cash, subject to a working capital adjustment, which the Company has estimated to be $0.5 million due to the sellers, as of December 31, 2009. The Company has included the estimated working capital adjustment in the preliminary purchase price allocation. The working capital adjustment is anticipated to be finalized 90 days from November 12, 2009, or February 12, 2010. Pursuant to the purchase agreement, the sellers agreed to indemnify the Company for certain potential contractual obligations. In accordance with the terms of the escrow agreement, $1.5 million of the purchase price was placed into an escrow account to secure such indemnification obligations. The escrow agreement ends on May 11, 2011, at which time any remaining funds would be distributed to the sellers. This data management solutions provider delivers offsite, online data backup and restore services which enable enterprises and government agencies to rapidly and securely backup and restore files, databases and operating

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

systems. The costs to acquire the data management solutions provider were allocated to the tangible and identified intangible assets acquired and liabilities assumed based on their respective fair values and any excess were allocated to goodwill. The following summarizes the allocation of the purchase price as of December 31, 2009 (in thousands):

 

 

The allocation of intangible assets acquired as of December 31, 2009 is summarized in the following table (in thousands):

 

 

 

 

Trade accounts receivable are recorded at the invoiced amount and do not bear interest. Unbilled revenue consists of revenues earned for which the customer has not been billed.

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

 

 

 

 

Depreciation and amortization expense was $25.9 million and $9.2 million for the nine and three months ended December 31, 2009, respectively. Depreciation and amortization expense was $18.3 million and $6.9 million for the nine and three months ended December 31, 2008, respectively.

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

 

 

The Company expects to record amortization expense associated with these intangible assets as follows for each of the fiscal years ended (in thousands):

 

 

Amortization of intangibles was $1.6 million and $0.5 million for the nine and three months ended December 31, 2009, respectively. Amortization of intangibles was $1.8 million and $0.6 million for the nine and three months ended December 31, 2008, respectively, and is included in depreciation and amortization in the Company’s condensed consolidated financial statements.

 

 

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

 

 

On June 24, 2009 (the “Closing Date”), the Company issued an aggregate principal amount of $420.0 million of 12% Senior Secured Notes, due June 15, 2017, which are guaranteed by substantially all of the Company’s domestic subsidiaries (the “Guarantors”). See Note 21. Additionally, the 12% Senior Secured Notes are secured by a first priority security interest in substantially all of the assets of the Company and the Guarantors, including the pledge of 100% of all outstanding capital stock of each of the Company’s domestic subsidiaries, excluding Terremark Federal Group, Inc. and Technology Center of the Americas, LLC, and 65% of all outstanding capital stock of substantially all of the Company’s foreign subsidiaries, subject to certain customary exceptions relating to our ability to remove the pledge with respect to certain significant subsidiaries which would otherwise result in additional audit requirements under SEC accounting rules. The 12% Senior Secured Notes were offered and sold in a private placement to qualified institutional buyers in the United States in reliance on Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”), and outside the United States in reliance on Regulation S under the Securities Act. The 12% Senior Secured Notes bear interest at 12.0% per annum, payable on December 15 and June 15 of each year.

 

The loan proceeds were used to satisfy and repay all of the Company’s outstanding secured indebtedness, including (i) loans under the First Lien Credit Agreement, with a face value of $150 million, due August 15, 2012, (ii) loans under the Second Lien Credit Agreement, with a face value of $100 million, due February 2, 2013 and (iii) $8.4 million for the settlement of the two interest rate swap agreements that were entered into in connection with the Credit Agreements. The Company paid prepayment premiums of $2.2 million to the holders of the Second Lien Credit Agreement in connection with this financing transaction.

 

The exchange of $150 million of the First Lien Credit Agreement and $100 million of the Second Lien Credit Agreement were accounted for as an early extinguishment of debt and the 12% Senior Secured Notes were accounted for as a new debt instrument at $387.0 million, net of original issue discount of $33.0 million that includes $12.5 million in fees paid to initial purchasers of the notes. The exchange of debt instruments resulted in a loss on the early extinguishment of debt of $10.3 million. The loss included $7.0 million of unamortized deferred financing costs, $2.3 million of prepayment penalties related to the Second Lien Credit Agreement, breakage fees related to the settlement of the interest rate swaps and $1.0 million of unamortized discount. In addition, the Company recorded $3.4 million of debt issuance costs related to the 12% Senior Secured Notes. For the nine months ended December 31, 2009, the Company amortized $1.2 million of the original issue discount into interest expense. For the nine months ended December 31, 2009, the Company amortized $0.1 million of the debt issuance costs into interest expense.

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

The 12% Senior Secured Notes were issued pursuant to an indenture, dated June 24, 2009 (the “Indenture”), among the Company, the Guarantors and The Bank of New York Mellon Trust Company, N.A., as trustee (the “Trustee”). The terms of the Indenture generally limit the Company’s ability and the ability of the Company’s subsidiaries to, among other things: (i) make restricted payments; (ii) incur additional debt and issue preferred or disqualified stock; (iii) create liens; (iv) create or permit to exist restrictions on the Company’s ability or the ability of the Company’s restricted subsidiaries to make certain payments or distributions; (v) engage in sale-leaseback transactions; (vi) engage in mergers or consolidations or transfer all or substantially all of the Company’s assets; (vii) make certain dispositions and transfers of assets; and (viii) enter into transactions with affiliates.

 

Any additional indebtedness permitted by the Indenture may rank pari passu with the 12% Senior Secured Notes, provided that the Company’s fixed charge coverage ratio would have been at least 2.0 to 1 on a pro forma basis (including a pro forma application of the net proceeds) as if such indebtedness had been incurred at and as of the beginning of the Company’s most recently completed four fiscal quarters for which internal financial statements are available. If there is a change of control, the Company is required to offer to repurchase all or any part of the notes in cash equal to not less than 101% of the aggregate principal amount of notes repurchased plus accrued and unpaid interest on the notes repurchased to the date of repurchase. Additionally, if the Company or a Guarantor sells assets, all or a portion of the net proceeds of which are not reinvested in accordance with the terms of the Indenture or are not used to repay certain debt, the Company will be required to offer to purchase an aggregate principal amount of the outstanding 12% Senior Secured Notes, in an amount equal to such remaining net proceeds, at a purchase price equal to 100% of the principal amount thereof, plus accrued interest and Additional Interest (if any and as defined below), to the payment date. The Indenture provides for customary events of default.

 

At any time prior to June 15, 2012, the Company may on any one or more occasions redeem up to 35% of the aggregate principal amount of 12% Senior Secured Notes at a redemption price equal to 112.0% of the principal amount, plus accrued and unpaid interest to the applicable redemption date, with the net cash proceeds of certain equity offerings; provided that (i) at least 65% of the aggregate principal amount of aggregate principal amount of notes remains outstanding immediately after such redemption, and (ii) the redemption occurs within 120 days of the date of the closing of such equity offering. At any time prior to June 15, 2013, the Company may redeem all or a part of the 12% Senior Secured Notes at a redemption price equal to 100% of the principal amount of the 12% Senior Secured Notes redeemed plus an applicable “make-whole” premium (as defined in the Indenture), as of, and accrued and unpaid interest, if any, to the applicable redemption date. Additionally, on or after June 15, 2013, the Company may redeem all or a part of the Notes on any one or more occasions, at the redemption prices (expressed as percentages of principal amount of the notes to be redeemed) set forth below plus accrued and unpaid interest on the Notes redeemed, to the applicable redemption date, if redeemed during the 12-month period beginning on June 15 of each of the years indicated below:

 

 

Pursuant to the Indenture, the Company may incur certain additional indebtedness, including up to $50 million under credit facilities that may be used for any purpose, rank pari passu with the Notes and which may be secured by parity liens on the collateral securing the Notes. Also, the Company may incur up to $75 million of additional junior indebtedness for the purpose of financing the purchase price or cost of construction or improvement of property, plant or equipment, including the acquisition of the capital stock of an entity that becomes a restricted subsidiary. Any or all of such $75 million of additional indebtedness may be secured by parity liens on the collateral securing the Notes, provided that our secured leverage ratio does not exceed 3:75 to 1 on a pro-forma basis as if the Company had incurred such indebtedness at and as of the beginning of our most recently completed four fiscal quarters for which internal financial statements are available. Irrespective of our leverage ratio, any or all of such $75 million of additional indebtedness may be secured by junior liens on the collateral securing the Notes.

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

In the event of a change in control, the Company will be required to commence and complete an offer to purchase all senior secured notes then outstanding at a price equal to 101% of their principal amount, plus accrued interest (if any), to the date of repurchase. Additionally, if the Company or a guarantor sell assets, all or a portion of the net proceeds of which are not reinvested in accordance with the terms of the indenture or are not used to repay certain debt, the Company will be required to offer to purchase an aggregate principal amount of the outstanding senior secured notes, in an amount equal to such remaining net proceeds, at a purchase price equal to 100% of the principal amount thereof, plus accrued interest and Additional Interest, if any and as defined below, to the payment date.

 

The 12% Senior Secured Notes have not been registered under the Securities Act or any state securities laws and may not be sold except in a transaction registered under, or exempt from, the registration provisions of the Securities Act and applicable state securities laws. On the Closing Date, the Company and the Guarantors entered into a registration rights agreement (the “Registration Rights Agreement”), pursuant to which the Company and the Guarantors have agreed for the benefit of the holders of the 12% Senior Secured Notes to use their best efforts to file with the Securities and Exchange Commission (the “Commission”) and cause to become effective a registration statement (the “Exchange Offer Registration Statement”) with respect to a registered offer to exchange the Notes and the Guarantees thereof for an issue of the Company’s senior secured notes (the “Exchange Notes”) guaranteed by the Guarantors (the “Exchange Note Guarantees” and, together with the Exchange Notes, the “Exchange Securities”) with terms identical to the 12% Senior Secured Notes, except that the Exchange Notes will not bear legends restricting transfer and will not contain terms providing for the payment of additional interest as described below and in the Registration Rights Agreement. In addition, the Company has agreed to file, in certain circumstances, a shelf registration statement covering resales of the Securities. If the exchange offer for the 12% Senior Secured Notes is not completed on or prior to January 20, 2010, the applicable interest rate will increase by 0.25% per annum for the first 90-day period thereafter, and the amount of such additional interest will increase by an additional 0.25% per annum for each subsequent 90-day period, up to a maximum of 1.0% per annum over the original interest rate (“Additional Interest”).

 

Additional interest will also become payable if any of the following occurs: (i) our failure to file with the Securities and Exchange Commission (the “Commission”) the Exchange Offer Registration Statement on or prior to September 22, 2009; (ii) our failure to file with the Commission a shelf registration statement on or prior to the 30th day following the occurrence of an event requiring that we file a shelf registration statement; (iii) if on or prior to December 21, 2009, neither the Exchange Offer Registration Statement nor a shelf registration statement has been declared effective by the Commission; (iv) if on or prior to January 20, 2010 a shelf registration statement, if required in lieu of Exchange Offer Registration Statement, has not been declared effective by the Commission; or (v) if either the Exchange Offer Registration Statement or a shelf registration statement that has been declared effective ceases to be effective. The Company has not yet filed the Exchange Offer Registration Statement and accordingly is accruing this additional interest. As of February 10, 2010, the Company has incurred $0.9 million in additional interest. Under the terms of the senior secured notes, the Company was required to pay to the holders approximately $245,000 of this additional interest when it paid the scheduled interest payment payable on December 15, 2009. The Company did not make this payment of additional interest at this time. The Company has since paid the additional interest and is in compliance with the terms of the senior secured notes.

 

The proceeds received from the issuance of the senior secured notes were used to repay term loan financing arrangements under the First Lien Credit Agreement and the Second Lien Credit Agreement described above.

 

In connection with the repayment of the obligations under the Credit Agreements, the Company settled interest rate swap agreements that had served as an economic hedge against increases in interest rates and were not designated as hedges for accounting purposes. See Note 11.

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

 

On June 15, 2009, all outstanding obligations related to the Company’s 0.5% Senior Subordinated Convertible Notes, (the “Series B Notes”) with a face value of $4.0 million, held by Credit Suisse, Cayman Islands Branch and Credit Suisse, International, were satisfied and repaid as the Series B Notes became due. On the date of the transaction, the Company paid $4.1 million to the holders which represented the principal amount, payment in kind and any unpaid or accrued interest. On June 15, 2009, all outstanding obligations related to 9% Senior Convertible Notes with a face value of $29.1 million were satisfied and repaid as the notes became due. On the date of the transaction, the Company paid $30.4 million to the holders which represented $29.1 million of principal and $1.3 million of unpaid interest. The 9% Senior Convertible Notes were unsecured obligations and ranked pari passu with all existing and future unsecured and unsubordinated indebtedness, senior in right of payment to all existing and future subordinated indebtedness, and ranked junior to any future secured indebtedness.

 

On May 2, 2007, the Company completed a private exchange offer of its 6.625% Senior Convertible Notes with a limited number of holders for $57.2 million aggregate principal amount of its outstanding 9% Senior Convertible Notes in exchange for an equal aggregate principal amount of the 6.625% Senior Convertible Notes. After completion of the private exchange offer, only $29.1 million aggregate principal amount of the 9% Senior Convertible Notes remained outstanding under the global note and indenture governing the 9% Senior Convertible Notes which notes were eventually repaid on June 15, 2009 as described above. The Company accounted for the exchange of $57.2 million of the 9% Senior Convertible Notes as an early extinguishment of debt and the 6.625% Senior Convertible Notes were accounted for as new debt instruments and recorded at $57.2 million on the date of the transaction. The exchange of the 9% Senior Convertible Notes with the 6.625% Senior Convertible Notes resulted in a loss on the early extinguishment of debt of $18.5 million. The loss included $2.2 million of unamortized deferred financing costs, $13.3 million of the unamortized discount on the 9% Senior Convertible Notes and the write off of $10.8 million of the derivative liability associated with the 9% Senior Convertible Notes that was bifurcated and accounted for separately. In addition, the exchange resulted in a substantial premium of $13.7 million associated with the fair value of the 6.625% Senior Convertible Notes that was recorded as additional paid-in capital.

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

Market data was used in the option pricing model to determine the volatility of the stock price of the Company, the interest rate term structure, the volatility of the interest rate and the correlation between the interest rate and the stock price.

 

The 6.625% Senior Convertible Notes are unsecured obligations and rank pari passu with all existing and future unsecured and unsubordinated indebtedness, senior in right of payment to all existing and future subordinated indebtedness, and rank junior to any future secured indebtedness. If there is a change in control, the holders of the 6.625% Senior Convertible Notes have the right to require the Company to repurchase their notes at a price equal to 100% of the principal amount, plus accrued and unpaid interest. If a holder surrenders notes for conversion at any time beginning on the effective notice of a change in control in which 10% or more of the consideration for the Company’s common stock consists of cash, the Company will increase the number of shares issuable upon such conversion by an amount not to exceed 5,085,513 additional shares. The number of additional shares is based on the date on which the partial cash buy-out becomes effective and the price paid or deemed to be paid per share of the Company’s common stock in the change of control. If the Company issues a cash dividend on its common stock, it must pay contingent interest to the holders of the 6.625% Senior Convertible Notes equal to the product of the per share cash dividend and the number of shares of common stock issuable upon conversion of such holder’s 6.625% Senior Convertible Notes.

 

 

The Company’s 6.625% Senior Convertible Notes contain two embedded derivatives that require separate valuation from the 6.625% Senior Convertible Notes: an equity participation right and a contingent put upon change in control.

 

The Company’s 9% Senior Convertible Notes contained three embedded derivatives that required separate valuation from the 9% Senior Convertible Notes: a conversion option that included an early conversion incentive, an equity participation right and a takeover make whole premium due upon a change in control. The early conversion incentive expired on June 14, 2007. The Company determined that with the expiration of the early conversion incentive on June 14, 2007, the conversion feature no longer met the conditions that would require separate accounting as a derivative.

 

The Company’s Series B Notes contained one embedded derivative that required separate valuation from the Series B Notes: a call option which provided the Company with the option to redeem the Series B Notes at fixed redemption prices plus accrued and unpaid interest and plus any difference in the fair value of the conversion feature.

 

The Company has estimated that the embedded derivatives within the 9% Senior Convertible Notes, the Series B Notes and the 6.625% Senior Convertible Notes amounted in the aggregate to a net liability of $0.2 million at March 31, 2009. The resulting loss of $0.3 million and income of $0.2 million was included in the change in the fair value of derivatives in the accompanying condensed consolidated statement of operations for the nine and three months ended December 31, 2008, respectively. In connection with the repayment of the 9% Senior Convertible Notes and the Series B Notes on their respective due dates, each of the embedded derivatives within these instruments was cancelled. As of December 31, 2009, the only remaining outstanding embedded derivatives were related to the 6.625% Senior Convertible Notes, which amounted in the aggregate to a liability of $0.3 million at June 30, 2009, September 30, 2009 and $0.6 million at December 31, 2009. The resulting loss of $0.4 and $0.5 million was included in the change in the fair value of derivatives in the nine and three months ended December 31, 2009, respectively.

 

On February 8, 2008, the Company entered into two interest rate swap agreements as required under the provisions of the Credit Agreements discussed in Note 9. One of the interest rate swap agreements was effective March 31, 2008 for a notional amount of $148 million and a fixed interest rate of 2.999%. Interest payments on this instrument are due on the last day of each March, June, September and December, ending on December 31, 2010.

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

The second interest rate swap agreement entered into was effective on July 31, 2008 for a notional amount of $102.0 million and a fixed interest rate of 3.067%. Interest payments on this instrument were due on the last day of each January, April, July and October, ending on January 31, 2011. The interest rate swap agreements served as an economic hedge against increases in interest rates and had not been designated as hedges for accounting purposes. Accordingly, the Company accounted for these interest rate swap agreements on a fair value basis and adjusts these instruments to fair value and the resulting changes in fair value are charged to earnings. At March 31, 2009, the fair value of the interest rate swap agreements was a liability of $6.1 million.

 

In connection with the repayment of the Credit Agreements on June 24, 2009, the interest rate swap agreements were unwound and settled for $8.4 million payable to the holders. The Company recorded $1.3 million for the change in the fair value of derivatives prior to June 24, 2009 and $0.9 million of interest expense related to the interest rate swap agreements in the nine months ended December 31, 2009.

 

 

 

 

In the ordinary course of conducting business, the Company becomes involved in various legal actions and claims. Litigation is subject to many uncertainties and the Company may be unable to accurately predict the outcome of such matters, some of which could be decided unfavorably to it. The Company’s participation in government contracts subjects the Company to inquiries, investigations and subpoenas regarding business with the federal government. Improper or illegal activities may subject the Company to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines, and suspension or debarment from doing business with federal government agencies. Management does not believe the ultimate outcome of pending matters of the nature described above would be material.

 

 

Issuance of Common stock

 

On May 29, 2009, the Company in a private transaction, issued to VMware Bermuda Limited (“VMware”), a wholly-owned subsidiary of VMware, Inc., four million shares of its common stock, valued at $19.9 million, net of issuance costs. The governing subscription agreement grants to VMware a right of first refusal with respect to certain future equity sales by the Company that occur within the 18-month period following the closing of the VMware purchase. If such equity sales are proposed to be made to a competitor of VMware or certain affiliates, VMware may elect to purchase such equity in lieu of the competitor. If such equity sales are proposed to be made to

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

a non-competitor of VMware, VMware will not have the ability to prevent such sale but will have the right to elect to purchase an additional amount of equity sufficient to maintain its initial equity percentage interest in the Company.

 

During the nine months ended December 31, 2009, the Company issued 1,168 shares of its common stock to certain employees valued at $2.3 million to settle share-based awards. Issued shares were net of shares surrendered to satisfy the employees’ withholding tax liability.

 

 

The following table sets forth potential shares of common stock that are not included in the diluted net loss per share calculation because to do so would be anti-dilutive for the periods indicated (in thousands):

 

 

 

Option Awards

 

On May 22, 2009, the Company granted 180,000 stock options to purchase shares of its common stock with an exercise price of $4.47 to members of the Company’s Board of Directors.

 

Nonvested Awards

 

The Company records the intrinsic value of the nonvested stock as additional paid-in capital. Share-based compensation expense is recognized ratably over the applicable vesting period. As of December 31, 2009, the future compensation expense related to nonvested stock that will be recognized is approximately $14.0 million. The cost is expected to be recognized over a weighted average period of 2.3 years. The Company recognized approximately $3.6 million and $1.8 million of share-based compensation expense, associated with nonvested stock, for the nine and three months ended December 31, 2009, respectively. The Company recognized approximately $3.2 million and $1.2 million of share-based compensation expense, associated with nonvested stock, for the nine and three months ended December 31, 2008, respectively. A summary of the Company’s nonvested stock as of December 31,

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

2009 and changes during the nine months ended December 31, 2009 is presented below (in thousands, except for per share data):

 

 

Share-based Compensation Recognized in the Statement of Operations

 

The following table presents, by operating expense category, the Company’s share-based compensation expense recognized for all outstanding equity awards (in thousands):

 

 

 

Following is a summary of transactions for the nine and three months ended December 31, 2009 and 2008 and balances with related parties included in the accompanying condensed consolidated statements of operations and the accompanying condensed consolidated balance sheets as of December 31, 2009 and March 31, 2009 (in thousands):

 

 

 

The Company has entered into consulting agreements with two members of its Board of Directors and into an employment agreement with another board member. One consulting agreement provided for annual compensation of $240,000, payable monthly. In addition, in October 2006, the Company’s Board of Directors approved the issuance to this director of 50,000 shares of nonvested stock vesting over a period of one year. The remaining consulting agreement and employment agreement provide for annual compensation aggregating $160,000. In June 2006, the Company agreed to issue 15,000 shares of nonvested stock to the director with the employment agreement, pursuant to a prior agreement in connection with the director bringing additional business to the Company. In February 2010, the Company entered into a consulting agreement with a new board member which provides for annual compensation of $100,000 and 20,000 shares of stock options.

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

 

 

Total arrangement consideration for managed web hosting solutions may include the procurement of equipment. Amounts allocated to equipment and software sold under these arrangements and included in managed and professional services were $7.5 million and $3.1 million for the nine and three months ended December 31, 2009, respectively, and $4.4 million and $1.2 million for the nine and three months ended December 31, 2008, respectively.

 

 

As of December 31, 2009 and March 31, 2009, the Company had one reportable business segment, which is the data center operation. The data center operations segment provides Tier 1 NAP, Internet infrastructure and managed services in a data center environment. Additionally, the segment provides NAP development and technology infrastructure buildout services.

 

 

 

 

On June 24, 2009, the Company completed an offering of $420 million of 12% Senior Secured Notes, which are guaranteed by substantially all of the Company’s domestic subsidiaries (the “Guarantor Subsidiaries”). Additionally, the debt is secured by a first priority security interest in substantially all of the assets of the Company and the Guarantors, including the pledge of 100% of all outstanding capital stock of each of the Company’s domestic subsidiaries, excluding Terremark Federal Group, Inc. and Technology Center of the Americas, LLC, and 65% of all outstanding capital stock of substantially all the Company’s foreign subsidiaries, subject to certain customary exceptions relating to our ability to remove the pledge with respect to certain significant subsidiaries which would otherwise result in additional audit requirements under SEC accounting rules.

 

In anticipation of the Guarantor Subsidiaries being guarantors of debt securities that are registered under the Securities Act of 1933, as amended, below are certain consolidating financial statements of the Company, the

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

Guarantor Subsidiaries and the Non-Guarantor Subsidiaries. In lieu of providing separate unaudited financial statements of the Guarantor Subsidiaries, condensed financial statements prepared in accordance with Rule 3-10 of Regulation S-X are presented below. The column marked “Issuer” includes the results of Terremark Worldwide, Inc. (the “Parent Company”). The column marked “Guarantor Subsidiaries” includes the results of the Guarantor Subsidiaries, which consists of all domestic subsidiaries. The column marked “Non-Guarantor Subsidiaries” includes results of the Non-Guarantor Subsidiaries, which consists primarily of foreign subsidiaries. Eliminations necessary to arrive at the information for the Company on a consolidated basis for the periods presented are included in the column so labeled and consist primarily of certain intercompany payments between the Parent Company and the Non-Guarantor Subsidiaries. Separate financial statements and other disclosures concerning the Guarantor Subsidiaries are not presented because management has determined that they are not material to investors.

 

The following represents the supplemental unaudited condensed financial statements of the Parent Company, the Guarantor Subsidiaries and the Non-Guarantor Subsidiaries. These condensed financial statements should be read in conjunction with our condensed consolidated financial statements and notes thereto.

 

TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

Condensed Consolidated Balance Sheet as of December 31, 2009