UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Form 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarterly period ended June 30, 2005 | ||
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from to |
Commission file number 001-12475
Terremark Worldwide, Inc.
Delaware | 84-0873124 | |
(State or Other Jurisdiction of Incorporation or Organization) | (IRS Employer Identification No.) |
2601 S. Bayshore Drive, Miami, Florida 33133
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 þ No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act. Yes þ No o
The registrant had 41,890,908 shares of common stock, $0.001 par value, outstanding as of July 31, 2005.
Table of Contents
1
PART I. FINANCIAL INFORMATION
Item 1. | Financial Statements |
TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, | March 31, | ||||||||
2005 | 2005 | ||||||||
(Unaudited) | |||||||||
Assets | |||||||||
Current assets: | |||||||||
Cash and cash equivalents | $ | 32,072,143 | $ | 44,001,144 | |||||
Restricted cash | 2,508,465 | 2,185,321 | |||||||
Accounts receivable, net of allowance for doubtful accounts of $200,000 | 5,942,434 | 4,388,889 | |||||||
Current portion of capital lease receivable | 2,280,000 | 2,280,000 | |||||||
Prepaid expenses and other current assets | 1,312,610 | 942,575 | |||||||
Total current assets | 44,115,652 | 53,797,929 | |||||||
Restricted cash | 5,647,501 | 5,641,531 | |||||||
Property and equipment, net of accumulated depreciation of $20,069,490 and $18,110,516 | 123,143,500 | 123,406,321 | |||||||
Debt issuance costs, net of accumulated amortization of $1,452,897 and $1,007,734 | 8,336,768 | 8,797,296 | |||||||
Other assets | 1,680,489 | 1,182,716 | |||||||
Capital lease receivable, net of current portion | 5,510,001 | 6,080,001 | |||||||
Goodwill | 9,999,870 | 9,999,870 | |||||||
Total assets | $ | 198,433,781 | $ | 208,905,664 | |||||
Liabilities and Stockholders’ Equity | |||||||||
Current liabilities: | |||||||||
Current portion of mortgage payable | $ | 705,338 | $ | 692,570 | |||||
Current portion of notes payable | 4,233,236 | 4,489,945 | |||||||
Construction payables | 33,747 | 427,752 | |||||||
Accounts payable and accrued expenses | 8,568,927 | 8,914,578 | |||||||
Current portion of capital lease obligations | 1,026,321 | 1,037,459 | |||||||
Interest payable | 765,204 | 2,680,882 | |||||||
Current portion of unearned interest | 677,559 | 724,686 | |||||||
Series H redeemable convertible preferred stock, at liquidation value | 624,202 | — | |||||||
Total current liabilities | 16,634,534 | 18,967,872 | |||||||
Mortgage payable, less current portion | 45,980,001 | 46,034,024 | |||||||
Convertible debt | 55,118,677 | 53,972,558 | |||||||
Derivatives embedded within convertible debt, at estimated fair value | 20,580,643 | 20,116,618 | |||||||
Notes payable, less current portion | 24,195,754 | 23,664,142 | |||||||
Deferred rent | 2,129,977 | 2,001,789 | |||||||
Unearned interest under capital lease receivables | 747,501 | 898,778 | |||||||
Capital lease obligations, less current portion | 362,544 | 434,441 | |||||||
Deferred revenue | 2,561,713 | 1,994,598 | |||||||
Series H redeemable convertible preferred stock, at liquidation value | — | 616,705 | |||||||
Total liabilities | 168,311,344 | 168,701,525 | |||||||
Minority interest | — | 28,090 | |||||||
Commitments and contingencies | — | — | |||||||
Stockholder’s equity: | |||||||||
Series I convertible preferred stock: $.001 par value, 369 and 383 shares issued and outstanding (liquidation value of approximately $10.1 million and $10.3 million) | 1 | 1 | |||||||
Common stock: $.001 par value, 100,000,000 shares authorized; 42,745,336 and 42,587,321 shares issued | 42,745 | 42,587 | |||||||
Common stock warrants | 13,624,760 | 13,599,704 | |||||||
Common stock options | 1,538,260 | 1,538,260 | |||||||
Additional paid-in capital | 279,051,205 | 279,063,085 | |||||||
Accumulated deficit | (256,805,341 | ) | (246,674,069 | ) | |||||
Accumulated other comprehensive loss | (108,556 | ) | (172,882 | ) | |||||
Treasury stock: 865,202 shares | (7,220,637 | ) | (7,220,637 | ) | |||||
Total stockholders’ equity | 30,122,437 | 40,176,049 | |||||||
Total liabilities and stockholders’ equity | $ | 198,433,781 | $ | 208,905,664 | |||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
2
TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months Ended | ||||||||||||
June 30, | ||||||||||||
2005 | 2004 | |||||||||||
(Unaudited) | ||||||||||||
Revenues | ||||||||||||
Data center — services | $ | 10,671,120 | $ | 7,111,171 | ||||||||
Construction contracts and fees | — | 784,340 | ||||||||||
Operating revenues | 10,671,120 | 7,895,511 | ||||||||||
Expenses | ||||||||||||
Data center operations — services, excluding depreciation | 7,011,649 | 5,736,681 | ||||||||||
Construction contract expenses, excluding depreciation | — | 705,346 | ||||||||||
General and administrative | 4,180,644 | 3,562,114 | ||||||||||
Sales and marketing | 1,759,074 | 970,346 | ||||||||||
Depreciation and amortization | 1,864,461 | 1,276,749 | ||||||||||
Operating expenses | 14,815,828 | 12,251,236 | ||||||||||
Loss from operations | (4,144,708 | ) | (4,355,725 | ) | ||||||||
Other income (expenses) | ||||||||||||
Change in fair value of derivatives embedded within convertible debt | (464,025 | ) | 3,303,375 | |||||||||
Gain on debt restructuring and extinguishment, net | — | 3,420,956 | ||||||||||
Interest expense | (5,996,853 | ) | (2,983,834 | ) | ||||||||
Interest income | 460,173 | 66,319 | ||||||||||
Other, net | 14,141 | (27,666 | ) | |||||||||
Total other income (expenses) | (5,986,564 | ) | 3,779,150 | |||||||||
Loss before income taxes | (10,131,272 | ) | (576,575 | ) | ||||||||
Income taxes | — | — | ||||||||||
Net loss | (10,131,272 | ) | (576,575 | ) | ||||||||
Preferred dividend | (187,789 | ) | (242,310 | ) | ||||||||
Net loss attributable to common shareholders | $ | (10,319,061 | ) | $ | (818,885 | ) | ||||||
Basic and diluted net loss per common share | $ | (0.25 | ) | $ | (0.02 | ) | ||||||
Weighted average common shares outstanding | 41,842,567 | 32,902,643 | ||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES
Common Stock Par | ||||||||||||||||||||||||||||||||||||
Value $.001 | Accumu- | |||||||||||||||||||||||||||||||||||
Preferred | Common | Common | Additional | Accumu- | lated Other | |||||||||||||||||||||||||||||||
Stock | Issued | Stock | Stock | Paid-in | lated | Compre- | Treasury | |||||||||||||||||||||||||||||
Series 1 | Shares | Amount | Warrants | Options | Capital | Deficit | hensive Loss | Stock | ||||||||||||||||||||||||||||
Balance at March 31, 2005 | $ | 1 | 42,587,321 | $ | 42,587 | $ | 13,599,704 | $ | 1,538,260 | $ | 279,063,085 | $ | (246,674,069 | ) | $ | (172,882 | ) | $ | (7,220,637 | ) | ||||||||||||||||
Conversion of preferred stock | — | 46,665 | 47 | — | — | (47 | ) | — | — | — | ||||||||||||||||||||||||||
Exercise of stock options | — | 111,350 | 111 | — | — | 175,956 | — | — | — | |||||||||||||||||||||||||||
Warrants issued for services | — | — | — | 25,056 | — | — | — | — | — | |||||||||||||||||||||||||||
Accrued dividends on preferred stock | — | — | — | — | — | (187,789 | ) | — | — | — | ||||||||||||||||||||||||||
Foreign currency translation adjustment | — | — | — | — | — | — | — | 64,326 | — | |||||||||||||||||||||||||||
Net loss | — | — | — | — | — | — | (10,131,272 | ) | — | — | ||||||||||||||||||||||||||
Balance at June 30, 2005 | $ | 1 | 42,745,336 | $ | 42,745 | $ | 13,624,760 | $ | 1,538,260 | $ | 279,051,205 | $ | (256,805,341 | ) | $ | (108,556 | ) | $ | (7,220,637 | ) | ||||||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements
4
TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended | ||||||||||||
June 30, | ||||||||||||
2005 | 2004 | |||||||||||
(Unaudited) | ||||||||||||
Cash flows from operating activities: | ||||||||||||
Net loss | $ | (10,131,272 | ) | $ | (576,575 | ) | ||||||
Adjustments to reconcile net loss to net cash used in operating activities | ||||||||||||
Depreciation and amortization of long-lived assets | 1,864,461 | 1,276,749 | ||||||||||
Change in estimated fair value of embedded derivatives | 464,025 | (3,303,375 | ) | |||||||||
Accretion on convertible debt and mortgage payables | 1,266,216 | 171,061 | ||||||||||
Amortization of beneficial conversion feature on issuance of convertible debentures | — | 904,761 | ||||||||||
Amortization of discount on notes payable | 259,737 | — | ||||||||||
Interest payment in kind on notes payable | 271,875 | — | ||||||||||
Amortization of debt issue costs | 460,528 | 51,437 | ||||||||||
Provision for bad debt | 111,465 | 2,151 | ||||||||||
Gain on debt restructuring and extinguishment | — | (3,626,956 | ) | |||||||||
Other, net | (72,432 | ) | 257,737 | |||||||||
Warrants issued for services | 25,056 | 172,650 | ||||||||||
Loss on disposal of property and equipment | 174,747 | — | ||||||||||
(Increase) decrease in: | ||||||||||||
Restricted cash | (329,114 | ) | — | |||||||||
Accounts receivable | (1,665,010 | ) | 1,465,976 | |||||||||
Capital lease receivable, net of unearned interest | 371,596 | — | ||||||||||
Prepaid expenses and other assets | (867,808 | ) | (539,049 | ) | ||||||||
Increase (decrease) in: | ||||||||||||
Accounts payable and accrued expenses | (533,440 | ) | (1,054,006 | ) | ||||||||
Interest payable | (1,915,678 | ) | (1,168,952 | ) | ||||||||
Deferred revenue | 567,115 | 1,763,051 | ||||||||||
Construction payables | (394,005 | ) | — | |||||||||
Deferred rent | 128,188 | 1,388,903 | ||||||||||
Net cash used in operating activities | (9,943,750 | ) | (2,814,437 | ) | ||||||||
Cash flows from investing activities: | ||||||||||||
Restricted cash | — | (4,542 | ) | |||||||||
Purchases of property and equipment | (1,872,671 | ) | (1,055,538 | ) | ||||||||
Acquisition of a majority interest in NAP Madrid | — | (1,174,860 | ) | |||||||||
Proceeds from notes receivable-related party | — | 50,000 | ||||||||||
Advances for the acquisition of minority interest in NAP Madrid | — | (1,362,767 | ) | |||||||||
Net cash used in investing activities | (1,872,671 | ) | (3,547,707 | ) | ||||||||
Cash flows from financing activities: | ||||||||||||
Increase in construction payables | — | (816,331 | ) | |||||||||
Payments on loans and mortgage payable | (205,612 | ) | (36,490,245 | ) | ||||||||
Issuance of convertible debt | — | 86,257,312 | ||||||||||
Payments on convertible debt | — | (9,881,800 | ) | |||||||||
Debt issuance costs | — | (5,255,912 | ) | |||||||||
Proceeds from sale of preferred stock | — | 2,131,800 | ||||||||||
Preferred stock issuance costs | — | (587,860 | ) | |||||||||
Payments under capital lease obligations | (83,035 | ) | (271,735 | ) | ||||||||
Proceeds from exercise of stock options and warrants | 176,067 | 122,761 | ||||||||||
Net cash (used in) provided by financing activities | (112,580 | ) | 35,207,990 | |||||||||
Net (decrease) increase in cash | (11,929,001 | ) | 28,845,846 | |||||||||
Cash and cash equivalents at beginning of period | 44,001,144 | 4,378,614 | ||||||||||
Cash and cash equivalents at end of period | $ | 32,072,143 | $ | 33,224,460 | ||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Business and Organization
Terremark Worldwide, Inc. (together with its subsidiaries, the “Company” or “Terremark”) operates Internet exchange points from which it provides colocation, interconnection and managed services to government entities, carriers, Internet service providers, network service providers and enterprises. The Company’s Internet exchange point facilities, or IXs, are located at strategic locations in Miami, Florida; Santa Clara, California; Madrid, Spain and Sao Paulo, Brazil. Those facilities serve as locations where networks meet to interconnect and exchange Internet traffic, including data, voice, audio and video traffic. The Company’s primary facility, the NAP of the Americas, in Miami, Florida is designed and built to disaster-resistant standards with maximum security to house mission-critical systems infrastructure.
2. Summary of Significant Accounting Policies
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and note disclosures required by generally accepted accounting principles for complete annual financial statements.
The unaudited condensed consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, which are, in the opinion of management, necessary to present fairly the financial position and the results of operations for the interim periods presented. Operating results for the quarter ended June 30, 2005 may not be indicative of the results that may be expected for the year ending March 31, 2006. Amounts as of March 31, 2005 included in the condensed consolidated financial statements have been derived from audited consolidated financial statements as of that date. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K for the year ended March 31, 2005. The condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All significant inter-company balances and transactions have been eliminated.
Use of estimates
The Company prepares its financial statements in conformity with generally accepted accounting principles in the United States of America. These principles require 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. Actual results could differ from those estimates.
Revenue and profit recognition
Revenue is recognized when there is persuasive evidence of an arrangement, the fee is fixed or determinable and collection of the receivable is reasonably assured. The Company assesses collection based on a number of factors, including past transaction history with the customer and the credit-worthiness of the customer. The Company does not request collateral from customers. If the Company determines that collection is not reasonably assured, the Company recognizes revenue at the time collection becomes reasonably assured, which is generally upon receipt of cash. The Company accounts for data center revenues in accordance with Emerging Issues Task Force Issue No. 00-21 “Revenue Arrangements with Multiple Deliverables” which provides guidance on separating multiple element revenue arrangements into separate units of accounting.
Data center revenues consist of monthly recurring fees for colocation, exchange point, and managed services fees. It also includes monthly rental income for unconditioned space in our Miami facility. Revenues from colocation and exchange point services, as well as rental income for unconditioned space, are recognized ratably over the term of the contract. Installation fees and significant related direct costs
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
are deferred and recognized ratably over the expected term of the customer relationship. Managed services fees are recognized in the period in which the services are provided.
Derivatives
The Company does not hold or issue derivative instruments for trading purposes. However, the Company’s 9% Senior Convertible Notes due June 15, 2009 (the “Senior Convertible Notes”) contain embedded derivatives that require separate valuation from the Senior Convertible Notes. The Company recognizes these derivatives as liabilities in its balance sheet and measures them at their estimated fair value, and recognizes changes in their estimated fair value in earnings in the period of change.
The Company, with the assistance of a third party, estimates the fair value of its embedded derivatives using available market information and appropriate valuation methodologies. These embedded derivatives derive their value primarily based on changes in the price and volatility of the Company’s common stock. Over the life of the Senior Convertible Notes, given the historical volatility of the Company’s common stock, changes in the estimated fair value of the embedded derivatives are expected to have a material effect on the Company’s results of operations. Furthermore, the Company has estimated the fair value of these embedded derivatives using a theoretical model based on the historical volatility of its common stock over the past year. If an active trading market develops for the Senior Convertible Notes or the Company is able to find comparable market data, it may in the future be able to use actual market data to adjust the estimated fair value of these embedded derivatives. Such adjustment could be significant and would be accounted for prospectively.
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.
Significant concentrations
The Company’s two largest customers accounted for approximately 24% and 13%, respectively, of data center revenues for the three months ended June 30, 2005. The same two customers accounted for approximately 25% and 14%, respectively, of data center revenues for the three months ended June 30, 2004.
Stock-based compensation
The Company uses the intrinsic value method to account for its employee stock-based compensation plans. Under this method, compensation expense is based on the difference, if any, on the date of grant, between the fair value of the Company’s shares and the option’s exercise price. The Company accounts for stock based compensation to non-employees using the fair value method.
7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The following table presents what the net loss and net loss per share would have been had the Company accounted for employee stock based compensation using the fair value method:
For the Three Months Ended | ||||||||
June 30, | ||||||||
2005 | 2004 | |||||||
Net loss attributable to common shareholders as reported | $ | (10,319,061 | ) | $ | (818,885 | ) | ||
Incremental stock-based compensation expense if the fair value method had been adopted | (193,924 | ) | (539,170 | ) | ||||
Pro forma net loss attributable to common shareholders | $ | (10,512,985 | ) | $ | (1,358,055 | ) | ||
Loss per common share — as reported | $ | (0.25 | ) | $ | (0.02 | ) | ||
Loss per common share — pro forma | $ | (0.25 | ) | $ | (0.04 | ) | ||
Fair value calculations for employee grants were made using the Black-Scholes option pricing model with the following weighted average assumptions:
2005 | 2004 | |||||||
Risk Free Rate | 3.69% - 4.13% | 2.14% - 3.50% | ||||||
Volatility (3 year historical) | 113% - 118% | 150% | ||||||
Expected Life | 5 years | 5 years | ||||||
Expected Dividends | 0% | 0% |
Stock warrants
The Company uses the fair value method to value warrants granted to non-employees. Some warrants are vested over time and some are vested upon issuance. The Company determines the fair value for non-employee warrants using the Black-Scholes option-pricing model with the same assumptions used for employee grants, except for the expected life, which was assumed to be between 1 and 7 years. When warrants to acquire the Company’s common stock are issued in connection with the sale of debt or other securities, aggregate proceeds from the sale of the warrants and other securities are allocated among all instruments issued based on their relative fair market values. Any resulting discount from the face value of debt is amortized to interest expense using the effective interest method over the term of the debt.
Loss per share
Effective May 16, 2005, the Company’s stockholders approved a one for ten reverse stock split. All share and per share information has been restated to account for the one for ten reverse stock split.
Basic EPS is calculated as income or loss available to common stockholders divided by the weighted average number of common shares outstanding during the period. If the effect is dilutive, participating securities that are convertible into common stock are included in the computation of basic EPS. Diluted EPS is calculated using the “if converted” method for common stock equivalents.
The Company’s 9% Senior Convertible Notes (the “Senior Convertible Notes”) contain contingent interest provisions which 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 H and I preferred stock contain participation rights which 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 H and I preferred stock are considered participating securities. As a result of the number of shares of the Company’s common stock currently outstanding, these participating securities have not had a significant impact on the calculation of earnings per share. Furthermore, these participating securities can only impact the calculation of earnings per share in periods when the Company presents net income.
8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Other comprehensive loss
Other comprehensive loss consists of net loss and foreign currency translation adjustments and changes in the value of any effective portion of the interest rate cap agreement designated as a cash flow hedge, and are presented in the accompanying consolidated statement of stockholders’ equity.
Recent accounting standards
In June 2004, the FASB issued EITF Issue 03-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” EITF Issue 03-1 establishes a common approach to evaluating other-than-temporary impairment to investments in an effort to reduce the ambiguity in impairment methodology found in APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock” and FASB No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, which has resulted in inconsistent application. In September 2004, the FASB issued FASB Staff Position EITF Issue 03-1-1, which deferred the effective date for the measurement and recognition guidance clarified in EITF Issue 03-1 indefinitely; however, the disclosure requirements remain effective for fiscal years ending after June 15, 2004. While the effective date for certain elements of EITF Issue 03-1 have been deferred, the adoption of EITF Issue 03-1 when finalized in its current form is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment.” SFAS No. 123(R) revises SFAS No. 123, “Accounting for Stock-Based Compensation”. SFAS No 123(R) requires companies to expense the fair value of employee stock options and other forms of stock-based compensation, such as employee stock purchase plans and restricted stock awards. In addition, SFAS No. 123(R) supersedes Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees” and amends SFAS No. 95, “Statement of Cash Flows.” Under the provisions of SFAS No. 123(R), stock-based compensation awards must meet certain criteria in order for the award to qualify for equity classification. An award that does not meet those criteria will be classified as liability and be remeasured each period. SFAS No. 123(R) retains the requirements on accounting for the income tax effects of stock-based compensation contained in SFAS No. 123; however, it changes how excess tax benefits will be presented in the statement of cash flows. In addition, in March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB No. 107”), which offers guidance on SFAS No. 123(R). SAB No. 107 was issued to assist preparers by simplifying some of the implementation challenges of SFAS No. 123(R) while enhancing the information that investors receive. Key topics of SAB No. 107 include discussion on the valuation models available to preparers and guidance on key assumptions used in these valuation models, such as expected volatility and expected term, as well as guidance on accounting for the income tax effects of SFAS No. 123(R) and disclosure considerations, among other topics. SFAS No. 123(R) and SAB No. 107 were effective for reporting periods beginning after June 15, 2005; however, in April 2005, the SEC approved a new rule that SFAS No. 123(R) and SAB No. 107 are now effective for public companies for annual, rather than interim, periods beginning after June 15, 2005. The Company is currently considering the financial accounting, income tax and internal control implications of SFAS No. 123(R) and SAB No. 107. The adoption of SFAS No. 123(R) and SAB No. 107 are expected to have a significant impact on the Company’s financial position and results of operations.
In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets, an Amendment of APB Opinion No. 29.” SFAS No. 153 addresses the measurement of exchanges of nonmonetary assets. It eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets contained in APB Opinion No. 29 and replaces it with an exception for exchanges that do not have commercial substance. SFAS No. 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of an entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for fiscal periods beginning after June 15, 2005. As the provisions of SFAS No. 153 are to be applied prospectively, the adoption of SFAS No. 153 will not have
9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
an impact on the Company’s historical financial statements; however, the Company will assess the impact of the adoption of this pronouncement on any future nonmonetary transactions that the Company enters into, if any.
In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations, an Interpretation of FASB Statement No. 143” (“FIN No. 47”). FIN No. 47 clarifies that the term, conditional retirement obligation, as used in SFAS No. 143, “Accounting for Asset Retirement Obligations”, refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. FIN No. 47 further clarifies that the obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and/or method of settlement and provides guidance on how an entity might reasonably estimate the fair value of such a conditional asset retirement obligation. FIN No. 47 is effective for fiscal years ending after December 15, 2005. The Company is currently in the process of evaluating the impact that the adoption of FIN No. 47 will have on its financial position, results of operations and cash flows.
In June 2005, the FASB approved EITF Issue 05-6, “Determining the Amortization Period for Leasehold Improvements Purchased after Lease Inception or Acquired in a Business Combination” (“EITF 05-6”). EITF 05-6 addresses the amortization period for leasehold improvements acquired in a business combination and leasehold improvements that are placed in service significantly after and not contemplated at the beginning of a lease term. EITF 05-6 states that (i) leasehold improvements acquired in a business combination should be amortized over the shorter of the useful life of the assets or a term that includes required lease periods and renewals that are deemed to be reasonably assured at the date of acquisition and (ii) leasehold improvements that are placed into service significantly after and not contemplated at or near the beginning of the lease term should be amortized over the shorter of the useful life of the assets or a term that includes required lease periods and renewals that are deemed to be reasonably assured at the date the leasehold improvements are purchased. EITF 05-6 is effective for leasehold improvements that are purchased or acquired in reporting periods beginning after June 29, 2005. The Company is currently in the process of evaluating the impact that the adoption of EITF 05-6 will have on its financial position and results of operations.
In June 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS No. 154”), which will require entities that voluntarily make a change in accounting principle to apply that change retrospectively to prior periods’ financial statements, unless this would be impracticable. SFAS No. 154 supersedes Accounting Principles Board Opinion No. 20, “Accounting Changes” (“APB No. 20”), which previously required that most voluntary changes in accounting principle be recognized by including in the current period’s net income the cumulative effect of changing to the new accounting principle. SFAS No. 154 also makes a distinction between “retrospective application” of an accounting principle and the “restatement” of financial statements to reflect the correction of an error. Another significant change in practice under SFAS No. 154 will be that if an entity changes its method of depreciation, amortization, or depletion for long-lived, non-financial assets, the change must be accounted for as a change in accounting estimate. Under APB No. 20, such a change would have been reported as a change in accounting principle. SFAS No. 154 applies to accounting changes and error corrections that are made in fiscal years beginning after December 15, 2005.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
3. Restricted Cash
Restricted cash consists of:
June 30, | March 31, | |||||||
2005 | 2005 | |||||||
Capital improvements reserve | $ | 4,000,000 | $ | 4,000,000 | ||||
Security deposits under bank loan agreement | 1,681,400 | 1,681,400 | ||||||
Security deposits under operating leases | 1,647,501 | 1,641,531 | ||||||
Escrow deposits under mortgage loan agreement | 827,065 | 503,921 | ||||||
8,155,966 | 7,826,852 | |||||||
Less: current portion | (2,508,465 | ) | (2,185,321 | ) | ||||
$ | 5,647,501 | $ | 5,641,531 | |||||
4. Mortgage Payable
In connection with the purchase of TECOTA, the Company obtained a $49.0 million loan from CitiGroup Global Markets Realty Corp., $4.0 million of which is restricted and can only be used to fund customer related capital improvements made to the NAP of the Americas in Miami. This loan is collateralized by a first mortgage on the NAP of the Americas building and a security interest in all then existing building improvements that Terremark has made to the building, certain of the Company’s deposit accounts and any cash flows generated from customers by virtue of their activity at the NAP of the Americas building. The loan bears interest at a rate per annum equal to the greater of 6.75% or LIBOR plus 4.75%, and matures in February 2009. This mortgage loan includes numerous covenants imposing significant financial and operating restrictions on Terremark’s business. See Note 7.
In connection with this financing, the Company issued to Citigroup Global Markets Realty Corp., for no additional consideration, warrants to purchase an aggregate of 500,000 shares of the Company’s common stock. Those warrants expire on December 31, 2011 and are divided into four equal tranches that differ only in respect of the applicable exercise prices, which are $6.80, $7.40, $8.10 and $8.70, respectively. The warrants were valued by an independent appraiser at approximately $2,200,000, which was recorded as a discount to the debt principal. Proceeds from the issuance of the mortgage note payable and the warrants were allocated based on their relative fair values. The costs related to the issuance of the mortgage loan were deferred and amounted to approximately $1,570,000. The discount to the debt principal and the debt issuance costs are being amortized to interest expense using the effective interest rate method over the term of the mortgage loan.
5. Convertible Debt
On June 14, 2004, the Company privately placed $86.25 million in aggregate principal amount of the Senior Convertible Notes to qualified institutional buyers. The Senior Convertible Notes bear interest at a rate of 9% per annum, payable semiannually, on each December 15 and June 15, and are convertible at the option of the holders, into shares of the Company’s common stock at a conversion price of $1.25 per share. The Company used the net proceeds from this offering to pay notes payable amounting to approximately $36.5 million and convertible debt amounting to approximately $9.8 million. In conjunction with the offering, the Company incurred $6,635,912 in debt issuance costs, including $1,380,000 in estimated fair value of warrants issued to the placement agent to purchase 1,815,789 shares of the Company’s common stock at $0.95 per share.
The Senior Convertible Notes 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 of the Company, the holders have the right to require the Company to repurchase their notes at a price equal to
11
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
100% of the principal amount, plus accrued and unpaid interest (the “Repurchase Price”). If a change in control occurs and at least 50% of the consideration for the Company’s common stock consists of cash, the holders of the Senior Convertible Notes may elect to receive the greater of the Repurchase Price or the Total Redemption Amount. The Total Redemption Amount will be equal to the product of (x) the average closing prices of the Company’s common stock for the five trading days prior to announcement of the change in control and (y) the quotient of $1,000 divided by the applicable conversion price of the Senior Convertible Notes, plus a make whole premium of $180 per $1,000 of principal if the change in control takes place before December 16, 2005 reducing to $45 per $1,000 of principal if the change in control takes place between June 16, 2008 and December 15, 2008. If the Company issues a cash dividend on its common stock, it will pay contingent interest to the holders of the 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 each holder’s note.
The Company may redeem some or all of the Senior Convertible Notes for cash at any time on or after June 15, 2007, if the closing price of the Company’s common shares has exceeded 200% of the applicable conversion price for at least 20 trading days within a period of 30 consecutive trading days ending on the trading day before the date it mails the redemption notice. If the Company redeems the notes during the twelve month period commencing on June 15, 2007 or 2008, the redemption price equals 104.5% or 102.25%, respectively, of their principal amount, plus accrued and unpaid interest, if any, to the redemption date, plus an amount equal to 50% of all remaining scheduled interest payments on the notes from, and including, the redemption date through the maturity date.
The Senior Convertible Notes contain an early conversion incentive for holders to convert their notes into shares of common stock before June 15, 2007. If exercised, the holders will receive the number of common shares to which they are entitled and an early conversion incentive payment in cash or common stock, at the Company’s option, equal to one-half the aggregate amount of interest payable through June 15, 2007.
The conversion option, including the early conversion incentive, and the equity participation feature embedded in the Senior Convertible Notes were determined to be derivative instruments to be considered separately from the debt and accounted for separately. As a result of the bifurcation of the embedded derivatives, the carrying value of the Senior Convertible Notes at issuance was approximately $50.8 million. The Company is accreting the difference between the face value of the Senior Convertible Notes ($86.25 million) and the carrying value to interest expense under the effective interest method on a monthly basis over the life of the Senior Convertible Notes.
6. Derivatives
The Senior Convertible Notes contain three embedded derivatives that require separate valuation from the Senior Convertible Notes: a conversion option that includes an early conversion incentive, an equity participation right and a takeover make whole premium due upon a change in control. The Company has estimated to date that the embedded derivatives related to the equity participation rights and the takeover make whole premium do not have significant value.
The Company estimated that the embedded derivatives had a March 31, 2005 estimated fair value of approximately $20,199,750 and a June 30, 2005 estimated fair value of approximately $20,663,775 resulting from the conversion option. The change of $464,025 in the estimated fair value of the embedded derivative was recognized as other expense in the three months ended June 30, 2005.
The interest rate on our mortgage loan is payable at variable rates indexed to LIBOR. To partially mitigate the interest rate risk on our mortgage loan, the Company paid $100,000 on December 31, 2004 to enter into a rate cap protection agreement. The rate cap protection agreement capped at the following
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
rates the $49.0 million mortgage payable for the four-year period for which the rate cap protection agreement is in effect:
• | 5.0% per annum, starting January 4, 2005; | |
• | 5.75% per annum, starting August 11, 2005; | |
• | 6.5% per annum, starting February 11, 2006; | |
• | 7.25% per annum, starting August 11, 2006; and | |
• | 7.72% per annum, starting February 11, 2007 until the termination date of the rate cap protection agreement. |
7. Notes Payable
In connection with the purchase of TECOTA, the Company issued Senior Secured Notes in an aggregate principal amount equal to $30.0 million and sold 306,044 shares of its common stock valued at $2.0 million to the Falcon investors. The Senior Secured Notes are collateralized by substantially all of the Company’s assets other than the TECOTA building, bear cash interest at 9.875% per annum and “payment in kind” interest at 3.625% per annum subject to adjustment upon satisfaction of specified financial tests, and mature in March 2009.
The Company issued to the Falcon investors, for no additional consideration, warrants to purchase an aggregate of 1.5 million shares of the Company’s common stock. Those warrants expire on December 30, 2011 and are divided into four equal tranches that differ only in respect of the applicable exercise prices, which are $6.90, $7.50, $8.20 and $8.80, respectively. The warrants were valued by a third party expert at approximately $6,600,000, which was recorded as a discount to the debt principal. Proceeds from the issuance of the senior secured notes and the warrants were allocated based on their relative fair values. The costs related to the issuance of the Senior Secured Notes were deferred and amounted to approximately $1,813,000. The discount to the debt principal and the debt issuance costs are being amortized to interest expense using the effective interest rate method over the term of the Senior Secured Notes.
The Company’s new mortgage loan and Senior Secured Notes include numerous covenants imposing significant financial and operating restrictions on its business. The covenants place restrictions on the Company’s ability to, among other things:
• | incur more debt; | |
• | pay dividends, redeem or repurchase its stock or make other distributions; | |
• | make acquisitions or investments; | |
• | enter into transactions with affiliates; | |
• | merge or consolidate with others; | |
• | dispose of assets or use asset sale proceeds; | |
• | create liens on our assets; and | |
• | extend the credit. |
Failure to comply with the obligations in the new mortgage loan or the Senior Secured Notes could result in an event of default under the new mortgage loan or the Senior Secured Notes, which, if not cured or waived, could permit acceleration of the indebtedness or other indebtedness which could have a material adverse effect on the Company’s financial condition.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
At June 30, 2005, the Company also had a bank loan with an outstanding balance of 3.5 million Euros (approximately $4.2 million at the June 30, 2005 exchange rate). The Company deposited 1,250,000 Euros (approximately $1.7 million at the June 30, 2005 exchange rate) with the lender as security for the loan. On June 24, 2005, the maturity date of the loan was extended through October 22, 2005.
8. Series H Redeemable Convertible Preferred Stock
On June 1, 2005, the Series H convertible preferred stock became redeemable in cash at the request of the holder, and accordingly, is presented as a current liability in the accompanying condensed consolidated balance sheet.
9. Changes in Stockholder’s Equity
Exercise of employee stock options |
During the three months ended June 30, 2005 the Company issued 111,350 shares of its common stock in conjunction with the exercise of options, including 111,017 shares issued to a director of the Company. The exercise price of the options ranged from $2.50 to $3.50.
Conversion of preferred stock |
During May and June, 2005, 14 shares of the Series I preferred stock were converted to 46,665 shares of common stock.
Issuance of warrants |
In April 2005, the Company issued 7,200 warrants with an estimated fair value of approximately $25,000 in connection with investor relations consulting services.
10. Related Party Transactions
Due to the nature of the following relationships, the terms of the respective agreements may not be the same as those that would result from transactions among wholly unrelated parties.
Following is a summary of transactions for the three months ended June 30, 2005 and 2004 and balances with related parties included in the accompanying balance sheet as of June 30, 2005 and March 31, 2005:
For the Three Months Ended | ||||||||
June 30, | ||||||||
2005 | 2004 | |||||||
Services purchased from related parties | $ | 285,657 | $ | 239,000 | ||||
Interest income from shareholder | 7,032 | 8,000 | ||||||
Services provided to a related party | 8,950 | — |
June 30, | June 30, | |||||||
2005 | 2004 | |||||||
Other assets | $ | 434,878 | $ | 499,009 | ||||
Note receivable — related party | — | 5,000,000 | ||||||
Notes payable to related parties | — | 35,516,977 | ||||||
Convertible debt | — | 4,150,000 |
During the three months ended June 30, 2005 and 2004, the Company purchased approximately $286,000 and $239,000, respectively, in services from Fusion Telecommunications International, Inc.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(“Fusion”). The Company’s Chief Executive Officer has a minority interest in Fusion and is a member of its board of directors.
11. Data Center Revenues
Data center revenues consist of the following:
For the Three Months Ended | ||||||||
June 30, | ||||||||
2005 | 2004 | |||||||
Colocation | $ | 6,047,603 | $ | 4,696,056 | ||||
Exchange point services | 1,316,093 | 1,031,995 | ||||||
Managed and professional services | 3,307,424 | 1,382,202 | ||||||
Other | — | 918 | ||||||
$ | 10,671,120 | $ | 7,111,171 | |||||
12. Information About the Company’s Operating Segments
As of March 31, 2005 and June 30, 2005, the Company had two reportable business segments, data center operations and real estate services. The data center operations segment provides Tier 1 NAP Internet infrastructure and managed services in a data center environment. The real estate services segment constructs and manages real estate projects focused in the technology sector. The Company’s reportable segments are strategic business operations that offer different products and services.
The accounting policies of the segments are the same as those described in significant accounting policies. Revenues generated among segments are recorded at rates similar to those recorded in third-party transactions. Transfers of assets and liabilities between segments are recorded at cost. The Company evaluates performance based on the segments’ net operating results.
The following presents information about reportable segments:
Data Center | Real estate | |||||||||||
For the Three Months Ended June 30, | Operations | Services | Total | |||||||||
2005 | ||||||||||||
Revenues | $ | 10,671,120 | $ | — | $ | 10,671,120 | ||||||
Loss from Operations | (4,153,604 | ) | 8,896 | (4,144,708 | ) | |||||||
Net Loss | (10,140,168 | ) | 8,896 | (10,131,272 | ) | |||||||
2004 | ||||||||||||
Revenues | $ | 7,111,171 | $ | 784,340 | $ | 7,895,511 | ||||||
Loss from Operations | (4,329,316 | ) | (26,409 | ) | (4,355,725 | ) | ||||||
Net Loss | (551,144 | ) | (25,431 | ) | (576,575 | ) | ||||||
Assets, as of | ||||||||||||
June 30, 2005 | $ | 198,455,919 | $ | (22,138 | ) | $ | 198,433,781 | |||||
March 31, 2005 | 208,905,664 | — | 208,905,664 |
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The following is a reconciliation of total segment loss from operations to loss before income taxes:
For the Three Months Ended June | |||||||||
30, | |||||||||
2005 | 2004 | ||||||||
Total segment loss from operations | $ | (4,144,708 | ) | $ | (4,355,725 | ) | |||
Change in fair value of derivatives | (464,025 | ) | 3,303,375 | ||||||
Debt restructuring | — | 3,420,956 | |||||||
Interest expense | (5,996,853 | ) | (2,983,834 | ) | |||||
Interest income | 460,173 | 66,319 | |||||||
Other income | 14,141 | (27,666 | ) | ||||||
Loss before income taxes | $ | 10,131,272 | ) | $ | (576,575 | ) | |||
13. Supplemental Cash Flow Information
For the Three Months Ended | |||||||||
June 30, | |||||||||
2005 | 2004 | ||||||||
Supplemental disclosures of cash flow information: | |||||||||
Cash paid for interest | $ | 5,625,154 | $ | 3,550,994 | |||||
Non-cash operating, investing and financing activities: | |||||||||
Warrants exercised and converted to equity | — | 121,440 | |||||||
Conversion of debt and related accrued interest to equity | — | 262,500 | |||||||
Conversion of convertible debt and related accrued interest to equity | — | 27,773,524 | |||||||
Settlement of notes receivable through extinguishment of convertible debt | — | 418,200 | |||||||
Non-cash preferred dividend | 187,789 | 40,000 | |||||||
Warrants to be issued related to issuance of convertible debt | — | 1,380,000 | |||||||
14. Subsequent Events
On August 5, 2005, we purchased all of the outstanding common stock of Dedigate, N.V., a leading managed hosting services provider in Europe. We paid a cash purchase price of€215,000 (approximately $266,000 as of August 5, 2005), subject to post-closing adjustments, as well as the issuance of 1,600,000 shares of our common stock. We agreed to file a registration statement to register such shares no later than 30 days after the closing and to cause this registration statement to be declared effective by the Securities and Exchange Commission no later than 120 days after Closing.
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
The information in this discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements are based upon current expectations that involve risks and uncertainties. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. For example, the words “believes,” “anticipates,” “plans,” “expects,” “intends” and similar expressions are intended to identify forward-looking statements. Our actual results and the timing of certain events may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a discrepancy include, but are not limited to, those discussed in “Other Factors Affecting Operating Results” and “Liquidity and Capital Resources” below. All forward-looking statements in this document are based on information available to us as of the date hereof and we assume no obligation to update any such forward-looking statements. The following discussion of results of operations and financial condition is based upon and should be read in conjunction with our condensed consolidated financial statements and related notes.
Recent Events
On August 5, 2005, we acquired all of the outstanding stock of Dedigate N.V., a privately held European managed dedicated hosting provider, in exchange for 1.6 million shares of our common stock, plus approximately $500,000 in cash.
Overview
We operate Internet exchange points from which we provide colocation, interconnection and managed services to the government and commercial sectors. Our Internet exchange point facilities, or IXs, are strategically located in Miami, Florida, Santa Clara, California, Madrid, Spain and Sao Paulo, Brazil and allow networks to interconnect and exchange Internet and telecommunications traffic. Our flagship facility, the NAP of the Americas, in Miami, Florida is designed and built to disaster-resistant standards with maximum security to house mission-critical systems infrastructure. Our secure presence in Miami, a key gateway to North American, Latin American and European telecommunications networks, has enabled us to establish customer relationships with U.S. Federal Government agencies, including the Department of State and the Department of Defense. We have been awarded sole-source contracts with the U.S. federal government which we believe will allow us to both penetrate further the government sector and continue to attract federal information technology providers. As a result of our fixed cost operating model, we believe that incremental customers and revenues will result in improved operating margins and increased profitability.
We generate revenue by providing high quality Internet infrastructure on a platform designed to reduce network connectivity costs. We provide our customers with the following:
• | space to house equipment and network facilities in immediate proximity to Internet and communications networks; | |
• | the platform to exchange telecommunications and Internet traffic and access to network-based services; and | |
• | related professional and managed services such as our network operations center, outsourced storage and remote monitoring. |
We differentiate ourselves from our competitors through the security and strategic location of our facilities and our carrier-neutral model, which provides access to a critical mass of Internet and telecommunications connectivity. We are certified by the U.S. federal government to house several “Secured Compartmentalized Information Facilities,” or “SCIFs,” which are facilities that comply with federal government security standards and are staffed by our employees. Approximately 29% of our employees maintain an active federal government security clearance.
The immediate proximity of our facilities to major fiber routes with access to North America, Latin America and Europe has attracted numerous telecommunications carriers, such as AT&T, Global
17
From time to time, we enter into outright sales or sales-type lease contracts for technology infrastructure build-outs that include procurement, installation and configuration of specialized equipment. Due to the typically short-term nature of these types of services, we record revenues under the completed contract method, whereby costs and related revenues are deferred in the balance sheet until services are delivered and accepted by the customer. Contract costs deferred are costs incurred for assets, such as costs for the purchase of materials and production equipment, under fixed price contracts. For these types of services, labor and other general and administrative costs are not significant and are included as period charges.
Pursuant to an outright sale contract, all rights and title to the equipment and infrastructure are purchased. In connection with an outright sale, we recognize the sale amount as revenue and the cost basis of the equipment and infrastructure is charged to cost of infrastructure build-outs.
Lease contracts qualifying for capital lease treatment are accounted for as sales-type leases. For sales-type lease transactions, we recognize as revenue the net present value of the future minimum lease payments. The cost basis of the equipment and infrastructure is charged to cost of infrastructure build-outs. During the life of the lease, we recognize as other income in each respective period, that portion of each periodic lease payment deemed to be attributable to interest income. The balance of each periodic lease payment, representing principal repayment, is recognized as a reduction of capital lease receivable.
Results of Operations
Results of Operations for the Three Months ended June 30, 2005 as Compared to the Three Months ended June 30, 2004. |
Revenue.The following charts provide certain information with respect to our revenues:
For the Three | ||||||||
Months Ended | ||||||||
June 30, | ||||||||
2005 | 2004 | |||||||
U.S. Operations | 98% | 99% | ||||||
Outside U.S. | 2% | 1% | ||||||
100% | 100% | |||||||
Data center | 100% | 90% | ||||||
Construction work | 0% | 9% | ||||||
Property and construction management | 0% | 1% | ||||||
100% | 100% | |||||||
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Data center revenues consist of:
For the Three Months Ended June 30, | |||||||||||||||||
2005 | 2004 | ||||||||||||||||
Colocation | $ | 6,047,603 | 57% | $ | 4,696,056 | 66% | |||||||||||
Managed and professional services | 3,307,424 | 31% | 1,382,202 | 19% | |||||||||||||
Exchange point services | 1,316,093 | 12% | 1,031,995 | 14% | |||||||||||||
Contract termination fee | — | 0% | 918 | 1% | |||||||||||||
Data center revenue | $ | 10,671,120 | 100% | $ | 7,111,171 | 100% | |||||||||||
The increase in data center revenues is mainly due to an increase in our deployed customer base and an expansion of services to existing customers. The increase in revenue from colocation and management and professional services was primarily the result of growth in our deployed customer base from 155 customers as of June 30, 2004 to 248 customers as of June 30, 2005. Data center revenues consist of:
• | colocation services, such as leasing of space and provisioning of power; | |
• | exchange point services, such as peering and cross connects; and | |
• | managed and professional services, such as network management, outsourced network operating center (NOC) services, network monitoring, procurement and installation of equipment and procurement of connectivity, managed router services, technical support and consulting. |
Our utilization of total net colocation space increased to 9.1% as of June 30, 2005 from 6.8% as of June 30, 2004. Our utilization of total net colocation space represents the percentage of space billed versus total space available for customers. On December 31, 2004, we purchased TECOTA, the entity that owns the 750,000 square foot building in which the NAP of the Americas is housed. Prior to this acquisition, we leased 240,000 square feet of the building. For comparative purposes, total space available to customers includes our estimate of space available to customers in the entire building for both June 30, 2005 and 2004.
The increase in exchange point services is mainly due to an increase in cross-connects billed to customers. Cross-connects billed to customers increased to 2,836 as of June 30, 2005 from 1,628 as of June 30, 2004.
The increase in managed and professional services is mainly due to an increase of approximately $1.4 million in managed services provided to the public sector. We also earned $500,000 in the quarter ended June 30, 2005 for professional services related to a feasibility study.
We anticipate an increase in revenue from colocation, exchange point and managed services as we add more customers to our network of NAPs, sell additional services to existing customers and introduce new products and services. We anticipate that the percentage of revenue derived from the public sector customers will fluctuate depending on the timing of exercise of expansion options under existing contracts and the rate at which we sell services to the public sector.
Construction Contract Revenue and Fees.We did not complete any construction contracts in the quarter ended June 30, 2005, and we have no construction contracts currently in process. We recorded $740,799 of construction contract revenues for the three months ended June 30, 2004. Due to our opportunistic approach to our construction business, we expect revenues from construction contracts to significantly fluctuate from quarter to quarter. During the three months ended June 30, 2004, we also collected a monthly management fee from TECOTA, the entity that then owned the building in which the NAP of the Americas is located, equal to the greater of approximately $8,000 or 3% of cash collected by TECOTA. On December 31, 2004, we purchased TECOTA. Therefore, we now eliminate in consolidation these management fees.
Data Center Operations Expenses.Data center expenses increased $1.3 million to $7.0 million for the three months ended June 30, 2005 from $5.7 million for the three months ended June 30, 2004. Data center operations expenses consist mainly of operations personnel, rent, insurance and property taxes, electricity, chilled water, procurement of equipment and connectivity, and security services. The increase in
19
The increase in personnel costs is mainly due to an increase in operations and engineering staff levels. Our staff levels increased to 133 employees as of June 30, 2005 from 86 as of June 30, 2004. The increase in the number of employees is mainly attributable to the hiring of personnel to work under existing and anticipated government contracts, and the expansion of operations in the Madrid NAP, Brazil NAP, and NAP-West.
The increase in facility costs is mainly due to our acquisition of TECOTA, the entity that owns the building that houses the NAP of the Americas. Facility costs include utilities, security, insurance and property taxes.
The increase in connectivity costs is mainly due to an increase in revenues from managed services and new bandwidth costs for interconnecting our Internet exchange point facilities.
The decrease in rent expense is mainly due to the elimination of rent as a result of the acquisition of TECOTA, partially offset by an increase in rent as a result of new leases in Madrid, Frankfurt, London and Herndon (Virginia).
Construction Contract Expenses.There was no construction activity during the three months ended June 30, 2005. Construction contract expenses were $705,000 for the three months ended June 30, 2004.
General and Administrative Expenses.General and administrative expenses increased $619,000 to $4.2 million for the three months ended June 30, 2005 from $3.6 million for the three months ended June 30, 2004. General and administrative expenses consist primarily of professional service fees, payroll and related expenses, travel, and other general corporate expenses. This increase was primarily due to increases of $681,000 in accounting and consulting fees. The increase in professional services is mainly due to additional audit and consulting fees resulting from our Sarbanes-Oxley compliance work efforts. We completed our March 31, 2005 assessment of our internal controls over financial reporting on August 5, 2005. Going forward, we expect our accounting and consulting fees, and general and administrative expenses, to decrease as we enter into our second year of Sarbanes-Oxley compliance.
Sales and Marketing Expenses.Sales and marketing expenses increased $789,000 to $1.8 million for the three months ended June 30, 2005 from $970,000 for the three months ended June 30, 2004. The most significant components of sales and marketing are payroll, sales commissions and promotional activities. Payroll increased $429,000 mainly due to increased staff levels. Our sales and marketing staff levels increased to 30 employees as of June 30, 2005 from 20 as of June 30, 2004. Commissions also increased by $177,000 consistent with our increase in revenues. A new advertising campaign resulted in an increase of $124,000 in marketing expenses.
Depreciation and Amortization Expenses.Depreciation and amortization expense increased $588,000 to $1.9 million for the three months ended June 30, 2005 from $1.3 million for the three months ended June 30, 2004. The increase is mainly due to the acquisition of TECOTA, the entity that owns the building that houses the NAP of the Americas.
Change in Fair Value of Derivatives Embedded within Convertible Debt.Our 9% senior convertible notes due June 15, 2009 contain embedded derivatives that require separate valuation from the senior convertible notes. We recognize these embedded derivatives as a liability in our balance sheet, measure them at their estimated fair value and recognize changes in the estimated fair value of the derivative instruments in earnings. We estimated that the embedded derivatives had a March 31, 2005 estimated fair value of approximately $20,200,000 and a June 30, 2005 estimated fair value of approximately $20,664,000. The embedded derivatives derive their value primarily based on changes in the price and volatility of our common stock. The closing price of our common stock increased to $7.00 on June 30, 2005 from $6.50 per share as of March 31, 2005. As a result, during the three months ended June 30, 2005, we recognized a $464,000 loss from the change in estimated fair value of the embedded derivatives. Over the life of the senior convertible notes, given the historical volatility of our common stock, changes in the estimated fair value of the embedded derivatives are expected to have a material effect on our results of operations. The
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Gain on Debt Extinguishment and Conversion.As a result of the early extinguishment of notes payable and convertible debentures, as well as the conversion of convertible debentures into common stock, during the three months ended June 30, 2004, we recognized a gain on debt extinguishment and conversion totaling $3.4 million, representing the recognition of the unamortized balance of a debt restructuring deferred gain and the write off of debt issuance costs, net of an early redemption premium payment. During the three months ended June 30, 2005, we did not have any extinguishment or conversion of debt.
Interest Expense.Interest expense increased $3.0 million from $3.0 million for the three months ended June 30, 2004 to $6.0 million for the three months ended June 30, 2005. This increase is mainly due to additional debt incurred, including our new mortgage loan, our senior secured notes and our senior convertible notes.
Interest Income.Interest income increased $394,000 from $66,000 for the three months ended June 30, 2004 to $460,000 for the three months ended June 30, 2005. This increase was due to available cash balances as a result of the March 14, 2005 sale of 6,000,000 shares of our common stock.
Net Loss.Net loss for our reportable segments was as follows:
For the Three Months Ended | ||||||||
June 30, | ||||||||
2005 | 2004 | |||||||
Data center operations | $ | (10,140,168 | ) | $ | (551,144 | ) | ||
Real estate services | 8,896 | (25,431 | ) | |||||
$ | (10,131,272 | ) | $ | (576,575 | ) | |||
The net loss from data center operations is primarily the result of insufficient revenues to cover our operating and interest expenses. We will generate net losses until we reach required levels of monthly revenues.
Liquidity and Capital Resources
Liquidity and Recent Developments |
On March 14, 2005, we sold 6,000,000 shares of our common stock at $7.30 per share through an underwritten public offering. We received net proceeds of approximately $40.7 million, after deducting underwriting discounts and commissions and estimated offering expenses. We have been and intend to continue using the net proceeds of the offering for general corporate purposes to support the growth of our business, which may include capital investments to build-out our existing facilities and potential acquisitions of complementary businesses.
On December 31, 2004, we purchased the remaining 99.16% equity interests of TECOTA that were not owned by us and TECOTA became our wholly-owned subsidiary. TECOTA owns the building in which the NAP of the Americas is housed. Throughout this report, we refer to this building as the NAP of the Americas building. In connection with this purchase, we paid approximately $40.0 million for the equity interests and repaid an approximately $35.0 million mortgage to which the NAP of the Americas building was subject. We financed the purchase and repayment of the mortgage from two sources. We obtained a $49.0 million first mortgage loan from Citigroup Global Markets Realty Corp., $4.0 million of the proceeds of which are restricted and can only be used to fund customer related improvements made to
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We may redeem some or all of the senior secured notes for cash at any time after December 31, 2005. If we redeem the notes during the twelve month period commencing on December 31, 2005 or the six month period commencing on December 31, 2006, June 30, 2007, or December 31, 2007, the redemption price equals 115.0%, 107.5%, 105.0%, and 102.3%, respectively, of their principal amount, plus accrued and unpaid interest, if any, to the redemption date. After June 30, 2008, the redemption price equals 100% of their principal amounts. Also, if there is a change in control, the holders of these notes will have the right to require us to repurchase their notes at a price equal to 100% of the principal amount, plus accrued and unpaid interest.
Our new mortgage loan and our senior secured notes include numerous covenants imposing significant financial and operating restrictions on our business. The covenants place restrictions on our ability to, among other things:
• | incur more debt; | |
• | pay dividends, redeem or repurchase our stock or make other distributions | |
• | make acquisitions or investments; | |
• | enter into transactions with affiliates; | |
• | merge or consolidate with others; | |
• | dispose of assets or use asset sale proceeds; | |
• | create liens on our assets; and | |
• | extend credit. |
Also, a change in control without the prior consent of the lenders could allow the lenders to demand repayment of the loan. Our ability to comply with these and other provisions of the new mortgage loan and the senior secured notes can be affected by events beyond our control. Our failure to comply with the obligations in the new mortgage loan and the senior secured notes could result in an event of default under the new mortgage loan and the senior secured notes, which, if not cured or waived, could permit acceleration of the indebtedness or other indebtedness which could have a material adverse effect on us.
In June 2004, we privately placed $86.25 million in aggregate principal amount of 9% senior convertible notes due June 15, 2009 to qualified institutional buyers. The notes bear interest at a rate of 9% per annum, payable semi-annually, on each December 15 and June 15 and are convertible at the option of the holders at $12.50 per share. We utilized net proceeds of $81.0 million to pay approximately
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If there is a change in control, the holders of the 9% senior convertible notes have the right to require us to repurchase their notes at a price equal to 100% of the principal amount, plus accrued and unpaid interest. If a change of control occurs and at least 50% of the consideration for our common stock consists of cash, the holders of the 9% senior convertible notes may elect to receive the greater of the repurchase price described above or the total redemption amount. The total redemption amount will be equal to the product of (x) the average closing prices of our common stock for the five trading days prior to the announcement of the change of control and (y) the quotient of $1,000 divided by the applicable conversion price of the 9% senior convertible notes, plus a make-whole premium of $180 per $1,000 of principal if the change of control takes place before December 16, 2005, reducing to $45 per $1,000 of principal if the change of control takes place between June 16, 2008 and December 15, 2008. If we issue a cash dividend on our common stock, we will pay contingent interest to the holders equal to the product of the per share cash dividend and the number of shares of common stock issuable upon conversion of each holder’s note.
We may redeem some or all of the 9% senior convertible notes for cash at any time on or after June 15, 2007 if the closing price of our common shares has exceeded 200% of the applicable conversion price for at least 20 trading days within a period of 30 consecutive trading days ending on the trading day before the date we mail the redemption notice. If we redeem the 9% senior convertible notes during the twelve month period commencing on June 15, 2007 or 2008, the redemption price equals 104.5% or 102.25%, respectively, of their principal amount, plus accrued and unpaid interest, if any, to the redemption date, plus an amount equal to 50% of all remaining scheduled interest payments on the 9% senior convertible notes from, and including, the redemption date through the maturity date.
The 9% senior convertible notes contain an early conversion incentive for holders to convert their notes into shares of common stock before June 15, 2007. If exercised, the holders will receive the number of shares of our common stock to which they are entitled and an early conversion incentive payment in cash or stock, at our option, equal to one-half the aggregate amount of interest payable through July 15, 2007.
We have incurred losses from operations in each quarter and annual period since our merger with AmTec, Inc. Our cash flows from operations for the quarters ended June 30, 2005 and 2004 were negative. As of June 30, 2005, our total liabilities were approximately $168.0 million. Due to cash used in operations and the acquisition of property, plant and equipment, our working capital decreased from $34.8 million, as of March 31, 2005, to $27.3 million as of June 30, 2005.
As of June 30, 2005, our principal source of liquidity was our $32.1 million in cash and cash equivalents. We anticipate that this cash, coupled with our anticipated cash flows generated from operations, will be sufficient to meet our capital expenditures, working capital, debt service and corporate overhead requirements in connection with our currently identified business objectives. Our projected revenues and cash flows depend on several factors, some of which are beyond our control, including the rate at which we provide services, the timing of exercise of expansion options by customers under existing contracts, the rate at which new services are sold to the government sector and the commercial sector, the ability to retain the customer base, the willingness and timing of potential customers in outsourcing the housing and management of their technology infrastructure to us, the reliability and cost-effectiveness of our services and our ability to market our services.
Sources and Uses of Cash
During the quarter ended June 30, 2005, we used $11.9 million in cash, including $9.9 million for operations. We do not believe this usage is indicative of our average future quarterly cash outflows. The June 30, 2005 quarter includes payment of $3.9 million in semi-annual interest payments and a $1.7 million increase in receivables and excludes expected inflows from recently signed new customer
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Cash used in operations for the quarter ended June 30, 2005 and 2004 was approximately $9.9 million and $2.8 million, respectively. We used cash to primarily fund our net loss, including cash interest payments on our debt. Cash payments for the three months ended June 30, 2005 included a semi-annual interest payment of $3.9 million on our senior convertible notes. In addition, an increase in accounts receivable of $1.6 million negatively impacted the cash used in our operating activities for the three months ended June 30, 2005.
Cash used in investing activities for the quarter ended June 30, 2005 was $1.9 million compared to cash used in investing activities of $3.5 million for the quarter ended June 30, 2004, a decrease of $1.6 million. This increase is primarily due to the payments made in the quarter ended June 30, 2004 for the acquisition of NAP Madrid.
Cash used in financing activities for the quarter ended June 30, 2005 was $0.1 million compared to cash provided by financing activities of $35.2 million for the quarter ended June 30, 2004, a decrease of $35.1 million. For the quarter ended June 30, 2004, cash provided by financing activities includes $86.2 million from the issuance of convertible debt, partially offset by $46.3 million in repayments of loans and convertible debt.
Guarantees and Commitments
Terremark Worldwide, Inc. has guaranteed TECOTA’s obligation, as borrower, to make payments of principal and interest under the mortgage loan with Citigroup Global Markets Realty Group to the extent any of the following events shall occur:
• | TECOTA files for bankruptcy or a petition in bankruptcy is filed against TECOTA with TECOTA’s or Terremark’s consent; | |
• | Terremark pays a cash dividend or makes any other cash distribution on its capital stock (except with respect to its outstanding preferred stock); | |
• | Terremark makes any repayments of its outstanding debt other than the scheduled payments provided in the terms of the debt; | |
• | Terremark pledges the collateral it has pledged to the lenders or pledges any of its existing cash balances as of December 31, 2004 as collateral for another loan; or | |
• | Terremark repurchases any of its common stock. |
In addition Terremark has agreed to assume liability for any losses incurred by the lenders under the credit facility related to or arising from:
• | Any fraud, misappropriation or misapplication of funds; | |
• | any transfers of the collateral held by the lenders in violation of the Citigroup credit agreement; | |
• | failure to maintain TECOTA as a “single purpose entity;” | |
• | TECOTA obtaining additional financing in violation of the terms of the Citigroup credit agreement; | |
• | intentional physical waste of TECOTA’s assets that have been pledged to the lenders; | |
• | breach of any representation, warranty or covenant provided by or applicable to TECOTA and Terremark which relates to environmental liability; | |
• | improper application and use of security deposits received by TECOTA from tenants; | |
• | forfeiture of the collateral pledged to the lenders as a result of criminal activity by TECOTA; | |
• | attachment of liens on the collateral in violation of the terms of the Citigroup credit agreement; |
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• | TECOTA’s contesting or interfering with any foreclosure action or other action commenced by lenders to protect their rights under the credit facility (except to the extent TECOTA is successful in these efforts); | |
• | any costs incurred by the lenders to enforce their rights under the credit facility; or | |
• | failure to pay assessments made against or to adequately insure the assets pledged to the lenders. |
We lease space for our operations, office equipment and furniture under non-cancelable operating leases. Some equipment is also leased under capital leases, which are included in leasehold improvements, furniture and equipment.
The following table represents the minimum future operating and capital lease payments for these commitments, as well as the combined aggregate maturities and interest for the following obligations as of June 30 2005:
Capital | ||||||||||||||||||||||||
Lease | Operating | Convertible | Mortgage | Notes | ||||||||||||||||||||
Obligations | Leases | Debt | Payable | Payable | Total | |||||||||||||||||||
2006 (nine months) | $ | 1,085,979 | $ | 3,235,935 | $ | 3,881,579 | $ | 3,164,884 | $ | 7,270,737 | $ | 18,639,114 | ||||||||||||
2007 | 278,060 | 3,313,294 | 7,763,158 | 4,219,846 | 4,050,000 | 19,624,358 | ||||||||||||||||||
2008 | 120,609 | 3,305,379 | 7,763,158 | 4,219,846 | 4,050,000 | 19,458,992 | ||||||||||||||||||
2009 | — | 3,120,718 | 7,763,158 | 49,414,809 | 34,050,000 | 94,348,685 | ||||||||||||||||||
2010 | — | 3,206,998 | 90,131,579 | — | — | 93,338,577 | ||||||||||||||||||
Thereafter | — | 29,940,932 | — | — | — | 29,940,932 | ||||||||||||||||||
$ | 1,484,648 | $ | 46,123,256 | $ | 117,302,632 | $ | 61,019,385 | $ | 49,420,737 | $ | 275,350,658 | |||||||||||||
As required by the terms of the Madrid lease agreement, we have obtained a five year bank guarantee in favor of the lessor in an amount equal to the annual rent payments. In connection with this bank guarantee, we have deposited 50% of the guaranteed amount, or approximately 475,000 Euros ($638,948 at the June 30, 2005 exchange rate), with the bank issuing the guarantee.
Recent Accounting Standards
In June 2004, the FASB issued EITF Issue 03-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” EITF Issue 03-1 establishes a common approach to evaluating other-than-temporary impairment to investments in an effort to reduce the ambiguity in impairment methodology found in APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock” and FASB No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, which has resulted in inconsistent application. In September 2004, the FASB issued FASB Staff Position EITF Issue 03-1-1, which deferred the effective date for the measurement and recognition guidance clarified in EITF Issue 03-1 indefinitely; however, the disclosure requirements remain effective for fiscal years ending after June 15, 2004. While the effective date for certain elements of EITF Issue 03-1 have been deferred, the adoption of EITF Issue 03-1 when finalized in its current form is not expected to have a material impact on our financial position, results of operations or cash flows.
In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment.” SFAS No. 123(R) revises SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123(R) requires companies to expense the fair value of employee stock options and other forms of stock-based compensation, such as employee stock purchase plans and restricted stock awards. In addition, SFAS No. 123(R) supersedes Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees” and amends SFAS No. 95, “Statement of Cash Flows.” Under the provisions of SFAS No. 123(R), stock-based compensation awards must meet certain criteria in order for the award to qualify for equity classification. An award that does not meet those criteria will be classified as liability and be remeasured each period. SFAS No. 123(R) retains the requirements on accounting for the income tax effects of stock-based compensation contained in SFAS No. 123; however, it changes how excess tax benefits will be presented in the statement of cash flows. In addition, in March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB No. 107”), which offers guidance on SFAS No. 123(R).
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In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets, an Amendment of APB Opinion No. 29.” SFAS No. 153 addresses the measurement of exchanges of nonmonetary assets. It eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets contained in APB Opinion No. 29 and replaces it with an exception for exchanges that do not have commercial substance. SFAS No. 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of an entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for fiscal periods beginning after June 15, 2005. As the provisions of SFAS No. 153 are to be applied prospectively, the adoption of SFAS No. 153 will not have an impact on our historical financial statements; however, we will assess the impact of the adoption of this pronouncement on any future nonmonetary transactions that we enter into, if any.
In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations, an Interpretation of FASB Statement No. 143” (“FIN No. 47”). FIN No. 47 clarifies that the term, conditional retirement obligation, as used in SFAS No. 143, “Accounting for Asset Retirement Obligations”, refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. FIN No. 47 further clarifies that the obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and/or method of settlement and provides guidance on how an entity might reasonably estimate the fair value of such a conditional asset retirement obligation. FIN No. 47 is effective for fiscal years ending after December 15, 2005. We are currently in the process of evaluating the impact that the adoption of FIN No. 47 will have on our financial position, results of operations and cash flows.
In June 2005, the FASB approved EITF Issue 05-6, “Determining the Amortization Period for Leasehold Improvements Purchased after Lease Inception or Acquired in a Business Combination” (“EITF 05-6”). EITF 05-6 addresses the amortization period for leasehold improvements acquired in a business combination and leasehold improvements that are placed in service significantly after and not contemplated at the beginning of a lease term. EITF 05-6 states that (i) leasehold improvements acquired in a business combination should be amortized over the shorter of the useful life of the assets or a term that includes required lease periods and renewals that are deemed to be reasonably assured at the date of acquisition and (ii) leasehold improvements that are placed into service significantly after and not contemplated at or near the beginning of the lease term should be amortized over the shorter of the useful life of the assets or a term that includes required lease periods and renewals that are deemed to be reasonably assured at the date the leasehold improvements are purchased. EITF 05-6 is effective for leasehold improvements that are purchased or acquired in reporting periods beginning after June 29, 2005. We are currently in the process of evaluating the impact that the adoption of EITF 05-6 will have on our financial position and results of operations.
In June 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS No. 154”), which will require entities that voluntarily make a change in accounting principle to apply that change retrospectively to prior periods’ financial statements, unless this would be impracticable. SFAS No. 154 supersedes Accounting Principles Board Opinion No. 20, “Accounting Changes” (“APB No. 20”), which previously required that most voluntary changes in accounting principle be recognized by including in the current periods’s net income the cumulative effect of changing to the new accounting principle. SFAS No. 154 also makes a distinction between “retrospective application” of an accounting
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Other Factors Affecting Operating Results
We have a history of losses, expect future losses and may not achieve or sustain profitability. |
We have incurred net losses from operations in each quarterly and annual period since our April 28, 2000 merger with AmTec, Inc. We incurred net losses of $9.9 million, $22.5 million, and $41.2 million for the years ended March 31, 2005, 2004 and 2003, respectively and incurred a loss from operations of $4.1 million for the three months ended June 30, 2005. As of June 30, 2005, our accumulated deficit was $256.8 million. We cannot guarantee that we will become profitable. Even if we achieve profitability, given the evolving nature of the industry in which we operate, we may not be able to sustain or increase profitability on a quarterly or annual basis, and our failure to do so would adversely affect our business, including our ability to raise additional funds.
We may not be able to compete successfully against current and future competitors. |
Our products and services must be able to differentiate themselves from existing providers of space and services for telecommunications companies, web hosting companies and other colocation providers. In addition to competing with neutral colocation providers, we must compete with traditional colocation providers, including local phone companies, long distance phone companies, Internet service providers and web hosting facilities. Likewise, with respect to our other products and services, including managed services, bandwidth services and security services, we must compete with more established providers of similar services. Most of these companies have longer operating histories and significantly greater financial, technical, marketing and other resources than us.
Because of their greater financial resources, some of our competitors have the ability to adopt aggressive pricing policies, especially if they have been able to restructure their debt or other obligations. As a result, in the future, we may suffer from pricing pressure that would adversely affect our ability to generate revenues and adversely affect our operating results. In addition, these competitors could offer colocation on neutral terms, and may start doing so in the same metropolitan areas where we have NAP centers. Some of these competitors may also provide our target customers with additional benefits, including bundled communication services, and may do so in a manner that is more attractive to our potential customers than obtaining space in our IBX centers. We believe our neutrality provides us with an advantage over these competitors. However, if these competitors were able to adopt aggressive pricing policies together with offering colocation space, our ability to generate revenues would be materially adversely affected. We may also face competition from persons seeking to replicate our IBX concept by building new centers or converting existing centers that some of our competitors are in the process of divesting. We may experience competition from our landlords in this regard. Rather than leasing available space in our buildings to large single tenants, they may decide to convert the space instead to smaller square foot units designed for multi-tenant colocation use. Landlords may enjoy a cost effective advantage in providing similar services as our NAPs, and this could also reduce the amount of space available to us for expansion in the future. Competitors may operate more successfully or form alliances to acquire significant market share. Furthermore, enterprises that have already invested substantial resources in outsourcing arrangements may be reluctant or slow to adopt our approach that may replace, limit or compete with their existing systems. In addition, other companies may be able to attract the same potential customers that we are targeting. Once customers are located in competitors’ facilities, it may be extremely difficult to convince them to relocate to our NAP centers.
Our success in retaining key employees and discouraging them from moving to a competitor is an important factor in our ability to remain competitive. As is common in our industry, our employees are typically compensated through grants of stock options in addition to their regular salaries. We occasionally
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We anticipate that an increasing portion of our revenues will be from contracts with agencies of the United States government, and uncertainties in government contracts could adversely affect our business. |
During the year ended March 31, 2005 and the quarter ended June 30, 2005, revenues under contracts with agencies of the U.S. federal government constituted 42% and 24%, respectively, of our data center revenues. Generally, U.S. government contracts are subject to oversight audits by government representatives, to profit and cost controls and limitations, and to provisions permitting modification or termination, in whole or in part, without prior notice, at the government’s convenience. In some cases, government contracts are subject to the uncertainties surrounding congressional appropriations or agency funding. Government contracts are subject to specific procurement regulations. Failure to comply with these regulations and requirements could lead to suspension or debarment from future government contracting for a period of time, which could limit our growth prospects and adversely affect our business, results of operations and financial condition. Government contracts typically have an initial term of one year. Renewal periods are exercisable at the discretion of the U.S. government. We may not be successful in winning contract awards or renewals in the future. Our failure to renew or replace U.S. government contracts when they expire could have a material adverse effect on our business, financial condition, or results of operations.
We derive a significant portion of our revenues from a few clients; accordingly, a reduction in our clients’ demand for our services or the loss of clients would likely impair our financial performance. |
During the year ended March 31, 2005, we derived approximately 42% and 12% of our data center revenues from two customers. During the quarter ended June 30, 2005, we derived approximately 24% and 13% of our data center revenues from these same two customers. Because we derive a large percentage of our revenues from a few major customers, our revenues could significantly decline if we lose one or more of these customers or if the amount of business we obtain from them is reduced.
We have significant debt service obligations which will require the use of a substantial portion of our available cash. |
We are a highly leveraged company. As of June 30, 2005, our total liabilities were approximately $168.4 million and our total stockholders’ equity was $30.1 million. Our new mortgage loan and our senior secured notes are, collectively, collateralized by substantially all of our assets. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”
Each of these obligations requires significant amounts of liquidity. Should we need additional capital or financing, our ability to arrange financing and the cost of this financing will depend upon many factors, including:
• | general economic and capital markets conditions, and in particular the non-investment grade debt market; | |
• | conditions in the Internet infrastructure market; | |
• | credit availability from banks or other lenders; | |
• | investor confidence in the telecommunications industry generally and our company specifically; and | |
• | the success of our facilities. |
We may be unable to find additional sources of liquidity on terms acceptable to us, if at all, which could adversely affect our business, results of operations and financial condition. Also, a default could result in acceleration of our indebtedness. If this occurs, our business and financial condition would be adversely affected.
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The mortgage loan with Citigroup and our senior secured notes contain numerous restrictive covenants. |
Our mortgage loan with Citigroup and our senior secured notes contain numerous covenants imposing restrictions on our ability to, among other things:
• | incur more debt; | |
• | pay dividends, redeem or repurchase our stock or make other distributions; | |
• | make acquisitions or investments; | |
• | enter into transactions with affiliates; | |
• | merge or consolidate with others; | |
• | dispose of assets or use asset sale proceeds; | |
• | create liens on our assets; and | |
• | extend credit. |
Our failure to comply with the obligations in our mortgage loan with Citigroup and our senior secured notes could result in an event of default under the mortgage loan or the senior secured notes, which, if not cured or waived, could permit acceleration of the indebtedness or our other indebtedness, or result in the same consequences as a default in payment. If the acceleration of the maturity of our debt occurs, we may not be able to repay our debt or borrow sufficient funds to refinance it on terms that are acceptable to us, which could adversely impact our business, results of operations and financial condition.
Our substantial leverage and indebtedness could adversely affect our financial condition, limit our growth and prevent us from fulfilling our debt obligations. |
Our substantial indebtedness could have important consequences to us and may, among other things:
• | limit our ability to obtain additional financing to fund our growth strategy, working capital, capital expenditures, debt service requirements or other purposes; | |
• | limit our ability to use operating cash flow in other areas of our business because we must dedicate a substantial portion of these funds to make principal payments and fund debt service requirements; | |
• | cause us to be unable to satisfy our obligations under our existing or new debt agreements; | |
• | make us more vulnerable to adverse general economic and industry conditions; | |
• | limit our ability to compete with others who are not as highly leveraged as we are; and | |
• | limit our flexibility in planning for, or reacting to, changes in our business, industry and market conditions. |
In addition, subject to restrictions in our existing debt instruments, we may incur additional indebtedness. If new debt is added to our current debt levels, the related risks that we now face could intensify. Our growth plans and our ability to make payments of principal or interest on, or to refinance, our indebtedness, will depend on our future operating performance and our ability to enter into additional debt and/or equity financings. If we are unable to generate sufficient cash flows in the future to service our debt, we may be required to refinance all or a portion of our existing debt, to sell assets or to obtain additional financing. We may not be able to do any of the foregoing on terms acceptable to us, if at all.
We have identified material weaknesses in our internal control over financial reporting that may prevent us from being able to accurately report our financial results or prevent fraud, which could harm our business and operating results, the trading price of our stock and our access to capital. |
Effective internal controls are necessary for us to provide reliable and accurate financial reports and prevent fraud. In addition, Section 404 under the Sarbanes-Oxley Act of 2002 requires that we assess, and our independent registered public accounting firm attest to, the design and operating effectiveness of our internal control over financial reporting. If we cannot provide reliable and accurate financial reports and
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If our financial condition deteriorates, we may be delisted by the American Stock Exchange and our stockholders could find it difficult to sell our common stock. |
Our common stock currently trades on the American Stock Exchange, or AMEX. The AMEX requires companies to fulfill specific requirements in order for their shares to continue to be listed. Our securities may be considered for delisting if:
• | our financial condition and operating results appear to be unsatisfactory; | |
• | we have sustained losses which are so substantial in relation to our overall operations or our existing financial condition has become so impaired that it appears questionable whether we will be able to continue operations and/or meet our obligations as they mature. |
If our shares are delisted from the AMEX, our stockholders could find it difficult to sell our stock. To date, we have had no communication from the AMEX regarding delisting. If our common stock is delisted from the AMEX, we may apply to have our shares quoted on NASDAQ’s Bulletin Board or in the “pink sheets” maintained by the National Quotation Bureau, Inc. The Bulletin Board and the “pink sheets” are generally considered to be less efficient markets than the AMEX. In addition, if our shares are no longer listed on the AMEX or another national securities exchange in the United States, our shares may be subject to the “penny stock” regulations. If our common stock were to become subject to the penny stock regulations it is likely that the price of our common stock would decline and that our stockholders would find it difficult to sell their shares.
We are dependent on key personnel and the loss of these key personnel could have a material adverse effect on our success. |
We are highly dependent on the skills, experience and services of key personnel, particularly Manuel D. Medina, our Chairman, President and Chief Executive Officer. The loss of Mr. Medina or other key personnel could have a material adverse effect on our business, operating results or financial condition. Our potential growth and expansion are expected to place increased demands on our management skills and resources. Therefore, our success also depends upon our ability to recruit, hire, train and retain additional skilled and experienced management personnel. Employment and retention of qualified personnel is important due to the competitive nature of our industry. Our inability to hire new personnel with the requisite skills could impair our ability to manage and operate our business effectively.
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Our business could be harmed by prolonged electrical power outages or shortages, or increased costs of energy. |
Substantially all of our business is dependent upon the continued operation of the TECOTA building. The TECOTA building and our other IX facilities are susceptible to regional costs of power, electrical power shortages and planned or unplanned power outages caused by these shortages. A power shortage at an IX facility may result in an increase of the cost of energy, which we may not be able to pass on to our customers. We attempt to limit exposure to system downtime by using backup generators and power supplies. Power outages, which last beyond our backup and alternative power arrangements, could harm our customers and our business.
We have acquired and may acquire other businesses, and these acquisitions involve numerous risks. |
As part of our strategy, we may pursue additional acquisitions of complementary businesses, products services and technologies to enhance our existing services, expand our service offerings and enlarge our customer base. If we complete future acquisitions, we may be required to incur or assume additional debt and make capital expenditures and issue additional shares of our common stock or securities convertible into our common stock as consideration, which will dilute our existing stockholders’ ownership interest and may adversely affect our results of operations. Our ability to grow through acquisitions involves a number of additional risks, including the following:
• | the ability to identify and consummate complementary acquisition candidates; | |
• | the possibility that we may not be able to successfully integrate the operations, personnel, technologies, products and services of the acquired companies in a timely and efficient manner; | |
• | diversion of management’s attention from normal daily operations to negotiate acquisitions and integrate acquired businesses; | |
• | insufficient revenues to offset significant unforeseen costs and increased expenses associated with the acquisitions; | |
• | challenges in completing products associated with in-process research and development being conducted by the acquired businesses; | |
• | risks associated with our entrance into markets in which we have little or no prior experience and where competitors have a stronger market presence; | |
• | deferral of purchasing decisions by current and potential customers as they evaluate the likelihood of success of our acquisitions; | |
• | issuance by us of equity securities that would dilute ownership of our existing stockholders; | |
• | incurrence and/or assumption of significant debt, contingent liabilities and amortization expenses; and | |
• | loss of key employees of the acquired companies. |
Failure to manage effectively our growth through acquisitions could adversely affect our growth prospects, business, results of operations and financial condition.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
We have not entered into any financial instruments for trading purposes. However, the estimated fair value of the derivatives embedded within our 9% senior convertible notes creates a market risk exposure resulting from changes in the price of our common stock. These embedded derivatives derive their value primarily based on the price and volatility of our common stock; however, we do not expect significant changes in the near term in the one-year historical volatility of our common stock used to calculate the estimated fair value of the embedded derivatives. Other factors being equal, as of June 30, 2005, the table below provides information about the estimated fair value of the derivatives embedded within our senior
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Price Per Share | Estimated Fair Value of | |||
of Common Stock | Embedded Derivatives | |||
$5.00 | $ | 13,079,813 | ||
$7.00 | $ | 20,663,776 | ||
$9.00 | $ | 28,337,438 | ||
$11.00 | $ | 35,736,825 | ||
$13.00 | $ | 42,554,025 |
Our exposure to market risk resulting from changes in interest rates results from the variable rate of our mortgage loan, as an increase in interest rates would result in lower earnings and increased cash outflows. The interest rate on our mortgage loan is payable at variable rates indexed to LIBOR. The effect of each 1% increase in the LIBOR rate on our mortgage loan (3.22% at June 30, 2005) would result in an annual increase in interest expense of approximately $475,000. Based on the U.S. yield curve as of June 30, 2005 and other available information, we project interest expense on our variable rate debt to increase approximately $250,000, $400,000, $475,000 and $525,000 for the quarter ended June 30, 2006, 2007, 2008 and 2009, respectively. To partially mitigate the interest rate risk on our mortgage loan, we paid $100,000 on December 31, 2004 to enter into a rate cap protection agreement. The rate cap protection agreement capped at the following rates the $49.0 million mortgage payable for the four-year period for which the rate cap protection agreement is in effect:
• | 5.0% per annum, through August 10, 2005; | |
• | 5.75% per annum, starting August 11, 2005; | |
• | 6.5% per annum, starting February 11, 2006; | |
• | 7.25% per annum, starting August 11, 2006; and | |
• | 7.72% per annum, starting February 11, 2007 until the termination date of the rate cap protection agreement. |
We have designated this interest rate cap agreement as a cash flow hedge. For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative instrument is recorded in accumulated other comprehensive loss, a separate component of stockholders’ equity, and reclassified into earnings in the period during which the hedge transaction affects earnings. The portion of the hedge which is not effective is immediately reflected in other income and expenses. Any change in fair value resulting from ineffectiveness will be recognized in current period earnings.
Our 9% senior convertible notes and our senior secured notes have fixed interest rates and, accordingly, are not exposed to market risk resulting from changes in interest rates. However, the fair market value of our long-term fixed interest rate debt is subject to interest rate risk. Generally, the fair market value of fixed interest rate debt will increase as interest rates fall and decrease as interest rates rise. These interest rate changes may affect the fair market value of the fixed interest rate debt but do not impact our earnings or cash flows.
Our carrying values of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses are reasonable approximations of their fair value.
As noted above, the estimated fair value of the embedded derivatives increases as the price of our common stock increases. These changes in estimated fair value will affect our results of operations but will not impact our cash flows.
To date, over 99% of our recognized revenue has been denominated in U.S. dollars, generated mostly from customers in the U.S., and our exposure to foreign currency exchange rate fluctuations has been minimal. In the future, a larger portion of our revenues may be derived from operations outside of the
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Furthermore, to the extent we engage in international sales that are denominated in U.S. dollars, an increase in the value of the U.S. dollar relative to foreign currencies could make our services less competitive in the international markets. Although we will continue to monitor our exposure to currency fluctuations, and when appropriate, may use financial hedging techniques in the future to minimize the effect of these fluctuations, we cannot conclude that exchange rate fluctuations will not adversely affect our financial results in the future.
Some of our operating costs are subject to price fluctuations caused by the volatility of underlying commodity prices. The commodity most likely to have an impact on our results of operations in the event of significant price change is electricity. We are closely monitoring the cost of electricity. To the extent that electricity costs rise, we have the ability to pass these additional power costs onto our customers that utilize this power. We do not employ forward contracts or other financial instruments to hedge commodity price risk.
Item 4. Controls and Procedures.
(a) Evaluation of Disclosure Controls and Procedures
Our Chief Executive Officer and the Chief Financial Officer carried out an assessment with the participation of our Disclosure Committee, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15(b) and 15d-15(b). Based upon, and as of the date of this assessment, the Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures were not effective at the reasonable assurance level due to the existence of the material weaknesses described below.
(b) | Changes in Internal Control Over Financial Reporting and Management’s Remediation Initiatives |
In connection with the assessment of our internal controls over financial reporting included in our annual report on form 10-K, as amended by form 10-K/ A filed on August 5, 2005, we determined that material weaknesses existed in our internal controls over financial reporting. In response to the material weaknesses identified, we are in the process of implementing the following remediation action plans:
• | Internal security deficiencies, which included allowing individuals in the information technology and accounting departments access to key financial information systems and data broader than that required by their roles and responsibilities, including an employee with check signing authority. Our information technology department is in the process of testing recent enhancements to our internal security through more restrictive user access and will also implement stronger system password controls; | |
• | Deficiencies over custody and processing of customer payments received by mail include having an employee with the ability to receive customer payments, reconcile our bank account and adjust customer balances. We are in the process of setting up a lockbox with our bank and directing our customers to mail payments directly to the lockbox; and | |
• | Deficiencies over completeness and accuracy of revenues include not reconciling invoices to data in customer contracts or to customer service delivery data and not having an independent review of invoices, or of the recording of revenues related to such invoices. We have retained an information technology consultant to assist us with the integration and/or reconciliation of invoices to customer service delivery data. We are also in the process of establishing the policies and procedures for an independent review of our invoices to customers. |
Except as disclosed above, there were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
The continued implementation of the described initiatives is among our highest priorities. Our Audit Committee will continually assess the progress and sufficiency of these initiatives and we will make adjustments as and when necessary. As of the date of this report, our management believes that the plan
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Limitations on Effectiveness |
Our management and the Audit Committee do not expect that our disclosure controls and procedures or internal control over financial reporting will prevent all errors or all instances of fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control gaps and instances of fraud have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple errors or mistakes. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and any design may not succeed in achieving its stated goals under all potential future conditions.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In the ordinary course of conducting our business, we become involved in various legal actions and other claims. Litigation is subject to many uncertainties and we may be unable to accurately predict the outcome of individual litigated matters. Some of these matters possibly may be decided unfavorably to us. It is the opinion of management that the ultimate liability, if any, with respect to these matters will not be material. Currently, there is no pending litigation involving the Company.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. |
None.
Item 3. Defaults upon Senior Securities.
None.
Item 4. | Submission of Matters to a Vote of Security Holders. |
We held a special meeting of our stockholders on May 16, 2005. At the meeting, our stockholders voted to amend our amended and restated certificate of incorporation to (i) effectuate a one-for-ten reverse stock split of our common stock and (ii) decrease the number of authorized shares of our common stock from six hundred million to one hundred million, as follows:
Unvoted/Broker | ||||||||||||||
For | Against | Abstain | Non-Votes | |||||||||||
29,177,499 | 182,473 | 17,043 | 13,652,663 |
Item 5. Other Information.
On August 5, 2005, we purchased all of the outstanding common stock of Dedigate, N.V., a leading managed hosting services provider in Europe. We paid a cash purchase price of€215,000 (approximately $266,000 as of August 5, 2005), subject to post-closing adjustments, as well as the issuance of 1,600,000 shares of our common stock. We agreed to file a registration statement to register such shares no later than 30 days after the closing and to cause this registration statement to be declared effective by the Securities and Exchange Commission no later than 120 days after Closing.
Item 6. Exhibits.
The following exhibits, which are furnished with this Quarterly Report or incorporated herein by reference, are filed as part of this Quarterly Report.
Exhibit | ||||
Number | Exhibit Description | |||
10 | .1 | Dedigate Stock Purchase Agreement | ||
10 | .1 | Dedigate Registration Rights Agreement | ||
31 | .1 | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | ||
31 | .2 | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | ||
32 | .1 | Certification of the Chief Executive Officer 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 the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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Pursuant to the requirements of Section 13 or 15(d) 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, on the 9th day of August, 2005.
TERREMARK WORLDWIDE, INC. | |
By: /s/ MANUEL D. MEDINA | |
Manuel D. Medina, | |
Chairman of the Board, | |
President and Chief Executive Officer | |
(Principal Executive Officer) | |
By: /s/ JOSÉ A. SEGRERA | |
José A. Segrera | |
Executive Vice President and | |
Chief Financial Officer | |
(Principal Accounting Officer) |
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