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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington,WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
xANNUAL REPORT
PURSUANT TO SECTIONSSECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 19341934.
For the fiscal year ended December 31, 20032005
OR
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: 1-31227number 1–31227
COGENT COMMUNICATIONS GROUP, INC.
(Exact nameName of Registrant as Specified in Its Charter)
Delaware |
| |
(State or Other Jurisdiction of | (I.R.S. Employer | |
Incorporation or Organization) | Identification No.) | |
1015 31st Street N.W. | ||
Washington, D.C. | 20007 | |
(Address of Principal Executive Offices) | (Zip Code) |
1015 31st Street N.W.Washington, D.C. 20007(Address of principal executive offices)
(202) 295-4200
Registrant’s Telephone Number, Including Area Code
(Registrant's telephone number, including area code)
Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value $0.001 per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No x
Indicate by check mark whether the registrantregistrant: (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 ýx No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant'sregistrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ox
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Securities Exchange Act. (Check one)
Large accelerated filer o Accelerated filer x Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ýx
AsThe number of June 30, 2003, 3,483,838 shares outstanding of the registrant'sissuer’s common stock, par value $0.001 per share, were outstanding. Asas of that date, theMarch 6, 2006 was 44,092,605.
The aggregate market value of the common stockCommon Stock held by non-affiliates of the registrant, was $7,664,444 based on athe closing price of $2.20$7.88 per share on March 6, 2006 as reported by the American Stock Exchange on such date. Directors, executive officers and 10% or greater shareholders are considered affiliates for purposes of this calculation but should not necessarily be deemed affiliates for any other purpose.NASDAQ National Market was approximately $146.6 million.
On March 19, 2004, the Company had 13,952,855 shares of common stock outstanding.DOCUMENTS INCORPORATED BY REFERENCE
Documents Incorporated by Reference
Portions of our Information Statementthe registrant’s definitive proxy statement for the 2004 Annual Meeting of Stockholders to be filed within 120 days after December 31, 2003registrant’s 2006 annual shareholders meeting are incorporated herein by reference in response to Part III Items 10 through 14, inclusive.of this Form 10-K.
COGENT COMMUNICATIONS GROUP, INC.
FORM 10-K ANNUAL REPORT
FOR THE YEAR ENDED DECEMBER 31, 2003
2005
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report may contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are not statements of historical facts, but rather reflect our current expectations concerning future results and events. You can identify these forward-looking statements by our use of words such as "anticipates," "believes," "continues," "expects," "intends," "likely," "may," "opportunity," "plans," "potential," "project," "will,"“anticipates,” “believes,” “continues,” “expects,” “intends,” “likely,” “may,” “opportunity,” “plans,” “potential,” “project,” “will,” and similar expressions to identify forward-looking statements, whether in the negative or the affirmative. We cannot guarantee that we actually will achieve these plans, intentions or expectations. These forward-looking statements are subject to risks, uncertainties and other factors, some of which are beyond our control, which could cause actual results to differ materially from those forecast or anticipated in such forward-looking statements.
You should not place undue reliance on these forward-looking statements, which reflect our view only as of the date of this report. We undertake no obligation to update these statements or publicly release the result of any revisions to these statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.
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We provideare a leading facilities-based provider of low-cost, high-speed Internet access and Internet Protocol, or IP, communications services. Our network is specifically designed and optimized to transmit data using IP. We deliver our services to small and medium-sized businesses, communications service providers and other telecommunicationsbandwidth-intensive organizations through approximately 10,000 customer connections in North America and Europe.
Our primary on-net service is Internet access at a speed of 100 Megabits per second, much faster than typical Internet access currently offered to businesses. We offer this on-net service exclusively through our own facilities, which run all the way to our customers’ premises. Because of our integrated network architecture, we are not dependent on local telephone companies to serve our on-net customers. Our typical customers in multi-tenant office buildings are law firms, financial services firms, advertising and marketing firms and other professional services businesses. We also provide on-net Internet access at a speed of one Gigabit per second and greater to certain bandwidth-intensive users such as universities, other ISPs and commercial content providers. TheseFor the years ended December 31, 2005, 2004 and 2003 our on-net customers generated 57.9%, 63.5% and 55.5%, respectively, of our total net service revenue.
In addition to providing our on-net services, we also provide Internet connectivity to customers that are not located in buildings directly connected to Cogent's fiber opticour network. Services are provided inWe serve these locationsoff-net customers using other carriers’ facilities to provide the “last mile” portion of the link from our customers’ premises to our network. For the years ended December 31, 2005, 2004 and 2003, our off-net customers utilizing Ethernet interfaces. We call thesegenerated 33.0%, 24.4% and 26.4%, respectively, of our total net service revenue.
Non-core services are those services we acquired and continue to support but do not actively sell. For the years ended December 31, 2005, 2004 and 2003 non-core services generated 9.1%, 12.1% and 18.0%, respectively, of our "on-net" services. total net service revenue.
We also offer services to customers utilizing leased circuits providing more traditional Internet access speeds of T1, E1, E3, and T3. We call these services our "off-net" services. The discussion below includes information on our French and Spanish and related European operations. However, because our French and Spanish operations were acquired in January 2004, the financial statements and other financial information included in this annual report reflect the results of operation of only our U.S. and Canadian operations.
In the buildings in which we offer our on-net services, we typically place a rack of equipment allowing us to terminate our optical signal from the metropolitan network and provide interconnection to our end customers either through cross connects within carrier-neutral facilities or riser facilities that we own, operate and terminate in our customer's suite.
We also provide high speed Internet access and rack co-location in approximately 2728 data centers in the United States and Europe.
In the United States and Canada, our network is linked to approximately 860 buildings in more than 20 metropolitan markets. In these markets, our network is constructed of dark fiber that we control pursuant to long-term supply agreements. This dark fiber connects at hubs (or central office locations) that we have constructed in each key market. Within these hub facilities, we deploy our metropolitan optical equipment, our core routing technology and a physical interconnection to our intercity long haul fiber-optic network. In Europe our network links approximately 39 markets, primarily in France and Spain, in which we have 42 on-net buildings.
Our intercity network is comprised of approximately 12,500 route-miles and 25,000 fiber-miles incomprising over 290,000 square feet throughout North America and approximately 10,000 route-kilometers and 20,000 fiber-kilometers in France and Spain. Our North American and European networks are interconnected via two leased high capacity STM-16 circuits. We interconnect our network at approximately 30 locations worldwide with over 400 other Internet service providers providing for our internetworking capacity. Our network has been optimized for transmission using Internet Protocol, or "IP". Our network has been designedEurope that allow customers to offer these services at speeds that we believe have not been generally and commercially available to our competitors. In addition to the core services described above, we also support a number of non-core products. These products include email, shared web hosting, managed web hosting, and dial up Internet access. We continue to support these products as customer contracts require.
Our network incorporates assets that we have purchased and deployed in connection with the nine major corporate acquisitions we have completed. Our acquisition strategy has focused on targets that employ technology that is complementary to the technology that we have deployed. The networkco-locate their equipment and infrastructure we acquired in these transactions have generally been re-deployed in an architecture meetingaccess our network design criteria.network.
Recent DevelopmentsCompetitive Advantages
Resolution of Default Under Cisco Credit Facility and Sale of Series F and Series G Preferred Stock. Prior to July 31, 2003 we were party to a $409 million credit facility with Cisco Systems Capital Corporation ("Cisco Capital"). The credit facility required compliance with certain financial and operational covenants. We were in violation of a financial covenant as of December 31, 2002 and as a
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result Cisco Capital could have declared a default and accelerated the due date of our indebtedness. These developments are discussed in greater detail below under Management's Discussion and Analysis of Financial Condition and Results of Operations "Liquidity and Capital Resources".
On June 12, 2003, our Board of Directors unanimously adopted a resolution authorizing us to consummate a transaction with Cisco Capital and Cisco Systems, Inc. ("Cisco") that would restructure our indebtedness to Cisco Capital as well as to offer and sell a new series of preferred stock to certain of our existing stockholders in order to acquire the cash needed to complete the restructuring. On June 26, 2003, our stockholders approved these transactions.
In order to complete the restructuring we entered into an agreement (the "Exchange Agreement") with Cisco and Cisco Capital pursuant to which, among other things, Cisco and Cisco Capital agreed to cancel the principal amount of indebtedness plus accrued interest and return warrants exercisable for the purchase of 0.8 million shares of our common stock (the "Cisco Warrants") in exchange for our cash payment of $20.0 million, the issuance of 11,000 shares of our Series F participating convertible preferred stock, and the issuance of an amended and restated promissory note for the aggregate principal amount of $17.0 million. Immediately prior to the closing of the restructuring on July 31, 2003, we were indebted to Cisco Capital for a total of $269.1 million ($262.8 million of principal and $6.3 million of accrued interest).
In order to complete the restructuring we also entered into an agreement (the "Purchase Agreement") with certain of our existing preferred stockholders (the "Investors"), pursuant to which we agreed to issue and sell to the Investors in several sub-series 41,030 shares of our Series G participating convertible preferred stock for $41.0 million in cash.
On July 31, 2003, we closed the transactions contemplated by the Exchange Agreement and the Purchase Agreement.
On January 5, 2004 we acquired Firstmark Communications Participations S.a.r.l. the parent company of LambdaNet Communications France SAS and LambdaNet Communications Espana SA (together, "LambdaNet France and Spain") by merging a subsidiary of ours with a company that had acquired them from LNG Holdings SA in a related transaction. In consideration of the merger, we issued approximately 2,575 shares of Series I preferred stock to the owners of the company that had acquired LambdaNet France and Spain. This transaction is described in greater detail in Note 14 to our financial statements.
After the closing of that merger, we attempted to acquire LambdaNet Communications Deutschland, AG ("LNCD"), a sister company of LambdaNet France and Spain, but were unable to reach agreement with LNCD's bank creditors. LNCD filed for insolvency in Germany on February 12, 2004. LambdaNet France and Spain have made use of LNCD's facilities to complete communications circuits into Germany and also have depended on LNCD for network operations support, billing and other services. We have begun the process of fully separating the operations of LambdaNet France and Spain from LNCD but that is not complete and there may be disruptions as this process proceeds.
We have entered into an agreement to acquire another German network and may acquire additional European networks.
Our Solutions
We believe that our network solutions effectivelywe address many of the unmetIP data communications needs of small-small and medium-sized business customersbusinesses, communications service providers and other telecommunications service providersbandwidth-intensive organizations by offering them quality, performance,high-quality Internet service at attractive pricing and service. These solutions consistprices.
Low Cost of our high-speed on-net Internet access service, our more traditional off-net Internet access service offered under the PSINet brand name, and our co-location services.
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Operation. We believe our solution differentiates us from our competitors due to the following factors:
Attractive price and performance:offer a streamlined set of products on an integrated network that operates on a single protocol. Our network architecturedesign allows us to offer on-netavoid many of the costs associated with circuit-switched networks related to provisioning, monitoring and maintaining multiple transport protocols. Our low cost of operation gives us greater pricing flexibility and an advantage in a competitive environment characterized by falling Internet access to our customers in Cogent-served buildings at attractive prices. Our service provides customers with substantially more bandwidth at a lower cost than traditional high-speed Internet access.
Reliable service:Independent Network. We believe our network provides reliability at all levels through the use of highly reliable optical technology. We use a ring structure in the majority of our network that enables us to route customer traffic simultaneously in both directions around the network rings both at the metropolitan and national levels. The availability of two data transmission paths around each ring acts as a backup that minimizes loss of service in the event of equipment failure or damage.
Direct customer interface:Our high-speed on-net Internet access service does not rely on existing local infrastructure controlled by the local incumbent telephone companies. We provide the entire network, including the last mile and the in-building wiring to the customer’s suite. This gives us more control over our servicesservice, quality and pricing and allows us to provision services more quickly and efficiently. We are typically able to activate customer services in one of our on-net buildings in fewer than twelve days.
High Quality, Reliable Service. We are able to offer high-quality Internet service due to our network, which was designed solely to transmit IP data, and dedicated intra-city bandwidth for each customer. This
design increases the speed and throughput of our network and reduces boththe number of data packets dropped during transmission. During 2005, our costsnetwork averaged 99.99% customer connection availability.
Low Capital Cost to Grow Our Business. We have incurred relatively minimal indebtedness in growing our business because of our network design of using Internet routers without additional legacy equipment and our strategy of acquiring optical fiber from the amountexcess capacity in existing networks.
Experienced Management Team. Our senior management team is composed of time that it takesseasoned executives with extensive expertise in the telecommunications industry as well as knowledge of the markets in which we operate. The members of our senior management team have an average of 20 years of experience in the telecommunications industry. Our senior management team has designed and built our network and led the integration of our network assets, customers and service offerings we acquired through 13 acquisitions.
Convergence. There is a clear industry and market trend for legacy products (e.g., TDM voice, Private Line, Frame Relay, and Asynchronous Transfer Mode) to connectconverge on IP. Many of our competitors will have to migrate their existing customers and products to IP. This migration can be costly, lengthy, and risky. We do not face this challenge because our network and products are IP.
We intend to become the leading provider of high quality Internet access and IP communications services and to improve our profitability and cash flow. The principal elements of our strategy include:
Focus on Providing Low-Cost, High-Speed Internet Access and IP Connectivity. We intend to further load our high-capacity network to respond to the growing demand for high-speed Internet service generated by bandwidth-intensive applications such as streaming media, online gaming, voice over IP (VOIP), remote data storage, distributed computing and virtual private networks. We intend to do so by continuing to offer our high-speed and high capacity services at competitive prices.
Pursuing On-Net Customer Growth. We intend to increase usage of our network and operational infrastructure by adding customers in our existing on-net buildings, as well as adding buildings to our network.
Deployment of cost effectiveSelectively Pursuing Acquisition Opportunities. In addition to adding customers through our sales and flexible technology: Because Ethernet is the lowest cost interface available for data connectivity, the 100 Mbps and 1 Gbps Cogent on-net Internet access services can be deployed at comparatively lower incremental cost than other available technologies. We believemarketing efforts, we will continue to seek out acquisition opportunities that our network infrastructure also provides us with a competitive advantage over operators of existing networks because such networks need to be upgraded to provide similar interactive bandwidth-intensive services.
Internet Access and Co-Location Services
Our acquisition of assets of PSINet and Fiber Network Solutions, Inc. and our acquisitions of LambdaNet France and Spain have allowed us to expand bothincrease our customer base, allowing us to take advantage of the unused capacity of our network and add revenues with minimal incremental costs. We may also make additional acquisitions to add network assets at attractive prices.
Our network is comprised of in-building riser facilities, metropolitan optical networks, metropolitan traffic aggregation points and inter-city transport facilities. We deliver a high level of technical performance because our product line. Following each acquisition, wenetwork is optimized for IP traffic. Our network is more reliable and delivers IP traffic at lower cost than networks built as overlays to traditional circuit-switched telephone networks.
Our network serves 95 metropolitan markets in North America and Europe and encompasses:
· over 800 multi-tenant office buildings strategically located in commercial business districts;
· over 220 carrier-neutral Internet aggregation facilities, data centers and single-tenant buildings;
· over 195 intra-city networks consisting of over 9,300 fiber miles;
· an inter-city network of more than 22,500 fiber route miles; and
· multiple leased high-capacity transatlantic circuits connecting the North American and European portions of our network.
We have migrated customerscreated our network by acquiring optical fiber from carriers with large amounts of unused fiber and directly connecting Internet routers to the existing optical fiber national backbone. We have expanded our network through key acquisitions of financially distressed companies or their assets at a significant discount to their original cost. Due to our network design and have usedacquisition strategy, we believe we are positioned to grow our revenue and increase profitability with limited incremental capital expenditures. We expect our future capital expenditure rates to be similar to the facilities thatrate we acquired to provide additional services to a broader market. In the U.S. we primarily offer our customers three types of fixed-price off-net Internet access products under the PSINet brand, namely, T1, T3 and OC3. In Canada these services are offered under the Cogent brand. These products are offeredexperienced in buildings that are typically within a ten-mile radius of a Cogent POP and are not currently targeted for our high-speed on-net Internet access service. We also provide co-location services in the data centers we acquired.2005.
Our NetworkInter-city Networks
Intercity
Our network consists of both Cogent-operated on-net facilities and off-net leased circuits, depending upon which service is being utilized. Customers of Cogent on-net Internet access service are served solely on Cogent-operated facilities. The North American inter-city backbone portion of the Cogentour inter-city network consists of two strands of optical fiber that we have acquired from WilTel Communications and 360networks under pre-paid indefeasible rights of use ("IRUs")(now owned by Level3). The WilTel fiber route is approximately 12,500 miles in length and runs through all of the metropolitan areas that we serve with the exception of Toronto, Ontario. We have the right to use the WilTel fiber for 20 yearsthrough 2020 and may extend the term for two five-year periods without additional payment. To serve the Toronto market, our Canadian affiliate, Fiber Services of Canada, Inc, and Cogent leasedwe lease two strands of optical fiber under pre-paid IRUs from affiliates of 360networks. This fiber runs from Buffalo, New York to our hubsite in Toronto. The 360networks IRUs run for 20 years, after which title to the fiber is to be transferred to Cogent and Fiber Services of Canada. Service in Toronto is offered through our subsidiary, Shared Technologies of Canada, Inc. While the IRUs are pre-paid, we pay WilTel and affiliates of 360networks to maintain their respective fibers during the period of the IRUs. We own and maintain the electronic equipment that transmits data through the fiber.
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IntracityIn Europe our inter-city network has been acquired from multiple providers. This network is approximately 10,000 route miles in length. The longest segment of this network is provided by Neuf Telecom and Telia and runs 5,400 route miles through France, the United Kingdom, Belgium, the Netherlands and Switzerland. We have the right to use the Neuf Telecom fiber pursuant to an IRU that expires in 2020. Various other carriers have provided us with optical fiber routes pursuant to IRUs that expire at various times between 2010 and 2020. As in North America we pay the providers of our optical fiber routes to maintain the fiber. We own and are responsible for the maintenance of the electronic equipment that transmits data through the fiber.
Intra-city Networks
In each North American metropolitan area in which we provide Cogent high-speed on-net Internet access service, theour backbone network is connected to a Cisco Systems router that provides a connectionconnected to one or more of our metropolitan optical networks. We create our intra-city networks through IRUs of optical fiber from carriers with large amounts of unused capacity. These metropolitan networks also consist of optical fiber that runs from the backbonecentral router in a market into buildings that we serve.routers located in on-net buildings. The on-net metropolitan fiber in most cases runs in a ring. The ring architecture, which provides redundancy so that if the fiber is cut, data can still be transmitted to the backbonecentral router by directing traffic in the opposite direction around the ring. Each on-net building is served by a Cisco router that is connected to the metropolitan fiber. The router in the building provides thea connection to each customer in the building. In addition to connecting customers to our network, the metropolitanon-net customer.
The European intra-city networks are used to connect our network to the networks of other Internet service providers.
Inside our on-net buildings, we install and manage a broadband data infrastructure that typically runs from the basement of the building to the customer location using the building's vertical utility shaft. Service for customers is initiated by connecting a fiber optic cable from a customer's local area network to the infrastructure in the vertical utility shaft. The customer then has dedicated and secure access to our network using Ethernet connections.
The off-net Internet access service use essentially the same architecture as in North America, with fiber rings connecting routers in each on-net building we offer is provided over both facilities thatserve to a central router. While these intra-city networks were originally built as legacy networks providing point-to-point services, we operate and leased facilities. The backbone for this service primarily consists ofare using excess capacity on these networks to implement our backbone, but for those cities not connected to the network we operate, the backbone partly consists of leased inter-city connections linking those cities to cities where we operate our own facilities. These leased inter-city connections are of varying capacities depending upon the needs of the market such connections serve.IP network.
Within the North American cities where we offer off-net Internet access service, we lease circuits, (typically T-1 lines)typically T1 lines, from telecommunications carriers, (primarilyprimarily local telephone companies)companies, to provide the "last-mile"last mile connection to the customer's premises off-net.customer’s premises. Typically, these circuits are aggregated at various locations in those cities onto higher-capacity leased circuits that ultimately connect the local aggregation route to our network backbone.
We are in the process of upgrading our network in France and Spain to conform to the architecturenetwork. In Europe, we have deployed in North America. When we acquired Lambdanet France and Spain their facilities were optimized to provide point-to-point connectivity for customers in their markets. With the deployment of additional equipment we already own, or may purchase, these networks will be better able to support our high speed Internet access services, including on-net service using Ethernet connections and off-net service provided over E-1 and E-3 connections.
Our Strategy
We intend to become a leading provider of high-capacity on-net and off-net broadband access to customers in large multi-tenanted office buildings in commercial business districts of the largest markets in the United States, as well as in the international markets we serve, and to leverage the fully-lit backbone we operate to offer traditional Internet access service in those markets and elsewhere. To achieve this objective, we intend to:
Focus on the most attractive markets and customers: We intend to build our customer base rapidly in our target markets. For our on-net Internet access service, we target buildings that have high-tenant count in dense commercial areas. We believe this approach will accelerate the return on our investments. The value of our network, and its ability to function both as a LAN-to-Internet and as a LAN-to-LAN network, is enhanced by the number of cities and customers connected to our network. However, we must select markets in which network construction cost and customer acquisition costs provide for an attractive return based upon our product offering and pricing. Our on-net solution will not be available to all potential customers in the markets we are targeting but rather will be offered on
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a selected basis. For our off-net Internet access service through leased E1and E3 lines.
In-Building Networks
We connect our routers to a cable containing 12 to 288 optical fiber strands that typically run from the basement of the building through the building riser to the customer location. Service for customers is initiated by connecting a fiber optic cable from a customer’s local area network to the infrastructure in the building riser. The customer then has dedicated and secure access to our network using an Ethernet connection. Ethernet is the lowest cost network connection technology and is used almost universally for the local area networks that businesses operate.
Internetworking
The Internet is an aggregation of interconnected networks. We interconnect our network with most major and hundreds of minor Internet Service Providers, or ISPs, at approximately 40 locations. We interconnect our network through public and private peering arrangements. Public peering is the means by which ISPs have traditionally connected to each other at central, public facilities. Larger ISPs also exchange traffic and interconnect their networks by means of direct private connections referred to as private peering.
Peering agreements between ISPs are necessary in order for them to exchange traffic. Without peering agreements, each ISP would have to buy Internet access from every other ISP in order for its customer’s traffic, such as email, to reach and be received from customers of other ISPs. We are considered a Tier 1 ISP and, as a result, have settlement-free peering arrangements with most other providers. This allows us to exchange traffic with those ISPs without payment by either party. In such arrangements, each party exchanging traffic bears its own cost of delivering traffic to the point at which it is handed off to the other party. We also engage in public peering arrangements in which each party also pays a fee to the owner of routing equipment that operates as the central exchange for all the participants. We do not treat our settlement-free peering arrangements as generating revenue or expense related to the traffic exchanged. Where we do not have a public or private settlement-free peering connection with an ISP, we exchange traffic through an intermediary, whereby such intermediary receives payment from us. Approximately 4% of our traffic is handled this way.
A few ISPs have begun challenging the traditional peering model—in which carriers exchange traffic without payment. These ISPs want ISPs like us that send more traffic to them than they send to us, to make some payment for the peering connection. Two such ISPs temporarily ceased peering with us during the year. This caused a disruption to the exchange of traffic between the networks involved and customers on both networks were affected until the connection was re-established pursuant to an agreement between us and the ISP involved or by our use of another ISPs facilities.
AT&T and Verizon have started a debate over what is called “net neutrality”. These ISPs have suggested that providers of content, such as Google, video delivery services, and others that deliver substantial traffic to customers, should make a payment to the ISPs that deliver that content to end users. This would be in addition to the amounts already paid by the end users to their ISPs for a connection to the Internet. No ISP has yet put such a plan into effect. We are unsure how this would affect our business.
Network Management and Control
Our primary network operations centers are located in Washington, D.C and Madrid, Spain. These facilities provide continuous operational support in both North America and Europe. Our network operations centers are designed to immediately respond to any problems in our network. To ensure the quick replacement of faulty equipment in the intra-city and long-haul networks, we have deployed field engineers across North America and Europe. In addition, we have maintenance contracts with numerous telecommunications providers allowing us to order last-mile connections at favorable rates. We can quickly determine if a customer can be served by usthird party vendors that specialize in a cost-effective manner,optical and by owning our own backbone, we believe we can handle increased volumes of Internet traffic with very little added cost.routed networks.
Maintain a simple pricing model:We offer our services at prices that are competitive with traditional Internet service providers. Pricing for T1high-speed Internet access today is comprised of two components: (1) the local loop, which is purchased generally from the incumbent local exchange carrier (ILEC), or a competitive local exchange carrier (CLEC), and (2) the Internet port connection, which is typically provided by the Internet service provider. Our on-net 100 megabits per second service is substantially faster than typical services offered by existing cable and telecommunications operators. We offer our 100 Mbps on-net service at flat rate prices.
TargetIP connectivity to small and medium-sized businesses, communications providers and other bandwidth-intensive organizations located in North America and Europe.
The table below shows our primary service offerings:
On - Net Services | Bandwidth (Mbps) | ||||||
Fiber500 | 0.5 | ||||||
Two Meg | 2.0 | ||||||
Fast Ethernet | 100 | ||||||
Gigabit Ethernet | 1,000 and up | ||||||
Co-location with Internet Access | 2 to 1,000 | ||||||
Point-to-Point | 1.5 to 10,000 | ||||||
Off-Net Services | |||||||
T1 or E1 | 1.5 or 2.0 | ||||||
T3 or E3 | 45 or 34 | ||||||
We offer on-net services in 84 metropolitan markets, including 36 North American markets in which we have metropolitan fiber rings allowing us to connect multiple buildings to our network. We serve over 1,000 buildings of which more than 900 are located in North America with directthe remainder located in Europe. Our most popular on-net service in North America is our Fast Ethernet service, which provides Internet access at 100 megabits per second. We typically offer our Fast Ethernet (Internet access) service at $1,000 a month to our small and medium-sized business customers. We also offer Internet access services at higher speeds of 1 gigabit per second and above. These services are generally used by customers that have businesses, such as web hosting, that are Internet based and are generally delivered at data centers and carrier hotels. We believe that, on a per-Megabit basis, this service offering is one of the lowest priced in the marketplace. We also offer colocation services in 28 locations in North America and Europe. This on-net service offers Internet access combined with rack space and power in a Cogent facility, allowing the customer to locate a server or other equipment at that location and connect to our Internet service. Our final on-net service offering is our “Point-to-Point” or “Layer 2” service. These point-to-point connections span North America and Europe and allow customers to connect geographically dispersed local area networks in a seamless manner. We emphasize the sale of on-net services because sales channel: Forof these services generate higher gross profit margins.
We offer off-net services to customers not located in our on-net buildings. These services are provided in the metropolitan markets in North America and Europe in which we offer on-net services and in approximately 10 additional markets. These services are generally provided to small and medium-sized businesses. A significant amount of our off-net revenues were acquired revenues, which churn at a greater rate than our on-net revenues. As a result, we expect the revenue from these off-net services to continue to decline. We expect the growth of our on-net Internet services to compensate for this loss.
We support a number of non-core services assumed with certain of our acquisitions. These services include our managed modem service, email service, dial-up Internet, shared web hosting and voice services in Toronto, Canada, managed web hosting, managed security and legacy point-to-point services. Our managed modem service is offered to larger businesses and other Internet service providers that serve individuals that dial in to the Internet. The business or ISP is our customer for this service. Individuals make use of the dial-in access through arrangements with the business or ISP. We expect the revenue from these non-core services to decline. We expect the growth of our on-net Internet services to compensate for this loss.
Sales. We employ a relationship-based sales and marketing approach. As of March 1, 2006, our sales force included 125 full-time employees focused solely on acquiring and retaining customers. Of these, 97 have individual quota responsibility. The 75 members of our outside direct sales force are each assigned a specific market or territory, based on customer type and geographic location. The 19 members of our inside sales force and the 3 members of our customer retention team operate from our outbound sales center in Herndon, Virginia and sell nationally. Our outside direct sales personnel work through direct face-to-face contact with potential customers in, or intending to locate in, on-net buildings. Through agreements with building owners, we are able to initiate and maintain personal contact with our customers by staging various promotional and social events in our on-net buildings. Direct sales personnel are compensated with a base salary plus quota-based commissions and incentives. We use a customer relationship management system to efficiently track activity levels and sales productivity.
Agent Program. In the fall of 2004, we launched an agent program as an alternate channel to distribute our products and services. The agent program consists of value-added resellers, IT consultants, and smaller telecom agents, who are managed by our direct sales personnel, and larger national or regional companies whose primary business is to sell telecommunications, data, and Internet services. The agent program includes over 60 agents.
Marketing. Because of our focus on a direct sales force, comprised of individuals whowe have not spent funds on television, radio or print advertising. Our marketing efforts are geographically dispersed throughout mostdesigned to drive awareness of our targeted markets. This retail sales effort is supported by an active program ofproducts and services, identify qualified leads through various direct mail marketing. Our off-net Internet access service is primarily marketed through a telesalesmarketing campaigns and provide our sales force based in Herndon, Virginia.
Our newly-acquired Frenchwith product brochures, collateral materials and Spanish subsidiaries have inrelevant sales tools to improve the pastoverall effectiveness of our sales organization. In addition, we conduct public relations efforts focused on larger customerscultivating industry analyst and on point-to-point circuits. We are inmedia relationships with the processgoal of developingsecuring media coverage and public recognition of our Internet communications services. Our marketing organization is responsible for our product strategy and direction based upon primary and secondary market research and the Internet access componentadvancement of their operations and sales activites.
Our Competitorsnew technologies.
We face competition from incumbent carriers, Internet service providers and facilities-based network operators, many established competitors withof whom are much bigger than us, have significantly greater financial resources, well-establishedbetter-established brand names and large, existing installed customer bases in the markets in which we compete. We also face competition from more recentother new entrants to the communications services market. Many of these companies offer products and services that are similar to our products and services, and we expect the level of competition to intensify in the future. Unlike some of our competitors, we do not have title to most of the dark fiber that makes up our network. Our interests in that dark fiber are in the form of long-term leases or IRUs obtained from their titleholders. We rely on the maintenance of such dark fiber to provide our on-net services to customers. We are also dependent on third-party providers, some of whom are our competitors, for the provision of lines to our off-net customers.
We believe that competition is based on many factors, including price, transmission speed, ease of access and use, breadth of service availability, reliability of service, customer support and brand recognition.
Incumbent Carriers. In each market we serve, we face, and expect to continue to face, significant competition from the incumbent carriers, which currently dominate the local telecommunications markets. In the United States and Canada, these typically are the local telephone companies, as described below. In Europe, these typically are the incumbent national telephone companies, such as Deutsche Telecom, KPN, France Telecom, British Telecom, Telia Sonnera and Telefonica. We compete with the incumbent carriers on the basis of product offerings, quality, capacity and reliability of network facilities, state-of-the-art technology, price, route diversity, ease of ordering and customer service. However, the incumbent carriers have long-standing relationships with their customers and typically offer those customers with various transmission and switching services that we do not currently offer. Because our fiber optic networks have been recently installed compared to those of the incumbent carriers, our state-of-the-art technology may provide us with cost, capacity, and service quality advantages over some existing incumbent carrier networks; however, our network may not support some of the breadth of productsservices supported by these legacy networks.
In-Building Competitors. Some competitors,networks, such as Cypress Communications, XO Communications, Yipes, Time Warner Telecom, Group Telecom, IntelliSpace, Eureka GGN Networks have gained access to office buildings in our markets. To the extent these competitors are successful, we may face difficulties in marketing our services within some buildings in our target markets. Our agreements to use utility shaft space (riser facilities) within buildings are generally not exclusive. Certain competitors already have rights to install networks in some of the buildings in which we have
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rights to install our networks. It is not clear whether it will be profitable for two or more different companies to operate networks within the same building. Where a competitor has a network in the same building, there is substantial price competition.
Local Telephone Companies. Incumbent local telephone companies, including companies such as Verizon, SBC, Qwest, BellSouth, Bell Canada, British Telecom, and France Telecom, have several competitive strengths that may place us at a competitive disadvantage. These strengths include an established brand name and reputation and significant capital that allows them to rapidly deploy or leverage existing communications equipment and broadband networks. Competitive local telephone companies often market their services to tenants of buildings within our target markets and selectively construct in-building facilities. In addition, incumbent local telephone companies historically have not been required to compensate building owners for access and distribution rights within a targeted building, as we typically have had to do.
Long Distance Companies. Many of the leading long distance companies, such as AT&T, MCI, Telus, Allstream and Sprint, could begin to build their own in-buildingcircuit-switched voice and data networks. The newer national long distance carriers, such as Qwest, Level 3, WilTel and Corvis (through its acquisition of Broadwing) have built and manage high speed fiber-based national voice and data networks, partnering with Internet service providers, and have extended their networks by installing in-building facilities and equipment.
Competitive Local Telephone Companies. Competitive local telephone companies often have broadband inter-building connections, market their services to tenants of large and medium-sized buildings, and selectively build in-building facilities, all of which competes against us.
Fixed Wireless Service Providers. Fixed wireless service providers, such as XO Communications, First Avenue Networks, AT&T, Telus, Sprint, Teligent and IDT (through its acquisition of Winstar Communications), provide high-speed communications services to customers using microwave or other facilities or satellite earth stations on building rooftops, and some of them are exploring the use of various forms of Wi-Fi technology to fill in service gaps. To the extent they are successful in providing service to a Cogent-served building, we compete with them for customers within that building.
Internet Service Providers. Internet service providers, such as AT&T WorldNet, EarthLink, SBC's Prodigy, the UUNET subsidiary of MCI, Level 3, Global Crossing, Tiscali, Sprint and Verio, provide traditional and high speed Internet access to residential and business customers, generally using the existing communications infrastructure. Digital subscriber line companies and/or their Internet service provider customers, such as MCI, AT&T, SBC, Verizon and Covad, typically provide broadband Internet access using digital subscriber line technology, which enables data traffic to be transmitted over standard copper telephone lines at much higher speeds than these lines would normally allow. Providers, such as America Online, Microsoft Network and Earthlink, generally target the residential market and provide Internet connectivity, ease-of-use and a stable environment for dialup modem connections.frame relay. While the Internet access speeds offered by these providerstraditional ISPs typically doesdo not match the Cogentour on-net offerings, these slower services are usually are priced lower than Cogent'sour offerings and thus provide competitive pressure on pricing, particularly for more price-sensitive customers. Additionally, some of our competitors have recently emerged from bankruptcy. Because the bankruptcy process allows for the discharge of debts and rejection
of certain obligations, we may have less of an advantage with respect to these competitors. These and other downward pricing pressures have diminished, and may further diminish, the competitive advantages that we have enjoyed as the result of our service pricing.
Cable-Based Service Providers. Cable-based service providers, such as Roadrunner, Comcast, Cox, Rogers, Shaw, AOL Time Warner and Charter Communications use cable television distribution systems to provide high-speed Internet access. Where they connect to our targeted buildings, they compete with us for customers. Where they connect to our targeted buildings, they compete with us for customers.
Other High-Speed Internet Service Providers. We may also lose potential customers to other high-speed Internet service. These providers, such as Yipes, XO Communications, Intellispace, Time
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Warner Telecom and OnFiber Communications, are often characterized as Ethernet metropolitan access networks. They have targeted a similar customer base and have business strategies with elements that parallel ours. The incumbent local telephone companies, including Bell South, Bell Canada, Verizon and SBC also have begun to offer similar services.
ILEC's and CLEC's. Shared Technologies of Canada, our subsidiary operating in Toronto, is also a building-centric provider of total voice solutions. Operating on a Nortel platform, it provides a complete voice service to tenants in major downtown buildings in Toronto, in addition to our broadband service. As such, Shared Technologies competes with the local and long distance carriers, and in some cases the interconnect companies, in the market for voice services. Other shared service providers such as U.S. RealTel also have made some initial preparations to enter this market.
Regulation
We are subject to numerous local regulations such as building and electrical codes, licensing requirements, and construction requirements. These regulations vary amongst the states, counties and cities in which we operate.
In the United States, the Federal Communications Commission (FCC) regulates common carriers'carriers’ interstate services and state public utilities commissions exercise jurisdiction over intrastate basic telecommunications services. TheOur Internet service offerings are not currently regulated by the FCC and mostor any state public utility commissions do not regulate Internet service providers.commission. However, as we expand our offerings we may become subject to regulation in the U.S. at the federal and state levels and in other countries. The offerings of many of our competitors and vendors, especially incumbent local telephone companies, are subject to direct federal and state regulations. These regulations change from time to time in ways that are difficult for us to predict.
There is no current legal requirement that owners or managers of commercial office buildings give access to competitive providers of telecommunications services, although the FCC does prohibit carriers from entering contracts that restrict the right of commercial multiunit property owners to permit any other common carrier to access and serve the property'sproperty’s commercial tenants.
One of our subsidiaries, Shared Technologies ofOur subsidiary, Cogent Canada, operates in Toronto, Canada. In addition to Internet service it offers voice services.and Internet services in Canada. Generally, the regulation of Internet access services and competitive voice services has been similar in Canada to that in the U.S. in that providers of such services face fewer regulatory requirements than the incumbent local telephone company. This may change. Also, the Canadian government has requirements limiting foreign ownership of certain telecommunications facilities in Canada. We are not subject to these restrictions today. We will have to comply with these regulations to the extent they change and to the extent we havebegin using facilities in a manner that are subjectsubjects us to these regulations.restrictions.
Our newly acquired European subsidiaries operate in a more highly regulated environment for the types of services they provide. In many Western European countries, a national license or a notice filed with a regulatory authority is required for the provision of data and Internet services. In addition, our subsidiaries operating in member countries of the European Union are subject to the directives and jurisdiction of the EU. EachEuropean Union. We believe that each of our subsidiaries holdshas the necessary licenses necessary to provide its services in the markets where it operates today. To the extent we expand our operations or service offerings in Europe or other new markets, we may face new regulatory obstacles to executing our plans.requirements.
There have been various statutes, regulations, and court cases relating to liability of Internet service providers and other on-line service providers for information carried on or through their services or equipment, including in the areas of copyright, indecency/obscenity, defamation, and fraud.
The laws in this arearelated to Internet telecommunications are unsettled and there may be new legislation and court decisions that may affect our services and expose us to liability.
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Employees
On December 31, 2003,As of March 1, 2006, we had 194340 employees. A union represents twenty-five of our employees in France. We believe that we have a satisfactory relationship with our employees.
We make available free of charge through our Internet website our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act. The reports are made available through a link to the SEC'sSEC’s Internet web sitewebsite at www.sec.gov.www.sec.gov. You can find these reports and request a copy of our Code of EthicsConduct on our website atwww.cogentco.comwww.cogentco.com under the "Investor Relations"“Investor Relations” link.
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If our operations do not produce positive cash flow to pay for our growth or meet our operating and financing obligations, and we are unable to otherwise raise additional capital to meet these needs, our ability to implement our business plan will be materially and adversely affected.
Until we can generate positive cash flow from our operations, we will continue to rely on our cash reserves and, potentially, additional equity and debt financings to meet our cash needs. Our future capital requirements likely will increase if we acquire or invest in additional businesses, assets, services or technologies. We may also face unforeseen capital requirements for new technology required to remain competitive or to comply with new regulatory requirements, for unforeseen maintenance of our network and facilities, and for other unanticipated expenses associated with running our business. In addition, if we do not retain existing customer or add new customers, we may be required to raise additional funds through the issuance of debt or equity. We cannot assure you that we will have access to necessary capital, nor can we assure you that any such financing will be available on terms that are acceptable to our stockholders or us. If issuing equity securities raises additional funds, substantial dilution to existing stockholders may result.
We need to retain existing customers and continue to add new customers in order to become profitable and cash flow positive.
In order to become profitable and cash flow positive, we need to both retain existing customers and continue to add a large number of new customers. The precise number of additional customers required to become profitable and cash flow positive is dependent on a number of factors, including the turnover of existing customers and the revenue mix among customers. We may not succeed in adding customers if our sales and marketing plan is unsuccessful. In addition, many of our target customers are existing businesses that are already purchasing Internet access services from one or more providers, often under a contractual commitment, and it has been our experience that such target customers are often reluctant to switch providers due to costs associated with switching providers.
We have historically incurred operating losses and these losses may continue for the foreseeable future.
Since we initiated operations in 2000, we have generated operating losses and these losses may continue for the foreseeable future. In 2003, we had an operating loss of $81.2 million, in 2004 we had an operating loss of $84.1 million and in 2005 we had an operating loss of $62.1 million. As of December 31, 2005, we had an accumulated deficit of $211.2 million. Continued losses may prevent us from pursuing our strategies for growth or may require us to seek unplanned additional capital and could cause us to be unable to meet our debt service obligations, capital expenditure requirements or working capital needs.
We are experiencing rapid growth of our business and operations and we may not be able to efficiently manage our growth.
We have rapidly grown our company through acquisitions of companies, assets and customers as well as implementation of our own network expansion and the acquisition of new customers through our own sales efforts. Our expansion places significant strains on our management, operational and financial infrastructure. Our ability to manage our growth will be particularly dependent upon our ability to:
· expand, develop and retain an effective sales force and qualified personnel;
· maintain the quality of our operations and our service offerings;
· maintain and enhance our system of internal controls to ensure timely and accurate compliance with our regulatory reporting requirements; and
· expand our accounting and operational information systems in order to support our growth.
If we fail to implement these measures successfully, our ability to manage our growth will be impaired.
We may experience difficulties in implementing our business plan in Europe and may incur related unexpected costs.
During the first quarter of 2004, we completed our acquisitions of Firstmark, the parent holding company of LambdaNet Communications France SAS, or LambdaNet France, and LambdaNet Communications Espana SA, or LambdaNet Spain, and have obtained the rights to certain dark fiber and other network assets that were once part of Carrier 1 International S.A. in Germany. Prior to these transactions, we had only minimal European operations. If we are not successful in developing our market presence in Europe, our operating results could be adversely affected.
LambdaNet France (now Cogent France) and LambdaNet Spain (now Cogent Spain) operated a combined telecommunications network and shared operations systems with a formerly affiliated entity, LambdaNet Germany. We did not acquire LambdaNet Germany and we are currently involved in litigation with LambdaNet Germany regarding amounts due to and from Cogent France, Cogent Spain and several other subsidiaries. If we are unable to resolve such litigation or we experience other unforeseen obligations in connection with the separation, we could be subject to liability or additional expenses.
We may experience delays and additional costs in expanding our on-net buildings.
Currently, we plan to increase our carrier-neutral facilities and other on-net buildings from 1,040 at December 31, 2005 to approximately 1,100 at December 31, 2006. We may be unsuccessful at identifying appropriate buildings or negotiating favorable terms for acquiring access to such buildings, and consequently, may experience difficulty in adding customers to our network and fully using the network’s capacity.
We may not successfully make or integrate acquisitions or enter into strategic alliances.
As part of our growth strategy, we intend to pursue selected acquisitions and strategic alliances. To date, we have completed 13 acquisitions. We compete with other companies for acquisition opportunities and we cannot assure you that we will be able to effect future acquisitions or strategic alliances on commercially reasonable terms or at all. Even if we enter into these transactions, we may experience:
· delays in realizing or a failure to realize the benefits we anticipate;
· difficulties or higher-than-anticipated costs associated with integrating any acquired companies, products or services into our existing business;
· attrition of key personnel from acquired businesses;
· unexpected costs or charges; or
· unforeseen operating difficulties that require significant financial and managerial resources that would otherwise be available for the ongoing development or expansion of our existing operations.
In the past, our acquisitions have often included assets, service offerings and financial obligations that are not compatible with our core business strategy. We have expended management attention and other resources to the divestiture of assets, modification of products and systems as well as restructuring financial obligations of acquired operations. In most acquisitions, we have been successful in renegotiating long-term agreements that we have acquired relating to long distance and local transport of data and IP traffic. If we are unable to satisfactorily renegotiate such agreements in the future or with respect to future acquisitions, we may be exposed to large claims for payment for services and facilities we do not need.
Consummating these transactions could also result in the incurrence of additional debt and related interest expense, as well as unforeseen contingent liabilities, all of which could have a material adverse effect on our business, financial condition and results of operations. Because we have purchased financially
distressed companies or their assets, and may continue to do so in the future, we have not had, and may not have, the opportunity to perform extensive due diligence or obtain contractual protections and indemnifications that are customarily provided in corporate acquisitions. As a result, we may face unexpected contingent liabilities arising from these acquisitions. We may also issue additional equity in connection with these transactions, which would dilute our existing shareholders.
Revenues generated by the customer contracts that we have acquired have accounted for a substantial portion of our historical growth in net service revenue. However, following an acquisition, we have experienced a decline in revenue attributable to acquired customers as these customers’ contracts have expired and they have entered into standard Cogent customer contracts at generally lower rates or have chosen not to renew service with us. We anticipate that we will experience similar declines with respect to customers we have acquired or will acquire.
We depend upon our key employees and may be unable to attract or retain sufficient qualified personnel.
Our future performance depends upon the continued contribution of our executive management team and other key employees, in particular, our Chairman and Chief Executive Officer, Dave Schaeffer. As founder of our company, Mr. Schaeffer’s knowledge of our business combined with his engineering background and industry experience makes him particularly well suited to lead our company.
Our connections to the Internet require us to establish and maintain relationships with other providers, which we may not be able to maintain.
The Internet is composed of various public and private network providers who operate their own networks and interconnect them at public and private interconnection points. Our network is one such network. In order to obtain Internet connectivity for our network, we must establish and maintain relationships with other providers and incur the necessary capital costs to locate our equipment and connect our network at these various interconnection points.
By entering into what are known as settlement-free peering arrangements, providers agree to exchange traffic between their respective networks without charging each other. Our ability to avoid the higher costs of acquiring dedicated network capacity and to maintain high network performance is dependent upon our ability to establish and maintain peering relationships. The terms and conditions of our peering relationships may also be subject to adverse changes, which we may not be able to control. For example, several network operators with large numbers of individual users are arguing that they should be able to charge or charge more to network operators and businesses that send traffic to those users. If we are not able to maintain or increase our peering relationships in all of our markets on favorable terms, we may not be able to provide our customers with high performance or affordable services, which could have a material adverse effect on our business. We have in the past encountered some disputes with certain of our providers regarding our peering arrangements, but we have generally been able to route our traffic through alternative peering arrangements, resolve such disputes, or terminate such peering arrangements with a minimal adverse impact on our business. In the past year we had two such disputes that resulted in a temporary disruption of the exchange of traffic between our network and the network of the other carrier. We cannot assure you that we will be able to continue to establish and maintain relationships with providers or favorably resolve disputes with providers.
We make some of these connections pursuant to agreements that make data transmission capacity available to us at negotiated rates. In some instances these agreements have minimum and maximum volume commitments. If we fail to meet the minimum, or exceed the maximum, volume commitments, our rates and costs may rise.
Our European and Canadian operations expose us to economic, regulatory and other risks.
The nature of our European and Canadian business involves a number of risks, including:
· fluctuations in currency exchange rates;
· exposure to additional regulatory requirements, including import restrictions and controls, exchange controls, tariffs and other trade barriers;
· difficulties in staffing and managing our foreign operations;
· changes in political and economic conditions; and
· exposure to additional and potentially adverse tax regimes.
As we continue to expand our European and Canadian business, our success will depend, in part, on our ability to anticipate and effectively manage these and other risks. Our failure to manage these risks and grow our European and Canadian operations may have a material adverse effect on our business and results of operations.
Fluctuations in foreign exchange rates may adversely affect our financial position and results of operations.
Our European and Canadian operations expose us to currency fluctuations and exchange rate risk. For example, while we record revenues and financial results from our European operations in euros, these results are reflected in our consolidated financial statements in U.S. dollars. Therefore, our reported results are exposed to fluctuations in the exchange rates between the U.S. dollar and the euro. In particular, we fund the euro-based operating expenses and associated cash flow requirements of our European operations, including IRU obligations, in U.S. dollars. Accordingly, in the event that the euro strengthens versus the dollar to a greater extent than we anticipate, the expenses and cash flow requirements associated with our European operations may be significantly higher in U.S.-dollar terms than planned.
Our business could suffer delays and problems due to the actions of network providers on whom we are partially dependent.
Our off-net customers are connected to our network by means of communications lines that are provided as services by local telephone companies and others. We may experience problems with the installation, maintenance and pricing of these lines and other communications links, which could adversely affect our results of operations and our plans to add additional customers to our network using such services. We have historically experienced installation and maintenance delays when the network provider is devoting resources to other services, such as traditional telephony. We have also experienced pricing problems when a lack of alternatives allows a provider to charge high prices for services in an area. We attempt to reduce this problem by using many different providers so that we have alternatives for linking a customer to our network. Competition among the providers tends to improve installation, maintenance and pricing.
If the information systems that we depend on to support our customers, network operations, sales and billing do not perform as expected, our operations and our financial results may be adversely affected.
We rely on complex information systems to operate our network and support our other business functions. Our ability to track sales leads, close sales opportunities, provision services and bill our customers for those services depends upon the effective integration of our various information systems. If our systems, individually or collectively, fail or do not perform as expected, our ability to process and provision orders, to make timely payments to vendors and to ensure that we collect revenue owed to us would be adversely affected. Such failures or delays could result in increased capital expenditures,
customer and vendor dissatisfaction, loss of business or the inability to add new customers or additional services, all of which would adversely affect our business and results of operations.
Our business could suffer from an interruption of service from our fiber providers.
The carriers from whom it has been obtained maintain our inter-city and intra-city dark fiber. If these carriers fail to maintain the fiber or disrupt our fiber connections for other reasons, such as business disputes with us and governmental takings, or us our ability to provide service in the affected markets or parts of markets would be impaired. While we have successfully mitigated the effects of prior service interruptions in the past, we may incur significant delays and costs in restoring service to our customers in connection with future service interruptions, and we may lose customers if delays are substantial.
Our business depends on license agreements with building owners and managers, which we could fail to obtain or maintain.
Our business depends upon our in-building networks. Our in-building networks depend on access agreements with building owners or managers allowing us to install our in-building networks and provide our services in the buildings. These agreements typically have terms of five to ten years, with one or more renewal options. Any deterioration in our existing relationships with building owners or managers could harm our marketing efforts and could substantially reduce our potential customer base. We expect to enter into additional access agreements as part of our growth plan. Current federal and state regulations do not require building owners to make space available to us or to do so on terms that are reasonable or nondiscriminatory. While the FCC has adopted regulations that prohibit common carriers under its jurisdiction from entering into exclusive arrangements with owners of multi-tenant commercial office buildings, these regulations do not require building owners to offer us access to their buildings. Building owners or managers may decide not to permit us to install our networks in their buildings or may elect not to renew or amend our access agreements. The initial term of most of our access agreements will conclude in the next several years. Most of these agreements have one or more automatic renewal periods and others may be renewed at the option of the landlord. While we have historically been successful in renewing these agreements and no single building access agreement is material to our success, the failure to obtain or maintain a number of these agreements would reduce our revenue, and we might not recover our costs of procuring building access and installing our in-building networks.
We may not be able to obtain or construct additional building laterals to connect new buildings to our network.
In order to connect a new building to our network we need to obtain or construct a lateral from our metropolitan network to the building. We may not be able to obtain fiber in an existing lateral at an attractive price from a provider and may not be able to construct our own lateral due to the cost of construction or municipal regulatory restrictions. Failure to obtain fiber in an existing lateral or to construct a new lateral could keep us from adding new buildings to our network and from increasing our revenues.
Impairment of our intellectual property rights and our alleged infringement on other companies’ intellectual property rights could harm our business.
We are aware of several other companies in our and other industries that use the word “Cogent” in their corporate names. One company has informed us that it believes our use of the name “Cogent” infringes on their intellectual property rights in that name. If such a challenge is successful, we could be required to change our name and lose the goodwill associated with the Cogent name in our markets.
The sector in which we operate is highly competitive, and we may not be able to compete effectively.
We face significant competition from incumbent carriers, Internet service providers and facilities-based network operators. Relative to us, many of these providers have significantly greater financial
resources, more well-established brand names, larger customer bases, and more diverse strategic plans and service offerings.
Intense competition from these traditional and new communications companies has led to declining prices and margins for many communications services, and we expect this trend to continue as competition intensifies in the future. Decreasing prices for high-speed Internet services have somewhat diminished the competitive advantage that we have enjoyed as a result of our service pricing.
Our competitors may also introduce new technology or services that make our services less attractive to potential customers. For example, some providers are introducing a new version of the Internet protocol (Ipv6) that we do not plan to introduce at this time. If this becomes important to Internet users our ability to compete may be lessened.
We issue projected results and estimates for future periods from time to time, and such projections and estimates are subject to inherent uncertainties and may prove to be inaccurate.
Financial information, results of operations and other projections that we may issue from time to time are based upon our assumptions and estimates. While we believe these assumptions and estimates to be reasonable, they are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. You should understand that certain unpredictable factors could cause our actual results to differ from our expectations and those differences may be material. No independent expert participates in the preparation of these estimates. These estimates should not be regarded as a representation by us as to our results of operations during such periods as there can be no assurance that any of these estimates will be realized. In light of the foregoing, we caution you not to place undue reliance on these estimates. These estimates constitute forward-looking statements.
Network failure or delays and errors in transmissions expose us to potential liability.
Our network uses a collection of communications equipment, software, operating protocols and proprietary applications for the high-speed transportation of large quantities of data among multiple locations. Given the complexity of our network, it is possible that data will be lost or distorted. Delays in data delivery may cause significant losses to one or more customers using our network. Our network may also contain undetected design faults and software bugs that, despite our testing, may not be discovered in time to prevent harm to our network or to the data transmitted over it. The failure of any equipment or facility on the network could result in the interruption of customer service until we effect necessary repairs or install replacement equipment. Network failures, delays and errors could also result from natural disasters, power losses, security breaches, computer viruses, denial of service attacks and other natural or man-made events. Our off-net services are dependent on the network of other providers or on local telephone companies. Network failures, faults or errors could cause delays or service interruptions, expose us to customer liability or require expensive modifications that could have a material adverse effect on our business.
As an Internet access provider, we may incur liability for information disseminated through our network.
The law relating to the liability of Internet access providers and on-line services companies for information carried on or disseminated through their networks is unsettled. As the law in this area develops and as we expand our international operations, the potential imposition of liability upon us for information carried on and disseminated through our network could require us to implement measures to reduce our exposure to such liability, which may require the expenditure of substantial resources or the discontinuation of certain products or service offerings. Any costs that are incurred as a result of such measures or the imposition of liability could harm our business.
Legislation and government regulation could adversely affect us.
As an enhanced service provider, we are not subject to substantial regulation by the FCC or the state public utilities commissions in the United States. Internet service is also subject to minimal regulation in Europe and in Canada. If we decide to offer traditional voice services or otherwise expand our service offerings to include services that would cause us to be deemed a common carrier, we will become subject to additional regulation. Additionally, if we offer voice service using IP (voice over IP) or offer certain other types of data services using IP we may become subject to additional regulation. This regulation could impact our business because of the costs and time required to obtain necessary authorizations, the additional taxes than we may become subject to or may have to collect from our customers, and the additional administrative costs of providing voice services, and other costs. Even if we do not decide to offer additional services, governmental authorities may decide to impose additional regulation and taxes upon providers of Internet service. All of these could inhibit our ability to remain a low cost carrier.
Much of the law related to the liability of Internet service providers remains unsettled. For example, many jurisdictions have adopted laws related to unsolicited commercial email or “spam” in the last several years. Other legal issues, such as the sharing of copyrighted information, transborder data flow, universal service, and liability for software viruses could become subjects of additional legislation and legal development. We cannot predict the impact of these changes on us. Regulatory changes could have a material adverse effect on our business, financial condition or results of operations.
Terrorist activity throughout the world and military action to counter terrorism could adversely impact our business.
The September 11, 2001 terrorist attacks in the United States and the continued threat of terrorist activity and other acts of war or hostility have had, and may continue to have, an adverse effect on business, financial and general economic conditions internationally. Effects from these events and any future terrorist activity, including cyber terrorism, may, in turn, increase our costs due to the need to provide enhanced security, which would adversely affect our business and results of operations. These circumstances may also damage or destroy the Internet infrastructure and may adversely affect our ability to attract and retain customers, our ability to raise capital and the operation and maintenance of our network access points. We are particularly vulnerable to acts of terrorism because our largest customer concentration is located in New York, our headquarters is in Washington, D.C., and we have significant operations in Paris and Madrid, cities that have historically been targets for terrorist attacks.
ITEM 2. DESCRIPTION OF PROPERTIES
We lease and own no material real property in North America. We are headquartered inspace for offices, data centers, co-location facilities, consistingand points-of-presence.
Our headquarters facilities consist of approximately 15,370 square feet located in Washington, D.C., which we occupy under a The lease for our headquarters is with an entity controlled by our Chief Executive Officer, that expiresOfficer. The lease is year-to-year on market terms. We have an option to renew this lease through August 31, 2004. We and our subsidiaries2007.
In North America we also lease approximately 327,000205,000 square feet of space in 40 locations to house our hosting centers,co-location facilities, regional offices and the equipment that provides the connection between our backbone network and our metropolitan networks. Approximately 77,400 square feet are used for metropolitan hub sites which average 3,100 square feet in size.operations centers. The terms of these leases generally are for ten years with two five-year renewal options, at annual rentsoptions.
In Europe we lease approximately 168,000 square feet of space in 20 locations to house our co-location facilities, regional offices and operations centers. The terms of these leases generally are for nine years with an opportunity to terminate the lease every three years. Through the acquisition of our French and Spanish subsidiaries in January 2004, we acquired three properties in France that we own. All three properties are data centers and points-of-presence, or POP, facilities ranging in size from $13.0011,838 to $77.25 per18,292 square foot. Muchfeet. On March 30, 2005, we sold one of the general office space has been sublet to third parties. three properties, located in Lyon, France, for net proceeds of approximately $5.1 million.
We believe that these facilities are generally in good condition and suitable for our operations.
ThroughWe have from our acquisition of Lamdanet France and Lambdanet Spain, in January, 2004, we acquired three properties in France. All three properties are Data Center and/or POP facilities ranging in size from 11,838 to 18,292 square feet. We believe that the current market value of these properties is 5.1 million euros (oracquisitions approximately $6.3 million US Dollars). One of the three properties, located in Lyon, France, is currently under contract to be sold for 3.9 million euros (or approximately $4.8 million US Dollars) and is expected to close in late 2004 subject to the purchaser obtaining the necessary entitlements to redevelop the property. Through our subsidiaries Lamdanet France and Lamdanet Spain we also lease approximately 229,52019,000 square feet of space to house our hosting centers, offices and the equipment that provides the connection between our backbone network and our metropolitan networks. Approximately 159,517 square feet of the total are used for active POP locations which house our network equipment and provide collocation space for our customers and have an average size of 9,900 square feet. The terms of their leases generally are for nine years with an opportunity to exit the lease every three years with annual rents ranging from $2.20 to $30.00 per square foot. Much of the general office space and non-active POPat two locations in Europe that are currently on the market to be sublet to third parties. We believe thatIn North America we have approximately 33,000 square feet of excess office space in seven locations. Three of these facilitieslocations are generally in good condition and suitablecurrently sublet to third parties. Four are currently being marketed for our operations.sublease.
Vendor Claims and Disputes.We are involved in a dispute with the former landlord of one of our subsidiaries, Allied Riser Operations Corporation, in Dallas, Texas. On July 15, 2002, the landlord filed suit in the 193rd District Court of the State of Texas alleging that Allied Riser's March 2002 termination of its lease with the landlord resulted in a default under the lease. We believe, and have responded, that the termination was consistent with the terms of the lease. Although the suit did not specify damages, we estimate, based upon the remaining payments under the lease and assuming no mitigation of damages by the landlord, that the amount in controversy may total approximately $3.0 million. We have not recognized a liability for this dispute and intend to vigorously defend our position.
9
We generally accrue for the amounts invoiced by our providers of telecommunications services. Liabilities for telecommunications costs are generally reduced when the vendor acknowledges the reduction in its invoice and the credit is granted. In 2002, one vendor invoiced us for approximately $1.7 million in excess of what we believe is contractually due to the vendor. The vendor has initiated an arbitration proceeding related to this dispute. We intend to vigorously defend our position related to these charges.
We are involved in other legal proceedings in the normal course of our business that we do not expect to have a material impactadverse affect on our operationsbusiness, financial condition or results of operations. For a discussion of the significant proceedings in which we are involved, see Note 9 to our financial statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of our security holders during the fourth quarter of the year ended December 31, 2003.2005.
1017
ITEM 5. MARKET FOR THE REGISTRANT'SREGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our sole class of common equity is our common stock, par value $0.001, which is currently traded on the NASDAQ National Market under the symbol “CCOI”. Prior to March 6, 2006, our common stock traded on the American Stock Exchange under the symbol "COI."“COI”. Prior to February 5, 2002 no established public trading market for theour common stock existed.
As of March 19, 2004,6, 2006, there were approximately 460135 holders of record of shares of our common stock holding 44,092,605 shares of our common stock.
The table below shows, for the quarters indicated, the reported high and low trading prices of our common stock on the American Stock Exchange.Exchange, which reflect the 1 for 20 reverse stock split (the “Reverse Stock Split”) we effected in March 2005 in connection with our public offering in June 2005.
| Calendar Year 2003 | HIGH | LOW | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
| High |
| Low |
| ||||||||
Calendar Year 2004 |
|
|
|
|
| ||||||||
| First Quarter | $ | 0.94 | $ | 0.40 |
| $ | 54.80 |
| $ | 22.00 |
| ||
| Second Quarter | 3.23 | 0.32 |
| 43.80 |
| 5.40 |
| ||||||
| Third Quarter | 2.39 | 0.80 |
| 8.00 |
| 4.60 |
| ||||||
| Fourth Quarter | 1.98 | 0.95 |
| 40.00 |
| 5.60 |
| ||||||
Calendar Year 2005 |
|
|
|
|
| ||||||||
First Quarter |
| $ | 25.40 |
| $ | 8.11 |
| ||||||
Second Quarter |
| 28.30 |
| 6.29 |
| ||||||||
Third Quarter |
| 8.37 |
| 4.56 |
| ||||||||
Fourth Quarter |
| 6.16 |
| 4.18 |
| ||||||||
We have not paid any dividends on our common stock since our inception and do not anticipate paying any dividends in the foreseeable future. Our line of credit prohibits the payment of dividends. Any future determination to pay dividends will be at the discretion of our board of directors and will be dependent upon then-existing conditions, including our financial condition, results of operations, contractual restrictions, capital requirements, business prospects and other factors our board of directors deems relevant. Additionally, our credit agreement with Cisco Capital prohibits us from paying cash dividends and restricts our ability to make other distributions to our stockholders.
11
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The annual financial information set forth below has been derived from theour audited consolidated financial statements included in this Report.statements. The information should be read in connection with, and is qualified in its entirety by reference to, the financial statements and notes included elsewhere in this Report. We were incorporated on August 9, 1999. Accordingly, no financial information prior to August 9, 1999 is available.report and in our SEC filings.
| | | | Years Ended December, 31 |
| Years Ended December 31, |
| |||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | August 9, 1999 to December 31, 1999 |
| 2001 |
| 2002 |
| 2003 |
| 2004 |
| 2005 |
| ||||||||||||||||||||
| | | 2000 | 2001 | 2002 | 2003 |
| (dollars in thousands) |
| |||||||||||||||||||||||||
| | (dollars in thousands) | ||||||||||||||||||||||||||||||||
| CONSOLIDATED STATEMENT OF | |||||||||||||||||||||||||||||||||
| OPERATIONS DATA: | |||||||||||||||||||||||||||||||||
| Net service revenue | $ | — | $ | — | $ | 3,018 | $ | 51,913 | $ | 59,422 | |||||||||||||||||||||||
CONSOLIDATED STATEMENT OF OPERATIONS DATA: |
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||||
Service revenue, net |
| $ | 3,018 |
| $ | 51,913 |
| $ | 59,422 |
| $ | 91,286 |
| $ | 135,213 |
| |||||||||||||||||
| Operating expenses: | Operating expenses: |
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||||
| Cost of network operations | — | 3,040 | 19,990 | 49,091 | 47,017 | ||||||||||||||||||||||||||||
| Amortization of deferred compensation — cost of network operations | — | — | 307 | 233 | 1,307 | ||||||||||||||||||||||||||||
Network operations |
| 19,990 |
| 49,091 |
| 47,017 |
| 63,466 |
| 85,794 |
| ||||||||||||||||||||||
Amortization of deferred compensation—network operations |
| 307 |
| 233 |
| 1,307 |
| 858 |
| 399 |
| ||||||||||||||||||||||
| Selling, general, and administrative | Selling, general, and administrative | 82 | 10,845 | 27,322 | 33,495 | 26,570 |
| 27,322 |
| 33,495 |
| 26,570 |
| 40,382 |
| 41,344 |
| ||||||||||||||||
| Amortization of deferred compensation — SG&A | — | — | 2,958 | 3,098 | 17,368 | ||||||||||||||||||||||||||||
Amortization of deferred compensation—SG&A |
| 2,958 |
| 3,098 |
| 17,368 |
| 11,404 |
| 12,906 |
| ||||||||||||||||||||||
| Gain on settlement of vendor litigation | Gain on settlement of vendor litigation | — | — | — | (5,721 | ) | — |
| — |
| (5,721 | ) | — |
| — |
| — |
| |||||||||||||||
Terminated public offering costs |
| — |
| — |
| — |
| 779 |
| — |
| ||||||||||||||||||||||
Restructuring charges |
| — |
| — |
| — |
| 1,821 |
| 1,319 |
| ||||||||||||||||||||||
| Depreciation and amortization | Depreciation and amortization | — | 338 | 13,535 | 33,990 | 48,387 |
| 13,535 |
| 33,990 |
| 48,387 |
| 56,645 |
| 55,600 |
| ||||||||||||||||
| Total operating expenses | Total operating expenses | 82 | 14,223 | 64,112 | 114,186 | 140,649 |
| 64,112 |
| 114,186 |
| 140,649 |
| 175,355 |
| 197,362 |
| ||||||||||||||||
| Operating loss | Operating loss | (82 | ) | (14,223 | ) | (61,094 | ) | (62,273 | ) | (81,227 | ) |
| (61,094 | ) | (62,273 | ) | (81,227 | ) | (84,069 | ) | (62,149 | ) | |||||||||||
| Settlement of note holder litigation | Settlement of note holder litigation | — | — | — | 3,468 | — |
| — |
| (3,468 | ) | — |
| — |
| — |
| ||||||||||||||||
Gains—lease obligation restructurings |
| — |
| — |
| — |
| 5,292 |
| 844 |
| ||||||||||||||||||||||
Gain—Allied Riser note exchange |
| — |
| — |
| 24,802 |
| — |
| — |
| ||||||||||||||||||||||
Gains—Cisco credit facility |
| — |
| — |
| 215,432 |
| — |
| 842 |
| ||||||||||||||||||||||
Gain—dispositions of assets |
| — |
| — |
| — |
| — |
| 3,372 |
| ||||||||||||||||||||||
| Interest income (expense) and other, net | Interest income (expense) and other, net | — | 2,462 | (5,819 | ) | (34,545 | ) | (18,264 | ) |
| (5,819 | ) | (34,545 | ) | (18,264 | ) | (10,883 | ) | (10,427 | ) | |||||||||||||
| Gain — Allied Riser note settlement | — | — | — | — | 24,802 | ||||||||||||||||||||||||||||
| Gain — Cisco credit facility — troubled debt restructuring | — | — | — | — | 215,432 | ||||||||||||||||||||||||||||
| (Loss) income before extraordinary gain | (Loss) income before extraordinary gain | (82 | ) | (11,761 | ) | (66,913 | ) | (100,286 | ) | 140,743 |
| (66,913 | ) | (100,286 | ) | 140,743 |
| (89,660 | ) | (67,518 | ) | ||||||||||||
| Extraordinary gain — Allied Riser merger | — | — | — | 8,443 | — | ||||||||||||||||||||||||||||
Extraordinary gain—Allied Riser merger |
| — |
| 8,443 |
| — |
| — |
| — |
| ||||||||||||||||||||||
| Net (loss) income | Net (loss) income | (82 | ) | (11,761 | ) | (66,913 | ) | (91,843 | ) | 140,743 |
| (66,913 | ) | (91,843 | ) | 140,743 |
| (89,660 | ) | (67,518 | ) | ||||||||||||
| Beneficial conversion of preferred stock | — | — | (24,168 | ) | — | (52,000 | ) | ||||||||||||||||||||||||||
| Net (loss) income applicable to common stock | $ | (82 | ) | $ | (11,761 | ) | $ | (91,081 | ) | $ | (91,843 | ) | $ | 88,743 | |||||||||||||||||||
| Net (loss) income per common share — basic | $ | (0.06 | ) | $ | (8.51 | ) | $ | (64.78 | ) | $ | (28.22 | ) | $ | 18.17 | |||||||||||||||||||
| Net (loss) income per common share — diluted | $ | (0.06 | ) | $ | (8.51 | ) | $ | (64.78 | ) | $ | (28.22 | ) | $ | 0.89 | |||||||||||||||||||
| Weighted-average common shares — basic | 1,360,000 | 1,382,360 | 1,406,007 | 3,254,241 | 7,744,350 | ||||||||||||||||||||||||||||
| Weighted-average common shares — diluted | 1,360,000 | 1,382,360 | 1,406,007 | 3,254,241 | 158,777,953 | ||||||||||||||||||||||||||||
CONSOLIDATED BALANCE SHEET DATA | |||||||||||||||||||||||||||||||||
| (AT PERIOD END): | |||||||||||||||||||||||||||||||||
Beneficial conversion charges |
| (24,168 | ) | — |
| (52,000 | ) | (43,986 | ) | — |
| ||||||||||||||||||||||
Net (loss) income applicable to common shareholders |
| $ | (91,081 | ) | $ | (91,843 | ) | $ | 88,743 |
| $ | (133,646 | ) | (67,518 | ) | ||||||||||||||||||
Net (loss) income per common share available to common shareholders—basic |
| $ | (1,295.60 | ) | $ | (564.45 | ) | $ | 11.18 |
| $ | (175.03 | ) | $ | (1.96 | ) | |||||||||||||||||
Net (loss) income per common share available common shareholders—diluted |
| $ | (1,295.60 | ) | $ | (564.45 | ) | $ | 11.18 |
| $ | (175.03 | ) | $ | (1.96 | ) | |||||||||||||||||
Weighted-average common shares—basic |
| 70,300 |
| 162,712 |
| 7,935,831 |
| 763,540 |
| 34,439,937 |
| ||||||||||||||||||||||
Weighted-average common shares—diluted |
| 70,300 |
| 162,712 |
| 7,938,898 |
| 763,540 |
| 34,439,937 |
| ||||||||||||||||||||||
CONSOLIDATED BALANCE SHEET DATA (AT PERIOD END): |
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||||
| Cash and cash equivalents | Cash and cash equivalents | $ | — | $ | 65,593 | $ | 49,017 | $ | 39,314 | $ | 7,875 |
| $ | 49,017 |
| $ | 39,314 |
| $ | 7,875 |
| $ | 13,844 |
| $ | 29,883 |
| ||||||
| Total assets | Total assets | 25 | 187,740 | 319,769 | 407,677 | 344,440 |
| 319,769 |
| 407,677 |
| 344,440 |
| 378,586 |
| 351,373 |
| ||||||||||||||||
| Long-term debt (including current portion) (net of unamortized discount of $78,140 in 2002 and $6,084 in 2003) | — | 77,936 | 202,740 | 347,930 | 83,702 | ||||||||||||||||||||||||||||
Long-term debt (including capital leases and current portion) (net of unamortized discount of $78,140 in 2002, $6,084 in 2003, $5,026 in 2004 and $3,478 in 2005) |
| 202,740 |
| 347,930 |
| 83,702 |
| 126,382 |
| 99,105 |
| ||||||||||||||||||||||
| Preferred stock | Preferred stock | — | 115,901 | 177,246 | 175,246 | 97,681 |
| 177,246 |
| 175,246 |
| 97,681 |
| 139,825 |
| — |
| ||||||||||||||||
| Stockholders' equity | 18 | 104,248 | 110,214 | 32,626 | 244,754 | ||||||||||||||||||||||||||||
Stockholders’ equity |
| 110,214 |
| 32,626 |
| 244,754 |
| 212,490 |
| 221,001 |
| ||||||||||||||||||||||
OTHER OPERATING DATA: | OTHER OPERATING DATA: |
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||||
| Net cash used in operating activities | Net cash used in operating activities | (75 | ) | (16,370 | ) | (46,786 | ) | (41,567 | ) | (27,357 | ) |
| (46,786 | ) | (41,567 | ) | (27,357 | ) | (26,425 | ) | (9,062 | ) | |||||||||||
| Net cash used in investing activities | Net cash used in investing activities | — | (80,989 | ) | (131,652 | ) | (19,786 | ) | (25,316 | ) |
| (131,652 | ) | (19,786 | ) | (25,316 | ) | (2,701 | ) | (14,055 | ) | ||||||||||||
| Net cash provided by financing activities | Net cash provided by financing activities | 75 | 162,952 | 161,862 | 51,694 | 20,562 |
| 161,862 |
| 51,694 |
| 20,562 |
| 34,486 |
| 39,824 |
| ||||||||||||||||
All share and per-share data in the table above reflects the ten-for-one1-for-20 reverse stock split that occurred in connection withMarch 2005. In February 2005, all of our merger with Allied Riser in February 2002.preferred stock was converted into common stock.
1219
ITEM 7. MANAGEMENT'S MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TheYou should read the following discussion and analysis should be read in conjunctiontogether with the“Selected Consolidated Financial and Other Data” and our consolidated financial statements and related notes and the other financial information included elsewhere in this report. ThisThe discussion in this report contains forward-looking statements aboutthat involve risks and uncertainties, such as statements of our businessplans, objectives, expectations and operations.intentions. The cautionary statements made in this report should be read as applying to all related forward-looking statements wherever they appear in this report. Our actual results could differ materially from those anticipateddiscussed here. Factors that could cause or contribute to these differences include those discussed in such forward-looking statements.“Risk Factors,” as well as those discussed elsewhere. You should read “Risk Factors” and “Special Note Regarding Forward-Looking Statements.”
We were formed on August 9, 1999 asare a Delaware corporation. We began invoicing our customers for our services in April 2001. We provide ourleading facilities-based provider of low-cost, high-speed Internet access and IP communications services. Our network is specifically designed and optimized to transmit data using IP. IP networks are significantly less expensive to operate and are able to achieve higher performance levels than the traditional circuit-switched networks used by our competitors, thus giving us cost and performance advantages in our industry. We deliver our services to small and medium-sized businesses, communications service providers and other bandwidth-intensive organizations through approximately 10,000 customer connections in North America and Western Europe. Our primary on-net service is Internet access at a speed of 100 Megabits per second, much faster than typical Internet access currently offered to businesses. We offer this on-net service exclusively through our own facilities, which run all the way to our customers’ premises.
Our network is comprised of in-building riser facilities, metropolitan optical fiber networks, metropolitan traffic aggregation points and inter-city transport facilities. The network is physically connected entirely through our facilities to 1,040 buildings in which we provide our on-net services, including over 800 multi-tenant office buildings. We also provide on-net services in carrier-neutral co-location facilities, data centers and single-tenant office buildings. Because of our integrated network architecture, we are not dependent on local telephone companies to serve our on-net customers. We emphasize the sale of on-net services because we believe we have a competitive advantage in providing these services and our sales of these services generate higher gross profit margins.
We also provide Internet connectivity to customers that are not located in buildings directly connected to our fiber opticnetwork. We serve these off-net customers using other carriers’ facilities to provide the last mile portion of the link from our customers’ premises to our network. We also provide certain non-core services which are legacy services which we acquired and continue to support but do not actively sell.
We believe our key opportunity is provided by our high-capacity network, which we call our "on-net" services. We charge monthly fees for on-net services. Our April 2, 2002 acquisitionprovides us with the ability to add a significant number of certain assets of PSINet, Inc. added a new elementcustomers to our operations in that in additionnetwork with minimal incremental costs. Our focus is to our current high-speed Internet access business, we began operating a more traditional Internet service provider business, with lower speed connections provided by leased circuits obtained from telecommunications carriers (primarily local telephone companies). We call these services our "off-net" services. Our February 4, 2002, merger with Allied Riser also added a new element to our operations as we began offering voice services in Toronto, Canada through our subsidiary, Shared Technologies of Canada. On January 5, 2004 we acquired Firstmark Communications Participations S.a.r.l. the parent company to LambdaNet France and LambdaNet Spain, as new European subsidiaries. These companies provide both on-net and off-net services.
Our core product set, which we actively market, is comprised of three primary product groups. Our Type I on-net Internet access allowsadd customers to directly connect to our network in approximately 860 North American buildings. These connections utilize facilities, whicha way that maximizes its use and at the same time provides us with a customer mix that produces strong profit margins. We are controlledresponding to this opportunity by us upincreasing our sales and marketing efforts including increasing our number of sales representatives. In addition, we may add customers to the customer premise. We operate in-building facilities that include riser distribution and cables as well as cross connections or horizontal connections directly to the customers' terminating equipment. The customers traffic is then transmitted across our network through strategic acquisitions.
We plan to expand our network to locations that can be economically integrated and represent significant concentrations of Internet traffic. We may identify locations that we desire to serve with our on-net product but cannot be cost effectively added to our network. One of our keys to developing a profitable business will be to carefully match the expense of extending our network to reach new customers with the revenue generated by equipment located withinthose customers.
We believe the buildingtwo most important trends in our industry are the continued growth in Internet traffic and a decline in Internet access prices. As Internet traffic continues to grow and prices per unit of traffic continue to decline, we believe our ability to load our network and gain market share from less efficient network operators will expand. However, continued erosion in Internet access prices will likely have a negative impact on the rate at which we can increase our revenues and our profit margins.
We have grown our net service revenue from $59.4 million for the year ended December 31, 2003 to $135.2 million for the year ended December 31, 2005. We have generated our revenue growth through the strategic acquisitions of communications network assets and customers, primarily from financially distressed companies, the continued expansion of our network of on-net buildings and the increase in customers generated by our sales and marketing efforts.
Our on-net service is sold exists.
Ourconsists of high-speed Internet access and IP connectivity ranging from 0.5 Megabits per second major product group is Type II dedicated Internet access. This product includesto several Gigabits per second of bandwidth. We offer our on-net services to customers located in buildings in we do not have direct fiber connectivity. We utilize traditional T1, E1, E3 and T3 transport circuits leased from local telecomm providers to provide this service. The majority of these circuits are leased from an incumbent local exchange carrier, or a competitive or alternate local exchange carrier. These dedicated transport circuits terminate at the customer's location and are then connected at the receiving location to our fiber optic Internet backbone. We operate fifty-two point of presence ("POP") locations that are aggregation points for these services in North America.
The third major product line that we actively support is co-location services within the data centers that we operate. Within these centers we provide our customers rack space in which the customer may place its own equipment or servers. We generally include with those racks dedicated Internet access bandwidth service to those customers.
We believe that our Type I Ethernet services provides us the greatest gross margin. For this service there is little additional equipment or services required to connect additional customers in our lit buildingsphysically connected to our network. The primary focus of our direct sales force is to sell these Type I products in the approximately 860 buildings which we have "on-net" in North America. These buildings include large commercial office buildings in which we sell our services to companies that utilize dedicated Internet access to support their businesses. We also sell into carrier neutral co-location facilities, telehouses, data centers and carrier hotels where we sell dedicated Internet access to companies that incorporate our services into their final products. We believe that these businesses generally utilize Internet access as one of their primary components in offering services to their end customers.
13
Our Type IIOff-net services are sold through a telesales organization to small and medium sized businesses that are located in buildings generally within a ten-mile radiusconnected to our network primarily by means of our fifty-two POPs in North America. The dedicated Internet access sold to these customers is generallyT1, T3, E1 and E3 lines obtained from other carriers. Our non-core services, which consist of significantly lower speeds than thoselegacy services sold in our Type I facilities. We believe that these products generally produce lower gross margins because each sale requires us to purchase dedicated Type II circuit from a local service provider. This circuit is generally provided as a transport link and is then connected between the customer premise and our POP. We then provide layer 3 transit services over these links. When possible we attempt to only commit to layer I transport purchase contracts that corresponded to the term of our dedicated Internet access contract with our customers. In some instancescompanies whose assets or businesses we have acquired, customers in which the layer 1 contract term and the dedicatedinclude managed modem services, email, retail dial-up Internet access, term may not coincide.
In our data centers, we actively market our co-location and bandwidth services. These facilities are on-net to us. We believe that the incremental costs associated with adding additional customers within these facilities are attributable only to the incremental power used by the customer's equipment. Our facilities have significant additional capacity to add customers and we do not anticipate needing to spend additional capital to augment these facilities.
We continue to support non-core products we have assumed in our acquisitions of various companies. These products includeshared web hosting, managed web hosting, shared hosting, email services, dial up Internet access,managed security, voice services and(only provided in Toronto, Canada), point to point transport services.private line services, and services that were provided to LambdaNet Germany under a network sharing arrangement as discussed below. We do not actively market these non-core services and expect the net service revenue associated with them to continue to decline.
Our on-net, off-net and non-core services comprised 63.5%, 24.4% and 12.1% of our net service revenue, respectively, for the exceptionyear ended December 31, 2004 and 57.9%, 33.0% and 9.1% for the year ended December 31, 2005. While we target our sales and marketing efforts at increasing on-net customers, customers we add through acquisitions will also affect the mix of point-to-point transporton-net and off-net revenues. For example, off-net service revenue increased as a percentage of total revenue in 2005 as compared to 2004 due to the inclusion of a full year of revenue from customers we added through our December 2004 acquisition of the off-net Internet access customers of Verio, Inc. We expect the percentage of on-net revenues to increase as a percentage of total revenues in 2006.
We have grown our gross profit from $12.4 million for the year ended December 31, 2003 to $49.4 million for the year ended December 31, 2005. Our gross profit margin has expanded from 20.9% in 2003 to 36.5% for the year ended December 31, 2005. We determine gross profit by subtracting network operation expenses (excluding amortization of deferred compensation) from our net service revenue. The amortization of deferred compensation classified as cost of network services was $1.3 million, $0.9 million and $0.4 million for the years ended December 31, 2003, 2004 and 2005, respectively. We believe that our gross profit will benefit and continue to expand as we are allocating the majority of our sales resources toward obtaining additional on-net customers and as sales of these services generate higher gross profit margins than our off-net and non-core services. We believe that as we add on-net customers we incur limited incremental expenses. We have not allocated depreciation and amortization expense to our network operations expense.
Due to our strategic acquisitions of network assets and equipment, we believe we are positioned to grow our revenue base and profitability without significant additional capital investments. We continue to deploy network equipment to other parts of our network to maximize the utilization of our assets. As a result, our future capital expenditures will be based primarily on our planned expansion of on-net buildings and the concentration and growth of our customer base. We expect our future capital expenditure rate to be similar to the rate we experienced for 2005. We plan to increase our number of on-net buildings to approximately 1,100 by December 31, 2006 from 1,040 at December 31, 2005.
Historically, our operating expenses have exceeded our net service revenue resulting in operating losses of $81.2 million, $84.1 million and $62.1 million in 2003, 2004 and 2005, respectively. In each of these periods, our European regionoperating expenses consisted primarily of the following:
· Network operations expenses which consist primarily of the cost of leased circuits, sites and voice servicesfacilities; telecommunications license agreements, network maintenance expenses, and salaries of, and expenses related to, employees who are directly involved with maintenance and operation of our network.
· Selling general and administrative expenses which consist primarily of salaries, commissions and related benefits paid to our employees and related selling and administrative costs including professional fees.
· Depreciation and amortization expenses which result from the depreciation of our property and equipment, including the assets associated with our network and the amortization of our intangible assets.
· Amortization of deferred compensation that results from the expense related to certain stock options and our restricted stock granted to our employees.
· Restructuring charges that resulted from the termination of our Paris office lease.
Since our inception, we have consummated 13 acquisitions through which we have generated revenue growth, expanded our network and customer base and added strategic assets to our business. We have accomplished this primarily by acquiring financially distressed companies or their assets at a significant discount to their original cost. The overall impact of these acquisitions on the operation of our business has been to extend the physical reach of our network in Canada.
Asboth North America and Western Europe, expand the breadth of our service offerings, and increase the number of customers to whom we provide our services. The overall impact of these acquisitions on our balance sheet and cash flows has been to significantly increase the assets on our balance sheet, including cash in the case of the Allied Riser merger, increase our indebtedness and increase our cash flows from operations due to our increased customer base. A substantial portion of our historical growth in net service revenue and specifically off-net and non-core revenues has been generated by the customer contracts we have acquired. Following an acquisition, we have historically experienced a decline in revenue attributable to acquired customers as these customers’ contracts have expired and they have entered into standard Cogent customer contracts at generally lower rates or have chosen not to renew service with us. We anticipate that we will experience similar declines with respect to customers we have acquired various operationsor will acquire.
Acquisition of other companiesVerio
In December 2004, we have attempted to maintain a common network architecture. Eachacquired most of the off-net Internet access customers of Verio Inc., a leading global IP provider and subsidiary of NTT Communications Corp. The acquired networks, as it is integrated intoassets included over 3,700 primarily off-net customer connections located in 23 of our U.S. markets, customer accounts receivable and certain network is reconfigured to mirror our layer 3 IP architecture. We have strived to consolidate services on a common network platform.equipment. We also have consolidated various information technology systemsassumed the liabilities associated with providing services to these customers including vendor relationships, accounts payable, and back office processes into a standard architecture, where possible, which is supported throughout allaccrued liabilities.
Acquisition of Aleron
In October 2004, we acquired certain assets of Aleron Broadband Services, formally known as AGIS Internet, and $18.5 million in cash, in exchange for 3,700 shares of our operating geographic regions. This integration process continuesSeries M preferred stock, which converted into approximately 5.7 million shares of our common stock in February 2005. We
acquired Aleron’s customer base and network, as well as Aleron’s Internet access and managed modem services.
Acquisition of Global Access
In September 2004, we continueacquired the transition frommajority of the assets of Global Access Telecommunications, Inc. in exchange for 185 shares of our Series L preferred stock. The Series L preferred stock issued in the transaction converted into approximately 0.3 million shares of our common stock in February 2005. Global Access provided Internet access and other data services in Germany. We acquired legacy systems to our standard information technology platforms.
Recent Developments
Resolution of Default Under Cisco Credit Facility and Sale of Series F and Series G Preferred Stock. Prior to July 31, 2003 we were party to a $409 million credit facility with Cisco Systems Capital Corporation ("Cisco Capital"). The credit facility required compliance with certain financial and operational covenants. We wereover 350 customer connections in violation of a financial covenant as of December 31, 2002 andGermany as a result Cisco Capital could have acceleratedof the due dateacquisition.
Acquisition of UFO
In August 2004, we acquired certain assets of Unlimited Fiber Optics, Inc., or UFO, for 2,600 shares of our indebtedness. These developments are discussed in greater detail below under "Liquidity and Capital Resources".
On June 12, 2003, our Board of Directors unanimously adopted a resolution authorizing us to consummate a transaction with Cisco Capital and Cisco Systems, Inc. ("Cisco") that would restructure our indebtedness to Cisco Capital as well as to offer and sell a new series ofSeries K preferred stock. The preferred stock to certain of our existing stockholdersissued in order to acquire the cash needed to complete the restructuring. On June 26, 2003, our stockholders approved these transactions.
In order to complete the restructuring we enteredmerger converted into an agreement (the "Exchange Agreement") with Cisco and Cisco Capital pursuant to which, among other things, Cisco and Cisco Capital agreed to cancel the principal amount of indebtedness plus accrued interest and return warrants exercisable for the purchase ofapproximately 0.8 million shares of our common stock (the "Cisco Warrants") in exchangeFebruary 2005. Among these assets were UFO’s customer base, which was comprised of data service customers located in San Francisco and Los Angeles. The acquired assets also included net cash of approximately $1.9 million and customer accounts receivable.
Acquisition of European Network
In 2004 we expanded our operations into Europe through a series of acquisitions in which we acquired customers and extended our network, primarily in France, Spain, and Germany.
In September 2003, we began exploring the possibility of acquiring LNG Holdings SA, or LNG, an operator of a European telecommunications network that was on the verge of insolvency. We determined that an acquisition of LNG in whole was not advisable at that time; however, the private equity funds that owned LNG refused to consider a transaction in which we would acquire only parts of the network. In order to prevent LNG from liquidating and to preserve our ability to structure an acceptable acquisition, in November 2003, our Chief Executive Officer formed a corporation that acquired a 90% interest in LNG in return for a commitment to cause at least $2 million to be invested in LNG’s subsidiary LambdaNet France and an indemnification of LNG’s selling stockholders by us and the acquiring corporation. In November 2003, we reached an agreement with investment funds associated with BNP Paribas and certain of our cash paymentexisting investors regarding the acquisition of $20.0the LNG networks in France, Spain and Germany.
We completed the first step of the European network acquisition in January 2004. The investors funded a corporation that they controlled with $2.5 million and acquired Firstmark Communications Participation S.à r.l., now named Cogent Europe S.à r.l., from LNG for one euro. Cogent Europe S.à r.l., or Cogent Europe, is the issuanceparent holding company of 11,000LambdaNet France, now named Cogent France, and LambdaNet Spain, now named Cogent Spain and our other European subsidiaries. As consideration, the investors, through the corporation they controlled, entered into a commitment to use reasonable efforts to cause LNG to be released from a guarantee of certain obligations of LambdaNet France and a commitment to fund LambdaNet France with $2.0 million. That corporation was then merged into one of our subsidiaries in a transaction in which the investors received 2,575 shares of Series I preferred stock that converted into approximately 0.8 million shares of our common stock in February 2005.
The planned second step of the transaction was the acquisition of the German network of LNG. We attempted to structure an acceptable acquisition that would have entailed using $19.5 million allocated by the investors to restructure the existing bank debt of LambdaNet Germany; however, we subsequently concluded that it was unlikely that we could structure an acceptable acquisition of LambdaNet Germany and we began to seek an alternative German network acquisition in order to complete the European portion of our network and meet the conditions required to cause the investors to fund $19.5 million.
In March 2004, we identified network assets in Germany formerly operated as part of the Carrier 1 network as an attractive acquisition opportunity. Pursuant to the November commitment, the investors funded a newly formed Delaware corporation with $19.5 million, and the corporation through a German subsidiary acquired the rights to certain assets of the Carrier 1 network in return for $2.7 million. That corporation then was merged into one of our subsidiaries, Cogent Germany, in a transaction in which the investors received shares of our Series F participating convertibleJ preferred stock that converted into approximately 6.0 million shares of our common stock in February 2005.
Acquisition of FNSI
In February 2003, we acquired the assets of Fiber Network Services, Inc., or FNSI, an Internet service provider in the Midwestern United States, in exchange for options to purchase 6,000 shares of our common stock and the assumption of certain of FNSI’s liabilities. With the acquisition of FNSI assets we expanded our off-net services.
Acquisition of PSINet
In April 2002, we purchased the principal U.S. assets of PSINet, Inc. out of bankruptcy in exchange for $9.5 million and the assumption of certain liabilities. With the acquisition of PSINet assets we began to offer our off-net service and acquired significant non-core services.
Allied Riser Merger
In February 2002, we acquired Allied Riser Communications Corporation, a facilities-based provider of broadband data, video and voice communications services to small and medium-sized businesses in the United States and Canada in exchange for the issuance of an amended and restated promissory note for the aggregate principal amount of $17.0 million. At the closing of the restructuring on July 31, 2003, we were
14
indebted to Cisco Capital for a total of $269.1approximately 0.1 million ($262.8 million of principal and $6.3 million of accrued interest).
In order to complete the restructuring we also entered into an agreement (the "Purchase Agreement") with certain of our existing preferred stockholders (the "Investors"), pursuant to which we agreed to issue and sell to the Investors in several sub-series, 41,030 shares of our Series G participating convertible preferred stock for $41.0 millioncommon stock. As a result of the merger, Allied Riser became a wholly owned subsidiary. In connection with the merger, we became co-obligor under Allied Riser’s 71¤2% Convertible Subordinated Notes which are due in cash.June 2007.
On July 31, 2003, we closedResults of Operations
Our management reviews and analyzes several key performance indicators in order to manage our business and assess the transactions contemplated by the Exchange Agreementquality of and potential variability of our net service revenues and cash flows. These key performance indicators include:
· net service revenues, which are an indicator of our overall business growth and the Purchase Agreement.success of our sales and marketing efforts;
On January 5,· gross profit, which is an indicator of both our service offering mix, competitive pricing pressures and the cost of our network operations;
· growth in our on-net customer base, which is an indicator of the success of our on net focused sales efforts;
· growth in our on-net buildings; and
· distribution of revenue across our service offerings.
Year Ended December 31, 2004 we acquired Firstmark Communications Participations S.a.r.l, the parent company to LambdaNet Communications France SAS and LambdaNet Communications Espana SA (together, "LambdaNet France and Spain"), from LNG Holdings SA by merging a subsidiary of ours with a company that had acquired them.
We issued our Series I preferred stockCompared to the owners of the company that had acquired LambdaNet France and Spain. This transaction is described in greater detail in Note 14 to our financial statements.
We attempted to acquire LambdaNet Communications Deutschland, AG ("LNCD"), a sister company of LambdaNet France and Spain, but were unable to reach agreement with LNCD's bank creditors. LNCD filed for insolvency in Germany on February 12, 2004. LambdaNet France and Spain have made use of LNCD's facilities to complete communications circuits into Germany and also have depended on LNCD for network operations support, billing and other services. We have begun the process of fully separating the operations of LambdaNet France and Spain from LNCD but that is not complete and there may be disruptions as this process proceeds.
We have entered into an agreement to acquire another German network, and may acquire additional European networks.
Year endedEnded December 31, 2003 compared to the year ended December 31, 20022005
The following summary table presents a comparison of our results of operations for the yearsyear ended December 31, 20022004 and 20032005 with respect to certain key financial measures. The comparisons illustrated in the table are discussed in greater detail below.
| | Year Ended December 31, | | ||||||
|---|---|---|---|---|---|---|---|---|
| | Percent Change | |||||||
| | 2002 | 2003 | ||||||
| | (dollars in thousands) | | ||||||
| Net service revenues | $ | 51,913 | $ | 59,422 | 14.5% | |||
| Network operation costs | 49,324 | 48,324 | (2.0)% | |||||
| Selling, general, and administrative expenses | 36,539 | 43,938 | 20.2% | |||||
| Depreciation and amortization expense | 33,990 | 48,387 | 42.4% | |||||
| Interest income | 1,739 | 1,512 | (13.1)% | |||||
| Interest expense | (36,284 | ) | (19,776 | ) | (45.5)% | |||
| Net income (loss) applicable to common stockholders | (91,843 | ) | 88,743 | (3.4)% | ||||
|
| Year Ended |
|
|
| ||||||
|
| 2004 |
| 2005 |
| Percent |
| ||||
|
| (in thousands) |
|
|
| ||||||
Net service revenue |
| $ | 91,286 |
| $ | 135,213 |
|
| 48.1 | % |
|
Network operations expenses(1) |
| 63,466 |
| 85,794 |
|
| 35.2 | % |
| ||
Gross profit(2) |
| 27,820 |
| 49,419 |
|
| 77.6 | % |
| ||
Selling, general, and administrative expenses(3) |
| 40,382 |
| 41,344 |
|
| 2.4 | % |
| ||
Restructuring charges |
| 1,821 |
| 1,319 |
|
| (27.6 | )% |
| ||
Terminated public offering costs |
| 779 |
| — |
|
| — |
|
| ||
Depreciation and amortization expenses |
| 56,645 |
| 55,600 |
|
| (1.8 | )% |
| ||
Gains—lease obligations, asset sales and debt restructurings |
| 5,292 |
| 5,058 |
|
| (4.4 | )% |
| ||
Net loss |
| (89,660 | ) | (67,518 | ) |
| (24.7 | )% |
| ||
(1) Excludes amortization of deferred compensation of $858 and $399 in the years ended December 31, 2004 and 2005, respectively, which, if included would have resulted in a period-to-period change of 34.0%.
(2) Excludes amortization of deferred compensation of $858 and $399 in the years ended December 31, 2004 and 2005, respectively, which if included would have resulted in a period-to-period change of 81.8%.
(3) Excludes amortization of deferred compensation of $11,404 and $12,906 in the years ended December 31, 2004 and 2005, respectively, which, if included would have resulted in a period-to-period change of 4.8%.
Net Service Revenue.Revenue Net. Our net service revenue increased 48.1% from $91.3 million for the year ended December 31, 2003 was $59.42004 to $135.2 million for the year ended December 31, 2005. For the years ended December 31, 2004 and 2005, on-net, off-net and non-core revenues represented 63.5%, 24.4% and 12.1% and 57.9%, 33.0% and 9.1% of our net service revenues, respectively. Off-net service revenue increased as a percentage of total revenue in 2005 as compared to $51.92004 primarily due to the inclusion of a full year of revenue from customers we added through our December 2004 acquisition of the off-net Internet access customers of Verio.
Our on-net revenues increased 35.2% from $57.9 million for the year ended December 31, 2004 to $78.3 million for the year ended December 31, 2005. Our on-net revenues increased as we increased the number of our on-net customer connections from approximately 2,800 at December 31, 2004 to approximately 4,700 at December 31, 2005. Notwithstanding the increase in on-net revenues, the percentage of on-net revenues of total revenues decreased from 2004 to 2005 due to the increase in off-net revenues from the acquisition of the off-net Internet access customers of Verio. We believe that our on-net revenues as a percentage of total revenues will increase as we are allocating the majority of our sales resources toward obtaining additional on-net customers. Our off-net revenues increased 100.4% from $22.3 million for the year ended December 31, 2004 to $44.6 million for the year ended December 31, 2005. Our off-net revenues increased as we increased the number of our off-net customer connections during 2005 primarily from the December 2004 Verio acquisition. Due primarily to the churn of these acquired customers during 2005, however, our off-net customer connections declined from approximately 4,500 at December 31, 2004 to approximately 4,000 at December 31, 2005. We expect that this loss of our
off-net customer connections will continue. Our non-core revenues increased 10.5% from $11.1 million for the year ended December 31, 2004 to $12.4 million for the year ending December 31, 2002.2005. Our non-core revenues increased as we added non-core managed modem customer connections from our October 2004 Aleron acquisition and certain non-core Verio customers in that December 2004 acquisition. The increase innumber of our non-core customer connections declined from approximately 1,790 at December 31, 2004 to approximately 1,300 at December 31, 2005. We do not actively market these acquired non-core services and expect that the net service revenue is primarily attributable to the increase inassociated with them will decline.
Our net service revenue from customers purchasing our on-net Internet access service offerings and the increase in off-net revenue from the customers acquired in the FNSI acquisition. Revenue related to the acquired assets of FNSI has beenour acquisitions is included in the consolidatedour statements of operations from the date of acquisition. The FNSI acquisition closed on February 28,
15
2003. Our increase in revenue was offset by a decline indates. Acquired net service revenues from the customers acquiredour UFO, Global Access, Aleron and Verio acquisitions, which occurred in our April 2, 2002 acquisition of certain PSINet customer accountsAugust 2004, September 2004, October 2004 and a stricter policy on cancellation of uncollectible customer accounts.
Network Operations Costs. Network operations costs during 2003 and 2002 were primarily comprised of the following elements:
The cost of network operations was $48.3December 2004, respectively, totaled $6.9 million for the year ended December 31, 2003 compared to $49.32004 and $35.5 million for the year ended December 31, 2002.2005, respectively. This increase is primarily due to the $21.7 million increase in acquired revenues from the December 2004 Verio acquisition. Approximately $2.0 million of our non-core Cogent Europe net service revenue during 2004 was derived from network sharing services rendered to LambdaNet Communications Deutschland AG, or LambdaNet Germany. LambdaNet Germany was majority-owned by LNG Holdings until April 2004 when it was sold to an unrelated third party. In the first quarter of 2005, this network sharing arrangement was terminated and there was no such revenue in 2005.
Network Operations Expenses.Our network operations expenses, excluding the amortization of deferred compensation, increased 35.2% from $63.5 million for the year ended December 31, 2004 to $85.8 million for the year ended December 31, 2005. The costincrease is primarily attributable to leased circuits and facilities costs incurred in connection with our 2004 acquisitions. We provide Internet connectivity to the acquired customers that are not located in buildings directly connected to our network. As a result we serve these off-net customers using other carriers’ facilities to provide the last mile portion of the link from our customers’ premises to our network and incur leased circuit costs to provide these services. Additionally, for the year ended December 31, 2004, Cogent Europe recorded $1.8 million of costs associated with using the LambdaNet Germany network. In 2005 this network sharing arrangement was terminated and there were no such costs in 2005.
Gross profit. Our gross profit, excluding amortization of deferred compensation, increased 77.6% from $27.8 million for the year ended December 31, 2004 to $49.4 million for the year ended December 31, 2005. The $21.6 million increase is primarily attributed to our increase in net service revenue. Our gross profit margin expanded from 30.5% in 2004 to 36.5% for the year ended December 31, 2005. We determine gross profit by subtracting network operation expenses from our net service revenue (excluding amortization of deferred compensation). Our gross profit has benefited from the limited incremental expenses associated with providing service to an increasing number of on-net customers. We have not allocated depreciation and amortization expense to our network operations expense. Our gross profit margin may be impacted by the timing and amounts of disputed circuit costs. We generally record these disputed amounts when billed by the vendor and reverse these amounts when the vendor credit has been received or the dispute has been otherwise resolved. We believe that our gross profit margin will increase as we are allocating the majority of our sales resources toward obtaining additional on-net customers and as sales of these services generate higher gross profit margins than our off-net and non-core services.
Selling, General, and Administrative Expenses. Our SG&A expenses, excluding the amortization of deferred compensation, increased 2.4% from $40.4 million for the year ended December 31, 2004 to $41.3 million for the year ended December 31, 2005. SG&A expenses increased primarily from the $2.8 million increase in salaries and related costs required to support our sales effort and an increase of approximately $0.5 million of auditor fees associated with our Sarbanes-Oxley Section 404 compliance requirements.
Amortization of Deferred Compensation. Deferred compensation is primarily related to restricted stock granted to our employees. The total amortization of deferred compensation increased from $12.3 million for the year ended December 31, 2004 to $13.3 million for the year ending December 31, 2005. The increase is primarily attributed to approximately $0.6 million of deferred compensation expense recorded in 2005 from the grant of additional restricted shares in 2005 and the amortization expense related to $4.7 million of deferred compensation related to options for restricted stock. These options were granted to certain of our employees in the third quarter of 2004 with an exercise price below the trading price of our common stock on the grant date. We amortize deferred compensation costs on a straight-line basis over the service period.
Restructuring charges. In 2004, Cogent France re-located its Paris headquarters. The estimated net present value of the remaining lease obligation, net of estimated sublease income, was approximately $1.8 million and was recorded as a restructuring charge in 2004. In the third quarter of 2005, we revised our estimate for sublease income and estimated that the net present value of the remaining lease obligation increased by approximately $1.3 million and recorded an additional restructuring charge.
Withdrawal of Public Offering. In May 2004, we filed a registration statement to sell shares of common stock in a public offering. In October 2004, we withdrew this registration statement and expensed the associated deferred costs of approximately $0.8 million.
Depreciation and Amortization Expenses. Our depreciation and amortization expense decreased 1.8% from $56.6 million for the year ended December 31, 2004 to $55.6 million for the year ended December 31, 2005. The decrease is primarily attributed to a $6.3 million decrease in the amortization expense of intangible assets, that were fully amortized in 2005. In addition, in the fourth quarter of 2005, we revised the number of lease renewal periods used in determining the lease term for purposes of amortizing certain of our leasehold improvements. This resulted in a net increase in depreciation expense of approximately $3.0 million.
Gains—Lease Obligations, Asset Sales and Debt Restructurings. In 2004, we renegotiated several capital lease obligations for our intra-city fiber in France and Spain. These transactions resulted in gains of approximately $5.3 million recorded as gains on lease obligation restructurings for the year ended December 31, 2004.
In March 2005, we sold our building and land located in Lyon, France for net proceeds of $5.1 million. These assets were acquired in the Cogent Europe acquisition. This transaction resulted in a gain of approximately $3.9 million. In June 2005, we used a portion of the proceeds from our Public Offering to repay our $17.0 million Amended and Restated Cisco Note. The repayment of the Amended and Restated Cisco Note resulted in a gain of $0.8 million representing the amount of the estimated future interest payments that was not required to be paid. In September 2005, we re-negotiated a capital lease obligation for our intra-city fiber in Spain. The modification to the IRU capital lease resulted in a gain of approximately $0.8 million.
Net Loss.Our net loss was $89.7 million for the year ended December 31, 2004 as compared to a net loss of $67.5 million for the year ended December 31, 2005. The $22.2 million reduction in our net loss occurred primarily due to the $21.6 million increase in our gross margin.
Buildings On-net. As of December 31, 2004 and 2005 we had a total of 989 and 1,040 on-net buildings connected to our network, respectively.
Year Ended December 31, 2003 Compared to the Year Ended December 31, 2004
The following summary table presents a comparison of our results of operations for the year ended December 31, 2003 and December 31, 2002 includes approximately $1.3 million and $0.2 million, respectively, of2004 with respect to certain key financial measures. The comparisons illustrated in the table are discussed in greater detail below.
|
| Year Ended |
|
|
| ||||
|
| 2003 |
| 2004 |
| Percent |
| ||
|
| (in thousands) |
|
|
| ||||
Net service revenue |
| $ | 59,422 |
| $ | 91,286 |
| 53.6 | % |
Network operations expenses(1) |
| 47,017 |
| 63,466 |
| 35.0 | % | ||
Gross profit(2) |
| 12,405 |
| 27,820 |
| 124.3 | % | ||
Selling, general, and administrative expenses(3) |
| 26,570 |
| 40,382 |
| 52.0 | % | ||
Restructuring charge |
| — |
| 1,821 |
| — |
| ||
Terminated public offering costs |
| — |
| 779 |
| — |
| ||
Depreciation and amortization expenses |
| 48,387 |
| 56,645 |
| 17.1 | % | ||
Gain—Cisco debt restructuring |
| 215,432 |
| — |
| — |
| ||
Gain—Allied Riser note exchange |
| 24,802 |
| — |
| — |
| ||
Gains—lease obligations restructuring |
| — |
| 5,292 |
| — |
| ||
Net income (loss) |
| 140,743 |
| (89,660 | ) | (163.7 | )% | ||
(1) Excludes amortization of deferred compensation expense. The increaseof $1,307 and $858 in the years ended December 31, 2003 and 2004, respectively, which, if included would have resulted in a period-to-period change of 33.1%.
(2) Excludes amortization of deferred compensation expense isof $1,307 and $858 in the years ended December 31, 2003 and 2004, respectively, which if included would have resulted in a period-to-period change of 142.9%.
(3) Excludes amortization of deferred compensation of $17,368 and $11,404 in the years ended December 31, 2003 and 2004, respectively, which, if included would have resulted in a period-to-period change of 17.9%.
Net Service Revenue. Our net service revenue increased 53.6% from $59.4 million for the year ended December 31, 2003 to $91.3 million for the year ending December 31, 2004. For the year ended December 31, 2003 and 2004, on-net, off-net and non-core revenues represented 55.5%, 26.4% and 18.1% and 63.5%, 24.4% and 12.1% of our net service revenues, respectively. On-net revenues increased as a percentage of total revenue in 2004 as compared to 2003 due to the faster rate at which on-net revenues increased compared to off-net and non-core revenues. This was primarily due to our sales and marketing efforts focusing on on-net customers.
Our on-net revenues increased 75.6% from $33.0 million for the year ended December 31, 2003 to $57.9 million for the year ended December 31, 2004. Our on-net revenues increased as we increased the number of our on-net customer connections from approximately 1,650 at December 31, 2003 to approximately 2,800 at December 31, 2004. Our off-net revenues increased 41.8% from $15.7 million for the year ended December 31, 2003 to $22.3 million for the year ending December 31, 2004. Our off-net revenues increased as we increased the number of our off-net customer connections served during 2004 primarily from the off-net customer connections acquired in the December 2004 Verio acquisition. Our non-core revenues increased 3.3% from $10.7 million for the year ended December 31, 2003 to $11.1 million for the year ending December 31, 2004. Our non-core revenues increased from 2004 to 2005 primarily due to an increase of $4.0 million in non-core revenue from our October 2004 Aleron acquisition, parly offset by the loss of $2.0 million of non-core net service revenue provided to Lambdanet Germany in
2004, discussed below. The number of our non-core customer connections declined from approximately 1,830 at December 31, 2003 to approximately 1,790 at December 31, 2004. We do not actively market these acquired non-core services and expect that the net service revenue associated with them will decline.
Our net service revenue related to our acquisitions is included in our statements of operations from the acquisition dates. Net service revenue from our January 5, 2004 Cogent Europe acquisition totaled approximately $23.3 million for the year ended December 31, 2004. Approximately $2.0 million of the Cogent Europe non-core net service revenue during the period was derived from network sharing services rendered to LambdaNet Communications Deutschland AG, or LambdaNet Germany. LambdaNet Germany was majority-owned by LNG Holdings until April 2004 when it was sold to an unrelated third party. In the first quarter of 2005, this network sharing arrangement was terminated and there was no such revenue recorded in 2005. Net service revenue from our UFO, Global Access, Aleron and Verio acquisitions that occurred in August 2004, September 2004, October 2004 and December 2004, respectively, totaled $6.9 million for the year ended December 31, 2004.
Network Operations Expenses. Our network operations expenses, excluding the amortization of deferred compensation, increased 35.0% from $47.0 million for the year ended December 31, 2003 to $63.5 million for the year ended December 31, 2004. The increase is primarily attributable to $15.4 million of costs incurred in connection with the operation of our European network after our Cogent Europe and Global Access acquisitions. For the year ended December 31, 2004, Cogent Europe recorded $1.8 million of costs associated with using the LambdaNet Germany network. In the first quarter of 2005, this network sharing arrangement was terminated.
Gross profit. Our gross profit, excluding amortization of deferred compensation, increased 124.3% from $12.4 million for the year ended December 31, 2003 to $27.8 million for the year ended December 31, 2004. The $15.4 million increase is attributed to both an increase in net service revenue and an increase in such revenue attributed to higher margin on-net services. Our gross profit margin expanded from 20.9% in 2003 to 30.5% for the year ended December 31, 2004 due primarily to the increase in the percentage of our revenues derived from our on-net revenue. We determine gross profit by subtracting network operation expenses (excluding amortization of deferred compensation) from our net service revenue. We have not allocated depreciation and amortization expense to our network operations expense.
Selling, General, and Administrative Expenses. Our SG&A expenses, excluding the amortization of deferred compensation, increased 52.0% from $26.6 million for the year ended December 31, 2003 to $40.4 million for the year ended December 31, 2004. SG&A expenses increased primarily from the $13.2 million of SG&A expenses associated with our operations in Europe after our Cogent Europe and Global Access acquisitions.
Amortization of Deferred Compensation. The total amortization of deferred compensation decreased from $18.7 million for the year ended December 31, 2003 to $12.3 million for the year ending December 31, 2004. The decrease is attributed to $13.1 million of amortization of deferred compensation expense recorded in connection withOctober 2003 since the grantvesting of restricted shares of Series H preferred stockgranted to our employees in 2003. Deferred compensation is being amortized over the vesting period of the Series H preferred stock. The vesting period for grants under our 2003 Incentive Award Plan and offer to exchange iswas 27% upon grant with the remaining shares vesting ratably over a three-year period, and for new employees 25% after one year and then ratably over a four-year period. Total
Deferred compensation expenseis related to Series H preferred stock was approximately $16.4 million for the year ended December 31, 2003. Beginning with the April 2, 2002 PSINet acquisition, we incurred transitional circuit and maintenance fees that were required to be paid for a seventy-five day period under the PSINet asset purchase agreement and recurring circuit fees for providing PSINet's off-net Internet access service. Recurring circuit fees decreased in the year ended December 31, 2003 compared to the year ended December 31, 2002 due to a reduction in the number of PSINet customers partly offset by an increase in circuit fees as a result of the February 28, 2003 FNSI acquisition. Fees associated with tenant license agreements acquired in the Allied Riser acquisition decreased in the year ended December 31, 2003 compared to the year ended December 31, 2002 due to the termination of many of these agreements.
Selling, General, and Administrative Expenses. Selling, general and administrative expenses, or SG&A, primarily include salaries and related administrative costs. SG&A expenses increased to $43.9 million for the year ended December 31, 2003 from $36.6 million for the year ended December 31, 2002. SG&A expenses for the year ended December 31, 2003 and December 31, 2002 included approximately $17.4 million and $3.1 million, respectively, of amortization of deferred compensation expense. The increase in amortization of deferred compensation expense is due to the amortization (described above) of deferred compensation expense recorded in connection with the our granting ofrestricted shares of Series H preferred stockgranted to our employees in 2003. Total compensation expense related to Series H preferred stock was approximately $16.4 million for the year ended December 31, 2003. SG&A for the year ended December 31, 2003 and December 31, 2002 included approximately $3.9 million and $3.2 million, respectively, of net expense for the valuation allowance for doubtful accounts. SG&A expenses before amortization of deferred compensation decreased primarily from a decrease in transitional activities associated with the PSINet and Allied Riser acquisitions and a decrease in headcount partially offset by an increase in the net expense for the valuation allowance for doubtful accounts. We capitalize the salaries and related benefits of employees directly involved with
16
our construction activities. We began capitalizing these costs in July 2000 and will continue to capitalize these costs while we are involved in construction activities. We capitalized $2.6 million of these costs for the year ended December 31, 2003 and $4.8 million for the year ended December 31, 2002. The decline in capitalized costs is due to a decrease in construction activities.
Depreciation and Amortization Expenses. Depreciation and amortization expenses include the depreciation of our property and equipment and the amortization of $4.7 million of deferred compensation related to stock options. These options were granted to certain of our intangible assets. employees in the third quarter of 2004 with an exercise price below the trading price of our common stock on the grant date. We amortize deferred compensation costs on a straight-line basis over the service period.
Restructuring charge. In July 2004, we abandoned an office in Paris obtained in the Cogent Europe acquisition and relocated operations to another Cogent Europe facility. We recorded a restructuring
charge of approximately $1.8 million related to the remaining commitment on the lease less our estimated sublease income.
Withdrawal of public offering. In May 2004, we filed a registration statement to sell shares of common stock in a public offering. In October 2004, we withdrew this registration statement and expensed the associated costs of approximately $0.8 million.
Depreciation and Amortization Expenses. Our depreciation and amortization expense increased to17.1% from $48.4 million for the year ended December 31, 2003 from $34.0to $56.6 million for the year ended December 31, 2002. Depreciation expense related to property and equipment was approximately $38.42004. Of this increase, $8.2 million and $26.6 million, for the years ended December 31, 2003 and December 31, 2002 respectively. Depreciation expense increased because we had more capital equipment and IRUs in service in 2003 than in the same period in 2002. Amortization expense related to intangible assets for the year ended December 31, 2003 and December 31, 2002 was approximately $10.0 million and $7.4 million, respectively. Amortization expense increased because we had more intangible assets in 2003 than in the same period in 2002. We begin to depreciate our capital assets once the related assets are placed in service. We believe that future depreciation expense will continue to increase primarily due to additional equipment being placed in service and an increase in IRUs as we expand our network.
Interest Income and Expense. Interest income relates to interest earned on our marketable securities including money market accounts, certificates of deposit and commercial paper. Interest income decreased to $1.5 million for the year ended December 31, 2003 from $1.7 million for the year ended December 31, 2002. The reduction in interest income resulted from a decrease in marketable securitiesdepreciation and a reduction in interest rates.
Interest expense includes interest charged on our credit facility, capital lease agreements, the convertible subordinated notes issued by our subsidiary Allied Riser and the amortization of deferred financing costs. Interest expense decreased to $19.8 million for the year ended December 31, 2003 from $36.3 million for the year ended December 31, 2002. The decreaseassets acquired in interest expense resulted from (1) the cancellation of $106.7 million in principal amount of the Riser convertible subordinated notes under the March 2003 settlementour Cogent Europe and exchange, (2) the July 31, 2003Global Access acquisitions.
Gain—Credit Facility Restructuring. The restructuring of our Cisco credit facility with Cisco Capital which eliminated the amortization of our deferred financing costs and significantly reduced our indebtedness to Cisco Capital and (3) to a lesser extent, a reduction in interest rates. Borrowings under the credit facility accrued interest at the three-month LIBOR rate, established at the beginning of each calendar quarter, plus 4.5 percent. The Cisco restructuring transaction was considered a troubled debt restructuring under Statement of Financial Accounting Standards ("SFAS") No.15, "Accounting by Debtors and Creditors of Troubled Debt Restructurings". Under SFAS No. 15, the $17.0 million Amended and Restated Cisco Note was recorded at its principal amount plus the estimated future interest payments. Interest payments begin in the 31st month following the effectiveness of the restructuring transaction and accrue at ninety day LIBOR plus 4.5%. No interest is payable, nor does interest accrue on the Amended and Restated Cisco Note for the first 30 months, unless the Company defaults under the terms of the Amended and Restated Credit Agreement. We believe that future interest expense will continue at a decreased rate due to the July 31, 2003 cancellation of debt outstanding under our credit facility, as discussed above.
Income Taxes. We recorded no income tax expense or benefit for the year ended December 31, 2003 or the year ended December 31, 2002. Due to the uncertainty surrounding the realization of our net operating losses and our other deferred tax assets, we have recorded a valuation allowance for the full amount of our net deferred tax asset. For federal and state tax purposes, our net operating loss carry-forwards could be subject to certain limitations on annual utilization if certain changes in ownership were to occur as defined by federal and state tax laws. For federal and state tax purposes, our net operating loss carry-forwards acquired in the Allied Riser merger will be subject to certain
17
limitations on annual utilization due to the change in ownership as defined by federal and state tax laws. However, we achieve profitability, our net deferred tax assets may be available to offset future income tax liabilities.
Under Section 108(a)(1)(B) of the Internal Revenue Code of 1986 gross income does not include any amount that would be includible in gross income by reason of the discharge of indebtedness to the extent that a non-bankrupt taxpayer is insolvent. Under Section 108(a)(1)(B) we believe that the gains on our debt restructuring with Cisco and settlement and exchange agreement with Allied Riser note holders will not result in taxable income, however, our net operating loss carry-forwards will be significantly reduced effective January 1, 2004 in connection with these transactions.
Settlement of Note holder Litigation and Gain on Note Exchange. In January 2003, we entered into an exchange agreement and a settlement agreement with the holders of approximately $106.7 million in face value of convertible subordinated notes issued by our subsidiary, Allied Riser. Pursuant to the exchange agreement, these note holders surrendered their notes, including accrued and unpaid interest thereon, in exchange for a cash payment of approximately $5.0 million, 3.4 million shares of our Series D preferred stock and 3.4 million shares of our Series E preferred stock. Pursuant to the settlement agreement, the note holders dismissed with prejudice litigation filed by the note holders in Delaware Chancery Court against Allied Riser. These transactions closed in March 2003 when the agreed amounts were paid and the Series D and Series E preferred shares were issued. This settlement and exchange eliminated the approximately $106.7 million principal payment obligation due in September 2007, interest accrued since the December 15, 2002 interest payment, all future interest payment obligations on these notes and settled the note holder litigation in exchange for the total cash payments of approximately $9.9 million and the issuance of preferred stock. At issuance, this preferred stock was convertible into approximately 4.2% of our then outstanding fully diluted common stock. The terms of the remaining $10.2 million of subordinated convertible notes were not impacted by these transactions and they continue to be due on June 15, 2007. These notes were recorded at their fair value of approximately $2.9 million at the merger date. The discount is accreted to interest expense through the maturity date
As of December 31, 2002, we had accrued the amount payable under the settlement agreement, net of the recovery of $1.5 million under our insurance policy. This resulted in a net expense of $3.5 million recorded in the fourth quarter of 2002. The $4.9 million payment under the settlement agreement was made in March 2003. We received the $1.5 million recovered under our insurance policy in April 2003.
The exchange agreement resulted in a gain of approximately $215.4 million. The gain resulting from the retirement of the amounts outstanding under the credit facility was determined as follows (in thousands):
Cash paid | $ | 20,000 |
|
|
Issuance of Series F preferred stock | 11,000 |
|
| |
Amended and Restated Cisco Note, principal plus future interest | 17,842 |
|
| |
Transaction costs | 1,167 |
|
| |
Total consideration | $ | 50,009 |
|
|
Amount outstanding under Cisco credit facility | (262,812 | ) |
| |
Interest accrued under the Cisco credit facility | (6,303 | ) |
| |
Book value of cancelled warrants | (8,248 | ) |
| |
Book value of unamortized loan costs | 11,922 |
|
| |
Total indebtedness prior to recapitalization | $ | (265,441 | ) |
|
Gain from recapitalization | $ | 215,432 |
|
|
Gain—Allied Riser Note Exchange. In connection with the exchange and settlement related to our 71¤2% Convertible Subordinated Notes we recorded a gain of approximately $24.8 million recorded during the year ended December 31, 2003. TheThis gain resulted from the difference between the $36.5 million net book value of the notes ($106.7 million face value less the related unamortized discount of $70.2 million) and $2.0 million of accrued interest, and the cash consideration of approximately $5.0 million in cash and the $8.5 million estimated fair market value for the Series D and Series E preferred stock issued to the note holders less approximately $0.2 million of transaction costs.
Gain—Cisco credit facility restructuring. The restructuringestimated fair market value for the Series D and Series E preferred stock was determined by using the price per share of our Cisco credit facility on July 31, 2003Series C preferred stock, which represented our most recent equity transaction for cash.
Gain—Lease obligations restructuring. In 2004, we re-negotiated several lease obligations for our intra-city fiber in France and Spain. These transactions resulted in a gaingains of approximately $215.4 million. On a basic$5.3 million recorded as gains on lease obligation restructurings for the year ended December 31, 2004.
Net Income (Loss). Net income and diluted income per share basis the gain was $27.82 and $1.36$140.7 million for the year ended December 31, 2003 respectively. The gain
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resulted fromas compared to a net loss of $(89.7) million for the retirement of the amounts outstanding under the Cisco credit facility and was determined as follows (in thousands):
| Cash paid | $ | 20,000 | ||
| Issuance of Series F Preferred Stock | 11,000 | |||
| Amended and Restated Cisco Note, principal plus future interest | 17,842 | |||
| Transaction costs | 1,167 | |||
| Total Consideration | $ | 50,009 | ||
Amount outstanding under Facility | (262,812 | ) | ||
| Interest accrued under the Facility | (6,303 | ) | ||
| Book value of cancelled warrants | (8,248 | ) | ||
| Book value of unamortized Facility loan costs | 11,922 | |||
| Gain from Exchange Agreement | $ | (215,432 | ) | |
Earnings Per Share. Basicyear ended December 31, 2004. Included in net (loss) income per common share applicable to common stock was $11.46 for the year ended December 31, 2003 and $(28.22) for the year ended December 31, 2002. The weighted-average shares of common stock outstanding increased to 7.7 million shares for the year ended December 31, 2003are gains from 3.3 million shares for the year ended December 31, 2002 due to the July 31, 2003 conversion of our Series A, B, C, D and E convertible preferred stock into 10.8 million shares of common stock. A beneficial conversion charge of $52.0 million was recorded on July 31, 2003 since the conversion rates on our Series F and Series G convertible preferred stock at issuance were less than the trading price of our common stock on that date. The beneficial conversion charge reduced basic earnings per common share by $6.71 for the year ended December 31, 2003. Without the charge, basic earnings per common share was $18.17 for the year ended December 31, 2003. The Allied Riser merger resulted in an extraordinary gain of $8.4 million, or $2.59 per common share for the year ended December 31, 2002. The loss per common share, excluding the impact of the extraordinary gain, was ($30.82) for the year ended December 31, 2002.debt restructurings totaling $240.2 million.
Diluted net (loss) income per common share applicable to common stock was $0.56 for the year endedBuildings On-net. As of December 31, 2003 and $(28.22) for the year ended December 31, 2002. The diluted weighted-average shares of common stock outstanding increased to 158.8 million shares for the year ended December 31, 2003 from 3.3 million shares for the year ended December 31, 2002 due primarily to the February 5, 2003 issuance of Series D and Series E convertible preferred stock, which were converible into approximately 0.7 million shares of our common stock,the July 31, 2003 issuance of Series F and Series G convertible preferred stock which is convertible into2004 we had a total of 323.1 million shares813 and 989 on-net buildings connected to our network, respectively.
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Liquidity and Capital Resources
In assessing our liquidity, our management reviews and analyzes our current cash balances on-hand, short-term investments, accounts receivable, accounts payable, capital expenditure commitments, and required capital lease and debt payments and other obligations.
We have recently engaged in a series of transactions that have impacted our common stock,liquidity. These included the July 31, 2003 conversion offollowing:
· On June 13, 2005, we consummated our Series A, B and C convertible preferred stock into approximately 10.1 million shares of common stock and the issuance of our shares of Series H preferred stockPublic Offering, in which is convertible into a total of approximately 41.4 million shares of our common stock. A beneficial conversion charge of $52.0 million was recorded on July 31, 2003 since the conversion rates on the Series F and Series G convertible preferred stock at issuance were less than the trading price of our common stock on that date. The beneficial conversion charge reduced diluted income per common share by $0.33 for the year ended December 31, 2003. Without the charge, diluted income per common share was $0.89 for the year ended December 31, 2003. The Allied Riser merger resulted in an extraordinary gain of $8.4 million, or $2.59 per common share for the year ended December 31, 2002. The loss per diluted common share, excluding the impact of the extraordinary gain, was ($30.82) for the year ended December 31, 2002.
For the year ended December 31, 2002, options to purchase 1.0we sold 10.0 million shares of common stock at a weighted-average exercisepublic offering price of $4.41$6.00 per share, 95.1 million shares of preferred stock, which were convertible into 10.1share. On June 16, 2005 the underwriters exercised their option to purchase an additional 1.5 million shares of common stock,stock. The Public Offering resulted in net proceeds of $63.7 million, after underwriting, legal, accounting and warrants for 0.9 million shares of commonprinting costs.
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stock are not included in the computation of diluted earnings per share as they are anti-dilutive. For the years ended December 31, 2002 and 2003, approximately 245,000 and 17,530 shares of common stock issuable on the conversion· In June 2005, we used a portion of the Allied Riser convertibleproceeds from the Public Offering to repay our $17.0 million Amended and Restated Cisco Note and our $10.0 million subordinated notes,note to Columbia Ventures Corporation plus $0.3 million of accrued interest. Both of these obligations were not included inrequired to be repaid with the computationPublic Offering proceeds under the terms of diluted earnings per share asthe related note agreements.
· On March 9, 2005, we entered into a resultcredit facility with a commercial bank. The credit facility provided for borrowings of their anti-dilutive effect.up to $10.0 million and is secured by our accounts receivable. In December 2005 we amended the facility and increased the available borrowings to up to $20.0 million and removed a $4.0 million restricted cash covenant.
Results of OperationsCash Flows
Year Ended December 31, 2002 Compared to the Year Ended December 31, 2001
The following summary table presents a comparison ofsets forth our results of operationsconsolidated cash flows for the years ended December 31, 20012003, 2004, and 2002 with respect to certain key financial measures. The comparisons illustrated2005.
|
| Year Ended December 31, |
| |||||||
|
| 2003 |
| 2004 |
| 2005 |
| |||
|
| (in thousands) |
| |||||||
Net cash used in operating activities |
| $ | (27,357 | ) | $ | (26,425 | ) | $ | (9,062 | ) |
Net cash used in investing activities |
| (25,316 | ) | (2,701 | ) | (14,055 | ) | |||
Net cash provided by financing activities |
| 20,562 |
| 34,486 |
| 39,824 |
| |||
Effect of exchange rates on cash |
| 672 |
| 609 |
| (668 | ) | |||
Net (decrease) increase in cash and cash equivalents during period |
| $(31,439 | ) | $ | 5,969 |
| $ | 16,039 |
| |
Net Cash Used in the table are discussedOperating Activities. Net cash used in greater detail below.
| | Year Ended December 31, | | ||||||
|---|---|---|---|---|---|---|---|---|
| | Percent Change | |||||||
| | 2001 | 2002 | ||||||
| | (dollars in thousands) | | ||||||
| Net service revenues | $ | 3,018 | $ | 51,913 | 1620.1% | |||
| Network operation costs | 20,297 | 49,324 | 143.0% | |||||
| Selling, general, and administrative expenses | 30,280 | 36,539 | 20.7% | |||||
| Depreciation and amortization expense | 13,535 | 33,990 | 151.1% | |||||
| Interest income | 2,126 | 1,739 | (18.2)% | |||||
| Interest expense | (7,945 | ) | (36,284 | ) | 356.7% | |||
| Net income (loss) applicable to common stockholders | (91,081 | ) | (91,843 | ) | 0.8% | |||
Net Service Revenue. Net service revenue for the year ended December 31, 2002operating activities was $51.9 million compared to $3.0 million for the year ending December 31, 2001. The increase in net service revenue is attributable to the increase in customers purchasing our service offerings including the customers acquired in the PSINet, Allied Riser and NetRail acquisitions.
Net service revenue for the three months December 31, 2002 was $13.8 million compared to $16.0 million for the three months ending September 30, 2002. This decline primarily resulted from service cancellations from customers acquired in the PSINet acquisition more than offsetting the increase in net service revenues from new installations of our on-net product offerings.
Network Operations Costs. Network operations costs during 2002 and 2001 were primarily comprised of the following elements:
The cost of network operations was $49.3$26.4 million for the year ended December 31, 20022004 compared to $20.3$9.1 million for 2005. The reduction is primarily due to the increase in gross margin dollars generated from our increase in revenues. Our primary sources of operating cash are receipts from our customers who are billed on a monthly basis for our services. Our primary uses of operating cash are payments made to our vendors and employees. Our net loss was $89.7 million for the year ended December 31, 2001. The increase was primarily due2004 compared to an increase in the numbera net loss of leased network facilities, circuit fees commencing in April 2002 related to the PSINet
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customers acquired, an increase in maintenance fees on our IRUs and network equipment, an increase in transit charges associated with an increase in network traffic, an increase in headcount, and an increase in the number of building access agreements and the related fees, including the building access agreements acquired in the February 2002 Allied Riser merger. These increases are partially offset by the elimination of temporary leased transmission capacity charges in 2002. The cost of temporary leased transmission capacity was $3.9$67.5 million for the year ended December 31, 2001. There were no such costs2005. Net loss for the year ended December 31, 2002. Leased transmission capacity costs were incurred until the remaining segments2004 included non-cash gains of $6.1 million related to our nationwide fiber-optic intercity network were placed in service. As this leased capacityrestructuring of the network was replaced with our dark fiber IRUs, the related cost of network operations decreased and depreciation and amortization expense increased. The cost of network operationscertain lease obligations. Net loss for the yearsyear ended December 31, 20012005 included non-cash gains of $4.8 million related to our restructuring of certain lease obligations, repayment of our Cisco note obligation and December 31, 2002 includes approximately $0.3 millionnet gains on asset sales. Depreciation and $0.2 million, respectively, ofamortization, including the amortization of deferred compensation.
Selling, General,compensation and Administrative Expenses. Selling, general and administrative expenses, or SG&A, primarily include salaries and related administrative costs. SG&A increased to $36.6the debt discount on the Allied Riser notes was $70.0 million for the year ended December 31, 2002 from $30.32004, and $70.5 million for the year ended December 31, 2001. SG&A for the years ended December 31, 20012005. Net changes in
operating assets and December 31, 2002 includes approximately $3.0 million and $3.1 million, respectively,liabilities resulted in a decrease to operating cash of amortization of deferred compensation. SG&A for the years ended December 31, 2001 and December 31, 2002 includes approximately $0.5 million and $3.2 million, respectively, of the valuation allowance for doubtful accounts. SG&A expenses increased primarily from an increase in activities required to support the increase in customers and expanding operations. We capitalize the salaries and related benefits of employees directly involved with our construction activities. We began capitalizing these costs in July 2000. We capitalized $7.0 million of these costs for the year ended December 31, 2001 and $4.7$0.6 million for the year ended December 31, 2002.
Gain on Settlement of Vendor Litigation. In December 2002 we reached an agreement with one of Allied Riser's vendors to settle the litigation brought by that vendor against Allied Riser. Under this settlement, Allied Riser agreed to make cash payments to the vendor of approximately $1.6 million in 2003. In exchange, the vendor dismissed the litigation and accepted that cash payment as payment in full of amounts due to the vendor under the contracts that were the subject of the litigation. In 2003, we paid $1.2 million of the $1.6 million settlement. The remaining $0.4 million was paid in equal monthly installments from April to July 2003. The settlement amount was less than the amounts recorded by Allied Riser resulting in a gain of approximately $5.7 million that was recorded in December 2002.
Settlement of Noteholder Litigation. In January 2003, Cogent Communications Group, Allied Riser and the holders of approximately $106.7 million in face value of subordinated convertible notes issued by Allied Riser entered into an exchange agreement2004 and a settlement agreement. Pursuant to the exchange agreement, the note holders surrendered to Allied Riser their notes, including accrued and unpaid interest thereon,decrease in exchange for an aggregateoperating cash payment by Allied Riser in the amount of approximately $5.0 million and 3.4 million shares of our Series D Preferred Stock and 3.4 million shares of our Series E Preferred Stock. Under the agreement the Series D and Series E shares have been valued at the estimated fair value of approximately $1.25 per share. Pursuant to the settlement agreement, the note holders dismissed their litigation with prejudice and delivered to us, Allied Riser and certain former directors of Allied Riser a general release in exchange for an aggregate cash payment by Allied Riser of approximately $4.9 million.
As of December 31, 2002, we accrued the amount payable under the settlement agreement, net of the recovery under our insurance policy. This resulted in a net expense of approximately $3.5 million recorded in 2002. The transaction under the exchange agreement resulted in a 2003 financial statement gain of approximately $25 million.
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Depreciation and Amortization. Depreciation and amortization expense increased to $34.0$7.2 million for the year ended December 31, 2002 from $13.5 million for the year ended December 30, 2001. These expenses include the depreciation of the capital equipment required to support our network, and the amortization of our IRUs and intangible assets. Amortization expense related to intangible assets for the years ended December 31, 2001 and December 31, 2002 was approximately $1.3 million and $7.4 million, respectively. There were no intangible assets in 2001 until the September 7, 2001 acquisition of certain assets of NetRail. Depreciation expense increased because we had more capital equipment and IRUs in service in 2002 than in the same period in 2001. We begin to depreciate our capital assets once the related assets are placed in service.2005.
Interest Income and Expense. Interest income decreased to $1.7 million for the year ended December 31, 2002 from $2.1 million for the year ended December 31, 2001. Interest income relates to interest earned on our marketable securities including money market accounts, certificates of deposit and commercial paper. The change in interest income resulted from a decrease in marketable securities and a reduction in interest rates.
Interest expense increased to $36.3 million for the year ended December 31, 2002 from $7.9 million for the year ended December 31, 2001. The increase in interest expense resulted from an increase in borrowings under our credit facility, an increase in the number of capital leases and the interest expense associated with the Allied Riser convertible subordinated notes and was partially offset by a reduction in interest rates. Interest expense includes interest charged on our vendor financing facility, capital lease agreements, the Allied Riser convertible subordinated notes and the amortization of deferred financing costs. Cogent began borrowing under its credit facility with Cisco Capital in August 2000 and had borrowed $250.3 million at December 31, 2002 and $181.3 million at December 31, 2001. We capitalized $0.8 million of interest expense for the year ended December 31, 2002 and $4.4 million for the year ended December 31, 2001. The reduction in capitalized interest resulted from a reduction in the dollar value of our network under construction during the period and a reduction in interest rates. We began capitalizing interest in July 2000. Borrowings under the credit facility accrued interest at the three-month LIBOR rate, established at the beginning of each calendar quarter, plus a stated margin.
Income Taxes. We recorded no income tax expense or benefit for the year ended December 31, 2002 or the year ended December 31, 2001. Due to the uncertainty surrounding the realization of our net operating losses and our other deferred tax assets, we have recorded a valuation allowance for the full amount of our net deferred tax asset. For federal and state tax purposes, our net operating loss carry-forwards could be subject to certain limitations on annual utilization if certain changes in ownership were to occur as defined by federal and state tax laws. For federal and state tax purposes, our net operating loss carry-forwards acquired in the Allied Riser merger will be subject to certain limitations on annual utilization due to the change in ownership as defined by federal and state tax laws. Should we achieve profitability, our net deferred tax assets may be available to offset future income tax liabilities.
Earnings Per Share. Basic and diluted net loss per common share applicable to common stock decreased to $(28.22) for the year ended December 31, 2002 from $(64.78) for the year ended December 31, 2001. The weighted-average shares of common stock outstanding increased to 3.3 million shares for the year ended December 31, 2002 from 1.4 million shares for the year ended December 31, 2001, due primarily to the issuance of approximately 2.0 million shares of common stock to the Allied Riser shareholders on February 4, 2002. The Allied Riser merger resulted in an extraordinary gain of $8.4 million, or $2.59 per common share for the year ended December 31, 2002. The loss per common share, excluding the impact of the extraordinary gain, was ($30.82) for the year ended December 31, 2002.
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For the years ended December 31, 2001 and 2002, options to purchase 1.2 million and 1.0 million shares of common stock at weighted-average exercise prices of $5.30 and $4.41 per share, respectively, are not included in the computation of diluted earnings per share as they are anti-dilutive. For the years ended December 31, 2001 and 2002, 95.6 million and 95.1 million shares of preferred stock, which were convertible into 10.1 million and 10.1 million shares of common stock, respectively, were not included in the computation of diluted earnings per share as a result of their anti-dilutive effect. For the years ended December 31, 2001 and 2002, warrants for 0.7 million and 0.9 million shares of common stock, respectively, were not included in the computation of diluted earnings per share as a result of their anti-dilutive effect. For the year ended December 31, 2002, approximately 245,000 shares of common stock issuable on the conversion of the Allied Riser convertible subordinated notes, were not included in the computation of diluted earnings per share as a result of their anti-dilutive effect.
Liquidity and Capital Resources
Since our inception, we have primarily funded our operations and capital expenditures through private equity financing, capital lease obligations and our credit facility with Cisco Capital. At December 31, 2003, our current cash and cash equivalents position and short-term investments totaled $12.0 million.
During the years ended December 31, 2003, two transactions in particular has an impact on our liquidity and our level of indebtedness. These were our restructuring transaction with Cisco Capital and Cisco and our settlement with the Allied Riser Noteholders.
Resolution of Default Under Cisco Credit Facility and Sale of Series F and Series G Preferred Stock. Prior to July 31, 2003 we were party to a $409 million credit facility with Cisco Systems Capital Corporation ("Cisco Capital"). The credit facility required compliance with certain financial and operational covenants. We were in violation of a financial covenant as of December 31, 2002 and as a result Cisco Capital could have accelerated the due date of our indebtedness.
On June 12, 2003, our Board of Directors unanimously adopted a resolution authorizing us to consummate a transaction with Cisco Capital and Cisco Systems, Inc. ("Cisco") that would restructure our indebtedness to Cisco Capital as well as to offer and sell a new series of preferred stock to certain of our existing stockholders in order to acquire the cash needed to complete the restructuring and additional working capital. On June 26, 2003, our stockholders approved these transactions.
In order to complete the restructuring we entered into an agreement (the "Exchange Agreement") with Cisco and Cisco Capital pursuant to which, among other things, Cisco and Cisco Capital agreed to cancel the principal amount of indebtedness plus accrued interest and return warrants exercisable for the purchase of 0.8 million shares of our common stock (the "Cisco Warrants") in exchange for our cash payment of $20.0 million, the issuance of 11,000 shares of our Series F participating convertible preferred stock, and the issuance of an amended and restated promissory note for the aggregate principal amount of $17.0 million. On July 31, 2003, we were indebted to Cisco Capital for a total of $269.1 million ($262.8 million of principal and $6.3 million of accrued interest).
In order to complete the restructuring we also entered into an agreement (the "Purchase Agreement") with certain of our existing preferred stockholders (the "Investors"), pursuant to which we agreed to issue and sell to the Investors in several sub-series, 41,030 shares of our Series G participating convertible preferred stock for $41.0 million in cash.
On July 31, 2003, we closed the transactions contemplated by the Exchange Agreement and the Purchase Agreement. The closing of these transactions resulted in the following:
Under the Purchase Agreement:
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Under the Exchange Agreement:
Settlement with Allied Riser Note Holders. In January 2003, we entered into settlement and exchange agreements with the holders of approximately $106.7 million of face value of Allied Riser's $117 million convertible subordinated notes issued by our subsidiary Allied Riser. Pursuant to the exchange agreement, the note holders agreed to surrender their notes including accrued and unpaid interest in exchange for a cash payment of approximately $5.0 million and the issuance of 3.4 million shares of our Series D convertible preferred stock and 3.4 million shares of our Series E convertible preferred stock. Pursuant to the settlement agreement, the note holders agreed to dismiss with prejudice their litigation against Allied Riser, in exchange for a cash payment of approximately $4.9 million and a general release from us. These transactions closed in March 2003 when the approximately $9.9 million was paid and the preferred shares were issued. These settlement and exchange agreements eliminated the approximately $106.7 million principal payment obligation due in September 2007 interest accrued at a 7.5% annual rate since the last interest payment made on December 15, 2002, the future semi-annual interest payment obligations on these notes, and the note holder litigation in exchange for cash payments totaling $9.9 million and the issuance of preferred stock convertible at the time of its issuance into approximately 4.2% of our then outstanding fully diluted common stock. The terms of the remaining $10.2 million of subordinated convertible notes were not impacted by these transactions and they continue to be due on June 15, 2007. These notes were recorded at their fair value of approximately $2.9 million at the merger date. The discount is accreted to interest expense through the maturity date.
Merger with Symposium Omega On March 30, 2004 we merged with Symposium Omega, Inc., ("Omega") a Delaware corporation. Prior to the merger Omega had raised approximately $19.5 million in cash and agreed to acquire a German fiber optic network. We issued 3,891 shares of our Series J convertible preferred stock to the shareholders of Omega in exchange for all of the outstanding common stock of Omega. This Series J convertible preferred stock will become convertible into approximately 120.6 million shares of our common stock.
Acquisition of German Network The German network includes a pair of single mode fibers under a fifteen-year IRU, network equipment, and the co-location rights to facilities in approximately thirty-five points of presence in Germany. The agreement will require a one-time payment of approximately 2.3 million euros and includes monthly service fees of approximately 85,000 EUROS for co-location services and maintenance for the pair of single mode fibers.
It is anticipated that the network will be delivered in full by May 2004. We intend to integrate this German network into our existing European networks and introduce point-to-point transport, transit services and our on-net product set in Germany.
Net Cash Used in Operating Activities.Net cash used in operating activities was $27.4 million for the year ended December 31, 2003 compared to $41.5$26.4 million for the year ended December 31, 2002. Net2004. Our net income was $140.7 million for the year ended December 31, 2003. Net (loss) was $(91.8)2003 compared to a net loss of $89.7 million
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for the year ended December 31, 2002.2004. Net income for the year ended December 31, 2003 includesincluded a non-cash gain of $24.8 million related to our settlement with certain Allied Riser note holders and a non-cash gain of $215.4 million related to the restructuring of our Cisco credit facility with Cisco Capital and a $24.8 million gain related to the exchange of Allied Riser subordinated convertible notes both as discussed above.facility. Net lossincome for the year ended December 31, 2002 includes an extraordinary gain2004 included non-cash gains of $8.4$6.1 million related to the Allied Riser merger.our restructuring of certain lease obligations and gains on asset sales. Depreciation and amortization, including the amortization of deferred compensation and the debt discount and deferred compensationon the Allied Riser notes was $70.2 million for the year ended December 31, 2003, and $45.9$70.0 million for the year ended December 31, 2002. Changes2004. Net changes in currentoperating assets and liabilities resulted in an increase to operating cash of $1.9 million for the year ended December 31, 2003 and an increasea decrease in operating cash of $18.5$0.6 million for the year ended December 31, 2002.2004.
Net Cash Used inIn Investing Activities.Net cash used in investing activities was $25.3 million for the year ended December 31, 2003, and $19.8$2.7 million for the year ended December 31, 2002. Purchases of property2004 and equipment were $24.0$14.1 million for the year ended December 31, 2005. Our primary use of investing cash during 2003 and $75.2was $24.0 million for the year ended December 31, 2002. Purchasespurchase of short-term investmentsproperty and equipment. Our primary uses of investing cash during 2004 were $0.6$10.1 million for the year ended December 31, 2003purchase of property and $1.8equipment and $1.9 million for the year ended December 31, 2002. Investing activitiespurchase of a network in Germany. Our primary uses of investing cash during 2005 were $17.3 million for the year ended December 31, 2002 includedpurchase of property and equipment, $0.9 million for the final payment on the purchase of $9.6a network in Germany and $0.8 million related tofor the April 2002 acquisitionnet purchases of certain assetsshort-term investments. Our primary sources of PSINet, the payment of $3.6 million to acquire the minority interests of STOC, and $70.4investing cash in 2004 were $2.3 million of cash acquired from our acquisitions of Cogent Europe and Global Access and $7.4 million from the proceeds of the sale of assets and short-term investments. Our primary source of investing cash equivalents acquired in 2005 was $5.1 million from the February 4, 2002 Allied Riser merger. Investing activities forproceeds of the year ended December 31, 2003 included an additional $0.7 million related to the PSINet acquisition.sale of assets.
Net Cash Provided by Financing Activities.Financing activities provided net cash of $20.6 million for the year ended December 31, 2003, and $51.7$34.5 million for the year ended December 31, 2002. We received proceeds from borrowing under our credit facility of $8.02004 and $39.8 million for the year ended December 31, 2005. Net cash provided by financing activities during 2003 and $54.4 million for the year ended December 31, 2002. For the year ended December 31, 2003 and December 31, 2002, we also borrowed $4.5 million and $14.8 million, respectively, to fund interest and fees related to theresulted principally from borrowings under our previous Cisco credit facility. The liquidation preference at December 31, 2003facility of all classes of our preferred stock, was approximately $143.1 million. In connection with the Series G stock purchase agreement, our outstanding Series A, B, C, D and E participating convertible preferred stock was converted into approximately 10.8$8.0 million shares of common stock. The liquidation preferences on our preferred stock require that at least $11.0 million will be paid to the holders of the Series F preferred stock, at least $123.0 million will be paid to the holders of the Series G preferred stock and at least $9.1 million will be paid to the holders of the Series H preferred stock, before any payment is made to the holders of the our common stock. Principal repayments of capital lease obligations were $3.1 million and $2.7 million for the years ended December 31, 2003 and December 31, 2002, respectively. Financing activities for the year ended December 31, 2003 included a $5.0 million payment related to the exchange of Allied Riser subordinated convertible notes, a $20.0 million payment to Cisco Capital under the restructuring of the Cisco credit facility and net proceeds of $40.6 million from the sale of preferred stock, partially offset by a $5.0 million payment related to the Allied Riser note exchange, a $20.0 million payment to Cisco Capital in connection with the Cisco recapitalization and $3.1 million in capital lease repayments. Net cash from financing activities during 2004 resulted from $42.4 million of acquired cash related to our Series G convertible preferred stock.mergers with Symposium Gamma, Symposium Omega, UFO Group, and Cogent Potomac. Net cash used in financing activities for 2004 included a $1.2 million payment to LNG Holdings and $6.6 million in principal payments under our capital leases. Net cash from financing activities during 2005 resulted from $63.7 million of net proceeds from our June 2005 public offering, $10.0 million from the issuance of our subordinated note and $10.0 million borrowed under our credit facility. Net cash used in financing activities for 2005 included $17.0 million for the repayment of our Cisco note, $10.0 million for the repayment of our subordinated note, $10.0 million for the repayment of the amount outstanding under our credit facility and $6.9 million in principal payments under our capital leases.
Cash Position and Indebtedness
Our total indebtedness, net of discount, at December 31, 2005 was $99.1 million and our total cash and cash equivalents and short-term investments were $31.2 million, $1.3 million of which is restricted. Our total indebtedness at December 31, 2005 includes $92.4 million of capital lease obligations for dark fiber primarily under 15-25 year IRUs, of which approximately $6.7 million is considered a current liability.
Subordinated Note
On February 24, 2005, we issued a subordinated note in the principal amount of $10.0 million to Columbia Ventures Corporation in exchange for $10 million in cash. Columbia Ventures Corporation is owned by one of the Company’s directors and shareholders. The terms of the subordinated note required the payment of all principal and accrued interest upon the occurrence of a liquidity event, which was defined as an equity offering of at least $30 million in net proceeds. Our June 2005 Public Offering was considered a liquidity event and in June 2005 we repaid the $10.0 million subordinated note, plus accrued interest of $0.3 million.
Credit Facility
On March 9, 2005, we entered into a $10.0 million credit facility with a commercial bank. The credit facility is secured by our accounts receivable and our other assets. In December 2005, we modified the credit facility, which increased the available borrowings to up to $20.0 million and removed a $4.0 million restricted cash covenant, among other revisions. The borrowing base is determined primarily by the aging characteristics related to our accounts receivable. In March 2005, we borrowed $10.0 million under the credit facility for working capital purposes. In June 2005, we repaid the $10.0 million with part of the proceeds of our Public Offering. Borrowings under the credit facility accrue interest at the prime rate plus 1.5% and may, in certain circumstances, be reduced to the prime rate plus 0.5%. Our obligations under the credit facility are guaranteed by our material domestic subsidiaries.. As of December 31, 2005, and since June 2005 there were no amounts outstanding under the credit facility.
Amended and Restated Cisco Note
Credit Facility.In connection with the Exchange Agreement and the restructuring of our indebtedness to Cisco Capital2003 recapitalization, we amended our credit facilityagreement with Cisco Capital (the "Amended and Restated Credit Agreement"). We closed our restructuring transaction andCapital. Our remaining $17.0 million of indebtedness to Cisco was evidenced by a promissory note, which we refer to as the Amended and Restated Credit Agreement became effective on July 31, 2003.
UnderCisco Note. We used a portion of the proceeds from our Public Offering to repay in full the indebtedness under the Amended and Restated Credit Agreement approximately $269.1 million ($262.8 millionCisco Note. The Cisco recapitalization was considered a troubled debt restructuring under Statement of principalFinancial Accounting Standards (SFAS) No. 15, Accounting by Debtors and $6.3 millionCreditors of accrued interest in indebtedness to Cisco Capital, was reduced to $17.0 million and Cisco Capital's obligation to make additional loans to us was terminated. AdditionallyTroubled Debt Restructurings. Under SFAS No. 15, the Amended and Restated Credit Agreement eliminated the covenants related to our financial performance. Cisco Capital retainedNote was recorded at its senior security interest in substantially allprincipal amount of our assets except that we will be permitted to subordinate Cisco Capital's security interest in our accounts receivable.
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The restructured Cisco debt is evidenced by an amended and restated note (the "New Note") for $17.0 million payable to Cisco Capital.plus the estimated future interest payments of $0.8 million. The New Note isestimated future interest was not required to be repaid in three installments. No interest is accrued or payable onpaid, so the New Note for the first 30 months unless we default under the termspayment of the Amended and Restated Credit Agreement. PrincipalCisco Note resulted in a gain of $0.8 million.
Convertible Subordinated Notes.
In connection with the March 2003 exchange and interest is paid as follows: a $7.0settlement related to our Convertible Subordinated Notes, we eliminated $106.7 million of principal payment is due after 30 months, a $5.0and $2.0 million principal payment plus interestof accrued is due in 42 months, and a final principal payment of $5.0 million plus interest is due in 54 months. When the New Note accrues interest, interest accrues at the 90-day LIBOR rate plus 4.5%.
interest. The New Note is subject to mandatory prepayment in full, without prepayment penalty, upon the occurrenceterms of the closingremaining $10.2 million of any change in control ofConvertible Subordinated Notes were not impacted by the Company, the completion of any equity financing or receipt of loan proceeds above $30.0 million,exchange and settlement and they continue to be due on June 15, 2007.
Contractual Obligations and Commitments
The following table summarizes our achievement of four consecutive quarters of operating cash flow of at least $5.0 million, or our merger resulting in a combined entity with an equity value greater than $100.0 million, each of these events as defined in the agreement. The debt is subject to partial mandatory prepayment in an amount equal to the lesser of $2.0 million or the amount raised if we raise less than $30.0 million in a future equity financing.
Product and Service Agreement with Cisco Systems. As part of our restructuring of our Cisco credit facility our product and services agreement with Cisco Systems was amended. The amended agreement has no minimum purchase commitment but does have a requirement that we purchase Cisco equipment for its network equipment needs. No financing is provided and we are required to pay Cisco in advance for any purchases.
Our contractual cash obligations and other commercial commitments as of December 31, 2005.
|
| Payments due by period |
| |||||||||||||||
|
| Total |
| Less than |
| 1-3 years |
| 3-5 years |
| After |
| |||||||
|
| (in thousands) |
| |||||||||||||||
Long term debt |
| $ | 11,337 |
|
| $ | 764 |
|
| $ | 10,573 |
| $ | — |
| $ | — |
|
Capital lease obligations |
| 151,046 |
|
| 14,334 |
|
| 25,111 |
| 25,010 |
| 86,591 |
| |||||
Operating leases(1) |
| 147,307 |
|
| 26,268 |
|
| 35,896 |
| 22,988 |
| 62,155 |
| |||||
Unconditional purchase obligations |
| 5,517 |
|
| 5,517 |
|
| — |
| — |
| — |
| |||||
Total contractual cash obligations |
| $ | 315,207 |
|
| $ | 46,883 |
|
| $ | 71,580 |
| $ | 47,998 |
| $ | 148,746 |
|
(1) These amounts include $149.2 million of operating lease, maintenance and license agreement obligations, reduced by sublease agreements of $1.9 million.
Capital Lease Obligations. The capital lease obligations above were incurred in connection with our IRUs for inter-city and intra-city dark fiber underlying substantial portions of our network. These capital leases are presented on our balance sheet at the net present value of the future minimum lease payments, or $92.4 million at December 31, 2005. These leases generally have terms of 15 to 25 years.
Letters of Credit. We are also party to letters of credit totaling $2.2 million at December 31, 2005. These obligations are fully secured by our restricted investments, and as follows:a result, are excluded from the contractual cash obligations above.
| | Payments due by period | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Total | Less than 1 year | 1-3 years | 4-5 years | After 5 years | ||||||||||
| | (in thousands) | ||||||||||||||
| Contractual Cash Obligations: | |||||||||||||||
| Long term debt | $ | 28,033 | $ | — | $ | 17,706 | $ | 10,327 | $ | — | |||||
| Capital lease obligations | 110,475 | 8,334 | 12,492 | 12,002 | 77,647 | ||||||||||
| Operating leases | 148,862 | 18,480 | 30,980 | 23,585 | 75,817 | ||||||||||
| Unconditional purchase obligations | 3,965 | 265 | 529 | 528 | 2,643 | ||||||||||
| Total contractual cash obligations | $ | 291,335 | $ | 27,079 | $ | 61,707 | $ | 46,442 | $ | 156,107 | |||||
Future Capital Requirements.Requirements
We believe that our cash on hand and our availability under our line of credit will be adequate to meet our working capital, capital expenditure, debt service and other cash requirements if we execute our business plan. Our future capital requirements will depend on abusiness plan includes increasing our number of factors, includingon-net buildings to approximately 1,100 by December 31, 2006 from 1,040 at December 31, 2005 and substantially increasing our success in increasing the number of customers using our services, regulatory changes, competition, technological developments, potential merger and acquisition activity and the economy. Managementsales representatives in 2006. Although management believes that if we arewill successfully mitigate our risks, management cannot give any assurances that it will be able to do so or that we will ever operate profitably. Our business plan also assumes, among other things, the following:
· our ability to increase the numbersize of customers using our services as planned,on-net customer base;
· our current cash positioncapital expenditure rate will continue at a rate similar to the rate we experienced in 2005;
· we will be able to maintain our recent sales productivity performance and incremental sales product mix;
· we will be able to locate and hire sales representatives according to our plan;
· no material change to the conversion rate between the euro and the cash obtainedU.S. dollar and the Canadian dollar and the U.S. dollar;
· no material increase in our revenue churn rate;
· no material decline in our product pricing;
· no material increase in our customer bad debt;
·the merger with Symposium Omega, Inc. ("Omega") would be sufficientcontinued availability of our line of credit; and
· our ability to fundadd additional productive buildings to our operations until we generate more cash than we consume. If we are unable to achieve revenue growthnetwork.
Additionally, any future acquisitions or if we haveother significant unplanned costs or cash requirements we may need torequire that we raise additional funds through the issuance of debt or equity. We cannot assure you that thissuch financing will be available on terms favorableacceptable to us or our stockholders, or at all. Insufficient funds may require us to delay or scale back the number of buildings that we serve, reduce our planned increase in our sales and marketing efforts, or require us to restructureotherwise alter our business.business plan or take other actions that could have a material adverse effect on our business, results of operations and financial condition. If additional funds are raised by issuing equity securities raises additional funds, substantial dilution to existing stockholders may result.
We may elect to purchase or otherwise retire the remaining $10.2 million face value of Allied Riser notes with cash, stock or assets from time to time in open market or privately negotiated transactions, either directly or through intermediaries where we believe that market conditions are favorable to do so. Such purchases may have a material effect on our liquidity, financial condition and
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results of operations. We may elect to pay the semi-annual interest payments on the $10.2 million face value of Allied Riser notes with our common stock.
We are subject to claims and lawsuits arising in the ordinary course of business. Management believes that the outcome of any such proceedings to which we are a party will not have a material adverse effect on us.Off-Balance Sheet Arrangements
Recent Accounting Pronouncements
In January 2003, the FASB issued Interpretation No. 46,Consolidation of Variable Interest Entities ("FIN 46") to clarify the conditions under which assets, liabilities and activities of another entity should be consolidated into the financial statements of a company. FIN 46 requires the consolidation of a variable interest entity by a company that bears the majority of the risk of loss from the variable interest entity's activities, is entitled to receive a majority of the variable interest entity's residual returns, or both. The adoption of FIN 46 did not have an impact on our financial position or results of operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others," which expands previously issued accounting guidance and disclosure requirements for certain guarantees. The Interpretation requires an entity to recognize an initial liability for the fair value of an obligation assumed by issuing a guarantee. The provision for initial recognition and measurement of the liability will be applied on a prospective basis to guarantees issued or modified after December 31, 2002. In November 2003 we provided an indemnification to certain shareholders discussed in Note 9 to our financial statements. Under the Interpretation, in 2003 we have recorded a long-term liability and corresponding asset of approximately $167,000 for the estimated fair value of this obligation.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities". SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. The new guidance amends SFAS No. 133 for decisions made: (a) as part of the Derivatives Implementation Group process that effectively required amendments to SFAS No. 133, (b) in connection with other Board projects dealing with financial instruments, and (c) regarding implementation issues raised in relation to the application of the definition of derivative. SFAS No. 149 is generally effective for contracts entered into or modified after June 30, 2003. The adoption of the provisions of SFAS No. 149 did not have an impact on our results of operations or financial position.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity". SFAS No. 150 requires certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity to be classified as liabilities. The provisions of SFAS No. 150 became effective for financial instruments entered into or modified after May 31, 2003 and to all other instruments that existed as of July 1, 2003. We do not have any financial instruments that meet the provisions of SFAS No. 150, therefore, adopting the provisions of SFAS No. 150 did not have an impact on our results of operationsrelationships with unconsolidated entities or financial position.partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.
In November 2002, the FASB's Emerging Issues Task Force reached a final consensus on Issue No.00-21. "Accounting for Revenue arrangements with Multiple Deliverables" ("EITF 00-21"), which is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. Under the EITF 00-21, revenue arrangements with multiple deliverables are required to be divided into separate units of accounting under certain circumstances. The adoption of EITF 00-21 did not have a material effect on our consolidated financial statements.
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In December 2003, the SEC issued Staff Accounting Bulletin No. 104, "Revenue Recognition", which updates the guidance in SAB No. 101, integrates the related set of Frequently Asked Questions, and recognizes the role of EITF 00-21. The adoption of SAB No. 104 did not have a material effect on our consolidated financial statements.
Critical Accounting Policies and Significant Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of consolidatedthese financial statements requires managementus to make judgments based upon estimates and assumptionsjudgments that are inherently uncertain. Such judgments affect the reported amounts of assets, liabilities, revenuesrevenue and expenses, and the related disclosure of contingent assets and liabilities. Management continuously evaluates itsOn an on-going basis, we evaluate our estimates and assumptions, including those related to allowances for doubtful accounts, revenue allowances, long-lived assets, accruals, contingencies and litigation, and the carrying values of assets and liabilities. Management bases itsWe base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances.circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
The following is a summary of ouraccounting policies we believe to be most critical accounting policiesto understanding our financial results and condition and that require complex, significant and subjective management judgments are discussed below. We historically have not experienced significant revisions to our estimates except to the extent that they result from (1) changes in estimated litigation accruals, (2) changes in estimated leased circuit obligations, (3) changes in the number of option renewal periods used in determining the preparationlease term for purposes of determining the amortization period for our consolidated financial statements.leasehold improvements, (4) changes in our estimates of the percentage of time our employees were involved in our construction activities and (5) changes in estimated sub-lease income which has caused us to revise our lease accruals for abandoned facilities.
Revenue Recognition
We recognize service revenue when the services are performed, evidence of an arrangement exists, the fee is fixed and determinable and collection is probable. Service discounts and incentives relatedoffered to telecommunications servicescertain customers are recorded as a reduction of revenue when granted or ratably over the estimated customer life.granted. Fees billed in connection with customer installations and other upfront charges are deferred and recognized ratably over the estimated customer life. Direct costs incurred for provisioning and installingWe determine the estimated customer life using a historical analysis of customer and sales and commissionretention. If our estimated customer life
increases, we will recognize installation revenue over a longer period. We expense direct costs associated with acquiringsales as incurred.
Allowances for Sales Credits and Unfulfilled Purchase Obligations
We have established allowances to account for sales credits and unfulfilled contractual purchase obligations.
· Our allowance for sales credits is recorded as a reduction to our service revenue to provide for situations when customers are granted a service termination adjustment for amounts billed in advance or a service level agreement credit or discount. This allowance is determined by actual credits granted during the new customerperiod and an estimate of unprocessed credits.
· Our allowance for unfulfilled contractual purchase obligations is designed to account for the possible non-payment of amounts under agreements that we have with certain of our customers that place minimum purchase obligations on them. Although we vigorously seek payments due pursuant to these purchase obligations, we have historically collected only a small portion of these billed obligations. In order to allow for this, we reduce our gross service revenue by the amount that has been invoiced to these customers. We reduce this allowance and recognize the related service revenue only upon the receipt of cash payments in respect of these invoices. This allowance is determined by the amount of unfulfilled contractual purchase obligations invoiced to our customers and with respect to which we are expensed as incurred.
Valuation Allowances for Doubtful Accounts Receivable and Deferred Tax Assets
We establish ahave established allowances associated with uncollectible accounts receivable and our deferred tax assets.
· Our valuation allowance for collection of doubtfuluncollectible accounts and other sales credit adjustments. Valuation allowancesreceivable is designed to account for sales credits are established through a charge to revenue, while valuation allowances for doubtfulthe expense associated with accounts are established through a charge to selling, general and administrative expenses.receivable that we estimate will not be collected. We assess the adequacy of these reserves monthlythis allowance by evaluating general factors, such as the length of time individual receivables are past due, historical collection experience, the economic and competitive environment, and changes in the credit worthinesscredit-worthiness of our customers. As considered necessary, weWe also assess the ability of specific customers to meet their financial obligations to us and establish specific valuation allowances based on the amount we expect to collect from these customers. We believe that
· Our valuation allowance for our established valuation allowances were adequate as of December 31, 2003 and December 31, 2002. If circumstances relating to specific customers change or economic conditions worsen such that our past collection experience and assessment ofnet deferred tax asset reflects the economic environment are no longer valid, our estimate ofuncertainty surrounding the recoverabilityrealization of our trade receivablesnet operating losses and our other deferred tax assets. For federal and state tax purposes, our net operating loss carry-forwards, including those that we have generated through our operations and those acquired in the Allied Riser merger could be changed. Ifsubject to significant limitations on annual use. To account for this occurs, we adjust our valuation allowance in the period the new information is known.
28
Impairment of Long-Lived Assets
We review our long-lived assets, including property and equipment, and intangible assets with definite useful lives to be held and used for impairment whenever events or changes in circumstances indicate that the carrying amount should be addressed pursuant to SFASthe Financial Accounting Standards Board’s (FASB) Statement of Financial Accounting Standards (SFAS) No. 144, "AccountingAccounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"). Pursuant to SFAS No. 144, impairment is determined by comparing the carrying value of these long-lived assets to our best estimate of future undiscounted cash flows expected to result from the use of the assets and their eventual disposition. As of December 31, 2003 and December 31, 2002 we tested our long-lived assets for impairment. We believe that no impairment existed under SFAS No. 144 as of December 31, 2003 and December 30, 2002.assets. In the event that there are changes in the planned use of our long-lived assets, or our expected future undiscounted cash flows are reduced significantly, our assessment of our ability to recover the carrying value of these assets under SFAS No. 144 could change.
Because management's bestour estimate of undiscounted
cash flows generated from these assets exceeds their carrying value for each of the periods presented, no impairment pursuant to SFAS No. 144 exists. However, because of the significant difficulties confronting the telecommunications industry, management believes that currently the fair value of our long-lived assets including our network assets and IRU's are significantly below the amounts we originally paid for them and may be less than their current depreciated cost basis.existed at December 31, 2004 or 2005.
Business Combinations
We account for our business combinations pursuant to SFAS No. 141, "Business Combinations" ("SFAS No. 141")Business Combinations. Under SFAS No. 141 we allocate the cost of an acquired entity to the assets acquired and liabilities assumed based upon their estimated fair values at the date of acquisition. Intangible assets are recognized when they arise from contractual or other legal rights or if they are separable as defined by SFAS No. 141.separable. We determine estimated fair values using quoted market prices, when available, or the usingby present values determinedof future cash flows discounted at appropriate current interest rates. Consideration not in the form of cash is measured based upon the estimated fair value of the consideration given.
29Other Accounting Policies
We record assets and liabilities under capital leases at the lesser of the present value of the aggregate future minimum lease payments or the fair value of the assets under lease.
We capitalize the direct costs incurred prior to an asset being ready for service. These costs include costs under the related construction contract and the salaries and benefits of employees directly involved with construction activities. Our capitalization of these costs is sensitive to the percentage of time and number of our employees involved in construction activities.
We estimate our litigation accruals based upon our estimate of the expected outcome after consultation with legal counsel.
We estimate our accruals for disputed leased circuit obligations based upon the nature and age of the dispute. Our network costs are impacted by the timing and amounts of disputed circuit costs. We generally record these disputed amounts when billed by the vendor and reverse these amounts when the vendor credit has been received or the dispute has otherwise been resolved.
We estimate the useful lives of our property and equipment based upon historical usage with consideration given to technological changes and trends in the industry that could impact the asset utilization.
We establish the number of renewal option periods used in determining the lease term for amortizing leasehold improvements based upon our assessment at the inception of the lease of the number of option periods that are reasonably assured in accordance with SFAS No. 13 “Accounting for Leases”.
We estimate our restructuring and abandoned lease facilities accruals based upon our estimate of the net present value of cash flows expected from these obligations including expected sub-lease income after consideration of market conditions for these and similar properties and the terms of the related lease agreement.
In December 2004, the FASB issued Statement No. 123 (revised 2004), Share-Based Payment (“SFAS 123(R)”). SFAS 123(R) requires all share-based payments to employees, including grants of stock options, to be recognized in the statement of operations based upon their fair values. We currently disclose the impact of valuing grants of stock options and recording the related compensation expense in a proforma footnote to our financial statements. For disclosure purposes, employee stock options are valued at the grant date using the Black-Scholes option pricing method and compensation expense is recognized
on a straight-line basis over the service period for the entire award. Under SFAS 123(R) this alternative is no longer available. We will be required to adopt SFAS 123(R) in the first quarter of 2006 and as a result will record additional compensation expense in our statements of operations. The impact of the adoption of SFAS 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had we adopted SFAS 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net (loss) income in the notes to our consolidated financial statements. We plan on using the modified prospective method of adoption under SFAS 123(R) and we are currently evaluating the impact of the adoption of SFAS 123(R) on our financial position and results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
All of our financial interestsinstruments that are sensitive to market risk are entered into for purposes other than trading. Our primary market risk exposure is related to interest rate fluctuations that affect our marketable securities.securities and certain of our debt instruments and currency fluctuations of the euro and the Canadian dollar versus the United States dollar. We place our marketable securitiessecurity investments in instruments that meet high credit quality standards as specified in our investment policy guidelines. Marketable securities were approximately $12.0$31.2 million at December 31, 2003, $7.92005, $29.9 million of which are considered cash and cash equivalents and mature in 90 days or less and $4.1$1.3 million are short-term investments, consisting of commercial paper and certificates of deposit. Approximately $0.8 million of these investmentswhich are restricted for collateral against letters of credit totaling $0.8 million.
credit. We also own approximately $1.6hold certificates of deposit totaling $1.1 million of commercial paper investments ($ 0.7 million) and a Canadian treasury bill ($ 0.9 million) that are classified as other long-term assets. These investmentsassets and are also restricted for collateral against letters of credit totaling approximately $1.6 million.credit.
As described in Item 2 effective on July 31, 2003 we restructured ourOur debt with Cisco Capital and reduced the principal amount outstanding to $17.0 million. The restructured debt is evidenced by an amended and restated note (the "New Note") for $17.0 million payable to Cisco Capital. The New Note was issued under the current credit agreement that is to be repaid in three installments. No interest is payable on the New Note for the first 30 months unless we default under the terms of the Amended and Restated Credit Agreement. Principal and interest is paid as follows: a $7.0 million principal payment is due after 30 months, a $5.0 million principal payment plus interest accrued is due in 42 months, and a final principal payment of $5.0 million plus interest is due in 54 months. When the New Note accrues interest, interest accrues at the 90-day LIBOR rate plus 4.5%.
If market rates were to increase immediately and uniformly by 10% from the levelobligations at December 31, 2003,2005, with the changeexception of our accounts receivable credit facility, carry fixed interest rates and the related cash flows are not subject to changes in interest rates. Our $20.0 million credit facility is indexed to the prime rate plus 1.5% and may, in certain circumstances be reduced to the prime rate plus 0.5%. There were no amounts outstanding under the accounts receivable credit facility at December 31, 2005. The Allied Riser convertible subordinated notes are due in June 2007 have a face value of $10.2 million. The notes were recorded at their fair value of approximately $2.9 million at the merger date. The resulting discount is being amortized to interest expense through the maturity date using the effective interest rate method. Based upon the borrowing rates for debt arrangements with similar terms we estimate the fair value of our Allied Riser convertible subordinated notes at $10.1 million. If there were a 10% increase in interest sensitiverates we estimate that this fair value would be $10.0 million.
Our European and Canadian operations expose us to currency fluctuations and exchange rate risk. For example, while we record revenues and financial results from our European and Canadian operations in euros and the Canadian dollar, respectively, these results are reflected in our consolidated financial statements in U.S. dollars. The assets and liabilities would have an immaterial effect onassociated with our European and Canadian operations are translated into U.S. dollars and reflected in our consolidated financial position,statements in U.S. dollars. Therefore, our reported results are exposed to fluctuations in the exchange rates between the U.S. dollar and the euro and the Canadian dollar. In addition, we fund the euro-based operating expenses and associated cash flow requirements of our European operations, including IRU obligations, in U.S. dollars. Accordingly, in the event that the euro strengthens versus the dollar to a greater extent, the expenses and cash flows over the next fiscal year. A 10% increaseflow requirements associated with our European operations may be significantly higher in the weighted-average interest rate for the year ended December 31, 2003 would have increased our interest expense for the period by approximately $1.7 million.U.S.-dollar terms than planned.
3038
ITEM 8. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page | ||||||||
Report of Independent | 40 | |||||||
Consolidated Balance Sheets as of December 31, | 41 | |||||||
42 | ||||||||
43 | ||||||||
46 | ||||||||
48 | ||||||||
31
39
Report of Independent Auditors
Registered Public Accounting Firm
The Board of Directors and Stockholders of Cogent Communications Group, Inc. Board of Directors:
We have audited the accompanying consolidated balance sheets of Cogent Communications Group, Inc. and subsidiaries (the "Company"“Company”) as of December 31, 20032005 and 2002,2004, and the related consolidated statements of operations, changes in stockholders'stockholders’ equity, and cash flows for each of the three years then ended.in the period ended December 31, 2005. Our audits also included the financial statement schedulesschedule listed in the index at Item 15(a)2. These financial statements and schedulesschedule are the responsibility of the Company'sCompany’s management. Our responsibility is to express an opinion on these financial statements and schedulesschedule based on our audits. The consolidated financial statements and schedule of the Company for the year ended December 31, 2001, were audited by other auditors who have ceased operations and whose report dated March 1, 2002 (except with respect to the matters discussed in Note 14, as to which the date is March 27, 2002) expressed an unqualified opinion on those statements and schedule.
We conducted our audits in accordance with auditingthe standards generally accepted inof the United States.Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the 2003 and 2002 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cogent Communications Group, Inc. and subsidiaries at December 31, 20032005 and 2002,2004, and the consolidated results of their operations and their cash flows for the each of the three years thenin the period ended December 31, 2005, in conformity with accounting principlesU.S. generally accepted in the United States.accounting principles. Also, in our opinion, the related financial statement schedules for the years ended December 31, 2003 and 2002,schedule, when considered in relation to the basic financial statements taken as a whole, presentpresents fairly in all material respects the information set forth therein.
/s/ Ernst & Young, LLP
McLean, VAMarch 2, 2004, except forWe have also audited, in accordance with the second paragraph under "Management's Plans and Business Risk" in Note 1 and Note 15, as to which the date is March 30, 2004
32
This is a copystandards of the audit report previously issued by Arthur Andersen LLP in connection withPublic Company Accounting Oversight Board (United States), the company's filing of its Annual Report on Form 10-K for the fiscal year ended December 31, 2001. This audit report has not been reissued by Arthur Andersen LLP in connection with this Annual Report on Form 10-K, nor has Arthur Andersen LLP provided a consent to include its report in this Annual Report on Form 10-K. The registrant hereby discloses that the lack of a consent by Arthur Andersen LLP may impose limitations on recovery by investors.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Cogent Communications Group, Inc., and Subsidiaries:
We have audited the accompanying consolidated balance sheetseffectiveness of Cogent Communications Group, Inc. (a Delaware corporation), and Subsidiaries (together the Company)subsidiaries internal control over financial reporting as of December 31, 2000 and 2001, and2005, based on criteria established in Internal Control—Integrated Framework issued by the related consolidated statementsCommittee of operations, changes in stockholders' equity, and cash flows for the period from inception (August 9, 1999) to December 31, 1999, and for the years ended December 31, 2000 and 2001. These consolidated financial statements are the responsibilitySponsoring Organizations of the Company's management. Our responsibility is to expressTreadway Commission and our report dated March 13, 2005 expressed an unqualified opinion on these financial statements based on our audits.thereon.
/s/ Ernst & Young LLP
McLean, VA
March 13, 2006
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cogent Communications Group, Inc., and Subsidiaries as of December 31, 2000 and 2001, and the results of their operations and their cash flows for the period from inception (August 9, 1999) to December 31, 1999, and for the years ended December 31, 2000 and 2001, in conformity with accounting principles generally accepted in the United States.40
ARTHUR ANDERSEN LLP
Vienna, VirginiaMarch 1, 2002 (except with respect to the matters discussed inNote 14, as to which the date is March 27, 2002)
33
COGENT COMMUNICATIONS GROUP, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 20022004 AND 20032005
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
| | | 2002 | 2003 |
| 2004 |
| 2005 |
| ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Assets | Assets |
|
|
|
|
| ||||||||||
| Current assets: | ||||||||||||||||
| Cash and cash equivalents | $ | 39,314 | $ | 7,875 | ||||||||||||
| Short term investments ($1,281 and $753 restricted, respectively) | 3,515 | 4,115 | ||||||||||||||
| Accounts receivable, net of allowance for doubtful accounts of $2,023 and $2,868, respectively | 5,516 | 5,066 | ||||||||||||||
| Prepaid expenses and other current assets | 2,781 | 905 | ||||||||||||||
| Total current assets | 51,126 | 17,961 | ||||||||||||||
Property and equipment: | ||||||||||||||||
| Property and equipment | 365,831 | 400,097 | ||||||||||||||
| Accumulated depreciation and amortization | (43,051 | ) | (85,691 | ) | ||||||||||||
| Total property and equipment, net | 322,780 | 314,406 | ||||||||||||||
Intangible assets: | ||||||||||||||||
| Intangible assets | 23,373 | 26,780 | ||||||||||||||
| Accumulated amortization | (8,718 | ) | (18,671 | ) | ||||||||||||
| Total intangible assets, net | 14,655 | 8,109 | ||||||||||||||
Other assets ($4,001 and $1,608 restricted, respectively) | 19,116 | 3,964 | ||||||||||||||
| Total assets | $ | 407,677 | $ | 344,440 | ||||||||||||
| Liabilities and stockholders' equity | ||||||||||||||||
| Current liabilities: | ||||||||||||||||
| Accounts payable | $ | 7,830 | $ | 7,296 | ||||||||||||
| Accrued liabilities | 18,542 | 7,885 | ||||||||||||||
| Cisco credit facility, in default at December 31, 2002 | 250,305 | — | ||||||||||||||
| Current maturities, capital lease obligations | 3,505 | 3,646 | ||||||||||||||
| Total current liabilities | 280,182 | 18,827 | ||||||||||||||
| Amended and Restated Cisco Note | — | 17,842 | ||||||||||||||
| Capital lease obligations, net of current | 55,280 | 58,107 | ||||||||||||||
| Convertible subordinated notes, net of discount of $78,140 and $6,084, respectively | 38,840 | 4,107 | ||||||||||||||
| Other long term liabilities | 749 | 803 | ||||||||||||||
| Total liabilities | 375,051 | 99,686 | ||||||||||||||
| Commitments and contingencies | ||||||||||||||||
Stockholders' equity: | ||||||||||||||||
| Convertible preferred stock, Series A, $0.001 par value; 26,000,000 shares authorized, issued, and outstanding in 2002, none at December 31, 2003 | 25,892 | — | ||||||||||||||
| Convertible preferred stock, Series B, $0.001 par value; 20,000,000 shares authorized; 19,370,223 shares issued and outstanding in 2002, none at December 31, 2003 | 88,009 | — | ||||||||||||||
| Convertible preferred stock, Series C, $0.001 par value; 52,173,463 shares authorized; 49,773,402 shares issued and outstanding in 2002, none at December 31, 2003 | 61,345 | — | ||||||||||||||
| Convertible preferred stock, Series F, $0.001 par value; none and 11,000 shares authorized, issued and outstanding at December 31, 2003; liquidation preference of $11,000 | — | 10,904 | ||||||||||||||
| Convertible preferred stock, Series G, $0.001 par value; none and 41,030 shares authorized, issued and outstanding at December 31, 2003; liquidation preference of $123,000 | — | 40,787 | ||||||||||||||
| Convertible preferred stock, Series H, $0.001 par value; none and 54,001 shares authorized, 53,372 shares issued and outstanding at December 31, 2003; liquidation preference of $9,110 | — | 45,990 | ||||||||||||||
| Common stock, $0.001 par value; 21,100,000 and 395,000,000 shares authorized, respectively; 3,483,838 and 13,071,340 shares issued and outstanding, respectively | 4 | 14 | ||||||||||||||
| Additional paid-in capital | 49,199 | 232,461 | ||||||||||||||
| Deferred compensation | (6,024 | ) | (32,680 | ) | ||||||||||||
| Stock purchase warrants | 9,012 | 764 | ||||||||||||||
| Treasury stock, none and 1,229,235 shares at December 31, 2003 | — | (90 | ) | |||||||||||||
| Accumulated other comprehensive (loss) income — foreign currency translation adjustment | (44 | ) | 628 | |||||||||||||
| Accumulated deficit | (194,767 | ) | (54,024 | ) | ||||||||||||
| Total stockholders' equity | 32,626 | 244,754 | ||||||||||||||
| Total liabilities and stockholders' equity | $ | 407,677 | $ | 344,440 | ||||||||||||
Current assets: |
|
|
|
|
| |||||||||||
Cash and cash equivalents |
| $ | 13,844 |
| $ | 29,883 |
| |||||||||
Short term investments ($355 and $1,283 restricted, respectively) |
| 509 |
| 1,283 |
| |||||||||||
Accounts receivable, net of allowance for doubtful accounts of $3,229 and $1,437, respectively |
| 13,564 |
| 16,452 |
| |||||||||||
Prepaid expenses and other current assets |
| 4,224 |
| 3,959 |
| |||||||||||
Total current assets |
| 32,141 |
| 51,577 |
| |||||||||||
Property and equipment: |
|
|
|
|
| |||||||||||
Property and equipment |
| 475,775 |
| 488,142 |
| |||||||||||
Accumulated depreciation and amortization |
| (138,500 | ) | (195,355 | ) | |||||||||||
Total property and equipment, net |
| 337,275 |
| 292,787 |
| |||||||||||
Total intangible assets, net |
| 3,125 |
| 2,554 |
| |||||||||||
Asset held for sale |
| 1,220 |
| — |
| |||||||||||
Deposits and other assets ($1,370 and $1,118 restricted, respectively) |
| 4,825 |
| 4,455 |
| |||||||||||
Total assets |
| $ | 378,586 |
| $ | 351,373 |
| |||||||||
Liabilities and stockholders’ equity |
|
|
|
|
| |||||||||||
Current liabilities: |
|
|
|
|
| |||||||||||
Accounts payable |
| $ | 16,090 |
| $ | 11,521 |
| |||||||||
Accrued liabilities |
| 20,669 |
| 16,275 |
| |||||||||||
Current maturities, capital lease obligations |
| 7,488 |
| 6,698 |
| |||||||||||
Total current liabilities |
| 44,247 |
| 34,494 |
| |||||||||||
Amended and Restated Cisco Note—related party |
| 17,842 |
| — |
| |||||||||||
Capital lease obligations, net of current maturities |
| 95,887 |
| 85,694 |
| |||||||||||
Convertible subordinated notes, net of discount of $5,026 and $3,478, respectively |
| 5,165 |
| 6,713 |
| |||||||||||
Other long term liabilities |
| 2,955 |
| 3,471 |
| |||||||||||
Total liabilities |
| 166,096 |
| 130,372 |
| |||||||||||
Commitments and contingencies: |
|
|
|
|
| |||||||||||
Stockholders’ equity: |
|
|
|
|
| |||||||||||
Convertible preferred stock, Series F, $0.001 par value; 11,000 shares authorized, issued and outstanding at December 31, 2004; none at December 31, 2005 |
| 10,904 |
| — |
| |||||||||||
Convertible preferred stock, Series G, $0.001 par value; 41,030 shares authorized, 41,021 shares issued and outstanding at December 31, 2004; none at December 31, 2005 |
| 40,778 |
| — |
| |||||||||||
Convertible preferred stock, Series H, $0.001 par value; 84,001 shares authorized, 45,821 shares issued and outstanding at December 31, 2004; none at December 31, 2005 |
| 44,309 |
| — |
| |||||||||||
Convertible preferred stock, Series I, $0.001 par value; 3,000 shares authorized, 2,575 shares issued and outstanding at December 31, 2004; none at December 31, 2005 |
| 2,545 |
| — |
| |||||||||||
Convertible preferred stock, Series J, $0.001 par value; 3,891 shares authorized, 3,891 shares issued and outstanding at December 31, 2004; none at December 31, 2005 |
| 19,421 |
| — |
| |||||||||||
Convertible preferred stock, Series K, $0.001 par value; 2,600 shares authorized, issued and outstanding at December 31, 2004; none at December 31, 2005 |
| 2,588 |
| — |
| |||||||||||
Convertible preferred stock, Series L, $0.001 par value; 185 shares authorized, issued and outstanding at December 31, 2004; none at December 31, 2005 |
| 927 |
| — |
| |||||||||||
Convertible preferred stock, Series M, $0.001 par value; 3,701 shares authorized, issued and outstanding at December 31, 2004; none at December 31, 2005 |
| 18,353 |
| — |
| |||||||||||
Common stock, $0.001 par value; 75,000,000 shares authorized; 827,487 and 44,092,652 shares issued and outstanding, respectively |
| 1 |
| 44 |
| |||||||||||
Additional paid-in capital |
| 236,692 |
| 440,500 |
| |||||||||||
Deferred compensation |
| (22,533 | ) | (9,680 | ) | |||||||||||
Stock purchase warrants |
| 764 |
| 764 |
| |||||||||||
Treasury stock, 61,462 shares |
| (90 | ) | (90 | ) | |||||||||||
Accumulated other comprehensive income—foreign currency translation adjustment |
| 1,515 |
| 665 |
| |||||||||||
Accumulated deficit |
| (143,684 | ) | (211,202 | ) | |||||||||||
Total stockholders’ equity |
| 212,490 |
| 221,001 |
| |||||||||||
Total liabilities and stockholders’ equity |
| $ | 378,586 |
| $ | 351,373 |
| |||||||||
The accompanying notes are an integral part of these consolidated balance sheets.
3441
COGENT COMMUNICATIONS GROUP, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2001,2003, DECEMBER 31, 20022004 AND DECEMBER 31, 20032005
(IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
DATA)
| | 2001 | 2002 | 2003 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Service revenue, net | $ | 3,018 | $ | 51,913 | $ | 59,422 | |||||
| Operating expenses: | |||||||||||
| Network operations (including $307, $233 and $1,307 of amortization of deferred compensation, respectively) | 20,297 | 49,324 | 48,324 | ||||||||
| Selling, general, and administrative (including $2,958, $3,098 and $17,368 of amortization of deferred compensation, and $479, $3,209 and $3,876 of allowance for doubtful accounts expense, respectively) | 30,280 | 36,593 | 43,938 | ||||||||
| Gain on settlement of vendor litigation | — | (5,721 | ) | — | |||||||
| Depreciation and amortization | 13,535 | 33,990 | 48,387 | ||||||||
| Total operating expenses | 64,112 | 114,186 | 140,649 | ||||||||
| Operating loss | (61,094 | ) | (62,273 | ) | (81,227 | ) | |||||
| Gain — Cisco credit facility — troubled debt restructuring | — | — | 215,432 | ||||||||
| Gain — Allied Riser note exchange | — | — | 24,802 | ||||||||
| Settlement of note holder litigation | — | (3,468 | ) | — | |||||||
| Interest income and other | 2,126 | 1,739 | 1,512 | ||||||||
| Interest expense | (7,945 | ) | (36,284 | ) | (19,776 | ) | |||||
| (Loss) income before extraordinary item | $ | (66,913 | ) | $ | (100,286 | ) | $ | 140,743 | |||
| Extraordinary gain — Allied Riser merger | — | 8,443 | — | ||||||||
| Net (loss) income | $ | (66,913 | ) | $ | (91,843 | ) | $ | 140,743 | |||
| Beneficial conversion charge | (24,168 | ) | — | (52,000 | ) | ||||||
| Net (loss) income applicable to common shareholders | $ | (91,081 | ) | $ | (91,843 | ) | $ | 88,743 | |||
| Net (loss) income per common share: | |||||||||||
| (Loss) income before extraordinary item | $ | (47.59 | ) | $ | (30.82 | ) | $ | 18.17 | |||
| Extraordinary gain | — | 2.59 | — | ||||||||
| Basic net (loss) income per common share | $ | (47.59 | ) | $ | (28.22 | ) | $ | 18.17 | |||
| Beneficial conversion charge | $ | (17.19 | ) | — | $ | (6.71 | ) | ||||
Basic net (loss) income per common share available to common shareholders | $ | (64.78 | ) | $ | (28.22 | ) | $ | 11.46 | |||
| Diluted net (loss) income per common share — before extraordinary item | $ | (47.59 | ) | $ | (30.82 | ) | $ | 0.89 | |||
Extraordinary gain | — | 2.59 | — | ||||||||
| Diluted net (loss) income per common share | $ | (47.59 | ) | $ | (28.22 | ) | $ | 0.89 | |||
| Beneficial conversion charge | $ | (17.19 | ) | — | $ | (0.33 | ) | ||||
| Diluted net (loss) income per common share available to common shareholders | $ | (64.78 | ) | $ | (28.22 | ) | $ | 0.56 | |||
| Weighted-average common shares — basic | 1,406,007 | 3,254,241 | 7,744,350 | ||||||||
| Weighted-average common shares — diluted | 1,406,007 | 3,254,241 | 158,777,953 | ||||||||
|
| 2003 |
| 2004 |
| 2005 |
| |||
Service revenue, net |
| $ | 59,422 |
| $ | 91,286 |
| $ | 135,213 |
|
Operating expenses: |
|
|
|
|
|
|
| |||
Network operations (including $1,307, $858 and $399 of amortization of deferred compensation expense, respectively, exclusive of amounts shown separately) |
| 48,324 |
| 64,324 |
| 86,193 |
| |||
Selling, general, and administrative (including $17,368, $11,404 and $12,906 of amortization of deferred compensation expense, and $3,876, $3,995 and $4,574 of bad debt expense, respectively) |
| 43,938 |
| 51,786 |
| 54,250 |
| |||
Restructuring charges |
| — |
| 1,821 |
| 1,319 |
| |||
Terminated public offering costs |
| — |
| 779 |
| — |
| |||
Depreciation and amortization |
| 48,387 |
| 56,645 |
| 55,600 |
| |||
Total operating expenses |
| 140,649 |
| 175,355 |
| 197,362 |
| |||
Operating loss |
| (81,227 | ) | (84,069 | ) | (62,149 | ) | |||
Gains—Cisco credit facility—related party |
| 215,432 |
| — |
| 842 |
| |||
Gain—Allied Riser note exchange |
| 24,802 |
| — |
| — |
| |||
Gains—capital lease obligation restructurings |
| — |
| 5,292 |
| 844 |
| |||
Gain—disposition of assets |
| — |
| — |
| 3,372 |
| |||
Interest income and other |
| 1,512 |
| 2,119 |
| 1,320 |
| |||
Interest expense |
| (19,776 | ) | (13,002 | ) | (11,747 | ) | |||
Net income (loss) |
| $ | 140,743 |
| $ | (89,660 | ) | $ | (67,518 | ) |
Beneficial conversion charges |
| (52,000 | ) | (43,986 | ) | — |
| |||
Net income (loss) available to common shareholders |
| $ | 88,743 |
| $ | (133,646 | ) | $ | (67,518 | ) |
Net income (loss) per common share: |
|
|
|
|
|
|
| |||
Basic net income (loss) per common share |
| $ | 17.74 |
| $ | (117.43 | ) | $ | (1.96 | ) |
Beneficial conversion charge |
| $ | (6.55 | ) | $ | (57.61 | ) | $ | — |
|
Basic net income (loss) per common share available to common shareholders |
| $ | 11.18 |
| $ | (175.03 | ) | $ | (1.96 | ) |
Diluted net income (loss) per common share |
| $ | 17.73 |
| $ | (117.43 | ) | $ | (1.96 | ) |
Beneficial conversion charge |
| $ | (6.55 | ) | $ | (57.61 | ) | $ | — |
|
Diluted net income (loss) per common share available to common shareholders |
| $ | 11.18 |
| $ | (175.03 | ) | $ | (1.96 | ) |
Weighted-average common shares—basic |
| 7,935,831 |
| 763,540 |
| 34,439,937 |
| |||
Weighted-average common shares—diluted |
| 7,938,898 |
| 763,540 |
| 34,439,937 |
| |||
The accompanying notes are an integral part of these consolidated statements.
35
COGENT COMMUNICATIONS GROUP, INC., AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITYFOR THE YEARS ENDED DECEMBER 31, 2001, DECEMBER 31, 2002 AND DECEMBER 31, 2003(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
| | Common Stock | | | | Stock Purchase Warrants | Preferred Stock — A | Preferred Stock — B | Preferred Stock — C | ||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Additional Paid-in Capital | Deferred Compensation | Treasury Stock | |||||||||||||||||||||||||||||||
| | Shares | Amount | Shares | Amount | Shares | Amount | Shares | Amount | ||||||||||||||||||||||||||
| Balance, December 31, 2000 | 1,400,698 | $ | 1 | $ | 189 | $ | — | $ | — | $ | — | 26,000,000 | $ | 25,892 | 19,809,783 | $ | 90,009 | — | $ | — | ||||||||||||||
| Exercises of stock options | 9,116 | — | 21 | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||
| Issuance of stock purchase warrants | — | — | — | — | — | 8,248 | — | — | — | — | — | — | ||||||||||||||||||||||
| Issuance of Series C convertible preferred stock, net | — | — | — | — | — | — | — | — | — | — | 49,773,402 | 61,345 | ||||||||||||||||||||||
| Deferred compensation | — | — | 14,346 | (14,346 | ) | — | — | — | — | — | — | — | — | |||||||||||||||||||||
| Beneficial conversion—Series B convertible preferred stock | — | — | 24,168 | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||
| Amortization of deferred compensation | — | — | — | 3,265 | — | — | — | — | — | — | — | — | ||||||||||||||||||||||
| Net loss | — | — | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||
| Balance at December 31, 2001 | 1,409,814 | 1 | 38,724 | (11,081 | ) | — | 8,248 | 26,000,000 | 25,892 | 19,809,783 | 90,009 | 49,773,402 | 61,345 | |||||||||||||||||||||
| Exercises of stock options | 7,296 | — | 1 | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||
| Issuance of common stock, options and warrants—Allied Riser merger | 2,009,678 | 3 | 10,230 | — | — | 764 | — | — | — | — | — | — | ||||||||||||||||||||||
| Deferred compensation adjustments | — | — | (1,756 | ) | 1,726 | — | — | — | — | — | — | — | — | |||||||||||||||||||||
| Conversion of Series B convertible preferred stock | 57,050 | — | 2,000 | — | — | — | — | — | (439,560 | ) | (2,000 | ) | — | — | ||||||||||||||||||||
| Foreign currency translation | — | — | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||
| Amortization of deferred compensation | — | — | — | 3,331 | — | — | — | — | — | — | — | — | ||||||||||||||||||||||
| Net loss | — | — | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||
| Balance at December 31, 2002 | 3,483,838 | 4 | 49,199 | (6,024 | ) | — | 9,012 | 26,000,000 | 25,892 | 19,370,223 | 88,009 | 49,773,402 | 61,345 | |||||||||||||||||||||
| Cancellations of shares granted to employees | — | — | (569 | ) | 995 | — | — | — | — | — | — | — | — | |||||||||||||||||||||
| Amortization of deferred compensation | — | — | — | 18,675 | — | — | — | — | — | — | — | — | ||||||||||||||||||||||
| Foreign currency translation | — | — | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||
| Issuances of preferred stock, net | — | — | — | (46,416 | ) | — | — | — | — | — | — | — | — | |||||||||||||||||||||
| Conversion of preferred stock into common stock | 10,775,725 | 10 | 183,744 | — | — | (8,248 | ) | (26,000,000 | ) | (25,892 | ) | (19,362,531 | ) | (87,974 | ) | (49,773,402 | ) | (61,345 | ) | |||||||||||||||
| Cancellation of common stock—treasury stock | (1,225,825 | ) | — | — | 90 | (90 | ) | — | — | — | — | — | — | — | ||||||||||||||||||||
| Shares returned to treasury—Allied Riser merger | (3,410 | ) | — | — | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||
| Common shares issued—Allied Riser merger | 41,012 | — | ||||||||||||||||||||||||||||||||
| Cancellation of Series B preferred stock | — | — | 35 | — | — | — | — | — | (7,692 | ) | (35 | ) | — | — | ||||||||||||||||||||
| Issuance of options for common stock—FNSI acquisition | — | — | 52 | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||
| Beneficial conversion charge | — | — | 52,000 | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||
| Reclassification of beneficial conversion charge to additional paid in capital | — | — | (52,000 | ) | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||
| Net income | — | — | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||
| Balance at December 31, 2003 | 13,071,340 | $ | 14 | $ | 232,461 | $ | (32,680 | ) | $ | (90 | ) | $ | 764 | — | $ | — | — | $ | — | — | $ | — | ||||||||||||
36
COGENT COMMUNICATIONS GROUP, INC., AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITYFOR THE YEARS ENDED DECEMBER 31, 2001, DECEMBER 31, 2002 AND DECEMBER 31, 2003(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
| | Preferred Stock — D | Preferred Stock — E | Preferred Stock — F | Preferred Stock — G | Preferred Stock — H | Foreign Currency Translation Adjustment | | | Accumulated Other Comprehensive Income | ||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Accmuluated Deficit | Total Stockholder's Equity | |||||||||||||||||||||||||||||||||||||
| | Shares | Amount | Shares | Amount | Shares | Amount | Shares | Amount | Shares | Amount | |||||||||||||||||||||||||||||
| Balance, December 31, 2000 | — | $ | — | — | $ | — | — | $ | — | — | $ | — | — | $ | — | $ | — | $ | (11,843 | ) | $ | 104,248 | $ | — | |||||||||||||||
| Exercises of stock options | — | — | — | — | — | — | — | — | — | — | — | — | 21 | — | |||||||||||||||||||||||||
| Issuance of stock purchase warrants | — | — | — | — | — | — | — | — | — | — | — | — | 8,248 | — | |||||||||||||||||||||||||
| Issuance of Series C convertible preferred stock, net | — | — | — | — | — | — | — | — | — | — | — | — | 61,345 | — | |||||||||||||||||||||||||
| Deferred compensation | — | — | — | — | — | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||||||
| Beneficial conversion—Series B convertible preferred stock | — | — | — | — | — | — | — | — | — | — | — | (24,168 | ) | — | — | ||||||||||||||||||||||||
| Amortization of deferred compensation | — | — | — | — | — | — | — | — | — | — | — | — | 3,265 | — | |||||||||||||||||||||||||
| Net loss | — | — | — | — | — | — | — | — | — | — | — | (66,913 | ) | (66,913 | ) | — | |||||||||||||||||||||||
| Balance at December 31, 2001 | — | — | — | — | — | —— | — | — | — | — | — | (102,924 | ) | 110,214 | — | ||||||||||||||||||||||||
| Exercises of stock options | — | — | — | — | — | — | — | — | — | — | — | — | 1 | — | |||||||||||||||||||||||||
| Issuance of common stock, options and warrants—Allied Riser merger | — | — | — | — | — | — | — | — | — | — | — | — | 10,998 | — | |||||||||||||||||||||||||
| Deferred compensation adjustments | — | — | — | — | — | — | — | — | — | — | — | — | (30 | ) | — | ||||||||||||||||||||||||
| Conversion of Series B convertible preferred stock | — | — | — | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||
| Foreign currency translation | — | — | — | — | — | — | — | — | — | — | (44 | ) | — | (44 | ) | (44 | ) | ||||||||||||||||||||||
| Amortization of deferred compensation | — | — | — | — | — | — | — | — | — | — | — | — | 3,331 | — | |||||||||||||||||||||||||
| Net loss | — | — | — | — | — | — | — | — | — | — | — | (91,843 | ) | (91,843 | ) | (91,843 | ) | ||||||||||||||||||||||
| Balance at December 31, 2002 | — | — | — | — | — | — | — | — | — | — | (44 | ) | (194,767 | ) | 32,626 | (91,887 | ) | ||||||||||||||||||||||
| Cancellations of shares granted to employees | — | — | — | — | — | — | — | — | (500 | ) | (426 | ) | — | — | — | — | |||||||||||||||||||||||
| Amortization of deferred compensation | — | — | — | — | — | — | — | — | — | — | — | — | 18,675 | — | |||||||||||||||||||||||||
| Foreign currency translation | — | — | — | — | — | — | — | — | — | — | 672 | — | 672 | 672 | |||||||||||||||||||||||||
| Issuances of preferred stock, net | 3,426,293 | 4,272 | 3,426,293 | 4,272 | 11,000 | 10,904 | 41,030 | 40,787 | 53,872 | 46,416 | — | — | 60,235 | — | |||||||||||||||||||||||||
| Conversion of preferred stock into common stock | (3,426,293 | ) | (4,272 | ) | (3,426,293 | ) | (4,272 | ) | — | — | — | — | — | — | — | — | (8,249 | ) | — | ||||||||||||||||||||
| Cancellation of common stock—treasury stock | — | — | — | — | — | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||||||
| Shares returned to treasury—Allied Riser merger | — | — | — | — | — | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||||||
| Common shares issued—Allied Riser merger | — | — | — | — | — | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||||||
| Cancellation of Series B preferred stock | — | — | — | — | — | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||||||
| Issuance of options for common stock—FNSI acquisition | — | — | — | — | — | — | — | — | — | — | — | — | 52 | — | |||||||||||||||||||||||||
| Beneficial conversion charge | — | — | — | — | — | — | — | — | — | — | — | (52,000 | ) | — | — | ||||||||||||||||||||||||
| Reclassification of benefical conversion charge to additional paid in capital | — | — | — | — | — | — | — | — | — | — | — | 52,000 | — | — | |||||||||||||||||||||||||
| Net income | — | — | — | — | — | — | — | — | — | — | — | 140,743 | 140,743 | 140,743 | |||||||||||||||||||||||||
| Balance at December 31, 2003 | — | $ | — | — | $ | — | 11,000 | $ | 10,904 | 41,030 | $ | 40,787 | 53,372 | $ | 45,990 | $ | 628 | $ | (54,024 | ) | $ | 244,754 | $ | 49,528 | |||||||||||||||
37
COGENT COMMUNICATIONS GROUP, INC., AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWSFOR THE YEARS ENDED DECEMBER 31, 2001, DECEMBER 31, 2002 AND DECEMBER 31, 2003(IN THOUSANDS)
| | 2001 | 2002 | 2003 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Cash flows from operating activities: | |||||||||||
| Net (loss) income | $ | (66,913 | ) | $ | (91,843 | ) | $ | 140,743 | |||
| Adjustments to reconcile net (loss) income to net cash used in operating activities — | |||||||||||
| Depreciation and amortization, including amortization of debt issuance costs | 13,594 | 36,490 | 49,746 | ||||||||
| Amortization of debt discount — convertible notes | — | 6,086 | 1,827 | ||||||||
| Amortization of deferred compensation | 3,265 | 3,331 | 18,675 | ||||||||
| Extraordinary gain — Allied Riser merger | — | (8,443 | ) | — | |||||||
| Gain — Cisco credit facility troubled debt restructuring | — | — | (215,432 | ) | |||||||
| Gain — Allied Riser note exchange | — | — | (24,802 | ) | |||||||
| Gain on settlement of vendor litigation | — | (5,721 | ) | — | |||||||
| Changes in assets and liabilities: | |||||||||||
| Accounts receivable | (1,156 | ) | (2,894 | ) | 712 | ||||||
| Prepaid expenses and other current assets | 1,107 | 1,189 | 744 | ||||||||
| Other assets | (2,660 | ) | 1,134 | 1,899 | |||||||
| Accounts payable and accrued liabilities | 5,977 | 19,104 | (1,469 | ) | |||||||
| Net cash used in operating activities | (46,786 | ) | (41,567 | ) | (27,357 | ) | |||||
| Cash flows from investing activities: | |||||||||||
| Purchases of property and equipment | (118,020 | ) | (75,214 | ) | (24,016 | ) | |||||
| Cash acquired in Allied Riser merger | — | 70,431 | — | ||||||||
| Purchase of minority interests in Shared Technologies of Canada, Inc. | — | (3,617 | ) | — | |||||||
| Purchases of short term investments, net | (1,746 | ) | (1,769 | ) | (600 | ) | |||||
| Purchases of intangible assets | (11,886 | ) | (9,617 | ) | (700 | ) | |||||
| Net cash used in investing activities | (131,652 | ) | (19,786 | ) | (25,316 | ) | |||||
| Cash flows from financing activities: | |||||||||||
| Borrowings under Cisco credit facility | 107,632 | 54,395 | 8,005 | ||||||||
| Exchange agreement payment — Allied Riser notes | — | — | (4,997 | ) | |||||||
| Exchange agreement payment — Cisco credit facility debt restructuring | — | — | (20,000 | ) | |||||||
| Proceeds from option exercises | 21 | 1 | — | ||||||||
| Repayment of capital lease obligations | (12,754 | ) | (2,702 | ) | (3,076 | ) | |||||
| Deferred equipment discount | 5,618 | — | — | ||||||||
| Issuances of preferred stock, net of issuance costs | 61,345 | — | 40,630 | ||||||||
| Net cash provided by financing activities | 161,862 | 51,694 | 20,562 | ||||||||
| Effect of exchange rate changes on cash | — | (44 | ) | 672 | |||||||
| Net decrease in cash and cash equivalents | (16,576 | ) | (9,703 | ) | (31,439 | ) | |||||
| Cash and cash equivalents, beginning of year | 65,593 | 49,017 | 39,314 | ||||||||
| Cash and cash equivalents, end of year | $ | 49,017 | $ | 39,314 | $ | 7,875 | |||||
38
| Supplemental disclosures of cash flow information: | |||||||||||
| Cash paid for interest | $ | 8,943 | $ | 12,440 | $ | 5,013 | |||||
| Cash paid for income taxes | — | — | — | ||||||||
| Non-cash financing activities — | |||||||||||
| Capital lease obligations incurred | 23,990 | 33,027 | 6,044 | ||||||||
| Warrants issued in connection with credit facility | 8,248 | — | — | ||||||||
| Borrowing under credit facility for payment of loan costs and interest | 6,441 | 14,820 | 4,502 | ||||||||
Allied Riser Merger | |||||||||||
| Fair value of assets acquired | $ | 74,791 | |||||||||
| Less: valuation of common stock, options & warrants issued | (10,967 | ) | |||||||||
| Less: extraordinary gain | (8,443 | ) | |||||||||
| Fair value of liabilities assumed | $ | 55,381 | |||||||||
NetRail Acquisition | |||||||||||
| Fair value of assets acquired | 12,090 | ||||||||||
| Less: cash paid | (11,740 | ) | |||||||||
| Fair value of liabilities assumed | 350 | ||||||||||
PSINet Acquisition | |||||||||||
| Fair value of assets acquired | 16,602 | 700 | |||||||||
| Less: cash paid | (9,450 | ) | (700 | ) | |||||||
| Fair value of liabilities assumed | 7,152 | — | |||||||||
FNSI Acquisition | |||||||||||
| Fair value of assets acquired | 3,018 | ||||||||||
| Less: valuation of options for common stock | (52 | ) | |||||||||
| Fair value of liabilities assumed | 2,966 | ||||||||||
Exchange Agreement with Cisco Capital (See Note 1)
Conversion of preferred stock under Purchase Agreement (See Note 1)
The accompanying notes are an integral part of these consolidated statements.
3942
COGENT COMMUNICATIONS GROUP, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2003 DECEMBER 31, 2004 AND DECEMBER 31, 2005
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
Common Stock | Additional | Deferred | Treasury | Stock | Preferred Stock—A | Preferred Stock—B | Preferred Stock—C | ||||||||||||||||||
Shares | Amount | Capital | Compensation | Stock | Warrants | Shares | Amount | Shares | Amount | Shares | Amount | ||||||||||||||
Balance at December 31, 2002 |
| 174,192 |
|
| $ | — |
|
|
| $ | 49,203 |
|
|
| $ | (6,024 | ) |
|
| $ | — |
|
|
| $ | 9,012 |
|
| 26,000,000 |
| $ | 25,892 |
| 19,370,223 |
| $ | 88,009 |
| 49,773,402 |
| $ | 61,345 |
|
Cancellations of shares granted to employees |
| — |
|
| — |
|
|
| (569 | ) |
|
| 995 |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Amortization of deferred compensation |
| — |
|
| — |
|
|
| — |
|
|
| 18,675 |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Foreign currency translation |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Issuances of preferred stock, net |
| — |
|
| — |
|
|
| — |
|
|
| (46,416 | ) |
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Conversion of preferred stock into common stock |
| 538,786 |
|
| 1 |
|
|
| 183,753 |
|
|
| — |
|
|
| — |
|
|
| (8,248 | ) |
| (26,000,000 | ) | (25,892 | ) | (19,362,531 | ) | (87,974 | ) | (49,773,402 | ) | (61,345 | ) | ||||||||
Cancellation of common stock—treasury stock |
| (61,291 | ) |
| — |
|
|
| — |
|
|
| 90 |
|
|
| (90 | ) |
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Shares returned to treasury—Allied Riser merger |
| (171 | ) |
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Common shares issued—Allied Riser merger |
| 2,051 |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Cancellation of Series B preferred stock |
| — |
|
| — |
|
|
| 35 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| — |
| (7,692 | ) | (35 | ) | — |
| — |
| ||||||||
Issuance of options for common stock—FNSI acquisition |
| — |
|
| — |
|
|
| 52 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Beneficial conversion charge |
| — |
|
| — |
|
|
| 52,000 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Reclassification of beneficial conversion charge to additional paid in capital |
| — |
|
| — |
|
|
| (52,000 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Net income |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Balance at December 31, 2003 |
| 653,567 |
|
| — |
|
|
| 232,475 |
|
|
| (32,680 | ) |
|
| (90 | ) |
|
| 764 |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Cancellations of shares granted to employees |
| — |
|
| — |
|
|
| — |
|
|
| 4,966 |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Amortization of deferred compensation |
| — |
|
| — |
|
|
| — |
|
|
| 12,262 |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Foreign currency translation |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Issuances of preferred stock, net |
| — |
|
| — |
|
|
| — |
|
|
| (2,370 | ) |
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Issuances of options for preferred stock |
| — |
|
| — |
|
|
| — |
|
|
| (4,711 | ) |
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Conversion of preferred stock into common stock |
| 173,920 |
|
| — |
|
|
| 3,808 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Beneficial conversion charge |
| — |
|
| — |
|
|
| 43,896 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Reclassification of beneficial conversion charge to additional paid in capital |
| — |
|
| — |
|
|
| (43,896 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Contribution of capital—LNG—related party |
| — |
|
| — |
|
|
| 410 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Net loss |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Balance at December 31, 2004 |
| 827,487 |
|
| 1 |
|
|
| 236,692 |
|
|
| (22,533 | ) |
|
| (90 | ) |
|
| 764 |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Cancellations of shares granted to employees |
| (23,069 | ) |
| — |
|
|
| (686 | ) |
|
| 697 |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Amortization of deferred compensation |
| — |
|
| — |
|
|
| — |
|
|
| 13,306 |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Foreign currency translation |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Issuances of common stock, net |
| 11,719,231 |
|
| 11 |
|
|
| 64,712 |
|
|
| (1,150 | ) |
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Conversion of preferred stock into common stock |
| 31,569,003 |
|
| 32 |
|
|
| 139,782 |
|
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Net loss |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||
Balance at December 31, 2005 |
| 44,092,652 |
|
| $ | 44 |
|
|
| $ | 440,500 |
|
|
| $ | (9,680 | ) |
|
| $ | (90 | ) |
|
| $ | 764 |
|
| — |
| $ | — |
| — |
| $ | — |
| — |
| $ | — |
|
The accompanying notes are an integral part of these consolidated statements.
COGENT COMMUNICATIONS GROUP, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Continued)
FOR THE YEARS ENDED DECEMBER 31, 2003 DECEMBER 31, 2004 AND DECEMBER 31, 2005
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
Preferred Stock—D | Preferred Stock—E | Preferred Stock—F | Preferred Stock—G | Preferred Stock—H | Preferred Stock—I | ||||||||||||||||||||
Shares | Amount | Shares | Amount | Shares | Amount | Shares | Amount | Shares | Amount | Shares | Amount | ||||||||||||||
Balance at December 31, 2002 |
| — |
|
| $ | — |
|
| — |
|
| $ | — |
|
|
| — |
|
|
| $ | — |
|
|
| — |
|
|
| $ | — |
|
|
| — |
|
|
| $ | — |
|
|
| — |
|
|
| $ | — |
|
|
Cancellations of shares granted to employees |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| (500 | ) |
|
| (426 | ) |
|
| — |
|
|
| — |
|
| ||||||
Amortization of deferred compensation |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Foreign currency translation |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Issuances of preferred stock, net |
| 3,426,293 |
|
| 4,272 |
|
| 3,426,293 |
|
| 4,272 |
|
|
| 11,000 |
|
|
| 10,904 |
|
|
| 41,030 |
|
|
| 40,787 |
|
|
| 53,873 |
|
|
| 46,416 |
|
|
| — |
|
|
| — |
|
| ||||||
Conversion of preferred stock into common stock |
| (3,426,293 | ) |
| (4,272 | ) |
| (3,426,293 | ) |
| (4,272 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Cancellation of common stock—treasury stock |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Shares returned to treasury—Allied Riser merger |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Common shares issued—Allied Riser merger |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Cancellation of Series B preferred stock |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Issuance of options for common stock—FNSI acquisition |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Beneficial conversion charge |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Reclassification of beneficial conversion charge to additional paid in capital |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Net income |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Balance at December 31, 2003 |
| — |
|
| — |
|
| — |
|
| — |
|
|
| 11,000 |
|
|
| 10,904 |
|
|
| 41,030 |
|
|
| 40,787 |
|
|
| 53,373 |
|
|
| 45,990 |
|
|
| — |
|
|
| — |
|
| ||||||
Cancellations of shares granted to employees |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| (5,127 | ) |
|
| (4,965 | ) |
|
| — |
|
|
| — |
|
| ||||||
Amortization of deferred compensation |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Foreign currency translation |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Issuances of preferred stock, net |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 1,913 |
|
|
| 2,370 |
|
|
| 2,575 |
|
|
| 2,545 |
|
| ||||||
Issuances of options for preferred stock |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 4,711 |
|
|
| — |
|
|
| — |
|
| ||||||
Conversion of preferred stock into common stock |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| (9 | ) |
|
| (9 | ) |
|
| (4,338 | ) |
|
| (3,797 | ) |
|
| — |
|
|
| — |
|
| ||||||
Beneficial conversion charge |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Reclassification of beneficial conversion charge to additional paid in capital |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Contribution of capital—LNG—related party |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
|
|
|
|
|
|
|
| ||||||
Net loss |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Balance at December 31, 2004 |
| — |
|
| $ | — |
|
| — |
|
| $ | — |
|
|
| 11,000 |
|
|
| $ | 10,904 |
|
|
| 41,021 |
|
|
| $ | 40,778 |
|
|
| 45,821 |
|
|
| $ | 44,309 |
|
|
| 2,575 |
|
|
| $ | 2,545 |
|
|
Cancellations of shares granted to employees |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| (14 | ) |
|
| (11 | ) |
|
| — |
|
|
| — |
|
| ||||||
Amortization of deferred compensation |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Foreign currency translation |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Issuances of common stock, net |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Conversion of preferred stock into common stock |
| — |
|
| — |
|
| — |
|
| — |
|
|
| (11,000 | ) |
|
| (10,904 | ) |
|
| (41,021 | ) |
|
| (40,778 | ) |
|
| (45,807 | ) |
|
| (44,298 | ) |
|
| (2,575 | ) |
|
| (2,545 | ) |
| ||||||
Net loss |
| — |
|
| — |
|
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||
Balance at December 31, 2005 |
| — |
|
| $ | — |
|
| — |
|
| $ | — |
|
|
| — |
|
|
| $ | — |
|
|
| — |
|
|
| $ | — |
|
|
| — |
|
|
| $ | — |
|
|
| — |
|
|
| $ | — |
|
|
The accompanying notes are an integral part of these consolidated statements.
COGENT COMMUNICATIONS GROUP, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Continued)
FOR THE YEARS ENDED DECEMBER 31, 2003 DECEMBER 31, 2004 AND DECEMBER 31, 2005
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
Preferred | Preferred | Preferred | Preferred | Foreign | Total | ||||||||||||||||||||
Shares | Amount | Shares | Amount | Shares | Amount | Shares | Amount | Translation | Accumulated | Stockholder’s | Comprehensive | ||||||||||||||
Balance at December 31, 2002 |
| — |
| $ | — |
| — |
| $ | — |
|
| — |
|
|
| $ | — |
|
| — |
| $ | — |
|
| $ | (44 | ) |
|
| $ | (194,767 | ) |
|
| $ | 32,626 |
|
|
| $ | — |
|
|
Cancellations of shares granted to employees |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||||
Amortization of deferred compensation |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| — |
|
|
| 18,675 |
|
|
| — |
|
| ||||||||
Foreign currency translation |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| 672 |
|
|
| — |
|
|
| 672 |
|
|
| 672 |
|
| ||||||||
Issuances of preferred stock, net |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| — |
|
|
| 60,235 |
|
|
| — |
|
| ||||||||
Conversion of preferred stock into common stock |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| — |
|
|
| (8,249 | ) |
|
| — |
|
| ||||||||
Cancellation of common stock—treasury stock |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| — |
|
|
| (0 | ) |
|
| — |
|
| ||||||||
Shares returned to treasury—Allied Riser merger |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||||
Common shares issued—Allied Riser merger |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||||
Cancellation of Series B preferred stock |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||||
Issuance of options for common stock—FNSI acquisition |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| — |
|
|
| 52 |
|
|
| — |
|
| ||||||||
Beneficial conversion charge |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| (52,000 | ) |
|
| — |
|
|
| — |
|
| ||||||||
Reclassification of beneficial conversion charge to additional paid in capital |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| 52,000 |
|
|
| — |
|
|
| — |
|
| ||||||||
Net income |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| 140,743 |
|
|
| 140,743 |
|
|
| 140,743 |
|
| ||||||||
Balance at December 31, 2003 |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| 628 |
|
|
| (54,024 | ) |
|
| 244,754 |
|
|
| 141,415 |
|
| ||||||||
Cancellations of shares granted to employees |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| — |
|
|
| 1 |
|
|
| — |
|
| ||||||||
Amortization of deferred compensation |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| — |
|
|
| 12,262 |
|
|
| — |
|
| ||||||||
Foreign currency translation |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| 887 |
|
|
| — |
|
|
| 887 |
|
|
| 887 |
|
| ||||||||
Issuances of preferred stock, net |
| 3,891 |
| 19,421 |
| 2,600 |
| 2,588 |
|
| 185 |
|
|
| 927 |
|
| — |
| — |
|
| — |
|
|
| — |
|
|
| 25,481 |
|
|
| — |
|
| ||||||||
Issuances of options for preferred stock |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||||
Conversion of preferred stock into common stock |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| 3,701 |
| 18,353 |
|
| — |
|
|
| — |
|
|
| 18,355 |
|
|
| — |
|
| ||||||||
Beneficial conversion charge |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| (43,896 | ) |
|
| — |
|
|
| — |
|
| ||||||||
Reclassification of beneficial conversion charge to additional paid in capital |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| 43,896 |
|
|
| — |
|
|
| — |
|
| ||||||||
Contribution of capital—LNG—related party |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| — |
|
|
| 410 |
|
|
| — |
|
| ||||||||
Net loss |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| (89,660 | ) |
|
| (89,660 | ) |
|
| (89,660 | ) |
| ||||||||
Balance at December 31, 2004 |
| 3,891 |
| 19,421 |
| 2,600 |
| 2,588 |
|
| 185 |
|
|
| 927 |
|
| 3,701 |
| 18,353 |
|
| 1,515 |
|
|
| (143,684 | ) |
|
| 212,490 |
|
|
| (88,773 | ) |
| ||||||||
Cancellations of shares granted to employees |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||||
Amortization of deferred compensation |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| — |
|
|
| 13,306 |
|
|
| — |
|
| ||||||||
Foreign currency translation |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| (850 | ) |
|
| — |
|
|
| (850 | ) |
|
| (850 | ) |
| ||||||||
Issuances of common stock, net |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| — |
|
|
| 63,573 |
|
|
| — |
|
| ||||||||
Conversion of preferred stock into common stock |
| (3,891 | ) | (19,421 | ) | (2,600 | ) | (2,588 | ) |
| (185 | ) |
|
| (927 | ) |
| (3,701 | ) | (18,353 | ) |
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||||
Net loss |
| — |
| — |
| — |
| — |
|
| — |
|
|
| — |
|
| — |
| — |
|
| — |
|
|
| (67,518 | ) |
|
| (67,518 | ) |
|
| (67,518 | ) |
| ||||||||
Balance at December 31, 2005 |
| — |
| $ | — |
| — |
| $ | — |
|
| — |
|
|
| $ | — |
|
| — |
| $ | — |
|
| $ | 665 |
|
|
| $ | (211,202 | ) |
|
| $ | 221,001 |
|
|
| $ | (68,368 | ) |
|
The accompanying notes are an integral part of these consolidated statements.
COGENT COMMUNICATIONS GROUP, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2003, DECEMBER 31, 2004 AND DECEMBER 31, 2005
(IN THOUSANDS)
|
| 2003 |
| 2004 |
| 2005 |
| |||
Cash flows from operating activities: |
|
|
|
|
|
|
| |||
Net income (loss) |
| $ | 140,743 |
| $ | (89,660 | ) | $ | (67,518 | ) |
Adjustments to reconcile net income (loss) to net cash used in operating activities |
|
|
|
|
|
|
| |||
Depreciation and amortization, including amortization of debt issuance costs |
| 49,746 |
| 56,645 |
| 55,600 |
| |||
Amortization of debt discount—convertible notes |
| 1,827 |
| 1,058 |
| 1,548 |
| |||
Amortization of deferred compensation |
| 18,675 |
| 12,262 |
| 13,305 |
| |||
Gains—Cisco credit facility—related party |
| (215,432 | ) | — |
| (842 | ) | |||
Gain—Allied Riser note exchange | �� | (24,802 | ) | — |
| — |
| |||
Gains—capital lease obligation restructurings and sales of assets, net |
| — |
| (6,124 | ) | (3,983 | ) | |||
Changes in assets and liabilities: |
|
|
|
|
|
|
| |||
Accounts receivable |
| 712 |
| 2,274 |
| (3,645 | ) | |||
Prepaid expenses and other current assets |
| 744 |
| 2,256 |
| 34 |
| |||
Other assets |
| 1,899 |
| 1,565 |
| (3,700 | ) | |||
Accounts payable and accrued liabilities |
| (1,469 | ) | (6,701 | ) | 139 |
| |||
Net cash used in operating activities |
| (27,357 | ) | (26,425 | ) | (9,062 | ) | |||
Cash flows from investing activities: |
|
|
|
|
|
|
| |||
Purchases of property and equipment |
| (24,016 | ) | (10,135 | ) | (17,342 | ) | |||
Purchases of intangible assets |
| (700 | ) | (317 | ) | (129 | ) | |||
(Purchases) maturities of short term investments, net |
| (600 | ) | 3,026 |
| (774 | ) | |||
Cash acquired—acquisitions |
| — |
| 2,336 |
| — |
| |||
Purchase of fiber optic network in Germany |
| — |
| (1,949 | ) | (932 | ) | |||
Proceeds from asset sales |
| — |
| 4,338 |
| 5,122 |
| |||
Net cash used in investing activities |
| (25,316 | ) | (2,701 | ) | (14,055 | ) | |||
Cash flows from financing activities: |
|
|
|
|
|
|
| |||
Borrowings under Cisco credit facility—related party |
| 8,005 |
| — |
| — |
| |||
Exchange agreement payment—Allied Riser notes |
| (4,997 | ) | — |
| — |
| |||
Exchange agreement payment—Cisco debt restructuring—related party |
| (20,000 | ) | — |
| — |
| |||
Repayment of capital lease obligations |
| (3,076 | ) | (6,630 | ) | (6,899 | ) | |||
Repayment of advance from LNG Holdings—related party |
| — |
| (1,242 | ) | — |
| |||
Cash acquired—mergers |
| — |
| 42,358 |
| — |
| |||
Proceeds from sales of stock, net |
| 40,630 |
| — |
| 63,723 |
| |||
Proceeds from issuance of subordinated note—related party |
| — |
| — |
| 10,000 |
| |||
Repayment of subordinated note—related party |
| — |
| — |
| (10,000 | ) | |||
Repayment of Cisco note—related party |
| — |
| — |
| (17,000 | ) | |||
Borrowings under credit facility |
| — |
| — |
| 10,000 |
| |||
Repayments under credit facility |
| — |
| — |
| (10,000 | ) | |||
Net cash provided by financing activities |
| 20,562 |
| 34,486 |
| 39,824 |
| |||
Effect of exchange rate changes on cash |
| 672 |
| 609 |
| (668 | ) | |||
Net (decrease) increase in cash and cash equivalents |
| (31,439 | ) | 5,969 |
| 16,039 |
| |||
Cash and cash equivalents, beginning of year |
| 39,314 |
| 7,875 |
| 13,844 |
| |||
Cash and cash equivalents, end of year |
| $ | 7,875 |
| $ | 13,844 |
| $ | 29,883 |
|
Supplemental disclosures of cash flow information: |
|
|
|
|
|
|
| |||
Cash paid for interest |
| $ | 5,013 |
| $ | 10,960 |
| $ | 12,598 |
|
Non-cash financing activities— |
|
|
|
|
|
|
| |||
Capital lease obligations incurred |
| 6,044 |
| 968 |
| 1,213 |
| |||
The accompanying notes are an integral part of these consolidated statements.
COGENT COMMUNICATIONS GROUP, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
FOR THE YEARS ENDED DECEMBER 31, 2003, DECEMBER 31, 2004 AND DECEMBER 31, 2005
(IN THOUSANDS)
|
| 2003 |
| 2004 |
| 2005 |
| ||
Borrowing under credit facility for payment of loan costs and interest |
| 4,502 |
| — |
| — |
| ||
Issuance of Series I preferred stock for Symposium Gamma common stock |
| — |
| 2,575 |
| — |
| ||
Issuance of Series J preferred stock for Symposium Omega common stock |
| — |
| 19,454 |
| — |
| ||
Issuance of Series K preferred stock for UFO Group common stock |
| — |
| 2,600 |
| — |
| ||
Issuance of Series L preferred stock for Global Access assets |
| — |
| 927 |
| — |
| ||
Issuance of Series M preferred stock for Cogent Potomac common stock |
| — |
| 18,352 |
| — |
| ||
PSINet Acquisition |
|
|
|
|
|
|
| ||
Fair value of assets acquired |
| $ | 700 |
|
|
|
|
| |
Less: cash paid |
| (700 | ) |
|
|
|
| ||
Fair value of liabilities assumed |
| — |
|
|
|
|
| ||
FNSI Acquisition |
|
|
|
|
|
|
| ||
Fair value of assets acquired |
| $ | 3,018 |
|
|
|
|
| |
Less: valuation of options for common stock |
| (52 | ) |
|
|
|
| ||
Fair value of liabilities assumed |
| 2,966 |
|
|
|
|
| ||
Symposium Gamma (Cogent Europe) Acquisition |
|
|
|
|
|
|
| ||
Fair value of assets acquired |
|
|
| $ | 155,468 |
|
|
| |
Negative goodwill |
|
|
| (77,232 | ) |
|
| ||
Less: valuation of preferred stock |
|
|
| (2,575 | ) |
|
| ||
Fair value of liabilities assumed |
|
|
| 75,661 |
|
|
| ||
Symposium Omega Acquisition |
|
|
|
|
|
|
| ||
Fair value of assets acquired |
|
|
| $ | 19,454 |
|
|
| |
Less: valuation of preferred stock |
|
|
| (19,454 | ) |
|
| ||
Fair value of liabilities assumed |
|
|
| — |
|
|
| ||
UFO Group Acquisition |
|
|
|
|
|
|
| ||
Fair value of assets acquired |
|
|
| $ | 3,326 |
|
|
| |
Less: valuation of preferred stock |
|
|
| (2,600 | ) |
|
| ||
Fair value of liabilities assumed |
|
|
| 726 |
|
|
| ||
Global Access Acquisition |
|
|
|
|
|
|
| ||
Fair value of assets acquired |
|
|
| $ | 1,931 |
|
|
| |
Less: valuation of preferred stock |
|
|
| (927 | ) |
|
| ||
Fair value of liabilities assumed |
|
|
| 1,004 |
|
|
| ||
Cogent Potomac (Aleron) Acquisition |
|
|
|
|
|
|
| ||
Fair value of assets acquired |
|
|
| $ | 20,622 |
|
|
| |
Less: valuation of preferred stock |
|
|
| (18,352 | ) |
|
| ||
Fair value of liabilities assumed |
|
|
| 2,270 |
|
|
| ||
Verio Acquisition |
|
|
|
|
|
|
| ||
Fair value of assets acquired |
|
|
| $ | 4,493 |
|
|
| |
Fair value of liabilities assumed |
|
|
| 4,493 |
|
|
| ||
See Note 7, which describes the Exchange Agreement with Cisco Capital and conversion of preferred stock under the Purchase Agreement where preferred stock was issued in connection with a troubled debt restructuring.
The accompanying notes are an integral part of these consolidated statements.
47
COGENT COMMUNICATIONS GROUP, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2002,2003, 2004 and 2003
2005
1. Description of the business and summary of significant accounting policies:
Cogent Communications, Inc. ("Cogent"(“Cogent”) was formed on August 9, 1999, as a Delaware corporation and is locatedheadquartered in Washington, DC. Cogent is a facilities-based Internet Services Provider ("ISP"), providing primarily Internet access to businesses in over 30 major metropolitan areas in the United States and in Toronto, Canada and in 2004 expanded its operations into Western Europe. In 2001, Cogent formed Cogent Communications Group, Inc., (the "Company"“Company”), a Delaware corporation. Effective on March 14, 2001, Cogent'sCogent’s stockholders exchanged all of their outstanding common and preferred shares for an equal number of shares of the Company, and Cogent became a wholly owned subsidiary of the Company. The common and preferred shares of the Company include rights and privileges identical to the common and preferred shares of Cogent. This was a tax-free exchange that was accounted for by the Company at Cogent'sCogent’s historical cost. All
The Company is a leading facilities-based provider of Cogent's options for shares of common stock were also converted to options of the Company.
The Company'slow-cost, high-speed Internet access and Internet Protocol (“IP”) communications services. The Company’s network is specifically designed and optimized to transmit data using IP. The Company delivers its services to small and medium-sized businesses, communications service providers and other bandwidth-intensive organizations through approximately 10,000 customer connections in North America and Western Europe.
The Company’s primary on-net service is deliveredInternet access at a speed of 100 Megabits per second, much faster than typical Internet access currently offered to businesses. The Company offers this on-net service exclusively through its own facilities, which run all the way to its customers’ premises. Because of its integrated network architecture, the Company is not dependent on local telephone companies to serve its on-net customers. The Company’s typical customers in multi-tenant office buildings are law firms, financial services firms, advertising and marketing firms and other professional services businesses. The Company also provides on-net Internet access at a speed of one Gigabit per second and greater to certain bandwidth-intensive users such as universities, other Internet service providers, telephone companies, cable television companies and commercial content providers.
In addition to providing on-net services, the Company also provides Internet connectivity to customers that are not located in buildings directly connected to its network. The Company serves these off-net customers using other carriers’ facilities to provide the “last mile” portion of the link from its customers’ premises to the Company's customers over a nationwide fiber-opticCompany’s network. The Company'sCompany operates data centers throughout North America and Western Europe that allow customers to collocate their equipment and access our network. The Company also provides certain non-core services that resulted from acquisitions and continues to support but does not actively sell these services.
The Company has created its network is dedicated solely to Internet Protocol data traffic. The Company's network includes 30-year indefeasible rights of use ("IRUs") to a nationwide fiber-optic intercity network of approximately 12,500 route miles (25,000 fiber miles) of darkby acquiring optical fiber from Wiltel Communications Group, Inc. ("Wiltel"). These IRUs are configured in two rings that connect manycarriers with large amounts of unused fiber and directly connecting Internet routers to the major metropolitan markets inexisting optical fiber national backbone. The Company has expanded its network through several acquisitions of financially distressed companies or their assets. The overall impact of these acquisitions on the United States. In orderoperation of its business has been to extend the Company's national backbone into local markets,physical reach of the Company’s network in both North America and Europe, expand the breadth of its service offerings, and increase the number of customers to whom the Company has entered into leased fiber agreements for intra-city dark fiber from approximately 20 providers. These agreements are primarily under 15-25 year IRUs. Since the Company's April 2002 acquisition of certain assets of PSINet, Inc. ("PSINet"), the Company began operating a more traditional Internet service providerprovides its services.
Management’s plans, liquidity and business with lower speed connections provided by leased circuits obtained from telecommunications carriers (primarily local telephone companies). The Company utilizes leased circuits (primarily T-1 lines) to reach these customers.risks
Merger with Symposium Gamma, Inc. and Acquisition of Firstmark Communications Participations S.a.r.l. and Subsidiaries ("FMCP")
In January 2004, Symposium Gamma, Inc. ("Gamma"), merged with the Company, as further discussed in Note 14. Under the merger agreement all of the issued and outstanding shares of Gamma common stock were converted into 2,575 shares of the Company's Series I convertible participating preferred stock. The Company plans to continue to support FMCP's products including point-to-point transport and transit services in over 40 markets and almost 30 data centers across Western Europe. The Company also intends to introduce in Western Europe a new set of products and services based on the Company's current North American product set.
Asset Purchase Agreement- Fiber Network Services, Inc.
On February 28, 2003, the Company purchased certain assets of Fiber Network Solutions, Inc. ("FNSI") in exchange for the issuance of options for 120,000 shares of the Company's common stock and the Company's agreement to assume certain liabilities. The acquired assets include FNSI's customer contracts and accounts receivable. Assumed liabilities include certain of FNSI's accounts payable, facilities leases, customer contractual commitments and note obligations.
40
Asset Purchase Agreement—PSINet, Inc.
In April 2002, the Company acquired certain of PSINet's assets and certain liabilities related to its operations in the United States for $9.5 million in cash in a sale conducted under Chapter 11 of the United States Bankruptcy Code. The acquired assets include certain of PSINet's accounts receivable and intangible assets, including customer contracts, settlement-free peering rights and the PSINet trade name. Assumed liabilities include certain leased circuit commitments, facilities leases, customer contractual commitments and co-location arrangements.
Merger Agreement—Allied Riser Communications Corporation
On February 4, 2002, the Company acquired Allied Riser Communications Corporation ("Allied Riser"). Allied Riser provided broadband data, voice and video communication services to small- and medium-sized businesses located in selected buildings in North America, including Canada. Upon the closing of the merger on February 4, 2002, Cogent issued approximately 2.0 million shares, or at that time 13.4% of its common stock, on a fully diluted basis, to the existing Allied Riser stockholders and became a public company listed on the American Stock Exchange. The acquisition of Allied Riser provided the Company with in-building networks, pre-negotiated building access rights with building owners and real estate investment trusts across the United States and in Toronto, Canada and the operations of Shared Technologies of Canada ("STOC"). STOC provides voice and data services in Toronto, Canada.
NetRail Inc.
On September 6, 2001, the Company paid approximately $11.7 million in cash for certain assets of NetRail, Inc, ("NetRail") a Tier-1 Internet service provider, in a sale conducted under Chapter 11 of the United States Bankruptcy Code. The purchased assets included certain customer contracts and the related accounts receivable, network equipment, and settlement-free peering arrangements.
Troubled Debt Restructuring and Sale of Preferred Stock
Prior to July 31, 2003, the Company was party to a $409 million credit facility with Cisco Systems Capital Corporation ("Cisco Capital"). The credit facility required compliance with certain financial and operational covenants. The Company violated a financial debt covenant during the fourth quarter of 2002 and failed to subsequently cure the violation. Accordingly, the Company was in default on the credit facility and Cisco Capital was able to accelerate the loan payments and make the outstanding balance immediately due and payable.
On June 12, 2003, the Board of Directors approved a transaction with Cisco Systems, Inc. ("Cisco") and Cisco Capital that restructured the Company's indebtedness to Cisco Capital while at the same time selling a new series of preferred stock to certain of the Company's existing stockholders. The sale of the new series of preferred stock was required to obtain the cash needed to complete the Cisco credit facility restructuring. On June 26, 2003, the Company's stockholders approved these transactions.
In order to restructure the Company's credit facility the Company entered into an agreement (the "Exchange Agreement") with Cisco and Cisco Capital pursuant to which, among other things, Cisco and Cisco Capital agreed to cancel the principal amount of $262.8 million of indebtedness plus $6.3 million of accrued interest and return warrants exercisable for the purchase of 0.8 million shares of Common Stock (the "Cisco Warrants") in exchange for a cash payment by the Company of $20 million, the issuance of 11,000 shares of the Company's Series F participating convertible preferred stock, and the issuance of an amended and restated promissory note (the "Amended and Restated Cisco Note") with an aggregate principal amount of $17.0 million. The Exchange Agreement provides that the entire debt to Cisco Capital is reinstated if Cisco Capital is forced to disgorge the cash payment received under the Exchange Agreement.
41
This transaction has been accounted for as a troubled debt restructuring pursuant to Statement of Financial Accounting Standards ("SFAS") No. 15, "Accounting by Debtors and Creditors of Troubled Debt Restructurings". Under SFAS No. 15, the Amended and Restated Cisco Note was recorded at its principal amount plus the total estimated future interest payments.
In order to restructure the Company's credit facility the Company also entered into an agreement (the "Purchase Agreement") with certain of the Company's existing preferred stockholders (the "Investors"), pursuant to which the Company sold to the Investors in several sub-series, 41,030 shares of the Company's Series G participating convertible preferred stock for $41.0 million in cash.
On July 31, 2003, the Company, Cisco Capital, Cisco and the Investors closed on the Exchange Agreement and the Purchase Agreement. The closing of these transactions resulted in the following:
Under the Purchase Agreement:
Under the Exchange Agreement:
The conversion of the Company's existing preferred stock into a total of 10.8 million shares of $0.001 par value common stock is detailed below. The conversion resulted in the elimination of the book values of these series of preferred stock and a corresponding increase to common stock of $10,000 based upon the common stock's par value and an increase in additional paid in capital of $183.7 million.
| Existing Preferred | Shares outstanding | Conversion Ratio | Common Conversion | |||
|---|---|---|---|---|---|---|
| Series A | 26,000,000 | 0.10000 | 2,600,000 | |||
| Series B | 19,362,531 | 0.12979 | 2,513,127 | |||
| Series C | 49,773,402 | 0.10000 | 4,977,340 | |||
| Series D | 3,426,293 | 0.10000 | 342,629 | |||
| Series E | 3,426,293 | 0.10000 | 342,629 | |||
| TOTAL | 101,988,519 | 10,775,725 | ||||
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The gain resulting from the retirement of the amounts outstanding under the credit facility under the Exchange Agreement was determined as follows (in thousands):
| Cash paid | $ | 20,000 | ||
| Issuance of Series F Preferred Stock | 11,000 | |||
| Amended and Restated Cisco Note, principal plus future interest payments | 17,842 | |||
| Transaction costs | 1,167 | |||
| Total consideration | 50,009 | |||
| Amount outstanding under the Cisco credit facility | (262,812 | ) | ||
| Interest accrued under the Cisco credit facility | (6,303 | ) | ||
| Book value of cancelled warrants | (8,248 | ) | ||
| Book value of unamortized Cisco credit facility loan costs | 11,922 | |||
| Gain — Cisco credit facility — troubled debt restructuring | $ | (215,432 | ) | |
On a basic income and diluted income per share basis the gain was $27.82 and $1.36, respectively, for the year ended December 31, 2003.
Management's Plans and Business Risk
The Company has experienced losses since its inception in 1999 and as of December 31, 2003 has2005 had an accumulated deficit of approximately $54 million and a working capital deficit of $0.9$211.2 million. The Company operates in the rapidly evolving Internet services industry, which is subject to intense competition and rapid technological change, among other factors. The
successful execution of the Company'sCompany’s business plan is dependent upon the Company'sCompany’s ability to increase and retain its customers, the number of customers purchasing services in the buildings connected to and being served by its network ("lit buildings"), its ability to increase its market share, the Company's ability to integrate acquired businesses and purchased assets, including its recent expansion into Western Europe into its operations and realize planned synergies, the availability of and access to intra-city dark fiber and multi-tenant office buildings, the availability and performance of the Company's network equipment, the extent to which acquired businesses and assets are able to meet the Company's expectations and projections, the Company'sCompany’s ability to retain and attract key employees, and the Company'sCompany’s ability to manage its growth including its increased sales and marketing efforts and geographic expansion, among other factors.
On March 30, 2004, the Company merged with Symposium Omega, Inc ("Omega"). Prior to the merger, Omega had raised approximately $19.5 million in cash. The Company issued 3,891 shares of Series J convertible preferred stock to the shareholders of Omega in exchange for all of the outstanding common stock of Omega. This Series J convertible preferred stock will become convertible into approximately 120.6 million shares of the Company's common stock. Management believes that the Company's resources are adequate to meet its funding requirements until cash generated from its operations exceeds its funding requirements. Although management believes that the Company will successfully mitigate its risks, management cannot give assurancesany assurance that it will be able to do so or that the Company will ever operate profitably.
Segments
The Company's chief operating decision maker evaluates performance based upon underlying information ofOn June 13, 2005 the Company assold 10.0 million shares of common stock at $6.00 per share in a whole. There is only one reporting segment.public offering (the “Public Offering”). On June 16, 2005 the underwriters exercised their option to purchase an additional 1.5 million shares of common stock at $6.00 per share. The Public Offering resulted in net proceeds, after underwriting, legal, accounting and printing costs of $63.7 million. In March 2005, the Company entered into a $10.0 million credit facility and in December 2005 increased the available borrowings under the facility to $20.0 million. Management believes that cash from the Public Offering, cash generated from the Company’s operations and the availability under the credit facility will be adequate to meet the Company’s future funding requirements.
43Any future acquisitions, other significant unplanned costs or cash requirements may require the Company to raise additional funds through the issuance of debt or equity. Such financing may not be available on terms acceptable to the Company or its stockholders, or at all. Insufficient funds may require the Company to delay or scale back the number of buildings that it serves, scale back its planned sales and marketing efforts, or require the Company to restructure its business. If issuing equity securities raises additional funds, substantial dilution to existing stockholders may result.
Summary of Significant Accounting Policies
Principles of consolidation
The consolidated financial statements have been prepared in accordance with accounting principlesUnited States generally accepted in the United Statesaccounting principles and include the accounts of the Company and all of its wholly owned and majority-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Reclassifications
Certain previously reported December 31, 2004 balance sheet and cash flow statement amounts have been reclassified in order to be consistent with the December 31, 2005 presentation.
Use of estimates
The preparation of consolidated financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from these estimates.
Revenue recognition
The Company recognizes revenue in accordance with Staff Accounting Bulletin No. 104, “Revenue Recognition.” The Company’s service offerings consist of telecommunications services provided under month-to-month or annual contracts billed monthly in advance. Net revenues from telecommunication services are recognized when the services are performed, evidence of an arrangement exists, the fee is fixed and determinable and collectibilitycollection is reasonably assured.probable. The probability of collection is determined by an analysis of a new customer’s credit history and historical payment patterns for existing customers. Service discounts and
incentives related to telecommunication services are recorded as a reduction of revenue when granted or ratably over the contract period.granted. Fees billed in connection with customer installations and other upfront charges are deferred and recognized ratably over the estimated customer life.life determined by a historical analysis of customer retention.
The Company invoices certain customers for amounts contractually due for unfulfilled minimum contractual obligations and recognizes a corresponding sales allowance equal to this revenue resulting in the recognition of no net revenue at the time the customer is billed. The Company recognizes net revenue as these billings are collected in cash. The Company vigorously seeks payment of these amounts.
The Company establishes a valuation allowance for collection of doubtful accounts and other sales credit adjustments. Valuation allowances for sales credits are established through a charge to revenue, while valuation allowances for doubtful accounts are established through a charge to selling, general and administrative expenses. The Company assesses the adequacy of these reserves on a monthly basis by evaluating general factors, such as the length of time individual receivables are past due, historical collection experience, the economic and competitive environment, and changes in the credit worthiness of its customers. The Company believes that its established valuation allowances were adequate as of December 31, 20022004 and 2003.2005. If circumstances relating to specific customers change or economic conditions worsenchange such that the Company'sCompany’s past collection experience and assessment of the economic environment are no longer relevant, the Company'sCompany’s estimate of the recoverability of its trade receivables could be further reduced.impacted.
Network operations
Network operations include costs associated with service delivery, network management, and customer support. This includes the costs of personnel and related operating expenses associated with these activities, network facilities costs, fiber maintenance fees, leased circuit costs, and access fees paid to office building owners. The Company estimates its accruals for disputed leased circuit obligations based upon the nature and age of the dispute. Network operations costs are impacted by the timing and amounts of disputed circuit costs. The Company generally records these disputed amounts when billed by the vendor and reverses these amounts when the vendor credit has been received or the dispute has otherwise been resolved. The Company does not allocate depreciation and amortization expense to its network operations expense.
International Operationsoperations
The Company began recognizing revenue from operations in Canada through its wholly owned subsidiary, ARCCogent Canada effective with the closing of the Allied Riser merger on February 4, 2002. All revenue is reported in United States dollars. Revenue for ARCCogent Canada for the period from February 4, 2002 to December 31, 2002 and the yearyears ended December 31, 2003, 2004 and 2005 was approximately $4.3$5.6 million, $6.2 million and $5.6$8.0 million, respectively. ARC Canada'sCogent Canada’s total assets were approximately $7.5$11.4 million at December 31, 20022004 and $11.8$12.0 million at December 31, 2003.2005.
Foreign Currency Translation Adjustment
The Company usesbegan recognizing revenue from operations in Europe effective with the U.S. dollar as itsJanuary 5, 2004 acquisition of Cogent Europe. Revenue for the Company’s European operations for the years ended December 31, 2004 and December 31, 2005 was $23.3 million and $27.0 million, respectively. Cogent Europe’s total consolidated assets were $68.3 million at December 31, 2004 and $57.1 million at December 31, 2005.
Foreign currency translation adjustment and comprehensive income (loss)
The functional currency for operations in the U.S. andof Cogent Canada is the Canadian dollardollar. The functional currency of Cogent Europe is the euro. The consolidated financial statements of Cogent Canada, and Cogent Europe, are translated into U.S. dollars using the period-end foreign currency exchange rates for STOC. The assets and liabilities of STOC are translated at the exchange rate prevailing at the balance sheet date. Related revenue and expense accounts for STOC are translated using the average foreign currency exchange rate duringrates for revenues and expenses. Gains and losses on
translation of the period. Cumulative foreignaccounts of the Company’s non-U.S. operations are accumulated and reported as a component of other comprehensive income (loss) in stockholders’ equity.
Statement of Financial Accounting Standard (“SFAS”) No. 130, “Reporting of Comprehensive Income” requires “comprehensive income” and the components of “other comprehensive income” to be reported in the financial statements and/or notes thereto. The Company’s only components of “other comprehensive income” are currency translation adjustments of $628,000 and ($44,000) at December 31, 2003 and 2002, respectively, are included in "Accumulated other comprehensive (loss) income" in the Consolidated Balance Sheets and in the Consolidated Statements of Changes in Shareholders' Equity.for all periods presented.
44
Financial instruments
The Company considers all highly liquid investments with an original maturity of three months or less at purchase to be cash equivalents. The Company determines the appropriate classification of its investments at the time of purchase and reevaluatesevaluates such designation at each balance sheet date. At December 31, 20022004 and 2003,2005, the Company's marketable securitiesCompany’s investments consisted of money market accounts and certificates of deposit and commercial paper.deposit.
The Company iswas party to letters of credit totaling approximately $2.4$2.2 million as of December 31, 2003.2005 and $1.7 million at December 31, 2004. These letters of credit are secured by certificates of deposit and commercial paper investments of approximately $2.4 million at December 31, 2005 and $1.7 million at December 31, 2004 that are restricted and included in short-term investments and other assets. No claims have been made against these financial instruments. Management does not expect any losses from the resolution of these financial instruments and is of the opinion that the fair value of these instruments is zero since performance is not likely to be required.
At December 31, 20022005 and 2003,2004, the carrying amount of cash and cash equivalents, short-term investments, accounts receivable, prepaid and other current assets, accounts payable, and accrued expenses approximated fair value because of the short maturity of these instruments. Based upon the borrowing rates for debt arrangements with similar terms the Company estimates the fair value of the Allied Riser convertible subordinated notes at $10.1 million using a discounted cash flows method and using an interest rate for obligations of similar characteristics. The Allied Riser convertible subordinated notes due in June 2007 have a face value of $10.2 million. The notes were recorded at their fair value of approximately $2.9 million at the merger date. The resulting discount is being accretedamortized to interest expense through the maturity date.date using the effective interest rate method.
Short-Term InvestmentsShort-term investments
Short-term investments consist primarily of commercial papercertificates of deposit with original maturities beyond three months, but less than 12 months. Such short-term investments are carried at cost, which approximates fair value due to the short period of time to maturity. Investments underlying our cash equivalents and short-term investments are classified as “available for sale” in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.”
Credit risk
The Company'sCompany’s assets that are exposed to credit risk consist of its cash equivalents, short-term investments, other assets and accounts receivable. The Company places its cash equivalents and short-term investments in instruments that meet high-quality credit standards as specified in the Company'sCompany’s investment policy guidelines. Accounts receivable are due from customers located in major metropolitan areas in the United States, Western Europe and in Ontario, Canada. RevenuesReceivables from the Company's wholesaleCompany’s net centric (wholesale) customers and customers obtained through business combinations are subject to a higher degree of credit risk than customers who purchase its traditional retailcorporate service.
Comprehensive Income (Loss)
Statement of Financial Accounting Standard ("SFAS") No. 130, "Reporting of Comprehensive Income" requires "comprehensive income" and the components of "other comprehensive income" to be reported in the financial statements and/or notes thereto. The Company did not have any significant components of "other comprehensive income," until the year ended December 31, 2002. Accordingly, reported net loss is the same as "comprehensive loss" for all periods presented prior to 2002 (amounts in thousands).
Property and equipment
Property and equipment are recorded at cost and depreciated once deployed using the straight-line method over the estimated useful lives of the assets. Useful lives are determined based on historical usage
with consideration given to technological changes and trends in the industry that could impact the network architecture and asset utilization. The direct costs incurred prior to an asset being ready for service are reflected as construction in progress. Interest isSystem infrastructure includes capitalized duringinterest, the construction
45
period based upon the rates applicable to borrowings outstanding during the period. Construction in progress includes costs incurred under the construction contract, interest, and thecapitalized salaries and benefits of employees directly involved with construction activities. Expenditures for maintenanceactivities and repairs are expensed as incurred.costs incurred by third party contractors. Assets and liabilities under capital leases are recorded at the lesser of the present value of the aggregate future minimum lease payments or the fair value of the assets under lease. Leasehold improvements include costs associated with building improvements. The Company determines the number of renewal option periods included in the lease term for purposes of amortizing leasehold improvements based upon its assessment at the inception of the lease of the number of option periods that are reasonably assured in accordance with SFAS No. 13 “Accounting for Leases”. Expenditures for maintenance and repairs are expensed as incurred.
Depreciation and amortization periods are as follows:
Type of asset | Depreciation or amortization period | ||||||
Indefeasible rights of use (IRUs) | Shorter of useful life or IRU lease agreement; generally 15 to 20 years, beginning when the IRU is ready for use | ||||||
Network equipment | 3 to | ||||||
Leasehold improvements | Shorter of lease term or useful life; generally | ||||||
Software | 2 to 5 years | ||||||
Owned buildings | 40 years | ||||||
Office and other equipment | 1 to | ||||||
System infrastructure | 5 to 10 years | ||||||
Long-lived assets
The Company'sCompany’s long-lived assets include property and equipment and identifiable intangible assets to be held and used. These long-lived assets are currently reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount should be addressed pursuant to Statement of Financial Standards No. 144, "Accounting“Accounting for the Impairment or Disposal of Long-Lived Assets."” Pursuant to SFAS No. 144, impairment is determined by comparing the carrying value of these long-lived assets to management'smanagement’s probability weighted estimate of the future undiscounted cash flows expected to result from the use of the assets and their eventual disposition. The cash flow projections used to make this assessment are consistent with the cash flow projections that management uses internally to assist in making key decisions. In the event an impairment exists, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the asset, which is generally determined by using quoted market prices or valuation techniques such as the discounted present value of expected future cash flows, appraisals, or other pricing models. Management evaluated these assets for impairment as of December 31, 2004 and 2005 in accordance with SFAS No. 144. Management believes that no such impairment existed in accordance with SFAS No. 144 as of December 31, 20022004 or 2003.2005. In the event there are changes in the planned use of the Company'sCompany’s long-term assets or the Company'sCompany’s expected future undiscounted cash flows are reduced significantly, the Company'sCompany’s assessment of its ability to recover the carrying value of these assets under SFAS No. 144 wouldcould change.
Because management's best estimate of undiscounted cash flows generated from these assets exceeds their carrying value for each of the periods presented, no impairment pursuant toAsset retirement obligations
In accordance with SFAS No. 144 exists. However, because of143, “Accounting for Asset Retirement Obligations,” the significant difficulties confronting the telecommunications industry, management believes that the current fair value of our long-lived assets including our network assets and IRU's are significantly below the amounts the Company originally paida liability for them and may be less than their current depreciated cost basis.
Use of estimates
The preparation of consolidated financial statements in conformity with accounting principles generally acceptedan asset retirement obligation is recognized in the United States requires managementperiod in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. The Company measures changes in the liability for an asset retirement obligation due to make estimates and assumptions that affectpassage of time by applying an interest method of allocation to the reported amountsamount of assets and liabilities and disclosures of contingent assets and liabilitiesthe liability at the datebeginning of the consolidated financial statements andperiod. The interest rate used to measure that change is the reported amounts of revenues and expenses duringcredit-adjusted risk-free rate that existed when the reporting period. Actual results could differ from those estimates.liability was initially measured.
4652
Income taxes
The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting“Accounting for Income Taxes."” Under SFAS No. 109, deferred tax assets or liabilities are computed based upon the differences between financial statement and income tax bases of assets and liabilities using the enacted marginal tax rate. Deferred income tax expense or benefits are based upon the changes in the assets or liability from period to period.
Stock-based compensation
The Company accounts for its stock option plan and shares of restricted preferred stock granted under its 2003 Incentive Award Plan in accordance with the provisions of Accounting Principles Board ("APB"(“APB”) Opinion No. 25, "Accounting“Accounting for Stock Issued to Employees,"” and related interpretations.interpretations using the intrinsic value method. As such, compensation expense related to fixed employee stock options and restricted shares is recorded only if on the date of grant, the fair value of the underlying stock exceeds the exercise price. price and is recognized using the straight-line method over the service period.
The Company has adopted the disclosure only requirements of SFAS No. 123, "Accounting“Accounting for Stock-Based Compensation,"” which allows entities to continue to apply the provisions of APB Opinion No. 25 for transactions with employees and to provide pro forma net income disclosures as if the fair value basedstock method of accounting described in SFAS No. 123 had been applied to employee stock option grants and restricted shares.stock. The following table illustrates the effect on net income and loss per share if the Company had applied the fair value recognition provisions of SFAS No. 123 (in thousands except share and per share amounts):
| | Year Ended December 31, 2001 | Year Ended December 31, 2002 | Year Ended December 31, 2003 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Net (loss) income, as reported | $ | (66,913 | ) | $ | (91,843 | ) | $ | 140,743 | |||
| Add: stock-based employee compensation expense included in reported net loss, net of related tax effects | 3,265 | 3,331 | 18,675 | ||||||||
| Deduct: total stock-based employee compensation expense determined under fair value based method, net of related tax effects | (3,159 | ) | (4,721 | ) | (19,866 | ) | |||||
| Pro forma — net (loss) income | $ | (66,807 | ) | $ | (93,233 | ) | $ | 139,552 | |||
| (Loss) income per share as reported — basic | $ | (47.59 | ) | $ | (28.22 | ) | $ | 18.17 | |||
| Pro forma (loss) income per share — basic | $ | (47.52 | ) | $ | (28.65 | ) | $ | 18.02 | |||
| (Loss) income per share as reported — diluted | $ | (47.59 | ) | $ | (28.22 | ) | $ | 0.89 | |||
| Pro forma (loss) income per share — diluted | $ | (47.52 | ) | $ | (28.65 | ) | $ | 0.88 | |||
|
| Year Ended |
| Year Ended |
| Year Ended |
| |||||||||
Net income (loss) available to common shareholders, as reported |
|
| $ | 88,743 |
|
|
| $ | (133,646 | ) |
|
| $ | (67,518 | ) |
|
Add: stock-based employee compensation expense included in reported net income (loss), net of related tax effects |
|
| 18,675 |
|
|
| 12,262 |
|
|
| 13,305 |
|
| |||
Deduct: total stock-based employee compensation expense determined under fair value based method, net of related tax effects |
|
| (19,866 | ) |
|
| (12,523 | ) |
|
| (13,918 | ) |
| |||
Pro forma—net income (loss) available to common shareholders |
|
| $ | 87,552 |
|
|
| $ | (133,907 | ) |
|
| $ | (68,131 | ) |
|
Income (loss) per share available to common shareholders, as reported—basic and diluted |
|
| $ | 11.18 |
|
|
| $ | (175.03 | ) |
|
| $ | (1.96 | ) |
|
Pro forma income (loss) per share available to common shareholders, —basic and diluted |
|
| $ | 11.03 |
|
|
| $ | (175.38 | ) |
|
| $ | (1.98 | ) |
|
The weighted-average per share grant date fair value of options grantedfor common stock was $14.85$11.20 in 2001, $2.442003, $6.21 in 20022004 and $0.56$4.95 in 2003.2005. The fair value of these options was estimated at the date of grant using the Black-Scholes method with the following weighted-average assumptions for 2001—assumptions—an average risk-free rate of 5.03.5 to 4.1 percent, a dividend yield of 0 percent, an expected life of 5.0 years, and expected volatility of 128%, for 2002—an151 to 197 percent. The weighted- average risk-free rate of 3.5 percent, a dividend yield of 0 percent, an expected life of 5.0 years, and expected volatility of 162% and for 2003—an average risk-free rate of 3.5 percent, a dividend yield of 0 percent, an expected life of 5.0 years, and expected volatility of 197%. The weighted-average per share grant date fair value of Series H convertible preferred sharesrestricted stock granted to employees in 2003 was $861.28$22.39 and $32.21 in 2004 and $4.93 in 2005 and was determined using the trading price of the Company'sCompany’s common stock on the date of grant. Each share of Series H convertible preferred stock converts into approximately 769 shares of common stock.
47
Basic and Diluted Net Loss Per Common Sharediluted net loss per common share
Net income (loss) per share is presented in accordance with the provisions of SFAS No. 128 "Earnings“Earnings per Share"Share”. SFAS No. 128 requires a presentation of basic EPS and diluted EPS. Basic EPS excludes dilution for common stock equivalents and is computed by dividing income or loss available to common stockholders by the weighted-average number of common shares outstanding for the period, adjusted, using the if-converted method, for the effect of common stock equivalents arising from the assumed conversion of participating convertible securities, if dilutive. Diluted net loss per common share is based on the weighted-averageweighted- average number of shares of common stock outstanding during each period, adjusted for the effect of common stock equivalents arising from the assumed exercise of stock options, warrants, the conversion of preferred stock and conversion of participating convertible securities, if dilutive. Common stock equivalents have been excluded from the net loss per share calculation for 20012004 and 20022005 because their effect would be anti-dilutive.
For the years ended December 31, 2001,2004, and 2002,2005, options to purchase 1.21.1 million and 1.01.2 million shares of common stock at weighted-average exercise prices of $5.30$2.30 and $4.41$2.68 per share, respectively, are not included in the computation of diluted earnings per share as they are anti-dilutive. Unvested restricted stock is not included in the computation of earnings per share until vested. For the yearsyear ended December 31, 2001, 2002 and 2003, 95.6 million and 95.12005, 0.3 million shares of unvested restricted stock are not included in the computation of basic earnings per share and will be included as this stock vests. For the year ended December 31, 2004, preferred stock, which werewas convertible into 10.1 million and 10.131.6 million shares of common stock werewas not included in the computation of diluted earnings per share as a result of theirits anti-dilutive effect. For the years ended December 31, 20012004 and 2002, warrants for 0.7 million and 0.9 million2005, approximately 6,300 shares, of common stock, respectively, were not included in the computation of diluted earnings per share as a result of their anti-dilutive effect. For the years ended December 31, 2002 and 2003, approximately 245,000 and 17,530 shares, respectively, of common stock issuable on the conversion of the Allied Riser convertible subordinated notes. For the years ended December 31, 2002notes and 2003, warrants for approximately 104,000 and 50,000 shares, respectively, of common stock were not included in the computation of diluted earnings per share as a result of their anti-dilutive effect.
The following details the determination of the diluted weighted average shares for the year ended December 31, 2003.
Year Ended | ||||||||
Weighted average common shares | 7,935,831 | |||||||
Dilutive effect of stock options and warrants | 3,067 | |||||||
Weighted average | ||||||||
7,938,898 | ||||||||
There is no effect on net income for the year ended December 31, 2003, caused by the conversion of any of the above securities included in the diluted weighted average shares calculation. The basic weighted average common shares outstanding for 2003 includes the effect of participating securities. These securities were excluded in 2004 as they are anti-dilutive for this period and included in 2005 upon conversion of the preferred stock.
Recent Accounting PronouncementsCash flows from financing activities
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which is effective for fiscal years beginning after June 15, 2002. The statement provides accounting and reporting standards for recognizing obligations related to asset retirement costs associatedconnection with the retirementacquisitions of tangible long-lived assets. Under thisCogent Europe, Symposium Omega, UFO and Cogent Potomac, certain of the Company’s shareholders invested in the entities that were used by the Company to acquire the operating assets and liabilities of the businesses acquired. As a result, these amounts are included in cash flows from financing activities in the accompanying consolidated statement legal obligations associated withof cash flows for 2004.
Recent accounting pronouncements
In December 2004, the retirementFASB issued Statement No. 123 (revised 2004), Share-Based Payment (“SFAS 123(R)”). SFAS 123(R) requires all share-based payments to employees, including grants of long-lived assets arestock options, to be recognized atin the statement of operations based upon their fair valuevalues. The Company
currently discloses the impact of valuing grants of stock options and recording the related compensation expense in a pro-forma footnote to the period in which theyfinancial statements. For disclosure purposes, employee stock options are incurred ifvalued at the grant date using the Black-Scholes option pricing method and compensation expense is recognized on a reasonable estimate of fair value can be made. The fair value of the asset retirement costs is capitalized as part of the carrying amount of the long-lived asset and expensed using a systematic and rational methodstraight-line basis over the assets' useful life. Any
48
subsequent changes toservice period for the fair value of the liabilityentire award. Under SFAS 123(R) this alternative is no longer available. The Company will be expensed. The adoption of this statementrequired to adopt SFAS 123(R) on January 1, 2003 did not have a material impact on the Company's operations or financial position.
On July 29, 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities". The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. Previous accounting guidance was provided by Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS 146 replaces Issue 94-3. SFAS 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The Company has not recognized costs associated with exit or disposal activities2006 and as a result will record additional compensation expense in its statements of operations. The impact of the adoption of SFAS 123(R) cannot be predicted at this statement did nottime because it will depend on levels of share-based payments granted in the future. However, had the Company adopted SFAS 123(R) in prior periods, the impact of that standard would have a materialapproximated the impact on the Company's operations or financial position.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure," or SFAS No. 148. SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition to SFAS No. 123's fair value method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure provisions of SFAS No. 123 and APB No. 28, "Interim Financial Reporting," to require disclosureas described in the summarydisclosure of significant accounting policiespro forma net income (loss) in the notes to these consolidated financial statements. The Company plans on using the modified prospective method of adoption under SFAS 123(R) and is currently evaluating the impact of the effects of an entity's accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. While SFAS No. 148 does not amend SFAS No. 123 to require companies to account for employee stock options using the fair value method, the disclosure provisionsadoption of SFAS No. 148 are applicable to all companies with stock-based employee compensation, regardless of whether they account for that compensation using the fair value method of SFAS No. 123 or the intrinsic value method of APB No. 28. The provisions of SFAS No. 148 are effective for fiscal years beginning after December 15, 2002 with respect to the amendments of SFAS No. 123 and effective for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002 with respect to the amendments of APB No. 28. The Company has adopted SFAS No. 148 by including the required additional disclosures.
In January 2003, the FASB issued Interpretation No. 46,Consolidation of Variable Interest Entities ("FIN 46") to clarify the conditions under which assets, liabilities and activities of another entity should be consolidated into the financial statements of a company. FIN 46 requires the consolidation of a variable interest entity by a company that bears the majority of the risk of loss from the variable interest entity's activities, is entitled to receive a majority of the variable interest entity's residual returns, or both. The adoption of FIN 46 did not have an impact123(R) on the Company'sits financial position or results of operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others," ("FIN 45") which expands previously issued accounting guidance and disclosure requirements for certain guarantees. FIN 45 requires an entity to recognize an initial liability for the fair value of an obligation assumed by issuing a guarantee. The provision for initial recognition and measurement of the liability will be applied on a prospective basis to guarantees issued or modified after December 31, 2002. In November 2003, the Company provided an indemnification to certain selling former shareholders of LNG as discussed in Note 9. Pursuant to FIN 45, the Company has recorded a long-term liability and corresponding asset of approximately $167,000 for the estimated fair value of this obligation.
49
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities". SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. The new guidance amends SFAS No. 133 for decisions made: (a) as part of the Derivatives Implementation Group process that effectively required amendments to SFAS No. 133, (b) in connection with other Board projects dealing with financial instruments, and (c) regarding implementation issues raised in relation to the application of the definition of derivative. SFAS No. 149 is generally effective for contracts entered into or modified after June 30, 2003. The adoption of the provisions of SFAS No. 149 did not have an impact on the Company's results of operations or financial position.
In May 2003,and support for the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity". SFAS No. 150 requires certain financial instrumentsassumptions that embody obligationsunderlie the valuation of the issuer and have characteristics of both liabilities and equity to be classified as liabilities. The provisions of SFAS No. 150 became effective for financial instruments entered into or modified after May 31, 2003 and to all other instruments that existed as of July 1, 2003.The Company does not have any financial instruments that meet the provisions of SFAS No. 150; therefore, adopting the provisions of SFAS No. 150 did not have an impact on the Company's results of operations or financial position.awards.
In November 2002, the FASB's Emerging Issues Task Force reached a final consensus on Issue No.00-21. "Accounting for Revenue arrangements with Multiple Deliverables" ("EITF 00-21"), which is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. Under EITF 00-21, revenue arrangements with multiple deliverables are required to be divided into separate units of accounting under certain circumstances. The adoption of EITF 00-21 did not have a material effect on the Company's consolidated financial statements.
In December 2003, the SEC issued Staff Accounting Bulletin No. 104, "Revenue Recognition", which updates the guidance in SAB No. 101, integrates the related set of Frequently Asked Questions, and recognizes the role of EITF 00-21. The adoption of SAB No. 104 did not have a material effect on the Company's consolidated financial statements.
The acquisition ofSince the Company’s inception, it has consummated several acquisitions through which it has generated revenue growth, expanded its network and customer base and added strategic assets of NetRail, PSINet and FNSI and the merger with Allied Riserto its business. These acquisitions were recorded in the accompanying financial statements under the purchase method of accounting. The FNSI purchase price allocation is preliminary and further refinements may be made. The PSINet purchase price was increased by $700,000 during 2003 to reflect the settlement of the pre-existing contingency discussed in Note 9. The operating results related to the acquired assets of NetRail, PSINet and FNSI and the merger with Allied Riser have been included in the consolidated statements of operations from the datesacquisition dates.
Verio acquisition
In December 2004, the Company acquired most of their acquisition.the off-net Internet access customers of Verio Inc., (“Verio”) a leading global IP provider and subsidiary of NTT Communications Corp. The NetRailacquired assets included over 3,700 customer connections located in twenty-three U.S. markets, customer accounts receivable and certain network equipment. The Company also assumed the liabilities associated with providing services to these customers including vendor relationships, accounts payable, customer contractual commitments and accrued liabilities.
Aleron acquisition closed onand merger with Cogent Potomac
In October 2004, the Company acquired certain assets of Aleron Broadband Services, formally known as AGIS Internet (“Aleron”), and $18.5 million in cash, in exchange for 3,700 shares of its Series M preferred stock. The acquisition was effected through a merger with Cogent Potomac. In February 2005, the Series M preferred stock converted into approximately 5.7 million shares of the Company’s common stock. The Company acquired Aleron’s customer base and network, as well as Aleron’s Internet access and managed modem service.
Global access acquisition
In September 6, 2001.2004, the Company issued 185 shares of Series L preferred stock to the shareholders of Global Access Telecommunications, Inc. (“Global Access”) in exchange for the majority of the assets of Global Access. In February 2005, the Series L preferred stock was converted into approximately 0.3 million shares of the Company’s common stock. Global Access provided Internet access and other data services in Germany. The Allied Riseracquired assets included customer contracts, accounts receivable and certain network equipment. Assumed liabilities include certain vendor relationships, and accounts payable and accrued liabilities.
Merger with UFO Group, Inc.
In August 2004, a subsidiary of the Company merged with UFO Group, Inc. (“UFO Group”). The Company issued 2,600 shares of Series K preferred stock in exchange for the outstanding shares of UFO Group. In February 2005, the Series K preferred stock converted into approximately 0.8 million shares of the Company’s common stock. Prior to the merger, closed onUFO Group had acquired the majority of the assets of Unlimited Fiber Optics, Inc. (“UFO”). UFO’s customer base was comprised of data service customers. The acquired assets included net cash of approximately $1.9 million, all of UFO’s customer contracts, customer accounts receivable and certain network equipment. Assumed liabilities included certain vendor relationships and accounts payable.
Merger with Symposium Omega
In March 2004, Symposium Omega, Inc., (“Omega”) a Delaware corporation and related party, merged with a subsidiary of the Company (Note 12). Prior to the merger, Omega had raised approximately $19.5 million in cash in a private equity transaction with certain existing investors in the Company and acquired the rights to a German fiber optic network. The German fiber optic network had no customers, employees or associated revenues. The Company issued 3,891 shares of Series J preferred stock to the shareholders of Omega in exchange for all of the outstanding common stock of Omega. In February 4, 2002.2005, the Series J preferred stock converted into approximately 6.0 million shares of the Company’s common stock. The PSINetaccounting for the merger resulted in the Company recording cash of approximately $19.5 million and issuing Series J preferred stock. The German fiber optic network includes a pair of single mode fibers under a fifteen-year IRU, network equipment, and the co-location rights to facilities in approximately thirty-five points of presence in Germany. Approximately $1.8 million of the $2.7 million purchase price of the German fiber optic network was paid through December 31, 2004 and the remaining payment ($0.9 million) was made in 2005.
Merger with Symposium Gamma, Inc. and acquisition closed on April 2, 2002.of Firstmark Communications Participations S.à r.l. and Subsidiaries (“Firstmark”)
In January 2004, a subsidiary of the Company merged with Symposium Gamma, Inc. (“Gamma”), a related party (Note 12). Immediately prior to the merger, Gamma had raised $2.5 million through the sale of its common stock in a private equity transaction with certain existing investors in the Company and new investors and in January 2004 acquired Firstmark for 1 euro. The FNSI acquisition closed onmerger expanded the Company’s network into Western Europe. Under the merger agreement all of the issued and outstanding shares of Gamma common stock were converted into 2,575 shares of the Company’s Series I preferred stock. In February 28, 2003.2005, the Series I preferred stock converted into approximately 0.8 million shares of the Company’s common stock. In 2004, Firstmark changed its name to Cogent Europe S.à r.l (“Cogent Europe”).
50
The following table summarizes the estimated fair values of the assets acquired and the liabilities assumed at the respectivefor our Cogent Europe acquisition dates (in thousands).
| | NetRail | Allied Riser | PSINet | FNSI | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Current assets | $ | 200 | $ | 71,502 | $ | 4,842 | $ | 291 |
| $ | 17,374 |
| ||||
| Property, plant & equipment | 150 | — | 294 | — |
| 55,862 |
| |||||||||
| Intangible assets | 11,740 | — | 12,166 | 2,727 |
| 855 |
| |||||||||
| Other assets | — | 3,289 | — | — |
| 4,145 |
| |||||||||
| Total assets acquired | $ | 12,090 | $ | 74,791 | $ | 17,302 | $ | 3,018 |
| $ | 78,236 |
| ||||
Current liabilities | — | 20,621 | 7,852 | 2,941 |
| 25,118 |
| |||||||||
| Long term debt | — | 34,760 | — | 25 |
| 49,683 |
| |||||||||
Other liabilities |
| 860 |
| |||||||||||||
| Total liabilities assumed | — | 55,381 | 7,852 | 2,966 |
| 75,661 |
| |||||||||
| Net assets acquired | $ | 12,090 | $ | 19,410 | $ | 9,450 | $ | 52 |
| $ | 2,575 |
| ||||
The intangible assets acquiredmerger with Cogent Europe was recorded in the NetRail acquisition were allocated to customer contracts ($0.7 million) and peering rights ($11.0 million) and are being amortized over a weighted average useful lifeaccompanying financial statements under the purchase method of 36 months. The intangible assets acquired in the PSINet acquisition were allocated to customer contracts ($4.7 million), peering rights ($5.4 million), trade name ($1.8 million), and a non-compete agreement ($0.3 million). These intangible assets are being amortized in periods ranging from two to five years. The intangible assets acquired in the FNSI acquisition were allocated to customer contracts ($2.6 million) and a non-compete agreement ($0.1 million). These intangible assets are being amortized in periods ranging from one to two years.
accounting. The purchase price of Allied RiserCogent Europe was approximately $12.5$78.2 million, which included the fair value of the Company’s Series I preferred stock of $2.6 million and included the issuanceassumed liabilities of 13.4% of the Company's common stock at the acquisition date, or approximately 2.0 million shares of common stock valued at approximately $10.2 million, the issuance of warrants and options for the Company's common stock valued at approximately $0.8 million and transaction expenses of approximately $1.5$75.7 million. The fair value of the common stock was determined by using the average closing price of Allied Risers' common stock in accordance with SFAS No. 141. Allied Riser's subordinated convertible notes were recorded at their fair value using their quoted market price at the merger date. The fair value of net assets acquired was approximately $55.5$155.5 million, resulting inwhich then gave rise to negative goodwill of approximately $43.0$77.3 million. Negative goodwill was allocated to long-lived assets, resulting in recorded assets acquired of approximately $34.6 million with the remaining $8.4 million recorded as an extraordinary gain.$78.2 million.
If the Allied Riser, PSINet and FNSI acquisitionsCogent Europe acquisition had taken place at the beginning of 2002 and 2003, the unaudited pro forma combined results of the Company for the yearsyear ended December 31, 2002 and 2003 would have been as follows (amounts in thousands, except per share amounts).
| | Year Ended December 31, 2002 | Year Ended December 31, 2003 | ||||
|---|---|---|---|---|---|---|
| Revenue | $ | 72,763 | $ | 61,172 | ||
| Net (loss) income before extraordinary items | (108,739 | ) | 140,236 | |||
| Net (loss) income | (100,296 | ) | 140,236 | |||
| (Loss) income per share before extraordinary items — basic | $ | (31.46 | ) | $ | 18.11 | |
| (Loss) income per share before extraordinary items — diluted | $ | (31.46 | ) | $ | 0.88 | |
| (Loss) income per share — basic | $ | (29.02 | ) | $ | 18.11 | |
| (Loss) income per share — diluted | $ | (29.02 | ) | $ | 0.88 | |
|
| Year Ended |
| |||
Revenue |
|
| $ | 85,952 |
|
|
Net income |
|
| $ | 218,269 |
|
|
Net income per share—basic |
|
| $ | 24.99 |
|
|
Net income per share—diluted |
|
| $ | 24.98 |
|
|
51
In management'smanagement’s opinion, these unaudited pro forma amounts are not necessarily indicative of what the actual results of the combined operations might have been if the Allied Riser, PSINet and FNSI acquisitionsCogent Europe acquisition had been effective at the beginning of 20022003. Cogent Europe’s results for the year ended December 31, 2003 included non-recurring gains of approximately $135 million. Because Cogent Europe’s results for the period from January 1, 2004 to January 4, 2004 were not material, the pro forma combined results for the year ended December 31, 2004 are not presented. Pro forma amounts for the UFO Group, Global Access, Aleron and 2003.Verio acquisitions are not presented as these acquisitions did not exceed the materiality reporting thresholds.
3. Property and equipment:equipment and asset held for sale:
Property and equipment consisted of the following (in thousands):
| | | December 31, |
| December 31, |
| ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | 2002 | 2003 |
| 2004 |
| 2005 |
| |||||||
| Owned assets: | Owned assets: |
|
|
|
|
| |||||||||
Network equipment |
| $ | 221,480 |
| $ | 233,275 |
| ||||||||
Leasehold improvements |
| 61,604 |
| 63,327 |
| ||||||||||
System infrastructure |
| 34,303 |
| 36,549 |
| ||||||||||
Software |
| 7,599 |
| 7,688 |
| ||||||||||
Office and other equipment |
| 5,661 |
| 5,973 |
| ||||||||||
Buildings |
| 1,654 |
| 1,435 |
| ||||||||||
Land |
| 260 |
| 226 |
| ||||||||||
| Network equipment | $ | 173,126 | $ | 186,204 |
| 332,561 |
| 348,473 |
| ||||||
| Software | 6,998 | 7,482 | |||||||||||||
| Office and other equipment | 2,600 | 4,120 | |||||||||||||
| Leasehold improvements | 35,016 | 50,387 | |||||||||||||
| System infrastructure | 29,996 | 32,643 | |||||||||||||
| Construction in progress | 5,866 | 988 | |||||||||||||
| 253,602 | 281,824 | ||||||||||||||
| Less — Accumulated depreciation and amortization | (36,114 | ) | (72,762 | ) | |||||||||||
Less—Accumulated depreciation and amortization |
| (117,352 | ) | (167,768 | ) | ||||||||||
| 217,488 | 209,062 |
| 215,209 |
| 180,705 |
| |||||||||
| Assets under capital leases: | Assets under capital leases: |
|
|
|
|
| |||||||||
| IRUs | 112,229 | 118,273 | |||||||||||||
| Less — Accumulated depreciation and amortization | (6,937 | ) | (12,929 | ) | |||||||||||
| 105,292 | 105,344 | ||||||||||||||
IRUs |
| 143,214 |
| 139,669 |
| ||||||||||
Less—Accumulated depreciation and amortization |
| (21,148 | ) | (27,587 | ) | ||||||||||
| 122,066 |
| 122,082 |
| |||||||||||
| Property and equipment, net | Property and equipment, net | $ | 322,780 | $ | 314,406 |
| $ | 337,275 |
| $ | 292,787 |
| |||
Depreciation and amortization expense related to property and equipment and capital leases was $12.2$38.4 million, $26.6$48.3 million and $38.4$53.7 million for the years ended December 31, 2001, 20022003, 2004 and 2003,2005, respectively.
58
Asset held for sale
In 2005, the Company sold its building and land located in Lyon, France for net proceeds of $5.1 million. These assets were acquired in the Cogent Europe acquisition. The associated net book value of $1.2 million is classified as “Asset Held for Sale” in the accompanying consolidated December 31, 2004 balance sheet. This transaction resulted in a gain of approximately $3.9 million.
Capitalized interest, labor and related costs
The Company capitalizes the salaries and related benefits of employees directly involved with its construction activities. In 2001, 20022003, 2004 and 2003, the Company capitalized interest of $4.4 million, $0.8 million and $0.1 million, respectively. In 2001, 2002 and 2003,2005, the Company capitalized salaries and related benefits of $7.0$2.6 million, $4.8$1.7 million and $2.6$2.2 million, respectively. These amounts are included in system infrastructure.
4. Accrued Liabilities:liabilities:
Paris office lease—restructuring charges
In 2004, the French subsidiary of Cogent Europe re-located its Paris headquarters. The estimated net present value of the remaining lease obligation, net of estimated sublease income, was approximately $1.8 million and was recorded as a restructuring charge in 2004. In 2005, the Company revised its estimate for sublease income and estimated that the net present value of the remaining lease obligation had increased by approximately $1.3 million and recorded an additional restructuring charge. A reconciliation of the amounts related to these contract termination costs is as follows (in thousands):
Restructuring accrual |
|
|
| |
Charged to costs—2004 |
| $ | 1,821 |
|
Amortization of discount |
| 145 |
| |
Amounts paid |
| (355 | ) | |
Balance—December 31, 2004 |
| 1,611 |
| |
Amortization of discount |
| 144 |
| |
Charged to costs - 2005 |
| 1,319 |
| |
Effect of exchange rates |
| (236 | ) | |
Amounts paid |
| (1,286 | ) | |
Balance—December 31, 2005 |
| 1,552 |
| |
Current portion (included in accrued liabilities) |
| (1,198 | ) | |
Long term portion (included in other long term liabilities) |
| $ | 354 |
|
Acquired lease obligations
In December 2004, the Company accrued for the net present value of estimated cash flows for amounts related to leases of abandoned facilities acquired in its Verio acquisition. In 2005, the Company revised its estimate for sublease income and estimated that the net present value of the remaining lease obligation increased by approximately $1.6 million and recorded a corresponding increase to the acquired intangible assets.
A reconciliation of the amounts related to these contract termination costs is as follows (in thousands):
Lease accrual |
|
|
| |
Assumed obligation—balance December 31, 2004 |
| $ | 1,894 |
|
Increase to obligation—2005 |
| 1,563 |
| |
Amortization of discount |
| 105 |
| |
Amounts paid |
| (842 | ) | |
Balance—December 31, 2005 |
| 2,720 |
| |
Current portion (included in accrued liabilities) |
| (657 | ) | |
Long term portion (included in other long term liabilities) |
| $ | 2,063 |
|
Asset retirement obligations
The Company provides for asset retirement obligations for certain points of presence in its networks. A reconciliation of the amounts related to these obligations as follows (in thousands):
Asset Retirement Obligations |
|
|
|
|
| |
Beginning balance |
| $ | — |
| ||
Acquired balance—Cogent Europe |
| 1,226 |
| |||
Amortization of discount |
| 40 |
| |||
Amounts paid |
| (64 | ) | |||
Balance—December 31, 2004 |
| 1,202 |
| |||
Effect of exchange rates |
| (128 | ) | |||
Amortization of discount |
| 45 |
| |||
Amounts paid |
| (274 | ) | |||
Balance—December 31, 2005 (recorded as other long term liabilities) |
| $ | 845 |
| ||
Accrued liabilities as of December 31 consist of the following (in thousands):
| | 2002 | 2003 |
| 2004 |
| 2005 |
| ||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| General operating expenditures | $ | 8,315 | $ | 4,541 |
| $ | 9,575 |
| $ | 7,890 |
| ||
| Litigation settlement accruals | 5,168 | 400 | |||||||||||
Restructuring accrual |
| 1,229 |
| 1,198 |
| ||||||||
Due to LNG—related party (Note 12) |
| 217 |
| 24 |
| ||||||||
Acquired lease accruals—Verio acquisition |
| 693 |
| 657 |
| ||||||||
| Deferred revenue | 1,250 | 486 |
| 1,940 |
| 1,302 |
| ||||||
| Payroll and benefits | 543 | 419 |
| 2,043 |
| 1,271 |
| ||||||
| Taxes | 1,937 | 1,584 |
| 1,004 |
| 817 |
| ||||||
| Interest | 1,329 | 455 |
| 3,968 |
| 3,116 |
| ||||||
| Total | $ | 18,542 | $ | 7,885 |
| $ | 20,669 |
| $ | 16,275 |
| ||
52
5. Intangible Assets:assets:
Intangible assets as of December 31 consist of the following (in thousands):
| | 2002 | 2003 |
| 2004 |
| 2005 |
| |||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Peering arrangements (weighted average life of 36 months) | $ | 15,740 | $ | 16,440 |
| $ | 16,440 |
| $ | 16,440 |
| |||
| Customer contracts (weighted average life of 25 months) | 5,575 | 8,145 | ||||||||||||
Customer contracts (weighted average life of 27 months) |
| 10,948 |
| 12,350 |
| |||||||||
| Trade name (weighted average life of 36 months) | 1,764 | 1,764 |
| 1,764 |
| 1,764 |
| |||||||
Other |
| 167 |
| — |
| |||||||||
| Non-compete agreements (weighted average life of 45 months) | 294 | 431 |
| 431 |
| 431 |
| |||||||
| Total (weighted average life of 33 months) | $ | 23,373 | $ | 26,780 | ||||||||||
| Less — accumulated amortization | (8,718 | ) | (18,671 | ) | ||||||||||
Licenses (weighted average life of 192 months) |
| 490 |
| 465 |
| |||||||||
Total (weighted average life of 35 months) |
| 30,240 |
| 31,450 |
| |||||||||
Less—accumulated amortization |
| (27,115 | ) | (28,896 | ) | |||||||||
| Intangible assets, net | $ | 14,655 | $ | 8,109 |
| $ | 3,125 |
| $ | 2,554 |
| |||
Intangible assets are being amortized over periods ranging primarily from 2412 to 60 months. Intangible assets are amortized on a straight-line basis or using an accellerated method consistent with expected cash flows. Amortization expense for the years ended December 31, 2001, 20022003, 2004 and 20032005 was approximately $1.3$10.0 million, $7.4$8.3 million and $10.0$2.0 million, respectively. Future amortization expense related to intangible assets is expected to be $7.0$1.5 million, $1.1$1.0 million $59,000, and $15,000$0.1 million, for the years ending December 31, 2004, 2005, 2006, 2007 and 2007,2008, respectively.
Other assetsWarrant sale
In the Cogent Europe acquisition the Company obtained warrants to purchase ordinary shares of a company listed on the NASDAQ. The warrants were valued at the acquisition date at a fair market value of approximately $2.6 million under the Black-Scholes method of valuation. In January 2004, the Company exercised the warrants and sold the related securities for proceeds of approximately $3.5 million resulting in a gain of approximately $0.9 million. The gain is included as a component of December 31 consistinterest and other income in the accompanying consolidated financial statements.
7. Long-term debt and credit facility:
Subordinated note
On February 24, 2005, the Company issued a subordinated note in the principal amount of $10.0 million to Columbia Ventures Corporation, a stockholder, in exchange for $10.0 million in cash. The note had an initial interest rate of 10.0% per annum. Interest on the note accrued and was payable on the note’s maturity date of February 24, 2009. The Company could prepay the note in whole or in part at any time without penalty. The terms of the following (in thousands):note required the payment of all principal and accrued interest upon the occurrence of a liquidity event, which was defined as an equity offering of at least $30 million in net proceeds. The Company’s June 2005 Public Offering was considered a liquidity event and in June 2005 the Company repaid the $10.0 million subordinated note, plus accrued interest of $0.3 million.
| | 2002 | 2003 | ||||
|---|---|---|---|---|---|---|
| Prepaid expenses | $ | 500 | $ | 378 | ||
| Deposits | 5,335 | 3,419 | ||||
| Indemnification | — | 167 | ||||
| Deferred financing costs | 13,281 | — | ||||
| Total | $ | 19,116 | $ | 3,964 | ||
Deferred financing costs were costsAccounts receivable credit facility
In March 2005, the Company entered into a credit facility with a commercial bank. The credit facility matures on January 31, 2007 and is secured by a first priority lien on the Company’s accounts receivable and on a majority of the Company’s other assets. The borrowing base is determined primarily by the aging characteristics related to the CiscoCompany’s accounts receivable. In March 2005, the Company borrowed $10.0 million. In June 2005, the Company repaid the initial $10.0 million borrowing. Under the credit facility. In connection with the restructuring
facility, $4.0 million of the Cisco credit facility, these amounts were written-off in 2003 as discussed in Note 1.
7. Long-term debt:
In March 2000, Cogent entered into a $280 million credit facility with Cisco Capital. In March 2001,Company’s cash was restricted and held by the credit facility was increased to $310 million and in October 2001 the agreement was increased to $409 million. The credit facility provided for the financing of purchases of up to $270 million of Cisco network equipment, software and related services, the funding up to $64 million of working capital, and funding up to $75 million for interest and fees related to the credit facility.lender. Borrowings under the credit facility were subjectaccrue interest at the prime rate plus 1.5% and may, in certain circumstances, be reduced to Cogent's satisfactionthe prime rate plus 0.5%. Interest is paid monthly. The line includes an unused facility fee of 0.375% and a 0.75% prepayment penalty. The agreements governing the credit facility contain certain operationalcustomary representations and financial covenants. Cogent was in violationwarranties, covenants, notice provisions and events of default including a 2002 financialrequirement to maintain a certain percentage of the Company’s unrestricted cash with the commercial bank.
In December 2005, the Company modified the credit facility. The amendment increased the available borrowings from up to $10.0 million to up $20.0 million, removed the $4.0 million restricted cash covenant, and failed to subsequently cureadded other revisions including financial covenants based upon the violation. Accordingly, the payment ofCompany’s operating performance and capital expenditures. There were no amounts outstanding borrowings under the credit facility may have been accelerated by Cisco Capital and made immediately due and payable. As a result, this obligation was recorded as a current liability on the accompanyingat December 31, 2002 balance sheet. Immediately prior2005.
Troubled debt restructuring—Cisco credit facility
Prior to the closing of the Exchange Agreement on July 31, 2003, the Company was indebted underparty to a credit facility with Cisco Systems Capital Corporation (“Cisco Capital”). In June 2003, the Board of Directors and shareholders approved a transaction with Cisco Systems, Inc. (“Cisco”) and Cisco Capital that restructured the Company’s indebtedness to Cisco Capital while at the same time selling Series G preferred stock to certain of the Company’s existing stockholders. The sale of Series G preferred stock was required to obtain the cash needed to complete the Cisco credit facility for a totalrestructuring. The Company entered into an agreement (the “Exchange Agreement”) with Cisco and Cisco Capital pursuant to which they agreed to cancel the principal amount of $269.1 million ($262.8$262.8 million of principal andindebtedness plus $6.3 million of accrued but unpaid interest)interest and return warrants exercisable for the purchase of common stock (the “Cisco Warrants”) in exchange for a cash payment by the Company of $20 million, the issuance of 11,000 shares of the Company’s Series F preferred stock, and the issuance of an amended and restated promissory note (the “Amended and Restated Cisco Note”).
53
Restructuring and The Amended and Restated Credit Agreement
In connection with the Exchange Agreement as further described inCisco Note 1, the Company entered into the Amended and Restated Credit Agreement with Cisco Capital which became effective on July 31, 2003. Under the Amended and Restated Credit Agreement the Company's indebtedness to Cisco was reduced to ahad an aggregate principal amount of $17.0 million noteunder the modified credit facility. This transaction was accounted for as a troubled debt restructuring pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 15, “Accounting by Debtors and Cisco Capital's obligation to make additional loans to the Company was terminated. Additionally the Amended and Restated Credit Agreement eliminated the Company's financial performance covenants. Cisco Capital retained its senior security interest in substantially allCreditors of the Company's assets, however, the Company may subordinate Cisco Capital's security interest in the Company's accounts receivable to another lender.
The restructured debt is evidenced byTroubled Debt Restructurings”. Under SFAS No. 15, the Amended and Restated Cisco Note forwas recorded at its $17.0 million payableprincipal amount plus the total estimated future interest payments of $0.8 million. The Company also entered into an agreement (the “Purchase Agreement”) with certain of the Company’s existing preferred stockholders (the “Investors”), pursuant to which the Company sold to the Investors in several sub-series, 41,030 shares of the Company’s Series G preferred stock for $41.0 million in cash. On July 31, 2003, the Company, Cisco Capital, Cisco and the Investors closed on the Exchange Agreement and the Purchase Agreement. The closing of these transactions resulted in the following:
Under the Purchase Agreement:
· The Company issued 41,030 shares of Series G preferred stock in several sub-series for gross cash proceeds of $41.0 million;
· The Company’s outstanding Series A, B, C, D and E preferred stock (“Existing Preferred Stock”) was converted into approximately 0.5 million shares of common stock. The conversion resulted in the elimination of the book values of these series of preferred stock and a corresponding increase to common stock based upon the common stock’s par value and an increase in additional paid in capital of $183.7 million.
Under the Exchange Agreement:
· The Company paid Cisco Capital $20.0 million in cash and issued to Cisco Capital.Capital 11,000 shares of Series F preferred stock;
· The Company issued to Cisco Capital the $17.0 million Amended and Restated Cisco Note;
· A default under the Cisco credit facility was eliminated;
· The amount outstanding under the Cisco credit facility including accrued interest was cancelled;
· A service provider agreement with Cisco was amended;
· The Cisco Warrants were cancelled.
The gain resulting from the retirement of the amounts outstanding under the credit facility under the Exchange Agreement was determined as follows (in thousands):
Cash paid |
| $ | 20,000 |
|
Issuance of Series F preferred stock |
| 11,000 |
| |
Amended and Restated Cisco Note, principal plus future interest payments |
| 17,842 |
| |
Transaction costs |
| 1,167 |
| |
Total consideration |
| 50,009 |
| |
Amount outstanding under the Cisco credit facility |
| (262,812 | ) | |
Interest accrued under the Cisco credit facility |
| (6,303 | ) | |
Book value of cancelled warrants |
| (8,248 | ) | |
Book value of unamortized Cisco credit facility loan costs |
| 11,922 |
| |
Gain—Cisco credit facility—troubled debt restructuring |
| $ | (215,432 | ) |
On a basic income and diluted income per share basis the gain was $27.14 per share for the year ended December 31, 2003.
In June 2005, the Company used a portion of the proceeds from its public offering to repay the $17.0 million Amended and Restated Cisco Note. The Amended and Restated Cisco Note was issued under the Amended and Restated Credit Agreement that is to be repaid in three installments. No interest is payable, nor does interest accrue on the Amended and Restated Cisco Note for the first 30 months, unless the Company defaults under the terms of the Amended and Restated Credit Agreement. Principal and interest is paid as follows: a $7.0 million principal payment is due after 30 months, a $5.0 million principal payment plus interest accrued is due in 42 months, and a final principal payment of $5.0 million plus interest accrued is due in 54 months. When the Amended and Restated Cisco Note accrues interest, interest accrues at the 90-day LIBOR rate plus 4.5%.
The Amended and Restated Cisco Note is subject to mandatory prepayment in full, without prepayment penalty, upon the occurrence of the closing of any change in control of the Company, the completion of any equity financing or receipt of loan proceeds in excess of $30.0 million, the achievement by the Companymillion. The repayment of four consecutive quarters of positive operating cash flow of at least $5.0 million, or the merger of the Company resulting in a combined entity with an equity value greater than $100.0 million, each of these events is defined in the agreement. The debt is subject to partial mandatory prepayment in an amount equal to the lesser of $2.0 million or the amount raised if the Company raises less than $30.0 million in a future equity financing.
Future maturities of principal and estimated future interest under the Amended and Restated Cisco Note are as follows (in thousands):resulted in a gain of $0.8 million representing the amount of the estimated future interest payments.
| For the year ending December 31, | | ||
|---|---|---|---|
| 2004 | $ | — | |
| 2005 | — | ||
| 2006 | 7,515 | ||
| 2007 | 5,304 | ||
| 2008 | 5,023 | ||
| Thereafter | — | ||
| $ | 17,842 | ||
Allied Riser convertible subordinated notes
On September 28, 2000, Allied Riser completed the issuance and sale in a private placement of an aggregate of $150.0 million in principal amount of its 7.50% convertible subordinated notes due SeptemberJune 15, 2007 (the "Notes"“Notes”). At the closing of the merger between Allied Riser and the Company, approximately $117.0 million of the Notes were outstanding. The Notes were convertible at the option of the holders into shares of Allied Riser's common stock at an initial conversion price of approximately 65.06 shares of Allied Riser common stock per $1,000 principal amount. The conversion ratio is adjusted upon the occurrence of certain events. The conversion rate was adjusted to approximately 2.09 shares of the Company's common stock per $1,000 principal amount in connection with the merger. Interest is payable semiannually on June 15 and December 15, and is payable, at the
54
election of the Company, in either cash or registered shares of the Company's common stock. The Notes are redeemable at the Company's option at any time on or after the third business day after June 15, 2004, at specified redemption prices plus accrued interest.
In January 2003, the Company, Allied Riser and the holders of approximately $106.7 million in face value of the Allied Riser notes entered into an exchange agreement and a settlement agreement. Pursuant to the exchange agreement, these note holders dismissed their litigation against the Company and surrendered their notes, including accrued and unpaid interest, in exchange for a cash payment of approximately $5.0 million, 3.4 million shares of the Company'sCompany’s Series D preferred stock and 3.4 million shares of the Company'sCompany’s Series E preferred stock. This preferred stock, at issuance, was convertible into approximately 4.2% of the Company's then outstanding fully diluted common stock. Pursuant to the settlement agreement, these note holders dismissed their litigation with prejudice in exchange for the cash payment. These transactions closed in March 2003 when the agreed amounts were paid and the Company issued the Series D and Series E preferred shares. The settlement and exchange transactions together eliminated $106.7 million in face amount of the notes due in June 2007, interest accrued on these notes since the December 15, 2002 interest payment, all future interest payment obligations on these notes and settled the note holder litigation discussed in Note 9. The terms of the remaining $10.2 million of subordinated convertible notes were not impacted by these transactions and they continue to be due on June 15, 2007. These notes were recorded at their fair value of approximately $2.9 million at the merger date. This discount is accreted to interest expense through the maturity date.
As of December 31, 2002, the Company had accrued the amount payable under the settlement agreement, net of a recovery of $1.5 million under its insurance policy. This resulted in a net expense of $3.5 million recorded in 2002. The $4.9$5.0 million payment required under the settlement agreement was paid in March 2003. The Company received the $1.5 million insurance recovery in April 2003. The exchange agreement resulted in a gain of approximately $24.8 million recorded in March 2003. The gain resulted from the difference between the $36.5 million net book value of the notes ($106.7 million face value less the related discount of $70.2 million) and $2.0 million of accrued interest and the exchange consideration which included $5.0 million in cash and the $8.5 million estimated fair market value for the Series D and Series E preferred stock less approximately $0.2 million of transaction costs. The estimated fair market value for the Series D and Series E preferred stock was determined by using the price per share of the Company’s Series C preferred stock, which represented the Company’s most recent equity transaction for cash. In June 2003, the Series D and E preferred stock was converted into common stock.
The terms of the remaining $10.2 million of Notes were not impacted by these transactions and the Notes continue to be due on June 15, 2007. These $10.2 million notes were recorded at their fair value of approximately $2.9 million at the merger date. The discount is amortized to interest expense through the maturity date. The Notes are convertible at the option of the holders into approximately 1,050 shares of the Company’s common stock. Interest is payable semiannually on June 15 and December 15, and is payable, at the election of the Company, in either cash or registered shares of the Company’s common stock. The Company has paid interest in cash. The Notes are redeemable at the Company’s option at any time on or after the third business day after June 15, 2004, at specified redemption prices plus accrued interest.
The net deferred tax asset is comprised of the following (in thousands):
| | December 31 |
| December 31 |
| ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2002 | 2003 |
| 2004 |
| 2005 |
| |||||||
| Net operating loss carry-forwards | $ | 179,151 | $ | 234,059 |
| $ | 283,860 |
| $ | 275,283 |
| |||
| Depreciation | (6,097 | ) | (23,627 | ) |
| (36,823 | ) | (47,764 | ) | |||||
| Start-up expenditures | 3,912 | 3,724 |
| 3,379 |
| 3,724 |
| |||||||
| Accrued liabilities | 4,833 | 3,633 |
| 726 |
| 3,407 |
| |||||||
| Deferred compensation | 2,677 | 10,255 |
| 15,230 |
| 20,432 |
| |||||||
| Other | 40 | 28 |
| 16 |
| 4 |
| |||||||
| Valuation allowance | (184,516 | ) | (228,072 | ) |
| (266,388 | ) | (255,086 | ) | |||||
| Net deferred tax asset | $ | — | $ | — |
| $ | — |
| $ | — |
| |||
Due to the uncertainty surrounding the realization of its net deferred tax asset, the Company has recorded a valuation allowance for the full amount of its net deferred tax asset. Should the Company achieve profitability,taxable income, its deferred tax assets may be available to offset future income tax liabilities. The Company has combined net operating loss carry-forwards of approximately $761 million. The federal and state net operating loss carry-forwards for the United States of approximately $577$393 million expire in 20202023 to 2023. For federal and state tax purposes, the Company's2026. The Company has net operating loss carry-forwards could be subjectcarry forwards related to certain limitations on annual utilization if certain changes in ownership were to occur as
55
defined by federal and state tax laws.its European operations of approximately $369 million, $368 million of which do not expire. The federal and state net operating loss carry-forwards of Allied Riser Communications Corporation as of February 4, 2002 of approximately $257$183 million are subject to certain limitations on annual utilization due to the change in ownership as a result of the merger as definedprescribed by federal and state tax laws. The Company’s net operating loss carry-forwards could be subject to certain limitations on annual utilization if certain changes in ownership have occurred or were to occur as prescribed by the laws in the respective jurisdictions.
Under Section 108(a)(1)(B) of the Internal Revenue Code of 1986 gross income does not include amounts that would be includible in gross income by reason of the discharge of indebtedness to the extent that a non-bankrupt taxpayer is insolvent. Under Section 108(a)(1)(B) the Company believes that its gains on the settlement of debt with certain Allied Riser note holders and its debt restructuring with Cisco Capital for financial reporting purposes willdid not result in taxable income. However, these transactions resulted in a reduction to the Company'sCompany’s net operating loss carry forwards of approximately $20 million in 2003 and will result in further reductions to the Company's net operating loss carry forwards of approximately $291$290 million in 2004.
63
The following is a reconciliation of the Federal statutory income tax rate to the effective rate reported in the financial statements.
| | 2001 | 2002 | 2003 |
| 2003 |
| 2004 |
| 2005 |
| ||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Federal income tax (benefit) at statutory rates | 34.0 | % | 34.0 | % | 34.0 | % |
| 34.0 | % | 34.0 | % | 34.0 | % | |
| State income tax (benefit) at statutory rates, net of Federal benefit | 6.6 | 7.6 | (3.7 | ) |
| (3.7 | ) | 6.6 |
| 6.6 |
| |||
Impact of foreign operations |
| — |
| (0.4 | ) | (0.4 | ) | |||||||
| Impact of permanent differences | — | 5.3 | (53.0 | ) |
| (53.0 | ) | 0.1 |
| 0.1 |
| |||
| Change in valuation allowance | (40.6 | ) | (46.9 | ) | 22.7 |
| 22.7 |
| (40.3 | ) | (40.3 | ) | ||
| Effective income tax rate | — | % | — | % | — | % |
| — | % | — | % | — | % | |
9. Commitments and contingencies:
Capital leases—Fiberfiber lease agreements
The Company has entered into lease agreements with several providers for intra-city and inter-city dark fiber primarily under 15-25 year IRUs.IRUs with additional renewal terms. These IRUs connect the Company's nationalCompany’s international backbone fiberfibers with the multi-tenant office buildings and the customers served by the Company. Once the Company has accepted the related fiber route, leases of intra-city and inter-city fiber-optic rings that meet the criteria for treatment as capital leases are recorded as a capital lease obligation and IRU asset. The future minimum commitments under these agreements are as follows (in thousands):
| For the year ending December 31, |
|
|
| |||||
| 2004 | $ | 8,334 | ||||||
| 2005 | 6,493 | |||||||
| 2006 | 5,999 |
| $ | 14,334 |
| |||
| 2007 | 6,001 |
| 12,661 |
| ||||
| 2008 | 6,001 |
| 12,450 |
| ||||
2009 |
| 10,543 |
| |||||
2010 |
| 14,467 |
| |||||
| Thereafter | 77,647 |
| 86,591 |
| ||||
| Total minimum lease obligations | 110,475 |
| 151,046 |
| ||||
| Less — amounts representing interest | (48,722 | ) | ||||||
Less—amounts representing interest |
| (58,654 | ) | |||||
| Present value of minimum lease obligations | 61,753 |
| 92,392 |
| ||||
| Current maturities | (3,646 | ) |
| (6,698 | ) | |||
| Capital lease obligations, net of current maturities | $ | 58,107 |
| $ | 85,694 |
| ||
56
Capital lease obligation amendmentsFiber Leases
In November 2004, Cogent Spain negotiated modifications to an IRU capital lease and Construction Commitments
Certainnote obligation with a vendor. In exchange for the return of one of two strands of leased optical fiber, Cogent Spain reduced its quarterly IRU lease payments, modified its payments and eliminated accrued and future interest on its note obligation. The note obligation arose in 2003, when Cogent Spain negotiated a settlement with the vendor that included converting certain amounts due under the capital lease into a note obligation. The first installment was due in 2005. The modified note is interest free and includes nineteen equal quarterly installments of $0.3 million and a final payment of $5.6 million due in January 2010. Cogent Spain paid $0.3 million at settlement. The modification to the note obligation resulted in a gain of approximately $0.3 million. The modification to the IRU capital lease resulted in a gain of approximately $4.9 million. This transaction resulted in a gain since the difference between the carrying value of the Company's agreements forold IRU obligation and the constructionnet present value of building laterals and for the leasingnew IRU obligation was greater than the carrying value of metro fiber rings and lateral fiber include minimum specified commitments. The Company has also submitted product orders but not yet accepted the related fiber route or lateral construction.IRU asset.
In September 2005, Cogent Spain further negotiated modifications to an IRU capital lease and reduced its quarterly IRU lease payments and extended the lease term. The future minimum commitments under these arrangements aremodification to the IRU capital lease resulted in a gain of approximately $0.8 million. The transaction resulted in a gain since the difference between the carrying value of the old IRU obligation and the net present value of the new IRU obligation was greater than the carrying value of the related IRU asset.
In March 2004, Cogent France paid approximately $0.3 million and settled amounts due from and due to a vendor. The vendor leased Cogent France its office facility and an intra-city IRU. The settlement agreement also restructured the IRU capital lease by reducing the lease payments. This transaction resulted in a reduction to the capital lease obligation and IRU asset of approximately $1.9 million.
Current and potential litigation
During 2004, Cogent Europe’s subsidiaries provided network services to and in turn utilized the network of LambdaNet Communications AG (“LambdaNet Germany”) in order for each entity to provide services to certain of their customers under a network sharing agreement. LambdaNet Germany was a majority owned subsidiary of a related party, LNG Holdings S.A. (“LNG”) from November 2003 until April 2004 when LambdaNet Germany was sold to an unrelated party as further discussed in Note 12. During the years endingyear ended December 31, 2004 through December 31, 2008Cogent Europe recorded revenue of $2.0 million from LambdaNet Germany and $2.7network costs of $1.8 million therafter.
Cisco equipment purchase commitment
In March 2000,under the Company entered into a five-year agreement to purchase from Cisco minimum annualnetwork sharing agreement. There were no amounts of equipment, professional services, and software. In October 2001, the commitment was increased to purchase a minimum of $270 million through December 2004. As of July 31, 2003, therecorded in 2005 as this arrangement has been terminated. The Company had purchased approximately $198.1 million towards this commitment and had met all of the minimum annual purchase commitment obligations. As part of the Company's restructuring of the Cisco credit facility this agreement was amended. The amended agreement has no minimum purchase commitment but does have a requirement that the Company purchase Cisco equipment for its network equipment needs. No financing is provided and the Company is required to pay Cisco in advance for any purchases.
Legal Proceedings
Vendor Claims and Disputes. One of the Company's subsidiaries, Allied Riser Operations Corporation, is involved in a dispute with its former landlord in Dallas, Texas. On July 15, 2002,over services provided by and to LambdaNet Germany during the landlord filed suit in the 193rd District Courttime LambdaNet Germany was a sister company of the StateCompany’s French and Spanish subsidiaries. LambdaNet Germany has filed a lawsuit in Germany against Cogent Spain seeking approximately $1.0 million. LambdaNet Germany has indicated that it also has similar claims totaling an additional $3.0 million against Cogent France and other Cogent subsidiaries. Cogent France and Cogent Spain are no longer sister companies of Texas alleging that Allied Riser's March 2002 termination of its lease with the landlord resulted in a default under the lease. The Company believes, and Allied Riser Operations Corporation has responded, that the termination was consistent with the terms of the lease. Although the suit did not specify damages, the Company estimates, based upon the remaining payments under the lease and assuming no mitigation of damages by the landlord, that the amount in controversy may total approximately $3.0 million. The Company has not recognized a liability for this dispute and intends to vigorously defend its position.
The Company generally accrues for the amounts invoiced by its providers of telecommunications services. Liabilities for telecommunications costs in dispute are generally reduced when the vendor acknowledges the reduction in its invoice and the credit is granted. In 2002, one vendor invoiced the Company for approximately $1.7 million in excess of what the Company believes is contractually due to the vendor. The vendor has initiated an arbitration proceeding related to this dispute. The Company has not reflected this disputed amount as a liability.LambdaNet Germany. The Company intends to vigorously defend its position related to these charges.charges and believes it has defenses and offsetting claims against LambdaNet Germany.
The Company is involved in disputes with three telephone companies that provide local circuits or leased optical fibers. In one case the provider has filed suit. In the other cases the provider has threatened to file suit or to terminate service, which would disrupt service to some of the Company’s customers. The total amount claimed by these vendors is $4.5 million. The Company does not believe these amounts are owed to these providers and intends to vigorously defend its position.
PSINet Liquidating, LLC. On March 19, 2003 PSINet Liquidating LLC filed a motionThe Company has been made aware of several other companies in its own and in other industries that use the United States Bankruptcy Court for the Southern District of New York seeking an order instructingword “Cogent” in their corporate names. One company has informed the Company to return certain equipment and to cease using certain equipment. The motion relates tothat it believes the asset purchase agreement under whichCompany’s use of the name “Cogent” infringes on its intellectual property rights in that name. If such a challenge is successful, the Company purchased throughcould be required to change its name and lose the bankruptcy process certain assets from the estate of PSINet, Inc. The PSINet estate alleged that the Company failed to make available for pick-up and failed to return all of the equipment that the Company was obligated to return under the terms of the asset purchase agreement and that the Company was in some cases making use of that equipment in violation of the agreement. On May 7, 2003 the Company agreedgoodwill associated with the PSINet estateCogent name in its markets. Management does not believe such a challenge, if successful, would have a material impact on a mechanism for identifying equipmentthe Company’s business, financial condition or results of operations.
In December 2003, several former employees of Cogent Spain filed claims related to their termination of employment. The Company intends to continue to vigorously defend its position related to these charges and feels that still must be returned and determining the compensationit has adequately reserved for any unreturned equipment. The bankruptcy courtpotential liability. One case has approved the agreementbeen resolved and the Company has funded a $600,000 escrow account related to this matter to resolve the potential remaining obligations for unreturned equipment. The Company believes that all equipment to be returned to the PSINet estate has been returned, and the Company isothers are in the processvarious stages of appeal.
57
of determining what, if any, amount will need to be released from the escrow account to the PSINet estate, as well as finalizing the purchase, in lieu of return, of selected equipment from the PSINet estate, for which the Company has accrued an additional $75,000.
Employment LitigationIn 2003, a claim wasformer employee filed a counterclaim against the Company by a former employee asserting primarily thatin state court in California seeking additional commissions were due to the employee.commissions. The Company had filed a claim against this employee for breach of contract, among other claims. A judgment was awarded to the former employee and the Company appealed the case. In 2004, the Company paid approximately $0.6 million to the state court as part of the appeal. In 2006, the appeals court ruled and remanded the case to the lower court. The case has filednow been
concluded and in 2006 the Company expects to receive a motion for reconsideration. The Company recorded a liability for the estimated net loss under this judgment. The matter is awaiting final adjudication.refund of amounts previously paid of approximately $0.4 million.
The Company is involved in other legal proceedings inIn the normal course of business which managementthe Company is involved in certain legal activities and claims. Because such matters are subject to many uncertainties and the outcomes are not predictable with assurance, the liability related to these legal actions and claims cannot be determined with certainty. Management does not believe that such claims and actions will have a material impact on the Company'sCompany’s financial condition or results of operations.
Operating leases, maintenance and license agreements
The Company leases office space, network equipment sites, and facilities under operating leases. The Company also enters into building access agreements with the landlords of its targeted multi- tenant office buildings. The Company acquired building access agreementspays fees for the maintenance of its intra-city and intercity leased fiber and in certain cases the Company connects its customers to its network under operating leaseslease commitments for facilities in connection with the Allied Riser merger.fiber. Future minimum annual commitments under these arrangements are as follows (in thousands):
| 2004 | $ | 15,019 | |||||
| 2005 | 13,054 | ||||||
| 2006 | 10,842 |
| $ | 27,341 |
| ||
| 2007 | 8,869 |
| 20,245 |
| |||
| 2008 | 7,346 |
| 16,478 |
| |||
2009 |
| 12,788 |
| ||||
2010 |
| 10,237 |
| ||||
| Thereafter | 28,469 |
| 62,155 |
| |||
| $ | 149,244 |
| ||||
| $ | 83,599 | ||||||
Rent expense relatesrelated to leased office spacefacilities and was $3.3$8.3 million in 2001 $3.32003, $12.3 million in 20022004 and $2.3$14.4 million in 2003.2005. The Company has subleasedsublet certain office space and facilities. Future minimum payments under these sub leasesub-lease agreements are approximately $1.1 million, $0.7 million, $0.3 million, $0.2$0.5 million, and $0.1$0.3 million for the years ending December 31, 20042006 through December 31, 2008.2008, respectively.
Maintenance and connectivity agreementsUnconditional purchase obligations
The Company pays a monthly fee per route mile over a minimum of 20 years for the maintenance of its two national backbone fibers. In certain cases, the Company connects its customers and the buildings it serves to its national fiber-optic backbone using intra-city and inter-city fiber under operating lease commitments.
Future minimumUnconditional purchase obligations as oftotaled approximately $5.5 million at December 31, 2003, related2005 and are expected to these arrangements are as follows (in thousands):be fulfilled within one year.
| Year ending December 31 | |||
| 2004 | $ | 3,461 | |
| 2005 | 3,507 | ||
| 2006 | 3,577 | ||
| 2007 | 3,649 | ||
| 2008 | 3,721 | ||
| Thereafter | 47,348 | ||
| $ | 65,263 | ||
58
Shareholder Indemnification
In November 2003 the Company's Chief Executive Officer acquired LNG Holdings S.A. ("LNG"). LNG, through its LambdaNet group of subsidiaries, operated a carriers' carrier fiber optic transport business in Europe. In connection with this transaction, the Company provided an indemnification to certain former LNG shareholders. The guarantee is without expiration and covers claims related to LNG's LambdaNet subsidiaries and actions taken in respect thereof including actions related to the transfer of ownership interests in LNG. Should the Company be required to perform the Company will defend the action and may attempt to recover from LNG and other involved entities. The Company has recorded a long-term liability and corresponding asset of approximately $167,000 for the estimated fair value of this obligation.
10. Stockholders'Stockholders’ equity:
Authorized shares
In June 2003,March 2005, the Company'sCompany’s board of directors and shareholders approved the Company's fourthan amended and restated certificate of incorporation. The amended and restated charter that increased the number of authorized shares of the Company'sCompany’s common stock from 21,100,000to 75.0 million shares to 395,000,000and designated 10,000 shares eliminated the reference to the Company's Series A, B, C, D, and E preferred stock ("Existing Preferred Stock") and authorized 120,000 shares of authorized but unissued and undesignated preferred stock.
On July 31, 2003Reverse stock split
In March 2005, the Company effected a 1-for-20 reverse stock split. Accordingly, all share and in connection withper share amounts have been retroactively adjusted to give effect to this event.
Equity conversion
In February 2005, holders of the Company's debt restructuring and the Purchase Agreement,Company’s preferred stock elected to convert all of the Company's Existing Preferred Stock was convertedtheir shares of preferred stock into approximately 10.831.6 million shares of the Company’s common stock. At the same timestock . As a result, the Company issued 11,000no longer has outstanding shares of Series F preferred stock to Cisco Capital understock. The accounting for this transaction resulted in the Exchange Agreement and issued 41,030 shares of Series G preferred stock for gross proceeds of $41.0 million to the Investors under the Purchase Agreement.
In September 2003, the Compensation Committee (the "Committee")elimination of the board of directors adopted and the stockholders approved, the Company's 2003 Incentive Award Plan (the "Award Plan"). The Award Plan reserved 54,001 shares of Series H preferred stock for issuance under the Award Plan.
Each sharebalances of the Series G preferred stock, Series F through M preferred stock and Series H preferred stock (collectively,an increase of approximately $139.7 million to additional paid-in-capital.
Public offering
On June 13, 2005 the "New Preferred") may be converted intoCompany sold 10.0 million shares of common stock at $6.00 per share in a public offering (the “Public Offering”). On June 16, 2005 the election of its holder at any time. The Series F preferred stock is convertible into 68.2underwriters exercised their option to purchase an additional 1.5 million shares of common stock. The Series G preferred stock is convertible into 254.9 million shares of common stock. The Series H preferred stock is convertible into 41.5 million shares of common stock. The New Preferred will be automatically converted into common stock at the then applicable conversion rate$6.00 per share. The Public Offering resulted in the eventnet proceeds of an underwritten$63.7 million, after underwriting, legal, accounting and printing costs.
Withdrawal of public offering of shares of
In May 2004, the Company atfiled a total offering of not less than $50 million at a post-money valuation of the Company of $500 million (a "Qualifying IPO"). The conversion prices are subjectregistration statement to adjustment, as defined.
The New Preferred stock votes together with the common stock and not as a separate class. Each share of the New Preferred has a number of votes equal to the number ofsell shares of common stock then issuable upon conversion of such shares. The consent of holders ofin a majority of the outstanding Series F preferred stock is required to declare or pay any dividend on the common or the preferred stock ofpublic offering. In October 2004, the Company andwithdrew the consent of the holders of 80% of the Series G preferred stock is required prior to an underwritten public offering and expensed the associated costs of the Company's stock unless the aggregate pre-money valuation of the Company at the time of the offering is at least $500 million, and the gross cash proceeds of the offering are $50approximately $0.8 million.
In the event of any dissolution, liquidation, or winding up of the Company, at least $11.0 million will be paid in cash to the holders of the Series F preferred stock, at least $123.0 million will be paid in cash to the holders of the Series G preferred stock and at least $9.1 million will be paid in cash to theWarrants
59
holders of the Series H preferred stock before any payment is made to the holders of the Company's common stock.
Warrants and options
Warrants to purchase 0.8 million shares of the Company's common stock were issued to Cisco Capital in connection with working capital loans under the Company's credit facility. On July 31, 2003 these warrants were cancelled as part of the restructuring of the Company's debt to Cisco Capital.
In connection with the February 2002 merger with Allied Riser, the Company assumed warrants issued by Allied Riser that convert into approximately 0.1 million5,000 shares of the Company'sCompany’s common stock. All of the warrants are exercisable at exercise prices ranging from $0 to $475$9,500 per share. These warrants
Dividends
The Company’s line of credit prohibits the Company from paying cash dividends and restricts the Company’s ability to make other distributions to its stockholders.
Beneficial conversion charges
Beneficial conversion charges of $2.5 million, $19.5 million, $2.6 million, $0.9 million and $18.5 million were valuedrecorded on January 5, 2004, March 30, 2004, August 12, 2004, September 15, 2004, and October 26, 2004 respectively, since the price per common share at approximately $0.8 million usingwhich the Black- Scholes method of valuationSeries I, Series J, Series K, Series L and are recorded asSeries M preferred stock purchase warrants usingwere convertible into were less than the following assumptions—average risk free rates of 4.7 percent, an estimated fair valuequoted trading price of the Company'sCompany’s common stock on that date. A beneficial conversion charge of $5.32, expected live$52.0 million was recorded on July 31, 2003 since the conversion prices on the Series F and Series G convertible preferred stock at issuance were less than the trading price of 8 years and expected volatility of 207.3%.
In connection with the February 2003 purchase of certain assets of Fiber Network Solutions, Inc., options for 120,000 shares ofCompany’s common stock at $0.45 per shareon that date.
Equity incentive plan
In 1999, the Company adopted its Equity Incentive Plan (the “Plan”) for granting of options to employees. Stock options granted under the Plan generally vest over a four-year period and have a term of ten years. Options outstanding under the Plan as of December 31, 2003, were issued to certain6,002 with a weighted-average exercise price of $9.03. Options outstanding as of December 31, 2004, and 2005 were 6,033 and 6,075, respectively, with a weighted-average exercise price of $9.00.
Incentive Award Plan
In September 2003, the former FNSI vendors. The fair valueCompensation Committee of these options was estimated at $52,000 at the dateboard of grant withdirectors adopted and the following weighted-average assumptions—an average risk-free rate of 3.5 percent, a dividend yield of 0 percent, an expected life of 10.0 years, and expected volatility of 128%stockholders approved, the Company’s Incentive Award Plan (the “Award Plan”).
Offer to exchange — Series H Preferred Stock
In September 2003, the Company offered its employees the opportunity to exchange eligible outstanding stock options and certain common stock for restricted shares of Series H participating convertible preferred stock. In order forstock, under an employeeOffer to participate in the exchange, the employee was required to forfeit any and all shares of commonExchange. The restricted stock ("Subject Common Stock") and his or her stock options granted under the Company's Amended and Restated Cogent Communications Group 2000 Equity Incentive Plan. Subject Common Stock included common stock received asOffer to Exchange vested 27% upon grant with the remaining shares vesting ratably over a result of a conversion of Series B and Series C preferred stock but excluded common stock purchased on public markets. In October 2003, pursuantthree-year period. Under the Offer to Exchange, the offer, the Company exchanged options representing the right to purchase an aggregate of approximately 1.0 million shares of the Company's common stock for approximately 53,500 shares of Series H restricted stock. In addition, all 1.2 million shares of Subject Common Stock were surrendered. The Company recorded a deferred compensation charge of approximately $46.1 million in the fourth quarter of 2003 related to these grants of restricted stock under this offer to exchange. The Company also granted approximately 350 shares of Series H preferred to certain new employees resulting in an additional deferred compensation charge of approximately $0.3 million. Deferred compensation is being amortized over the vesting period of the Series H preferred stock. 2003.
For shares granted under the offer to exchange, the vesting period was 27% upon grant with the remaining shares vesting ratably over a three year period forand options grants to newly hired employees, the vesting period is generally 25% after one year with the remaining shares vesting occurring ratably over fourthree years. Compensation expense for all awards is recognized ratably over the service period.
In April 2005, the Company’s board of directors and stockholders approved an increase in the number of shares available for grant under the Award Plan of 0.6 million shares of common stock to a total of 3.8 million available shares.
Stock options exercised, granted, and canceled under the Award Plan during the period from December 31, 2003 to December 31, 2005, were as follows:
|
| Number of |
| Weighted-average |
| |||
Outstanding at December 31, 2003 |
| — |
|
| $ | — |
|
|
Granted |
| 1,057,667 |
|
| $ | 2.27 |
|
|
Cancellations |
| (2,347 | ) |
| $ | 6.17 |
|
|
Outstanding at December 31, 2004 |
| 1,055,320 |
|
| $ | 2.26 |
|
|
Granted |
| 216,053 |
|
| $ | 5.59 |
|
|
Cancellations |
| (36,682 | ) |
| $ | 7.66 |
|
|
Outstanding at December 31, 2005 |
| 1,234,691 |
|
| $ | 2.68 |
|
|
68
Stock options outstanding and exercisable under the Award Plan by price range at December 31, 2005 were as follows:
OUTSTANDING AND EXERCISABLE BY PRICE RANGE
As of December 31, 2005
Range of Exercise Prices |
|
|
| Number |
| Weighted Average |
| Weighted-Average |
| Number |
| Weighted-Average |
| ||||||||||||
$0.00 (granted below market value) |
|
| 673,085 |
|
|
| 8.69 |
|
|
| $ | 0.00 |
|
|
| 36,147 |
|
|
| $ | 0.00 |
|
| ||
$4.39 to $4.88 |
|
| 152,296 |
|
|
| 9.79 |
|
|
| $ | 4.84 |
|
|
| 7,500 |
|
|
| $ | 4.88 |
|
| ||
$4.90 to $5.94 |
|
| 23,186 |
|
|
| 9.56 |
|
|
| $ | 5.50 |
|
|
| 1,989 |
|
|
| $ | 5.54 |
|
| ||
$6.00 |
|
| 324,581 |
|
|
| 8.50 |
|
|
| $ | 6.00 |
|
|
| 114,980 |
|
|
| $ | 6.00 |
|
| ||
$6.20 to $32.00 |
|
| 61,543 |
|
|
| 9.11 |
|
|
| $ | 8.12 |
|
|
| 8,909 |
|
|
| $ | 8.56 |
|
| ||
$0.00 to $32.00 |
|
| 1,234,691 |
|
|
| 8.81 |
|
|
| $ | 2.68 |
|
|
| 169,525 |
|
|
| $ | 4.80 |
|
| ||
Shares of restricted stock granted under the Award Plan and canceled for the period from December 31, 2002 to December 31, 2005, were as follows:
Number of | |||
Outstanding at December 31, 2002 | — | ||
Granted (weighted average fair value of $22.39) | 2,072,064 | ||
Cancellations | (19,017 | ) | |
Outstanding at December 31, 2003 | 2,053,047 | ||
Granted (weighted average fair value of $32.31) | 92,808 | ||
Cancellations | (198,950 | ) | |
Outstanding at December 31, 2004 | 1,946,905 | ||
Granted (weighted average fair value of $4.93) | 200,000 | ||
Cancellations | (23,305 | ) | |
Outstanding at December 31, 2005 | 2,123,600 |
There were 1,707,658 vested shares outstanding as of December 31, 2005.
Deferred compensation charges—stock options and restricted stock
The Company recorded a deferred compensation charge of approximately $14.3 million in 2001 related to Series H preferredoptions granted at exercise prices below the estimated fair market value of the Company’s common stock on the date of grant. This deferred compensation charge was amortized over the service period of the related options, which was generally four years. In connection with the 2003 Offer to Exchange the remaining $3.2 million unamortized balance of deferred compensation is now amortized over the vesting period of the restricted stock granted under the Offer to Exchange. In addition to shares granted under the Offer to Exchange, the Company has granted shares of restricted stock to its employees resulting in additional deferred compensation including approximately $16.4$1.0 million for grants made in 2005.
In 2004, the year ended December 31, 2003. WhenCompany granted 673,085 options with an exercise price below the trading price of the Company’s common stock on grant date. These option grants resulted in deferred compensation of $4.7 million. Deferred compensation for these option grants was determined by multiplying the difference between the exercise price and the market value of common stock on grant date by the number of shares granted.
For grants of restricted stock, when an employee terminates prior to full vesting, the total remaining deferred compensation charge is reduced, the employee retains their vested shares and the employees'employees’ unvested shares are returned to the plan.
Dividends
The Cisco credit facility prohibits the Company from paying cash dividends and restricts the Company's ability to make other distributions to its stockholders.
60
Beneficial Conversion Charges
The October 2001 issuance For grants of Series C preferred stock resulted in an adjustment of the conversion rate of the Series B preferred stock from 1.0 shares ofoptions for common stock, per ten shares of Series B preferredwhen an employee terminates prior to 1.2979 shares of common stock per ten shares of Series B preferred. This equates to an additional 0.6 million shares of common stock. This transaction resulted in a non-cash beneficial conversion charge of approximately $24.2 million that wasfull vesting, previously recorded in the Company's fourth quarter 2001 financial statements as a reduction to retained earnings and earnings available to common shareholders and an increase to additional paid-in capital.
A beneficial conversion charge of $52.0 million was recorded on July 31, 2003 since the price per common share at which the Series F and Series G convertible preferred stock converted into at issuance were less than the quoted trading price of the Company's common stock on that date.
11. Stock option plan:
In 1999, the Company adopted its Equity Incentive Plan (the "Plan") for granting of options to employees, directors, and consultants under which 1,490,000 shares are reserved for issuance. Options granted under the Plan may be designated as incentive or nonqualified at the discretion of the Plan administrator. Stock options granted under the Plan generally vest over a four-year period and have a term of ten years. Stock options exercised, granted, and canceled during the period from inception (August 9, 1999) to December 31, 2003, were as follows:
| | Number of options | Weighted-average exercise price | |||
|---|---|---|---|---|---|
| Outstanding at December 31, 2000 | 608,136 | $ | 9.90 | ||
| Granted | 822,072 | $ | 4.04 | ||
| Exercised | (9,116 | ) | $ | 2.25 | |
| Cancellations | (263,173 | ) | $ | 12.10 | |
| Outstanding at December 31, 2001 | 1,157,919 | $ | 5.30 | ||
| Granted | 153,885 | $ | 1.93 | ||
| Exercised | (7,296 | ) | $ | 0.13 | |
| Cancellations | (271,222 | ) | $ | 6.94 | |
| Outstanding at December 31, 2002 | 1,033,286 | $ | 4.41 | ||
| Granted | 157,175 | $ | 0.49 | ||
| Exercised | — | — | |||
| Cancellations | (1,068,861 | ) | $ | 4.28 | |
| Outstanding at December 31, 2003 | 121,600 | $ | 0.45 | ||
Options exercisable as of December 31, 2001, were 223,523 with a weighted-average exercise price of $7.24. Options exercisable as of December 31, 2002, were 506,833 with a weighted-average exercise price of $4.78. Options exercisable as of December 31,2003, were 120,043 with a weighted-average exercise price of $0.45. The weighted-average remaining contractual life of the outstanding options at December 31, 2003, was approximately 9 years.
61
OUTSTANDING AND EXERCISABLE BY PRICE RANGEAs of December 31, 2003
| Range of Exercise Prices | Number Outstanding 12/31/2003 | Weighted Average Remaining Contractual Life (years) | Weighted-Average Exercise Price | Number Exercisable As of 12/31/2002 | Weighted-Average Exercise Price | |||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| $0.45 | 121,500 | 9.16 | $ | 0.45 | 120,000 | $ | 0.45 | |||||
| $2.00 | 100 | 8.01 | $ | 2.00 | 43 | $ | 2.00 | |||||
Deferred Compensation Charge—Stock Options
The Company recorded a deferred compensation charge of approximately $14.3 million in the fourth quarter of 2001 related to options granted at exercise prices below the estimated fair market value of the Company's common stock on the date of grant. The deferred compensation charge was amortized over the vesting period of the related options which was generally four years. In connection with the October 2003 offer to exchange and granting of Series H preferred stock the remaining $3.2 million unamortized balance of deferred compensation is now amortized overreversed, the vestingemployee may elect to exercise their vested options for a period of ninety days and any of the Series H preferred stock.employees’ unvested options are returned to the plan.
CompensationThe amortization of deferred compensation expense related to stock options and restricted stock was approximately $3.3 million for the years ended December 31, 2001 and 2002 and $2.3$18.7 million for the year ended December 31, 2003.2003, $12.3 million for the year ended December 31, 2004 and $13.3 million for the year ended December 31, 2005.
12. Related party:party transactions:
Office lease
The Company'sCompany’s headquarters is located in an office building owned by an entity controlled by the Company'sCompany’s Chief Executive Officer. The Company paid $453,000 in 2001, $410,000 in 2002 and $367,000 in 2003, $409,000 in 2004 and $417,000 in 2005 in rent to this entity. InThe lease expires in August 2003,2006 and the Company has the option to extend the lease was amended to expire in August 2004. There are no amounts due to or from related parties at December 31, 2002 or 2003.2007.
In November 2003 the Company's Chief Executive Officer acquired LNG Holdings S.A. ("LNG"). LNG, through its LambdaNet group of subsidiaries, operated a carriers' carrier fiber optic transport business Europe. In connection with this transaction the Company provided an indemnification to certain former LNG shareholders.
62
13. Quarterly financial information (unaudited):
| | Three months ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | March 31, 2002 | June 30, 2002 | September 30, 2002 | December 31, 2002 | |||||||||
| | (in thousands, except share and per share amounts) | ||||||||||||
| Net service revenue | $ | 3,542 | $ | 18,578 | $ | 15,960 | $ | 13,833 | |||||
| Cost of network operations, including amortization of deferred compensation | 6,908 | 16,007 | 14,243 | 12,166 | |||||||||
| Operating loss | (16,684 | ) | (15,523 | ) | (16,875 | ) | (13,192 | ) | |||||
| Net loss | (17,959 | ) | (24,562 | ) | (25,409 | ) | (23,914 | ) | |||||
| Net loss applicable to common stock | (17,959 | ) | (24,562 | ) | (25,409 | ) | (23,914 | ) | |||||
| Net loss per common share | (6.81 | ) | (7.18 | ) | (7.34 | ) | (6.86 | ) | |||||
| Weighted-average number of shares outstanding | 2,637,951 | 3,419,582 | 3,463,995 | 3,483,838 | |||||||||
| | Three months ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | March 31, 2003 | June 30, 2003 | September 30, 2003 | December 31, 2003 | |||||||||
| | (in thousands, except share and per share amounts) | ||||||||||||
| Net service revenue | $ | 14,233 | $ | 15,519 | $ | 15,148 | $ | 14,522 | |||||
| Cost of network operations, including amortization of deferred compensation | 10,739 | 12,282 | 12,067 | 13,236 | |||||||||
| Operating loss | (14,880 | ) | (16,568 | ) | (15,901 | ) | (33,878 | ) | |||||
| Gain — Cisco credit facility — troubled debt restructuring | — | — | 215,432 | — | |||||||||
| Gain — Allied Riser note exchange | 24,802 | — | — | — | |||||||||
| Net (loss) income | 1,914 | (22,796 | ) | 196,462 | (34,837 | ) | |||||||
| Net (loss) income applicable to common stock | 1,914 | (22,796 | ) | 144,462 | (34,837 | ) | |||||||
| Net (loss) income per common share — basic | 0.55 | (6.54 | ) | 18.48 | (2.64 | ) | |||||||
| Net (loss) income per common share — diluted | 0.14 | (6.54 | ) | 0.86 | (2.64 | ) | |||||||
| Weighted-average number of shares outstanding — basic | 3,483,838 | 3,483,838 | 10,628,612 | 13,204,582 | |||||||||
| Weighted-average number of shares outstanding — diluted | 13,845,149 | 3,483,838 | 228,595,536 | 13,204,582 | |||||||||
The net loss applicable to common stock for the first and fourth quarters of 2002 includes extraordinary gains of approximately $4.5 million and $3.9 million, respectively, related to the merger with Allied Riser. The net loss applicable to common stock for the third quarter of 2003 includes a non-cash beneficial conversion charge of $52.0 million.
63
14. Subsequent events:
Merger with Symposium Gamma, Inc. and Acquisition of Firstmark Communications Participations S.a.r.l. and Subsidiaries ("FMCP")
In November 2003, approximately 90% of the stock of LNG, the then parent company to FMCP,of Cogent Europe was acquired by Symposium Inc. ("Symposium"(“Symposium”) a Delaware corporation. Symposium is wholly ownedThe acquisition was for no cash consideration and in return for a commitment to cause at least $2.0 million to be invested in LNG’s subsidiary Cogent France and an indemnification of LNG’s selling stockholders by the Company'sCompany and Symposium. The Company’s Chief Executive Officer.Officer owns 100% of Symposium. In January 2004, LNG transferred its interest in FMCPCogent Europe to Symposium Gamma, Inc. ("Gamma"(“Gamma”), a Delaware corporation, in return for $1 and a commitment by Gamma to invest at least $2$2.0 million in the operations of LambdaNetCogent France. Gamma (and the Company after the merger) undertook to obtain the release of LNG from certain guarantee obligations. Prior to thisthe transfer, Gamma had raised approximately $2.5 million in a private equity transaction with certain existing investors in the Company and a new investor.
investors. In January 2004, Gamma merged withtransferred $2.5 million to Cogent France and, by so doing, fulfilled the Company. Under the merger agreement all$2.0 million commitment. Symposium continues to own approximately 90% of the issued and outstanding sharesstock of Gamma common stock were converted into 2,575 shares of the Company's Series I convertible participating preferred stock and the Company became Gamma and FMCP's sole shareholder. The 2,575 shares of the Series I convertible participating preferred stock is convertible into approximately 16.0 million shares of the Company's common stock.LNG. LNG operates as a holding company. Its subsidiaries that have not been sold hold assets related to their former telecommunications operations (which operations have been terminated).
The Company plans to continue to support the FMCP's products including point-to-point transport and transit services. The Company also intends to introduce in Europe a new set of products and services based on the Company's current North American product set.
Short Term Loans to FMCP
In January 2004, FMCP's subsidiary$271 million of Cogent Europe’s total debt of $272 million owed to its previous parent LNG, and other amounts payable of $6.2 million owed to LNG were assigned to Gamma at their fair market value of 1 euro in France borrowed approximately $1.4 million from the Company. This amount was repaid in full in February 2004. In February 2004, FMCP's subsidiaries in France and Spain each borrowed approximately $895,000 from the Company.
15. Mergerconnection with Symposium Omega
On March 30, 2004 the Company merged with Symposium Omega, Inc., ("Omega") a Delaware corporation.Gamma’s acquisition of Cogent Europe. Prior to the Company’s merger with Gamma, and advanced as part of the Gamma merger, LNG transferred $1.2 million to Cogent France. Cogent France repaid the $1.2 million to LNG in March 2004. Accordingly, $271 million of the total $272 million of the debt obligation and $6.2 million of the other amounts payable eliminated in the consolidation of these financial statements.
Gamma and Omega
Gamma and Symposium Omega Inc. (“Omega”), a Delaware corporation, are considered related parties to the Company since both entities had raised cash in private equity transactions with certain existing investors in the Company. Gamma was formed in order to acquire Cogent Europe. Omega was formed in order to acquire the rights to the German fiber optic network that was acquired by the Company in 2004. In December 2003, Gamma was capitalized with approximately $2.5 million in exchange for 100% of Gamma’s common stock. In March 2004, Omega was capitalized with approximately $19.5 million in cashexchange for 100% of Omega’s common stock.
In 2004, Cogent Europe’s subsidiaries provided network services to and in turn utilized the network of Lambdanet Germany in order for each entity to provide services to certain of their customers under a network sharing agreement. Lambdanet Germany was a majority owned subsidiary of LNG from November 2003 until April 2004 when Lambdanet Germany was sold to an unrelated party. During the year ended December 31, 2004 Cogent Europe recorded revenue of $2.0 million from Lambdanet Germany and network costs of $1.8 million under the network sharing agreement. There were no amounts recorded in 2005 as this arrangement has been terminated. As of December 31, 2004 and 2005 Cogent Europe had recorded net amounts due from and due to Lambdanet Germany of $1.7 million and $1.7 million, respectively. The Company is currently in negotiations with the new owner of Lambdanet Germany over the terms of settling these amounts.
Marketing agreement
The Company has entered into an agency sales and mutual marketing agreement with CTC Communications Corporation, a company owned indirectly by one of the Company’s directors. CTC is also a customer and the Company has billed and recorded revenue from CTC of approximately $6,000 per month since January 2004.
Transatlantic circuits
The Company uses transatlantic circuits provided by a company owned by one of its directors. The Company pays approximately $53,000 per month under this arrangement.
Customer agreement
In connection with the August 2004 UFO acquisition the Company acquired Cisco as a customer. Cisco is a stockholder of the Company. The Company billed and recorded revenue from Cisco of approximately $40,000 per month from August 2004 until June 2005.
Vendor settlement
Cogent Spain and LNG settled a number of disputes between those entities and Iberbanda, a Spanish entity from whom Cogent Spain had been leasing space and obtaining services. In the settlement, LNG released to Iberbanda a $0.4 million bond that had been put in place by LNG with the Spanish government as part of a bid for the right to construct a wireless network. In consideration for LNG’s release of the bond, Iberbanda settled a claim for approximately $0.9 million of back rent due and service charges. The rent related to the former Madrid offices of Cogent Spain. In addition, Cogent Spain granted a credit for services to Iberbanda in the amount of $0.2 million and agreed to acquirepay approximately $0.1 million in cash over a German fiber optic network.period of 18 months. LNG’s release of the bond has been recorded as a contribution of capital from a shareholder as a result of the Company’s Chief Executive Officer’s ownership of LNG.
Reimbursement for services provided by LNG employees
In 2005, the Company reimbursed LNG for the approximate $200,000 of salaries paid to two employees of LNG that were providing Cogent Europe accounting and management services during 2004. In November 2004, these two employees became employees of Cogent Europe.
Purchases from Cisco Systems, Inc.
In April 2005, the Company entered into a letter of credit for $0.5 million between its commercial bank and Cisco Capital related to a $1.2 million purchase of Cisco network equipment. The equipment was delivered to the Company in the third quarter of 2005. In October 2005, the Company entered into an additional $0.5 million letter of credit related to a $3.6 million purchase order for Cisco equipment and
prepaid $0.7 million against this purchase. The letters of credit and the $1.0 million restricted short-term investments securing these letters of credit are expected to be released in the first half of 2006 when the final payments for this equipment are made. The Company issued 3,891 sharespurchased approximately $5.0 million of Series J convertible preferred stocknetwork equipment from Cisco for the year ended December 31, 2005. There were no purchases in the year ended December 31, 2004. At December 31, 2005 the Company had outstanding purchase obligations to Cisco of approximately $1.8 million.
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the shareholders of Omegachief operating decision maker in exchange for all ofdeciding how to allocate resources and in assessing performance. The Company has one operating segment. Below are the outstandingCompany’s net revenues and long lived assets by geographic region (in thousands):
|
| Years Ended December 31, |
| |||||||
|
| 2003 |
| 2004 |
| 2005 |
| |||
Service Revenue, net |
|
|
|
|
|
|
| |||
North America |
| $ | 59,422 |
| $ | 68,009 |
| $ | 108,260 |
|
Europe |
| — |
| 23,277 |
| 26,953 |
| |||
Total |
| $ | 59,422 |
| $ | 91,286 |
| $ | 135,213 |
|
|
| December 31, 2004 |
| December 31, 2005 |
| ||||||
Long lived assets, net |
|
|
|
|
|
|
|
|
| ||
North America |
|
| $ | 287,204 |
|
|
| $ | 252,343 |
|
|
Europe |
|
| 54,416 |
|
|
| 42,998 |
|
| ||
Total |
|
| $ | 341,620 |
|
|
| $ | 295,341 |
|
|
14. Quarterly financial information (unaudited):
|
| Three months ended |
| ||||||||||||||
|
| March 31, |
| June 30, |
| September 30, |
| December 31, |
| ||||||||
|
| (in thousands, except share and per share amounts) |
| ||||||||||||||
Service revenue, net |
| $ | 20,945 |
| $ | 20,387 |
|
| $ | 21,736 |
|
|
| $ | 28,218 |
|
|
Network operations, including amortization of deferred compensation |
| 15,947 |
| 13,486 |
|
| 14,510 |
|
|
| 20,381 |
|
| ||||
Operating loss |
| (21,939 | ) | (19,218 | ) |
| (20,160 | ) |
|
| (22,752 | ) |
| ||||
Gains—capital lease obligations restructurings |
| — |
| — |
|
| — |
|
|
| 5,292 |
|
| ||||
Net loss |
| (24,170 | ) | (22,225 | ) |
| (23,041 | ) |
|
| (20,224 | ) |
| ||||
Net loss available to common stock |
| (46,198 | ) | (22,225 | ) |
| (26,496 | ) |
|
| (38,727 | ) |
| ||||
Net loss per common share—basic and diluted |
| (35.94 | ) | (29.51 | ) |
| (28.58 | ) |
|
| (24.66 | ) |
| ||||
Weighted-average number of shares outstanding—basic and diluted |
| 672,457 |
| 753,130 |
|
| 806,151 |
|
|
| 820,125 |
|
| ||||
|
| Three months ended |
| ||||||||||
|
| March 31, |
| June 30, |
| September 30, |
| December 31, |
| ||||
|
| (in thousands, except share and per share amounts) |
| ||||||||||
Service revenue, net |
| $ | 34,414 |
| $ | 33,806 |
| $ | 33,772 |
| $ | 33,222 |
|
Network operations, including amortization of deferred compensation |
| 23,033 |
| 21,494 |
| 21,590 |
| 20,077 |
| ||||
Operating loss |
| (15,694 | ) | (13,659 | ) | (14,814 | ) | (17,981 | ) | ||||
Gains—asset sales, lease and debt obligations |
| 3,372 |
| 842 |
| 844 |
| — |
| ||||
Net loss |
| (14,973 | ) | (16,151 | ) | (16,106 | ) | (20,288 | ) | ||||
Net loss per common share—basic and diluted |
| (0.96 | ) | (0.48 | ) | (0.37 | ) | (0.47 | ) | ||||
Weighted-average number of shares outstanding—basic and diluted |
| 15,610,722 |
| 33,963,566 |
| 43,474,555 |
| 43,619,506 |
| ||||
The net losses applicable to common stock for the first quarter of Omega. This Series J convertible preferred stock will become convertible into approximately 120.62004, third quarter of 2004 and fourth quarter of 2004 include non-cash beneficial conversion charges of $22.0 million, shares$3.5 million and $18.5 million, respectively. In the fourth quarter of 2005, the Company's common stock. The German network includesCompany revised the number of lease renewal periods used in determining the lease term for purposes of amortizing certain of its leasehold improvements resulting in a pair of single mode fibers under a fifteen-year IRU, network equipment, and the co-location rights to facilitiesnet increase in approximately thirty-five points of presence in Germany. The agreement will require a one-time paymentdepreciation expense of approximately 2.3 million EUROS and includes monthly service fees of approximately 85,000 EUROS for co location and maintenance for the pair of single mode fibers.$3.0 million.
It is anticipated that the network will be delivered in full by May 2004. The Company intends to integrate this German network into its existing European networks and introduce point-to-point transport, transit services and its North American product set in Germany.73
64
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
On July 10, 2002, we dismissed our independent auditors, Arthur Andersen LLP, and appointed Ernst & Young LLP to serve as our new independent auditors for the year ending December 31, 2002. Our Board of Directors approved this decision. We filed a current report on Form 8-K with the SEC on July 10, 2002, which included a notification of this change.None.
Arthur Andersen's report on our financial statements for the fiscal year ending December 31, 2001 did not contain an adverse opinion or disclaimer of opinion, nor were such reports qualified or modified as to uncertainty, audit scope or accounting principles.
During the fiscal year ending December 31, 2001, there were: (i) no disagreements with Arthur Andersen on any matter of accounting principle or practice, financial statement disclosure or auditing scope or procedure which, if not resolved to Arthur Andersen's satisfaction, would have caused them to make reference to the subject matter in connection with their report on our financial statements for such years; and (ii) there were no reportable events as defined in Item 304(a)(1)(v) of Regulation S-K.
During the fiscal year ending December 31, 2001 and through the date of their appointment, we did not consult Ernst & Young with respect to the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on our financial statements, or any other matters or reportable events as set forth in Items 304(a)(2)(i) and (ii) of Regulation S-K.
ITEM 9A. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act reportsof 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC'sSecurities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely for decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
We carried outAs required by SEC Rule 13a-15(b), an evaluation was performed under the supervision and with the participation of our management, including the Chief Executive Officerour principal executive officer and the Chief Financial Officer,our principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of December 31, 2003 the end of the period covered by this report. Based on the foregoing,upon that evaluation, our Chief Executive Officermanagement, including our principal executive officer and Chief Financial Officerour principal financial officer, concluded that ourthe design and operation of these disclosure controls and procedures were effective at the reasonable assurance levellevel.
There has been no change in our internal controls over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
MANAGEMENT’S REPORT ON INTERNAL CONTROL
OVER FINANCIAL REPORTING
We are responsible for the preparation and integrity of our published financial statements. The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and, accordingly, include amounts based on judgments and estimates made by our management. We also prepared the other information included in the annual report and are responsible for its accuracy and consistency with the financial statements.
We are responsible for establishing and maintaining a system of internal control over financial reporting, which is intended to provide reasonable assurance to our management and Board of Directors regarding the reliability of our financial statements. The system includes but is not limited to:
· a documented organizational structure and division of responsibility;
· established policies and procedures, including a code of conduct to foster a strong ethical climate which is communicated throughout the company;
· Regular reviews of our financial statements by qualified individuals; and
· the careful selection, training and development of our people.
There are inherent limitations in the effectiveness of any system of internal control, including the possibility of human error and the circumvention or overriding of controls. Also, the effectiveness of an internal control system may change over time. We have implemented a system of internal control that was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles.
We have assessed our internal control system in relation to criteria for effective internal control over financial reporting described in “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based upon these criteria, we believe that, as of December 31, 2003.2005, our system of internal control over financial reporting was effective.
ThereThe independent registered public accounting firm, Ernst & Young LLP, has audited our 2005 financial statements. Ernst & Young LLP was given unrestricted access to all financial records and related data, including minutes of all meetings of stockholders, the Board of Directors and committees of the Board. Ernst & Young LLP has issued an unqualified audit opinion on our 2005 financial statements as a result of the audit and also has issued an attestation report on management’s assessment of its internal control over financial reporting which is attached hereto.
Cogent Communications Group, Inc.
March 13, 2006
By:
/s/ DAVID SCHAEFFER |
David Schaeffer |
Chief Executive Officer |
/s/ THADDEUS WEED |
Thaddeus Weed |
Chief Financial Officer |
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The Board of Directors and Stockholders
Cogent Communications Group, Inc.
We have been no significantaudited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Cogent Communications Group, Inc. maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Cogent Communications Group, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Cogent Communications Group, Inc. maintained effective internal controls orcontrol over financial reporting as of December 31, 2005, is fairly stated, in other factors that could significantly affectall material respects, based on the COSO criteria. Also, in our opinion, Cogent Communications Group, Inc. maintained, in all material respects, effective internal controls duringcontrol over financial reporting as of December 31, 2005, based on the fourth quarterCOSO criteria.
We also have audited, in accordance with the standards of 2003.the Public Company Accounting Oversight Board (United States), the 2005 consolidated financial statements of Cogent Communications Group Inc. and our report dated March 13, 2006 expressed an unqualified opinion thereon.
65/s/ ERNST & YOUNG LLP
McLean, Virginia
March 13, 2006
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Not applicable.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item 10 is incorporated in this report by reference to the information set forth under the captions entitled “Election of Directors,” “The Board of Directors and Committees,” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the 2003 definitive information statement2006 Proxy Statement for the 20032006 Annual Meeting of Stockholders, which is expected to be filed with the Commission within 120 days after the close of our fiscal year.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is incorporated in this report by reference to the information set forth under the caption "Executive Officers Compensation"captions entitled “The Board of Directors and Committees,” “Executive Compensation”, “Employment Agreements”, “Compensation Committee Report on Executive Compensation,” and “Compensation Committee Interlocks and Insider Participation” in the 2003 definitive information statement2006 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item 12 is incorporated in this report by reference to the information set forth under the caption "Security“Security Ownership of Certain Beneficial Owners and Management"Management” in the 2003 definitive information statement.2006 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item 13 is incorporated in this report by reference to the information set forth under the caption "Certain Transactions"“Certain Transactions” in the 2003 definitive information statement.2006 Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item 14 is incorporated in this report by reference to the information set forth under the caption "Principal Accountant Fees and Services"“Relationship With Independent Public Accountants” in the 2003 definitive information statement.
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ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) | 1. | Financial Statements. A list of financial statements included herein is set forth in the Index to Financial Statements appearing in | ||
2. | Financial Statement Schedules. The Financial Statement | |||
Description | ||||
Schedule | ||||
All other financial statement schedules are not required under the relevant instructions or are inapplicable and therefore have been omitted. |
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(b) Exhibits.
Exhibit | Description | |||
2.1 | ||||
Agreement and Plan of Merger, dated as of January 2, 2004, among Cogent Communications Group, Inc., Lux Merger Sub, Inc. and Symposium Gamma, Inc. | ||||
2.2 | Agreement and Plan of Merger, dated as of March 30, 2004, among Cogent Communications Group, Inc., DE Merger Sub, Inc. and Symposium Omega, Inc. | |||
2.3 | Agreement and Plan of Merger, dated as of August 12, 2004, among Cogent Communications Group, Inc., Marvin Internet, Inc., and UFO Group, Inc. (previously filed as Exhibit 2.6 to our Annual Report on Form 10-K, filed on March 31, 2005, and incorporated herein by reference) |
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2.4 | Asset Purchase Agreement, dated as of September 15, 2004, between Global Access telecommunications Inc., Symposium Gamma, Inc. and Cogent Communications Group, Inc. (previously filed as Exhibit 2.7 to our Annual Report on Form 10-K, filed on March 31, 2005, and incorporated herein by reference) | |||
2.5 | Agreement and Plan of Merger, dated as of October 26, 2004, among Cogent Communications Group, Inc., Cogent Potomac, Inc. and NVA Acquisition, Inc. (previously filed as Exhibit 2.8 to our Annual Report on Form 10-K, filed on March 31, 2005, and incorporated herein by reference) | |||
2.6 | Agreement for the Purchase and Sale of Assets, dated December 1, 2004, among Cogent Communications Group, Inc., SFX Acquisition, Inc. and Verio Inc. (previously filed as Exhibit 2.9 to our Annual Report on Form 10-K, filed on March 31, 2005, and incorporated herein by reference) | |||
3.1 | Fifth Amended and Restated Certificate of Incorporation | |||
3.2 | Amended and Restated Bylaws of | |||
4.1 | ||||
First Supplemental Indenture, among Allied Riser Communications Corporation, as issuer, Cogent Communications Group, Inc., as co-obligor, and Wilmington Trust Company, as | ||||
4.2 | Indenture, dated as of July 28, 2000 by and between Allied Riser Communications Corporation and Wilmington Trust Company, as trustee, relating to Allied | |||
4.3 | Subordinated Note in the principal amount of $10.0 million issued by the Company to Columbia Ventures Corporation, pursuant to a Note Purchase Agreement (previously filed as Exhibit 4.1 to our Periodic Report on Form 8-K, filed on February 28, 2005, and | |||
10.1 | Seventh Amended and Restated Registration Rights Agreement of Cogent Communications Group, Inc., dated | |||
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10.2 | ||||
Fiber Optic Network Leased Fiber Agreement, dated February 7, 2000, by and between Cogent Communications, Inc. and Metromedia Fiber Network Services, Inc., as amended July 19, 2001 | ||||
10.3 | Dark Fiber IRU Agreement, dated April 14, 2000, between | |||
10.4 | David Schaeffer Employment Agreement with Cogent Communications Group, Inc., dated February 7, 2000 | |||
10.5 | Form of Restricted Stock Agreement relating to Series H Participating Convertible Preferred Stock | |||
10.6 | Lease for Headquarters Space by and between 6715 Kenilworth Avenue Partnership and Cogent Communications Group, Inc., dated September 1, 2000 | |||
10.7 |
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Renewal of Lease for Headquarters Space, by and between 6715 Kenilworth Avenue Partnership and Cogent Communications Group, Inc., dated August 5, 2003 | ||||
10.8 | The Amended and Restated Cogent Communications Group, Inc. 2000 Equity Plan | |||
10.9 | 2003 Incentive Award Plan of Cogent Communications Group, Inc. | |||
10.10 | 2004 Incentive Award Plan of Cogent Communications Group, Inc. (incorporated by reference to Appendix A to our Definitive Information Statement on Schedule 14C, filed on September 22, 2004) | |||
10.11 | Dark Fiber Lease Agreement dated November 21, 2001, by and between Cogent Communications, Inc. and Qwest Communications Corporation | |||
10.12 | ||||
Robert N. Beury, Jr. Employment Agreement with Cogent Communications Group, Inc., dated June 15, 2000 | ||||
10.13 | Mark Schleifer Employment Agreement with Cogent Communications Group, Inc., dated September 18, 2000 | |||
10.14 | R. Reed Harrison Employment Agreement with Cogent Communications Group, Inc., dated July 1, 2004 (incorporated by reference to Exhibit 10.3 to our Quarterly Report on Form 10-Q, filed on August 16, 2004) | |||
10.15 | Conversion and Lock-up Letter Agreement, dated as of February 9, 2005, by and among Cogent Communications Group, Inc. and each of the several stockholders signatory thereto (incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K filed on February 15, 2005) |
10.16 | Conversion and Lock-up Letter Agreement, dated as of February 9, 2005, by and among Cogent Communications Group, Inc., Dave Schaeffer and the Schaeffer Descendents Trust (incorporated by reference to Exhibit 10.3 of our Current Report on Form 8-K filed on February 15, 2005) | |||
10.17 | Brad Kummer Employment Agreement with Cogent Communications Group, Inc., dated January 11, 2000, (incorporated by reference to Exhibit 10.23 to our Registration Statement on Form S-1, Commission File No. 333-122821, filed on February 14, 2005) | |||
10.18 | Note Purchase Agreement by and among Cogent Communications Group, Inc. and Columbia Ventures Corporation dated February 24, 2005 (incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K filed on February 28, 2005) | |||
10.19 | Extension of Lease for Headquarters Space, by and between 6715 Kenilworth Avenue Partnership and Cogent Communications Group, Inc., dated February 3, 2005 (previously filed as Exhibit 10.27 to our Annual Report on Form 10-K, filed on March 31, 2005, and incorporated herein by reference) | |||
10.20 | Amended and Restated Loan and Security Agreement by and between Cogent Communications, Inc., Cogent Communications Group, Inc. and other subsidiaries, and Silicon Valley Bank, dated as of December 16, 2005, (previously filed as Exhibit 10.1 to our Periodic Report on Form 8-K, filed on December 16, 2005, and incorporated herein by reference) | |||
10.21 | Notice of Grant, dated November 4, 2005, made to David Schaeffer (previously filed as Exhibit 10.1 to our Periodic Report on Form 8-K, filed on November 7, 2005, and incorporated herein by reference) | |||
10.22 | Extension of Lease for Headquarters Space to August 31, 2006, by and between 6715 Kenilworth Avenue Partnership and Cogent Communications Group, Inc., dated July 21, 2005 (previously filed as Exhibit 10.1 to our Quarterly Report on Form 10-K, filed on August 15, 2005, and incorporated herein by reference) | |||
10.23 | Option for extension of Lease for Headquarters Space to August 31, 2007, by and between 6715 Kenilworth Avenue Partnership and Cogent Communications Group, Inc., dated July 21, 2005 (previously filed as Exhibit 10.2 to our Quarterly Report on Form 10-K, filed on August 15, 2005, and incorporated herein by reference) | |||
21.1 | Subsidiaries (filed herewith) | |||
23.1 | ||||
Consent of Ernst & Young LLP (filed herewith) | ||||
31.1 | Certification of Chief Executive Officer (filed herewith) | |||
31.2 | Certification of Chief Financial Officer (filed herewith) | |||
32.1 | Certification of Chief Executive Officer (filed herewith) | |||
32.2 | Certification of Chief Financial Officer (filed herewith) |
*Confidential treatment requested and obtained as to certain portions. Portions have been omitted pursuant to this request where indicated by an asterisk.
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The following report is a copy of a report previously issued by Arthur Andersen LLP and has not been reissued by Arthur Andersen LLP. Certain financial information for each of the years in the periods ended December 31, 2000 and December 31, 2001, was not reviewed by Arthur Andersen LLP and includes additional disclosures to conform with new accounting pronouncements and SEC rules and regulations issued during such fiscal year. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" for discussion of related risks.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Cogent Communications Group, Inc., and Subsidiaries:
We have audited, in accordance with generally accepted auditing standards, the consolidated financial statements of Cogent Communications Group, Inc. (a Delaware corporation), and Subsidiaries included in this Form 10-K and have issued our report thereon dated March 1, 2002. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in item 14(a) are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state, in all material respects, the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Vienna, VAMarch 1, 2002 (except with respect to the matters discussed inNote 14, as to which the date is March 27, 2002)
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Cogent Communications Group, Inc.Condensed Financial Information of Registrant(Parent Company Only)Condensed Balance SheetAs of December 31, 2002 and December 31, 2003(in thousands, except share data)
| | 2002 | 2003 | ||||||
|---|---|---|---|---|---|---|---|---|
| ASSETS | ||||||||
| Current Assets: | ||||||||
| Due from Cogent Communications, Inc. | $ | 17 | $ | 17 | ||||
| Total current assets | 17 | 17 | ||||||
Other Assets: | ||||||||
| Due from Cogent Communications, Inc. | — | 60,286 | ||||||
| Investment in Allied Riser, Inc. | 20,746 | 20,746 | ||||||
| Investment in Cogent Communications, Inc. | 178,147 | 178,147 | ||||||
| Total assets | $ | 198,910 | $ | 259,196 | ||||
| LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||
| Liabilities: | ||||||||
| Due to Cogent Communications, Inc. | $ | 2,239 | $ | 2,239 | ||||
| Total liabilities | 2,239 | 2,239 | ||||||
| Stockholders Equity: | ||||||||
| Convertible preferred stock, Series A, $0.001 par value: 26,000,000 shares authorized, issued and outstanding; none at December 31, 2003 | 25,892 | — | ||||||
| Convertible preferred stock, Series B, $0.001 par value: 20,000,000 shares authorized, 19,370,223 shares issued and outstanding; none at December 31, 2003 | 88,009 | — | ||||||
| Convertible preferred stock, Series C, $0.001 par value: 52,137,643 shares authorized, 49,773,402 shares issued and outstanding; none at December 31, 2003 | 61,345 | — | ||||||
| Convertible preferred stock, Series F, $0.001 par value; none and 11,000 shares authorized issued and outstanding at December 31, 2003; liquidation preference of $11,000 | — | 10,904 | ||||||
| Convertible preferred stock, Series G, $0.001 par value; none and 41,030 shares authorized issued and outstanding at December 31, 2003; liquidation preference of $123,000 | — | 40,787 | ||||||
| Convertible preferred stock, Series H, $0.001 par value; none and 54,001 shares authorized, 53,372 shares issued and outstanding at December 31, 2003; liquidation preference of $9,110 | — | 45,990 | ||||||
| Common stock, $0.001 par value, 21,100,000 and 395,000,000 shares authorized, respectively; 3,483,838 and 13,071,340 shares issued and outstanding, respectively | 4 | 14 | ||||||
| Treasury stock, none and 1,229,235 shares at December 31, 2003 | — | (90 | ) | |||||
| Additional paid in capital | 49,199 | 232,461 | ||||||
| Deferred compensation | (6,024 | ) | (32,680 | ) | ||||
| Stock purchase warrants | 764 | 764 | ||||||
| Accumulated deficit | (22,518 | ) | (41,193 | ) | ||||
| Total stockholders' equity | 196,671 | 256,957 | ||||||
| Total liabilities & stockholders equity | $ | 198,910 | $ | 259,196 | ||||
The accompanying notes are an integral part of these balance sheets
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Schedule I continuedII
Cogent Communications Group, Inc.Condensed Financial Information of Registrant(Parent Company Only)Condensed Statement of OperationsFor the Years Ended December 31, 2002 and 2003(in thousands)
| | 2002 | 2003 | |||||
|---|---|---|---|---|---|---|---|
| Operating expenses: | |||||||
| Selling, general and administrative | $ | 48 | $ | — | |||
| Amortization of deferred compensation | 3,331 | 18,675 | |||||
| Total operating expenses | 3,379 | 18,675 | |||||
| Operating loss | (3,379 | ) | (18,675 | ) | |||
| Loss before extraordinary item | (3,379 | ) | (18,675 | ) | |||
| Extraordinary gain — Allied Riser merger | 8,443 | — | |||||
| Beneficial conversion charge related to preferred stock | — | (52,000 | ) | ||||
| Net (loss) income applicable to common stock | $ | 5,064 | $ | (70,675 | ) | ||
The accompanying notes are an integral part of these statements
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Schedule I continued
Cogent Communications Group, Inc.Condensed Financial Information of Registrant(Parent Company Only)Condensed Statement of Cash FlowsFor the Years Ended December 31, 2002 and 2003(in thousands)
| | 2002 | 2003 | |||||||
|---|---|---|---|---|---|---|---|---|---|
| Cash flows from operating activities: | |||||||||
| Net income (loss) | $ | 5,064 | $ | (18,675 | ) | ||||
| Adjustments to reconcile net income (loss) to net cash used in operating activities: | |||||||||
| Extraordinary gain — Allied Riser merger | (8,443 | ) | — | ||||||
| Amortization of deferred compensation | 3,331 | 18,675 | |||||||
| Changes in Assets and Liabilities: | |||||||||
| Prepaid and other | 30 | — | |||||||
| Due from Cogent Communications, Inc. | 18 | — | |||||||
| Net cash used in operating activities | — | — | |||||||
| Net increase (decrease) in cash and cash equivalents | — | — | |||||||
| Cash and cash equivalents — beginning of period | — | — | |||||||
| Cash and cash equivalents — end of period | $ | — | $ | — | |||||
| Supplemental cash flow disclosures: | |||||||||
| Non-cash financing & investing activities: | |||||||||
| Professional fees paid by Cogent Communications, Inc. on behalf of the Parent | $ | 1,353 | $ | — | |||||
| Investment in Allied Riser | $ | 20,746 | $ | — | |||||
| Investment in Cogent Communications, Inc. | $ | — | $ | 60,286 | |||||
Exchange Agreement with Cisco Capital (See Note 1 to Consolidated Financial Statements)
Conversion of preferred stock under Purchase Agreement (See Note 1 to Consolidated Financial Statements)
The accompanying notes are an integral part of these statements
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COGENT COMMUNICATIONS GROUP, INC.CONDENSED FINANCIAL INFORMATION OF REGISTRANT(Parent Company Only)AS OF DECEMBER 31, 2002 AND DECEMBER 31, 2003
Note A: Background and Basis for Presentation
Cogent Communications, Inc. ("Cogent") was formed on August 9, 1999, as a Delaware corporation and is located in Washington, DC. Cogent is a facilities-based Internet Services Provider ("ISP"), providing Internet access to businesses in over 30 major metropolitan areas in the United States and in Toronto, Canada. In 2001, Cogent formed Cogent Communications Group, Inc., (the "Company"), a Delaware corporation. Effective on March 14, 2001, Cogent's stockholders exchanged all of their outstanding common and preferred shares for an equal number of shares of the Company, and Cogent became a wholly owned subsidiary of the Company. The common and preferred shares of the Company include rights and privileges identical to the common and preferred shares of Cogent. This was a tax-free exchange that was accounted for by the Company at Cogent's historical cost. All of Cogent's options for shares of common stock were also converted to options of the Company.
Note B: Troubled Debt Restructuring and Sale of Preferred Stock
Prior to July 31, 2003, Cogent was party to a $409 million credit facility with Cisco Systems Capital Corporation ("Cisco Capital"). The Cisco credit facility required compliance with certain financial and operational covenants. Cogent violated a financial debt covenant for the fourth quarter of 2002. Accordingly, Cogent was in default and Cisco Capital was able to accelerate the loan payments and make the outstanding balance immediately due and payable.
On June 12, 2003, the Board of Directors approved a transaction with Cisco Systems, Inc. ("Cisco") and Cisco Capital that restructured Cogent's indebtedness to Cisco Capital and approved an offer to sell a new series of preferred stock to certain of the Company's existing stockholders. The sale of the new series of preferred stock was required to obtain the cash needed to complete the restructuring. On June 26, 2003, the Company's stockholders approved these transactions.
In order to restructure the Cogent's credit facility the Company entered into an agreement (the "Exchange Agreement") with Cisco and Cisco Capital pursuant to which, among other things, Cisco and Cisco Capital agreed to cancel the principal amount of $262.8 million of Cogent's indebtedness plus $6.3 million of accrued interest and return warrants exercisable for the purchase of 0.8 million shares of Common Stock (the "Cisco Warrants") in exchange for a cash payment by the Company of $20 million, the issuance of 11,000 shares of the Company's Series F participating convertible preferred stock, and the issuance of an amended and restated promissory note (the "Amended and Restated Cisco Note") for an aggregate principal amount of $17.0 million. The Exchange Agreement provides that the entire debt to Cisco Capital is reinstated if Cisco Capital is forced to disgorge the payment received under the Exchange Agreement.
In order to restructure Cogent's credit facility the Company also entered into an agreement (the "Purchase Agreement") with certain of the Company's existing preferred stockholders (the "Investors"), pursuant to which the Company agreed to issue and sell to the Investors in several sub-series, 41,030 shares of the Company's Series G participating convertible preferred stock for $41.0 million in cash.
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On July 31, 2003, the Company, Cogent, Cisco Capital, Cisco and the Investors closed the Exchange Agreement and the Purchase Agreement. The closing of these transactions resulted in the following:
Under the Purchase Agreement:
Under the Exchange Agreement:
The conversion of the Company's existing preferred stock into a total of 10.8 million shares of $0.001 par value common stock is detailed below. The conversion resulted in the elimination of the book values of these series of preferred stock and a corresponding increase to common stock of $10,000 and an increase to additional paid in capital of $183.7 million.
| Existing Preferred | Shares outstanding | Conversion Ratio | Common Conversion | |||
|---|---|---|---|---|---|---|
| Series A | 26,000,000 | 0.10000 | 2,600,000 | |||
| Series B | 19,362,531 | 0.12979 | 2,513,127 | |||
| Series C | 49,773,402 | 0.10000 | 4,977,340 | |||
| Series D | 3,426,293 | 0.10000 | 342,629 | |||
| Series E | 3,426,293 | 0.10000 | 342,629 | |||
| TOTAL | 101,988,519 | 10,775,725 | ||||
Beneficial conversion charge
A beneficial conversion charge of $52.0 million was recorded on July 31, 2003 since the conversion prices on the Series F and Series G convertible preferred stock at issuance were less than the trading price of the Company's common stock on that date.
Please see the attached Notes to Consolidated Financial Statements for additional information related to this transaction.
Note C: Allied Riser convertible subordinated notes
On September 28, 2000, Allied Riser, one of the Company's wholly owned subsidiaries, completed the issuance and sale in a private placement of an aggregate of $150.0 million in principal amount of its 7.50% convertible subordinated notes due September 15, 2007 (the "Notes"). At the closing of the
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merger between Allied Riser and the Company, approximately $117.0 million of the Notes were outstanding. The Notes were convertible at the option of the holders into shares of Allied Riser's common stock at an initial conversion price of approximately 65.06 shares of Allied Riser common stock per $1,000 principal amount. The conversion ratio is adjusted upon the occurrence of certain events. The conversion rate was adjusted to approximately 2.09 shares of the Company's common stock per $1,000 principal amount in connection with the merger. Interest is payable by Allied Riser semiannually on June 15 and December 15, and is payable, at the election of Allied Riser, in either cash or registered shares of the Company's common stock. The Notes are redeemable at Allied Riser's option at any time on or after the third business day after June 15, 2004, at specified redemption prices plus accrued interest.
In January 2003, the Company, Allied Riser and the holders of approximately $106.7 million in face value of the Allied Riser notes entered into an exchange agreement and a settlement agreement. Pursuant to the exchange agreement, these note holders surrendered their notes, including accrued and unpaid interest, in exchange for a cash payment by Allied Riser of approximately $5.0 million, 3.4 million shares of the Company's Series D preferred stock and 3.4 million shares of the Company's Series E preferred stock. This preferred stock, at issuance, was convertible into approximately 4.2% of the Company's then outstanding fully diluted common stock. Pursuant to the settlement agreement, these note holders dismissed their litigation against Allied Riser with prejudice in exchange for a cash payment by Allied Riser of approximately $4.9 million. These transactions closed in March 2003 when the agreed amounts were paid by Allied Riser and the Company issued the Series D and Series E preferred shares. The settlement and exchange transactions together eliminated Allied Riser's $106.7 million principal payment obligation due in June 2007, interest accrued since the December 15, 2002 interest payment, all future interest payment obligations on these notes and settled the note holder litigation.
As of December 31, 2002, Allied Riser had accrued the amount payable under the settlement agreement, net of a recovery of $1.5 million under its insurance policy. This resulted in a net expense of $3.5 million recorded by Allied Riser in 2002. The $4.9 million payment required under the settlement agreement was paid by Allied Riser in March 2003. Allied Riser received the $1.5 million insurance recovery in April 2003. The exchange agreement resulted in a gain recorded by Allied Riser of approximately $24.8 million recorded in March 2003. The gain resulted from the difference between the $36.5 million net book value of the notes ($106.7 face value less the related discount of $70.2 million) and $2.0 million of accrued interest and the consideration which included $5.0 million in cash and the $8.5 million estimated fair market value for the Company's Series D and Series E preferred stock less approximately $0.2 million of transaction costs.
The terms of Allied Riser's remaining $10.2 million of subordinated convertible notes were not impacted by these transactions and they continue to be due on June 15, 2007. These notes were recorded by Allied Riser at their fair value of approximately $2.9 million at the merger date. The discount is accreted to interest expense by Allied Riser through the maturity date.
Please see the attached Notes to Consolidated Financial Statements for additional information related to this transaction.
77
COGENT COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
Description |
|
|
| Balance at |
| Charged to |
| Acquisitions |
| Deductions |
| Balance at |
| |||||||||||||||
Allowance for doubtful accounts (deducted from accounts receivable), (in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Year ended December 31, 2003 |
|
| $ | 2,023 |
|
|
| $ | 5,165 |
|
|
| $ | 125 |
|
|
| $ | 4,445 |
|
|
| $ | 2,868 |
|
| ||
Year ended December 31, 2004 |
|
| $ | 2,868 |
|
|
| $ | 4,406 |
|
|
| $ | 2,247 |
|
|
| $ | 6,292 |
|
|
| $ | 3,229 |
|
| ||
Year ended December 31, 2005 |
|
| $ | 3,229 |
|
|
| $ | 4,831 |
|
|
| $ | — |
|
|
| $ | 6,623 |
|
|
| $ | 1,437 |
|
| ||
Allowance for Credits (deducted from accounts receivable), (in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Year ended December 31, 2003 |
|
| $ | 200 |
|
|
| $ | — |
|
|
| $ | — |
|
|
| $ | 50 |
|
|
| $ | 150 |
|
| ||
Year ended December 31, 2004 |
|
| $ | 150 |
|
|
| $ | 140 |
|
|
| $ | — |
|
|
| $ | 140 |
|
|
| $ | 150 |
|
| ||
Year ended December 31, 2005 |
|
| $ | 150 |
|
|
| $ | 33 |
|
|
| $ | — |
|
|
| $ | — |
|
|
| $ | 183 |
|
| ||
Allowance for Unfulfilled Purchase Obligations (deducted from accounts receivable), (in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Year ended December 31, 2003 |
|
| $ | 15 |
|
|
| $ | 1,317 |
|
|
| $ | — |
|
|
| $ | 1,015 |
|
|
| $ | 317 |
|
| ||
Year ended December 31, 2004 |
|
| $ | 317 |
|
|
| $ | 537 |
|
|
| $ | 1,254 |
|
|
| $ | 1,944 |
|
|
| $ | 164 |
|
| ||
Year ended December 31, 2005 |
|
| $ | 164 |
|
|
| $ | 2,008 |
|
|
| $ | — |
|
|
| $ | 1,767 |
|
|
| $ | 405 |
|
| ||
Restructuring accrual (in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
Year ended December 31, 2004 |
|
| $ | — |
|
|
| $ | 1,821 |
|
|
| $ | — |
|
|
| $ | 210 |
|
|
| $ | 1,611 |
|
| ||
Year ended December 31, 2005 |
|
| $ | 1,611 |
|
|
| $ | 1,319 |
|
|
| $ | — |
|
|
| $ | 1,378 |
|
|
| $ | 1,552 |
|
| ||
(a)
| Description | Balance at Beginning of Period | Charged to Costs and Expenses(a) | Acquisitions | Deductions | Balance at End of Period | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Allowance for doubtful accounts (deducted from accounts receivable, in thousands) | |||||||||||||||
| Year ended December 31, 2001 | $ | — | $ | 263 | $ | 945 | $ | 1,096 | $ | 112 | |||||
| Year ended December 31, 2002 | $ | 112 | $ | 3,887 | $ | 2,863 | $ | 4,839 | $ | 2,023 | |||||
| Year ended December 31, 2003 | $ | 2,023 | $ | 5,165 | $ | 125 | $ | 4,445 | $ | 2,868 | |||||
7881
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.
COGENT COMMUNICATIONS GROUP, INC. | ||||
Dated: March | By: | /s/ DAVID SCHAEFFER | ||
Name: David Schaeffer | ||||
Title: Chairman and Chief Executive Officer | ||||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature | Title | Date | ||||||||||||
/s/ DAVID SCHAEFFER | Chairman | March | ||||||||||||
David Schaeffer | (Principal Executive Officer) | |||||||||||||
/s/ | ||||||||||||||
Chief Financial Officer | March 14, 2006 | |||||||||||||
Thaddeus G. Weed | (Principal Financial and Accounting Officer) | |||||||||||||
/s/ EDWARD GLASSMEYER | Director | March | ||||||||||||
Edward Glassmeyer | ||||||||||||||
/s/ EREL MARGALIT | Director | March | ||||||||||||
Erel Margalit | ||||||||||||||
/s/ | Director | March | ||||||||||||
Jean-Jacques Bertrand | ||||||||||||||
/s/ | Director | March | ||||||||||||
Timothy Weingarten | ||||||||||||||
/s/ | Director | March | ||||||||||||
7914, 2006
Steven Brooks | ||||||||||
/s/ KENNETH D. PETERSON, JR. | Director | March 14, 2006 | ||||||||
Kenneth D. Peterson, Jr. | ||||||||||
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