CCOI

Cogent Communications Group, Inc. - Q1 2010 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2010. Cogent Communications Group, Inc. is a facilities-based provider of low-cost, high-speed Internet access and IP communications services in North America and Europe. The company operates a single segment, delivering on-net services to net-centric customers (universities, ISPs) and corporate customers, as well as off-net services via third-party carriers.

Key Financial Metrics

Note: All figures in millions unless otherwise noted. Debt includes $107.1 million in capital lease obligations and $67.5 million in convertible senior notes (net of discount).

Material Changes vs. Prior Period

• Revenue Growth: Service revenue increased 14.0% year-over-year, driven by a 12.1% increase in on-net revenue and a 24.8% increase in off-net revenue. Foreign exchange rates contributed approximately $1.5 million to the revenue increase.
• Profitability Improvement: The company moved from an operating loss of $4.5 million in Q1 2009 to an operating profit of $2.7 million in Q1 2010. Net loss narrowed significantly from $8.2 million to $0.6 million.
• Expense Management: Equity-based compensation expense dropped 69.5% to $1.2 million due to the completion of vesting periods for prior grants. Depreciation and amortization decreased 7.6% to $13.5 million, aided by a $0.9 million reduction in asset retirement obligations.
• Customer Base: On-net customer connections grew 23.3% to approximately 18,100, while off-net connections grew 10.0% to 3,300.

Outlook, Risks, and Unusual Items

• Guidance and Strategy: Management plans to expand the network by adding approximately 120 on-net buildings by December 31, 2010. The company expects to continue focusing on a broad mix of customers, including lower-bandwidth connections, which may pressure average revenue per connection.
• Unusual Items:
  • Asset Retirement Obligations: A $0.9 million reduction in estimated restoration costs for leased facilities resulted in a $0.7 million reduction to depreciation and $0.2 million to SG&A expenses.
  • Impairment Charge: A $0.6 million impairment charge for certain property and equipment was recorded in Q1 2010.
  • Tax Benefit: A $0.5 million income tax benefit was recognized, primarily due to a refund receivable for federal alternative minimum tax paid in prior years.
• Risks and Contingencies:
  • Liquidity: The company maintains a $20.0 million revolving credit facility expiring October 2010, with no borrowings as of the filing date. Covenants require a funded debt to adjusted EBITDA ratio of less than 3.0:1.0.
  • Convertible Notes: $92.0 million principal of 1.00% Convertible Senior Notes is outstanding. The fair value was approximately $65.1 million as of March 31, 2010.
  • Legal: Disputes with vendors totaling approximately $0.3 million are ongoing, though management does not believe these amounts are owed.

Investor Verification Checklist

• Debt Covenants: Verify continued compliance with the revolving credit facility covenants, specifically the funded debt to adjusted EBITDA ratio and minimum cash deposit requirements.
• Revenue Quality: Assess the sustainability of revenue growth given the decline in average revenue per on-net connection and the shift toward lower-bandwidth customers.
• Capital Expenditures: Monitor the $11.3 million in CapEx for the quarter against the plan to add 120 new buildings by year-end.
• Convertible Notes: Review the conversion terms and potential dilution impact, noting the current conversion price of $49.18 per share.
• Asset Retirement Obligations: Confirm the stability of the revised estimates for facility restoration costs that reduced expenses in Q1 2010.