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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q/A
Amendment No. 1
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarterly period ended September 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.
(Exact Name of Registrant as Specified in Its Charter)
Delaware | 84-0873124 | |
(State or Other Jurisdiction of Incorporation or Organization) | (IRS Employer Identification No.) |
2601 S. Bayshore Drive, Miami, Florida 33133
(Address of Principal Executive Offices, Including Zip Code)
Registrant’s telephone number, including area code:
(305) 856-3200
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 44,384,029 shares of common stock, $0.001 par value, outstanding as of November 7, 2005.
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Explanatory Note
Terremark Worldwide, Inc. (the Company) is amending its quarterly report on Form 10-Q for the quarter ended September 30, 2005 to restate its previously disclosed September 30, 2004 interim period disclosures of diluted earnings per share as disclosed in Note 2 to the accompanying condensed consolidated financial statements. 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 six and three months ended September 30, 2004 to correct its basic earnings per share calculation under the “two-class” method. This adjustment reduced basic earnings per share for those periods from $0.05 and $0.07, respectively to $0.04 and $0.06, respectively. 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 is adjusting the interest expense used to calculate the diluted earnings per share using the “if converted” method. This adjustment changed interest expense used to calculate diluted earnings per share using the “if converted” method by approximately $3,200,000 and $430,000 for the six and three months ended September 30, 2004, respectively. As a result, the diluted loss per share increased from $(0.14) to $(0.22) for the six months ended September 30, 2004 and from ($0.10) to ($0.11) for the three months ended September 30, 2004.
None of these adjustments affect previously recorded operating revenues, net loss, cash flow from operation 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 and did not accordingly 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 September 30, 2005, which was originally filed on November 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. “Control and Procedures” as set forth in the Original Filing and to attach a signature page to the Original Filing, which was inadvertently removed from the Original Filing during transmittal.
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.
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PART I. FINANCIAL INFORMATION
Item 1. | Financial Statements |
TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, | March 31, | |||||||
2005 | 2005 | |||||||
(Unaudited) | ||||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 29,201,130 | $ | 44,001,144 | ||||
Restricted cash | 2,834,743 | 2,185,321 | ||||||
Accounts receivable, net of allowance for doubtful accounts of $200,000 each year | 8,295,936 | 4,388,889 | ||||||
Current portion of capital lease receivable | 2,495,269 | 2,280,000 | ||||||
Prepaid expenses and other current assets | 2,602,352 | 942,575 | ||||||
Total current assets | 45,429,430 | 53,797,929 | ||||||
Restricted cash | 5,647,501 | 5,641,531 | ||||||
Property and equipment, net of accumulated depreciation of $21,891,144 and $18,110,516 | 123,538,626 | 123,406,321 | ||||||
Debt issuance costs, net of accumulated amortization of $1,895,531 and $1,007,734 | 7,878,186 | 8,797,296 | ||||||
Other assets | 2,386,957 | 1,182,716 | ||||||
Capital lease receivable, net of current portion | 5,233,464 | 6,080,001 | ||||||
Intangibles, net of accumulated amortization of $130,000 | 4,070,000 | — | ||||||
Goodwill | 16,483,530 | 9,999,870 | ||||||
Total assets | $ | 210,667,694 | $ | 208,905,664 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Current portion of mortgage payable | $ | 718,341 | $ | 692,570 | ||||
Current portion of notes payable | 4,201,549 | 4,489,945 | ||||||
Construction payables | — | 427,752 | ||||||
Accounts payable and accrued expenses | 11,617,988 | 8,914,578 | ||||||
Current portion of capital lease obligations | 1,202,843 | 1,037,459 | ||||||
Interest payable | 3,787,525 | 2,680,882 | ||||||
Current portion of unearned interest | 660,820 | 724,686 | ||||||
Series H redeemable convertible preferred stock: $.001 par value, 294 shares issued and outstanding, at liquidation value | 631,699 | — | ||||||
Total current liabilities | 22,820,765 | 18,967,872 | ||||||
Mortgage payable, less current portion | 45,924,733 | 46,034,024 | ||||||
Convertible debt | 56,398,741 | 53,972,558 | ||||||
Derivatives embedded within convertible debt, at estimated fair value | 10,138,943 | 20,116,618 | ||||||
Notes payable, less current portion | 24,469,885 | 23,664,142 | ||||||
Deferred rent | 2,239,678 | 2,001,789 | ||||||
Unearned interest under capital lease receivables | 628,933 | 898,778 | ||||||
Capital lease obligations, less current portion | 593,980 | 434,441 | ||||||
Deferred revenue | 4,248,119 | 1,994,598 | ||||||
Series H redeemable convertible preferred stock: $.001 par value, 294 shares issued and outstanding, at liquidation value | — | 616,705 | ||||||
Total liabilities | 167,463,777 | 168,701,525 | ||||||
Minority interest | — | 28,090 | ||||||
Commitments and contingencies | — | — | ||||||
Stockholders’ equity: | ||||||||
Series I convertible preferred stock: $.001 par value, 369 and 383 shares issued and outstanding (liquidation value of approximately $10.2 million and $10.3 million) | 1 | 1 | ||||||
Common stock: $.001 par value, 100,000,000 shares authorized; 44,384,029 and 42,745,336 shares issued | 44,384 | 42,587 | ||||||
Common stock warrants | 13,603,860 | 13,599,704 | ||||||
Common stock options | 1,538,260 | 1,538,260 | ||||||
Additional paid-in capital | 289,870,765 | 279,063,085 | ||||||
Accumulated deficit | (254,139,192 | ) | (246,674,069 | ) | ||||
Accumulated other comprehensive loss | (148,994 | ) | (172,882 | ) | ||||
Treasury stock: 865,202 shares | (7,220,637 | ) | (7,220,637 | ) | ||||
Notes receivable | (344,530 | ) | — | |||||
Total stockholders’ equity | 43,203,917 | 40,176,049 | ||||||
Total liabilities and stockholders’ equity | $ | 210,667,694 | $ | 208,905,664 | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For the Six Months Ended | For the Three Months Ended | |||||||||||||||||||
September 30, | September 30, | |||||||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||||||
(as restated) | (as restated) | |||||||||||||||||||
Revenues | ||||||||||||||||||||
Data center | $ | 24,632,200 | $ | 15,025,915 | $ | 13,961,080 | $ | 7,914,744 | ||||||||||||
Construction contracts and fees | — | 1,087,708 | — | 303,368 | ||||||||||||||||
Operating revenues | 24,632,200 | 16,113,623 | 13,961,080 | 8,218,112 | ||||||||||||||||
Expenses | ||||||||||||||||||||
Data center operations, excluding depreciation | 15,729,856 | 12,200,670 | 8,718,207 | 6,463,989 | ||||||||||||||||
Construction contract expenses, excluding depreciation | — | 948,813 | — | 243,467 | ||||||||||||||||
General and administrative | 7,684,085 | 6,979,446 | 3,503,439 | 3,417,332 | ||||||||||||||||
Sales and marketing | 3,780,133 | 2,033,119 | 2,021,059 | 1,062,773 | ||||||||||||||||
Depreciation and amortization | 3,911,615 | 2,573,054 | 2,047,154 | 1,296,305 | ||||||||||||||||
Operating expenses | 31,105,689 | 24,735,102 | 16,289,859 | 12,483,866 | ||||||||||||||||
Loss from operations | (6,473,489 | ) | (8,621,479 | ) | (2,328,779 | ) | (4,265,754 | ) | ||||||||||||
Other income (expenses) | ||||||||||||||||||||
Change in fair value of derivatives embedded within convertible debt | 9,977,675 | 13,679,250 | 10,441,700 | 10,375,875 | ||||||||||||||||
Gain on debt restructuring and extinguishment, net | — | 3,420,956 | — | — | ||||||||||||||||
Interest expense | (12,301,995 | ) | (6,433,148 | ) | (6,305,142 | ) | (3,449,314 | ) | ||||||||||||
Interest income | 899,434 | 196,243 | 439,261 | 129,924 | ||||||||||||||||
Gain on sale of asset | 499,388 | — | 499,388 | — | ||||||||||||||||
Other, net | (66,136 | ) | (4,260 | ) | (80,276 | ) | 23,406 | |||||||||||||
Total other (expenses) income | (991,634 | ) | 10,859,041 | 4,994,931 | 7,079,891 | |||||||||||||||
(Loss) income before income taxes | (7,465,123 | ) | 2,237,562 | 2,666,152 | 2,814,137 | |||||||||||||||
Income taxes | — | — | — | — | ||||||||||||||||
Net (loss) income | (7,465,123 | ) | 2,237,562 | 2,666,152 | 2,814,137 | |||||||||||||||
Preferred dividend | (372,489 | ) | (486,821 | ) | (184,700 | ) | (244,511 | ) | ||||||||||||
Earnings allocation to participating security holders | — | (240,611 | ) | (396,616 | ) | (488,423 | ) | |||||||||||||
Net (loss) income attributable to common stockholders | $ | (7,837,612 | ) | $ | 1,510,130 | $ | 2,084,836 | $ | 2,081,203 | |||||||||||
Net (loss) income per common share: | ||||||||||||||||||||
Basic | $ | (0.18 | ) | $ | 0.04 | $ | 0.05 | $ | 0.06 | |||||||||||
Diluted | $ | (0.22 | ) | $ | (0.22 | ) | $ | (0.09 | ) | $ | (0.11 | ) | ||||||||
Weighted average shares outstanding — basic | 42,369,338 | 33,605,480 | 42,890,383 | 35,066,003 | ||||||||||||||||
Weighted average shares outstanding — diluted | 49,269,338 | 37,630,480 | 49,790,383 | 41,966,003 | ||||||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
(Unaudited)
Common Stock | ||||||||||||||||||||||||||||||||||||||||
Par Value $.001 | Accumulated | |||||||||||||||||||||||||||||||||||||||
Additional | Other | |||||||||||||||||||||||||||||||||||||||
Preferred | Issued | Common Stock | Common Stock | Paid-in | Accumulated | Comprehensive | Notes | |||||||||||||||||||||||||||||||||
Stock Series I | Shares | Amount | Warrants | Options | Capital | Deficit | Loss | Treasury Stock | Receivable | |||||||||||||||||||||||||||||||
(Unaudited) | ||||||||||||||||||||||||||||||||||||||||
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 | — | 112,123 | 112 | — | — | 179,371 | — | — | — | — | ||||||||||||||||||||||||||||||
Warrants issued for services | — | — | — | 25,056 | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Accrued dividends on preferred stock | — | — | — | — | — | (372,489 | ) | — | — | — | — | |||||||||||||||||||||||||||||
Foreign currency translation adjustment | — | — | — | — | — | — | — | 23,888 | — | — | ||||||||||||||||||||||||||||||
Exercise of warrants | 10,000 | 10 | (20,900 | ) | — | 73,890 | — | — | — | — | ||||||||||||||||||||||||||||||
Issuance of common stock in lieu of cash-preferred stock dividend | 27,920 | 28 | — | — | 173,355 | — | — | — | — | |||||||||||||||||||||||||||||||
Common stock issued in acquisition | 1,600,000 | 1,600 | — | — | 10,753,600 | — | — | — | — | |||||||||||||||||||||||||||||||
Loans issued to employees | — | — | — | — | — | — | — | — | (344,530 | ) | ||||||||||||||||||||||||||||||
Net loss | — | — | — | — | — | — | (7,465,123 | ) | — | — | — | |||||||||||||||||||||||||||||
Balance at September 30, 2005 | $ | 1 | 44,384,029 | $ | 44,384 | $ | 13,603,860 | $ | 1,538,260 | $ | 289,870,765 | $ | (254,139,192 | ) | $ | (148,994 | ) | $ | (7,220,637 | ) | $ | (344,530 | ) | |||||||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended | ||||||||||
September 30, | ||||||||||
2005 | 2004 | |||||||||
(Unaudited) | ||||||||||
Cash flows from operating activities: | ||||||||||
Net (loss) income | $ | (7,465,123 | ) | $ | 2,237,562 | |||||
Adjustments to reconcile net loss to net cash used in operating activities | ||||||||||
Depreciation and amortization of long-lived assets | 3,911,615 | 2,573,054 | ||||||||
Change in estimated fair value of embedded derivatives | (9,977,675 | ) | (13,679,250 | ) | ||||||
Accretion on convertible debt and mortgage payables | 2,668,412 | 1,197,426 | ||||||||
Amortization of beneficial conversion feature on issuance of convertible debentures | — | 904,761 | ||||||||
Amortization of discount on notes payable | 533,868 | — | ||||||||
Interest payment in kind on notes payable | 271,875 | — | ||||||||
Amortization of debt issue costs | 926,226 | 327,346 | ||||||||
Provision for bad debt | 241,916 | — | ||||||||
Gain on debt restructuring and extinguishment | — | (3,626,956 | ) | |||||||
Other, net | (72,605 | ) | 175,873 | |||||||
Warrants issued for services | — | — | ||||||||
Stock-based compensation | — | 172,650 | ||||||||
Loss on disposal of property and equipment | 174,747 | — | ||||||||
Gain on sale of asset | (499,388 | ) | — | |||||||
(Increase) decrease in: | ||||||||||
Restricted cash | (655,391 | ) | — | |||||||
Accounts receivable | (3,171,815 | ) | 1,006,537 | |||||||
Contracts receivable | — | 250,892 | ||||||||
Capital lease receivable, net of unearned interest | 297,557 | — | ||||||||
Other assets | (2,577,264 | ) | (1,346,785 | ) | ||||||
Deferred costs under government contracts | — | (3,592,328 | ) | |||||||
Increase (decrease) in: | ||||||||||
Accounts payable and accrued expenses | 611,201 | (23,949 | ) | |||||||
Interest payable | 1,106,643 | 780,061 | ||||||||
Deferred revenue | 2,253,521 | 538,660 | ||||||||
Construction payables | (394,005 | ) | 90,976 | |||||||
Deferred rent | 237,889 | 2,777,806 | ||||||||
Net cash used in operating activities | (11,577,796 | ) | (9,235,664 | ) | ||||||
Cash flows from investing activities: | ||||||||||
Restricted cash | — | (4,542 | ) | |||||||
Purchases of property and equipment | (3,646,110 | ) | (5,605,762 | ) | ||||||
Acquisition of a majority interest in NAP Madrid | — | (2,537,627 | ) | |||||||
Advance for acquisition of unconsolidated entity and other | — | (2,413,274 | ) | |||||||
Issuance of notes receivable | (344,530 | ) | — | |||||||
Proceeds from notes receivable-related party | — | 50,000 | ||||||||
Acquisition of Dedigate | 360,125 | — | ||||||||
Proceeds from sale of assets | 762,046 | — | ||||||||
Net cash used in investing activities | (2,868,469 | ) | (10,511,205 | ) | ||||||
Cash flows from financing activities: | ||||||||||
Dividends on preferred stock | (14,000 | ) | — | |||||||
Payments on loans and mortgage payable | (414,456 | ) | (36,490,245 | ) | ||||||
Issuance of convertible debt | — | 86,257,312 | ||||||||
Payments on convertible debt | — | (10,131,800 | ) | |||||||
Debt issuance costs | (7,117 | ) | (5,255,912 | ) | ||||||
Proceeds from sale of preferred stock | — | 2,131,800 | ||||||||
Net increase in construction payables | — | 1,500,000 | ||||||||
Other borrowings | — | 182,097 | ||||||||
Repayments of capital lease obligations | (150,659 | ) | (530,611 | ) | ||||||
Preferred stock issuance costs | — | (587,860 | ) | |||||||
Proceeds from exercise of stock options and warrants | 232,483 | 124,760 | ||||||||
Net cash (used in) provided by financing activities | (353,749 | ) | 37,199,541 | |||||||
Net (decrease) increase in cash | (14,800,014 | ) | 17,452,672 | |||||||
Cash and cash equivalents at beginning of period | 44,001,144 | 4,378,614 | ||||||||
Cash and cash equivalents at end of period | $ | 29,201,130 | $ | 21,831,286 | ||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. | Business and Organization |
Terremark Worldwide, Inc. (together with its subsidiaries, the “Company” or “Terremark”) is a leading operator of integrated Tier-1 Internet exchanges and a global provider of managed IT infrastructure solutions for government and private sectors. Terremark delivers its portfolio of services from seven locations in the U.S., Europe and Latin America and from our four service aggregation and distribution locations in Europe and Asia. Terremark’s flagship facility, the NAP of the Americas, is the model for the carrier-neutral Internet exchanges and is designed and built to disaster-resistant standards with maximum security to house mission-critical systems infrastructure.
2. | Restatement |
In December 2005, the Company concluded that it would further restate its September 30, 2004 interim period disclosures of diluted earnings per share as previously reported on November 9, 2005 in its Form 10-Q for the quarter ended September 30 2005. As previously 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 the fair value of the embedded derivatives within those same Senior Convertible Notes. The effect of these matters in calculating diluted earning per share for the six and three months period ended September 30, 2004 was to increase the net income by approximately $3.7 and $3.0 million, respectively, for the adjustment of interest expense, decrease of net income by approximately $13.7 million and $10.4 million, respectively, to reverse the effect of the change in the fair value of the embedded derivative within the senior convertible notes and increase in weighted average common shares outstanding by approximately 4.0 million and 6.9 million shares respectively. 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 interim period in the fiscal year ended March 31, 2005 when reporting restated amounts in its Current Report on Form 10-Q filed on November 9, 2005. As a result, the Company is adjusting the interest expense used in the calculation of diluted earnings per share under the “if converted” method for the six and three months ended September 30, 2004 from those amounts previously disclosed in its Form 10-Q for the quarter ended September 30, 2005. This adjustment changed interest expense used to calculate diluted earnings per share using the “if converted” method by approximately $3,200,000 and $430,000 for the six and three months ended September 30, 2004, respectively. The effect of these matters on amounts originally reported and disclosed within the Company’s Quarterly Reports on Form 10-Q is as follows:
Six Months Ended | Three Months Ended | |||||||
September 30, 2004 | September 30, 2004 | |||||||
Net (loss) income per common share: | ||||||||
As originally reported: | ||||||||
Diluted: | $ | 0.05 | $ | 0.07 | ||||
As previously reported within the Company’s Quarterly Report on Form 10-Q filed on November 9, 2005: | ||||||||
Diluted: | $ | (0.14 | ) | $ | (0.10 | ) | ||
As currently reported and restated: | ||||||||
Diluted: | $ | (0.22 | ) | $ | (0.11 | ) | ||
As noted above, the Company is amending its disclosure of the reconciliation of net income to the numerator used for diluted loss per share to correct interest expense for the six and three month periods
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TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
ended September 30, 2004 as previously reported in the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2005.
For the Six Months Ended | For the Three Months Ended | ||||||||||||||||
September 30, | September 30, | ||||||||||||||||
2004 | 2004 | 2004 | 2004 | ||||||||||||||
(as previously | (as restated) | (as previously | (as restated) | ||||||||||||||
reported) | reported) | ||||||||||||||||
Net income | $ | 2,237,562 | $ | 2,237,562 | $ | 2,814,137 | $ | 2,814,137 | |||||||||
Adjustments: | |||||||||||||||||
Preferred dividend | (486,821 | ) | (486,821 | ) | (244,511 | ) | (244,511 | ) | |||||||||
Earnings allocation attributable to preferred stock | (59,739 | ) | (59,739 | ) | (78,901 | ) | (78,901 | ) | |||||||||
Interest expense, including amortization of discount and debt issue costs | 6,874,408 | 3,651,193 | 3,510,194 | 3,079,254 | |||||||||||||
Change in fair value of derivatives embedded within convertible debt | (13,679,250 | ) | (13,679,250 | ) | (10,375,875 | ) | (10,375,875 | ) | |||||||||
$ | (5,113,840 | ) | $ | (8,337,055 | ) | $ | (4,374,956 | ) | $ | (4,805,896 | ) | ||||||
These adjustments increased diluted earnings per share from $(0.14) as previously reported to $(0.22) (as restated) for the six months ended September 30, 2004 and from $(0.10) as previously reported to $(0.11) (as restated) for the three months ended September 30, 2004.
Additionally, on November 9, 2005 the Company made an adjustment to its previously reported basic earnings per share for the six and three months ended September 30, 2004 to correct its basic earnings per share calculation under the two-class method. This adjustment reduced basic earnings per share for those periods from $0.05 and $0.07, respectively, to $0.04 and $0.06, respectively. As a result, the Company is also disclosing within the condensed consolidated statements of operations for these periods, the net income available to common stockholders after an allocation of earnings to participating security holders as follows:
September 30, 2004 | |||||||||
Six Months Ended | Three Months Ended | ||||||||
Net income attributable to common shareholders | |||||||||
As previously reported | $ | 1,750,741 | $ | 2,569,626 | |||||
As restated | $ | 1,510,130 | $ | 2,081,203 | |||||
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 or
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TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
the six months ended September 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 certain data center revenues by 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 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.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
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, if any, that the Company may eventually pay to settle these embedded derivatives.
Significant concentrations |
The Company’s two largest customers accounted for approximately 18% and 12%, respectively, of data center revenues for the six months ended September 30, 2005. The same two customers accounted for approximately 18% and 10%, respectively, of data center revenues for the three months ended September 30, 2005. These same customers accounted for approximately 22% and 17%, respectively, of data center revenues for the six months ended September 30, 2004. These customers also accounted for approximately 20% and 19%, respectively, of data center revenues for the three months ended September 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.
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 Six Months Ended | For the Three Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
(as restated) | (as restated) | |||||||||||||||
Net loss attributable to common stockholders as reported | $ | (7,837,612 | ) | $ | 1,510,130 | $ | 2,084,836 | $ | 2,081,203 | |||||||
Incremental stock-based compensation expense if the fair value method had been adopted | (665,261 | ) | $ | (616,609 | ) | $ | (339,668 | ) | $ | (77,439 | ) | |||||
Pro forma net loss attributable to common stockholders | $ | (8,502,873 | ) | $ | 893,521 | $ | 1,745,168 | $ | 2,003,764 | |||||||
Basic (loss) income per common share — as reported | $ | (0.18 | ) | $ | 0.04 | $ | 0.05 | $ | 0.06 | |||||||
Basic (loss) income per common share — pro forma | $ | (0.20 | ) | $ | 0.03 | $ | 0.04 | $ | 0.06 | |||||||
Diluted loss per common share — as reported | $ | (0.22 | ) | $ | (0.22 | ) | $ | (0.09 | ) | $ | (0.11 | ) | ||||
Diluted loss per common share — pro forma | $ | (0.24 | ) | $ | (0.24 | ) | $ | (0.10 | ) | $ | (0.12 | ) | ||||
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TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
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% — 4.28% | 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.
Income (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.
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.
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TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The following table presents the reconciliation of net (loss) income to the numerator used for diluted loss per share (unaudited):
For the Six Months Ended | For the Three Months Ended | ||||||||||||||||
September 30, | September 30, | ||||||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||||||
(as restated) | (as restated) | ||||||||||||||||
Net (loss) income | $ | (7,465,123 | ) | $ | 2,237,562 | $ | 2,666,152 | $ | 2,814,137 | ||||||||
Adjustments: | |||||||||||||||||
Preferred dividend | (372,489 | ) | (486,821 | ) | (184,700 | ) | (244,511 | ) | |||||||||
Earnings allocation attributable to preferred stock | — | (59,739 | ) | (61,218 | ) | (78,901 | ) | ||||||||||
Interest expense, including amortization of discount and debt issue costs | 6,874,408 | 3,651,193 | 3,510,194 | 3,079,254 | |||||||||||||
Change in fair value of derivatives embedded within convertible debt | (9,977,675 | ) | (13,679,250 | ) | (10,441,700 | ) | (10,375,875 | ) | |||||||||
$ | (10,940,879 | ) | $ | (8,337,055 | ) | $ | (4,511,272 | ) | $ | (4,805,896 | ) | ||||||
The following table presents the reconciliation of weighted average shares outstanding to basic and diluted weighted average shares outstanding (unaudited):
For the Six Months Ended | For the Three Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
(as restated) | (as restated) | |||||||||||||||
Basic: | ||||||||||||||||
Weighted average common shares outstanding | 42,369,338 | 33,605,480 | 42,890,383 | 35,066,003 | ||||||||||||
Diluted: | ||||||||||||||||
Weighted average common shares outstanding — basic | 42,369,338 | 33,605,480 | 42,890,383 | 35,066,003 | ||||||||||||
Weighted average Senior Convertible Notes | 6,900,000 | 4,025,000 | 6,900,000 | 6,900,000 | ||||||||||||
Weighted average common shares outstanding — diluted | 49,269,338 | 37,630,480 | 49,790,383 | 41,966,003 | ||||||||||||
The following table sets forth 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 (unaudited):
September 30, | ||||||||
2005 | 2004 | |||||||
Series I convertible preferred stock | 1,230,000 | 1,300,000 | ||||||
Series H redeemable convertible preferred stock | 29,400 | 29,400 | ||||||
Common stock warrants | 2,702,436 | 844,558 | ||||||
Common stock options | 1,632,296 | 1,760,106 |
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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 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, 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. Accordingly, the Company expects to adopt the provisions of SFAS No. 123(R) and SAB No. 107 in the first quarter of fiscal 2007. 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 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 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
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
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 adoption of EITF 05-6 is not expected to have significant impact, if any, on the Company’s 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.
In September 2005, the FASB approved EITF Issue 05–7, “Accounting for Modifications to Conversion Options Embedded in Debt Securities and Related Issues” (“EITF 05–7”). EITF 05–7 addresses that the changes in the fair value of an embedded conversion option upon modification should be included in the analysis under EITF Issue 96–19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments,” to determine whether a modification or extinguishment has occurred and that changes to the fair value of a conversion option affects the interest expense on the associated debt instrument following a modification. Therefore, the change in fair value of the conversion option should be recognized upon the modification as a discount or premium associated with the debt, and an increase or decrease in additional paid-in capital. EITF 05–7 is effective for all debt modifications in annual or interim periods beginning after December 15, 2005. The adoption of EITF 05–7 is not expected to have significant impact, if any, on the Company’s financial position and results of operations.
In September 2005, the FASB approved EITF Issue 05–8, “Income Tax Consequences of Issuing Convertible Debt with a Beneficial Conversion Feature” (“EITF 05–8”). EITF 05–8 addresses that (i) the recognition of a beneficial conversion feature creates a difference between the book basis and tax basis (“basis difference”) of a convertible debt instrument, (ii) that basis difference is a temporary difference for which a deferred tax liability should be recorded and (iii) the effect of recognizing the deferred tax liability should be charged to equity in accordance with SFAS No. 109. EITF 05–8 is effective for financial statements for periods beginning after December 15, 2005, and must be adopted through retrospective application to all periods presented. As a result, EITF 05–8 applies to debt instruments that were converted or extinguished in prior periods as well as to those currently outstanding. The adoption of EITF 05–8 is not expected to have significant impact, if any, on the Company’s financial position, results of operations and cash flows.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
4. | Acquisition |
On August 5, 2005, the Company acquired all of the outstanding common stock of Dedigate, N.V., a leading managed host services provider in Europe. The preliminary purchase price of $11,982,460 was comprised of: (i) 1,600,000 shares of the Company’s common stock with a fair value of $10,755,200, (ii) cash consideration of $653,552 and (iii) direct transaction costs of $573,708. The fair value of the Company’s stock was determined using the five-day trading average price of the Company’s common stock for two days before and after the date the transaction was announced in August 2005.
The costs to acquire Dedigate were allocated to the tangible and identified intangible assets acquired and liabilities assumed based on their respective fair values, and any excess was allocated to goodwill. The purchase price allocation below is based on the best information currently available and is subject to change and refinement as the Company is in the process of obtaining a third-party valuation of certain intangible assets and assessing certain contingent liabilities.
Cash and cash equivalents | $ | 1,587,384 | ||
Accounts receivable | 977,150 | |||
Other current assets | 130,931 | |||
Property and equipment | 831,170 | |||
Intangibles assets, including goodwill | 10,683,660 | |||
Other assets | 44,051 | |||
Accounts payable and accrued expenses | (1,285,553 | ) | ||
Other liabilities | (986,333 | ) | ||
Net assets acquired | $ | 11,982,460 | ||
The allocation of acquisition intangible assets as of September 30, 2005 is summarized in the following tables:
Gross Carrying | Amortization | Accumulated | |||||||||||
Amount | Period | Amortization | |||||||||||
Intangibles no longer amortized: | |||||||||||||
Goodwill | $ | 6,483,660 | — | $ | — | ||||||||
Amortizable intangibles | |||||||||||||
Customer base | 1,800,000 | 10 years | 30,000 | ||||||||||
Technology acquired | 2,400,000 | 4 years | 100,000 |
The results of Dedigate’s operations have been included in the condensed consolidated financial statements since the acquisition date. The following unaudited pro forma financial information of the Company for the three and six months ended September 30, 2005 and 2004 have been presented as if the acquisition of Dedigate had occurred as of the beginning of each period. This pro forma information does
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
not necessarily reflect the results of operations if the business had been managed by the Company during these periods and is not indicative of results that may be obtained in the future.
For the Six Months Ended | For the Three Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
(as restated) | (as restated) | |||||||||||||||
Revenues | $ | 27,246,068 | $ | 18,904,623 | $ | 14,498,948 | $ | 9,535,112 | ||||||||
Net (loss) income | (7,322,774 | ) | 2,268,562 | 2,756,803 | 2,887,137 | |||||||||||
Basic net (loss) income per share | $ | (0.18 | ) | $ | 0.04 | $ | 0.05 | $ | 0.06 | |||||||
Diluted net loss per share | $ | (0.22 | ) | $ | (0.22 | ) | $ | (0.14 | ) | $ | (0.11 | ) | ||||
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 the existing building improvements that the Company 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 the Company’s business. See Note 8.
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 method over the term of the mortgage loan.
6. | Restricted Cash |
Restricted cash consists of:
September 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 | 1,153,342 | 1,641,531 | ||||||
Escrow deposits under mortgage loan agreement | 1,647,501 | 503,921 | ||||||
8,482,243 | 7,826,852 | |||||||
Less: current portion | (2,834,742 | ) | (2,185,321 | ) | ||||
$ | 5,647,501 | $ | 5,641,531 | |||||
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
7. | 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 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.
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TERREMARK WORLDWIDE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
8. | 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 September 30, 2005 estimated fair value of approximately $10,222,075 resulting from the conversion option. The change of $9,977,675 in the estimated fair value of the embedded derivatives was recognized as other income in the six months ended September 30, 2005. For the three months ended September 30, 2005, the change in the estimated fair value of the embedded derivatives was $10,441,700 and was recognized as other income in the three months ended September 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 rates the $49.0 million mortgage payable for the four-year period for which the rate cap protection agreement is in effect:
• | 5.75% per annum through February 10, 2006; | |
• | 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. |
9. | 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; |
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
• | 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.
At September 30, 2005, the Company also had a bank loan with an outstanding balance of $3.5 million Euros (approximately $4.2 million at the September 30, 2005 exchange rate). This bank loan is collateralized by the 865,202 shares of the Company’s common stock owned by NAP Madrid. The Company also deposited 1,250,000 Euros (approximately $1.5 million at the September 30, 2005 exchange rate) with the lender as security for the loan.
10. | 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.
11. | Changes in Stockholder’s Equity |
Exercise of employee stock options |
During the six months ended September 30, 2005, the Company issued 112,123 shares of its common stock in conjunction with the exercise of options, including 111,107 shares issued to a director of the Company. The exercise price of the options ranged from $2.50 to $6.50.
Issuance of warrants |
In April 2005, the Company issued 7,200 warrants with an estimated fair value of $25,000 in connection with investor relations consulting services.
Exercise of warrants |
In July, 2005, warrants were exercised for 10,000 shares of common stock at $5.30 per share.
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.
Loans issued to employees |
In connection with the acquisition of Dedigate, the Company extended loans to certain Dedigate employees to exercise their Dedigate stock options. The Dedigate shares received upon exercise of those options were then exchanged for shares of the Company’s common stock under the terms of the acquisition. The loans are evidenced by full recourse promissory notes, bear interest at 2.50% per annum,
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
mature in September 2006 and are collateralized by the shares of stock acquired with the loan proceeds. The outstanding principal balance on such loans is reflected as a reduction to stockholders’ equity in the accompanying balance sheet at September 30, 2005.
12. | 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 six and three months ended September 30, 2005 and 2004 and balances with related parties included in the accompanying balance sheet as of September 30, 2005 and March 31, 2005:
For the Six Months Ended | For the Three Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Rent Expense | $ | — | $ | 3,879,189 | $ | — | $ | 1,939,189 | ||||||||
Services purchased from Fusion Telecommunications International, Inc. | 612,193 | 465,865 | $ | 326,536 | $ | 226,865 | ||||||||||
Property management and construction fees | — | 90,922 | $ | — | $ | 46,922 | ||||||||||
Interest income on notes receivable — third party | — | 50,278 | $ | — | $ | 29,278 | ||||||||||
Interest income from shareholder | 14,251 | 15,032 | 7,219 | 7,032 | ||||||||||||
Services provided to a related party | 15,338 | 657,536 | 6,388 | 88,876 |
September 30, | March 31, | |||||||
2005 | 2005 | |||||||
Other assets | $ | 440,771 | $ | 477,846 | ||||
Note receivable — related party | 345,851 | — |
The Company’s Chief Executive Officer has a minority interest in Fusion Telecommunications International, Inc. and is a member of its board of directors.
13. | Data Center Revenues |
Data center revenues consist of the following:
For the Six Months Ended | For the Three Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Colocation | $ | 13,627,929 | $ | 9,728,114 | $ | 7,580,326 | $ | 5,105,479 | ||||||||
Managed and professional services | 8,254,502 | 3,171,041 | 4,947,078 | 1,715,419 | ||||||||||||
Exchange point services | 2,743,580 | 2,125,842 | 1,427,487 | 1,093,846 | ||||||||||||
Contract termination fee | 6,189 | 918 | 6,189 | — | ||||||||||||
Data center revenue | $ | 24,632,200 | $ | 15,025,915 | $ | 13,961,080 | $ | 7,914,744 | ||||||||
14. | Information About the Company’s Operating Segments |
As of March 31, 2005 and September 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
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
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 September 30, | Operations | Services | Total | ||||||||||
2005 | |||||||||||||
Revenues | $ | 13,961,080 | $ | — | $ | 13,961,080 | |||||||
Loss from Operations | (2,358,619 | ) | 29,840 | (2,328,779 | ) | ||||||||
Net income | 2,637,322 | 28,830 | 2,666,152 | ||||||||||
2004 | |||||||||||||
Revenues | $ | 7,914,744 | $ | 303,368 | $ | 8,218,112 | |||||||
Loss from Operations | (4,230,047 | ) | (35,707 | ) | (4,265,754 | ) | |||||||
Net income (loss) | 2,849,662 | (35,525 | ) | 2,814,137 | |||||||||
Assets as of | |||||||||||||
September 30, 2005 | $ | 210,667,694 | $ | — | $ | 210,667,694 | |||||||
March 31, 2005 | 208,905,664 | — | 208,905,664 |
Data Center | Real Estate | |||||||||||
For the Six Months Ended September 30, | Operations | Services | Total | |||||||||
2005 | ||||||||||||
Revenues | $ | 24,632,200 | $ | — | $ | 24,632,200 | ||||||
Loss from Operations | (6,512,225 | ) | 38,736 | (6,473,489 | ) | |||||||
Net income (loss) | (7,502,849 | ) | 37,726 | (7,465,123 | ) | |||||||
2004 | ||||||||||||
Revenues | $ | 15,025,915 | $ | 1,087,708 | $ | 16,113,623 | ||||||
Loss from Operations | (8,559,363 | ) | (62,116 | ) | (8,621,479 | ) | ||||||
Net income (loss) | 2,298,518 | (60,956 | ) | 2,237,562 |
The following is a reconciliation of total segment loss from operations to loss before income taxes:
For the Six Months Ended | For the Three Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Total segment loss from operations | $ | (6,473,489 | ) | $ | (8,621,479 | ) | $ | (2,328,779 | ) | $ | (4,265,754 | ) | ||||
Change in fair value of derivatives | 9,977,675 | 13,679,250 | 10,441,700 | 10,375,875 | ||||||||||||
Debt restructuring | — | 3,420,956 | — | — | ||||||||||||
Gain on sale of asset | 499,388 | — | 499,388 | — | ||||||||||||
Interest expense | (12,301,995 | ) | (6,433,148 | ) | (6,305,142 | ) | (3,449,314 | ) | ||||||||
Interest income | 899,434 | 196,243 | 439,261 | 129,924 | ||||||||||||
Other, net | (66,136 | ) | (4,260 | ) | (80,276 | ) | 23,406 | |||||||||
Loss before income taxes | $ | (7,465,123 | ) | $ | 2,237,562 | $ | 2,666,152 | $ | 2,814,137 |
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
15. | Supplemental Cash Flow Information |
For the Six Months Ended | ||||||||
September 30, | ||||||||
2005 | 2004 | |||||||
Supplemental disclosure of cash flow information: | ||||||||
Cash paid for interest | $ | 6,796,947 | $ | 2,374,223 | ||||
Non-cash operating, investing and financing activities | ||||||||
Warrants issued related to issuance of debt | — | 1,522,650 | ||||||
Assets acquired under capital leases | 528,313 | — | ||||||
Warrants exercised and converted to equity | — | 261,640 | ||||||
Conversion of debt and related accrued interest to equity | — | 262,500 | ||||||
Conversion of preferred stock to equity | — | 333 | ||||||
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 dividends | 372,489 | 486,821 | ||||||
Warrants issued for services | 25,056 | — | ||||||
Settlement of notes receivable — related party by tendering Terremark stock | — | 5,000,000 | ||||||
Net assets acquired in exchange for common stock | 10,755,200 | — |
16. | Subsequent Event |
On November 7, 2005, the Company paid in full a bank loan with an outstanding balance of $4.2 million at September 30, 2005.
Item 4. | Controls and Procedures. |
(a) | Evaluation of Disclosure Controls and Procedures |
Our Chief Executive Officer and our 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, this assessment as of September 30, 2005, our Chief Executive Officer and our 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.
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
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
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.
(b) | Internal Control Over Financial Reporting |
In connection with the assessment of our internal control 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 control over financial reporting. A material weakness is a control deficiency, or combination of control deficiencies, that results in a more than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. These material weaknesses related to (i) maintaining adequate controls to restrict access to key financial applications and data, and controls over custody and processing of disbursements and of customer payments received by mail; and (ii) controls over the billing function to ensure invoices capture all services delivered to customers and that such services are invoiced and recorded accurately as revenue.
As discussed in Note 2 to the condensed consolidated financial statements of this Form 10-Q/A, we restated the September 30, 2004 previously issued financial statements to correct the disclosure of diluted earnings per share. In connection with this restatement, management determined that another material weakness existed as of 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 June 30, 2004, 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 financial statements that would not be prevented or detected. Accordingly, management determined that this control deficiency constitutes a material weakness.
In response to the material weaknesses identified, we implemented the following remediation actions:
• | We have restricted access to key financial information systems and data, particularly for employees with purchase order approval and check signing authority. | |
• | We have segregated the custody of payments received by mail from the processing of customer payments and from reconciliation of bank accounts. |
We have not fully remediated the previously described material weaknesses as we are still in the process of implementing the following remediation actions:
• | We are in the process of upgrading our main financial information system to be able to effectively monitor activities of database and system administrators. | |
• | We have set up a lockbox with our bank and are currently directing our customers to mail payments directly to the lockbox. | |
• | We are in the process of integrating our customer contract and billing data in one database. We continue to work with an information technology consultant to assist us with this integration. Concurrently, we are also in the process of establishing the procedures for an independent review of our invoices to customers. |
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
• | 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 for the remediation 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.
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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 |
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Signature Page
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 November, 2005.
TERREMARK WORLDWIDE, INC. |
By: | /s/ MANUEL D. MEDINA |
Manuel D. Medina | |
Chairman of the Board, | |
President and Chief Executive Officer | |
(Principal Executive Officer) | |
TERREMARK WORLDWIDE, INC. |
By: | /s/ JOSE A. SEGRERA |
Jose A. Segrera | |
Executive Vice President and | |
Chief Financial Officer | |
(Principal Accounting Officer) |
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Signature Page
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this amendment 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) | |
TERREMARK WORLDWIDE, INC. |
By: | /s/ JOSE A. SEGRERA |
Jose A. Segrera | |
Executive Vice President and | |
Chief Financial Officer | |
(Principal Accounting Officer) |
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