CCOI

Business Context and Reporting Period

Company: Cogent Communications Group, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2010
Business Overview: Cogent 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 operating segment, delivering on-net services to net-centric customers (e.g., ISPs, universities) and corporate customers, as well as off-net services via third-party carriers.

Key Financial Metrics

Note: Total debt includes $109.4 million in capital lease obligations and $68.7 million in convertible senior notes (net of discount).

Material Changes vs. Prior Period

• Revenue Growth: Service revenue increased 11.0% for the quarter and 12.5% for the six months compared to the prior year periods.
  • On-Net Revenue: Increased 8.2% (quarter) and 10.1% (six months), driven by a 20.0% increase in customer connections, though average revenue per connection declined due to pricing discounts.
  • Off-Net Revenue: Increased 26.6% (quarter) and 25.7% (six months), outpacing connection growth due to higher average revenue per connection.
  • Non-Core Revenue: Declined 20.9% (quarter) and 15.6% (six months) as the company does not actively market these legacy services.
• Profitability: The company returned to operating profitability in the second quarter of 2010 ($2.98 million) compared to an operating loss of $1.1 million in the same period in 2009. Net loss narrowed significantly to $0.9 million for the quarter from $4.5 million in 2009.
• Expenses:
  • Network Operations: Increased 18.8% (quarter) due to network expansion and higher off-net costs.
  • SG&A: Decreased 3.4% (quarter) excluding equity-based compensation, driven by lower professional fees and bad debt expense.
  • Equity-Based Compensation: Decreased 23.6% (quarter) and 52.0% (six months) due to the completion of vesting periods for prior grants, partially offset by new grants in Q2 2010.
  • Depreciation & Amortization: Decreased 7.7% (quarter) due to fully depreciated assets and a $0.9 million reduction in asset retirement obligations.

Guidance, Outlook, and Risks

• Outlook: Management plans to expand the network by adding approximately 120 on-net buildings by December 31, 2010. The company expects non-core service revenue to continue declining.
• Liquidity: The company maintains a $20.0 million revolving line of credit expiring October 14, 2010, with no borrowings as of June 30, 2010. Management believes cash on hand and operating cash flow are sufficient to meet requirements.
• Risks and Contingencies:
  • Market Risk: Exposure to foreign exchange rates (Euro-USD) and potential declines in Internet access prices.
  • Regulatory: Potential impact of net neutrality rules and Universal Service Fund contributions.
  • Legal: Disputes with telecommunications vendors totaling approximately $0.3 million; management believes these are adequately reserved.
  • Debt: $92.0 million face value of 1.00% Convertible Senior Notes due 2027. Fair value was approximately $70.1 million as of June 30, 2010.

Investor Verification Checklist

• Revenue Quality: Verify the sustainability of off-net revenue growth versus the decline in average revenue per on-net connection.
• Capital Expenditures: Confirm the $24.5 million in CapEx for the six months aligns with the plan to add 120 buildings by year-end.
• Debt Covenants: Review compliance with the revolving credit facility covenants, specifically the funded debt to adjusted EBITDA ratio and the $10.0 million minimum deposit requirement.
• Asset Retirement Obligations: Assess the impact of the $0.9 million liability reduction on future depreciation and cash flow projections.
• Equity Dilution: Monitor the vesting schedule of the 1.0 million restricted shares granted in Q2 2010 valued at $9.8 million.