UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Form 10-Q/A
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 a large accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o Accelerated filer þ Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes o No þ
The registrant had 41,890,908 shares of common stock, $0.001 par value, outstanding as of July 31, 2005.
Explanatory Note
Terremark Worldwide, Inc. (the “Company”) is amending its Quarterly Report on Form 10-Q for the quarter ended June 30, 2005 to correct the disclosures of diluted earnings per share as described in more detail below.
As previously reported, the Company is restating its previously reported annual and interim disclosures of diluted earnings per share. As reported on November 9, 2005, in calculating diluted earnings per share using the “if converted” method for the year ended March 31, 2005 and for certain interim periods therein, the Company adjusted the net income or loss attributable to common stockholders for the interest expense on its 9% Senior Convertible Notes due June 15, 2009 (the “Senior Convertible Notes”); however, it did not consider the effect on net income or loss attributable to common stockholders of the change in fair value of the embedded derivatives within those same Senior Convertible Notes. Additionally, the Company made an adjustment to its previously reported basic earnings per share for the three and six months ended September 30, 2004 to correct its basic earnings per share calculation under the “two-class” method. On December 14, 2005, the Company concluded that it failed to use the correct interest expense amount in calculating diluted earnings per share for the September 30, 2004 and December 31, 2004 interim periods in the fiscal year ended March 31, 2005 when reporting restated amounts in its Current Report on Form 8-K filed on November 9, 2005. The Company had previously noted that it failed to use the correct interest expense amount in calculating diluted earnings per share for the June 30, 2004 interim period but had not reported this matter. The Company has determined that the effect of these matters was material to amounts previously disclosed for the year ended March 31, 2005, the nine months ended December 31, 2004, the three and six months ended September 30, 2004 and the three months ended June 30, 2004. See Note 2 to the consolidated financial statements for the quarter ended June 30, 2004 in the Quarterly Report on Form 10-Q/ A.
None of these adjustments affect previously recorded operating revenues, net loss, cash flow from operations or the Company’s financial position as reported on its balance sheets. However, in connection with the restatement described above, management determined that the Company did not maintain effective controls over the evaluation of interest expense and the impact of embedded derivatives within the Senior Convertible Notes in the calculation of diluted earnings per share under the “if converted” method and did not accurately calculate basic earnings per share under the two-class method, in accordance with generally accepted accounting principles, and that this control deficiency constitutes a material weakness. Accordingly, the Company is filing this Amendment No. 1 on Form 10-Q/A to its Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2005, which was originally filed on August 9, 2005 (the “Original Filing”). This Amendment No. 1 is being filed for the purpose of amending and restating Item 1. “Condensed Consolidated Financial Statements” and Item 4. “Controls and Procedures” as set forth in the Original Filing.
As a result of these amendments, the certifications pursuant to Section 302 and Section 906 of the Sarbanes-Oxley Act of 2002 have been re-executed and re-filed as of the date of this Form 10-Q/A.
Except for the amendments described above, this Form 10-Q/ A does not modify or update other disclosures.
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, | ||||||||||||
2004 | ||||||||||||
2005 | (Restated) | |||||||||||
(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 | ) | ||||||
Net loss per common share: | ||||||||||||
Basic | $ | (0.25 | ) | $ | (0.02 | ) | ||||||
Diluted | $ | (0.25 | ) | $ | (0.10 | ) | ||||||
Weighted average common shares outstanding-basic | 41,842,567 | 32,902,643 | ||||||||||
Weighted average common shares outstanding-diluted | 48,742,567 | 34,052,643 | ||||||||||
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. Restatement
The accompanying consolidated financial statements for the quarter ended June 30, 2004 have been restated to correct the disclosures of diluted earnings per share. In calculating diluted earnings per share using the “if converted” method, the Company failed to use the correct interest expense amount in adjusting the net income or loss attributable to common stockholders for the interest expense on its 9% Senior Convertible Notes due June 15, 2009 (the ’‘Senior Convertible Notes”); additionally, it did not consider the effect on net income or loss attributable to common stockholders of the change in fair value of the embedded derivatives within those Senior Convertible Notes. The Company has determined that this effect was dilutive for the three months ended June 30, 2004. The effect of these matters in calculating diluted earnings per share was to decrease the net loss by $572,000 for the adjustment of interest expense, increase the net loss by approximately $3.3 million to reverse the effect of the change in the fair value of the embedded derivative within the senior convertible notes and increase the weighted average common shares outstanding by approximately 1.1 million shares. These adjustments increased diluted loss per share from $(0.02) (as previously reported) to $(0.10) (as restated).
The accompanying notes have been restated to reflect the above matters and the additional disclosures required when presenting diluted earnings per share that are not equal to basic earnings per share.
3. 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
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
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 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.
7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
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.
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 | ) | ||
Basic loss per common share — as reported | $ | (0.25 | ) | $ | (0.02 | ) | ||
Basic loss per common share — pro forma | $ | (0.25 | ) | $ | (0.04 | ) | ||
Diluted loss per common share — (as restated) | $ | (0.25 | ) | $ | (0.10 | ) | ||
Diluted loss per common share — pro forma | $ | (0.25 | ) | $ | (0.12 | ) | ||
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
The Company’s 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.
8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
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 are included in the computation of basic EPS. Our participating securities do not have a contractual obligation to share in the losses in any given period. As a result, these participating securities will not be allocated any losses in the periods of net losses, but will be allocated income in the periods of net income using the two-class method. The two-class method is an earnings allocation formula that determines earnings for each class of common stock and participating securities according to dividends declared or accumulated and participation rights in undistributed earnings. Under the two-class method, net income is reduced by the amount of dividends declared in the current period for each class of stock and by the contractual amounts of dividends that must be paid for the current period. The remaining earnings are then allocated to common stock and participating securities to the extent that each security may share in earnings as if all of the earnings for the period had been distributed. Diluted EPS is calculated using the treasury stock and “if converted” methods for potential common stock. For diluted earnings (loss) per share purposes, however, the Company’s preferred stock will continue to be treated as a participating security in periods in which the use of the “if converted” method results in anti-dilution.
The following table presents the reconciliation of net loss to the numerator used for diluted loss per share.
For the Three Months Ended | |||||||||
June 30, | |||||||||
2004 | |||||||||
2005 | (Restated) | ||||||||
Net loss | $ | (10,131,272 | ) | $ | (576,575 | ) | |||
Adjustments: | |||||||||
Preferred dividend | (187,789 | ) | (242,310 | ) | |||||
Interest expense, including amortization of discount and debt issue costs | — | 571,939 | |||||||
Change in fair value of derivatives embedded within convertible debt | — | (3,303,375 | ) | ||||||
$ | (10,319,061 | ) | $ | (3,550,321 | ) | ||||
The following table represents the reconciliation of weighted average shares outstanding to basic and diluted weighted average shares outstanding.
For the Three Months Ended | ||||||||
June 30, | ||||||||
2004 | ||||||||
2005 | (Restated) | |||||||
Basic: | ||||||||
Weighted average common shares outstanding — basic | 41,842,567 | 32,902,643 | ||||||
Diluted: | ||||||||
Weighted average common shares outstanding — basic | 41,842,567 | 32,902,643 | ||||||
Weighted average Senior Convertible Notes | — | 1,150,000 | ||||||
Weighted average common shares outstanding — diluted | 41,842,567 | 34,052,643 | ||||||
9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The following table presents potential shares of common stock that are not included in the diluted net loss per share calculation above because to do so would be anti-dilutive for the periods indicated:
June 30, | ||||||||
2004 | ||||||||
2005 | (Restated) | |||||||
Series I convertible preferred stock | 1,230,000 | 1,333,333 | ||||||
Series H redeemable preferred stock | 29,400 | 29,400 | ||||||
Senior convertible notes | 6,900,000 | — |
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
10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
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 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
11
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
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.
4. 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 | |||||
5. 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.
6. 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.
12
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
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 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.
7. 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.
13
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
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 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. |
8. 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
14
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
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.
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.
9. 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.
10. 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.
11. 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 |
15
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
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. (“Fusion”). The Company’s Chief Executive Officer has a minority interest in Fusion and is a member of its board of directors.
12. 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 | |||||
13. 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 |
16
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 | ) | |||
14. 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 | |||||||
15. 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.
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.
17
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(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. |
As discussed in Note 2 to the condensed consolidated financial statements of this Form 10-Q/A, we restated previously disclosed interim period disclosures of diluted earnings per share. In connection with this restatement, management determined that another material weakness existed as of June 30, 2005 and has not been remediated through September 30, 2005. The Company did not maintain effective controls over the accounting for and calculation of earnings per share. Specifically, we did not maintain effective controls over the evaluation of interest expense and the impact of embedded derivatives within the Senior Convertible Notes in the calculation of diluted earnings per share under the “if converted” method and did not accurately calculate basic earnings per share under the two-class method, in accordance with generally accepted accounting principles. This control deficiency resulted in the restatement of the annual March 31, 2005 consolidated financial statements and interim September 30, 2004 and December 31, 2004 consolidated financial statements, as well as an audit adjustment in the September 30, 2005 interim consolidated financial statements. Additionally, this material weakness could result in a misstatement of disclosures of earnings per share that would result in a material misstatement of the annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, management determined that this control deficiency constitutes a material weakness. We are currently evaluating potential steps that we can take to remediate the material weaknesses in our internal controls over financial reporting, including steps that can be taken in the process of documenting and evaluating the applicable accounting treatment for and calculation of earnings per share.
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 outlined above, when completed, will remediate the material weaknesses in internal control over financial reporting as described above.
18
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
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.
19
PART II. OTHER INFORMATION
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 | |||
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 |
20
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 2nd day of February, 2006.
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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